Lam Research Corporation 4650 Cushing Parkway Fremont, California 94538 Phone: 1.510.572.0200 www.lamresearch.com 2006 Annual Report execute to the needs of our customers extend our leadership position in etch leverage our expertise into adjacent markets deliver best-in-class fi nancial performance BOARD OF DIRECTORS BOARD OF DIRECTORS James W. Bagley James W. Bagley Executive Chairman Executive Chairman EXECUTIVE MANAGEMENT EXECUTIVE MANAGEMENT Stephen G. Newberry Stephen G. Newberry President and Chief Executive Offi cer President and Chief Executive Offi cer Stephen G. Newberry Stephen G. Newberry President and Chief Executive Offi cer President and Chief Executive Offi cer James W. Bagley James W. Bagley Executive Chairman Executive Chairman David G. Arscott David G. Arscott President, Compass Technology Group President, Compass Technology Group Robert M. Berdahl Robert M. Berdahl President of the Association of President of the Association of American Universities American Universities Richard J. Elkus, Jr. Richard J. Elkus, Jr. Director, Scripps Research Institute, and Director, Scripps Research Institute, and Former Director, KLA-Tencor Former Director, KLA-Tencor Jack R. Harris Jack R. Harris Chairman, HT, Inc., and Chairman, HT, Inc., and Executive Chairman, Metara, Inc. Executive Chairman, Metara, Inc. Grant M. Inman Grant M. Inman General Partner, General Partner, Inman Investment Management Inman Investment Management Catherine P. Lego Catherine P. Lego General Partner, The Photonics Fund, LP General Partner, The Photonics Fund, LP Seiichi Watanabe Seiichi Watanabe Executive General Manager, Executive General Manager, Terumo Corporation Terumo Corporation Patricia S. Wolpert Patricia S. Wolpert Owner, Wolpert Consulting LLC Owner, Wolpert Consulting LLC Nicolas J. Bright Nicolas J. Bright Executive Vice President, Executive Vice President, Regional Business and Global Products Regional Business and Global Products Martin B. Anstice Martin B. Anstice Group Vice President, Chief Financial Offi cer Group Vice President, Chief Financial Offi cer and Chief Accounting Offi cer and Chief Accounting Offi cer Daniel Liao Daniel Liao Group Vice President, Asia Pacifi c Group Vice President, Asia Pacifi c Steven A. Lindsay Steven A. Lindsay Group Vice President, Corporate Marketing Group Vice President, Corporate Marketing and Corporate Communication and Corporate Communication Ernest E. Maddock Ernest E. Maddock Group Vice President, Global Operations Group Vice President, Global Operations Harold M. Goldstein Harold M. Goldstein Group Vice President, Group Vice President, Global Human Resources Global Human Resources Thomas J. Bondur Thomas J. Bondur Vice President, Business Development Vice President, Business Development Jean-Francois Deschamps Jean-Francois Deschamps Vice President, North America and Europe Vice President, North America and Europe Richard A. Gottscho, Ph.D. Richard A. Gottscho, Ph.D. Vice President and General Manager, Vice President and General Manager, Etch Products Etch Products Abdi Hariri Abdi Hariri Vice President and General Manager, Vice President and General Manager, Customer Support Business Group Customer Support Business Group Marc A. Haugen Marc A. Haugen Vice President, Global Business Operations Vice President, Global Business Operations David J. Hemker, Ph.D David J. Hemker, Ph.D Vice President, New Product Development Vice President, New Product Development Hwee Tong Lim Hwee Tong Lim Vice President, Southeast Asia Vice President, Southeast Asia Jeffrey Marks, Ph.D. Jeffrey Marks, Ph.D. Vice President, New Businesses Vice President, New Businesses Masayuki Mike Morita Masayuki Mike Morita Vice President, Japan Vice President, Japan Yang Pan, Ph.D. Yang Pan, Ph.D. Vice President, China Vice President, China Les Spencer Les Spencer Vice President and Chief Information Offi cer Vice President and Chief Information Offi cer Inhak Harry Suh Inhak Harry Suh Vice President, Korea Vice President, Korea James Wheat James Wheat Vice President, Corporate Controller Vice President, Corporate Controller Jeffrey Zellmer Jeffrey Zellmer Vice President, Business Finance Vice President, Business Finance ©2006 Lam Research Corporation. All rights reserved. ©2006 Lam Research Corporation. All rights reserved. 670017255-10/06 670017255-10/06 Lam Research Corporation October 6, 2006 LETTER TO STOCKHOLDERS To Our Stockholders: Fiscal 2006 was a year of continued growth for Lam Research, even though spending in the wafer fabrication equip- ment market declined 6 percent year-over-year. While advancing our product set, expanding our market share worldwide, and fundamentally enhancing our business model, we have transformed Lam into a model for fi nancial and operational excellence in our industry. These efforts have helped to both generate record profi ts for the Company in the just-completed year and set the stage for continued value creation long-term. To summarize several of the key fi nancial highlights: • Revenue topped $1.6 billion, an increase of 9 percent year-over-year • Our closing total net cash balance reached $1.2 billion • Gross margins exceeded 50 percent of revenues for the second straight year • Operating margins were 24.7 percent • Net income grew 12.2 percent to $336 million Taken together, these numbers tell a simple story; namely, that our people and our business model continue to give us a critical, competitive edge. From research and development, to engineering, to operations, to marketing and sales, and to our customer service organization; this story is being increasingly recognized outside of Lam: for the fi rst time Fortune Magazine cited us as one of “America’s Fastest Growing Companies.” As important as these results are, it is the foundation they create for future opportunities and growth to which we are now adding focus. Now is the time to leverage this strength and commit to prudent investments in developing and positioning new products into adjacent markets. Here at Lam, we believe we are in the early stages of a new chapter in the Company’s growth. Our leadership team, made up of executives, managers, and key individual contributors with long-term proven track records in our industry, has continually focused on the development of our people and organizational capability. As a result, we have been able to increase productivity every year as evidenced by our world-class revenue-per-employee numbers, best-in-industry retention of key employees, and 78 percent of promotions from within into management positions. During our analyst and investor meetings in March and again in July, we shared our key areas of near-term focus. Highlights include: • Executing to the needs of our customers • Extending our leadership position in etch • Leveraging our expertise into adjacent markets • Delivering best-in-class fi nancial performance Executing to the needs of our customers We are successfully supporting our customers’ 90 nm and 65 nm production ramp by quickly developing cost-com- petitive solutions to meet their processing challenges. We are proud to announce that Lam also shipped its 1,000th 2300® Exelan® Process Module, a milestone that testifi es to the product’s range and adaptability. Extending our leadership position in etch Extending Lam’s leadership position in etch continues to be key to our outstanding performance. We expect our market share in calendar 2006 to be approximately 45 percent; which represents growth of nearly 10 points over the 35 percent- age points of market share as noted by Dataquest for calendar year 2005. Looking forward, we believe our market share in 65/45nm applications will continue to add to the solid gains we have achieved at prior technology nodes. One of the chief reasons for Lam’s market share growth has been our development team’s ability to leverage our conductor and dielectric etch technologies year after year. This is very important to our customers, as we consistently demonstrate a strong track-record of production-worthy results that support our customers’ ability to produce cost effective semiconductor devices. 133777_LAM_LTR_r2 1 133777_LAM_LTR_r2 1 10/7/06 12:23:22 AM 10/7/06 12:23:22 AM Leveraging our expertise into adjacent markets New materials and smaller device structures are presenting challenges to our customers. Lam is targeting opportuni- ties that will leverage our expertise into markets adjacent to etch where there are new processing segments which we believe will benefi t from new uses of our plasma etch core capabilities. These include bevel clean, next generation patterning, and resist strip. The value of expanding into markets adjacent to our core strength is clear: • Knowledge: Applying our core competencies to new areas benefi ts our customers and effectively leverages our expertise • Innovation: Working closely with our customers on their etch processing challenges enables us to anticipate future requirements and apply our technology in fresh ways • Infrastructure: Existing operations can be effectively deployed in support of new product areas In addition we believe we are in a strong position to leverage our etch and strip knowledge by entering the wafer cleaning segment. We intend to work with our customers to improve device yield while cleaning residues left on the wafer post etch and strip processing. These new segments could double our served available market within the total wafer fabrication equipment market to 22 percent by 2010. Specifi cally, over the next 3 to 5 years, these markets represent a $700 to $900 million incremental revenue opportunity for Lam. As we introduce these new technologies, we plan to leverage Lam’s 2300 platform and product architectures, with their proven performance in software, reliability, and through-put optimization. Delivering best-in-class fi nancial performance Lam’s lean, agile, team-based approach enables us to rapidly deliver our portfolio of products and services to the industry, and empowers our customers to continue to innovate while optimizing their capital investments. This model, in which the Lam team outsources non-core functions, enables the Company to create a stable work environment through all stages of the semiconductor business cycle. This model has also empowered Lam to support the growth and operating profi tability outlined above and detailed later in this annual report. Our performance has been increasingly noticed by others. In addition to Fortune, Business 2.0 ranked Lam at 21 on its annual list of the 100 Fastest-Growing Technology Companies, and Forbes designated Lam a “Best Managed” company among its Platinum 400: Best Big Companies in America. We work hard to deliver for all of our stakeholders, and are proud when independent observers recognize our achievements. What we accomplish is not the only measure of our success. How we achieve our goals – how we practice Lam’s Core Values from day to day – is important, as well. That’s why we’re so proud that Business Ethics once again named Lam to its list of 100 Best Corporate Citizens in 2006. At the same time, Lam employees – responding to survey questions from leading Bay Area business media – earned our Company one of the very top rankings in the Bay Area’s annual “Best Places to Work” list. All of this recognition is no coincidence. We feel that the qualitative factors these sorts of accolades recognize contribute directly to the value we create for all of our stakeholders. The year ahead promises to be one of great opportunity. While uncertainty is always a factor in the dynamic environ- ment in which we operate, we remain confi dent in our capacity to adapt quickly to changing conditions while serving our customers and our shareholders. On behalf of all Lam employees, we thank you for your continued investment in our Company and we look forward to hearing from you at our Annual Meeting. Sincerely, Stephen G. Newberry President and Chief Executive Offi cer James W. Bagley Executive Chairman of the Board 133777_LAM_LTR_r2 2 133777_LAM_LTR_r2 2 10/7/06 12:23:23 AM 10/7/06 12:23:23 AM LAM RESEARCH CORPORATION NOTICE OF ANNUAL MEETING OF STOCKHOLDERS To be held November 2, 2006 To the Stockholders: NOTICE IS HEREBY GIVEN that the 2006 Annual Meeting of Stockholders of Lam Research Corporation, a Delaware corporation (the “Company” or “Lam”), will be held on Thursday, November 2, 2006, 11:00 a.m., local time, at the principal executive offices of the Company at 4650 Cushing Parkway, Fremont, California 94538, for the following purposes: 1. 2. 3. 4. 5. To elect directors to serve for the ensuing year, and until their successors are elected; To approve an amendment to the Lam 2004 Executive Incentive Plan; To approve the adoption of the Lam 2007 Stock Incentive Plan; To ratify the appointment of Ernst & Young LLP as the independent registered public accounting firm of the Company for the fiscal year ending June 24, 2007; and To transact such other business as may properly come before the meeting, or for any adjournment thereof. The foregoing items of business are more fully described in the Proxy Statement accompanying this Notice. Only stockholders of record at the close of business on September 15, 2006, are entitled to notice of and to vote at the meeting, and for any adjournment thereof. All stockholders are cordially invited to attend the meeting in person. However, to assure your representation at the meeting, you are urged to vote by proxy via telephone, Internet, or mail in accordance with the voting instructions on the proxy card. If you vote by mail, please mark, sign, and date the enclosed proxy card and return it as promptly as possible in the postage-prepaid and return-addressed envelope enclosed for that purpose. Any stockholder of record attending the meeting may vote in person, even if the stockholder has previously returned a proxy. Stockholders who wish to cast their votes in person must attend the meeting. A simultaneous webcast will be available on Lam’s web site at www.lamresearch.com for stockholders who cannot attend in person and wish to listen to the Annual Meeting and any discussion by management immediately after its adjournment. By Order of the Board of Directors, Fremont, California October 6, 2006 George M. Schisler, Jr. Assistant Secretary YOUR VOTE IS IMPORTANT In order to assure your representation at the meeting, you are requested to vote by proxy via telephone, Internet, or mail in accordance with the voting instructions on the proxy card. If you vote by mail, you should mark, sign, and date the enclosed proxy card as promptly as possible and return it in the enclosed return-addressed envelope. LAM RESEARCH CORPORATION PROXY STATEMENT FOR ANNUAL MEETING OF STOCKHOLDERS To Be Held November 2, 2006 TABLE OF CONTENTS Information Concerning Solicitation and Voting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proposal No. 1 — Election of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Corporate Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . . . . . . . . Director Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Executive Compensation and Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Compensation Committee Interlocks and Insider Participation . . . . . . . . . . . . . . . . . . . . . . . . Report of the Compensation Committee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Report of the Audit Committee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Relationship with Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . . . Comparative Stock Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Securities Authorized for Issuance Under Equity Compensation Plans . . . . . . . . . . . . . . . . . . Proposal No. 2 — Approval of Amendment of the Lam 2004 Executive Incentive Plan . . . Proposal No. 3 — Approval of the Lam 2007 Stock Incentive Plan . . . . . . . . . . . . . . . . . . . . Proposal No. 4 — Ratification of Appointment of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Section 16(a) Beneficial Ownership Reporting Compliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Appendix A — Audit Committee Charter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Appendix B — 2004 Executive Incentive Plan, Amended and Restated. . . . . . . . . . . . . . . . . . . . Appendix C — 2007 Stock Incentive Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 1 4 8 13 14 15 19 19 19 25 26 28 29 31 39 47 47 47 A-1 B-1 C-1 LAM RESEARCH CORPORATION PROXY STATEMENT FOR 2006 ANNUAL MEETING OF STOCKHOLDERS INFORMATION CONCERNING SOLICITATION AND VOTING General The enclosed proxy is solicited on behalf of Lam Research Corporation, a Delaware corporation (the “Company” or “Lam”), for use at the Annual Meeting of Stockholders to be held Thursday, November 2, 2006, at 11:00 a.m., local time (the “Annual Meeting”), or for any adjournment thereof, for the purposes set forth herein and in the accompanying Notice of Annual Meeting of Stockholders. The Annual Meeting will be held at the principal executive offices of the Company at 4650 Cushing Parkway, Fremont, California 94538. The Company’s telephone number at that location is (510) 572-0200. Stockholders who wish to cast their votes in person must attend the meeting. For those stockholders who cannot attend in person and wish to listen to the proceedings, the Annual Meeting and any discussion by management after its adjournment will be available via simultaneous webcast. The webcast may be accessed via the Lam Internet web site at www.lamresearch.com, by locating the link in the Investor Relations/Webcasts section of the web site. These proxy solicitation materials will be mailed on or about October 6, 2006, to all stockholders entitled to vote at the meeting. A copy of Lam’s 2006 Annual Report to Stockholders accompanies this Proxy Statement. Record Date and Principal Share Ownership Stockholders of record at the close of business on September 15, 2006, are entitled to receive notice of and to vote at the Annual Meeting. At the record date, 142,206,849 shares of the Company’s Common Stock were outstanding. Revocability of Proxies Any proxy given pursuant to this solicitation may be revoked by the person giving it at any time before its use by delivering to the Company a written notice of revocation or a duly executed proxy bearing a later date, or by attending the Annual Meeting and voting in person. However, attending the Annual Meeting in and of itself does not constitute a revocation of a proxy. Voting and Solicitation Each stockholder voting on Proposal No. 1, the election of directors, may cumulate such stockholder’s votes and give one candidate a number of votes equal to the number of directors to be elected (ten at this meeting) multiplied by the number of shares held by such stockholder, or distribute the stockholder’s votes on the same principle among as many candidates as the stockholder deems appropriate. However, votes cannot be cast for more than ten candidates. No stockholder shall be entitled to cumulate votes for a candidate unless the candidate’s name has been placed in nomination prior to the voting. Where no vote is specified or where a vote FOR all nominees is marked, the cumulative votes represented by a proxy will be cast, unless contrary instructions are given, at the direction of the proxy holders in order to elect as many nominees as believed possible under the then-prevailing circumstances. If a stockholder desires to cumulate his or her votes, the accompanying proxy card should be marked to indicate clearly that the stockholder desires to exercise the right to cumulate votes and should specify how the votes are to be allocated among the nominees for directors. For example, a stockholder may write next to the name(s) of the nominee or nominees for whom the stockholder desires to cast votes the number of votes to be cast for such nominee or nominees. Alternatively, without exercising his or her right to vote cumulatively, a stockholder may instruct the proxy holders not to vote for one or more nominees by writing the name(s) of such nominee 1 or nominees on the space provided on the proxy card. Unless indicated to the contrary in the space provided on the proxy card, if a stockholder withholds authority to vote for one or more nominees, all cumulative votes of such stockholder will be distributed among the remaining nominees at the discretion of the proxy holders. On all other matters, each share has one vote. Stockholders may vote FOR, AGAINST, or to ABSTAIN from voting with respect to Proposal Nos. 2, 3 and 4, by properly marking the attached proxy card or otherwise submitting their proxy votes in accordance with the voting instructions. Votes cast by proxy or in person at the Annual Meeting will be tabulated by the Inspector of Elections (the “Inspector”). The Inspector will also determine whether or not a quorum is present. The ten candidates for election as directors at the Annual Meeting who receive the highest number of affirmative votes will be elected. The approval of Proposal No. 2 (amendment to the Lam 2004 Executive Incentive Plan), Proposal No. 3 (adoption of the Lam 2007 Stock Incentive Plan), and Proposal No. 4 (ratification of the appointment of the independent registered public accounting firm for the Company for the current fiscal year) will require the affirmative vote of a majority of the shares of the Company’s Common Stock present or represented and entitled to vote with respect to such matters. The final voting results will be made available on the Company’s web site at www.lamresearch.com via the Investor Relations page within fourteen days after the Annual Meeting. In general, Delaware law provides that a quorum consists of a majority of the shares entitled to vote at the Annual Meeting. Abstentions will be treated as shares that are present or represented and entitled to vote for purposes of determining the presence of a quorum but will not be treated as votes in favor of approving any matter submitted to the stockholders for a vote. Thus, abstentions will have the same effect in this regard as negative votes. Any proxy that is properly dated, executed, and returned using the method or form of proxy enclosed, or properly submitted via telephone or Internet, will be voted at the Annual Meeting in accordance with the instructions of the stockholder. If no specific instructions are given, the shares will be voted for the election of directors, for approval of the amendment to the Lam 2004 Executive Incentive Plan, for approval of the adoption of the Lam 2007 Stock Incentive Plan, and for ratification of the appointment of the designated independent registered public accounting firm, and, with respect to any other matter or matters that may come before the meeting, as the proxy holders deem advisable in accordance with their reasonable judgment. For shares held in “street name” through a broker or other nominee, the broker or nominee may not be permitted to exercise voting discretion with respect to some of the matters to be acted upon. If a broker indicates on the enclosed proxy or its substitute that he or she does not have discretionary authority as to certain shares to vote on a particular matter (“broker non-votes”), or with respect to shares as to which proxy authority has been withheld with respect to a matter, those shares will be counted as present in determining whether a quorum for the meeting is present but will not be considered as present or represented with respect to that matter. Thus, once it is determined that a quorum is present at the Annual Meeting, broker non-votes will have no effect on either of the four proposals being voted on at the Annual Meeting. The Company believes that the tabulation procedures to be followed by the Inspector of Elections are consistent with the general statutory requirements in Delaware concerning voting of shares and determination of a quorum. Employee participants in the Company’s Savings Plus Plan, Lam Research 401(k) (the “401(k) Plan”) who held Company stock in their personal 401(k) Plan accounts as of the record date are being provided with this Proxy Statement as a 401(k) Plan participant so that each such stockholder may vote his or her interest in the Company’s Common Stock as held in the 401(k) Plan. Upon receipt of properly marked and returned proxies, Lam Research Corporation as the 401(k) Plan Administrator, or the 401(k) Plan trustee, will vote the aggregate voted proxies of the 401(k) Plan participants in accordance with the proxies received. If a 401(k) Plan participant does not vote his or her interest with respect to the proposals to be voted on at this year’s Annual Meeting, then those non-voted shares will not be voted. 2 The cost of soliciting proxies will be borne by the Company. The Company may reimburse brokerage firms and other persons representing beneficial owners of shares for their expenses in forwarding solicitation materials to such beneficial owners. Proxies may also be solicited by certain of the Company’s directors, officers, and regular employees, without additional compensation, personally or by telephone or other communication means. Stockholder Proposals to be Included in the Company’s 2007 Proxy Statement Pursuant to Rule 14a-8(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), some stockholder proposals may be eligible for inclusion in the Company’s 2007 proxy statement. Any such proposal must be received by the Company no later than June 3, 2007. Stockholders interested in submitting such a proposal are advised to contact counsel familiar with the detailed requirements of the applicable securities rules. Stockholder Proposals and Nominations to be Voted on at 2007 Annual Meeting Stockholders of the Company may submit proposals, in addition to Rule 14a-8(e) proposals referred to above, that they believe should be voted on at an annual meeting or nominate persons for election to the Board of Directors (the “Board”). In accordance with the Company’s bylaws, any such proposal or nomination for the 2007 annual meeting, currently scheduled for November 1, 2007, must be submitted in writing and received by the Secretary of the Company no earlier than August 2, 2007, and no later than September 2, 2007. A stockholder’s notice to the Secretary must set forth (a) as to each person whom the stockholder proposes to nominate for election as a director (i) the name, age, business address and residence address of the person, (ii) the principal occupation or employment of the person, (iii) the class or series and number of shares of capital stock of the Company that are owned beneficially or of record by the person, and (iv) any other information relating to the person that would be required to be disclosed in a proxy statement or other filings required to be made in connection with solicitations of proxies for election of directors pursuant to Section 14 of the Exchange Act, and the rules and regulations promulgated thereunder; and (b) as to the stockholder giving the notice (i) the name and record address of such stockholder, (ii) the class or series and number of shares of capital stock of the Company that are owned beneficially or of record by such stockholder, (iii) a description of all arrangements or understandings between such stockholder and each proposed nominee and any other person or persons (including their names) pursuant to which the nomination(s) is to be made by such stockholder, (iv) a representation that such stockholder intends to appear in person or by proxy at the meeting to nominate the person(s) named in its notice, and (v) any other information relating to such stockholder that would be required to be disclosed in a proxy statement or other filings required to be made in connection with solicitations of proxies for election of directors pursuant to Section 14 of the Exchange Act and the rules and regulations promulgated thereunder. Such notice must be accompanied by a written consent of each proposed nominee to being named as a nominee and to serve as a director if elected. Proposals or nominations that do not meet the requirements will not be entertained at the annual meeting. Submissions or questions should be sent to: George M. Schisler, Jr., Office of the Secretary, Lam Research Corporation, 4650 Cushing Parkway, Fremont, California 94538. Stockholder nominations for director will be evaluated by Lam’s Nominating/Governance Committee in accordance with substantially the same criteria and procedures as candidates identified by the Board, its Nominating/Governance Committee, or other sources. See the section entitled “Corporate Governance” below. 3 PROPOSAL NO. 1 ELECTION OF DIRECTORS Nominees A board of ten directors is to be elected at the Annual Meeting. By a resolution duly adopted by the Board pursuant to the bylaws of the Company, the Board of Directors has fixed the number of directors at ten. The proxies cannot be voted for a greater number of persons than the ten nominees named below. Unless otherwise instructed, the proxy holders will vote the proxies received by them for the ten nominees named below, each of whom is currently a director of the Company. If any nominee of the Company should decline or be unable to serve as a director as of the time of the Annual Meeting, the proxies will be voted for any substitute nominee designated by the present Board of Directors to fill the vacancy. The Company is not aware of any nominee who will be unable or will decline to serve as a director. In the event that additional persons are nominated for election as directors, the proxy holders intend to vote all proxies received by them in such a manner in accordance with cumulative voting as will assure the election of as many of the nominees listed below as possible, and in such event the specific nominees to be voted for will be determined by the proxy holders. Discretionary authority to cumulate the votes held by the proxy holders is solicited by this Proxy Statement. The term of office of each person elected as a director will continue until a successor has been elected and qualified or until his or her earlier resignation or removal. The Board, upon the recommendation of the Nominating/Governance Committee, has nominated the following individuals for election to the Board of Directors in accordance with the criteria and procedures discussed below in “Corporate Governance.” THE BOARD OF DIRECTORS OF THE COMPANY RECOMMENDS A VOTE “FOR” EACH OF THE NOMINEES FOR DIRECTOR SET FORTH BELOW. The following table sets forth certain information concerning the nominees, which is based on data furnished by them: Nominees for Director James W. Bagley Director Since 1997 Age 67 Principal Occupation and Business Experience During Past Five Years Mr. Bagley is the Executive Chairman of the Board of Directors. He has been a director of the Company since the merger of Lam and OnTrak Systems, Inc., in August 1997, and has served as Chairman of the Board since September 1998. Mr. Bagley was appointed to the office of Executive Chairman in June 2005. From August 1997 until June 2005, Mr. Bagley served as Chief Executive Officer of the Company. From June 1996 to August 1997, Mr. Bagley served as Chairman of the Board and Chief Executive Officer of OnTrak Systems, Inc. He was formerly Chief Operating Officer and Vice Chairman of the Board of Applied Materials, Inc., where he also served in other senior executive positions during his 15-year tenure. Mr. Bagley held various management positions at Texas Instruments, Inc., before he joined Applied Materials. Mr. Bagley is also currently a director of Micron Technology, Inc. and Teradyne, Inc. 4 Nominees for Director David G. Arscott (1) Director Since 1980 Age 62 Robert M. Berdahl (2,3) 69 2001 Richard J. Elkus, Jr. (2,3) 71 1997 Jack R. Harris (2) 64 1982 Principal Occupation and Business Experience During Past Five Years Mr. Arscott has been a director of the Company since 1980, and was Chairman of the Board of Directors from 1982 to 1984. He is currently, and has been since 1988, a General Partner of Compass Technology Group, an investment management firm. From 1978 to 1988, Mr. Arscott was a Managing General Partner of Arscott, Norton & Associates, a venture capital firm. Mr. Arscott is a director of Toolwire, Inc., StarVox, Inc., and Percutaneous Systems, Inc. Dr. Berdahl has been a director of the Company since 2001. Dr. Berdahl is currently, and has been since May 2006, the President of the Association of American Universities. From 2004 to May 2006, Dr. Berdahl held the position of Professor in the History Department of the University of California, Berkeley and Professor of Public Policy in the Goldman School of Public Policy, UC Berkeley. From 1997 to 2004, Dr. Berdahl served as Chancellor of the University of California, Berkeley. From 1993 to 1997, Dr. Berdahl was President of the University of Texas at Austin, and from 1986 to 1993, he was Vice Chancellor of Academic Affairs of the University of Illinois at Urbana-Champaign. Mr. Elkus has been a director of the Company since 1997. He is currently, and has been since 1996, Chairman of Voyan Technology. From 1994 until 1997, Mr. Elkus was Vice Chairman of the Board of Tencor Instruments, Inc., and from 1994 to 1996, he was Executive Vice President of Tencor Instruments. Mr. Elkus is also currently a director of SOPRA S.A., CAMECA, the National Science and Technology Medals Foundation, and the Scripps Research Institute. Mr. Harris has been a director of the Company since 1982. Mr. Harris is currently, and since 1999 has been, Chairman of HT, Inc., and is currently, and since 2001 has been, Executive Chairman of Metara, Inc. From 1986 until 1999, Mr. Harris was Chairman, Chief Executive Officer, and President of Optical Specialties, Inc. Mr. Harris is also currently a director of Innovative Robotic Solutions. 5 Nominees for Director Grant M. Inman (1,3) Director Since 1981 Age 64 Catherine P. Lego* (1) 50 2006 Stephen G. Newberry 53 2005 Principal Occupation and Business Experience During Past Five Years Mr. Inman has been a director of the Company since 1981. Mr. Inman is currently, and since 1998 has been, a General Partner of Inman Investment Management. From 1985 until 1998, Mr. Inman was a General Partner of Inman & Bowman, a venture capital investment partnership. Mr. Inman is also currently a director of Paychex, Inc., Wind River Systems, Inc., and AlphaCard Systems. Ms. Lego has been a director of the Company since her appointment in January 2006. Ms. Lego is currently, and since 1992 has been, a member of Lego Ventures, LLC, a technology consulting firm. She is also, and since 1999 has been, the General Partner of The Photonics Fund, LLP, a venture capital investment firm. From 1981 to 1992, Ms. Lego was a general partner of Oak Investment Partners, LLP, a venture capital firm. Ms. Lego is also currently a director of SanDisk Corporation, WJ Communications, Inc., and tau-Metrics, Inc. Mr. Newberry has been a director of the Company since 2005. Mr. Newberry is the Chief Executive Officer (CEO) and President of the Company, positions he has held since June 2005. He served as the President and Chief Operating Officer of the Company from July 1998 until his appointment as CEO in June 2005. Mr. Newberry held the positions of Executive Vice President and Chief Operating Officer from the time he joined the Company in August 1997 until July 1998. Prior to joining the Company, Mr. Newberry held various senior management positions at Applied Materials, Inc., during a 17-year tenure. Mr. Newberry is also a director of Nextest Systems Corporation and Semiconductor Equipment & Materials Institute (SEMI), the industry’s trade association. 6 Nominees for Director Seiichi Watanabe (1) Director Since 2005 Age 65 Patricia S. Wolpert* (2) 56 2006 Principal Occupation and Business Experience During Past Five Years Dr. Watanabe has been a director of the Company since 2005. Dr. Watanabe is, and since 2005 has been, the Executive General Manager, Research & Development, for Terumo Corporation of Japan. From 2004 to 2005, Dr. Watanabe served as an Advisor to Sony Corporation following his retirement from Sony in June 2004. During his tenure at Sony, Dr. Watanabe served as Executive Vice President of Environmental Affairs (2002-04), President of Frontier Science Laboratories (Sony) (1998-2002), President of the Semiconductor Division (1993-98), and Director of the Research Center (1989-93). Dr. Watanabe is also currently a director of Tekkugeito-inbestomento Corporation. Ms. Wolpert has been a director of the Company since her appointment in August 2006. Ms. Wolpert is currently, and since 2003 has been, the owner of Wolpert Consulting LLC. From 1993 to 2003, Ms. Wolpert served in a variety of senior management positions with International Business Machines, Inc., including: Vice President, Sales Transformation, Americas (2001-2003), Vice President, Central Region, Americas (2000-2001), Vice President, Business Operations, Americas (1999 to 2000), and various other management positions at IBM (1972-1999). Ms. Wolpert is also currently a director of Teradyne, Inc. (1) Member of Audit Committee. (2) Member of Compensation Committee. (3) Member of Nominating/Governance Committee. * Ms. Lego was initially recommended to the Board for consideration as a director nominee by a non- management director of the Company. Ms. Wolpert was initially recommended to the Board for consideration as a director nominee by one of the Company’s executive officers. The Company did not retain or pay a fee to any third party to identify or evaluate potential nominees with respect to the appointment of either Ms. Lego or Ms. Wolpert. 7 CORPORATE GOVERNANCE Lam’s Board of Directors and management are committed to responsible corporate governance to ensure that the Company is managed for the long-term benefit of its stockholders. To that end, the Board of Directors and management periodically review and update, as appropriate, the Company’s corporate governance policies and practices. In doing so, the Board and management review published guidelines and recommendations of institutional shareholder organizations and current best practices of similarly situated public companies. The Board and management also regularly evaluate and, when appropriate, revise Lam’s corporate governance policies and practices in accordance with the requirements of the Sarbanes-Oxley Act of 2002 and the rules and listing standards issued by the Securities and Exchange Commission (“SEC”) and The NASDAQ® Stock Market, Inc. (“NASDAQ”). Corporate Governance Policies and Practices Lam has instituted a variety of policies and practices to foster and maintain responsible corporate governance, including the following: Corporate Governance Guidelines — The Company adheres to written Corporate Governance Guidelines, adopted by the Board and reviewed from time to time by the Nominating/Governance Committee, selected provisions of which are detailed below. Corporate Code of Ethics — The Company maintains a Code of Ethics that applies to all Lam employees, officers, and members of the Board. A copy of the Code of Ethics is available on the Company’s web site at www.lamresearch.com, via the Investor Relations page. Global Standards of Business Conduct Policy — The Company maintains written standards of business conduct applicable to its employees worldwide. Board Committee Charters — Each of Lam’s Audit, Compensation, and Nominating/Governance Committees has written charters adopted by Lam’s Board of Directors that establish practices and procedures for each committee in accordance with applicable corporate governance rules and regulations. Lam’s Audit Committee and Nominating/Governance Committee Charters are available on the Company’s web site at www.lamresearch.com, via the Investor Relations page. The Audit Committee Charter is attached to this proxy statement as Appendix A. Board Nomination Policies and Procedures • Board Membership Criteria — Lam’s Corporate Governance Guidelines provide that nominees for director are evaluated on the basis of a range of criteria, including (but not limited to) business and industry experience, wisdom, integrity, analytical ability, ability to make independent judgments, understanding of the Company’s business and competitive environment, willingness and ability to devote adequate time to Board duties, and other appropriate considerations. No director shall be nominated or re-nominated after having attained the age of seventy-five years, and no director may serve on more than a total of four boards of public companies (including the Company’s Board). • Nomination Procedure — The Nominating/Governance Committee is responsible for identifying, evaluating, and recommending candidates for election to the Board, with due consideration for recommendations made by other Board members, the CEO, stockholders, and other sources. In addition to the above criteria, the Nominating/Governance Committee also considers the appropriate balance of experience, skills, and characteristics desirable among the members of the Board. The independent members of the Board review the Nominating/Governance Committee recommendations and nominate candidates for election by the Company’s stockholders. 8 Director Independence • Requirements — Lam’s Corporate Governance Guidelines require that at least a majority of the Board shall be independent in accordance with NASDAQ rules and other applicable criteria for independence. In addition, no non-employee director may serve as a consultant or service provider to the Company without the approval of a majority of the independent directors. • • • • Current Board Members — The Board has determined that the following directors are independent in accordance with NASDAQ criteria for director independence: David Arscott, Robert Berdahl, Richard Elkus, Jr., Jack Harris, Grant Inman, Catherine Lego, Seiichi Watanabe, and Patricia Wolpert. Board Committees — All members of each of the Company’s three standing committees — the Audit, Compensation, and Nominating/Governance Committees — are required to be independent in accordance with NASDAQ and other applicable criteria. See “Board Meetings and Committees” below for a description of the responsibilities of the Board’s standing committees. Lead Independent Director — Pursuant to the Corporate Governance Guidelines, the Board may designate an independent director as the Lead Independent Director. Upon appointment, the Lead Independent Director is responsible for coordinating the activities of the independent members of the Board and acting as the principal liaison between the independent directors and the Executive Chairman and CEO when necessary and appropriate. Director Robert Berdahl has served as the Lead Independent Director since 2004. Executive Sessions of Independent Directors — The Board and its standing committees periodically hold meetings of only the independent directors or Committee members without management present. Board Access to Independent Advisors • The Board as a whole, and each of the Board committees separately, have authority to retain and terminate such independent consultants, counselors, or advisors to the Board or a respective committee as each may deem necessary or appropriate. Board Training and Self-Assessment • The Corporate Governance Guidelines provide that directors are expected to attend one or more training sessions or conferences to enhance their ability to fulfill their responsibilities. Each of the directors who served during fiscal year 2006 fulfilled this expectation. In fiscal year 2005, a majority of the directors then serving attended at least one conference certified by an institutional investor services organization. From time to time, the Nominating/Governance Committee conducts a review of the functioning of the Board and the Board committees. Director and Executive Officer Stock Ownership • During fiscal year 2006, the Board adopted new director stock ownership guidelines. Pursuant to the Company’s Corporate Governance Guidelines, as amended, each director is expected to own at least 5,000 shares of Lam common stock by the later of five years after commencing service on the Board or November 2010. • During fiscal year 2006, the Company adopted executive stock ownership guidelines. Under the guidelines, executives designated by the Compensation Committee, including the Chief Executive Officer, the Chief Financial Officer, and certain other officers, are expected to own a number of shares of Lam common stock equal in value to a multiple of each executive’s base annual salary. The multiple varies according to the seniority of the office. Executives are expected to achieve the requisite stock ownership levels by the later of five years following appointment to office or December 2010. 9 Director Resignation or Notification Upon Change in Executive Officer Status • The Corporate Governance Guidelines provide that a director who is also an executive officer of the Company shall submit a resignation of his directorship to the Board if the officer ceases to be an executive officer of the Company. • The Corporate Governance Guidelines require that a non-employee director notify the Nominating/ Governance Committee if such director experiences a change of executive position held at another company. Upon any such notification, the Nominating/Governance Committee will review the appropriateness of the director’s continued Board membership under the circumstances, and the director will be expected to act in accordance with the Nominating/Governance Committee’s recommendation. Shareholder Communications with Board of Directors • Direct Communications — Any stockholder desiring to communicate with the Board of Directors or with any director regarding the Company may write to the Board or the director, c/o George M. Schisler, Jr., Office of the Secretary, Lam Research Corporation, 4650 Cushing Parkway, Fremont, CA 94538. The Office of the Secretary will forward all such communications to the director(s). In addition, any stockholder, employee, or other person may communicate any complaint regarding any accounting, internal accounting control, or audit matter to the attention of the Board’s Audit Committee by sending written correspondence to: Lam Research Corporation, Attention: Board Audit Committee, P.O. Box 5010, Fremont, CA 94536. • Annual Meeting —The Company encourages and expects its directors to attend the annual meeting of stockholders each year. All of Lam’s then-current directors attended the 2005 annual meeting. Additional Policies and Practices In addition to the measures discussed above, the Company maintains various other policies and practices to promote responsible corporate governance, such as: • • Periodic review of committee charters for each of the Audit, Compensation, and Nominating/ Governance Committees which address corporate governance issues. Preparation of a plan of succession for the offices of the CEO and other senior executives. • • Evaluation and approval of the CEO’s and Executive Chairman’s compensation by the independent members of the Board, based on recommendations of the Compensation Committee. Evaluation and determination of the compensation of other executive officers by the Compensation Committee. • Maintenance of disclosure control policies and procedures, including a Disclosure Control Committee. • Maintenance of a Compliance Committee, composed of the Chief Financial Officer and other Company managers and staff, for the purpose of identifying and addressing securities regulation compliance matters. • Maintenance of a procedure for receipt and treatment by the Audit Committee of anonymous and/or confidential employee complaints or concerns regarding audit or accounting matters. • • Comparison by the Board and its committees of the Company’s corporate governance policies with industry best practices and those of its peers. Availability of final proxy vote results on the Lam web site promptly following final compilation of the voting results. 10 Termination of Stockholder Rights Plan During fiscal year 2005, the Board of Directors adopted a resolution that accelerated the expiration of the Company’s Stockholder Rights Plan (a so-called “poison pill”), upon a determination by the Company that the Stockholder Rights Plan was no longer necessary to protect its stockholders’ interests. The expiration was effective as of February 28, 2005. Board Meetings and Committees The Board of Directors of the Company held a total of eight regularly scheduled or special meetings during fiscal year 2006. All of the directors who served for the entire fiscal year attended at least 75% of the aggregate number of Board meetings and meetings of Board committees on which they were a member during fiscal year 2006. The Board of Directors has an Audit Committee, a Compensation Committee, and a Nominating/ Governance Committee. During the first half of fiscal year 2006, the Audit Committee consisted of Board members Arscott, Elkus, and Inman. During the second half of fiscal year 2006 (from February 17, 2006), the Audit Committee consisted of Board members Arscott, Inman, Lego, and Watanabe. All Audit Committee members are independent, non-employee directors. The Audit Committee held nine meetings during fiscal year 2006. The Audit Committee appoints and provides for the compensation of the Company’s independent registered public accounting firm; oversees and evaluates the work and performance of the independent registered public accounting firm; reviews the scope of the audit; considers comments made by the independent registered public accounting firm with respect to accounting procedures and internal controls and the consideration given thereto by the Company’s management; approves in accordance with applicable securities laws all professional services to be provided to the Company by its independent registered public accounting firm; reviews internal accounting procedures and controls with the Company’s financial and accounting staff; oversees a procedure that provides for the receipt, retention and treatment of complaints received by the Company and for the confidential and anonymous submission by employees regarding questionable accounting or auditing matters; reviews and approves all related-party transactions; and performs related duties as set forth in applicable securities laws, NASDAQ corporate governance guidelines, and the Committee charter. The Lam Board of Directors has determined that Ms. Lego is an Audit Committee financial expert and that Ms. Lego is independent in accordance with the NASDAQ criteria for director independence. During the first half of fiscal year 2006, the Compensation Committee consisted of Board members Berdahl and Harris. During the second half of fiscal year 2006 (from February 17, 2006), the Compensation Committee consisted of Board members Berdahl, Elkus, and Harris. All Compensation Committee members are independent, non-employee directors. The Compensation Committee held six meetings during fiscal year 2006. The Compensation Committee recommends the salary level, incentives, and other forms of compensation for the Chief Executive Officer and the Executive Chairman, subject to approval by the independent members of the Board. It also approves salary levels, incentives, and other forms of compensation for the other executive officers of the Company. The Committee reviews and recommends to the Board all compensation arrangements applicable to the members of the Board. The Compensation Committee reviews, recommends and approves, subject to stockholder and/or Board approval as required, the creation, amendment, or termination of certain equity-based compensation plans of the Company and such other compensation plans as the Board may designate. In addition, this Committee has authority with respect to grants of stock options, restricted stock and stock units, deferred stock, and performance share awards to officers and other employees of the Company. During fiscal year 2006, the Nominating/Governance Committee consisted of Board members Berdahl, Elkus, and Inman. All Nominating/Governance Committee members are independent, non- employee directors. The Nominating/Governance Committee held one meeting during fiscal year 2006. This Committee recommends, for approval by the independent members of the Board, nominees for election as directors of the Company. Pursuant to the Committee’s charter and the Corporate Governance Guidelines, 11 the Nominating/Governance Committee is also responsible for recommending the composition of Board committees for approval by the Board, reviewing and assessing the Corporate Governance Guidelines from time to time and recommending changes for approval by the Board, reviewing the functioning of the Board and its committees and reporting the evaluation to the Board, and reviewing the suitability of each director for continuing service on the Board. The Nominating/Governance Committee recommended for Board approval, and the Board approved, the nominees for director of the Company as set forth in Proposal No. 1 above. The Nominating/Governance Committee recommended the nominees for director in accordance with the criteria and procedures set forth above in “Board Nomination Policies and Procedures.” The Nominating/Governance Committee will consider for nomination persons properly nominated by stockholders in accordance with the same policies and criteria as are applied to other nominees. In order for the Nominating/Governance Committee to consider the nomination of a person submitted by a stockholder for next year’s annual meeting, such nomination must be made in accordance with the Company’s bylaws and other procedures described above in the section captioned “Stockholder Proposals and Nominations to be Voted on at 2007 Annual Meeting.” 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The table below sets forth the beneficial ownership of shares of Common Stock of the Company by: (i) each person or entity whom, based on information obtained, the Company believes beneficially owned more than 5% of the Company’s Common Stock, and the address of each such person or entity (“5% stockholder”); (ii) each current director of the Company; (iii) each named executive officer (“named executive”) described below in the section of this proxy statement captioned “Executive Compensation and Other Information”; and (iv) all current directors and current executive officers as a group. With the exception of 5% stockholders, the information below concerning the number of shares beneficially owned is provided with respect to holdings as of September 15, 2006 (the Record Date), and, with respect to the 5% stockholders, the information below is provided with respect to holdings as of June 30, 2006, unless otherwise identified. The percentage is calculated using 142,206,849 as the number of shares outstanding as of the Record Date. Name of Person or Identity of Group Barclays Global Investors, NA . . . . . . . . . . . . . . . . . . . . . . . . . . . . Shares Beneficially Owned (1) 16,842,405(2) Percent of Class 11.84% 45 Fremont Street San Francisco, California 94105 Wellington Management Company LLP . . . . . . . . . . . . . . . . . . . . . 11,364,061(2) 7.99% 75 State Street Boston, Massachusetts 02109 Fidelity Management & Research Company . . . . . . . . . . . . . . . . . . 11,150,233(2) 7.84% 1 Federal Street Boston, Massachusetts 02110 James W. Bagley . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . David G. Arscott . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Robert M. Berdahl . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Richard J. Elkus, Jr. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Jack R. Harris . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Grant M. Inman . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Catherine P. Lego . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stephen G. Newberry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Seiichi Watanabe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Patricia S. Wolpert . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Martin B. Anstice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Nicolas J. Bright . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Ernest E. Maddock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . All current directors and current executive officers as a group 183,000 155,735 33,000 131,370 146,330 172,750 0 210,500 0 0 7,523 4,101 (3) 31,374 (14 persons)(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,079,627 * * * * * * * * * * * * * * * Less than one percent 13 (1) Includes shares subject to outstanding stock options and restricted stock units (RSUs) that are exercisable within 60 days after September 15, 2006, if any, with respect to: James Bagley David Arscott Robert Berdahl Richard Elkus, Jr. Jack Harris Grant Inman Catherine Lego Stephen Newberry 2,000 options Seiichi Watanabe 117,000 options 33,000 options Patricia Wolpert 99,000 options Martin Anstice 135,000 options Nicolas Bright 81,000 options Ernest Maddock 0 options Abdi Hariri 210,500 options 0 options 0 options 2,849 options 2,949 options 30,850 options 1,822 options (2) This information was obtained from NASDAQ and represents the respective entities’ quarterly 13F filings with the SEC reflecting holdings as of June 30, 2006. (3) Includes 120 shares held in trust for Mr. Bright’s dependent children. (4) Current directors and current executive officers, as of September 15, 2006, include: Mr. Bagley, Mr. Arscott, Dr. Berdahl, Mr. Elkus, Mr. Harris, Mr. Inman, Ms. Lego, Mr. Newberry, Dr. Watanabe, Ms. Wolpert, Mr. Anstice, Mr. Bright, Mr. Maddock, and Mr. Hariri. DIRECTOR COMPENSATION Directors who are not employees of the Company customarily receive annual base retainers of $36,000. A base retainer of $36,000 was paid to each non-employee director in fiscal year 2006. Directors who serve as chair of a committee of the Board receive an additional $2,000 annual retainer. The Lead Independent Director receives an additional $2,000 annual retainer. Additionally, non-employee directors receive $1,000 per committee meeting attended, provided that the meeting is attended in person and occurs on a day other than a day when a full board meeting is held. During fiscal year 2006, the Board modified the equity compensation portion of the compensation provided to non-employee directors. In November 2005, the Board amended the Company’s Amended and Restated 1997 Stock Incentive Plan (“1997 Plan”) to delete the provision providing for an annual stock option grant to non-employee directors on December 15 of each year. The Board resolved that each non-employee director will receive an annual equity grant, if any, in an amount, on such terms, and on such date as may be determined annually by the Board . During fiscal year 2006, each non-employee director then serving received a grant of 5,000 restricted stock units (RSUs). In addition, Director Seiichi Watanabe received an additional grant of 5,000 RSUs, in recognition of his services as director during calendar year 2005, for which he had not previously received equity compensation. Each such RSU grant was issued on January 31, 2006, and, subject to the director’s continued service on the Board, vests in full on January 31, 2007. 14 EXECUTIVE COMPENSATION AND OTHER INFORMATION Summary of Cash and Certain Other Compensation The following table provides, for the three fiscal years ended June 25, 2006, June 26, 2005, and June 27, 2004, respectively, certain summary information concerning compensation paid or accrued by the Company to or on behalf of (i) the Company’s Chief Executive Officer, Stephen G. Newberry, and (ii) each of the four other most highly compensated executive officers of the Company (determined as of the end of the last fiscal year) (collectively, the “named executive officers” or “NEOs”). Summary Compensation Table Annual Compensation Name and Principal Position James W. Bagley . . . . . . . . . . . . . Executive Chairman of the Board Stephen G. Newberry . . . . . . . . . Chief Executive Officer and President Martin B. Anstice . . . . . . . . . . . . Chief Financial Officer and Group Vice President Nicolas J. Bright. . . . . . . . . . . . . . Exec.Vice President, Regional Business & Global Products Ernest E. Maddock . . . . . . . . . . . Group Vice President, Global Operations Fiscal Year 2006 2005 2004 2006 2005 2004 2006 2005 2004 2006 2005 2004 2006 2005 2004 Salary ($)(1) 575,000 656,240 650,000 650,000 615,385 567,308 305,371 276,148 216,346 435,845 387,315 351,950 357,860 332,757 283,385 Bonus ($)(1)(2) 843,700 1,183,000 235,000 944,568 1,200,000 530,000 350,437 307,381 104,712 494,236 520,113 260,000 362,135 424,792 180,000 Long-Term or Other Compensation Other Annual Compensation ($)(3) 15,023 14,070 11,193 Number of Securities Underlying Options (#) — — — All Other Compensation ($) (4) 4,500(5) 4,500(5) — 3,929 5,928 6,477 — — — 3,079 4,532 4,600 1,290 698 474 — — — — — — — — — — — — 1,275(6) 1,274(6) 1,274(6) 7,309(7) 4,888(7) 6,014(7) 11,890(8) 7,960(8) 5,683(8) 5,652(9) 4,242(9) 3,994(9) (1) (2) Includes amounts and bonuses earned in fiscal years 2006, 2005, and 2004 under the Company’s short term annual incentive programs, even if deferred at the election of the executive officer under the Company’s deferred compensation plans and/or the Company’s 401(k) Plan. In addition to the amounts set forth in the “Bonus” column, amounts were accrued for the final two quarters of fiscal 2006 under the Company’s Multi-Year Cash Incentive Program (“MYIP”) in the amounts listed below and shall become payable on a determination date in February 2008 for the following executive officers who remain continuously employed at Lam through such date: Mr. Newberry, $1,623,432; Mr. Anstice, $674,349; Mr. Bright, $749,277; and Mr. Maddock, $611,910. Additional amounts were also accrued under the MYIP to become payable on a determination date in February 2007 for Mr. Anstice ($836,213) and Mr. Maddock ($386,670), also contingent upon their continuous employment. (3) Reflects interest earned on deferred compensation, to the extent that the interest rate exceeded 120% of the applicable federal long-term rate. 15 (4) Does not include payments of deferred compensation earned in and deferred from prior years. (5) (6) Consists of the Company’s matching contributions to the Company’s 401(k) Plan in the amount of $4,500 for 2006 and $4,500 for 2005. Consists of Company-paid term life insurance premiums of $1,275 for 2006, $1,274 for 2005, and $1,274 for 2004. (7) Consists of the Company’s matching contributions to the Company’s 401(k) Plan in the amounts of $5,888 for 2006, $4,557 for 2005, and $5,307 for 2004; Company-paid term life insurance premiums of $331 for 2006, $331 for 2005, and $331 for 2004; and the Company contribution to the Elective Deferred Compensation Plan in lieu of matching contributions to the 401(k) Plan in the amount of $1,090 for 2006. (8) (9) Consists of the Company’s matching contributions to the Company’s 401(k) Plan in the amounts of $6,803 for 2006, $7,960 for 2005, and $5,683 for 2004; Company-paid term life insurance premiums of $418 for 2006; and a patent inventorship award of $4,669 for 2006. Consists of the Company’s matching contributions to the Company’s 401(k) Plan in the amounts of $1,875 for 2006, $3,407 for 2005, and $3,324 for 2004; Company-paid term life insurance premiums of $835 for 2006, $835 for 2005, and $670 for 2004; and the Company contribution to the Elective Deferred Compensation Plan in lieu of matching contributions to the 401(k) Plan in the amount of $1,090 for 2006. Stock Plans No stock option grants or RSUs were made to any of the named executives during fiscal year 2006. The Company does not presently grant stock appreciation rights (SARs). The following table provides certain information concerning the exercise of options to purchase the Company’s Common Stock in the fiscal year ended June 25, 2006, and the unexercised options held as of June 25, 2006, by the named executive officers. Aggregated Option Exercises by Named Executive Officers in Last Fiscal Year, and Fiscal Year-End Option Values Name James W. Bagley Stephen G. Newberry Martin B. Anstice Nicolas J. Bright Ernest E. Maddock No. of Shares Acquired on Exercise 970,000 1,390,565 56,500 561,949 50,350 Value Realized ($)(1) $33,964,941 $37,478,178 $ 1,102,738 $ 11,008,682 555,791 $ No. of Unexercised Options at Fiscal Year-End Exercisable Unexercisable 1,000 205,250 2,000 0 28,800 1,000 5,250 849 6,949 3,050 Value of Unexercised In-The-Money Options at Fiscal Year-End(2) Exercisable $ 31,330 $3,630,483 37,480 $ 0 $ 603,072 Unexercisable $ 26,850 $140,963 $ 22,796 $159,981 $ 75,243 (1) Market value of underlying securities at exercise, minus the exercise price. (2) Market value of underlying securities at fiscal year-end, minus the exercise price. Multi-Year Performance-Based Cash Incentive Program On February 17, 2006, the Board, upon recommendation from the Compensation Committee, established a performance-based multi-year incentive program (MYIP) commencing in the first quarter of calendar year 2006, pursuant to which certain senior executives, including the named executive officers designated in footnote 2 of the “Summary Compensation Table” above, are eligible to receive cash awards which will vary depending upon the level of achievement of specific objectives and are contingent upon certain employment 16 conditions. These multi-year cash incentive awards may be used solely, or in conjunction with stock option or RSU grants, to provide competitive long-term incentives for senior executives and to reward behaviors that result in long-term stockholder value growth. In order to receive an award under the MYIP, participants generally must be continuously employed at Lam through the date(s) on which the Compensation Committee determines the actual award amounts under the program (the “determination date”). Performance factors are established annually and measured and accrued on a quarterly basis. Quarterly accrued amounts are then held and paid out on a cumulative basis after eight quarters on a determination date typically set to occur in the following quarter. Accordingly, awards under the 2006 MYIP cover calendar years 2006 and 2007 and will become payable on a determination date in February 2008. In addition, Messrs. Anstice and Maddock will participate in a supplemental cash-incentive program based on the Company’s operating profit performance which covers performance in calendar year 2006, contingent on their respective continued employment through February 2007. This supplemental program is in consideration for the absence of equity incentive grants to certain senior executives in recent years. Under the 2006 MYIP, in the first quarter of calendar year 2006 the Compensation Committee (and the independent members of the Board with respect to the CEO) established individual target incentive amounts for each participant and the performance-based metrics upon which actual incentive awards will be calculated for 2006. The MYIP program performance metrics for 2006 include the Company’s operating profit and stock price performance. Performance metrics for calendar year 2007 are expected to be established by the Compensation Committee (and the independent members of the Board with respect to the CEO) in the first quarter of calendar year 2007 and may differ, as deemed appropriate at such time, from those established for 2006. Actual incentive amounts are provisionally calculated and accrued on a quarterly basis during the calendar year in relation to the attainment of the performance criteria. The MYIP provides that the maximum award amount payable to a participant may not exceed 2.5 times the target incentive amounts. Under the target incentive amounts established for calendar year 2006 under the 2006 MYIP, the maximum award amount that may be accrued for an individual executive officer for calendar year 2006 performance is $8,125,000. Target incentive amounts for calendar year 2007 will be established when the Compensation Committee and the Board set performance metrics for that year and, accordingly, the maximum award amount for calendar year 2007 performance will not be determinable until that time. Under the supplemental program, the maximum award amount that may be accrued for an individual executive officer for calendar year 2006 performance is $3,325,000. Incentive awards are not considered earned by a participant unless and until he or she meets the retention and other eligibility criteria. Participants who do not meet the retention and performance criteria will not receive payment of accrued award amounts for 2006 and 2007. The sum of the actual award amounts accrued for performance during calendar years 2006 and 2007 under the 2006 MYIP will be determined and become payable for participants who meet the retention criteria in February 2008. The actual award amounts accrued under the supplemental program will similarly be determined and become payable in February 2007. In the event there are one or more participants who are no longer employed by the Company on the payment determination date, the aggregate amount accrued in each program year pool will be distributed to other eligible employees. In addition, the Compensation Committee may exercise discretion to reduce the rate of future accruals on a quarter-by-quarter basis. The 2006 MYIP and the supplemental program are administered by the Compensation Committee as part of the Company’s 2004 Executive Incentive Plan (2004 EIP) and in accordance with the 2004 EIP, to the extent permitted thereunder. See “Report of the Compensation Committee” below. Subject to approval by the Compensation Committee and the Board, it is anticipated that a multi-year MYIP similar to the 2006 MYIP, also administered as part of the 2004 EIP, will commence in 2007 for performance in calendar years 2007 and 2008. For a further description of the 2004 EIP, see “Proposal No. 2 - Approval of Amendment of Lam 2004 Executive Incentive Plan,” below. 17 Employment and Termination Agreements, Change-of-Control Arrangements, and Retirement Benefits Employment Agreement with Stephen G. Newberry The Company and Mr. Newberry entered into an employment agreement effective January 1, 2003 (the “Newberry Agreement”). The initial term of the Newberry Agreement was from January 1, 2003, through October 31, 2005, and automatically extends for subsequent one-year periods without limit unless terminated by either Mr. Newberry or the Company in accordance with the provisions of the Newberry Agreement. The Newberry Agreement provides for a base salary, at a rate to be set at least annually by the Board of Directors. Under the Newberry Agreement, Mr. Newberry is entitled to participate in any performance incentive plan offered by the Company, in the Company’s executive deferred compensation plan(s), and in other benefit plans and compensation programs generally applicable to key executives of the Company. In the event of involuntary termination without cause or a change in control of the Company followed by either involuntary termination or the acceptance of a position of materially lesser authority or responsibility offered to Mr. Newberry by the Company, or if the Company is acquired by another entity so that there will be no market for the Common Stock of the Company and the acquiring entity does not provide options comparable to unvested stock options held by Mr. Newberry, all unvested stock options granted to Mr. Newberry will automatically be accelerated in full so as to become fully vested. Mr. Newberry will have two years from the date of termination in which to exercise such options. If Mr. Newberry’s employment is involuntarily terminated without cause, he will be entitled to receive a lump sum payment equal to fifteen months of his then-annual base compensation, and the Company will pay for fifteen months of COBRA benefits following the date of termination. If Mr. Newberry resigns voluntarily, he is not entitled to receive any severance benefits under the Newberry Agreement. The Newberry Agreement provides that for a period of six months following Mr. Newberry’s termination of employment with the Company, Mr. Newberry may not solicit any of the Company’s employees to become employed by any other business enterprise. Employment Agreement with Nicolas J. Bright Effective August 1, 2003, the Company and Mr. Bright entered into an employment agreement (the “Bright Agreement”). The initial term of the Bright Agreement was from August 1, 2003, through January 31, 2006, and automatically extends for subsequent one-year periods without limit unless terminated by either Mr. Bright or the Company in accordance with the provisions of the Bright Agreement. The Bright Agreement provides for a base salary, at a rate to be set at least annually by the Board of Directors. Under the Bright Agreement, Mr. Bright is entitled to participate in any performance incentive plan offered by the Company, in the Company’s executive deferred compensation plan(s), and in other benefit plans and compensation programs generally applicable to key executives of the Company. In the event of a change in control of the Company, subject to certain conditions set forth in the Bright Agreement, or involuntary termination of Mr. Bright without cause, all unvested stock options granted to Mr. Bright will automatically be accelerated in full so as to become fully vested. Mr. Bright will have two years from the date of termination in which to exercise such options. If Mr. Bright’s employment is involuntarily terminated without cause, he will be entitled to receive a lump sum payment equal to fifteen months of his then-annual base compensation, and the Company will pay for fifteen months of COBRA benefits following the date of termination. If Mr. Bright resigns voluntarily, he is not entitled to receive any severance benefits under the Bright Agreement. The Bright Agreement provides that for a period of six months following Mr. Bright’s termination of employment with the Company, Mr. Bright may not solicit any of the Company’s employees to become employed by any other business enterprise. 18 Change-of-Control Arrangements In addition to the change-of-control provisions in the foregoing agreements, certain of the Company’s Stock Option Plans and its Employee Stock Purchase Plan provide, generally, that, upon a merger of the Company with or into another corporation or the sale of substantially all of the assets of the Company, each outstanding option or right to purchase Common Stock shall be assumed, or an equivalent option or right substituted, by the successor corporation or a parent or subsidiary of the successor corporation. In the event that the successor corporation does not agree to assume the option or right or substitute an equivalent option or right, at the discretion of the plan administrator, some or all of the options granted under certain of the Stock Option Plans shall be accelerated so as to be fully exercisable, and all of the rights granted under the Employee Stock Purchase Plans shall be fully exercisable following the merger for a period from the date of notice by the Board of Directors. Following the expiration of such periods, the options and rights will terminate. Under certain other Stock Option Plans, the Plan Administrator may make other adjustments or provisions to compensate option holders. The 2007 Stock Incentive Plan proposed for adoption by Lam stockholders at the Annual Meeting allows the Company broad discretion to provide for vesting acceleration of awards on change-of-control transactions. See “Proposal No. 3 - Approval of the Lam 2007 Stock Incentive Plan” below. Retirement Medical and Dental Benefits Board members and executives who retire from the Company and who meet certain age and service requirements are allowed to continue to participate in the Company’s group medical and dental plans after retirement. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS No family relationships exist or existed during fiscal year 2006 among any of the Company’s directors and executive officers. No related-party transactions occurred during fiscal year 2006. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION No interlocking relationship exists or existed during fiscal year 2006, between any member of our compensation committee and any member of any other company’s board of directors or compensation committee. The Compensation Committee consisted of Messrs. Berdahl and Harris during the first half of fiscal year 2006; and Messrs. Berdahl, Elkus, and Harris during the second half of fiscal year 2006. REPORT OF THE COMPENSATION COMMITTEE Notwithstanding anything to the contrary set forth in any of the Company’s previous filings under the Securities Act of 1933, as amended (“Securities Act”), or the Exchange Act, that might incorporate all or portions of future filings, including this Proxy Statement, the following Report of the Compensation Committee, and the Comparative Stock Performance graph below, shall not be incorporated by reference into any such filings, nor shall they be deemed to be soliciting material or deemed filed with the SEC under the Securities Act or the Exchange Act. The Compensation Committee (the “Committee”) of the Board of Directors develops and reviews compensation policies, programs, and practices applicable to the Company’s executive officers, including the criteria upon which executive compensation is based and the mix of compensation components offered to executive officers. It also reviews such policies and programs and recommends new policies, and material changes to existing policies, to the independent members of the Board for approval. In addition, the Committee establishes and periodically reviews corporate goals and objectives for the Chief Executive Officer and the Executive Chairman; evaluates the CEO’s and Executive Chairman’s performances in light of those goals and objectives; and, based on such evaluation, recommends, for approval by the independent members of the Board, the CEO’s and Executive Chairman’s compensation packages, including any employment agreement, 19 severance or change-in-control agreement, equity grant, or special or supplemental employee benefit, and any material amendment to any of the foregoing. The Committee also determines compensation packages for the other executive officers of the Company, consistent with the policies approved by the independent members of the Board. The Committee was composed of the following independent non-employee directors during fiscal year 2006: Messrs. Berdahl and Harris during the first half of fiscal year 2006; and Messrs. Berdahl, Elkus, and Harris during the second half of fiscal year 2006. As of the date of this Proxy Statement, the Committee is composed of Directors Berdahl, Elkus, Harris, and Wolpert. Compensation Policies One of the Committee’s primary goals in setting compensation policies is to maintain competitive programs to attract, retain, and motivate high-caliber executives and maximize the long-term success of the Company by appropriately rewarding such individuals for their achievements. Another goal is to provide an incentive to executives to focus efforts on long-term strategic goals for the Company by closely aligning their financial interests with stockholder interests without causing undue dilution of the Company’s shares. In response to changes in the regulatory, tax, and accounting environments, the Company also endeavors to tailor its compensation programs to remain competitive while taking into account the accounting treatment and tax deductibility of executive compensation expense. To attain these goals, the Committee has designed the Company’s executive compensation program for fiscal and calendar years 2006 to include base salary, annual incentives, and long-term incentives. In formulating and administering the individual elements of the Company’s executive compensation program, the Committee emphasizes achievement of short- and long-term objectives based on quantitative and strategic performance objectives and metrics, regularly evaluates corporate and individual performance against such objectives, and applies its prudent judgment, in light of actual performance, to determine the amounts of incentive awards appropriate for the Company’s executive officers. The Committee believes that the Company’s executive compensation programs have met these objectives for fiscal year 2006. The Company has been able to attract and retain the executive talent necessary to support the corporation and promote its long-term growth. The Company’s executive compensation programs have also enabled the Company to adjust, both downwardly and upwardly when appropriate, the amounts of incentive payments to its executive officers in response to changes in the Company’s business performance. Compensation Components Base Salary The Committee establishes the base salaries of executive officers after consideration of the officers’ respective responsibilities, experience, and performance, and after review of relevant data of other executives with similar responsibilities from published industry reports and surveys of similarly situated companies. Accordingly, the Committee generally strives to maintain the Company’s annual executive salaries at levels competitive with the market median base salaries of executive officers in similar positions at similarly situated companies. The relevant market of similarly situated companies used for comparative purposes is comprised of similarly sized high-technology companies within and outside the Company’s industry. During the last fiscal year, adjustments were made to the base salaries of certain executive officers to recognize individual performance, changes in an executive’s role and responsibilities, and/or market competitiveness. 20 Annual Incentives The Company maintains an annual incentive program to motivate and reward its executives as part of its comprehensive compensation program. The annual incentive program operates on a calendar-year basis. The annual incentive levels are intended to provide and account for appropriate elements of variability and risk. Annual incentive awards to the executives are customarily based on the achievement of specific corporate and/or individual performance objectives. The Committee customarily establishes a target incentive amount in advance (either annually or semi-annually) for each executive officer, determined through review of competitive market data for executives at similar levels, which amount will be incrementally reduced if the Company or the executive does not meet targeted performance objectives or increased if the Company or the executive exceeds targeted performance objectives. Increases above the target incentive amount are subject to a mathematical limit, which for bonuses payable in fiscal year 2006 was 2.25 times annual base salary. Annual incentive bonuses earned for a calendar year are customarily paid in February of the following year. Annual incentive bonus payments made to certain executive officers during fiscal year 2006, including bonuses paid to the Chief Executive Officer under the 2004 Executive Incentive Plan, were based on the achievement of specific criteria, including goals and objectives relating to each officer’s performance and to corporate revenue, gross margin, operating profit, cash from operations, and market share targets. The specific annual incentive amounts paid to the Chief Executive Officer and the named executive officers in fiscal year 2006, for annual incentives earned for calendar year 2005, are set forth in the “Summary Compensation Table” included in the section of this Proxy Statement entitled “Executive Compensation And Other Information.” Long-Term Incentives Stock Options and Other Equity Incentives The Committee periodically grants or recommends the grant of equity incentives, such as stock options or restricted stock units (RSUs), as part of its compensation program. The Committee believes that such awards can be effectively used to focus an executive’s attention on the long-term performance of the Company and to maximize stockholder value. The grant of equity incentives is closely tied to an individual executive’s performance and responsibility level. The Committee grants or recommends the grant of such equity incentives after a review of various factors, including the executive’s potential contributions to the Company, current equity ownership in the Company, and vesting rates of existing stock options and other equity incentives, if any. Stock options are granted with an exercise price equal to the fair market value of the Company’s stock at the time of grant and utilize vesting periods intended to encourage retention of executive officers. RSUs, if granted in the future to executive officers, would likely also utilize vesting periods intended to encourage retention, although they may also or instead be earned only upon achievement of specified performance objectives. Because of the direct benefit executive officers receive from equity incentives if the Company’s stock value increases while they hold such awards, the Committee believes equity incentives serve to align the interests of executive officers closely with those of other stockholders. At the same time, the Committee is also aware of the potential for dilution of the Company’s shares and in recent years it has targeted reduction of the overhang of stock incentive awards on the Company’s outstanding common stock. Accordingly, the Committee has not granted stock incentive awards to named executive officers since fiscal year 2003 and the Committee deemed it appropriate to continue that policy by relying primarily on cash compensation during fiscal year 2006. Therefore, no equity grants were made to the Company’s executive officers during fiscal year 2006 and a major consideration for the adoption of the Multi-Year Performance-Based Cash Incentive Program described below is to continue to minimize share dilution during calendar years 2006 and 2007. Nonetheless, in formulating the Company’s executive compensation program in future years, it is possible that in light of changing circumstances the Committee may determine that a mix of long-term cash and equity incentives, or equity incentives alone, may become more appropriate for future periods. 21 Multi-Year Cash Incentive Program On February 17, 2006, the Board, upon recommendation from the Compensation Committee, established a performance-based multi-year incentive program (MYIP) commencing in the first quarter of calendar year 2006, pursuant to which certain senior executives are eligible to receive cash awards which will vary depending upon the level of achievement of specific objectives and are contingent upon certain employment conditions. These multi-year cash incentive awards may be used solely, or in conjunction with stock option or RSU grants, to provide competitive long-term incentives for senior executives and to reward behaviors that result in long-term stockholder value growth. In the event that the Committee believes it is in the best interests of the shareholders to use stock option or RSU grants in conjunction with cash awards under the MYIP, then those cash award targets would be altered to reflect the value expected to be received from the stock options or RSU grants. A significant driver of the creation of the MYIP is the Company’s desire and objective to have as much of the Company’s expenses as possible, including expense for executive incentive compensation, be variable commensurate with the level of the Company’s business performance. The funding parameters of the 2006 MYIP are primarily based on the profitability of the Company and change in value of the Company’s stock price during relevant accrual periods, thereby achieving that objective. In contrast, stock options and restricted stock grants generally must be amortized based on a valuation determined at the time of grant, thus typically creating a fixed cost once they are granted. In summary description, the MYIP requires participating executives to achieve pre-established retention targets and corporate performance metrics relating to operating profits and stock price performance in order to receive payments under the MYIP. In order to receive an award under the MYIP, participants generally must be continuously employed at Lam through the date(s) on which the Compensation Committee determines the actual award amounts under the program (the “determination date”). Performance factors are established annually and measured and accrued on a quarterly basis. Quarterly accrued amounts are then held and paid out on a cumulative basis after eight quarters. Accordingly, awards under the 2006 MYIP cover calendar years 2006 and 2007 and become payable on a determination date in February 2008. More detailed information regarding the structure and other provisions of the MYIP are described in the section above entitled “Executive Compensation And Other Information/Multi-Year Performance-Based Cash Incentive Program.” Information regarding the maximum amounts that may be earned by Lam’s named executive officers under the 2006 MYIP is also set forth in that section. The MYIP program is administered by the Compensation Committee in accordance with and as a sub-program of the Company’s 2004 Executive Incentive Plan (2004 EIP), provided that to the extent that award amounts under the MYIP exceed the annual maximum per-participant dollar limitation under the 2004 EIP, such excess amount may be paid as separate bonuses outside the 2004 EIP. In that event, any such excess may not qualify as tax-deductible performance-based compensation under Code Section 162(m). The Compensation Committee believes that the MYIP supports the Committee’s and the Company’s stated compensation objectives by providing appropriate long-term performance-based incentives to the Company’s executives. The Committee further believes that the proposed amendment of the 2004 EIP, presented herein for stockholder approval at the 2006 Annual Meeting and described below under the heading “Proposal No. 2 - Amendment of Lam 2004 Executive Incentive Plan,” will assist the Company in appropriately compensating its senior executives while at the same time enhancing the Company’s ability to deduct amounts paid under Section 162(m). Deferred Compensation Plan Another component of the Company’s executive compensation program is its elective deferred compensation plans (the “Deferred Compensation Plans”). The Company adopted a deferred compensation plan in 1994 (“the 1994 Deferral Plan”). The 1994 Deferral Plan remains in effect but was closed to further contributions as of December 31, 2004. The Company adopted a new deferred compensation plan (“the 2005 22 Deferral Plan”) effective January 1, 2005. Contributions by eligible executives on or after January 1, 2005, will be maintained in the 2005 Deferral Plan. Both Deferred Compensation Plans are voluntary, non-tax- qualified, deferred compensation plans that encourage executives to save for retirement. Under the Deferred Compensation Plans, participants were and are entitled to defer compensation until retirement, death, other termination of employment, or until specified dates. Executive Stock Ownership Guidelines During fiscal year 2006, the Company adopted executive stock ownership guidelines, pursuant to which senior executives are expected and encouraged to own and maintain certain minimum levels of the Company’s common stock. The Compensation Committee believes that these guidelines are an appropriate addition to the Company’s equity compensation policies and, in conjunction with Lam’s equity and cash- based incentive plans, will further serve to align the long-term interests of the senior executives with those of the Company’s stockholders. Compensation of Chief Executive Officer The Committee bases the compensation of the Company’s Chief Executive Officer (“CEO”) on the policies, objectives, and criteria described above and below. In determining the CEO’s base salary and incentive bonus (if any), the Committee also considers compensation levels for other chief executive officers in high-technology firms within and outside the industry. The Committee compares this information to the relevant performance of such firms relative to the Company’s performance. Pursuant to the Compensation Committee Charter, to determine the CEO’s compensation, the Committee reviews corporate goals and objectives relevant to the CEO; evaluates the CEO’s performance in light of these goals and objectives; and, based on this evaluation, recommends the CEO’s compensation package for approval by the independent members of the Board, including any employment agreement, severance arrangement, change-in-control arrangement, equity grant, or special or supplemental employee benefit, and any material amendment to any of the foregoing, between the Company and the CEO. Stephen G. Newberry Mr. Newberry served as CEO of the Company during fiscal year 2006. The Company and Mr. Newberry entered into an employment agreement (the “Newberry Agreement”) effective January 1, 2003, which continues in effect pursuant to the automatic renewal provision therein. The terms of the Newberry Agreement are described above in the section entitled “Employment and Termination Agreements, Change-of-Control Arrangements, and Retirement Benefits.” The Newberry Agreement provides for a base salary at a rate to be set at least annually by the Board of Directors. During fiscal year 2006, the Committee recommended, and the Board approved, a base salary at an annualized rate of $710,000 for Mr. Newberry. Mr. Newberry is entitled to participate in the Company’s incentive bonus programs available to other senior executives. During fiscal year 2006, Mr. Newberry received incentive compensation totaling $944,568 for his performance in calendar year 2005, based on the achievement of certain specific goals and objectives for calendar year 2005, including corporate revenue, gross margin, operating profit, cash from operations, and market share targets. The Committee and the Board established such objectives in February 2005 for the first half of calendar year 2005, and then, after review of Mr. Newberry’s first-half performance in relation to the objectives, established additional objectives in August 2005 for the second half of calendar year 2005, so as to administer his incentive compensation in accordance with the Company’s 2004 Executive Incentive Plan and qualify it as “performance-based compensation” under Code Section 162(m). In February 2006, the Committee and the Board then reviewed and evaluated Mr. Newberry’s performance for the second half of 2005 and the entire calendar year. Mr. Newberry’s incentive compensation was determined by applying a 23 numeric factor, derived from the degree to which his objectives were achieved, to his base salary, subject to review by the Committee and the Board as to the reasonableness of the quantitatively ascertained incentive compensation. With respect to Mr. Newberry’s potential annual incentive bonus compensation for calendar year 2006, the Compensation Committee and the Board are following the same process, as described above, of pre- establishing target objectives for the first half and second half of the calendar year and reviewing the CEO’s performance against those objectives, in order to determine the CEO’s annual incentive bonus. In addition, in February 2006, the Compensation Committee recommended, and the Board approved, target incentive amounts that might be paid to Mr. Newberry in fiscal year 2008 under the MYIP for calendar year 2006. See the “Executive Compensation And Other Information/Multi-Year Performance-Based Cash Incentive Program” section above for further information. No new stock options, RSUs, or other equity awards were granted to Mr. Newberry in fiscal year 2006. Effect of Section 162(m) of the Internal Revenue Code Section 162(m) of the Internal Revenue Code (“the Code”) generally limits the annual corporate deduction for compensation paid during the applicable year to certain executive officers to $1 million, unless the compensation qualifies as “performance-based” compensation under the Section 162(m) rules. To the extent compensation qualifies as “performance-based,” the employer company can deduct it without application of the $1 million limit established by Section 162(m). The Company anticipates that certain of the cash incentive compensation that may be earned by executive officers with respect to fiscal year 2006, in particular compensation that may become payable outside the limits of the 2004 EIP under the terms of the new MYIP, may not be fully deductible under Code Section 162(m). In the course of transitioning the Company’s executive compensation program since 2003 from a program that relied primarily on equity compensation to provide long-term incentives to a program that instead relies primarily on cash compensation, the Committee has considered the potential impact of Code Section 162(m) and desires over the long term to structure the Company’s compensation programs in a manner that will allow the Company to maximize its ability to deduct compensation in whatever form used to pay the Company’s executive officers. Accordingly, in order to permit it to deduct a greater portion of its executive compensation in future years, the Company submits herein for stockholder approval the amendment to the 2004 Executive Incentive Plan, which amendment will increase the amount of compensation paid thereunder that may qualify as performance-based compensation and so be fully deductible under Section 162(c), and the adoption of the 2007 Equity Plan, which is designed to allow for performance-based compensation qualifying under Section 162(m). See “Proposal No. 2 – Approval of Amendment of Lam 2004 Executive Incentive Plan,” and “Proposal No. 3 – Adoption of 2007 Equity Plan,” below. The Committee notes, however, that notwithstanding approval of such plans, it reserves the right to pay compensation that will not in fact be fully deductible by Lam if it determines from time to time in the future that doing so is in the best interests of the Company and its stockholders. COMPENSATION COMMITTEE Robert M. Berdahl Richard J. Elkus, Jr. Jack R. Harris Patricia S. Wolpert 24 REPORT OF THE AUDIT COMMITTEE Notwithstanding anything to the contrary set forth in any of the Company’s previous filings under the Securities Act or the Exchange Act that might incorporate all or portions of future filings, including this Proxy Statement, the following Report of the Audit Committee shall not be incorporated by reference into any such filings, nor shall they be deemed to be soliciting material or deemed filed with the SEC under the Securities Act or the Exchange Act. Under the guidance of a written charter adopted by the Board of Directors, the purpose of the Audit Committee is to monitor the integrity of the financial statements and the effectiveness of internal control over financial reporting of the Company, oversee the independence of the Company’s independent registered public accounting firm, appoint and provide for the compensation of the independent registered public accounting firm, and evaluate the performance of the independent registered public accounting firm. Pursuant to the Audit Committee Charter, the Audit Committee is also responsible for reviewing and approving, if appropriate, all related-party transactions. A copy of the Audit Committee Charter is attached to this Proxy Statement as Appendix A. Each of the members of the Audit Committee meets the independence requirements of NASDAQ. The Audit Committee consisted of Messrs. Arscott, Elkus, and Inman during the first half of fiscal year 2006, and of Directors Arscott, Inman, Lego, and Watanabe during the second half of fiscal year 2006. As of the date of this Proxy Statement, the Audit Committee consists of Directors Arscott, Inman, Lego, and Watanabe. Management has primary responsibility for the system of internal control and the financial reporting process. The independent registered public accounting firm has the responsibility to express an opinion on the financial statements and the system of internal control over financial reporting based on an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (U.S.). The Audit Committee has the responsibility to monitor and oversee these processes. In this context and in connection with the audited financial statements contained in the Company’s Annual Report on Form 10-K, the Audit Committee: • • • • reviewed and discussed the audited financial statements with Company management; reviewed and discussed with management its assessment of and report on the effectiveness of the Company’s internal control over financial reporting as of June 25, 2006, which management prepared using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal-Control Integrated Framework. The Committee also reviewed and discussed with Ernst & Young LLP, the Company’s independent registered public accounting firm, Ernst & Young LLP’s attestation report on management’s assessment of and report on the Company’s internal control over financial reporting; discussed with Ernst & Young LLP the matters required to be discussed by Statement of Auditing Standards No. 61, “Communication with Audit Committees,” as amended by Statement of Auditing Standards No. 90, “Audit Committee Communications”; reviewed the written disclosures and the letter from Ernst & Young LLP, required by the Independence Standards Board Standard No. 1, “Independence Discussions with Audit Committees,” and discussed with the independent registered public accounting firm its independence; 25 • • based on the foregoing reviews and discussions, recommended to the Board of Directors that the audited financial statements be included in the Company’s 2006 Annual Report on Form 10-K for the fiscal year ended June 25, 2006, filed with the SEC; and instructed management and the independent registered public accounting firm that the Committee expects to be advised if there are any subjects that require special attention. AUDIT COMMITTEE David G. Arscott Grant M. Inman Catherine P. Lego Seiichi Watanabe RELATIONSHIP WITH INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Ernst & Young LLP has audited the Company’s consolidated financial statements since the Company’s inception. Fees Billed by Ernst & Young LLP The table below shows the fees billed by Ernst & Young LLP for audit and other services provided to the Company in fiscal years 2006 and 2005. Services / Type of Fee Audit Fees (1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Audit-Related Fees (2) . . . . . . . . . . . . . . . . . . . . . . . . . Tax Fees (3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . All Other Fees (4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . TOTAL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fiscal Year 2006 $2,137,000 136,000 — — $2,273,000 Fiscal Year 2005 $2,515,000 21,000 — 5,000 $2,541,000 (1) Audit fees represent fees for professional services provided in connection with the audits of annual financial statements, reviews of quarterly financial statements, and audit services related to other statutory or regulatory filings or engagements. In addition, audit fees include those fees related to Ernst & Young LLP’s audit of the effectiveness of the Company’s internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act. (2) Audit-related fees consist of assurance and related services that are reasonably related to the audit or review of the Company’s financial statements and are not reported above under “Audit Fees.” (3) Tax fees represent fees for services primarily related to international tax compliance. (4) All other fees relate principally to fees for subsidiary-related services. The Audit Committee reviewed summaries of the services provided by Ernst & Young LLP and the related fees during fiscal year 2006 and has determined that the provision of non-audit services was compatible with maintaining the independence of Ernst & Young LLP as the Company’s independent registered public accounting firm. 26 Policy on Audit Committee Pre-Approval of Audit and Non-Audit Services It is the responsibility of the Audit Committee to approve, in accordance with Sections 10A(h) and (i) of the Exchange Act and the Rules and Regulations of the SEC, all professional services, to be provided to the Company by its independent registered public accounting firm, provided that the Audit Committee shall not approve any non-audit services proscribed by Section 10A(g) of the Exchange Act in the absence of an applicable exemption. It is the policy of the Company that the Audit Committee pre-approves all audit and permissible non- audit services provided by the Company’s independent registered public accounting firm, consistent with the criteria set forth in the Audit Committee Charter and applicable laws and regulations. The Committee has delegated to the Chair of the Committee the authority to pre-approve such services, provided that the Chair shall report any decision on his part to pre-approve such services to the full Audit Committee at its next regular meeting. These services may include audit services, audit-related services, tax services, and other services. The independent registered public accounting firm and Company management are required to periodically report to the Audit Committee regarding the extent of services provided by the independent registered public accounting firm pursuant to any such pre-approval. 27 COMPARATIVE STOCK PERFORMANCE The following graph and table compare the cumulative total stockholder return on the Company’s Common Stock (“LRCX”) with the cumulative total return on The NASDAQ Stock Market Index® (U.S. companies only) and the Research Data Group (“RDG”) Semiconductor Composite Index (“RDG Index”) over the last five fiscal years (July 1 to June 30 for purposes of this graph and table). The graph and table assume an investment of $100 in LRCX and in each index on July 1, 2001, and that dividends, if any, were reinvested. The graph and table depict the change in value of LRCX in relation to the indices as of June 30th of each year (and not for any interim or other period). The stock price performance shown on the graph and table below is not necessarily indicative of future price performance. The graph and table below have been furnished by RDG. Information about The NASDAQ Stock Market Index and the RDG Index can be found at www.nasdaq.com and www.researchdatagroup.com, respectively. COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN* AMONG LAM RESEARCH CORPORATION, THE NASDAQ STOCK MARKET (U.S.) INDEX, AND THE RDG SEMICONDUCTOR COMPOSITE INDEX D O L L A R S 180 160 140 120 100 80 60 40 20 0 6/01 6/02 6/03 6/04 6/05 6/06 LAM RESEARCH CORPORATION NASDAQ STOCK MARKET (U.S.) INDEX RDG SEMICONDUCTOR COMPOSITE * $100 invested on 6/30/01 in stock or index, including reinvestment of dividends. Fiscal year ending June 30. Lam Research Corporation . . . . . . . . . . . . . . . . . NASDAQ Stock Market (U.S.) . . . . . . . . . . . . . . RDG Semiconductor Composite . . . . . . . . . . . . 2001 100.00 100.00 100.00 2002 60.64 70.34 67.27 2003 61.59 78.10 61.76 2004 90.39 98.58 81.32 2005 97.64 99.24 76.71 2006 157.57 105.85 77.46 Cumulative Total Return ($$) ($100 Initial Investment) As of June 30 28 SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS The following table provides information as of June 25, 2006, regarding securities authorized for issuance under the Company’s equity compensation plans. The equity compensation plans of the Company include the 1991 Stock Option Plan, the 1996 Performance-Based Restricted Stock Plan, the 1997 Stock Incentive Plan, the 1999 Stock Option Plan, and the 1999 Employee Stock Purchase Plan. Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants, and Rights (a) 968,436(1) Plan Category Equity compensation plans approved by security holders . . . . . . . . . . . . . . . . . Equity compensation plans not approved by security holders . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,605,014(3) 6,573,450 Weighted-Average Exercise Price of Outstanding Options, Warrants, and Rights (b) Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (excluding securities reflected in column (a)) (c) $17.00 $20.66 $20.04 10,746,915(2) 2,513,709 13,260,624 (1) (2) (3) Includes shares issuable under the Company’s 1997 Stock Incentive Plan (the “1997 Plan”). The 1997 Plan was adopted by the Board in May 1997 and approved by the stockholders of the Company in August 1997. In October 2002, the Board amended the 1997 Plan to provide for the issuance of restricted stock unit awards, allow all 1997 Plan participants to participate in exchanges of stock options previously permitted under the 1997 Plan, and provide that vesting of restricted stock, deferred stock, performance share and restricted stock unit awards would be determined by the Administrator of the Plan at the time of the award grant. Pursuant to the provisions of the 1997 Stock Incentive Plan approved by Lam’s stockholders, the number of shares reserved for issuance under the plan will automatically be increased each calendar quarter if and to the extent necessary to provide that the ratio of (a) the number of shares reserved for issuance under all of Lam’s stock-based incentive plans to (b) the total number of shares of Lam Common Stock outstanding on a fully-diluted basis will be equal to 18.5%; provided, that the number of shares reserved for issuance under the Lam 1997 Stock Plan will in no event exceed fifteen million shares. During fiscal year 2006, there were no additional amounts reserved for issuance. Includes 3,313,227 shares available for future issuance under the 1999 Employee Stock Purchase Plan (“1999 ESPP”). This number does not include shares that may be added to the 1999 ESPP share reserve in the future in accordance with the terms of the 1999 ESPP, as amended. Includes shares issuable under the Company’s 1999 Stock Option Plan (the “1999 Option Plan”). The 1999 Option Plan reserves for issuance up to 27,500,000 shares of the Company’s Common Stock. The 1999 Option Plan was adopted by the Board as of November 5, 1998 (the “Effective Date”) and amended and restated as of October 16, 2002 and November 7, 2002. All directors, officers and employees of Lam and its designated subsidiaries, as well as consultants, advisors or independent contractors who provide valuable services to the Company or such subsidiaries, are eligible to participate in the 1999 Option Plan. Nonstatutory stock options, deferred stock, restricted stock, performance shares, and restricted stock unit awards (collectively, the “Awards”) may be granted under the plan. Stock options granted under the 1999 Option Plan must have an exercise price that is not less than the fair market value of the Company’s Common Stock on the date of the grant. The Administrator shall determine the participants to whom Awards shall be granted and the terms of such Awards. The 1999 Option Plan terminates ten years from the Effective Date. 29 In the event of a corporate transaction such as a change of control, the 1999 Option Plan provides that each outstanding Award shall be assumed, or an equivalent Award substituted, by the successor corporation or a parent or subsidiary of the successor corporation. In the event that the successor corporation does not agree to assume the Award or substitute an equivalent Award, subject to limitations that may be placed on an Award on the date of grant, outstanding Awards shall accelerate and become fully exercisable. 30 PROPOSAL NO. 2 APPROVAL OF AMENDMENT OF THE LAM 2004 EXECUTIVE INCENTIVE PLAN On August 14 and 15, 2006, the Compensation Committee and the Board of Directors, respectively, adopted, subject to stockholder approval, an amendment (the “Amendment”) to the Lam 2004 Executive Incentive Plan, as amended (the “Executive Incentive Plan”). The Amendment increases the limit on the aggregate amount of cash awards paid under the Executive Incentive Plan to any one participant in respect of specified performance goals for any twelve-month measurement period from $2,000,000 to $12,000,000 (such limit subject to proportionate adjustment in the event of a performance period that is shorter or longer than one year). The amended Executive Incentive Plan, attached to this Proxy Statement as Appendix B, is proposed to be effective for measurement periods beginning on or after November 3, 2006, and ending on or prior to November 2, 2010, and specifically as applied to cash awards, shall be effective for awards accrued for financial statement purposes for measurement periods beginning on or after November 3, 2006. The Executive Incentive Plan provides for a non-exclusive performance-based incentive compensation structure under which performance bonuses may become payable to selected members of Lam’s senior management upon the Company’s achievement of specified corporate, financial or other business goals. The Compensation Committee and the Board believe it is in the best interests of Lam and its stockholders for the Company to have a stockholder-approved bonus plan such as the Executive Incentive Plan that allows Lam both to provide members of senior management with a strong incentive to meet or exceed specified financial and business goals and to be able to fully deduct for U.S. federal corporate income tax purposes amounts paid under such plan in connection with providing these incentives. Specifically, Lam seeks stockholder approval of the Amendment to fulfill one of the requirements to qualify amounts paid under the plan for a corporate income tax deduction under Code Section 162(m), which statute could otherwise limit the amount Lam may deduct with respect to compensation paid to certain executive officers. To the extent the stockholders do not approve the Amendment, the Executive Incentive Plan will remain unchanged from the plan terms approved by the stockholders in November 2005 and the operative limit on the amount of cash awards that may be paid under the plan in a given year will continue to be $2 million. BACKGROUND General Information about the Executive Incentive Plan. The Executive Incentive Plan was initially adopted by Lam’s stockholders in November 2003 and became effective for periods beginning on or after December 29, 2003. The Executive Incentive Plan was amended by Lam’s stockholders in November 2005 to (i) allow the Company to issue performance-based stock awards in addition to cash payments, (ii) provide that the independent members of the Board shall be entitled to review and approve the Compensation Committee’s determinations of awards to be paid to Lam’s Chief Executive Officer and Executive Chairman, (iii) provide the Compensation Committee discretion to designate members of senior management eligible to participate in the Executive Incentive Plan, and (iv) to revise the business criteria that the Compensation Committee can select from in establishing the business goals that must be achieved for a participant to earn an award under the Executive Incentive Plan. Lam currently operates two incentive compensation programs under its Executive Incentive Plan. The first such program (the “Annual Incentive Program”) is described above under the “Compensation Components/Annual Incentive” of the Compensation Committee Report, and the second program (the “Multi-Year Incentive Program” or “MYIP”) is described above in the section of this Proxy Statement entitled “Executive Compensation And Other Information/Multi-Year Performance-Based Cash Incentive Program.” Amounts that might be paid under the Executive Incentive Plan in years following an approval of the Amendment submitted in this Proposal No. 2 under the Annual Incentive Program, the MYIP or any other program established by Lam hereafter are not determinable at this time and will depend on 31 Compensation Committee actions and the Company’s achievement of performance goals as of various future dates. Additional information about the amount of awards made under the Annual Incentive Program and the MYIP are set forth at the end of this Proposal. Description of the Amendment. The Amendment increases the amount of cash awards that may be paid to any one participant in respect of achievement of specified performance goals for any twelve-month measurement period to $12,000,000 (the “Amended Cash Limit”). Currently, the Executive Incentive Plan allows for cash awards to be paid to any one participant in a calendar year under the Executive Incentive Plan not in excess of $2,000,000 (the “Existing Cash Limit”). Under the terms of the Amendment, the Amended Cash Limit would be increased or decreased proportionately if the Compensation Committee establishes a measurement period that is shorter or longer than one year, so that, for example, if the Compensation Committee established a two-year measurement period, the limitation applicable to the two-year period would be $24 million, or if it established a six-month measurement period, the limitation would be $6 million. To the extent that Lam operates more than one compensation program at a time under the Executive Incentive Plan, as it currently does with respect to a portion of each of the Annual Incentive Program and the MYIP, the aggregate amount payable to any individual with respect to a given twelve-month period under all such programs operated under the Executive Incentive Plan must not exceed the Amended Cash Limit (again, with proportionate adjustments made for performance periods that are longer or shorter than one year). In addition, to the extent a participant elects under the Lam Elective Deferred Compensation Plan to defer receipt of any portion of an award made under the Executive Incentive Plan, or to the extent the structure of an award requires payment of an amount earned with respect to a given measurement period after the end of the measurement period, then such later payment will not affect the application to such participant of the plan’s annual limit set forth above. Measurement periods used under the Executive Incentive Plan, if this Proposal is approved, may commence on or after November 3, 2006 and must end on or prior to November 2, 2010. The actual amendment proposed to be made to the Executive Incentive Plan restates the second sentence of the second paragraph of Section 7 of the Executive Incentive Plan to read as follows: “Cash awards paid to any one participant under the Plan in respect of performance goals for any twelve-month measurement period shall not exceed $12,000,000; provided however that (a) in the event a measurement period of longer or shorter duration than twelve-months, this limit will be increased or decreased, respectively, on a proportionate basis; (b) receipt by a participant of payment until a later period of an award amount earned with respect to a measurement period, either through elective deferral by the participant or a deferral included as part of the award structure, shall not affect application of the above cash limit to the participant during the later period; and (c) measurement periods used under the Plan may commence on or after November 3, 2006 and must end on or prior to November 2, 2010.” Increasing the Executive Incentive Plan’s Existing Cash Limit is intended to support and help achieve the compensation policies set by the Compensation Committee by increasing the amount of performance- based cash bonuses that Lam may pay on a fully-deductible basis under federal corporate income tax law. As a result of recent and ongoing changes to the technical rules and market practices affecting executive compensation, the Compensation Committee has determined that it is appropriate for Lam to have flexibility in making compensation awards to its senior management and desires to have the ability to make either equity or cash awards, or a combination thereof, in a manner that it believes will provide the best incentives to Lam’s executive officers to manage the Company and its business in a way that maximizes long-term stockholder value. The Compensation Committee believes that the amount of cash that can be awarded as long-term, performance-based incentives on a deductible basis under applicable tax law should approximately equal the value of long-term equity awards, such as options and restricted stock or restricted stock unit awards, that Lam might otherwise grant to its officers during any period in which it chooses to implement a cash-based compensation structure, and that the current annual cash limit of $2 million is not adequate for this purpose. By increasing the amount payable under the Executive Incentive Plan, the Compensation Committee is not seeking to change its compensation policy or to pre-determine the amount of compensation it may pay 32 in future periods, but rather to increase the tools at its disposal to implement that policy. The “Report of the Compensation Committee” contained elsewhere in this Proxy Statement provides further information regarding Lam’s compensation policies and practices. The above restatement of the Existing Cash Limit is the only change that the proposed amendment makes to the Executive Incentive Plan. Code Section 162(m). In general, Code Section 162(m) may limit the amount of compensation paid in a given year by a public company such as Lam to its named executive officers that the company may deduct for federal income tax purposes. Specifically, Section 162(m) provides that compensation paid to each such person in excess of $1 million in a taxable year is not generally deductible unless such compensation qualifies as “performance-based” under Section 162(m), in which case the amount so qualifying does not count against the $1 million limitation. One of the requirements of “performance-based” compensation under these tax rules is that the material terms of the performance goal(s) under which the compensation may be paid must be disclosed to and approved by the company’s stockholders. For purposes of Section 162(m), the material plan terms include the employees eligible to receive the compensation, a description of the performance goals upon achievement of which the compensation may be paid, and the maximum amount of compensation that can be paid to an employee under the plan if the performance goal is achieved. The Amendment affects only the maximum amount of compensation that can be paid with respect to a year to an employee if the performance goal(s) are achieved under the Executive Incentive Plan and, although other aspects of the Executive Incentive Plan are discussed below, stockholder approval of the Amendment will be deemed to constitute approval only of the increase in the annual cash limit from the Existing Cash Limit to the Amended Cash Limit. Stockholder approval of the Executive Incentive Plan is only one of several requirements under Section 162(m) that must be satisfied for amounts payable under the plan to qualify for the “performance-based” compensation exception under the rule and submission of the Amendment to stockholder approval cannot be a guarantee that all amounts paid under the Executive Incentive Plan will in fact be deductible by Lam or that Lam will utilize the Executive Incentive Plan for compensation paid. DESCRIPTION OF THE 2004 EXECUTIVE INCENTIVE PLAN The following is a summary of certain important features of the amended Executive Incentive Plan, which is qualified in its entirety by reference to the full text of the Executive Incentive Plan, as proposed to be amended by this Proposal No. 2, which is attached to this Proxy Statement as Appendix B. Administration. The Compensation Committee administers the Executive Incentive Plan. The Compensation Committee is composed of at least two “outside directors” as defined under Section 162(m) and, therefore, is intended to be a qualifying compensation committee as required under the Section 162(m) rules. For each incentive compensation measurement period, the Compensation Committee selects the participants from among the senior management of the Company. The Compensation Committee also determines the business criteria, performance goals, and incentive compensation formula (generally including a target incentive compensation amount for each participant) that will be used to determine the incentive amount, if any, earned by each participant for the incentive compensation measurement period. The Compensation Committee makes these determinations no later than 90 days after the beginning of the incentive compensation measurement period, but in any case on or before 25% of the measurement period has elapsed and while the performance outcome is substantially uncertain. The Compensation Committee also determines the incentive compensation amount to be paid to each participant based on the attainment of the previously established performance goals, with the Compensation Committee having the ability to decrease (but never increase) the amount actually to be paid upon achievement of such goals. The Executive Incentive Plan provides that the Compensation Committee’s determinations are final and binding on all participants; provided that with respect to Lam’s Chief Executive Officer and Executive Chairman, the independent members of the Company’s Board shall be entitled (but are not required) to review and approve the Compensation Committee’s determinations. 33 Eligibility. All senior management of the Company are eligible to be selected for participation. For purposes of the Executive Incentive Plan, senior management are currently defined as all officers who are subject to Section 16(a) of the Exchange Act and any other officer designated as eligible by the Compensation Committee. Although other officers are eligible to be granted awards under the Executive Incentive Plan, the Company expects to use the Executive Incentive Plan primarily for its Section 16 officers. At the end of fiscal year 2006, six officers of the Company were subject to Section 16(a). Maximum Potential Incentive Compensation Awards. The Amendment provides for an increase in the $2 million Existing Cash Limit to the $12,000,000 Amended Cash Limit (subject to proportionate adjustment as described above in the event of performance periods that are shorter or longer than one year). The Executive Incentive Plan also sets 300,000 shares (the “Share Limit”) of common stock or restricted stock units as the maximum number of shares that may be issued to any participant in any calendar year under the plan. The Share Limit, which is subject to adjustment in the event of a stock dividend, stock split, extraordinary cash dividend or similar recapitalization of the Company, is not affected by the Amendment. In addition, the Share Limit is separate from the limit imposed under the Executive Incentive Plans to cash awards, and the cash-based limit and the share-based limit do not restrict each other. In other words, if Lam were to make a performance-based share award under the Executive Incentive Plan, it could also award 300,000 shares to a participant in the relevant calendar year. Similarly, a performance-based share award made to a participant in a given year would not reduce below the applicable cash limit the amount of performance-based cash awards that could be made under the plan to the participant in that year. Term of Executive Incentive Plan. Lam may grant compensation intended to qualify for the Section 162(m) exception for performance-based compensation under the Executive Incentive Plan, as amended by the Amendment, for measurement periods that begin on or after November 3, 2006, and that end on or prior to November 2, 2010. Thereafter, for amounts paid under the Executive Incentive Plan to continue to be eligible to qualify as performance-based compensation, Lam would be required to obtain stockholder approval of certain of the terms of the Executive Incentive Plan. BUSINESS CRITERIA ON WHICH PERFORMANCE GOALS MAY BE BASED Incentive compensation amounts or grants earned under the Executive Incentive Plan are determined based on the Company’s achievement, over the incentive compensation measurement period, of established business goals that are long-term determinants of stockholder value. In establishing incentive compensation terms under the Executive Incentive Plan for any given incentive compensation measurement period, the Compensation Committee may select only from business criteria specified in the Executive Incentive Plan that have been approved by the stockholders. Based upon the approval given by the stockholders at the annual stockholders meeting in November 2005, the Compensation Committee is empowered under the Executive Incentive Plan to select from the following list of business criteria: • • • • • Return on equity: total capital, assets, or invested capital. Stockholder return, actual or relative to an appropriate index (including share price, market capitalization, or market share). Actual or growth of revenue, orders, operating income, or net income (with or without regard to amortization/impairment of goodwill). Free cash flow generation. Operational performance, including assets turns, revenue per employee, days sales outstanding, and inventory turns. 34 • Individually designed goals and objectives that are consistent with the participant’s specific duties and responsibilities and that are designed to improve the financial performance of the Company or a specific division or affiliate. The goals and objectives shall also be derived from and consistent with the operating plan of the Company, division, or affiliate for the particular year to which the participant’s performance is measured. ADDITIONAL TERMS AND CONDITIONS OF THE EXECUTIVE INCENTIVE PLAN Requirement of Continued Employment. In general, an eligible employee must be continuously employed by the Company for the entire incentive compensation measurement period to be a participant. However, unless the Committee determines in its sole discretion that payment is not appropriate, if the employment of a participant ends by reason of the death, disability, or termination of employment, the participant shall be paid a pro rata portion of the incentive compensation award, if any (as determined in the discretion of the Compensation Committee), that otherwise would have been payable under the Executive Incentive Plan. In addition, the Compensation Committee may include an eligible employee hired after the commencement of an incentive compensation measurement period for the remaining portion of the incentive compensation measurement period. Impact of Certain Acquisitions. Unless otherwise specified by the Compensation Committee in its establishment of incentive compensation criteria for a given incentive compensation measurement period, if the Company or its affiliates consummate one or more acquisitions that, individually or in the aggregate, constitute a “triggering acquisition” (“Triggering Acquisition”), the incentive compensation measurement period will be terminated early and pro-rated incentive compensation awards will be paid or granted based on the degree of attainment of the performance goals during the shortened incentive compensation measurement period. A Triggering Acquisition is an acquisition in which the acquired entity’s operating earnings for the four calendar quarters before the acquisition is equal to 10% or more of the pro-forma operating earnings for the combined entities for the same period. Incentive Compensation Adjustments. The Compensation Committee may adjust actual incentive compensation awards for a participant under the Executive Incentive Plan to the extent that doing so will not cause any part of that participant’s incentive compensation to become nondeductible to the Company. In no event will the Compensation Committee use its discretion to increase the amount of bonus that may be paid to a participant upon achievement of the applicable performance goals. Amendment and Termination. The Compensation Committee may amend or terminate the Executive Incentive Plan on a prospective basis at any time. The Compensation Committee may not, however, amend or terminate the Executive Incentive Plan so as to increase, reduce, or eliminate incentive compensation payable under the Executive Incentive Plan retroactively. The Compensation Committee also does not have the power to amend the Executive Incentive Plan in any fashion that would cause the Executive Incentive Plan to fail to qualify as performance-based compensation with respect to any “covered employee” under Section 162(m) of the Code. STOCK AWARDS GRANTED PURSUANT TO THE EXECUTIVE INCENTIVE PLAN Lam may grant stock awards under the Executive Incentive Plan from and in such forms permitted under the Company’s (i) 1997 Stock Incentive Plan (the “1997 Plan”), (ii) 1999 Stock Option Plan (the “1999 Plan”), and (iii) any stock option or equity incentive plan adopted by the Company’s Board of Directors and approved by its stockholders in the future, including the 2007 Stock Plan, if adopted by the Lam stockholders (see “Proposal No. 3 - Approval of the Lam 2007 Stock Incentive Plan” below). Currently, an aggregate of 6,090,013 shares of our common stock is reserved and to be issued under the 1997 Plan and the 1999 Plan (the “Prior Plans”). As of September 15, 2006, 9,903,354 shares of common stock remain available for future issuance under the Prior Plans. If the 2007 Stock Plan is approved by the stockholders, 15,000,000 shares of common stock will be reserved for future issuance under the 2007 Stock Plan, Lam will no longer grant stock awards under the Executive Incentive Plan from the available shares under the Prior Plans and any 35 issuance of stock awards in connection with an Executive Incentive Plan award will be issued from the 2007 Stock Plan. If the stockholders do not approve the 2007 Stock Plan, then any issuance of stock awards in connection with an Executive Incentive Plan award will be issued from the Prior Plans. As described above, the Executive Incentive Plan provides a Share Limit of 300,000 shares of common stock or restricted stock units that may be issued to any participant in any calendar year under the plan, which limit is not affected by the Amendment. A summary of the terms of the 2007 Stock Plan is provided below in “Proposal No. 3 - Approval of the Lam 2007 Stock Incentive Plan” in this Proxy Statement, and a copy of the 2007 Stock Plan is attached hereto as Appendix C. Stock awards granted under the 2007 Stock Plan, including stock options and stock appreciation rights, may also separately qualify as performance-based compensation under Section 162(m) and will not be considered as granted under the Executive Incentive Plan or aggregated with the Share Limit. As such, separate and additional Section 162(m) limits on the number of shares granted under the 2007 Stock Plan apply to awards granted thereunder, which limits are further described in Proposal No. 3. Copies of the 1997 Plan and the 1999 Plan are attached as exhibits to Lam’s current report filed on Form 8-K dated June 26, 2005 and Lam’s registration statement on Form S-8 filed with the SEC on August 28, 2005, respectively, available on the web site of the SEC at www.sec.gov. To date, Lam has not granted any performance-based awards under the Executive Incentive Plan that it intends to satisfy with stock awards. NON-EXCLUSIVITY Nothing contained in the Executive Incentive Plan prevents the Board from adopting other or additional compensation arrangements that provide for bonuses or other forms of compensation for Lam’s executive officers, directors or other employees regardless of stockholder approval of the Executive Incentive Plan. Such other arrangements may or may not qualify for deductibility under Section 162(m) of the Code and may be either applicable only for specific executives, directors or employees or may be generally applicable. However, for payments under the Executive Incentive Plan to qualify as performance-based compensation under Section 162(m), any such other or additional compensation arrangements may not be designed to provide Executive Incentive Plan participants all or part of the compensation they would receive under the Executive Incentive Plan regardless of whether the applicable performance goal is attained. FEDERAL INCOME TAX CONSIDERATIONS All amounts paid pursuant to the Executive Incentive Plan constitute taxable income to the employee when received. If an employee elects to defer a portion of an Executive Incentive Plan bonus, he or she may be entitled to defer receipt of the bonus payment and the recognition of income to a later year. Generally, and subject to Section 162(m), Lam will be entitled to a federal income tax deduction when amounts paid under the Executive Incentive Plan are included in employee income. Subject to stockholder approval of the Amendment, the failure of any aspect of the Executive Incentive Plan to satisfy Section 162(m) will not void any action taken by the Compensation Committee under the plan. As discussed more fully above, stockholder approval of the Executive Incentive Plan is only one of several requirements under Section 162(m) that must be satisfied for amounts payable under the plan to qualify for the “performance-based” compensation exception and Lam cannot be a guarantee that in practice it will be able to deduct all amounts paid under the Executive Incentive Plan. The foregoing is only a brief summary of the federal income tax consequences for participants and Lam with respect to operation of the Executive Incentive Plan. It does not purport to be complete and does not discuss the tax consequences arising in connection with a participant’s death or under any tax law other than U.S. federal income tax law. 36 2004 Executive Incentive Plan Benefits Applicable proxy rules require disclosure of the amounts of compensation under the amended Executive Incentive Plan to be paid in fiscal year 2007 or, if such amounts are not determinable, the amounts that would have been paid in fiscal year 2006 had the amended Executive Incentive Plan been in effect in fiscal year 2006. The Executive Incentive Plan provides for a range of business criteria upon which performance objectives can be based, and the mix of factors used in establishing incentive compensation goals for senior management, both individually and collectively, may be changed from time to time. Therefore, neither the amount that will be paid in fiscal year 2007 nor the amount that would have been paid in 2006 had the plan been operated during that year as proposed to be amended can be determined at this time. We provide the following information about awards under the Annual Incentive Program and the MYIP because they are the two programs Lam currently operates, in part, under the Executive Incentive Plan. The following table shows the amounts of incentive awards made under the Company’s Annual Incentive Program during fiscal year 2006. Of the amounts listed below, only the amounts paid to Messrs. Bagley and Newberry were paid under the current Executive Incentive Plan. However, in conjunction with the establishment of the Company’s multi-year performance-based cash incentive program (MYIP) with respect to calendar year 2006, the Company expects that Annual Incentive Program awards payable to executive officers would also be paid under the Executive Incentive Plan as it is proposed to be amended. Accordingly, all Annual Incentive Program awards paid to the Company’s named executive officers during fiscal year 2006 are set forth below. Name and Position Dollar Value James W. Bagley, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 843,700 Executive Chairman Stephen G. Newberry, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 944,568 Chief Executive Officer & President Martin B. Anstice, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 350,437 Chief Financial Officer and Group Vice President Nicolas J. Bright, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 494,236 Executive Vice President, Regional Business & Global Products Ernest E. Maddock, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 362,135 Group Vice President, Global Operations Executive Group (1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,215,676 Non-Executive Director Group . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-Executive Officer Employee Group . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2) (3) In addition, the maximum amount that may be paid to any one individual with respect to the 2006 MYIP is $8.125 million. (1) Performance-based incentive compensation may also be awarded to executive officers outside of the Executive Incentive Plan; such compensation was paid to executive officers other than Messrs. Bagley and Newberry in fiscal year 2006. See the “Executive Compensation and Other Information” section, above. (2) Non-executive directors are not eligible to participate in the Executive Incentive Plan. (3) Annual Incentive Program payments were not made during fiscal 2006 under the Executive Incentive Plan to persons who are not current executive officers. 37 Approval of Proposal No. 2 will require the affirmative vote of a majority of the outstanding shares of Common Stock present or represented and voting on such Proposal at the Annual Meeting. Unless marked otherwise, proxies received will be voted “FOR” the approval of the proposed amendment of the 2004 Executive Incentive Plan. THE BOARD OF DIRECTORS OF THE COMPANY RECOMMENDS A VOTE “FOR” THE APPROVAL OF THE AMENDMENT OF THE LAM 2004 EXECUTIVE INCENTIVE PLAN. 38 PROPOSAL NO. 3 APPROVAL OF THE LAM 2007 STOCK INCENTIVE PLAN On August 15, 2006, the Board approved the Lam 2007 Stock Incentive Plan (the “2007 Stock Plan”) under which 15,000,000 shares of common stock will be reserved for issuance (approximately 10.6% of the outstanding shares as of September 15, 2006). The Board adopted the 2007 Stock Plan because its current stockholder-approved equity plan, the 1997 Stock Incentive Plan, will expire in August 2007, and the Board believes Lam should continue to have a stockholder-approved equity compensation plan in order to make equity compensation awards to attract and retain employees, executive officers, directors and other service providers. The 2007 Stock Plan will not become effective unless and until it is approved by Lam’s stockholders. If the stockholders approve the 2007 Stock Plan, this approval is intended to satisfy the stockholder approval requirements under Section 162(m) of the Internal Revenue Code, as amended, (the “Code”), so as to permit Lam to deduct under federal income tax law certain amounts paid under the plan to executive officers that might otherwise not be deductible, and to permit Lam to grant “incentive stock options” eligible for special tax treatment under Code Section 422. If the 2007 Stock Plan is approved by the stockholders, the Company will cease granting awards under its 1999 Stock Option Plan and 1997 Stock Incentive Plan (collectively the “Prior Plans”). If the 2007 Stock Plan is not approved by the stockholders, the Prior Plans will continue in operation pursuant to their terms. See the section “Securities Authorized for Issuance Under Equity Incentive Plan” for more information about the Prior Plans. The material terms of the 2007 Stock Plan include the following: • the types of awards that may be granted are stock options (including incentive stock options and nonstatutory stock options), restricted stock, restricted stock units, deferred stock, stock appreciation rights (SAR’s), performance shares, phantom stock and other similar types of awards; • • • • • • the maximum number of shares of common stock that will be available for issuance under the 2007 Stock Plan is 15,000,000 shares; shares subject to awards that are canceled, forfeited, repurchased or otherwise expire (including with respect to any shares that have been issued under an award) will be available for re-grant or re-issuance under the 2007 Stock Plan; if an awardee pays the exercise or purchase price of an award through the withholding or tendering of shares or if award shares are withheld or tendered to satisfy applicable withholding obligations, the number of shares tendered or withheld shall become available for re-grant or re-issuance under the 2007 Stock Plan; the exercise or purchase price of an option or stock award (including the grant date fair market value that applies to a stock appreciation right) may not be reduced without stockholder approval (other than in connection with certain changes in Lam's capitalization such as stock splits, as further described below); no employee may be granted, in any fiscal year under the 2007 Stock Plan, options or SARs covering more than 1,000,000 shares, except that, in connection with his or her initial employment with Lam, an employee may be granted options or SARs covering up to an additional 1,000,000 shares; no employee may be granted stock awards, such as restricted stock, deferred stock, restricted stock units, performance shares, phantom stock or similar types of stock awards, in any fiscal year under the 2007 Stock Plan covering more than 300,000 shares; 39 • • • • in the event of any stock split, reverse stock split, recapitalization, combination or reclassification of stock, stock dividend, spin-off, extraordinary cash dividend or similar change to the capital structure of the Company (not including a change of control), the Board or committee shall make appropriate adjustments to preserve the proportionate value of awards or the 2007 Stock Plan to (1) the number and type of shares that may be granted subject to awards granted under the 2007 Stock Plan, (2) the number and type of shares that may be granted to any employee under the 2007 Stock Plan, (3) the terms of any stock appreciation right, (4) the purchase price or repurchase price of any stock award, (5) the exercise price and number and class of securities issuable under each outstanding option, and (6) the repurchase price of any securities substituted for award shares that are subject to repurchase rights; stockholder approval is required for certain types of amendments to the 2007 Stock Plan; the 2007 Stock Plan permits the grant of awards intended to qualify as “performance-based compensation” under Code Section 162(m), and awards may be granted under the 2007 Stock Plan to satisfy Lam’s obligations under performance-based awards it makes under its 2004 EIP (see Proposal No.2 - Approval of Amendment to Lam 2004 Executive Incentive Plan); and the 2007 Stock Plan will terminate in 2017 unless it is extended or terminated earlier pursuant to its terms. SUMMARY OF THE 2007 STOCK PLAN General. The purpose of the 2007 Stock Plan is to enhance the long-term stockholder value of Lam by offering opportunities to eligible individuals to participate in the growth in value of the equity of the Company. Stock options, stock appreciation rights and stock awards, including restricted stock, deferred stock, restricted stock units, performance shares, phantom stock and similar types of awards, may be granted under the 2007 Stock Plan. Options granted under the 2007 Stock Plan may be either “incentive stock options,” as defined in Section 422 of the Code, or non-statutory stock options. Administration. The 2007 Stock Plan may be administered by the Board, a committee of the Board, or an employee of the Company or an affiliate delegated by the Board or the Board committee in accordance with the terms of the 2007 Stock Plan (as applicable, the “Administrator”). Eligibility. Awards may be granted under the 2007 Stock Plan to employees, including officers, directors and consultants of Lam and its affiliates. Incentive stock options may be granted only to employees of Lam or its affiliates. There are approximately 3,000 employees and consultants and nine non-employee directors eligible to receive awards under the 2007 Stock Plan. The Board or committee, in its discretion, selects the employees, directors and consultants to whom awards may be granted, the time or times at which such awards are granted, and the terms of such awards. Section 162(m) Limitations. Section 162(m) of the Code generally disallows a tax deduction to a public company for compensation in excess of $1 million paid in a year to the company’s Chief Executive Officer or any of the four other most highly compensated officers. Stock options and other awards pursuant to which the recipient’s compensation is based solely on the appreciation of the value of the underlying shares from the date of grant until the date of the income recognition event may qualify as performance-based compensation if the company satisfies certain requirements in connection with the plan under which the awards are granted. Among other requirements, the plan must be stockholder-approved and must contain a limit on the number of shares that may be granted to any one individual under the plan during a specified period. Accordingly, the 2007 Stock Plan provides that no employee may be granted options or stock appreciation rights covering more than 1,000,000 shares in any fiscal year, except that an employee may be granted options or stock appreciation rights covering up to an additional 1,000,000 shares in connection with his or her initial employment with Lam. In addition, no employee may be granted stock awards (other than options or stock appreciation rights) in any fiscal year under the 2007 Stock Plan covering more than 300,000 shares. The 2004 Executive Incentive Plan authorizes the use of stock awards to satisfy the Company’s obligations 40 under that plan and imposes a limit of 300,000 shares that may be granted under such an arrangement to an employee in any calendar year. As the shares to fund stock award grants under the 2004 Executive Incentive Plan will come from the 2007 Stock Plan, if it is adopted, the 300,000 share limit in each plan will operate in a given calendar year in a cumulative manner with each other. The 1,000,000 and 2,000,000 share limit applicable to options and stock appreciation rights in the 2007 Stock Plan described above will not operate in a cumulative manner with the 300,000 share stock award limit in either the 2007 Stock Plan or the 2004 Executive Incentive Plan. Additional requirements apply to certain forms of compensation, such as stock awards, in order for them to qualify as performance-based compensation, including a requirement that payment of the value of the awards be contingent upon achievement of performance goals that are established in a manner specified under Section 162(m) of the Code. The 2007 Stock Plan permits Lam to issue awards incorporating performance objectives called “objectively determinable performance conditions.” (See “Objectively Determinable Performance Conditions” below.) Stockholder approval of this proposal will constitute stockholder approval of the share limitations as well as of the objectively determinable performance conditions for Section 162(m) purposes. Although the Company seeks stockholder approval of the 2007 Stock Plan in a manner that will allow awards granted thereunder to qualify as performance-based compensation under Section 162(m), it does not guarantee that awards granted hereunder will so qualify and the Company from time to time may choose to grant awards that cannot so qualify. Terms and Conditions of Options. Each option is evidenced by a stock option agreement between Lam and the optionee and is subject to the following additional terms and conditions. Exercise Price. The Board or committee determines the exercise price of options at the time the options are granted. The exercise price of an incentive stock option or a nonstatutory stock option may not be less than 100% of the fair market value of the common stock on the date the option is granted; provided that the exercise price of an incentive stock option granted to an employee who holds more than 10% of the voting stock of Lam may not be less than 110% of the fair market value of the common stock on the date the option is granted. However, Lam may grant options with exercise prices equal to less than the fair market value of our common stock on the date of grant in connection with an acquisition by Lam of another company. The fair market value of our common stock is the closing price for the shares as quoted on the Nasdaq Global Select Market as of the applicable date. As of September 15, 2006, the closing price of our common stock was $41.57 per share. No option may be repriced to reduce the exercise price of such option without stockholder approval (except in connection with a change in Lam’s capitalization—see “Adjustments upon Changes in Capitalization, Change of Control or Dissolution” below). Exercise of Option; Form of Consideration. The Board or committee determines when options vest and become exercisable and in its discretion may accelerate the vesting of any outstanding option. With limited exceptions, Lam’s standard vesting schedule applicable to options granted to employees has been quarterly or annual vesting over vesting periods from one year to four years. The means of payment for shares issued upon exercise of an option are specified in each option agreement. The 2007 Stock Plan permits payment to be made by cash, check, wire transfer, other shares of common stock of Lam (with some restrictions), broker assisted same-day sales, cancellation of debt, in certain circumstances a delivery of stock for any net appreciation in the shares at the time of exercise over the exercise price, any other form of consideration permitted by applicable law and the Administrator, or any combination thereof. Term of Option. The term of an option may be no more than ten years from the date of grant; provided that the term of an incentive stock option granted to a stockholder who holds more than 10% of the voting stock of Lam may be no more than five years from the date of grant. No option may be exercised after the expiration of its term. Termination of Employment. If an optionee’s employment terminates for any reason other than cause, death or disability, then options held by the optionee under the 2007 Stock Plan generally will be exercisable to the extent they are vested on the termination date for a period of 90 days (or such other period set by the 41 Administrator) after the termination but not after the expiration date. If an optionee’s employment terminates for cause, then all options held by the optionee under the 2007 Stock Plan terminate immediately upon the optionee’s termination. The Administrator has the authority to extend the period of time for which an award is to remain exercisable following an awardee’s termination (taking into account limitations and consequences under the Code) but not beyond the expiration of the term of the award and to permit an award to be exercised with respect to unvested shares at the time of awardee’s termination. Leave of Absence, Death, or Disability. An award may not be exercised more than three months after the beginning of a leave of absence, other than a personal or medical leave approved by an authorized representative of Lam with employment guaranteed upon return. Generally, if an optionee’s employment terminates as a result of the optionee’s death or disability, then all options to the extent they are vested and exercisable on the termination date may be exercised for one year (or such other period set by the Administrator) following the termination date but in no event after the expiration date. Terms and Conditions of Stock Appreciation Rights. Stock appreciation rights are rights to receive cash and/or shares of our common stock based on the amount by which the exercise date fair market value of a specific number of shares exceeds the grant date fair market value of the exercised portion of the stock appreciation right. The specific terms and conditions applicable to a stock appreciation right will be provided in an award agreement. The grant or vesting of a stock appreciation right may, but need not, be made contingent on the achievement of objectively determinable performance conditions. Terms and Conditions of Stock Awards. Stock awards may be restricted stock grants, restricted stock units, deferred stock, stock appreciation rights, performance shares or other similar stock awards (including awards that do not require the awardee to pay any amount in connection with receiving the shares or that have an exercise or purchase price that is less than the grant date fair market value of our stock). Restricted stock grants are awards of a specific number of shares of our stock. Restricted stock units represent a promise to deliver shares of our common stock, or an amount of cash or property equal to the value of the underlying shares, at a future date. Deferred stock is a grant of shares of our common stock that are distributed in the future upon satisfaction of certain conditions. Performance shares are rights to receive amounts, denominated in cash or shares of our common stock, based upon Lam’s or an awardee’s performance during the period between the date of grant and a pre-established future date. Each stock award agreement will contain provisions regarding (1) the number of shares subject to the stock award, (2) the purchase price of the shares, if any, and the means of payment for the shares, (3) the performance criteria (including objectively determinable performance conditions), if any, and level of achievement versus these criteria that will determine the number of shares granted, issued, retainable and vested, as applicable, (4) such terms and conditions on the grant, issuance, vesting and forfeiture of the shares, as applicable, as may be determined from time to time by the Administrator, (5) restrictions on the assignability and transferability of the stock award or the shares, and (6) such further terms and conditions, in each case not inconsistent with the 2007 Stock Plan, as may be determined from time to time by the Administrator. Nontransferability. Generally, awards granted under the 2007 Stock Plan are not transferable other than by will or the laws of descent and distribution or to a designated beneficiary upon the awardee’s death. If so permitted by the Administrator, awards may be transferred and exercised in accordance with a domestic relations order or in any manner allowed under the Form S-8 rules. Objectively Determinable Performance Conditions. Objectively determinable performance criteria means any one of more of the performance criteria listed below, either individually, alternatively or in combination, applied to either Lam as a whole or to a business unit, affiliate or business segment, either individually, alternatively or in any combination, and measured either annually or cumulatively over a period of years, on an absolute basis or relative to a pre-established target, to previous years’ results or to a designated comparison group, in each case as specified by the committee in the award agreement. The performance criteria may include actual, growth, or performance-to-target for: 42 • • • • • • • • • • • • • • • cash flow, including free cash flow; earnings (including revenue, gross margin, operating profit, earnings before interest and taxes, earnings before taxes, and net earnings) or earnings per share; stock price; return on equity or average stockholders’ equity; total stockholder return, either actual or relative to share price or market capitalization; return on capital; return on assets or net assets; return on investment or invested capital; return on operating revenue; income, net income, operating income, net operating income, operating profit, net operating profit or operating margin (with or without regard to amortization/impairment of goodwill); market share or applications won; operational performance, including orders, backlog, deferred revenues, revenue per employee, overhead, days sales outstanding, inventory turns, or other expense levels; stockholder value or return relative to the moving average of the S&P 500 Index or peer group index; asset turns; and strategic plan development and implementation (including individually designed goals and objectives that are consistent with the participant’s specific duties and responsibilities and that are designed to improve the financial performance of the Company, an affiliate, or a specific business unit thereof and are consistent with and derived from the strategic operating plan of the Company, an affiliate, or any of their business units for the applicable performance period). The committee may adjust any evaluation of performance criteria to exclude any of the following events that occurs during a performance period: (A) asset write-downs; (B) litigation or claim judgments or settlements; (C) the effect of changes in the tax law, accounting principles or other such laws and provisions affecting reported results; (D) accruals for reorganization and restructuring programs; and (E) any extraordinary non-recurring items as described in Accounting Principles Board Opinion No. 30 and/or in management’s discussion and analysis of financial condition and results of operations appearing in the Company’s annual report to stockholders for the applicable year. Awards to Non-Employee Directors. The Administrator, or if applicable law requires Board action, the Board may grant awards to non-employee directors on such terms and conditions as it determines, including to provide for satisfaction of director fee or retainer payments through issuance of awards under the 2007 Stock Plan. Awards may be granted by establishing an annual or periodic grant program or by making individual awards from time to time. The Administrator can amend, suspend or terminate an annual or periodic grant program with respect to awards that have not yet been granted without obtaining approval of any non-employee directors who might otherwise have benefited from such awards or of the Company’s stockholders. 43 Deferral of Award Benefits. The Administrator may permit awardees whom it selects to (1) defer compensation payable pursuant to the terms of an award, or (2) defer compensation arising outside the terms of the 2007 Stock Plan pursuant to a program that provides for deferred payment in satisfaction of other compensation amounts through the issuance of one or more awards under the 2007 Stock Plan. Adjustments upon Changes in Capitalization, Change of Control or Dissolution. In the event of any stock split, reverse stock split, recapitalization, combination or reclassification of stock, stock dividend, spin-off, extraordinary cash dividend or similar change to the capital structure of the Company (not including a change of control), the Board or committee shall make appropriate adjustments to preserve the proportionate value of awards or the 2007 Stock Plan to (1) the number and type of shares that may be granted subject to awards granted under the 2007 Stock Plan, (2) the number and type of awards that may be granted to any employee under the 2007 Stock Plan, (3) the terms of any stock appreciation right, (4) the purchase price or repurchase price of any stock award, (5) the exercise price and number and class of securities issuable under each outstanding option, and (6) the repurchase price of any securities substituted for award shares that are subject to repurchase rights. In the event of a merger with or into another corporation, a sale of substantially all of our assets or a tender offer or a similar change of control transaction, all outstanding awards shall be subject to the definitive agreement governing the change of control transaction. The transaction agreement may provide, without limitation, for (1) the assumption, substitution or replacement with equivalent awards of outstanding plan awards by the surviving corporation or its parent, (2) continuation of outstanding awards by the Company if the Company is a surviving corporation, (3) accelerated vesting, or lapse of repurchase rights or forfeiture conditions applicable to, and accelerated expiration or termination of, the outstanding awards, or (4) settlement of outstanding awards (including termination thereof) in cash. In the event of a liquidation or dissolution, any options or stock awards that have not been exercised will terminate immediately prior to the transaction. The Administrator has the authority to accelerate vesting of outstanding awards under the 2007 Stock Plan at any time in its sole discretion. Amendment and Termination of the Plan. The Board may amend, suspend or terminate the 2007 Stock Plan at any time. However, the Company will obtain stockholder approval for any amendment to the 2007 Stock Plan if stockholder approval is necessary or desirable to comply with any applicable law, Nasdaq Global Select Market listing requirements or incentive stock option requirements. In addition, the Company will obtain stockholder approval of any of the following: (1) an increase to the shares reserved for issuance under the 2007 Stock Plan other than an increase in connection with a change in Lam’s capitalization as described in “Adjustments upon Changes in Capitalization, Change of Control or Dissolution” above; (2) an expansion of the class of persons eligible to receive awards under the 2007 Stock Plan; or (3) any amendment of outstanding options or stock appreciation rights that affects a repricing of such awards or other lowering of the original exercise price or grant date fair market value that applies to a stock appreciation right. The Board may also, but need not, require that the Company’s stockholders approve any other amendments to the 2007 Stock Plan. New Plan Benefits. Because benefits under the 2007 Stock Plan will depend on the Administrator’s actions and the fair market value of common stock at various future dates, it is not possible to determine the benefits that will be received by employees, officers, directors and consultants if the 2007 Stock Plan is approved by the stockholders. No awards have been granted or promised to be granted under the 2007 Stock Plan to any individual as of the date of this Proxy Statement. During fiscal 2006, the Company did not grant awards under the Prior Plans to its named executive officers. See the section entitled “Director Compensation” for information on equity incentive grants made to the Company’s non-employee directors during fiscal 2006. 44 FEDERAL INCOME TAX CONSEQUENCES THE FOLLOWING IS A GENERAL SUMMARY OF THE FEDERAL INCOME TAX CONSEQUENCES OF THE ISSUANCE AND EXERCISE OF OPTIONS OR OTHER AWARDS UNDER THE 2007 STOCK INCENTIVE PLAN. IT DOES NOT DESCRIBE STATE OR OTHER TAX CONSEQUENCES OF THE ISSUANCE AND EXERCISE OF OPTIONS OR OTHER AWARDS. Options. The grant of an incentive stock option has no federal income tax effect on the optionee. Upon exercise the optionee does not recognize income for “regular” tax purposes. However, the excess of the fair market value of the stock subject to an option over the exercise price of such option (the “option spread”) is includible in the optionee’s “alternative minimum taxable income” for purposes of the alternative minimum tax. If the optionee does not dispose of the stock acquired upon exercise of an incentive stock option until more than two years after the option grant date and more than one year after exercise of the option, any gain (or loss) upon sale of the shares will be a long-term capital gain (or loss). If shares are sold or otherwise disposed of before these periods have expired (a “disqualifying disposition”), the option spread at the time of exercise of the option (but not more than the amount of the gain on the sale or other disposition) is ordinary income in the year of such sale or other disposition. If gain on a disqualifying disposition exceeds the amount treated as ordinary income, the excess is taxable as capital gain (which will be long-term capital gain if the shares have been held more than one year after the date of exercise of the option). The Company is not entitled to a federal income tax deduction in connection with incentive stock options, except to the extent that the optionee has taxable ordinary income on a disqualifying disposition (unless limited by Section 162(m)). The grant of a non-statutory option having an exercise price equal to the grant date fair market value of our common stock has no federal income tax effect on the optionee. Upon the exercise of a non-statutory option, the optionee has taxable ordinary income (and unless limited by Section 162(m) the Company is entitled to a corresponding deduction) equal to the option spread on the date of exercise. Upon the disposition of stock acquired upon exercise of a non-statutory stock option, the optionee recognizes either long-term or short-term capital gain or loss, depending on how long such stock was held, on any difference between the sale price and the exercise price, to the extent not recognized as taxable income on the date of exercise. The Company may allow non-statutory stock options to be transferred subject to conditions and restrictions imposed by the Administrator; special tax rules may apply on such a transfer. In the case of both incentive stock options and non-statutory stock options, special federal income tax rules apply if Company common stock is used to pay all or part of the option price, and different rules than those described above will apply if unvested shares are purchased on exercise of the option. Stock Awards. Stock awards will generally be taxed in the same manner as non-statutory stock options. Shares issued under a restricted stock award are subject to a “substantial risk of forfeiture” within the meaning of Section 83 of the Code to the extent the shares will be forfeited in the event that the participant ceases to provide services to the Company and are not transferable. As a result of this substantial risk of forfeiture, the participant will not recognize ordinary income at the time the award shares are issued. Instead, the participant will recognize ordinary income on the dates when the stock is no longer subject to a substantial risk of forfeiture, or when the stock becomes transferable, if earlier. The participant’s ordinary income is measured as the difference between the amount paid for the stock, if any, and the fair market value of the stock on the date the stock is no longer subject to forfeiture. The participant may accelerate his or her recognition of ordinary income, if any, and begin his or her capital gains holding period by timely filing (i.e., within thirty days of the share issuance date) an election pursuant to Section 83(b) of the Code. In such event, the ordinary income recognized, if any, is measured as the difference between the amount paid for the stock, if any, and the fair market value of the stock on the date of such issuance, and the capital gain holding period commences on such date. The ordinary income recognized by an employee will be subject to tax withholding by the Company. The Company is entitled to a deduction in the same amount as and at the time the employee recognizes ordinary income. 45 The American Jobs Creation Act of 2004 added Section 409A to the Code, generally effective January 1, 2005. The IRS has issued proposed regulations which, in part, give employers until the end of 2006 to effect Section 409A implementation in almost all circumstances. Section 409A covers most programs that defer the receipt of compensation to a succeeding year. It provides rules for elections to defer, if any, and for timing of payouts. There are significant penalties placed on the individual participant for failure to comply with Section 409A. However, it does not impact Lam’s ability to deduct deferred compensation. Section 409A applies to restricted stock units and performance shares. Grants will continue to be taxed at vesting but will be subject to new limits on terms governing when vesting may occur. If grants do not allow employees to elect further deferral on vesting or on distribution, under the proposed regulations no negative impact should attach to the grants. However, further guidance from the IRS is expected and could change the way such grants must be governed. Section 409A does not apply to incentive stock options, nonstatutory stock options that have an exercise price that is at least equal to the grant date fair market value and restricted stock provided there is no deferral of income beyond the vesting date. Section 409A also does not cover stock appreciation rights if the exercise price is not less than the fair market value of the underlying stock on the date of grant, the rights are settled in such stock and no features defer the recognition of income beyond the exercise date. ACCOUNTING TREATMENT The Company will recognize compensation expense in connection with awards granted under the 2007 Stock Plan as required under applicable accounting standards, including under Statement of Financial Accounting Standards No. 123(R). The Company currently amortizes compensation expense associated with equity awards over an award’s requisite service period and establishes fair value of equity awards in accordance with applicable accounting standards. ____________________________ Incorporation by Reference The foregoing is only a summary of the 2007 Stock Plan and is qualified in its entirety by reference to its full text, a copy of which is attached hereto as Appendix C. Approval of Proposal No. 3 will require the affirmative vote of a majority of the outstanding shares of Common Stock present or represented and voting on such Proposal at the Annual Meeting. Unless marked otherwise, proxies received will be voted “FOR” the approval of the Lam 2007 Stock Incentive Plan. THE BOARD OF DIRECTORS OF THE COMPANY RECOMMENDS A VOTE “FOR” THE APPROVAL OF THE LAM 2007 STOCK INCENTIVE PLAN. 46 PROPOSAL NO. 4 RATIFICATION OF APPOINTMENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Unless marked otherwise, proxies received will be voted “FOR” the ratification of the appointment of Ernst & Young LLP as the independent registered public accounting firm for the Company for the current fiscal year. Ernst & Young LLP has been the Company’s independent registered public accounting firm (independent auditor) since fiscal year 1981. The audit services of Ernst & Young LLP during fiscal year 2006 included the examination of the consolidated financial statements and the system of internal control over financial reporting of the Company and services related to filings with the SEC and other regulatory bodies. The Audit Committee of the Company meets with Ernst & Young LLP on an annual or more frequent basis. At such time, the Audit Committee reviews both audit and non-audit services performed by Ernst & Young LLP, as well as the fees charged for such services. Among other things, the Committee examines the effect that the performance of non-audit services, if any, may have upon the independence of the independent registered public accounting firm. All professional services provided by Ernst & Young LLP, including such non-audit services, if any, are subject to approval by the Audit Committee in accordance with applicable securities laws, rules, and regulations. For more information, see the “Report of the Audit Committee” and the “Relationship with Independent Registered Public Accounting Firm” sections above. A representative of Ernst & Young LLP is expected to be present at the Annual Meeting and will have an opportunity to make a statement if he or she so desires. The representative will also be available to respond to appropriate questions from the stockholders. Approval of Proposal No. 4 will require the affirmative vote of a majority of the outstanding shares of Common Stock present or represented and voting on such Proposal at the Annual Meeting. Unless marked otherwise, proxies received will be voted “FOR” the approval of Proposal No. 4. THE BOARD OF DIRECTORS OF THE COMPANY RECOMMENDS A VOTE “FOR” THE RATIFICATION OF THE APPOINTMENT OF ERNST & YOUNG LLP AS THE INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM FOR FISCAL YEAR 2007. SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Exchange Act requires the Company’s executive officers, directors, and persons who own more than 10% of a registered class of the Company’s equity securities to file an initial report of ownership on Form 3 and changes in ownership on Forms 4 or 5 with the SEC. Executive officers, directors, and greater-than-10% stockholders are also required by SEC rules to furnish the Company with copies of all Section 16(a) forms they file. Specific due dates for these reports have been established, and the Company is required to disclose in this Proxy Statement any failure to file such reports on a timely basis. Based solely on its review of the copies of such forms received by it, or written representations from certain reporting persons, the Company believes that all of these requirements were satisfied during the 2006 fiscal year, except as follows: a report on Form 4 that was due on August 31, 2005, in connection with an exercise and sale of stock options by Mr. Harris was filed on September 1, 2005. OTHER MATTERS The Company knows of no other matters to be submitted to the meeting. If any other matters properly come before the meeting, it is the intention of the proxy holders named in the enclosed form of proxy to vote the shares they represent as the Board of Directors may recommend. 47 It is important that your stock holdings be represented at the meeting, regardless of the number of shares you hold. You are, therefore, urged to execute and return, at your earliest convenience, the accompanying proxy card in the enclosed envelope or otherwise exercise your stockholder voting rights by telephone or Internet, as provided in the materials accompanying this Proxy Statement. By Order of The Board of Directors, Fremont, California Dated: October 6, 2006 George M. Schisler, Jr. Assistant Secretary 48 APPENDIX A AUDIT COMMITTEE CHARTER Amended and Restated by the Board of Directors of Lam Research Corporation on November 2, 2005 Purpose The purpose of the Audit Committee of the Board of Directors of Lam Research Corporation is to oversee the accounting and financial reporting processes of the Company and the audits of its financial statements. The Audit Committee is not responsible, however, for planning or conducting audits, or determining whether the Company’s financial statements are complete and accurate or in accordance with generally accepted accounting principles. Composition The Audit Committee shall be composed of three or more directors, as determined by the Board of Directors, each of whom shall be independent, as defined by current laws, rules and regulations applicable to the Company and shall meet the independence and financial literacy requirements of NASDAQ, and at least one of whom shall have past employment experience in finance or accounting, requisite professional certification in accounting, or any other comparable experience or background which results in the individual’s financial sophistication, including being or having been a chief executive officer, chief financial officer or other senior officer with financial oversight responsibilities. Responsibilities 1. Appoint and provide for the compensation of an independent registered public accounting firm to serve as the Company’s independent auditor, oversee the work of the independent auditor (including resolution of any disagreements between management and the independent auditor regarding financial reporting), evaluate the performance of the independent auditor and, if so determined by the Audit Committee, replace the independent auditor; it being acknowledged that the independent auditor is ultimately accountable to the Board of Directors and the Audit Committee, as representatives of the stockholders. 2. Ensure the receipt of, and evaluate, the written disclosures and the letter that the independent auditor submits to the Audit Committee regarding the auditor’s independence in accordance with Independence Standards Board Standard No. 1, discuss such reports with the auditor, oversee the independence of the independent auditor, and, if so determined by the Audit Committee in response to such reports, take appropriate action to address issues raised by such evaluation. 3. Discuss with the independent auditor the matters required to be discussed by SAS 61, as it may be modified or supplemented. 4. Instruct management, the independent auditor and the internal auditor (if any) that the Audit Committee expects to be informed if there are any subjects that require special attention or if any significant deficiencies or material weaknesses to the system of internal control over financial reporting are identified. Review with management and the independent auditor any material changes to the system of internal control over financial reporting. 5. Instruct the independent auditor to report to the Audit Committee on all critical accounting policies of the Company, all alternative treatments of financial information within generally accepted accounting principles that have been discussed with management, ramifications of the use of such alternative disclosures and treatments and the treatment preferred by the auditors, and other material written communications between the auditors and management. A-1 6. Meet with management and the independent auditor to discuss the annual financial statements and the report of the independent auditor thereon, and to discuss significant issues encountered in the course of the audit work, including restrictions on the scope of activities, access to required information, the adequacy of internal control over financial reporting; the adequacy of disclosure of off-balance sheet transactions, arrangements, obligations, and relationships in reports filed with the Securities and Exchange Commission. 7. Review deficiencies analysis delivered by the independent auditor in connection with the audit. 8. Following such review and discussions, if so determined by the Audit Committee, recommend to the Board of Directors that the annual financial statements be included in the Company’s annual report. 9. Meet quarterly with management and the independent auditor to discuss the quarterly financial statements prior to the filing of the Form 10Q; provided that this responsibility may be delegated to the chairman of the Audit Committee or a member of the Audit Committee who is a financial expert. 10. Meet at least once each year in separate executive sessions with management, the internal auditor (if any), and the independent auditor to discuss matters that any of them or the Audit Committee believes could significantly affect the financial statements and should be discussed privately. 11. Review significant changes to the Company’s accounting principles and practices proposed by the independent auditor, the internal auditor (if any), or management. 12. Review the scope and results of internal audits (if any). 13. Evaluate the performance of the internal auditor (if any) and, if so determined by the Audit Committee, recommend replacement of the internal auditor. 14. Conduct or authorize such inquiries into matters within the Audit Committee’s scope of responsibility as the Audit Committee deems appropriate. 15. Provide minutes of Audit Committee meetings to the Board of Directors, and report to the Board of Directors on any significant matters arising from the Audit Committee’s work. 16. At least annually, review and reassess this Charter and, if appropriate, recommend proposed changes to the Board of Directors. 17. Prepare the report required by the rules and regulations of the Securities and Exchange Commission to be included in the Company’s annual proxy statement. 18. Establish a procedure for receipt, retention, and treatment of any complaints received by the Company about its accounting, internal accounting controls, or auditing matters, and for the confidential and anonymous submission by employees of concerns regarding questionable accounting or auditing matters. 19. Approve, in accordance with and in a manner consistent with the laws, rules, and regulations applicable to the Company, all professional services to be provided to the Company by its independent auditor. The Audit Committee may adopt policies and procedures for the approval of such services, which may include delegation of authority to a designated member or members of the Audit Committee to approve such services so long as any such approvals are disclosed to the full Audit Committee at its next scheduled meeting. 20. Review and approve all related party transactions. Authority By adopting this Charter, the Board of Directors delegates to the Audit Committee full authority, in its discretion, to: 1. Perform each of the responsibilities of the Audit Committee described above. 2. Appoint a chair of the Audit Committee unless a chair is designated by the Board. A-2 3. Engage independent counsel and other advisers as the Audit Committee determines necessary to carry out its responsibilities. 4. Cause the officers of the Company to provide such funding as the Audit Committee shall determine to be appropriate for the payment of compensation to the Company’s independent auditor and any legal counsel or other advisers engaged by the Audit Committee, and payment of ordinary administrative expenses of the Audit Committee that are necessary or appropriate in carrying out its duties. A-3 APPENDIX B LAM RESEARCH CORPORATION 2004 EXECUTIVE INCENTIVE PLAN Amended and Restated Effective as of November 4, 2005 _____________________ As Further Amended by the Board of Directors on August 15, 2006, Subject to Stockholder Approval The Compensation Committee (the “Compensation Committee”) of the Board of Directors of Lam Research Corporation (“Company”) previously adopted and then amended the 2004 Executive Incentive Plan (“Plan”). The Compensation Committee hereby adopts this amended and restated version of the Plan, effective for measurement periods beginning on or after November 3, 2006, subject to stockholder approval as described in Section 3. 1. Purpose. The purpose of the Plan is to provide performance-based incentive compensation in the form of cash payments or stock awards to executive officers and senior management of the Company and any affiliates which might subsequently adopt the Plan. The Plan is intended to qualify as performance-based compensation under Section 162(m) of the Internal Revenue Code (“Section 162(m)”). 2. Administration. The Plan has been established by, and shall be administered by, the Compensation Committee. The Compensation Committee is composed solely of 2 or more outside directors as defined in Section 162(m) and, therefore, qualifies as an independent compensation committee under Section 162(m). 3. Stockholder Approval. The Plan shall be effective if, and only if, the Company’s stockholders, by a majority of the votes considered present or represented and entitled to vote with respect to this matter, approve the material terms of the Plan, specifically, the employees eligible to receive compensation under the Plan; the business criteria on which the performance goals may be based; and the maximum amount of compensation that may be paid to any employee under the Plan in any year. No compensation or award will be paid and vested under the Plan until after this approval is obtained. To the extent necessary for the Plan to qualify as performance- based compensation under Section 162(m) or its successor under then applicable law, these material terms of the Plan shall be disclosed to and reapproved by the stockholders no later than the first stockholder meeting that occurs in the fifth year following the year in which stockholders previously approved the material terms of the Plan. 4. Participants. For each measurement period (which may but need not be a fiscal year), the Compensation Committee will choose, in its sole discretion, those eligible employees who will participate in the Plan during that measurement period and will be eligible to receive payment under the Plan for that measurement period. a) Eligible Employees. Persons who are eligible to participate in the Plan are all members of senior management of the Company and its affiliates. For purposes of the Plan, senior management is defined as any officer who is subject to the reporting rules of Section 16(a) of the Securities Exchange Act of 1934, or who is designated as eligible for the Plan by the Compensation Committee in its discretion. B-1 b) Employment Criteria. In general, to participate in the Plan an eligible employee must be continuously employed by the Company or an affiliate for the entire measurement period. The foregoing notwithstanding: (i) if an otherwise eligible employee joins the Company or an affiliate during the measurement period, the Compensation Committee may, in its discretion, add the employee to the Plan for the partial measurement period, and (ii) if the employment of an otherwise eligible employee ends before the end of the measurement period because of death, disability or, termination of employment (as determined in the discretion of the Compensation Committee), the employee shall be paid a pro-rata portion of the compensation, if any, that otherwise would have been payable under the Plan, unless the Committee determines in its sole discretion that payment is not appropriate. If a participant is on unpaid leave status for any portion of the measurement period, the Compensation Committee, in its discretion, may reduce the participant’s payment on a pro-rata basis. All determinations under the Plan, including those related to interpretation of the Plan, eligibility, or the payment or pro-ration of any payment shall be made by the Compensation Committee pursuant to the above terms, and those determinations shall be final and binding on all employees. 5. Awards. The Compensation Committee shall determine the size and terms of an individual award that can be made in cash or stock. Stock awards may be made from and in such forms permitted under the Company’s (i) 1997 Stock Incentive Plan; (ii) 1999 Stock Option Plan, or (iii) any stock option, equity incentive or similar plan that may hereafter be adopted by the Company’s Board of Directors and approved by its stockholders. The stock awards shall be granted and/or vested based upon the attainment of performance goals as set forth in Section 6. 6. Business Criteria on Which Performance Goals Shall be Based. Payment under the Plan shall be based on the Company’s attainment of performance goals based on one or more of the following business criteria: • Return on equity: total capital, assets, or invested capital. • Shareholder return, actual or relative to an appropriate index (including share price, market capitalization, or market share). • Actual or growth of revenue, orders, operating income, or net income (with or without regard to amortization/impairment of goodwill). • Free cash flow generation. • Operational performance, including assets turns, revenue per employee, days sales outstanding, and inventory turns. • Individually designed goals and objectives that are consistent with the participant’s specific duties and responsibilities and that are designed to improve the financial performance of the Company or a specific division or affiliate. The goals and objectives shall also be derived from and consistent with the operating plan of the Company, division, or affiliate for the particular year to which the participant’s performance is measured. 7. Establishing Performance Goals. The Compensation Committee shall establish, for each measurement period: a) b) the length of the measurement period; the specific business criterion or criteria, or combination thereof, that will be used; B-2 c) d) e) f) g) the specific performance targets that will be used for the selected business criterion or criteria; any special adjustments that will be applied in calculating whether the performance targets have been met to factor out extraordinary items; the formula for calculating compensation eligible for payment under the Plan in relation to the performance targets; the eligible employees who will participate in the Plan for that measurement period; and if applicable, the target amounts for each participant for the measurement period. The Compensation Committee shall make these determinations in writing no later than 90 days after the start of each measurement period, on or before 25% of the measurement period has elapsed, and while the outcome is substantially uncertain. Cash awards paid to any one participant under the Plan in respect of performance goals for any twelve-month measurement period shall not exceed $12,000,000; provided however that (a) in the event a measurement period of longer or shorter duration than twelve-months, this limit will be increased or decreased, respectively, on a proportionate basis; (b) receipt by a participant of payment until a later period of an award amount earned with respect to a measurement period, either through elective deferral by the participant or a deferral included as part of the award structure, shall not affect application of the above cash limit to the participant during the later period; and (c) measurement periods used under the Plan may commence on or after November 3, 2006 and must end on or prior to November 2, 2010. Stock awards or restricted stock unit awards granted to any one participant in any one calendar year (which may vest over multiple years) under the Plan shall not exceed 300,000 shares of the Company’s common stock. The 300,000 shares shall be adjusted in the discretion of the Compensation Committee in the event of stock dividend, stock split, extraordinary cash dividend, or similar recapitalization of the Company. Unless otherwise specified by the Compensation Committee in its written determinations establishing the criteria for the particular measurement period, if the Company or its affiliates consummate one or more acquisitions during the measurement period that, individually or in the aggregate, constitute a “triggering acquisition” (“Triggering Acquisition”), the measurement period shall end early, on the last day of the calendar quarter immediately before the consummation of the first acquisition that constitutes a Triggering Acquisition (either individually or when aggregated with prior acquisitions during the measurement period), and pro-rated payments shall be paid based on the degree of attainment of the performance goals during the shortened measurement period. For purposes of this paragraph, a Triggering Acquisition means an acquisition (or combination of acquisitions) in which the acquired entity’s operating earnings (earnings before transaction-related expense) for the four quarters completed immediately before consummation of the acquisition is equal to 10% or more of the pro-forma operating earnings for the same four quarters for the combination of the Company and its affiliates and the acquired entity. (If either the Company and its affiliates or the entity being acquired had consummated other acquisitions during the four quarters in question, the calculation described in the prior sentence shall be done using pro-forma earnings for each combined entity.) If an employee joins the Company or an affiliate during the measurement period and becomes an eligible employee pursuant to Paragraph 4(b), and if the employee is a “covered employee” within the meaning of Section 162(m), then to the extent necessary for the Plan to qualify as performance-based compensation under Section 162(m) or its successor under then applicable law, all relevant elements of the performance goals established pursuant to paragraph 6 of this Plan for that employee must be established on or before the date on which 25% of the time from the commencement of employment to the end of the measurement period has elapsed, and the outcome under the performance goals for the measurement period must be substantially uncertain at the time those elements are established. B-3 8. Determination of Attainment of Performance Goals. The Compensation Committee shall determine, pursuant to the performance goals and other elements established pursuant to section 6 of the Plan, the amounts to be paid to each employee for each measurement period or the extent to which awards have vested. The Compensation Committee’s determinations shall be final and binding on all participants. However, with respect to the Chief Executive Officer and Executive Chairman, the Company’s outside directors shall be entitled (but are not required) to review and approve (by majority vote) the Compensation Committee’s determination. These determinations must be certified in writing before payments are made, which requirement may be satisfied by approved minutes of the Compensation Committee meeting setting out the determinations made. The Compensation Committee shall not have discretion to increase the amount of an award or accelerate the vesting of an award to any employee who is a “covered employee” within the meaning of Section 162(m) if such action would cause the award or any part thereof to not be deductible under the Internal Revenue Code. 9. Amendments. The Compensation Committee may not amend or terminate the Plan so as to increase, reduce or eliminate awards under the Plan for any given measurement period retroactively, that is, on any date later than 90 days after the start of the measurement period. The Compensation Committee may amend or terminate the Plan at any time on a prospective basis and/or in any fashion that does not increase, reduce or eliminate awards retroactively. The foregoing notwithstanding, except as required by applicable law, the Compensation Committee shall not have the power to amend the Plan in any fashion that would cause the Plan to fail to qualify as performance-based compensation with respect to any “covered employee” as defined under Section 162(m) or its successor. Without limiting the generality of the foregoing, to the extent it would cause the Plan to fail to qualify as performance-based compensation with respect to any “covered employee” as defined under Section 162(m) or its successor under then applicable law, the Compensation Committee shall not have the power to change the material terms of the performance goals unless (i) the modified performance goals are established by the Compensation Committee no later than 90 days after the start of the applicable measurement period, on or before 25 percent of the measurement period has elapsed, and while the outcome is substantially uncertain; and (ii) no payments are made under the modified performance goals until after the material terms of the modified performance goals are disclosed to and approved by the Company’s stockholders. 10. Rule 10b5-1 Trading Plans; Stock Withholding. It is expected that participants under the Plan will establish or modify stock trading plans under Rule 10b5-1 of the Securities Exchange Act of 1934, as amended, to provide for the sale of Company shares and remit to the Company the proceeds to meet the Company’s withholding obligations in connection with stock awards hereunder. To the extent participants fail to establish or modify 10b5-1 plans in accordance with the foregoing, the Company shall at its election either require the participant to pay cash sufficient to meet the withholding obligation or the Company shall withhold the number of shares under a stock award sufficient (based on the fair market value of the Shares) to meet such withholding obligation. 11. Effect on Employment/Right to Receive. Employment with the Company and its affiliates is on an at-will basis. Nothing in the Plan shall interfere with or limit in any way the right of the Company to terminate any participant’s employment or service at any time, with or without cause or notice. Furthermore, the Company expressly reserves the right, which may be exercised at any time and without regard to any measurement period, to terminate any individual’s employment with or without cause, and to treat him or her without regard to the effect which such treatment might have upon him or her as a participant under this Plan. For purposes of this Plan, transfers of employment between the Company and/or its affiliates shall not be deemed a termination of employment. No person shall have the right to be selected to receive a Stock Award under the Plan, or, having been so selected, have the right to receive a future award. B-4 12. Successors. All obligations of the Company under the Plan, with respect to awards granted hereunder, shall be binding on any successor to the Company, whether the existence of such successor is the result of a direct or indirect purchase, merger, consolidation, or otherwise, of all or substantially all the business or assets of the Company. 13. Nontransferability of Awards. No award granted under this Plan may be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated, other than by will, by the laws of descent and distribution, or to the extent permitted by the Company’s 1997 Stock Incentive Plan, 1999 Stock Incentive Plan or other equity plan, to the extent an award is payable from such plans. All rights with respect to an award granted under this Plan shall be available during his or her lifetime only to the participant to whom the award under this Plan is granted. 14. Effectiveness; Prior Plans Superseded. Upon stockholder approval as described in Section 3, the amended and restated Plan shall be effective for measurement periods beginning on or after November 4, 2005, and shall replace and supersede any prior executive incentive plans. B-5 LAM RESEARCH CORPORATION 2007 STOCK INCENTIVE PLAN APPENDIX C As Adopted by the Board of Directors on August 15, 2006, Subject to Stockholder Approval 1. Purpose of this Plan The purpose of this 2007 Stock Incentive Plan is to enhance the long-term stockholder value of Lam Research Corporation by offering opportunities to eligible individuals to participate in the growth in value of the equity of Lam Research Corporation. 2. Definitions and Rules of Interpretation 2.1 Definitions. This Plan uses the following defined terms: (a) “Administrator” means the Board or the Committee, or any officer or employee of the Company to whom the Board or the Committee delegates authority to administer this Plan. (b) “Affiliate” means a “parent” or “subsidiary” (as each is defined in Section 424 of the Code) of the Company, and any other entity that the Board or Committee designates as an “Affiliate” for purposes of this Plan. (c) “Applicable Law” means any and all laws of whatever jurisdiction, within or without the United States, and the rules of any stock exchange or quotation system on which Shares are listed or quoted, applicable to the taking or refraining from taking of any action under this Plan, including the administration of this Plan and the issuance or transfer of Awards or Award Shares. (d) “Award” means a Stock Award, SAR, or Option granted in accordance with the terms of this Plan. Award. (e) “Award Agreement” means the document evidencing the grant of an Award. (f) “Award Shares” means Shares covered by an outstanding Award or purchased under an (g) “Awardee” means: (i) a person to whom an Award has been granted, including a holder of a Substitute Award, or (ii) a person to whom an Award has been transferred in accordance with all applicable requirements of Sections 6.5, 7(h), and 17. (h) “Board” means the Board of Directors of the Company. (i) “Cause” means employment related dishonesty, fraud, misconduct or disclosure or misuse of confidential information, or other employment related misconduct that is likely to cause significant injury to the Company, an Affiliate, or any of their respective employees, officers or directors (including, without limitation, commission of a felony or similar offense), in each case as determined by the Administrator. “Cause” shall not require that a civil judgment or criminal conviction have been entered against or guilty plea shall have been made by the Awardee regarding any of the matters referred to in the previous sentence. Accordingly, the Administrator shall be entitled to determine “Cause” based on the Administrator’s good faith belief. If the Awardee is criminally charged with a felony or similar offense that shall be a sufficient, but not a necessary, basis for such belief. (j) “Change in Control” means any transaction or event that the Board specifies as a Change in Control under Section 10.3. C-1 (k) “Code” means the Internal Revenue Code of 1986. (l) “Committee” means a committee composed of Company Directors appointed in accordance with the Company’s charter documents and Section 4. (m) “Company” means Lam Research Corporation, a Delaware corporation. (n) “Company Director” means a member of the Board. (o) “Consultant” means an individual who (including as an employee or agent of an entity that) provides bona fide services to the Company or an Affiliate not in connection with the offer or sale of securities in a capital-raising transaction, but who is not an Employee. (p) “Director” means a member of the Board of Directors of the Company or an Affiliate. (q) “Domestic Relations Order” means a “domestic relations order” as defined in, and otherwise meeting the requirements of, Section 414(p) of the Code, except that reference to a “plan” in that definition shall be to this Plan. (r) “Effective Date” means the date the shareholders of the Company approve the Plan. In the event the shareholders do not approve the Plan, the Plan shall be null and void and no terms of the Plan shall take effect. (s) “Employee” means a regular employee of the Company or an Affiliate, including an officer or Director, who is treated as an employee in the personnel records of the Company or an Affiliate, but not individuals who are classified by the Company or an Affiliate as: (i) leased from or otherwise employed by a third party, (ii) independent contractors, or (iii) intermittent or temporary workers. The Company’s or an Affiliate’s classification of an individual as an “Employee” (or as not an “Employee”) for purposes of this Plan shall not be altered retroactively even if that classification is changed retroactively for another purpose as a result of an audit, litigation or otherwise. An Awardee shall not cease to be an Employee due to transfers between locations of the Company, or between the Company and an Affiliate, or to any successor to the Company or an Affiliate that assumes the Awardee’s Options under Section 10. Neither service as a Director nor receipt of a director’s fee shall be sufficient to make a Director an “Employee.” (t) “Exchange Act” means the Securities Exchange Act of 1934. (u) “Executive” means, if the Company has any class of any equity security registered under Section 12 of the Exchange Act, an individual who is subject to Section 16 of the Exchange Act or who is a “covered employee” under Section 162(m) of the Code, in either case because of the individual’s relationship with the Company or an Affiliate. If the Company does not have any class of any equity security registered under Section 12 of the Exchange Act, “Executive” means any (i) officer elected or appointed by the Board, or (ii) beneficial owner of more than 10% of any class of the Company’s equity securities. (v) “Expiration Date” means, with respect to an Award, the date stated in the Award Agreement as the expiration date of the Award or, if no such date is stated in the Award Agreement, then the last day of the maximum exercise period for the Award, disregarding the effect of an Awardee’s Termination or any other event that would shorten that period. (w) “Fair Market Value” means the value of Shares as determined under Section 18.2. (x) “Good Reason” means (i) a material diminution in responsibility or compensation in connection with his or her employment relationship with the Company or an Affiliate, as applicable, or (ii) requiring Awardee to work for the Company or an Affiliate in a location (other than normal business travel) which is more than 50 miles from Awardee’s principal place of employment before the Change in Control as the case may be. C-2 (y) “Grant Date” means the date the Administrator approves the grant of an Award. However, if the Administrator specifies that an Award’s Grant Date is a future date or the date on which a condition is satisfied, the Grant Date for such Award is that future date or the date that the condition is satisfied. (z) “Incentive Stock Option” means an Option intended to qualify as an incentive stock option under Section 422 of the Code and designated as an Incentive Stock Option in the Award Agreement for that Option. (aa) “Involuntary Termination” means termination by the Company without Cause or termination by the Awardee for Good Reason. (bb) “Nonstatutory Option” means any Option other than an Incentive Stock Option. (cc) “Objectively Determinable Performance Condition” shall mean any one or more of the following performance criteria, either individually, alternatively or in any combination, applied to either the Company as a whole or to a business unit, Affiliate or business segment, either individually, alternatively or in any combination, and measured either annually or cumulatively over a period of years, on an absolute basis or relative to a pre-established target, to previous years’ results or to a designated comparison group, in each case as specified by the Committee in the Award and may include actual, growth, or performance-to- target for: (i) cash flow, including free cash flow; (ii) earnings (including revenue, gross margin, operating profit, earnings before interest and taxes, earnings before taxes, and net earnings) or earnings per share; (iii) stock price; (iv) return on equity or average shareholders’ equity; (v) total stockholder return, either actual or relative to share price or market capitalization; (vi) return on capital; (vii) return on assets or net assets; (viii) return on investment or invested capital; (ix) return on operating revenue; (x) income, net income, operating income, net operating income, operating profit, net operating profit, or operating margin (with or without regard to amortization/impairment of goodwill); (xi) market share or applications won; (xii) operational performance, including orders, backlog, deferred revenues, revenue per employee, overhead, days sales outstanding, inventory turns, or other expense levels; (xiii) stockholder value or return relative to the moving average of the S&P 500 Index or a peer group index; (xiv) asset turns; and (xv) strategic plan development and implementation (including individually designed goals and objectives that are consistent with the Participant’s specific duties and responsibilities and that are designed to improve the financial performance of the Company, an Affiliate, or a specific business unit thereof and that are consistent with and derived from the strategic operating plan of the Company, an Affiliate or any of their business units for the applicable performance period). The Committee may appropriately adjust any evaluation of performance under an Objectively Determinable Performance Criteria to exclude any of the following events that occurs during a performance period: (A) asset write-downs; (B) litigation or claim judgments or settlements; (C) the effect of changes in tax law, accounting principles or other such laws or provisions affecting reported results; (D) accruals for reorganization and restructuring programs; and (E) any extraordinary non-recurring items as described in Accounting Principles Board Opinion No. 30 and/or in management’s discussion and analysis of financial condition and results of operations appearing in the Company’s annual report to shareholders for the applicable year. (dd) “Officer” means an officer of the Company as defined in Rule 16a-1 adopted under the Exchange Act. (ee) “Option” means a right to purchase Shares of the Company granted under this Plan. (ff) “Option Price” means the price payable under an Option for Shares, not including any amount payable in respect of withholding or other taxes. (gg) “Option Shares” means Shares covered by an outstanding Option or purchased under an Option. (hh) “Plan” means this 2007 Stock Incentive Plan of Lam Research Corporation. C-3 (ii) “Prior Plans” mean the Company’s 1999 Stock Option Plan and 1997 Stock Incentive Plan. (jj) “Purchase Price” means the price payable under a Stock Award for Shares, not including any amount payable in respect of withholding or other taxes. (kk) “Rule 16b-3” means Rule 16b-3 adopted under Section 16(b) of the Exchange Act. (ll) “SAR” or “Stock Appreciation Right” means a right to receive cash and/or Shares based on a change in the Fair Market Value of a specific number of Shares pursuant to an Award Agreement, as described in Section 8.1. (mm) “Securities Act” means the Securities Act of 1933. (nn) “Share” means a share of the common stock of the Company or other securities substituted for the common stock under Section 10. (oo) “Stock Award” means an offer by the Company to sell or issue shares, including shares subject to certain restrictions pursuant to the Award Agreement as described in Section 8.2 or, as determined by the Committee, a notional account representing the right to be paid an amount based on Shares. Types of Awards which may be granted as Stock Awards include such awards as are commonly known as restricted stock, deferred stock, restricted stock units, performance shares, phantom stock or similar types of awards as determined by the Administrator. (pp) “Substitute Award” means a Substitute Option, Substitute SAR or Substitute Stock Award granted in accordance with Sections 6.6, 8.1(d) and 8.2(e) of this Plan. (qq) “Substitute Option” means an Option granted in substitution for, or upon the conversion of, an option granted by another entity to purchase equity securities in the granting entity. (rr) “Substitute SAR” means a SAR granted in substitution for, or upon the conversion of, a stock appreciation right granted by another entity with respect to equity securities in the granting entity. (ss) “Substitute Stock Award” means a Stock Award granted in substitution for, or upon the conversion of, a stock award granted by another entity to purchase equity securities in the granting entity. (tt) “Termination” means that the Awardee has ceased to be, with or without any cause or reason, an Employee, Director or Consultant. However, unless so determined by the Administrator, or otherwise provided in this Plan, “Termination” shall not include a change in status from an Employee, Consultant or Director to another such status. An event that causes an Affiliate to cease being an Affiliate shall be treated as the “Termination” of that Affiliate’s Employees, Directors, and Consultants. 2.2 Rules of Interpretation. Any reference to a “Section,” without more, is to a Section of this Plan. Captions and titles are used for convenience in this Plan and shall not, by themselves, determine the meaning of this Plan. Except when otherwise indicated by the context, the singular includes the plural and vice versa. Any reference to a statute is also a reference to the applicable rules and regulations adopted under that statute. Any reference to a statute, rule or regulation, or to a section of a statute, rule or regulation, is a reference to that statute, rule, regulation, or section as amended from time to time, both before and after the Effective Date and including any successor provisions. 3. Shares Subject to this Plan; Term of this Plan 3.1 Number of Award Shares. The Shares issuable under this Plan shall be authorized but unissued or reacquired Shares, including Shares repurchased by the Company on the open market. Subject to adjustment under Section 10, the number of Shares initially reserved for issuance or sale over the term of this Plan shall be 15,000,000. Except as required by Applicable Law, Shares shall not reduce the number of Shares reserved for issuance under this Plan until the actual date of delivery of the Shares to the Awardee. Shares subject to Awards granted under this Plan that are cancelled, expire or are forfeited or repurchased (including without limitation any such Shares that have been issued under the Award to the Participant) shall C-4 be available for re-grant or re-issuance under the Plan following such cancellation, expiration, forfeiture or repurchase. If an Awardee pays the exercise or purchase price of an Award granted under the Plan through the withholding of Award Shares or the tender of Shares, or if Shares are withheld from the Award or otherwise tendered to satisfy any applicable withholding obligations, the number of Shares so tendered or withheld shall become available for re-grant or re-issuance thereafter under the Plan following such tender or withholding. 3.2 Term of this Plan. (a) This Plan shall be effective on, and Awards may be granted under this Plan on and after, the earliest the date on which the Plan has been both adopted by the Board and approved by the Company’s stockholders. (b) Subject to the provisions of Section 13, Awards may be granted under this Plan for a period of ten years from the latest date the Company’s stockholders approve this Plan, including any subsequent amendment or restatement of this Plan. 4. Administration 4.1 General. (a) The Board shall have ultimate responsibility for administering this Plan. The Board may delegate certain of its responsibilities to a Committee, which shall consist of at least two members of the Board. The Board or the Committee may further delegate its responsibilities to any Employee of the Company or any Affiliate. Where this Plan specifies that an action is to be taken or a determination made by the Board, only the Board may take that action or make that determination. Where this Plan specifies that an action is to be taken or a determination made by the Committee, only the Committee may take that action or make that determination; provided that, if for some reason the Committee cannot act or make a determination, then the Board shall also be entitled to take such action or make such determination. Where this Plan references the “Administrator,” the action may be taken or determination made by the Board, the Committee, or other Administrator. However, only the Board or the Committee may approve grants of Awards to Executives, and an Administrator other than the Board or the Committee may grant Awards only within the guidelines established by the Board or Committee. Moreover, all actions and determinations by any Administrator are subject to the provisions of this Plan. (b) So long as the Company has registered and outstanding a class of equity securities under Section 12 of the Exchange Act, the Committee shall consist of Company Directors who are “Non-Employee Directors” as defined in Rule 16b-3 and, after the expiration of any transition period permitted by Treasury Regulations Section 1.162-27(h)(3), who are “outside directors” as defined in Section 162(m) of the Code. So long as the Shares are listed with Nasdaq, the Committee shall comply with applicable Nasdaq rules and listing standards. 4.2 Authority of the Board or the Committee. Subject to the other provisions of this Plan, the Board or the Committee shall have the authority to: (a) grant Awards, including Substitute Awards; (b) determine the Fair Market Value of Shares; (c) determine the Option Price and the Purchase Price of Awards; (d) select the Awardees; (e) determine the times Awards are granted; (f) determine the number of Shares subject to each Award; (g) determine the methods of payment that may be used to purchase Award Shares; C-5 (h) determine the methods of payment that may be used to satisfy withholding tax obligations; (i) determine the other terms of each Award, including but not limited to the time or times at and the conditions upon which Awards may be exercised or become vested, whether and under what conditions an Award is assignable, whether an Option is a Nonstatutory Option or an Incentive Stock Option, automatic cancellation of the Award if certain objective requirements determined by the Administration are not met, and whether the Award or Award Shares are subject to any forfeiture or other conditions; (j) modify or amend any Award; (k) authorize any person to sign any Award Agreement or other document related to this Plan on behalf of the Company; (l) determine the form of any Award Agreement or other document related to this Plan, and whether that document, including signatures, may be in electronic form; (m) interpret this Plan and any Award Agreement or document related to this Plan; (n) correct any defect, remedy any omission, or reconcile any inconsistency in this Plan, any Award Agreement or any other document related to this Plan; (o) adopt, amend, and revoke rules and regulations under this Plan, including rules and regulations relating to sub-plans and Plan addenda; (p) adopt, amend, and revoke special rules and procedures which may be inconsistent with the terms of this Plan, set forth (if the Administrator so chooses) in sub-plans regarding (for example) the operation and administration of this Plan and the terms of Awards, if and to the extent necessary or useful to accommodate non-U.S. Applicable Laws and practices as they apply to Awards and Award Shares held by, or granted or issued to, persons working or resident outside of the United States or employed by Affiliates incorporated outside the United States; (q) determine whether a transaction or event should be treated as a Change in Control, as well as the effect of a Change of Control; and (r) make all other determinations the Administrator deems necessary or advisable for the administration of this Plan. 4.3 Scope of Discretion. Subject to the provisions of this Section 4.3, on all matters for which this Plan confers the authority, right or power on the Board, the Committee, or other Administrator to make decisions, that body may make those decisions in its sole and absolute discretion. Those decisions will be final, binding and conclusive. In making its decisions, the Board, Committee or other Administrator need not treat all persons eligible to receive Awards, all Awardees, all Awards or all Award Shares the same way. Notwithstanding anything herein to the contrary, and except as provided in Section 13.3, the discretion of the Board, Committee or other Administrator is subject to the specific provisions and specific limitations of this Plan, as well as all rights conferred on specific Awardees by Award Agreements and other agreements. 5. Persons Eligible to Receive Awards 5.1 Eligible Individuals. Awards (including Substitute Awards) may be granted to, and only to, Employees, Directors and Consultants. However, Incentive Stock Options may only be granted to Employees, as provided in Section 7(g). 5.2 Section 162(m) Limitation. (a) Options and SARs. Subject to the provisions of this Section 5.2, for so long as the Company is a “publicly held corporation” within the meaning of Section 162(m) of the Code, no Employee may be granted one or more Options or SARs within any fiscal year of the Company under this Plan giving him or her the right to purchase or be issued more than 1,000,000 Shares under such Options or SARs, C-6 or to receive compensation calculated with reference to more than that number of Shares under Options and SARs, subject to adjustment pursuant to Section 10. If an Option or SAR is cancelled without being exercised or if the Option Price of an Option is reduced, that cancelled or repriced Option or SAR shall continue to be counted against the annual limit on Options and SARs that may be granted to any individual under this Section 5.2. Notwithstanding anything herein to the contrary, a new Employee of the Company or an Affiliate shall be eligible to be granted in the fiscal year in which he or she commences employment Options and SARs giving him or her the right to purchase or be issued up to a maximum of 2,000,000 Shares, or to receive compensation calculated with reference to that number of Shares under such Options and SARs, subject to adjustment pursuant to Section 10. (b) Stock Awards. Any Stock Award intended as “qualified performance-based compensation” within the meaning of Section 162(m) of the Code, whether granted solely under this Plan or pursuant to the terms of any other stockholder-approved compensation plan awards granted under which are intended to comply with Code Section 162(m) (including without limitation the Company’s 2004 Executive Incentive Plan (the “2004 EIP”)), must be granted, vest or become exercisable contingent on the achievement of one or more Objectively Determinable Performance Conditions. The Committee shall have the discretion to determine the time and manner of compliance with Section 162(m) of the Code. Notwithstanding anything to the contrary contained herein or in the 2004 EIP, no Employee may be granted one or more Stock Awards within any fiscal year of the Company under this Plan (whether the Company’s obligation to issue such Shares arises solely under this Plan or also under any other stockholder-approved compensation plan, including the 2004 EIP) giving him or her the right to purchase or be issued more than 300,000 Shares under such Stock Awards, or to receive compensation calculated with reference to more than that number of Shares under Stock Awards, subject to adjustment pursuant to Section 10. 6. Terms and Conditions of Options The following rules apply to all Options: 6.1 Price. No Option may have a per-Share Option Price less than the Fair Market Value of a Share on the Grant Date. 6.2 Term. No Option shall be exercisable after its Expiration Date. No Option may have an Expiration Date that is more than ten years after its Grant Date. Additional provisions regarding the term of Incentive Stock Options are provided in Sections 7(a) and 7(e). 6.3 Vesting. Options shall vest and become exercisable: (a) on the Grant Date, or (b) in accordance with a schedule related to the Grant Date, the date the Optionee’s directorship, employment or consultancy begins, or a different date specified in the Option Agreement. Additional provisions regarding the vesting of Incentive Stock Options are provided in Section 7(c). 6.4 Form and Method of Payment. (a) The Board or Committee shall determine the acceptable form and method of payment for exercising an Option. So long as there is no material adverse accounting consequence during the term of the Award or at the time of exercise, the Board or Committee may require the delivery in Shares for the value of the net appreciation of the Shares at the time of exercise over the exercise price. The difference between full number of Shares covered by the exercised portion of the Award and the number of Shares actually delivered shall be restored to the amount of Shares reserved for issuance under Section 3.1. (b) Acceptable forms of payment for all Option Shares are cash, check or wire transfer, denominated in U.S. dollars except as specified by the Administrator for non-U.S. Employees or non-U.S. sub-plans. (c) In addition, the Administrator may permit payment to be made by any of the following methods: C-7 Shares, or the designation of Shares, in either case whether Shares subject to the Option or not, that have a Fair Market Value on the date of surrender equal to the Option Price of the Shares as to which the Option is being exercised; (i) (ii) provided that a public market exists for the Shares, consideration received by the Company under a procedure under which a licensed broker-dealer advances funds on behalf of an Optionee or sells Option Shares on behalf of an Optionee (a “Cashless Exercise Procedure”), provided that if the Company extends or arranges for the extension of credit to an Optionee under any Cashless Exercise Procedure, no Officer or Director may participate in that Cashless Exercise Procedure; cancellation of any debt owed by the Company or any Affiliate to the Optionee by the Company including without limitation waiver of compensation due or accrued for services previously rendered to the Company; and (iii) (iv) any combination of the methods of payment permitted by any paragraph of this Section 6.4. (d) The Administrator may also permit any other form or method of payment for Option Shares permitted by Applicable Law. 6.5 Nonassignability of Options. Except as determined by the Administrator, no Option shall be assignable or otherwise transferable by the Optionee except by will or by the laws of descent and distribution. However, Options may be transferred and exercised in accordance with a Domestic Relations Order, or in any manner allowed under the Form S-8 rules if so permitted by the Administrator and may be exercised by a guardian or conservator appointed to act for the Optionee. Incentive Stock Options may only be assigned in compliance with Section 7(h). 6.6 Substitute Options. The Board may cause the Company to grant Substitute Options in connection with the acquisition by the Company or an Affiliate of equity securities of any entity (including by merger, tender offer, or other similar transaction) or of all or a portion of the assets of any entity. Any such substitution shall be effective on the effective date of the acquisition. Substitute Options may be Nonstatutory Options or Incentive Stock Options. Unless and to the extent specified otherwise by the Board, Substitute Options shall have the same terms and conditions as the options they replace, except that (subject to the provisions of Section 10) Substitute Options shall be Options to purchase Shares rather than equity securities of the granting entity and shall have an Option Price determined by the Board. 7. Incentive Stock Options The following rules apply only to Incentive Stock Options and only to the extent these rules are more restrictive than the rules that would otherwise apply under this Plan. With the consent of the Optionee, or where this Plan provides that an action may be taken notwithstanding any other provision of this Plan, the Administrator may deviate from the requirements of this Section, notwithstanding that any Incentive Stock Option modified by the Administrator will thereafter be treated as a Nonstatutory Option. (a) Except as provided in Section 7(e), the Expiration Date of an Incentive Stock Option shall not be later than ten years from its Grant Date, with the result that no Incentive Stock Option may be exercised after the expiration of ten years from its Grant Date. (b) No Incentive Stock Option may be granted more than ten years from the date this Plan was approved by the Board. (c) Options intended to be incentive stock options under Section 422 of the Code that are granted to any single Optionee under all incentive stock option plans of the Company and its Affiliates, including incentive stock options granted under this Plan, may not vest at a rate of more than $100,000 in Fair Market Value of Shares (measured on the grant dates of the options) during any calendar year. For this purpose, an option vests with respect to a given share of stock the first time its holder may purchase that share, notwithstanding any right of the Company to repurchase that share. Unless the administrator of that C-8 option plan specifies otherwise in the related agreement governing the option, this vesting limitation shall be applied by, to the extent necessary to satisfy this $100,000 rule, treating certain stock options that were intended to be Incentive Stock Options under Section 422 of the Code as Nonstatutory Options. The stock options or portions of stock options to be reclassified as Nonstatutory Options are those with the highest option prices, whether granted under this Plan or any other equity compensation plan of the Company or any Affiliate that permits that treatment. This Section 7(c) shall not cause an Incentive Stock Option to vest before its original vesting date or cause an Incentive Stock Option that has already or would otherwise be vested to cease to vest or be vested. (d) In order for an Incentive Stock Option to be exercised for any form of payment other than those described in Section 6.4(b), that right must be stated at the time of grant in the Option Agreement relating to that Incentive Stock Option. (e) Any Incentive Stock Option granted to a Ten Percent Stockholder, must have an Expiration Date that is not later than five years from its Grant Date, with the result that no such Option may be exercised after the expiration of five years from the Grant Date. A “Ten Percent Stockholder” is any person who, directly or by attribution under Section 424(d) of the Code, owns stock possessing more than ten percent of the total combined voting power of all classes of stock of the Company or of any Affiliate on the Grant Date. (f) The Option Price of an Incentive Stock Option shall never be less than the Fair Market Value of the Shares at the Grant Date. The Option Price for the Shares covered by an Incentive Stock Option granted to a Ten Percent Stockholder shall never be less than 110% of the Fair Market Value of the Shares at the Grant Date. (g) Incentive Stock Options may be granted only to Employees. If an Optionee changes status from an Employee to a Consultant, that Optionee’s Incentive Stock Options become Nonstatutory Options if not exercised within the time period described in Section 7(i) (determined by treating that change in status as a Termination solely for purposes of this Section 7(g)). (h) No rights under an Incentive Stock Option may be transferred by the Optionee, other than by will or the laws of descent and distribution. During the life of the Optionee, an Incentive Stock Option may be exercised only by the Optionee. The Company’s compliance with a Domestic Relations Order, or the exercise of an Incentive Stock Option by a guardian or conservator appointed to act for the Optionee, shall not violate this Section 7(h). (i) An Incentive Stock Option shall be treated as a Nonstatutory Option if it remains exercisable after, and is not exercised within, the three-month period beginning with the Optionee’s Termination for any reason other than the Optionee’s death or disability (as defined in Section 22(e) of the Code). In the case of Termination due to death, an Incentive Stock Option shall continue to be treated as an Incentive Stock Option if it remains exercisable after, and is not exercised within, the three month period after the Optionee’s Termination provided it is exercised before the Expiration Date. In the case of Termination due to disability, an Incentive Stock Option shall be treated as a Nonstatutory Option if it remains exercisable after, and is not exercised within, one year after the Optionee’s Termination. 8. Stock Appreciation Rights and Stock Awards 8.1 Stock Appreciation Rights. The following rules apply to SARs: (a) General. SARs may be granted either alone, in addition to, or in tandem with other Awards granted under this Plan. The Administrator may grant SARs to eligible participants subject to terms and conditions not inconsistent with this Plan and determined by the Administrator. The specific terms and conditions applicable to the Awardee shall be provided for in the Award Agreement. SARs shall be exercisable, in whole or in part, at such times as the Administrator shall specify in the Award Agreement. The grant or vesting of a SAR may be made contingent on the achievement of Objectively Determinable Performance Conditions. C-9 (b) Exercise of SARs. Upon the exercise of an SAR, in whole or in part, an Awardee shall be entitled to a payment in an amount equal to the excess of the Fair Market Value of a fixed number of Shares covered by the exercised portion of the SAR on the date of exercise, over the Fair Market Value of the Shares covered by the exercised portion of the SAR on the Grant Date. The amount due to the Awardee upon the exercise of a SAR shall be paid in cash, Shares or a combination thereof, as specified in the Award Agreement, over the period or periods specified in the Award Agreement. An Award Agreement may place limits on the amount that may be paid over any specified period or periods upon the exercise of a SAR, on an aggregate basis or as to any Awardee. A SAR shall be considered exercised when the Company receives written notice of exercise in accordance with the terms of the Award Agreement from the person entitled to exercise the SAR. If a SAR has been granted in tandem with an Option, upon the exercise of the SAR, the number of shares that may be purchased pursuant to the Option shall be reduced by the number of shares with respect to which the SAR is exercised. (c) Nonassignability of SARs. Except as determined by the Administrator, no SAR shall be assignable or otherwise transferable by the Awardee except by will or by the laws of descent and distribution. Notwithstanding anything herein to the contrary, SARs may be transferred and exercised in accordance with a Domestic Relations Order or in any manner allowed under the Form S-8 rules if so permitted by the Administrator. (d) Substitute SARs. The Board may cause the Company to grant Substitute SARs in connection with the acquisition by the Company or an Affiliate of equity securities of any entity (including by merger) or all or a portion of the assets of any entity. Any such substitution shall be effective on the effective date of the acquisition. Unless and to the extent specified otherwise by the Board, Substitute SARs shall have the same terms and conditions as the awards they replace, except that (subject to the provisions of Section 9) Substitute SARs shall be exercisable with respect to the Fair Market Value of Shares rather than with regard to the value of equity securities of the granting entity and shall be on terms that, as determined by the Board in its sole and absolute discretion, properly reflects the substitution. 8.2 Stock Awards. The following rules apply to all Stock Awards: (a) General. The specific terms and conditions of a Stock Award applicable to the Awardee shall be provided for in the Award Agreement. The Award Agreement shall state the number of Shares that the Awardee shall be entitled to receive or purchase, the terms and conditions on which the Shares shall vest, the price to be paid (if any), whether Shares are to be delivered at the time of grant or at some deferred date specified in the Award Agreement, whether the Award is payable solely in Shares, cash or either and, if applicable, the time within which the Awardee must accept such offer. The offer shall be accepted by execution of the Award Agreement. The Administrator may require that all Shares subject to a right of repurchase or risk of forfeiture be held in escrow until such repurchase right or risk of forfeiture lapses. The grant or vesting of a Stock Award may be made contingent on the achievement of Objectively Determinable Performance Conditions. (b) Right of Repurchase. If so provided in the Award Agreement, Award Shares acquired pursuant to a Stock Award may be subject to repurchase by the Company or an Affiliate if not vested in accordance with the Award Agreement. (c) Form of Payment. If the Awardee is required to pay any amount to purchase Shares subject to the Stock Award, then the Administrator shall determine the acceptable form and method of payment for exercising a Stock Award. Acceptable forms of payment for all Award Shares are cash, check or wire transfer, denominated in U.S. dollars except as specified by the Administrator for non-U.S. sub-plans. In addition, the Administrator may permit payment to be made by any of the methods permitted with respect to the exercise of Options pursuant to Section 6.4. C-10 (d) Nonassignability of Stock Awards. Except as determined by the Administrator, no Stock Award shall be assignable or otherwise transferable by the Awardee except by will or by the laws of descent and distribution. Notwithstanding anything to the contrary herein, Stock Awards may be transferred and exercised in accordance with a Domestic Relations Order and in any manner allowed under the Form S-8 rules if so permitted by the Administrator. (e) Substitute Stock Award. The Board may cause the Company to grant Substitute Stock Awards in connection with the acquisition by the Company or an Affiliate of equity securities of any entity (including by merger) or all or a portion of the assets of any entity. Unless and to the extent specified otherwise by the Board, Substitute Stock Awards shall have the same terms and conditions as the stock awards they replace, except that (subject to the provisions of Section 10) Substitute Stock Awards shall be Stock Awards to purchase Shares rather than equity securities of the granting entity and shall have a Purchase Price that, as determined by the Board in its sole and absolute discretion, properly reflects the substitution. Any such Substituted Stock Award shall be effective on the effective date of the acquisition. 9. Exercise of Awards 9.1 In General. An Award shall be exercisable in accordance with this Plan and the Award Agreement under which it is granted. 9.2 Time of Exercise. Options and Stock Awards shall be considered exercised when the Company (or its authorized agent) receives: (a) written (including electronic) notice of exercise from the person entitled to exercise the Option or Stock Award, (b) full payment, or provision for payment, in a form and method approved by the Administrator, for the Shares for which the Option or Stock Award is being exercised, and (c) if applicable, payment, or provision for payment, in a form approved by the Administrator, of all applicable withholding taxes due upon exercise. An Award may not be exercised for a fraction of a Share. SARs shall be considered exercised when the Company receives written notice of the exercise from the person entitled to exercise the SAR. 9.3 Issuance of Award Shares. The Company shall issue Award Shares in the name of the person properly exercising the Award. If the Awardee is that person and so requests, the Award Shares shall be issued in the name of the Awardee and the Awardee’s spouse. The Company shall endeavor to issue Award Shares promptly after an Award is exercised or after the Grant Date of a Stock Award, as applicable. Until Award Shares are actually issued, as evidenced by the appropriate entry on the stock register of the Company or its transfer agent, the Awardee will not have the rights of a stockholder with respect to those Award Shares, even though the Awardee has completed all the steps necessary to exercise the Award. No adjustment shall be made for any dividend, distribution, or other right for which the record date precedes the date the Award Shares are issued, except as provided in Section 10 or with regard to Stock Awards, except as set forth in the Award Agreement. 9.4 Termination. (a) In General. Except as provided in an Award Agreement or in writing by the Administrator, including in an Award Agreement, and as otherwise provided in Sections 9.4(b), (c), and (d) after an Awardee’s Termination for other than Cause, the Awardee’s Awards shall be exercisable to the extent (but only to the extent) they are vested on the date of that Termination and only during the ninety (90) days after the Termination, but in no event after the Expiration Date. Except as provided in an Award Agreement, or otherwise in writing by the Administrator (including, pursuant to Section 9.4(d)(ii)), an Award shall terminate as to all Shares that are unvested as of the Awardee’s date of termination for any reason. Unless otherwise provided in the Award Agreement, in the event of termination for Cause the Award may not be exercised after the date of Termination (even as to vested Shares). To the extent the Awardee does not exercise an Award within the time specified for exercise, the Award shall automatically terminate. (b) Leaves of Absence. Unless otherwise provided in the Award Agreement, no Award may be exercised more than three months after the beginning of a leave of absence, other than a personal or medical leave approved by an authorized representative of the Company with employment guaranteed upon C-11 return. Awards shall not continue to vest during a leave of absence, unless otherwise determined by the Administrator with respect to an approved personal or medical leave with employment guaranteed upon return. (c) Death or Disability. Unless otherwise provided by the Administrator, if an Awardee’s Termination is due to death or disability (as determined by the Administrator with respect to all Awards other than Incentive Stock Options and as defined by Section 22(e) of the Code with respect to Incentive Stock Options), all Awards of that Awardee to the extent exercisable at the date of that Termination may be exercised for one year after that Termination, but in no event after the Expiration Date. In the case of Termination due to death, an Award may be exercised as provided in Section 16. In the case of Termination due to disability, if a guardian or conservator has been appointed to act for the Awardee and been granted this authority as part of that appointment, that guardian or conservator may exercise the Award on behalf of the Awardee. Death or disability occurring after an Awardee’s Termination shall not cause the Termination to be treated as having occurred due to death or disability. To the extent an Award is not so exercised within the time specified for its exercise, the Award shall automatically terminate. (d) Administrator Discretion. Notwithstanding the provisions of Section 9.4 (a)-(c), the Plan Administrator shall have complete discretion, exercisable either at the time an Award is granted or at any time while the Award remains outstanding, to: (i) After considering any tax and accounting consequences of such change, extend the period of time for which the Award is to remain exercisable, following the Awardee’s Termination, from the limited exercise period otherwise in effect for that Award to such greater period of time as the Administrator shall deem appropriate, but in no event beyond the Expiration Date; and/or (ii) Permit the Award to be exercised, during the applicable post-Termination exercise period, not only with respect to the number of vested Shares for which such Award may be exercisable at the time of the Awardee’s Termination but also with respect to one or more additional installments in which the Awardee would have vested had the Awardee not been subject to Termination. (e) Consulting or Employment Relationship. Nothing in this Plan or in any Award Agreement, and no Award or the fact that an Award remains unvested or that Award Shares remain subject to repurchase rights or other forfeiture conditions, shall: (A) interfere with or limit the right of the Company or any Affiliate to terminate the employment or consultancy of any Awardee at any time, whether with or without cause or reason, and with or without the payment of severance or any other compensation or payment, or (B) interfere with the application of any provision in any of the Company’s or any Affiliate’s charter documents or Applicable Law relating to the election, appointment, term of office, or removal of a Director. 10. Certain Transactions and Events 10.1 In General. Except as provided in this Section 10, the existence of outstanding Awards shall not affect in any way the right or power of the Company or its shareholders to make or authorize any or all adjustments, recapitalizations, reorganizations, exchanges, or other changes in the Company’s capital structure or its business, or any merger or consolidation of the Company or any issuance of Shares or other securities or subscription rights thereto, or any issuance of bonds, debentures, preferred or prior preference stock ahead of or affecting the Shares or other securities of the Company or the rights thereof, or the dissolution or liquidation of the Company, or any sale or transfer of all or any part of its assets or business, or any other corporate act or proceeding, whether of a similar character or otherwise. Further, except as expressly provided in this Section 10 or otherwise expressly provided for in a writing approved by the Board or Committee, (i) the issuance by the Company of shares of stock or any class of securities convertible into shares of stock of any class, for cash, property, labor or services, upon direct sale, upon the exercise of rights or warrants to subscribe therefor, or upon conversion of shares or obligations of the Company convertible into such shares or other securities, (ii) the payment of a dividend in property other than Shares, or (iii) the C-12 occurrence of any similar transaction, and in any case whether or not for fair value, shall not affect, and no adjustment by reason thereof shall be made with respect to, the number of Shares subject to Options or other Awards theretofore granted or the purchase or repurchase price per Share. 10.2 Changes in Capital Structure. In the event of any stock split, reverse stock split, recapitalization, combination or reclassification of stock, stock dividend, spin-off, extraordinary cash dividend or similar change to the capital structure of the Company (not including a Change of Control), the Board or Committee shall make appropriate adjustments to preserve the proportionate value of such Awards or the Plan to: (a) the number and type of Shares that may be granted subject to Awards granted under this Plan, (b) the number and type of Awards that may be granted to any individual under this Plan, (c) the terms of any SAR, (d) the Purchase Price or repurchase price of any Stock Award, (e) the Option Price and number and class of securities issuable under each outstanding Option, and (f) the repurchase price of any securities substituted for Award Shares that are subject to repurchase rights. The specific adjustments to be made to effectuate the intent of the preceding sentence shall be determined by the Board or the Committee, whose determination in this regard shall be final and binding on all parties. Unless the Board or Committee specifies otherwise, any securities issuable as a result of any such adjustment shall be rounded down to the next lower whole security. The Board or Committee need not adopt the same rules for each Award or each Awardee. 10.3 Change of Control Transactions. In the event of (a) any merger or consolidation in which the Company shall not be the surviving entity or survives only as a subsidiary of another entity whose shareholders did not own all or substantially all of the Common Stock in substantially the same proportions as immediately prior to such transaction (which transaction shall not include a merger or consolidation with a wholly-owned subsidiary, a reincorporation of the Company in a different jurisdiction, or other transaction in which there is no substantial change in the stockholders of the Company or their relative stock holdings and the Awards granted under this Plan are assumed, converted or replaced by the successor corporation, which assumption shall be binding on all Participants), (b) the sale, transfer or other disposition of all or substantially all of the assets of the Company, including a liquidation or dissolution of the Company, or (c) the acquisition, sale, or transfer of more than 50% of the outstanding shares of the Company by tender offer or similar transaction (each, a “Change of Control”), any or all outstanding Awards shall be subject to the definitive agreement governing the Change of Control transaction. Such transaction agreement may provide, without limitation and in a manner that is binding on all parties, for (1) the assumption, substitution or replacement with equivalent awards of outstanding Awards (but in each case adjusted to reflect the transaction terms) by the surviving corporation or its parent, (2) continuation of outstanding Awards (but again adjusted to reflect the transaction terms) by the Company if the Company is a surviving corporation, (3) accelerated vesting, or lapse of repurchase rights or forfeiture conditions applicable to, and accelerated expiration or termination of, the outstanding Awards, or (4) settlement of outstanding Awards (including termination thereof) in cash. Except for adjustments to reflect the transaction terms as referenced above or, to the extent any Award or Award Shares are subject to accelerated vesting or lapse of restrictions approved by the Board or Committee upon specific events or conditions (and then only to the extent such acceleration benefits are reflected in the transaction agreement, the applicable Award Agreement or another written agreement between the participant and the Company), any outstanding Awards that are assumed, substituted, replaced with equivalent awards or continued shall continue following the transaction to be subject to the same vesting or other restrictions that applied to the original Award. The Administrator need not adopt the same rules or apply the same treatment for each Award or Awardee. 10.4 Dissolution. Notwithstanding anything herein to the contrary, in the event of a dissolution or liquidation of the Company, to the extent an Award has not been exercised or the Shares subject thereto have not been issued in full prior to the earlier of the completion of the transaction or the applicable Award Expiration Date, then outstanding Awards shall terminate immediately prior to the transaction. C-13 11. Award Grants to Non-Employee Directors Consistent with the terms of this Plan and as reflected in individual Award Agreements, the Administrator or, if required by Applicable Law, the Board, may grant Awards to Directors who are not Employees (“Non-Employee Directors”) on such terms and conditions as it determines, including to provide for satisfaction of Director fee or retainer payments through issuance of Awards under the Plan. Such Awards may be done by establishing an annual or other periodic grant program, or may done through action taken to approve individual Awards from time to time. To the extent that the Administrator or the Board from time to time establish an annual or other periodic grant program for Non-Employee Directors, it may at any time amend, suspend or terminate such program with respect to Awards that have not yet been granted, without the need for approval from any Non-Employee Director who might otherwise have benefited from such Awards or from the stockholders. 12. Tax Matters 12.1 Tax Withholding. (a) General. Whenever Awards are granted, Award Shares vest, are issued or become free of restrictions, or Awards or Award Shares are transferred, the Company may require the Awardee to remit to the Company an amount sufficient to satisfy any applicable tax withholding requirement, whether the related tax is imposed on the Awardee or the Company. The Company shall have no obligation to deliver Award Shares or release Award Shares from an escrow or permit a transfer of Award Shares until the Awardee has satisfied those tax withholding obligations. The Awardee accepts this requirement as a condition of her or her receipt of the Award. To the extent any payment in satisfaction of Awards is made in cash, the payment will be reduced by an amount sufficient to satisfy all tax withholding requirements. (b) Method of Payment. The Awardee shall pay any required withholding using the forms of consideration described in Section 6.4(b), except that, in the discretion of the Administrator, the Company may also permit the Awardee to use any of the forms of payment described in Section 6.4(c). If the Administrator permits Award Shares to be withheld from the Award to satisfy applicable withholding obligations, the Fair Market Value of the Award Shares withheld, as determined as of the date of withholding, shall not exceed the amount determined by the applicable minimum statutory withholding rates to the extent the Administrator determines such limit is necessary or advisable in light of generally accepted accounting principles. 12.2 Reporting of Dispositions. Any holder of Option Shares acquired under an Incentive Stock Option shall promptly notify the Administrator, following such procedures as the Administrator may require, of the sale or other disposition of any of those Option Shares if the disposition occurs during: (a) the longer of two years after the Grant Date of the Incentive Stock Option and one year after the date the Incentive Stock Option was exercised, or (b) such other period as the Administrator has established. 12.3 Liability for Applicable Taxes. Regardless of any action the Company or the Awardee’s employer (the “Employer”) takes with respect to any or all income tax, social security, payroll tax, payment on account, other tax-related withholding or information reporting (“Tax-Related Items”), the Awardee acknowledges and agrees that the ultimate liability for all Tax-Related Items legally due by him is and remains the Awardee ’s responsibility and that the Company and or the Employer (i) make no representations nor undertakings regarding the treatment of any Tax-Related Items in connection with any aspect of an Award; and (ii) do not commit to structure the terms or any aspect of an Award granted hereunder to reduce or eliminate the Awardee ’s liability for Tax- Related Items. The Awardee shall pay the Company or the Employer any amount of Tax-Related Items that the Company or the Employer may be required to withhold as a result of the Awardee’s participation in the Plan that cannot be satisfied by the means previously described. The Company may refuse to deliver any benefit under the Plan if the Awardee fails to comply with his or her obligations in connection with the Tax- Related Items. C-14 13. Compliance with Law 13.1 General. The grant of Awards and the issuance and subsequent transfer of Award Shares shall be subject to compliance with all Applicable Law, including all applicable securities laws. Awards may not be exercised, and Award Shares may not be transferred, in violation of Applicable Law. Thus, for example, Awards may not be exercised or issued unless: (a) a registration statement under the Securities Act is then in effect with respect to the related Award Shares, or (b) in the opinion of legal counsel to the Company, those Award Shares may be issued in accordance with an applicable exemption from the registration requirements of the Securities Act and any other applicable securities laws. The failure or inability of the Company to obtain from any regulatory body the authority considered by the Company’s legal counsel to be necessary or useful for the lawful issuance of any Award Shares or their subsequent transfer shall relieve the Company of any liability for failing to issue those Award Shares or permitting their transfer. As a condition to the exercise of any Award or the transfer of any Award Shares, the Company may require the Awardee to satisfy any requirements or qualifications that may be necessary or appropriate to comply with or evidence compliance with any Applicable Law. The Company shall have no liability to any Awardee or any party who might claim through the Awardee to the extent that the Awardee (or his or her permitted transferee) is required to forfeit an Award, or the benefits received or to be received under an Award, pursuant to any Applicable Law. 13.2 Tax Matters. Notwithstanding anything to the contrary contained herein, to the extent that the Administrator determines that any Award granted under the Plan is subject to Code Section 409A and unless otherwise specified in the applicable Award Agreement, the Award Agreement evidencing such Award shall incorporate the terms and conditions necessary for such Award to avoid the consequences described in Code Section 409A(a)(1), and to the maximum extent permitted under Applicable Law (and unless otherwise stated in the applicable Award Agreement), the Plan and the Award Agreements shall be interpreted in a manner that results in their conforming to the requirements of Code Section 409A(a)(2), (3) and (4) and any Department of Treasury or Internal Revenue Service regulations or other interpretive guidance issued under Section 409A (whenever issued, the “Guidance”). Notwithstanding anything to the contrary in this Plan (and unless the Award Agreement provides otherwise, with specific reference to this sentence), to the extent that a Participant holding an Award that constitutes “deferred compensation” under Section 409A and the Guidance is a “specified employee” (also as defined thereunder), no distribution or payment of any amount shall be made before a date that is six months following the date of such Participant’s “separation from service” (as defined in Section 409A and the Guidance) or, if earlier, the date of the Participant’s death. 14. Amendment or Termination of this Plan or Outstanding Awards 14.1 Amendment and Termination. The Board may at any time amend, suspend, or terminate this Plan. 14.2 Stockholder Approval. The Company shall obtain the approval of the Company’s stockholders for any amendment to this Plan if stockholder approval is necessary or desirable to comply with any Applicable Law or with the requirements applicable to the grant of Awards intended to be Incentive Stock Options; provided however that the Company shall obtain stockholder approval of any of the following: (a) other than an increase under Section 10.2, an increase to the Shares reserved for issuance hereunder; (b) an expansion of the class of persons eligible to receive Awards hereunder; or (c) any amendment of outstanding Options or SARs that effects a repricing of such Awards or other lowering of the original Option Price or grant date Fair Market Value that applies to a SAR. For Stock Awards to continue to be eligible to qualify as “performance- based compensation” under Code Section 162(m), the Company’s stockholders must re-approve the material terms of the performance goals included in the Plan by the date of the first stockholder meeting that occurs in the fifth year following the year in which the stockholders first approved the Plan. The Board may also, but need not, require that the Company’s stockholders approve any other amendments to this Plan. 14.3 Effect. No amendment, suspension, or termination of this Plan, and no modification of any Award even in the absence of an amendment, suspension, or termination of this Plan, shall impair any existing contractual rights of any Awardee unless the affected Awardee consents to the amendment, suspension, termination, or modification. Notwithstanding anything herein to the contrary, no such consent C-15 shall be required if the Board determines, in its sole and absolute discretion, that the amendment, suspension, termination, or modification: (a) is required or advisable in order for the Company, this Plan or the Award to satisfy Applicable Law, to meet the requirements of any accounting standard or to avoid any adverse accounting treatment, or (b) in connection with any transaction or event described in Section 10, is in the best interests of the Company or its stockholders. The Board may, but need not, take the tax or accounting consequences to affected Awardees into consideration in acting under the preceding sentence. Those decisions shall be final, binding and conclusive. Termination of this Plan shall not affect the Administrator’s ability to exercise the powers granted to it under this Plan with respect to Awards granted before the termination of Award Shares issued under such Awards even if those Award Shares are issued after the termination. 15. Reserved Rights 15.1 Nonexclusivity of this Plan. This Plan shall not limit the power of the Company or any Affiliate to adopt other incentive arrangements including, for example, the grant or issuance of stock options, stock, or other equity-based rights under other plans. 15.2 Unfunded Plan. This Plan shall be unfunded. Although bookkeeping accounts may be established with respect to Awardees, any such accounts will be used merely as a convenience. The Company shall not be required to segregate any assets on account of this Plan, the grant of Awards, or the issuance of Award Shares. The Company and the Administrator shall not be deemed to be a trustee of stock or cash to be awarded under this Plan. Any obligations of the Company to any Awardee shall be based solely upon contracts entered into under this Plan, such as Award Agreements. No such obligations shall be deemed to be secured by any pledge or other encumbrance on any assets of the Company. Neither the Company nor the Administrator shall be required to give any security or bond for the performance of any such obligations. 16. Special Arrangements Regarding Award Shares 16.1 Escrow of Stock Certificates. To enforce any restrictions on Award Shares, the Administrator may require their holder to deposit the certificates representing Award Shares, with stock powers or other transfer instruments approved by the Administrator endorsed in blank, with the Company or an agent of the Company to hold in escrow until the restrictions have lapsed or terminated. The Administrator may also cause a legend or legends referencing the restrictions to be placed on the certificates. 16.2 Repurchase Rights. (a) General. If a Stock Award is subject to vesting or other forfeiture conditions, the Company shall have the right, during such period after the Awardee’s Termination as is specified by the Administrator to repurchase any or all of the Award Shares that were unvested or otherwise subject to forfeiture as of the date of that Termination. The repurchase price shall be such price as is determined by the Administrator and set forth in the Award Agreement, subject to adjustment under Section 10. The repurchase price shall be paid in cash. The Company may assign this right of repurchase. (b) Procedure. The Company or its assignee may choose to give the Awardee a written notice of exercise of its repurchase rights under this Section 16.2. However, the Company’s failure to give such a notice shall not affect its rights to repurchase Award Shares. The Company must, however, tender the repurchase price during the period specified in this Section 16.2 for exercising its repurchase rights in order to exercise such rights. 16.3 Deferral of Award Benefits. The Administrator may in its discretion and upon such terms and conditions as it determines appropriate permit one or more Participants whom it selects to (a) defer compensation payable pursuant to the terms of an Award, or (b) defer compensation arising outside the terms of this Plan pursuant to a program that provides for deferred payment in satisfaction of such other compensation amounts through the issuance of one or more Awards. Any such deferral arrangement shall be evidenced by an Award Agreement in such form as the Administrator shall from time to time establish, and no such deferral arrangement shall be a valid and binding obligation unless evidenced by a fully executed Award Agreement, the form of which the Administrator has approved, including through the Administrator’s C-16 establishing a written program (the “Program”) under this Plan to govern the form of Award Agreements participating in such Program. Any such Award Agreement or Program shall specify the treatment of dividends or dividend equivalent rights (if any) that apply to Awards governed thereby, and shall further provide that any elections governing payment of amounts pursuant to such Program shall be in writing, shall be delivered to the Company or its agent in a form and manner that complies with Code Section 409A and the Guidance, and shall specify the amount to be distributed in settlement of the deferral arrangement, as well as the time and form of such distribution in a manner required by the Administrator, and shall specify the amount to be distributed in settlement of the deferral arrangement, as well as the time and form of such distribution. 17. Beneficiaries An Awardee may file a written designation of one or more beneficiaries who are to receive the Awardee’s rights under the Awardee’s Awards after the Awardee’s death. An Awardee may change such a designation at any time by written notice. If an Awardee designates a beneficiary, the beneficiary may exercise the Awardee’s Awards after the Awardee’s death. If an Awardee dies when the Awardee has no living beneficiary designated under this Plan, the Company shall allow the executor or administrator of the Awardee’s estate to exercise the Award or, if there is none, the person entitled to exercise the Option under the Awardee’s will or the laws of descent and distribution; provided the Company may require of any such person, evidence of authority to act in such capacity as it deems appropriate. In any case, no Award may be exercised after its Expiration Date. 18. Miscellaneous 18.1 Governing Law. This Plan, the Award Agreements and all other agreements entered into under this Plan, and all actions taken under this Plan or in connection with Awards or Award Shares, shall be governed by the laws of the State of Delaware. 18.2 Determination of Value. Fair Market Value shall be determined as follows: (a) Listed Stock. If the Shares are traded on any established stock exchange or quoted on a national market system, Fair Market Value shall be the closing sales price for the Shares as quoted on that stock exchange or system for the date the value is to be determined (the “Value Date”) as reported in The Wall Street Journal or a similar publication. If no sales are reported as having occurred on the Value Date, Fair Market Value shall be that closing sales price for the last preceding trading day on which sales of Shares are reported as having occurred. If no sales are reported as having occurred during the five trading days before the Value Date, Fair Market Value shall be the closing bid for Shares on the Value Date (or on the last preceding date on which a closing bid for the Shares was made). If Shares are listed on multiple exchanges or systems, Fair Market Value shall be based on sales or bid prices on the primary exchange or system on which Shares are traded or quoted. (b) Stock Quoted by Securities Dealer. If Shares are regularly quoted by a recognized securities dealer but selling prices are not reported on any established stock exchange or quoted on a national market system, Fair Market Value shall be the mean between the high bid and low asked prices on the Value Date. If no prices are quoted for the Value Date, Fair Market Value shall be the mean between the high bid and low asked prices on the last preceding trading day on which any bid and asked prices were quoted. (c) No Established Market. If Shares are not traded on any established stock exchange or quoted on a national market system and are not quoted by a recognized securities dealer, and unless otherwise required by Applicable Law, the Administrator (following guidelines established by the Board or Committee) will determine Fair Market Value in good faith using any reasonable valuation method. The Administrator will consider the following factors, and any others it considers significant, in determining Fair Market Value: (i) the price at which other securities of the Company have been issued to purchasers other than Employees, Directors, or Consultants, (ii) the Company’s stockholder’s equity, prospective earning power, dividend-paying capacity, present value of future cash flows, and value of tangible and intangible C-17 assets, if any, and (iii) any other relevant factors, including the economic outlook for the Company and the Company’s industry, the Company’s position in that industry, the Company’s goodwill and other intellectual property, and the values of securities of other businesses in the same industry. 18.3 Reservation of Shares. During the term of this Plan, the Company shall at all times reserve and keep available such number of Shares as are still issuable under this Plan. 18.4 Electronic Communications. Any Award Agreement, notice of exercise of an Award, or other document required or permitted by this Plan may be delivered in writing or, to the extent determined by the Administrator, electronically. Signatures may also be electronic if permitted by the Administrator. 18.5 Notices. Unless the Administrator specifies otherwise, any notice to the Company under any Option Agreement or with respect to any Awards or Award Shares shall be in writing (or, if so authorized by Section 18.4, communicated electronically), shall be addressed to the Secretary of the Company, and shall only be effective when received by the Secretary of the Company. C-18 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (MARK ONE) FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended June 25, 2006 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________ TO __________ Commission file number: 0-12933 LAM RESEARCH CORPORATION (Exact name of registrant as specified in its charter) Delaware (State or other jurisdiction of incorporation or organization) 4650 Cushing Parkway Fremont, California (Address of principal executive offices) 94-2634797 (I.R.S. Employer Identification No.) 94538 (Zip code) Registrant’s telephone number, including area code: (510) 572-0200 Securities registered pursuant to Section 12(b) of the Act: Common Stock, Par Value $0.001 Per Share Securities registered pursuant to Section 12(g) of the Act: None (Title of class) Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [X] No [ ] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X] Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] The aggregate market value of the Registrant’s Common Stock, $0.001 par value, held by non-affiliates of the Registrant, as of December 25, 2005, the last business day of the most recently completed second fiscal quarter was $3,442,134,484. Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock has been excluded from this computation in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination of such status for other purposes. As of August 4, 2006, the Registrant had 141,861,073 outstanding shares of Common Stock. DOCUMENTS INCORPORATED BY REFERENCE Parts of the Registrant’s Proxy Statement for the Annual Meeting of Stockholders to be held on November 2, 2006 are incorporated by reference into Part III of this Form 10-K Report. (The Report of the Audit Committee, Compensation Committee, and the Comparative Stock Performance graph of the Registrant’s Proxy Statement are expressly not incorporated by reference herein.) (This page is intentionally left blank.) LAM RESEARCH CORPORATION 2006 ANNUAL REPORT ON FORM 10-K TABLE OF CONTENTS Part I. Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 1A. Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 2 9 Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Part II. Item 5. Market for the Registrant’s Common Stock and Related Stockholder Matters . . . . . . . . . . . . . 18 Item 6. Selected Consolidated Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations . . 21 Item 7A. Quantitative and Qualitative Disclosures about Market Risk . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Item 8. Consolidated Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . 34 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . . 35 Item 9A. Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 Item 9B. Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 Part III. Item 10. Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 Item 14. Principal Independent Registered Public Accounting Firm Fees and Services . . . . . . . . . . . . 36 Part IV. Item 15. Exhibits, Consolidated Financial Statement Schedules, and Reports on Form 8-K . . . . . . . . . 37 Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 Exhibit Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 1 PART I CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS With the exception of historical facts, the statements contained in this discussion are forward-looking statements, which are subject to the safe harbor provisions created by the Private Securities Litigation Reform Act of 1995. Certain, but not all, of the forward-looking statements in this report are specifically identified. The identification of certain statements as “forward-looking” is not intended to mean that other statements not specifically identified are not forward-looking. Forward-looking statements include, but are not limited to, statements that relate to our future revenue, product development, demand, acceptance and market share, competitiveness, gross margins, levels of research and development (R&D), outsourcing plans and operating expenses, tax expenses, our management’s plans and objectives for our current and future operations, management’s plans for repurchasing Company stock pursuant to the authorization of our Board, the levels of customer spending or R&D activities, general economic conditions and the sufficiency of financial resources to support future operations, and capital expenditures. Such statements are based on current expectations and are subject to risks, uncertainties, and changes in condition, significance, value and effect, including those discussed below under the heading “Risk Factors” within Item 1A of this report and other documents we file from time to time with the Securities and Exchange Commission (SEC), such as our quarterly reports on Form 10-Q and our current reports on Form 8-K. Such risks, uncertainties and changes in condition, significance, value and effect could cause our actual results to differ materially from those expressed herein and in ways not readily foreseeable. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof and are based on information currently and reasonably known to us. We undertake no obligation to release the results of any revisions to these forward-looking statements, which may be made to reflect events or circumstances which occur after the date hereof or to reflect the occurrence or effect of anticipated or unanticipated events. All references to fiscal years apply to our fiscal years, which ended June 25, 2006, June 26, 2005, and June 27, 2004. Item 1. Business Lam Research Corporation (Lam or the Company), a Delaware corporation, was founded in 1980 and is headquartered in Fremont, California. The mailing address for our principal executive offices is 4650 Cushing Parkway, Fremont, California 94538, and our telephone number is (510) 572-0200. Additional information about Lam is available on our web site at http://www.lamresearch.com. Our Forms 10-K, Forms 10-Q, and Forms 8-K are available online at the Securities and Exchange Commission (SEC) web site on the Internet. The address of that site is http://www.sec.gov. We also make available free of charge the Forms 10-K, Forms 10-Q, and Forms 8-K and any amendments to those reports on our corporate web site at http://www.lamresearch.com as soon as reasonably possible after we file them with or furnish them to the SEC. We design, manufacture, market, and service semiconductor processing equipment used in the fabrication of integrated circuits and are recognized as a major provider of such equipment to the worldwide semiconductor industry. Semiconductor wafers are subjected to a complex series of process steps that result in the simultaneous creation of many individual integrated circuits. Our products selectively remove portions of various films from the wafer in the creation of semiconductors. We leverage our expertise in these areas to develop intellectual property (IP) for integrated processing solutions. Etch Process Etch processes, which are repeated numerous times during the wafer fabrication cycle, are required to manufacture every type of semiconductor device produced today. To etch devices designed at current and future technology nodes, our etch systems employ various technologies utilized to generate plasma sources, a critical requirement of the etch process. The etch process defines linewidths and other microscopic and sub-microscopic features on integrated circuits. Plasma etching was developed to meet the demand for device geometries smaller than 3 microns. Plasma consists of charged and neutral species that react with exposed portions of the wafer surface to remove dielectric, metal, or polysilicon material and produce the finely delineated features and patterns of an integrated circuit. 2 Advanced integrated circuit manufacturing requires etch systems capable of creating structures for the 90/65 nanometer (nm) technology node for current-generation products and for the 65 nm and below technology nodes for future semiconductor products. At this time, memory manufacturers are continuing to transition from aluminum to copper conductive lines, while leading logic manufacturers are progressing with the implementation of more fragile dielectric insulating materials (low k and porous low k). Advanced manufacturing facilities are producing integrated circuits on 300 millimeter (mm) (12 inch) silicon wafers while other facilities use wafer diameters of 200 mm (8 inch) and smaller. Semiconductor manufacturers will continue to require more precise control over the etching process in order to accommodate these decreasing linewidths and increasing wafer diameters. Our etch products and services are defined around the Alliance® and 2300® Etch Series platforms. Dielectric Etch Products Exelan®, Exelan High Performance, Exelan HPT, 2300 Exelan, 2300 Exelan Flex™, and 2300 Exelan Flex45™ Systems. The Exelan family of products improves productivity and enables our customers to create today’s most advanced semiconductor devices. These systems, based on Lam’s patented Dual Frequency Confined (DFC) technology, can be extended to keep pace with the semiconductor industry’s roadmap for etching smaller features and newer dielectric materials. Exelan was introduced to meet the requirements for manufacturing copper conductive lines using dual damascene etch schemes. Exelan has been extended through a series of performance improvement upgrades, Exelan High Performance and Exelan HPT, to meet the etch requirements for the sub-130 nm technology node. The 2300 Exelan, which was introduced to address the industry’s transition to 300 mm wafers, is a 200 mm and 300 mm wafer capable product. The 2300 Exelan Flex and Exelan Flex45 extend the capability of the 2300 Exelan family of products to address the requirements for 65 nm and below technology nodes. Conductor Etch Products TCP® 9400 and TCP® 9600 Series and 2300 Versys® Series Systems. The first TCP products were introduced in late 1992. They use Lam’s patented Transformer Coupled Plasma™ source technology, a high-density, low- pressure plasma source that can etch features for the 130 nm and below technology nodes. For 200 mm wafer sizes, we offer the TCP® 9400PTX and TCP® 9400DFM for silicon etch applications, the TCP® 9400DSiE™ for MEMS (micro-electromechanical systems) based deep silicon etch, and the TCP® 9600PTX and TCP® 9600DFM for metal etch applications. These systems are used in the production of a broad range of advanced logic and memory devices as well as MEMS applications. The 2300 Versys system for etching silicon and metal films employs a scaled design of TCP technology to address leading-edge device structure requirements. The 2300 Versys system has the capability to process 200 mm and 300 mm wafer sizes. The 2300 Versys HP addresses metal etch requirements for the 90 nm node and beyond. The 2300 Versys Metal45™ addresses backend metal etch uniformity and throughput needs for memory customers at 70 nm and beyond as well as metal hard mask applications for logic customers at 45 nm and beyond. The 2300 Versys Star™ silicon etch system enables sequential step tuning of gas flow and wafer temperature, which provides the critical dimension uniformity required for sub-110 nm technology nodes. The 2300 Versys Kiyo™ and Versys Kiyo45 enable processing at sub-65 nm technology nodes. Lam 2300 process chambers can be converted within our customers’ facilities from 200 mm to 300 mm, which has the advantage of providing customers with greater flexibility and lower costs. This capability, combined with an overall system footprint comparable to 200 mm systems, allows semiconductor manufacturers to develop integrated circuits using 200 mm wafers instead of more expensive 300 mm wafers and later scale up to 300 mm wafer processing. Resist Strip Products Lam offers integrated strip modules that remove the photoresist following metal and silicon etch for both 200 mm and 300 mm wafer manufacturing. Stripping the resist on the same system prevents exposure to air, protecting the wafers from corrosion. For 65 nm technologies and below, resist stripping after ion implantation is becoming a critical step because of the difficulty in fully cleaning resist residues without removing too much of the silicon. To address 3 this emerging market, Lam has extended its successful silicon etch product line used in combination with a microwave resist stripper for both 200 mm and 300 mm wafer processing. Cleaning Process As semiconductor devices are manufactured through a series of deposition and patterning steps, wafers must be cleaned periodically to remove residues and contamination that could degrade device performance. These cleaning operations, which typically follow a plasma etch or strip step, involve placing a wafer in contact with a liquid cleaning agent, which removes surface residues through a combination of reaction and dissolution. At the 65 nm technology node and below, wafer cleaning is becoming increasingly challenging because the smaller, more fragile devices are more susceptible to damage from the chemistries and mechanical forces of the cleaning process. As a result, many semiconductor manufacturers are transitioning from batch to single-wafer cleaning systems, which enable better control of the cleaning process. Lam provides technologies that it believes address the damage concerns of wafer cleaning at sub-65 nm, allowing chemical cleaning to be extended to future technology nodes. 2300 cleaning products. Based on the production-proven 2300 Etch platform, Lam’s products are designed to offer cleaning capability for sub-65 nm technologies. Lam’s proprietary Confined Chemical Cleaning™ technology provides a short chemical exposure time that limits contact with device structures, thereby lowering the risk of damage. In addition, the short exposure time allows greater flexibility in selecting cleaning chemicals for effective removal of process residues. There were no fiscal year 2006 revenues from 2300 cleaning products. 2300 Bevel Clean product. Lam offers bevel clean modules that remove films on the edge of the wafer using edge confined plasma technology. For 65 nm technologies and below, a primary source of device yield limiters are coming from defects transferred from the wafer edge. During device patterning, complex interactions of film deposition, lithography, etching and chemical mechanical polishing (CMP) result in a wide range of unstable film stacks on the wafer edge. In subsequent steps these film layers can produce defects that are transported to the device area of the wafer. Removal of these films at select points in the integration flow results in reduced defects and higher device yields. To address this emerging market, Lam’s edge confined plasma provides customers with the latitude to control the wafer edge at multiple steps during the device fabrication process. Plasma processing can remove a broad range of films with precise control of the processing zone. There were no fiscal year 2006 revenues from 2300 Bevel Clean products. 9400, 9600, Confined Chemical Cleaning, DFC, DFM, DSiE, Dual Frequency Confined, Flex, Kiyo, Kiyo45, Metal45, PTX, Star, and Transformer Coupled Plasma are trademarks of Lam Research Corporation. 2300, Alliance, DSS, Exelan, the Lam logo, Lam Research, TCP, and Versys are registered trademarks of Lam Research Corporation. Research and Development The market for semiconductor capital equipment is characterized by rapid technological change and product innovation. Our ability to maintain competitive advantage depends in part on our continued and timely development of new products and enhancements to existing products. Accordingly, we devote a significant portion of our personnel and financial resources to R&D programs and seek to maintain close and responsive relationships with our customers and suppliers. Our R&D expenses during fiscal years 2006, 2005, and 2004 were $228.9 million, $194.1 million, and $170.5 million, respectively. Expenditures are targeted at developing new product areas and continued enhancements to our existing products. We believe current challenges for customers in the pre- and post-etch applications present opportunities for us. Many of these challenges are new and are a result of the transition to sub 90-nanometer device structures. We plan to leverage our extensive production experience in etch and strip into new products and new capabilities for our customers at the 65, 45, and 32-nanometer nodes, including post ion implantation strip, clean, and patterning. We expect to continue to make substantial investments in R&D to meet our customers’ product needs and enhance our competitive position. 4 Marketing, Sales, and Service Our marketing and sales efforts are focused on building long-term relationships with our customers. These efforts are supported by a team of product marketing and sales professionals as well as equipment and process engineers that work closely with individual customers to develop solutions to their processing needs. We maintain ongoing support relationships with our customers and have an extensive network of field service personnel in place throughout the United States, Europe, Korea, Japan and Asia Pacific. We believe that comprehensive support programs and close working relationships with customers are essential to maintaining high customer satisfaction and our competitiveness in the marketplace. We offer standard warranties for our systems that generally run for a period of 12 months from system acceptance, not to exceed 14 months from shipment of the system to the customer. The warranty provides that systems shall be free from defects in material and workmanship and conform to our published specifications. The warranty is limited to repair of the defect or replacement with new or like-new equivalent goods and is valid when the buyer provides prompt notification within the warranty period of the claimed defect or non-conformity and also makes the items available for inspection and repair. We also offer extended warranty packages to our customers to purchase as desired. Export Sales A significant portion of our sales and operations occur outside the United States and, therefore, may be subject to certain risks, including but not limited to tariffs and other barriers, difficulties in staffing and managing non-U.S. operations, adverse tax consequences, exchange rate fluctuations, changes in currency controls, compliance with U.S. and international laws and regulations, including U.S. export restrictions, and economic and political conditions. There can be no assurance that any of these factors will not have a material adverse effect on our business, financial position, and results of operations and cash flows. Sales were as follows: June 25, 2006 Net sales: United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Asia Pacific . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Korea . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Japan. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 238,009 208,369 470,912 366,939 357,942 $ 1,642,171 Year Ended June 26, 2005 (in thousands) $ 234,112 184,014 582,033 280,605 221,689 $ 1,502,453 June 27, 2004 $ 164,528 177,380 397,681 92,063 104,294 $ 935,946 Customers Our customers include many of the world’s leading semiconductor manufacturers. Customers continue to establish joint ventures, alliances and technology licensing arrangements, which have the potential to positively or negatively impact our competitive position. In fiscal year 2006, revenues from Samsung Electronics Company, Ltd., accounted for approximately 15% of total revenues and revenues from Toshiba Corporation accounted for approximately 12% of total revenues. In fiscal year 2005, revenues from Samsung Electronics Company, Ltd., accounted for approximately 13% of total revenues, and, in fiscal year 2004, revenues from ST Microelectronics accounted for approximately 15% of total revenues. A material reduction in orders from our customers in the semiconductor industry could adversely affect our results of operations and projected financial condition. Our business depends upon the expenditures of semiconductor manufacturers. Semiconductor manufacturers’ business, in turn, depends on the current and anticipated market demand for integrated circuits and the availability of equipment capacity to support that demand. 5 Backlog Our unshipped orders backlog includes orders for systems, spares, and services where written customer requests have been accepted and the delivery of products or provision of services is anticipated within the next 12 months. Our policy is to revise our backlog for order cancellations and to make adjustments to reflect, among other things, spares volume estimates and customer delivery date changes. We schedule production of our systems based upon purchase orders in backlog and our customers’ delivery requirements. Included in our systems backlog are orders for which written requests have been accepted, prices and product specifications have been agreed upon, and shipment of systems is expected within one year. The spares and services backlog includes customer orders for products that have not yet shipped and for services that have not yet been provided. Where specific spare parts and customer service purchase contracts do not contain discrete delivery dates, we use volume estimates at the contract price and over the contract period, not exceeding 12 months, in calculating backlog amounts. As of June 25, 2006 and June 26, 2005, our backlog was approximately $521 million and $351 million, respectively. Generally, orders for our products and services are subject to cancellation by our customers with limited penalties. Because some orders are received for shipments in the same quarter and due to possible customer changes in delivery dates and cancellations of orders, our backlog at any particular date is not necessarily indicative of business volumes or actual revenue levels for succeeding periods. Manufacturing Our manufacturing operations consist mainly of assembling and testing components, sub-assemblies, and modules that are then integrated into finished systems prior to shipment to our customers. Most of the assembly and testing of our products is conducted in cleanroom environments. We have agreements with third parties to outsource certain aspects of our manufacturing, production warehousing, and logistics functions. We continue to believe that these outsourcing contracts provide us more flexibility to scale our operations up or down in a more timely and cost effective manner, enabling us to respond to the cyclical nature of our business. We believe that we have selected reputable providers and have secured their performance on terms documented in written contracts. However, it is possible that one or more of these providers could fail to perform as we expect, and such failure could have an adverse impact on our business and have a negative effect on our operating results and financial condition. Overall, we believe we have effective mechanisms to manage risks associated with our outsourcing relationships. Refer to Note 15 of our Consolidated Financial Statements, included in Item 8 herein, for further information concerning our outsourcing commitments. Certain components and subassemblies included in our products are only obtained from a single supplier. We believe that, in many cases, alternative sources could be obtained and qualified to supply these products. Nevertheless, a prolonged inability to obtain these components could have an adverse effect on our operating results and could unfavorably impact our customer relationships. Environmental Matters We are subject to a variety of governmental regulations related to the management of hazardous materials. We are currently not aware of any pending notices of violation, fines, lawsuits, or investigations arising from environmental matters that would have any material effect on our business. We believe that we are in general compliance with these regulations and that we have obtained (or will obtain or are otherwise addressing) all necessary environmental permits to conduct our business. Nevertheless, the failure to comply with present or future regulations could result in fines being imposed on us, suspension of production, and cessation of our operations or reduction in our customers’ acceptance of our products. These regulations could require us to alter our current operations, to acquire significant equipment, or to incur substantial other expenses to comply with environmental regulations. Our failure to control the use, sale, transport or disposal of hazardous substances could subject us to future liabilities. Employees As of August 4, 2006, we had approximately 2,430 regular full-time employees. 6 Each of our employees is required to sign an agreement to maintain the confidentiality of our proprietary information. All employees are required to sign an acknowledgement that they have read and agree to abide by a statement of standards of business conduct. In the semiconductor and semiconductor equipment industries, competition for highly skilled employees is intense. Our future success depends to a significant extent upon our continued ability to attract and retain qualified employees, particularly in the R&D and customer support functions. Competition The semiconductor capital equipment industry is characterized by rapid change and is highly competitive throughout the world. In order to compete effectively, we invest significant financial resources to continue to strengthen and enhance our product and services portfolio and to maintain customer service and support locations globally. Semiconductor manufacturers evaluate capital equipment suppliers in many areas, including, but not limited to, process performance, productivity, customer support, defect control, and overall cost of ownership, which can be affected by many factors such as equipment design, reliability, software advancements, etc. Our ability to succeed in the marketplace will depend upon our ability to maintain existing products and introduce product enhancements and new products on a timely basis. In addition, semiconductor manufacturers must make a substantial investment to qualify and integrate new capital equipment into semiconductor production lines. As a result, once a semiconductor manufacturer has selected a particular supplier’s equipment and qualified it for production, the manufacturer generally maintains that selection for that specific production application and technology node. Accordingly, we may experience difficulty in selling to a given customer if that customer has qualified a competitor’s equipment. We must also continue to meet the expectations of our installed base of customers through the delivery of high-quality and cost efficient spare parts in the presence of third-party spares provider competition. We face significant competition with all of our products and services. Certain of our existing and potential competitors have substantially greater financial resources and more extensive engineering, manufacturing, marketing, and customer service and support organizations than we do. We expect our competitors to continue to improve the design and performance of their current products and processes and to introduce new products and processes with enhanced price/performance characteristics. If our competitors make acquisitions or enter into strategic relationships with leading semiconductor manufacturers, or other entities, covering products similar to those we sell, our ability to sell our products to those customers could be adversely affected. There can be no assurance that we will continue to compete successfully in the future. Our primary competitors in the etch market are Tokyo Electron, Ltd. and Applied Materials, Inc. Patents and Licenses Our policy is to seek patents on inventions relating to new or enhanced products and processes developed as part of our ongoing research, engineering, manufacturing, and support activities. We currently hold a number of United States and foreign patents covering various aspects of our products and processes. We believe that the duration of our patents generally exceeds the useful life of the technologies and processes disclosed and claimed therein. Our patents, which cover material aspects of our past and present core products, have current durations ranging from approximately 3 to 17 years. We believe that, although the patents we own and may obtain in the future will be of value, they will not alone determine our success, which depends principally upon our engineering, marketing, support, and delivery skills. However, in the absence of patent protection, we may be vulnerable to competitors who attempt to imitate our products, manufacturing techniques, and processes. In addition, other companies and inventors may receive patents that contain claims applicable or similar to our products and processes. The sale of products covered by patents of others could require licenses that may not be available on terms acceptable to us, or at all. For further discussion of legal matters, see Item 3, “Legal Proceedings,” of this Form 10-K. Other Cautionary Statements See the discussion of risks in the section of this Form 10-K entitled Item 1A, “Risk Factors.” 7 EXECUTIVE OFFICERS OF THE COMPANY As of August 16, 2006, the executive officers of Lam were as follows: Name James W. Bagley Stephen G. Newberry Martin B. Anstice Nicolas J. Bright Ernest E. Maddock Abdi Hariri Age 67 52 39 50 48 45 Title Executive Chairman President and Chief Executive Officer Group Vice President, Chief Financial Officer and Chief Accounting Officer Executive Vice President, Regional Business and Global Products Group Vice President, Global Operations Vice President and General Manager, Customer Support Business Group James W. Bagley was Chief Executive Officer and a Director of the Company since the merger of Lam and OnTrak Systems, Inc., in 1997. Effective September 1, 1998, he was appointed Chairman of the Board. On June 27, 2005, Mr. Bagley transitioned from Chairman of the Board and Chief Executive Officer to Executive Chairman of the Board of Lam. Mr. Bagley currently is a director of Teradyne, Inc. and Micron Technology, Inc. From June 1996 to August 1997, Mr. Bagley served as Chairman of the Board and Chief Executive Officer of OnTrak Systems, Inc. He was formerly Chief Operating Officer and Vice Chairman of the Board of Applied Materials, Inc., where he also served in other senior executive positions during his 15-year tenure. Mr. Bagley held various management positions at Texas Instruments, Inc., before he joined Applied Materials, Inc. Stephen G. Newberry joined the Company in August 1997 as Executive Vice President and Chief Operating Officer. He was appointed President and Chief Operating Officer of Lam in July 1998 and President and Chief Executive Officer in June 2005. Mr. Newberry currently serves as a director of Lam Research Corporation; SEMI, the industry’s trade association; and Nextest Systems Corporation. Prior to joining Lam, Mr. Newberry served as Group Vice President of Global Operations and Planning at Applied Materials, Inc. During his 17 years at Applied Materials, he held various positions of increased responsibility including assignments in manufacturing, product development, sales and marketing, and customer service. Mr. Newberry is a graduate of the U.S. Naval Academy and the Harvard Graduate School of Business Program for Management Development and served 5 years in naval aviation prior to joining Applied Materials. Martin B. Anstice joined Lam in April 2001 as Senior Director, Operations Controller, was promoted to the position of Managing Director and Corporate Controller in May 2002, and was promoted to Group Vice President, Chief Financial Officer, and Chief Accounting Officer in June 2004. Mr. Anstice began his career at Raychem Corporation where, during his 13-year tenure, he held numerous finance roles of increasing responsibility in Europe and North America. Subsequent to Tyco International’s acquisition of Raychem in 1999, he assumed responsibilities supporting mergers and acquisition activities of Tyco Electronics. Mr. Anstice is an associate member of the Chartered Institute of Management Accountants in the United Kingdom. Nicolas J. Bright joined the Company in May 1998 as Vice President of Technology and Engineering. He currently holds the position of Executive Vice President, Regional Business and Global Products. Prior to joining Lam, Mr. Bright was employed by Applied Materials, Inc. During his 16-year tenure at that Company, Mr. Bright held senior management positions in engineering and technology within etch, ion implant, and automation business units. He has also held positions at General Electric Co. in the United Kingdom and ABB in Sweden. Mr. Bright holds numerous patents in semiconductor manufacturing disciplines. Ernest E. Maddock, Group Vice President of Global Operations since October 2003, currently oversees Global Operations which consists of: Information Technology, Global Supply Chain, Production Operations, Corporate Quality, Global Security, and Global Real Estate and Facilities. Mr. Maddock joined the Company in November 1997. Mr. Maddock’s previously held positions with the Company include Vice President of the Customer Support Business Group. Prior to his employment with Lam, he was Managing Director, Global Logistics and Repair Services Operations, and Chief Financial Officer, Software Products Division, of NCR Corporation. He has also held a variety of executive roles in finance and operations in several industries ranging from commercial real estate to telecommunications. 8 Abdi Hariri, Vice President and General Manager of the Customer Support Business Group since August 2004, joined the Company in April 1989 and has served in a number of different assignments with the Field Sales and Product Groups. Prior to his current appointment, Mr. Hariri served as the General Manager of Lam Research Co. Ltd. (Japan) for approximately 18 months. His experience prior to his appointment in Japan included over thirteen years at the Company with various responsibilities, including global business development and engineering. Prior to his employment at Lam, Mr. Hariri served as a Process Engineer at Siliconix, Inc. He holds a Masters Degree in Chemical Engineering from Stanford University. Item 1A. Risk Factors In addition to the other information in this Form 10-K, the following risk factors should be carefully considered in evaluating the Company and its business because such factors may significantly impact our business, operating results, and financial condition. As a result of these risk factors, as well as other risks discussed in our other SEC filings, our actual results could differ materially from those projected in any forward- looking statements. No priority or significance is intended, or should be attached, to the order in which the risk factors appear. Our Quarterly Revenues and Operating Results are Unpredictable Our revenues and operating results may fluctuate significantly from quarter to quarter due to a number of factors, not all of which are in our control. We manage our expense levels based in part on our expectations of future revenues. If revenue levels in a particular quarter do not meet our expectations, our operating results may be adversely affected. Because our operating expenses are based in part on anticipated future revenues, and a certain amount of those expenses are relatively fixed, a change in the timing of recognition of revenue and/or the level of gross profit from a single transaction can unfavorably affect operating results in a particular quarter. Factors that may cause our financial results to fluctuate unpredictably include, but are not limited to: • • • • • • • • • • • • • • • • • • economic conditions in the electronics and semiconductor industry generally and the equipment industry specifically; the extent that customers use our products and services in their business; timing of customer acceptances of equipment; the size and timing of orders from customers; customer cancellations or delays in our shipments, installations, and/or acceptances; changes in average selling prices and product mix; our ability in a timely manner to develop, introduce and market new, enhanced and competitive products; our competitors’ introduction of new products; legal or technical challenges to our products and technology; changes in import/export regulations; transportation, communication, demand, information technology or supply disruptions based on factors outside our control such as acts of God, wars, terrorist activities and natural disasters; legislative, tax, accounting, or regulatory changes or changes in their interpretation; procurement shortages; manufacturing difficulties; the failure of our suppliers or outsource providers to perform their obligations in a manner consistent with our expectations; changes in our estimated effective tax rate; new or modified accounting regulations; and exchange rate fluctuations. 9 Further, because a significant amount of our R&D and administrative operations and capacity is located at our Fremont, California campus, natural, physical, logistical or other events or disruptions affecting these facilities (including labor disruptions, earthquakes, and power failures) could adversely impact our financial performance. We Derive Our Revenues Primarily from a Relatively Small Number of High-Priced Systems System sales constitute a significant portion of our total revenue. Our systems can typically range in price up to approximately $6.0 million per unit, and our revenues in any given quarter are dependent upon the acceptance of a rather limited number of such systems. As a result, the inability to declare revenue on even a few systems can cause a significant adverse impact on our revenues for that quarter. Variations in the Amount of Time it Takes for Our Customers to Accept Our Systems May Cause Fluctuation in Our Operating Results We generally recognize revenue for new system sales on the date of customer acceptance or the date the contractual customer acceptance provisions lapse. As a result, the fiscal period in which we are able to recognize new systems revenues is typically subject to the length of time that our customers require to evaluate the performance of our equipment after shipment and installation, which could cause our quarterly operating results to fluctuate. The Semiconductor Equipment Industry Is Volatile and Reduced Product Demand Has a Negative Impact on Shipments Our business depends on the capital equipment expenditures of semiconductor manufacturers, which in turn depend on the current and anticipated market demand for integrated circuits and products using integrated circuits. The semiconductor industry is cyclical in nature and historically experiences periodic downturns. Business conditions historically have changed rapidly and unpredictably. Fluctuating levels of investment by semiconductor manufacturers could continue to materially affect our aggregate shipments, revenues and operating results. Where appropriate, we will attempt to respond to these fluctuations with cost management programs aimed at aligning our expenditures with anticipated revenue streams, which sometimes result in restructuring charges. Even during periods of reduced revenues, we must continue to invest in research and development and maintain extensive ongoing worldwide customer service and support capabilities to remain competitive, which may temporarily harm our financial results. We Depend on New Products and Processes for Our Success. Consequently, We are Subject to Risks Associated with Rapid Technological Change Rapid technological changes in semiconductor manufacturing processes subject us to increased pressure to develop technological advances enabling such processes. We believe that our future success depends in part upon our ability to develop and offer new products with improved capabilities and to continue to enhance our existing products. If new products have reliability or quality problems, our performance may be impacted by reduced orders, higher manufacturing costs, delays in acceptance of and payment for new products, and additional service and warranty expenses. We may be unable to develop and manufacture new products successfully, or new products that we introduce may fail in the marketplace. Our failure to complete commercialization of these new products in a timely manner could result in unanticipated costs and inventory obsolescence, which would adversely affect our financial results. In order to develop new products and processes, we expect to continue to make significant investments in R&D and to pursue joint development relationships with customers, suppliers or other members of the industry. We must manage product transitions and joint development relationships successfully, as introduction of new products could adversely affect our sales of existing products. Moreover, future technologies, processes or product developments may render our current product offerings obsolete, leaving us with non-competitive products, or obsolete inventory, or both. 10 We Are Subject to Risks Relating to Product Concentration and Lack of Product Revenue Diversification We derive a substantial percentage of our revenues from a limited number of products, and we expect these products to continue to account for a large percentage of our revenues in the near term. Continued market acceptance of these products is, therefore, critical to our future success. Our business, operating results, financial condition, and cash flows could therefore be adversely affected by: • • • a decline in demand for even a limited number of our products; a failure to achieve continued market acceptance of our key products; export restrictions or other regulatory or legislative actions which limit our ability to sell those products to key customer or market segments; increased pressure from competitors that offer broader product lines; technological change that we are unable to address with our products; and a failure to release new or enhanced versions of our products on a timely basis. an improved version of products being offered by a competitor in the market we participate in; • • • • In addition, the fact that we offer a more limited product line creates the risk that our customers may view us as less important to their business than our competitors that offer additional products as well. This may impact our ability to maintain or expand our business with certain customers. Such product concentration may also subject us to additional risks associated with technology changes. Since we are primarily a provider of etch equipment, our business is affected by our customers’ use of etching steps in their processes. Should technologies change so that the manufacture of semiconductor chips requires fewer etching steps, this might have a larger impact on our business than it would on the business of our less concentrated competitors. We Have a Limited Number of Key Customers Sales to a limited number of large customers constitute a significant portion of our overall revenue, new orders and profitability. As a result, the actions of even one customer may subject us to revenue swings that are difficult to predict. Similarly, significant portions of our credit risk may, at any given time, be concentrated among a limited number of customers, so that the failure of even one of these key customers to pay its obligations to us could significantly impact our financial results. Strategic Alliances May Have Negative Effects on our Business Increasingly, semiconductor companies are entering into strategic alliances with one another to expedite the development of processes and other manufacturing technologies. Often, one of the outcomes of such an alliance is the definition of a particular tool set for a certain function or a series of process steps that use a specific set of manufacturing equipment. While this could work to our advantage if Lam’s equipment becomes the basis for the function or process, it could work to our disadvantage if a competitor’s tools or equipment become the standard equipment for such function or process. In the latter case, even if Lam’s equipment was previously used by a customer, that equipment may be displaced in current and future applications by the tools standardized by the alliance. Similarly, our customers may team with, or follow the lead of, educational or research institutions that establish processes for accomplishing various tasks or manufacturing steps. If those institutions utilize a competitor’s equipment when they establish those processes, it is likely that customers will tend to use the same equipment in setting up their own manufacturing lines. These actions could adversely impact our market share and subsequent business. We Are Dependent Upon a Limited Number of Key Suppliers We obtain certain components and sub-assemblies included in our products from a single supplier or a limited group of suppliers. We have established long-term contracts with many of these suppliers. These long- term contracts can take a variety of forms. We may renew these contracts periodically. In some cases, these suppliers sold us products during at least the last four years, and we expect that we will continue to renew these 11 contracts in the future or that we will otherwise replace them with competent alternative suppliers. However, several of our outsourced assembly suppliers are relatively new providers to us so that our experience with them and their performance is limited. Where practical, our intent is to establish alternative sources to mitigate the risk that the failure of any single supplier will adversely affect our business. Nevertheless, a prolonged inability to obtain certain components could impair our ability to ship products, lower our revenues and thus adversely affect our operating results and result in damage to our customer relationships. Our Outsource Providers May Fail to Perform as We Expect Outsource providers have played and will play key roles in our manufacturing operations and in many of our transactional and administrative functions, such as information technology, facilities management, and certain elements of our finance organization. Although we aim at selecting reputable providers and secure their performance on terms documented in written contracts, it is possible that one or more of these providers could fail to perform as we expect and such failure could have an adverse impact on our business. In addition, the expansive role of outsource providers has required and will continue to require us to implement changes to our existing operations and to adopt new procedures to deal with and manage the performance of these outsource providers. Any delay or failure in the implementation of our operational changes and new procedures could adversely affect our customer relationships and/or have a negative effect on our operating results. Once a Semiconductor Manufacturer Commits to Purchase a Competitor’s Semiconductor Manufacturing Equipment, the Manufacturer Typically Continues to Purchase That Competitor’s Equipment, Making It More Difficult for Us to Sell our Equipment to That Customer Semiconductor manufacturers must make a substantial investment to qualify and integrate wafer processing equipment into a semiconductor production line. We believe that once a semiconductor manufacturer selects a particular supplier’s processing equipment, the manufacturer generally relies upon that equipment for that specific production line application. Accordingly, we expect it to be more difficult to sell to a given customer if that customer initially selects a competitor’s equipment. We Are Subject to Risks Associated with Our Competitors’ Strategic Relationships and Their Introduction of New Products and We May Lack the Financial Resources or Technological Capabilities of Certain of Our Competitors Needed to Capture Increased Market Share We expect to face significant competition from multiple current and future competitors. We believe that other companies are developing systems and products that are competitive to ours and are planning to introduce new products, which may affect our ability to sell our existing products. We face a greater risk if our competitors enter into strategic relationships with leading semiconductor manufacturers covering products similar to those we sell or may develop, as this could adversely affect our ability to sell products to those manufacturers. We believe that to remain competitive we will require significant financial resources to offer a broad range of products, to maintain customer service and support centers worldwide, and to invest in product and process R&D. Certain of our competitors have substantially greater financial resources and more extensive engineering, manufacturing, marketing, and customer service and support resources than we do and therefore have the potential to increasingly dominate the semiconductor equipment industry. These competitors may deeply discount or give away products similar to those that we sell, challenging or even exceeding our ability to make similar accommodations and threatening our ability to sell those products. For these reasons, we may fail to continue to compete successfully worldwide. In addition, our competitors may provide innovative technology that may have performance advantages over systems we currently, or expect to, offer. They may be able to develop products comparable or superior to those we offer or may adapt more quickly to new technologies or evolving customer requirements. In particular, while we currently are developing additional product enhancements that we believe will address future customer requirements, we may fail in a timely manner to complete the development or introduction of these additional product enhancements successfully, or these product enhancements may not achieve market acceptance or be competitive. Accordingly, we may be unable to continue to compete in our markets, competition may intensify, or future competition may have a material adverse effect on our revenues, operating results, financial condition, and/or cash flows. 12 Our Future Success Depends on International Sales and the Management of Global Operations Non-U.S. sales accounted for approximately 86% in fiscal year 2006, 84% in fiscal year 2005 and 82% in fiscal year 2004 of our total revenue. We expect that international sales will continue to account for a significant portion of our total revenue in future years. We are subject to various challenges related to the management of global operations, and international sales are subject to risks including, but not limited to: trade balance issues; changes in currency controls; economic and political conditions; fluctuations in interest and currency exchange rates; our ability to develop relationships with local suppliers; compliance with U.S. and international laws and regulations, including U.S. export restrictions; differences in the enforcement of intellectual property and contract rights in varying jurisdictions; • • • • • • • • • Certain international sales depend on our ability to obtain export licenses from the U.S. Government. Our failure or inability to obtain such licenses would substantially limit our markets and severely restrict our revenues. Many of the challenges noted above are applicable in China, which is a fast developing market for the semiconductor equipment industry and therefore an area of potential significant growth for our business. As the business volume between China and the rest of the world grows, there is inherent risk, based on the complex relationships between China, Taiwan, Japan, and the United States, that political and diplomatic influences might lead to trade disruptions which would adversely affect our business with China and/or Taiwan and perhaps the entire Asia region. A significant trade disruption in these areas could have a material, adverse impact on our future revenue and profits. our ability to secure and retain qualified people for the operation of our business. the need for technical support resources in different locations; and We are potentially exposed to adverse as well as beneficial movements in foreign currency exchange rates. The majority of our sales and expenses are denominated in U.S. dollars except for certain of our revenues in Japan that are denominated in Japanese Yen, certain of our spares and service contracts which are denominated in other currencies, and expenses related to our non-U.S. sales and support offices which are denominated in these countries’ local currency. We currently enter into foreign currency forward contracts to minimize the short-term impact of the exchange rate fluctuations on Japanese Yen-denominated assets and forecasted Japanese Yen-denominated revenue where we currently believe our primary exposure to currency rate fluctuation lies and will continue to enter into hedging transactions, for the purposes outlined, in the foreseeable future. However, these hedging transactions may not achieve their desired effect because differences between the actual timing of customer acceptances and our forecasts of those acceptances may leave us either over- or under-hedged on any given transaction. Moreover, by hedging our Yen-denominated assets with currency forward contracts, we may miss favorable currency trends, that would have been advantageous to us but for the hedges. Additionally, we currently do not enter into such forward contracts for currencies other than the Yen, and we therefore are subject to both favorable and unfavorable exchange rate fluctuations to the extent that we transact business (including intercompany transactions) in other currencies. Our Financial Results May Be Adversely Impacted By Higher Than Expected Tax Rates Or Exposure To Additional Income Tax Liabilities As a global company, our effective tax rate is highly dependent upon the geographic composition of worldwide earnings and tax regulations governing each region. We are subject to income taxes in both the United States and various foreign jurisdictions, and significant judgment is required to determine worldwide tax liabilities. Our effective tax rate could be adversely affected by changes in the split of earnings between 13 countries with differing statutory tax rates, in the valuation of deferred tax assets, in tax laws or by material audit assessments, which could affect our profitability. In particular, the carrying value of deferred tax assets, which are predominantly in the United States, is dependent on our ability to generate future taxable income in the United States. In addition, the amount of income taxes we pay is subject to ongoing audits in various jurisdictions, and a material assessment by a governing tax authority could affect our profitability. Changes in Accounting Standards for Equity-Based Compensation May Adversely Affect our Operating Results, Our Stock Price, and Our Competitiveness in the Employee Marketplace The adoption of SFAS No. 123(R) required us to expense all equity-based compensation provided to employees and directors beginning with our quarter ending September 25, 2005. The environment for skilled employees that are knowledgeable about our products and services is a competitive one, and we believe that equity-based compensation is an important part of the overall compensation that we offer to attract and retain such employees. SFAS No. 123(R) has decreased and will continue to decrease our earnings based on its measure of the value of equity-based compensation. There is some risk that the design of our compensation plans is ineffective at balancing our profitability and employee retention objectives. A Failure to Comply with Environmental Regulations May Adversely Affect Our Operating Results We are subject to a variety of governmental regulations related to the discharge or disposal of toxic, volatile or otherwise hazardous chemicals. We believe that we are in general compliance with these regulations and that we have obtained (or will obtain or are otherwise addressing) all necessary environmental permits to conduct our business. These permits generally relate to the disposal of hazardous wastes. Nevertheless, the failure to comply with present or future regulations could result in fines being imposed on us, suspension of production, cessation of our operations or reduction in our customers’ acceptance of our products. These regulations could require us to alter our current operations, to acquire significant equipment or to incur substantial other expenses to comply with environmental regulations. Our failure to control the use, sale, transport or disposal of hazardous substances could subject us to future liabilities. If We Are Unable to Adjust the Scale of Our Business in Response to Rapid Changes in Demand in the Semiconductor Equipment Industry, Our Operating Results and Our Ability to Compete Successfully May Be Impaired The business cycle in the semiconductor equipment industry has historically been characterized by frequent periods of rapid change in demand that challenge our management to adjust spending and resources allocated to operating activities. During periods of rapid growth or decline in demand for our products and services, we face significant challenges in maintaining adequate financial and business controls, management processes, information systems and procedures and in training, managing, and appropriately sizing our supply chain, our work force and other components of our business on a timely basis. Our success will depend, to a significant extent, on the ability of our executive officers and other members of our senior management to identify and respond to these challenges effectively. If we do not adequately meet these challenges, our gross margins and earnings may be impaired during periods of demand decline, and we may lack the infrastructure and resources to scale up our business to meet customer expectations and compete successfully during periods of demand growth. If We Choose to Acquire or Dispose of Product Lines and Technologies, We May Encounter Unforeseen Costs and Difficulties That Could Impair Our Financial Performance An important element of our management strategy is to review acquisition prospects that would complement our existing products, augment our market coverage and distribution ability, or enhance our technological capabilities. As a result, we may make acquisitions of complementary companies, products or technologies, or we may reduce or dispose of certain product lines or technologies, which no longer fit our long-term strategies. Managing an acquired business, disposing of product technologies or reducing personnel entails numerous operational and financial risks, including difficulties in assimilating acquired operations and new personnel or separating existing business or product groups, diversion of management’s attention away from other business concerns, amortization of acquired intangible assets and potential loss of key employees or customers of acquired or disposed operations among others. There can be no assurance that we will be able to achieve and 14 manage successfully any such integration of potential acquisitions, disposition of product lines or technologies, or reduction in personnel or that our management, personnel, or systems will be adequate to support continued operations. Any such inabilities or inadequacies could have a material adverse effect on our business, operating results, financial condition, and cash flows. In addition, any acquisitions could result in changes such as potentially dilutive issuances of equity securities, the incurrence of debt and contingent liabilities, the amortization of related intangible assets, and goodwill impairment charges, any of which could materially adversely affect our business, financial condition, and results of operations and/or the price of our Common Stock. The Market for Our Common Stock is Volatile, Which May Affect Our Ability to Raise Capital or Make Acquisitions The market price for our Common Stock is volatile and has fluctuated significantly over the past years. The trading price of our Common Stock could continue to be highly volatile and fluctuate widely in response to factors, including but not limited to the following: • • • • • general market, semiconductor, or semiconductor equipment industry conditions; global economic fluctuations; variations in our quarterly operating results; variations in our revenues or earnings from levels experienced by other companies in our industry or forecasts by securities analysts; announcements of restructurings, technological innovations, reductions in force, departure of key employees, consolidations of operations, or introduction of new products; liquidity of Lam; government regulations; disruptions with key customers or suppliers; or success or failure of our new and existing products; developments in, or claims relating to, patent or other proprietary rights; • • • • • • In addition, the stock market experiences significant price and volume fluctuations. Historically, we have witnessed significant volatility in the price of our Common Stock due in part to the actual or anticipated movement in interest rates and the price of and markets for semiconductors. These broad market and industry factors have and may again adversely affect the price of our Common Stock, regardless of our actual operating performance. In the past, following volatile periods in the price of stock, many companies became the object of securities class action litigation. If we are sued in a securities class action, we could incur substantial costs, and it could divert management’s attention and resources and have an unfavorable impact on the price for our Common Stock. political, economic, or environmental events occurring globally or in any of our key sales regions. We Rely Upon Certain Critical Information Systems for the Operation of our Business We maintain and rely upon certain critical Information Systems for the effective operation of our business. These Information Systems include telecommunications, the internet, our corporate intranet, various computer hardware and software applications, network communications, and e-mail. These Information Systems may be owned by us or by our outsource providers or even third parties such as vendors and contractors and may be maintained by us or by such providers and third parties. These Information Systems are subject to attacks, failures, and access denials from a number of potential sources including viruses, destructive or inadequate code, power failures, and physical damage to computers, hard drives, communication lines, and networking equipment. To the extent that these Information Systems are under our control, we have implemented security procedures, such as virus protection software and emergency recovery processes, to address the outlined risks; 15 however, security procedures for Information Systems cannot be guaranteed to be failsafe and our inability to use or access these Information Systems at critical points in time could unfavorably impact the timely and efficient operation of our business. Intellectual Property and Other Claims Against Us Can Be Costly and Could Result in the Loss of Significant Rights Which Are Necessary to Our Continued Business and Profitability Third parties may assert infringement, unfair competition or other claims against us. From time to time, other parties send us notices alleging that our products infringe their patent or other intellectual property rights. In addition, our Bylaws and indemnity obligations provide that we will indemnify officers and directors against losses that they may incur in legal proceedings resulting from their service to Lam. In such cases, it is our policy either to defend the claims or to negotiate licenses or other settlements on commercially reasonable terms. However, we may be unable in the future to negotiate necessary licenses or reach agreement on other settlements on commercially reasonable terms, or at all, and any litigation resulting from these claims by other parties may materially adversely affect our business and financial results. Moreover, although we seek to obtain insurance to protect us from claims and cover losses to our property, there is no guarantee that such insurance will fully indemnify us for any losses that we may incur. We May Fail to Protect Our Proprietary Technology Rights, Which Would Affect Our Business Our success depends in part on our proprietary technology. While we attempt to protect our proprietary technology through patents, copyrights and trade secret protection, we believe that our success also depends on increasing our technological expertise, continuing our development of new systems, increasing market penetration and growth of our installed base, and providing comprehensive support and service to our customers. However, we may be unable to protect our technology in all instances, or our competitors may develop similar or more competitive technology independently. We currently hold a number of United States and foreign patents and pending patent applications. However, other parties may challenge or attempt to invalidate or circumvent any patents the United States or foreign governments issue to us or these governments may fail to issue patents for pending applications. In addition, the rights granted or anticipated under any of these patents or pending patent applications may be narrower than we expect or, in fact provide no competitive advantages. We Are Subject to the Internal Control Evaluation and Attestation Requirements of Section 404 of the Sarbanes-Oxley Act of 2002 Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we are required to include in our annual report our assessment of the effectiveness of our internal control over financial reporting and our audited financial statements as of the end of each fiscal year. Furthermore, our independent registered public accounting firm (Firm) is required to attest to whether our assessment of the effectiveness of our internal control over financial reporting is fairly stated in all material respects and separately report on whether it believes we maintained, in all material respects, effective internal control over financial reporting as of the end of each fiscal year. We have successfully completed our assessment and obtained our Firm’s attestation as to the effectiveness of our internal control over financial reporting as of June 25, 2006. In future years, if we fail to timely complete this assessment, or if our Firm cannot timely attest to our assessment, we could be subject to regulatory sanctions and a loss of public confidence in our internal control. In addition, any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to timely meet our regulatory reporting obligations. Our Independent Registered Public Accounting Firm Must Confirm Its Independence in Order for Us to Meet Our Regulatory Reporting Obligations on a Timely Basis Our independent registered public accounting firm communicates with us at least annually regarding any relationships between the Firm and Lam that, in the Firm’s professional judgment, might have a bearing on the Firm’s independence with respect to us. If, for whatever reason, our independent registered public accounting firm finds that it cannot confirm that it is independent of Lam based on existing securities laws and registered public accounting firm independence standards, we could experience delays or other failures to meet our regulatory reporting obligations. 16 Item 2. Properties Our executive offices and principal operating and R&D facilities are located in Fremont, California, and are held under operating leases expiring from fiscal years 2008 to 2014. These leases generally include options to renew or purchase the facilities. As a result of the restructuring of our operations, we have subleased some of our idle facilities, (refer to Note 15 of our Consolidated Financial Statements, included in Item 8 herein, for further information concerning our property leases). In addition, we lease properties for our service, technical support and sales personnel throughout the United States, Europe, Korea, Japan, and Asia Pacific. Our fiscal year 2006 rental payments for the space occupied during that period aggregated approximately $8.9 million. Our facilities lease obligations are subject to periodic increases, and we believe that our existing facilities are well-maintained and in good operating condition. Item 3. Legal Proceedings From time to time, we have received notices from third parties alleging infringement of such parties’ patent or other intellectual property rights by our products. In such cases it is our policy to defend the claims, or if considered appropriate, negotiate licenses on commercially reasonable terms. However, no assurance can be given that we will be able to negotiate necessary licenses on commercially reasonable terms, or at all, or that any litigation resulting from such claims would not have a material adverse effect on our consolidated financial position, liquidity, operating results, or our consolidated financial statements taken as a whole. Item 4. Submission of Matters to a Vote of Security Holders None. 17 PART II Item 5. Market for the Registrant’s Common Stock and Related Stockholder Matters The information required by this Item is incorporated by reference from Item 6, “Selected Consolidated Financial Data,” below. In October, 2004, we announced that our Board of Directors had authorized the repurchase of up to $250 million of our common stock from the public market or in private purchases. The terms of the repurchase program permit us to repurchase shares through September 30, 2007. In August, 2005, we announced that our Board of Directors had authorized the repurchase of an additional $500 million of our common stock from the public market or private purchase. The terms of the repurchase program permit us to repurchase shares through September 30, 2008. We plan to continue to execute the authorized repurchases. Share repurchases under the authorizations were as follows: Period As of June 26, 2005 . . . . . . . . . . . . . . . . . . . . . . . Additional authorization of $500 million — August 24, 2005 . . . . . . . . . . . . . . . . . . . . Quarter Ending September 25, 2005. . . . . . . . . . Quarter Ending December 25, 2005 . . . . . . . . . . Quarter Ending March 26, 2006 . . . . . . . . . . . . . Quarter Ending June 25, 2006. . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 6. Selected Consolidated Financial Data Total Number of Shares Repurchased Total Cost of Repurchase Average Price Paid Per Share Amount Available For Repurchase Under the Plan (in thousands, except per share data) 5,855 $167,081 $28.54 $ 82,919 2,644 1,848 1,698 788 12,833 78,690 61,917 73,602 37,002 $418,292 29.76 33.50 43.36 46.93 $32.59 OPERATIONS: Total revenue . . . . . . . . . . . . . . . . . . . . Gross margin . . . . . . . . . . . . . . . . . . . . Restructuring charges, net(1) . . . . . . . Operating income (loss)(2) . . . . . . . . . Loss on equity derivative contracts in Company stock (EITF 00-19) . . . . Net income (loss) . . . . . . . . . . . . . . . . . Net income (loss) per share: June 25, 2006 Year Ended June 29, June 27, June 26, 2005 2003 2004 (in thousands, except per share data) $ 1,642,171 $ 1,502,453 $ 827,394 — 406,265 — 335,755 764,092 14,201 391,002 — 299,341 935,946 $ 431,049 8,327 106,180 755,234 303,829 15,901 (5,385) — 82,988 (16,407) (7,739) Basic . . . . . . . . . . . . . . . . . . . . . . . . Diluted(3) . . . . . . . . . . . . . . . . . . . . $ $ 2.42 $ 2.34 $ 2.17 $ 2.10 $ 0.63 $ 0.59 $ (0.06) (0.06) BALANCE SHEET: Working capital . . . . . . . . . . . . . . . . . . Total assets. . . . . . . . . . . . . . . . . . . . . . Long-term obligations, less current $ 1,140,143 $ 2,313,344 865,703 $ 519,782 $ 1,448,815 1,198,626 655,794 1,198,275 portion . . . . . . . . . . . . . . . . . . . . . . 350,969 2,786 9,554 332,209 359,691 (1) Restructuring charges, net exclude restructuring charges (recoveries) included in cost of goods sold and reflected in gross margin of ($1.7) million, ($1.0) million, and $5.9 million for fiscal years 2004, 2003, and 2002, respectively. These amounts primarily relate to the write-off of selected, older product line inventories in connection with our restructuring plans and the partial recovery of the charges from the 18 $ 582,919 $ 504,229 $ 442,312 $ 368,710 $ 331,708 June 30, 2002 $ $ $ $ 943,114 266,089 44,850 (119,838) (8,236) (90,051) (0.71) (0.71) 757,880 1,632,291 subsequent sale of a portion of such inventories. These restructuring charges/(recoveries) are included as a component of cost of goods sold in accordance with Emerging Issues Task Force 96-9, “Classification of Inventory Markdowns and Other Costs Associated with a Restructuring” (EITF 96-9). There were no restructuring charges or recoveries included in cost of goods sold in fiscal years 2006 and 2005. Fiscal year 2005 restructuring charges consist only of additional liabilities related to prior restructuring plans. (2) Operating income during the fiscal year ended June 25, 2006 includes $22.8 million of equity-based compensation expense as a result of the adoption of Statement of Financial Accounting Standards No. 123R, “Share-Based Payment.” (3) Diluted net income per share for the fiscal year ended June 27, 2004 includes the assumed conversion of the convertible subordinated 4% notes. Accordingly, interest expense, net of taxes, of $3.2 million has been added back to net income for computing diluted net earnings per share. UNAUDITED SELECTED QUARTERLY FINANCIAL DATA QUARTERLY FISCAL YEAR 2006: Total revenue . . . . . . . . . . . . . . . . . . . . . . Gross margin . . . . . . . . . . . . . . . . . . . . . . Operating income . . . . . . . . . . . . . . . . . . Net income. . . . . . . . . . . . . . . . . . . . . . . . Net income per share Basic . . . . . . . . . . . . . . . . . . . . . . . . . . Diluted . . . . . . . . . . . . . . . . . . . . . . . . Price range per share . . . . . . . . . . . . . . . . Number of shares used in per share calculations: Basic . . . . . . . . . . . . . . . . . . . . . . . . . . Diluted . . . . . . . . . . . . . . . . . . . . . . . . QUARTERLY FISCAL YEAR 2005: Total revenue . . . . . . . . . . . . . . . . . . . . . . Gross margin . . . . . . . . . . . . . . . . . . . . . . Restructuring charges, net(1) . . . . . . . . . Operating income . . . . . . . . . . . . . . . . . . Net income. . . . . . . . . . . . . . . . . . . . . . . . Net income per share Basic . . . . . . . . . . . . . . . . . . . . . . . . . . Diluted . . . . . . . . . . . . . . . . . . . . . . . . Price range per share . . . . . . . . . . . . . . . . Number of shares used in per share calculations: Basic . . . . . . . . . . . . . . . . . . . . . . . . . . Diluted . . . . . . . . . . . . . . . . . . . . . . . . Three Months Ended June 25, 2006 March 26, 2006 December 25, 2005 September 25, 2005 (in thousands, except per share data) $ 525,596 274,151 159,406 122,149 $ $ 0.87 0.84 $ 437,423 219,654 110,268 86,337 $ $ 0.62 0.60 $ 358,245 177,510 76,909 77,778 $ $ 0.57 0.55 $ 320,907 156,079 59,682 49,491 $ $ 0.36 0.35 $41.54-$53.74 $35.44-$48.57 $28.37-$39.18 $27.77-$32.61 141,168 144,683 140,122 144,846 136,572 142,525 136,453 141,430 Three Months Ended June 26, 2005 March 27, 2005 December 26, 2004 September 26, 2004 (in thousands, except per share data) $ 353,767 175,859 — 82,531 66,526 $ $ 0.48 0.47 $ 349,337 174,570 14,201 78,625 59,451 $ $ 0.42 0.41 $ 379,800 198,902 — 108,570 83,614 $ $ 0.61 0.59 $ 419,549 214,761 — 121,276 89,750 $ $ 0.66 0.64 $24.24-$31.78 $25.35-$32.26 $20.88-$29.70 $19.71-$26.84 138,208 142,518 139,967 144,756 137,255 142,268 135,478 139,808 (1) Fiscal year 2005 restructuring charges consist only of additional liabilities related to prior restructuring plans. 19 Stock and Dividend Information: Our Common Stock is traded on the Nasdaq Global Select Market under the symbol LRCX. The price range per share is the highest and lowest bid prices, as reported by the National Association of Security Dealers, Inc., on any trading day during the respective quarter. As of August 4, 2006, we had 444 stockholders of record. In fiscal years 2006 and 2005 we did not declare or pay cash dividends to our stockholders. We currently have no plans to declare or pay cash dividends. During fiscal year 2006, we repurchased 6,978,403 shares of common stock at a total price of $251.2 million under terms of our repurchase programs discussed earlier in Item 5 of this Annual Report on Form 10-K. As of June 25, 2006, the total amount available for repurchase was $331.7 million. We plan to continue to execute the authorized repurchases. 20 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 Annual Report on 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 Annual Report on Form 10-K ). The semiconductor industry is cyclical in nature and has historically experienced periodic downturns and upturns. Today’s leading indicators of changes in customer investment patterns may not be any more reliable than in prior years. Demand for our equipment can vary significantly from period to period as a result of various factors, including, but not limited to, economic conditions, supply, demand, and prices for semiconductors, customer capacity requirements, and our ability to develop and market competitive products. For these and other reasons, our results of operations for fiscal years 2006, 2005, and 2004 may not necessarily be indicative of future operating results. Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) provides a description of our results of operations and should be read in conjunction with our Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K. MD&A consists of the following sections: Executive Summary provides a summary of the key highlights of our results of operations Results of Operations provides an analysis of operating results Critical Accounting Policies 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 Corporation (Lam or the Company) is a major provider of wafer fabrication equipment and services to the world’s semiconductor industry. We actively market and sell product offerings that include single- wafer plasma etch systems with a wide range of applications, and an array of services designed to optimize the utilization of these systems by our customers. The following summarizes certain key quarterly and annual financial information for the periods indicated below (in thousands, except per share data and percentages) and demonstrates our strong performance and the quarter-over-quarter growth in all areas throughout fiscal year 2006: Revenue . . . . . . . . . . . . . . . . . . . . . . . . Gross margin . . . . . . . . . . . . . . . . . . . Gross margin as a percent of total revenue . . . . . . . . . . . . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . . . . . Diluted net earnings per share . . . . . . Three Months Ended June 25, 2006 $ 525,596 274,151 March 26, 2006 $ 437,423 219,654 December 25, 2005 $ 358,245 177,510 September 25, 2005 $ 320,907 156,079 Year Ended June 25, 2006 $ 1,642,171 827,394 52.2% 50.2% 49.5% 48.6% 50.4% 122,149 0.84 $ 86,337 0.60 $ 77,778 0.55 $ 49,491 0.35 $ 335,755 2.34 $ Our business model, which utilizes the capabilities of outsource providers, enables us to focus on new and existing product development, sales and marketing, and customer support. We are focused on executing to the near term production requirements of our customers, expanding our leadership position in Etch, leveraging our Etch expertise into adjacent markets, and our objective of delivering best-in-class financial performance. 21 Customer demand increased throughout fiscal year 2006. Fiscal year 2006 new orders entered into backlog increased 31% compared to fiscal year 2005 with growth occurring in all regions as a function of the increase in customer demand. Fiscal year 2006 revenues, derived from our shipment levels and installation and acceptance timelines, increased 9% compared to fiscal year 2005 revenues reflecting the increase in customer demand which we believe included market share gains in both the dielectric and conductor product segments of the etch market, with the strongest geographic momentum in Japan and Korea. Gross margin as a percent of revenues remained greater than 50% for the second consecutive year. Fiscal year 2006 quarterly gross margin as a percent of revenues showed steady growth on increasing volume. Total operating expenses increased 13% during fiscal year 2006 compared to fiscal year 2005, primarily driven by increases in discretionary R&D spending consistent with our product and market expansion plans, equity-based compensation expense, salary costs as a result of increased headcount, planned increases in employee base compensation, and employee incentive-based costs. Fiscal year 2005 operating expenses included $14.2 million in restructuring charges related to prior restructuring plans. Equity-based compensation expense recognized during fiscal year 2006 in cost of goods sold and operating expenses was $5.0 million and $17.8 million, respectively. Results of Operations New Orders and Backlog New orders entered into backlog during fiscal year 2006 are presented in the table below. Unshipped orders in backlog as of June 25, 2006 were approximately $521 million. The basis for recording new orders is defined in our backlog policy. Our unshipped orders backlog includes orders for systems, spares, and services where written customer requests have been accepted and the delivery of products or provision of services is anticipated within the next 12 months. Our policy is to revise our backlog for order cancellations and to make adjustments to reflect, among other things, spares volume estimates and customer delivery date changes. Please refer to “Backlog” in Part I Item 1, “Business” of this Annual Report on Form 10-K for additional information on our backlog policy. Regional geographic breakdown of new orders is as follows: New Orders (in millions) . . . . . . . North America . . . . . . . . . . . . . . . Europe . . . . . . . . . . . . . . . . . . . . . . Asia Pacific . . . . . . . . . . . . . . . . . . Korea . . . . . . . . . . . . . . . . . . . . . . . Japan . . . . . . . . . . . . . . . . . . . . . . . New Orders (in millions) . . . . . . . North America . . . . . . . . . . . . . . . Europe . . . . . . . . . . . . . . . . . . . . . . Asia Pacific . . . . . . . . . . . . . . . . . . Korea . . . . . . . . . . . . . . . . . . . . . . . Japan . . . . . . . . . . . . . . . . . . . . . . . June 25, 2006 $640 12% 16% 44% 11% 17% June 26, 2005 $315 9% 12% 35% 16% 28% Three Months Ended December 25, 2005 $403 March 26, 2006 $520 September 25, 2005 $326 Year Ended June 25, 2006 $1,889 15% 15% 28% 29% 13% 13% 12% 29% 23% 23% 17% 15% 33% 13% 22% 14% 15% 34% 19% 18% Three Months Ended December 26, 2004 $387 March 27, 2005 $315 September 26, 2004 $429 Year Ended June 26, 2005 $1,446 16% 19% 29% 14% 22% 14% 9% 25% 40% 12% 20% 19% 26% 15% 20% 15% 15% 28% 22% 20% 22 Fiscal year 2005 started with a declining trend in new orders which stabilized in the March 2005 and June 2005 quarters. The four quarters ending June 25, 2006 showed sequentially increasing demand in new orders driven by increased capital investments by our customers and our market share gains. During fiscal year 2006, 300 millimeter applications represented approximately 81% of total systems new orders and 83% of total systems new orders were for applications at less than or equal to the 90 nanometer technology node. We classify total systems new orders market segmentation for fiscal year 2006 as Memory at approximately 54%, IDM Logic/Other at 27% and Foundry at 19% of the total. We expect new orders for the quarter ending September 24, 2006 to increase 5% to 10% compared with the quarter ended June 25, 2006. This expectation is a forward-looking statement and actual results could differ materially as a result of certain factors as referred to in Part I of this Annual Report on Form 10-K. Revenue Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,642,171 June 25, 2006 Year Ended June 26, 2005 (in thousands) $1,502,453 June 27, 2004 $935,946 The increase in revenues during fiscal year 2006 and fiscal year 2005 reflected the improved market environment which was evidenced by expanded levels of capital investments by semiconductor manufacturers. We believe we have gained market share in both the dielectric and conductor product segments of the etch market over this period, with particularly strong geographic performance in Japan and Korea during fiscal year 2006 and the overall Asia region during fiscal year 2005. The overall Asia region continues to account for a significant portion of our revenues as a substantial amount of the worldwide capacity additions for semiconductor manufacturing continues to occur in this region. Our deferred revenue balance increased to $229.7 million as of June 25, 2006 compared to $150.5 million at June 26, 2005, consistent with overall business volumes. The anticipated future revenue value of orders shipped from backlog to Japanese customers that are not recorded as deferred revenue was approximately $74 million as of June 25, 2006: these shipments are classified as inventory at cost until title transfers. Regional geographic breakdown of revenue is as follows: North America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Asia Pacific . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Korea . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Japan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . June 25, 2006 14% 13% 29% 22% 22% Year Ended June 26, 2005 16% 12% 38% 19% 15% June 27, 2004 18% 19% 42% 10% 11% Our current estimate for revenues for the quarter ending September 24, 2006 ranges from $580 million to $600 million. This is a forward-looking statement and actual results could differ materially as a result of certain factors as referred to in Part I of this Annual Report on Form 10-K. Gross Margin June 25, 2006 Year Ended June 26, 2005 June 27, 2004 Gross Margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Percent of total revenue . . . . . . . . . . . . . . . . . . . . . . . 23 (in thousands, except percentages) $764,092 $827,394 $431,049 50.4% 50.9% 46.1% Gross margin as a percent of revenue during fiscal year 2006 remained greater than 50% for the second consecutive year. Gross margin as a percent of revenue for fiscal year 2006 compared with fiscal year 2005 decreased slightly, impacted by the inclusion of equity-based compensation as a result of the adoption of Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123R) of $5.0 million, or 0.3%. The impact of product mix was generally offset by improved installation and warranty performance, and improved factory utilization which was facilitated by higher volumes. The increase in gross margin as a percent of revenue during fiscal year 2005 compared with fiscal year 2004 was driven primarily by improved product mix and effective asset management on higher sales volume. We expect that gross margin as a percent of revenue will be approximately 51.5% for the quarter ending September 24, 2006. This expectation is a forward-looking statement and actual results could differ materially as a result of certain factors as referred to in Part I of this Annual Report on Form 10-K. Research and Development June 25, 2006 Year Ended June 26, 2005 June 27, 2004 Research & Development (R&D) . . . . . . . . . . . . . . . . Percent of total revenue . . . . . . . . . . . . . . . . . . . . . . . (in thousands, except percentages) $194,115 $228,891 $170,479 13.9% 12.9% 18.2% We invested significantly in research and development focused on leading-edge plasma etch, strip and clean product and market applications. The growth in absolute spending levels during fiscal year 2006 compared to fiscal year 2005 was primarily due to approximately $19 million in increased supplies and outside services, approximately $9 million in increased equity-based compensation expense and approximately $4 million in increased salary and benefit costs due to planned increases of employee base compensation and increased headcount. Approximately 66% of fiscal year 2006 systems revenues were derived from products introduced over the previous two years. The growth in absolute spending levels during fiscal year 2005 compared to fiscal year 2004 was primarily due to increases in salary and benefits costs of approximately $5 million for planned increases of employee base compensation as well as roughly $9 million for incentive-based compensation triggered by higher profits. The remainder of the increase was primarily the result of an increase in R&D supplies expense of approximately $6 million. Selling, General and Administrative Selling, General & Administrative (SG&A) . . . . . . . Percent of total revenue . . . . . . . . . . . . . . . . . . . . . . . June 25, 2006 Year Ended June 26, 2005 (in thousands, except percentages) $164,774 June 27, 2004 $146,063 $192,238 11.7% 11.0% 15.6% The increase in SG&A expenses during the year ended June 25, 2006 compared with the prior year was driven by increases in salary and benefits costs of approximately $4 million due to planned increases of employee base compensation and increased headcount. Increases in incentive-based cash compensation of approximately $7 million were principally due to our long-term executive compensation program implemented during fiscal year 2006 and equity-based compensation was approximately $9 million. Fiscal year 2005 SG&A expenses were lower due to the March 2005 receipt of an $8 million tax refund noted below. The increase in SG&A expenses during fiscal year 2005 compared with fiscal year 2004 was driven by increases in salary and benefits costs of approximately $5 million due to planned increases of employee base compensation as well as roughly $14 million due to incentive-based compensation triggered by higher profits. Also included in the increase was approximately $10 million in professional services which included, among other items, expenditures for certain discretionary information technology projects designed to contribute to 24 productivity improvements across the Company. These increases were partially offset by the receipt in fiscal year 2005 of a net $8 million tax refund from the California State Board of Equalization for previously paid sales and use tax and approximately $3 million in equity-based compensation expense recorded in fiscal year 2004 in connection with the modification of terms of a fixed stock option award. Other Income (Expense), net Other income (expense), net, consisted of the following: Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign exchange loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Debt issue cost amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net gain on settlement of swap and retirement of 4% Notes . . . . . . Equity method investment losses . . . . . . . . . . . . . . . . . . . . . . . . . . . Equity method investment impairment . . . . . . . . . . . . . . . . . . . . . . Charitable contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . June 25, 2006 $38,189 (677) (1,458) (368) — — — (1,000) 336 $35,022 Year Ended June 26, 2005 (in thousands) $17,537 (1,413) (1,175) — — (205) (445) (5,500) (679) $ 8,120 June 27, 2004 $ 9,915 (4,634) (1,334) (1,593) 4,505 (426) — (1,000) (963) $ 4,470 The sequential increase in interest income during fiscal year 2006 compared to fiscal year 2005 was due to the combined effect of increased cash and cash equivalents, short-term investments, and restricted cash and investments balances as well as increases in interest rate yields. During fiscal year 2006, average interest rate yields on the Company’s portfolio increased approximately 170 basis points compared to fiscal year 2005. The Company’s total balances of cash and cash equivalents, short-term investments, and restricted cash and investments, increased approximately $626 million from fiscal year 2005. This increase included the Company’s wholly-owned subsidiary’s drawdown against a $350 million Credit Agreement to support the Company’s foreign earnings repatriation of $500 million under the American Jobs Creation Act of 2004 (AJCA). The remaining increase of $276 million was primarily driven by $361 million from cash flows from operating activities. The sequential increase in interest income during fiscal year 2005 compared to fiscal year 2004 was due primarily to the increase in interest rate yields. Interest expense and debt issue cost amortization decreased due to the early retirement of our convertible subordinated $300.0 million 4% notes (4% Notes) in June 2004. Tax Expense Our annual income tax expense was $105.5 million, $99.8 million, and $27.7 million, in fiscal years 2006, 2005, and 2004, respectively. Our effective tax rate for fiscal year 2006 was 23.9%. The effective tax rate for fiscal year 2006, excluding the discrete event discussed below, was 18.4%. The decrease in our effective tax rate in fiscal year 2006 related to the increase in income in jurisdictions with a lower tax rate, the realization of state R&D tax credits not previously benefited, favorable tax rulings on prior year tax returns filed and the reversal of tax reserves with respect to the agreement of a bi-lateral advanced pricing arrangement. These favorable adjustments for the year were offset by a discrete event for the repatriation during fiscal year 2006 of a $500 million extraordinary dividend under the American Jobs Creation Act of 2004, combined with the impact of the accounting for equity-based awards in accordance with SFAS No. 123R and the deductibility of those awards in some jurisdictions, and the expiration of the research tax credit on December 31, 2005. The fiscal year 2005 tax rate was 25.0%, which primarily reflects the impact of R&D tax credits and foreign income taxed at lower than U.S. statutory tax rates. In fiscal year 2004, we released a valuation allowance on specific deferred tax assets after we determined that the valuation allowance was no longer required. This resulted in a $12.7 million credit recorded to income tax expense, during fiscal year 2004. 25 Deferred Income Taxes We had gross deferred tax assets, related primarily to reserves and accruals that are not currently deductible, and tax credit carryforwards of $119.2 million and $142.1 million in fiscal years 2006 and 2005, respectively. The gross deferred tax assets were offset by deferred tax liabilities of $27.0 million and $22.2 million in fiscal years 2006 and 2005, respectively. Pursuant to Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123R), the additional tax benefit associated with the accumulated stock award attributes is not recognized until the deduction reduces cash taxes payable. As such, we have elected to net our net operating loss and tax credit carryforward deferred tax assets and related valuation allowance for the accumulated stock award tax benefits determined under Accounting Principles Board (APB) Opinion No. 25 “Accounting for Stock Issued to Employees” (APB No. 25). We will track these stock award attributes separately and will only realize these attributes in accordance with Footnote 82 of SFAS 123(R). These additional tax benefits of net operating loss and tax credit carryforwards related to the tax benefit from the exercise of employee stock awards were $125.2 million and $106.0 million in fiscal years 2006 and 2005, respectively. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Realization of our net deferred tax assets is dependent on future taxable income. We believe it is more likely than not that such assets will be realized; however, ultimate realization could be negatively impacted by market conditions and other variables not known or anticipated at this time. In the event that we determine that we would not be able to realize all or part of our net deferred tax assets, an adjustment would be charged to earnings in the period such determination is made. Likewise, if we later determine that it is more likely than not that the deferred tax assets would be realized, then the previously provided valuation allowance would be reversed. We evaluate the realizability of the deferred tax assets quarterly and will continue to assess the need for additional valuation allowances, if any. During fiscal year 2004, we released a valuation allowance of $12.7 million on specific deferred tax assets after we determined that the valuation allowance was no longer required. Subsequent Events On July 12, 2006, the Supreme Court of California denied review of lower and appellate court judgments in favor of Lam with respect to a lawsuit filed by us alleging breach of purchase order contracts by one of our customers. As a result of the denied review, the prior rulings from the trial and appellate courts stand resulting in a judgment in favor of Lam of approximately $15.8 million, which includes approximately $2.0 million in post-judgment interest. We plan to record this amount in other income (expense), net during the quarter ending September 24, 2006. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make certain judgments, estimates and assumptions that could affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. We based our estimates and assumptions on historical experience and on various other assumptions believed to be applicable, and evaluated them on an on-going basis to ensure they remained reasonable under current conditions. Actual results could differ significantly from those estimates. The significant accounting policies used in the preparation of our financial statements are described in Note 2 of our Consolidated Financial Statements. Some of these significant accounting policies are considered to be critical accounting policies. 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. We believe that the following critical accounting policies reflect the more significant judgments and estimates used in the preparation of our consolidated financial statements. Revenue Recognition: We recognize all revenue when persuasive evidence of an arrangement exists, delivery has occurred and title has passed or services have been rendered, the selling price is fixed or determinable, collection of the receivable is reasonably assured, and we have completed our system installation obligations, received customer acceptance or are otherwise released from our installation or customer acceptance 26 obligations. In the event that 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. In circumstances where 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 where it can be reliably demonstrated that the delivered system meets all of the agreed to customer specifications. In situations with multiple deliverables, revenue is recognized 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. Revenue from multiple element arrangements is allocated among the separate elements based on their relative fair values, provided the elements have value on a stand alone basis, there is objective and reliable evidence of fair value, the arrangement does not include a general right of return relative to the delivered item and delivery or performance of the undelivered item(s) is considered probable and substantially in our control. The maximum revenue recognized on a delivered element is limited to the amount that is not contingent upon the delivery of additional items. Revenue related to sales of spare parts and system upgrade kits is generally recognized upon shipment. Revenue related to services is generally recognized upon completion of the services requested by a customer order. Revenue for extended maintenance service contracts with a fixed payment amount is recognized on a straight-line basis over the term of the contract. Inventory Valuation: Inventories are stated at the lower of cost or market using standard costs, which approximate actual costs on a first-in, first-out basis. We maintain a perpetual inventory system and continuously record the quantity on-hand and standard cost for each product, including purchased components, subassemblies and finished goods. We maintain the integrity of perpetual inventory records through periodic physical counts of quantities on hand. Finished goods are reported as inventories until the point of title transfer to the customer. Generally, title transfer is documented in the terms of sale. When the terms of sale do not specify, we assume title transfers when we complete physical transfer of the products to the freight carrier unless other customer practices prevail. Transfer of title for shipments to Japanese customers generally occurs at time of customer acceptance. Standard costs are re-assessed at least annually and reflect achievable acquisition costs, generally the most recent vendor contract prices for purchased parts, currently obtainable assembly and test labor utilization levels, and overhead for internally manufactured products. Manufacturing labor and overhead costs are attributed to individual product standard costs at a level planned to absorb spending at average utilization volumes. All intercompany profits related to the sales and purchases of inventory between our legal entities are eliminated from our consolidated financial statements. Management evaluates the need to record adjustments for impairment of inventory at least quarterly. Our policy is to assess the valuation of all inventories, including manufacturing raw materials, work-in- process, finished goods and spare parts in each reporting period. Obsolete inventory or inventory in excess of management’s estimated usage requirements over the next 12 to 36 months is written down to its estimated market value, if less than cost. Inherent in the estimates of market value are management’s forecasts related to our future manufacturing schedules, customer demand, technological and/or market obsolescence, general semiconductor market conditions, possible alternative uses and ultimate realization of excess inventory. 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 sales in the period the revision is made. Warranty: Typically, the sale of semiconductor capital equipment includes providing parts and service warranty to customers as part of the overall price of the system. We offer standard warranties for our systems that run generally for a period of 12 months from system acceptance, not to exceed 14 months from shipment of the system to the customer. When appropriate, we record a provision for estimated warranty expenses to cost of sales for each system upon revenue recognition. The amount recorded is based on an analysis of historical activity, which uses factors such as type of system, customer, geographic region, and any known factors such as tool reliability trends. All actual parts and labor costs incurred in subsequent periods are charged to those established reserves through the application of detailed project record keeping. 27 Actual warranty expenses are incurred on a system-by-system basis, and may differ from our original estimates. While we periodically monitor the performance and cost of warranty activities, if actual costs incurred are different than our estimates, we may recognize adjustments to provisions in the period in which those differences arise or are identified. We do not maintain general or unspecified reserves; all warranty reserves are related to specific systems. In addition to the provision of standard warranties, we offer customer-paid extended warranty services. Revenues for extended maintenance and warranty services with a fixed payment amount are recognized on a straight-line basis over the term of the contract. Related costs are recorded either as incurred or when related liabilities are determined to be probable and estimable. Equity-based Compensation — Employee Stock Purchase Plan and Employee Stock Plans: Beginning on June 27, 2005 we account for our employee stock purchase plan (ESPP) and stock plans under the provisions of SFAS No. 123R. SFAS No. 123R requires the recognition of the fair value of equity-based compensation in net income. The fair value of our restricted stock units was calculated based upon the fair market value of Company stock at the date of grant. The fair value of our stock options and ESPP awards was estimated using a Black- Scholes option valuation model. This model requires the input of highly subjective assumptions and elections in adopting and implementing SFAS No. 123R, including expected stock price volatility and the estimated life of each award. The fair value of equity-based awards is amortized over the vesting period of the award and we have elected to use the straight-line method for awards granted after the adoption of SFAS No. 123R and continue to use a graded vesting method for awards granted prior to the adoption of SFAS No. 123R. We make quarterly assessments of the adequacy of our tax credit pool to determine if there are any deficiencies which require recognition in our consolidated statements of operations. Prior to the adoption of SFAS No. 123R, we accounted for our ESPP and stock option plans under the provisions of Accounting Principles Board (APB) Opinion No. 25 “Accounting For Stock Issued to Employees” (APB No. 25) and Financial Accounting Standards Board (FASB) Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation — an Interpretation of APB Opinion No. 25” and made pro forma footnote disclosures as required by Statement of Financial Accounting Standards (SFAS) No. 148, “Accounting For Stock-Based Compensation — Transition and Disclosure”, which amends SFAS No. 123, “Accounting For Stock-Based Compensation”. Pro forma net income and pro forma net income per share disclosed in the footnotes to our consolidated financial statements were estimated using a Black-Scholes option valuation model. As a result of the adoption of SFAS No. 123R, we will only recognize a benefit from stock-based compensation in paid-in-capital if an incremental tax benefit is realized after all other tax attributes currently available to us have been utilized. In addition, we have elected to account for the indirect benefits of stock-based compensation on the research tax credit and the extraterritorial income deduction through the income statement (continuing operations) rather than through paid-in-capital. We have also elected to net deferred tax assets and the associated valuation allowance related to net operating loss and tax credit carryforwards for the accumulated stock award tax benefits determined under APB No. 25 for income tax footnote disclosure purposes. We will track these stock award attributes separately and will only recognize these attributes through paid-in-capital in accordance with Footnote 82 of SFAS123(R). Income Taxes: Deferred income taxes reflect the net effect of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Realization of our net deferred tax assets is dependent on future taxable income. We believe it is more likely than not that such assets will be realized; however, ultimate realization could be negatively impacted by market conditions and other variables not known or anticipated at this time. In the event that we determine that we would not be able to realize all or part of our net deferred tax assets, an adjustment would be charged to earnings in the period such determination is made. Likewise, if we later determine that it is more likely than not that the deferred tax assets would be realized, then the previously provided valuation allowance would be reversed. We calculate our current and deferred tax provision based on estimates and assumptions that could differ from the actual results reflected in income tax returns filed during the subsequent year. Adjustments based on filed returns are recorded when identified. 28 We provide for income taxes on an interim basis on the basis of annual estimated effective income tax rates. Our estimated effective income tax rate reflects the underlying profitability of the Company, the level of R&D spending, the regions where profits are recorded and the respective tax rates imposed. We carefully monitor these factors and adjust the effective income tax rate, if necessary. If actual results differ from estimates, we could be required to record an additional valuation allowance on deferred tax assets or adjust our effective income tax rate, which could have a material impact on our business, results of operations, and financial condition. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws. Our estimate for the potential outcome of any uncertain tax issue is highly judgmental. Resolution of these uncertainties in a manner inconsistent with the Company’s expectations could have a material impact on the Company’s results of operation and financial condition. The Company accounts for the income tax contingencies in accordance with SFAS No. 5, “Accounting for Contingencies.” Recent Accounting Pronouncements In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation 48, “Accounting for Income Tax Uncertainties” (FIN 48). FIN 48 defines the threshold for recognizing the benefits of tax return positions in the financial statements as “more-likely-than-not” to be sustained by the taxing authority. The recently issued literature also provides guidance on the derecognition, measurement and classification of income tax uncertainties, along with any related interest and penalties. FIN 48 also includes guidance concerning accounting for income tax uncertainties in interim periods and increases the level of disclosures associated with any recorded income tax uncertainties. FIN 48 is effective for fiscal years beginning after December 15, 2006. Any differences between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption will be accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. We are currently in the process of determining the impact, if any, of adopting the provisions of FIN 48 on our financial position, results of operations and liquidity. Liquidity and Capital Resources As of June 25, 2006, we had $1.5 billion in cash and cash equivalents, short-term investments, and restricted cash and investments compared with $894.3 million at June 26, 2005. We entered into long-term debt of $350.0 million during fiscal year 2006 to provide sufficient liquidity to support our foreign earnings repatriation of $500 million under the American Jobs Creation Act of 2004. The remaining increase of $276.1 million was derived from cash flows from operating activities of $360.7 million, issuance of common stock from employee equity- based plans of $194.6 million, partially offset by stock repurchases of $251.2 million and capital expenditures and purchases of intangible assets of $42.1 million. Cash Flows From Operating Activities Net cash provided by operating activities of $360.7 million during fiscal year 2006 consisted of (in millions): Net income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-cash charges: Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Equity-based compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income tax benefit on equity-based compensation plans . . . . . . . . . . . . . . . . . . . . . . . Excess tax benefit on equity-based compensation plans . . . . . . . . . . . . . . . . . . . . . . . Decrease in deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Change in other working capital accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $335.8 22.0 22.8 2.3 27.8 (17.8) 27.7 (59.9) $360.7 29 Significant changes in assets and liabilities included increases in accounts receivable and inventory of $175.3 million and $58.7 million, respectively, due to the increased volume of business. These changes were partially offset by an increase in deferred profit of $50.4 million due to increased volume of shipments, an increase in accounts payable of $48.3 million, and increases in accrued liabilities of $88.4 million primarily due to VAT and income taxes payable related to higher profit levels, and an increase in accrued compensation based on incentive-based compensation. Cash Flows from Investing Activities Net cash used for investing activities during fiscal year 2006 was $244.3 million and consisted of a transfer to restricted cash and investments of $385.0 million due to our guarantee agreement related to the obligations of our wholly-owned subsidiary under the $350.0 million credit agreement entered into during the quarter ended June 25, 2006. Our obligations under the Guarantee Agreement are collateralized by readily marketable securities in an amount equal to 110% of the outstanding balance of our obligations under the Guarantee Agreement. In addition, we purchased $42.1 million for capital expenditures, consisting primarily of engineering equipment, and the purchase of intangible assets of intellectual property. Partially offsetting these uses of cash were proceeds from the net sales of short-term investments of $182.8 million. Cash Flows from Financing Activities Net cash provided by financing activities during fiscal year 2006 was $310.7 million consisting of $350.0 million from the issuance of long-term debt, $194.6 million from the issuance of our common stock related to employee equity-based plans, and $17.8 million of excess tax benefits on equity-based compensation plans, partially offset by stock repurchases of $251.2 million. During fiscal year 2006, we repurchased approximately 7.0 million shares of common stock at a total price of $251.2 million under Board authorized repurchase programs which run through September 30, 2008. As of June 25, 2006 the total amount remaining available for repurchase under Board authorizations was $331.7 million. We expect to continue to repurchase shares consistent with the Board authorizations, the level of which will be determined by, including but not limited to, the needs of the business and the stock price and daily trading volumes of our stock. Given the cyclical nature of the semiconductor equipment industry, we believe that maintaining sufficient liquidity reserves is important to support sustaining levels of investment in R&D and capital infrastructure. Based upon our current business outlook, our levels of cash, cash equivalents, and short-term investments at June 25, 2006 are expected to be sufficient to support our presently anticipated levels of operations, investments, debt service requirements, and capital expenditures, through at least the next 12 months. In the longer term, liquidity will depend to a great extent on our future revenues and our ability to appropriately manage our costs based on demand for our products. Should additional funding be required, we may need to raise the required funds through borrowings or public or private sales of debt or equity securities. We believe that, in the event of such requirements, we will be able to access the capital markets on terms and in amounts adequate to meet our objectives. However, given the possibility of changes in market conditions or other occurrences, there can be no certainty that such funding will be available in needed quantities or on terms favorable to us. 30 Off-Balance Sheet Arrangements and Contractual Obligations We have certain obligations, some of which are recorded on our balance sheet and some which are not, to make future payments under various contracts. Obligations are recorded on our balance sheet in accordance with U.S. generally accepted accounting principles. The obligations recorded on our consolidated balance sheet include restructuring liabilities and long-term debt which are outlined in the following table and are discussed below. Our off-balance sheet arrangements include contractual relationships and are presented as operating leases and purchase obligations in the table below. Our contractual cash obligations and commitments relating to these agreements, and our guarantees are included in the following table: Operating Leases Purchase Obligations Restructuring Liabilities Long-term Debt and Interest Expense Total (in thousands) Payments due by period: Less than 1 year . . . . . . . . . . . . 1-3 years . . . . . . . . . . . . . . . . . . 4-5 years . . . . . . . . . . . . . . . . . . Over 5 years . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . $ 14,821 86,613 2,142 2,175 $ 105,751 $ 154,482 42,905 8,306 — $ 205,693 $1,590 — — — $1,590 $ 20,050 40,209 390,044 — $ 450,303 $ 190,943 169,727 400,492 2,175 $ 763,337 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, which expire at various dates through 2021. Certain of our facility leases for buildings located at our Fremont, California headquarters 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. Included in the operating leases 1-3 years section of the table above is $75.0 million in guaranteed residual values for lease agreements relating to certain properties at our Fremont, California campus. As part of the lease agreements, we have the option to purchase the remaining buildings at any time for a total purchase price for all remaining properties related to these leases of approximately $85.0 million. We are required to guarantee the lessor a residual value on the properties of up to $75.0 million at the end of the lease terms in fiscal year 2008 (in the event that the leases are not renewed, we do not exercise the purchase options, the lessor sells the properties and the sale price is less than the lessor’s costs). We maintain cash collateral of $85.0 million as part of the lease agreements as of June 25, 2006 in separate, specified certificates of deposit and interest-bearing accounts which are recorded as restricted cash and investments in our Consolidated Balance Sheet. The lessor under the lease agreements is a substantive independent leasing company that does not have the characteristics of a variable interest entity (VIE) as defined by FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” and is therefore not consolidated by us. The remaining operating lease balances primarily relate to non-cancelable facility-related operating leases. 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. We continue to enter into new agreements and maintain existing agreements to outsource certain activities, including elements of our manufacturing, warehousing, logistics, facilities maintenance, certain information technology functions, and certain transactional general and administrative functions. The contractual cash obligations and commitments table presented above contains our minimum obligations at June 25, 2006 under these arrangements and others. Actual expenditures will vary based on the volume of transactions and length of contractual service provided. In addition to minimum spending commitments, certain of these agreements provide for potential cancellation charges. 31 Consignment inventories, which are owned by vendors but located in our storage locations and warehouses, are not reported as our inventory until title is transferred to us or our purchase obligation is determined. At June 25, 2006, vendor-owned inventories held at our locations and not reported as our inventory increased to $31.1 million compared to $14.8 million at June 26, 2005, due to the increased volume of our business. Restructuring Liabilities Our total restructuring reserves as of June 25, 2006 were $1.6 million, which consists primarily of lease payments on vacated buildings. Through cash generated from operations, we expect the remaining balance to be paid over the next twelve months. Long-Term Debt and Interest Expense On June 16, 2006, our wholly-owned subsidiary, Lam Research International SARL (LRI), as borrower, entered into a $350 million Credit Agreement (the Credit Agreement). Under the Credit Agreement, on June 19, 2006, LRI borrowed $350 million in principal amount. The loan under the Credit Agreement shall be fully repaid not later than five years following the closing date and will bear interest at LIBOR plus a spread ranging from 0.10% to 0.50%, depending upon a consolidated leverage ratio, as defined in the Credit Agreement. The initial spread under the Credit Agreement is 0.10%. LRI may prepay the loan under the Credit Agreement in whole or in part at any time without penalty, subject to reimbursement of lenders’ breakage and redeployment costs in certain cases. The amounts in the table above include the principal payment of $350 million due on June 19, 2011 and interest payments estimated based on the current LIBOR rate of 5.5% and initial spread of ten basis points. The fair value of long-term debt approximates its carrying value due to the variable interest rate applicable to the debt. We used the proceeds from the credit facility entered into by LRI to facilitate the repatriation of $500 million of foreign earnings in the June 2006 quarter under the provisions of the American Jobs Creation Act of 2004 (AJCA). We have now completed our repatriation of foreign earnings under the provisions of the AJCA. Guarantees We account for our guarantees in accordance with Financial Accounting Standards Board (FASB) Interpretation No. 45 “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN No. 45). FIN No. 45 requires a company that is a guarantor to make specific disclosures about its obligations under certain guarantees that it has issued. FIN No. 45 also requires a company (the Guarantor) to recognize, at the inception of a guarantee, a liability for the obligations it has undertaken in issuing the guarantee. We lease several facilities at our headquarters location in Fremont, California. As part of certain of the lease agreements, we have the option to purchase the remaining buildings at any time for a total purchase price for all remaining properties related to these leases of approximately $85.0 million. We are required to guarantee the lessor a residual value on the properties of up to $75.0 million at the end of the lease terms in fiscal year 2008 (in the event that the leases are not renewed, we do not exercise the purchase options, the lessor sells the properties and the sale price is less than the lessor’s costs). We maintain cash collateral of $85.0 million as part of the lease agreements as of June 25, 2006 in separate, specified certificates of deposit and interest-bearing accounts which are recorded as restricted cash and investments in our Consolidated Balance Sheet. The lessor under the lease agreements is a substantive independent leasing company that does not have the characteristics of a variable interest entity (VIE) as defined by FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” and is therefore not consolidated by us. We have issued certain indemnifications to our lessors under some of our agreements. We have entered into certain insurance contracts which may limit our exposure to such indemnifications. As of June 25, 2006, we have not recorded any liability on our financial statements in connection with these indemnifications, as we do not believe, based on information available, that it is probable that any amounts will be paid under these guarantees. In connection with the Credit Agreement entered into by LRI noted above, we entered into a Guarantee Agreement (the Guarantee Agreement) guaranteeing the obligations of LRI under the Credit Agreement. Our obligations under the Guarantee Agreement are collateralized by readily marketable securities in an amount 32 equal to 110% of the outstanding balance of our obligations under the Guarantee Agreement, representing $385.0 million at June 25, 2006. This collateral is reflected in the balance of restricted cash and investments in our Consolidated Balance Sheet. 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 any material amounts will be paid under these guarantees. We offer standard warranties on our systems that run generally for a period of 12 months from system acceptance, not to exceed 14 months from the date of shipment of the system to the customer. The liability amount is based on actual historical warranty spending activity by type of system, customer, and geographic region, modified for any known differences such as the impact of system reliability improvements. Item 7A. Quantitative and Qualitative Disclosures about Market Risk Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio and variable rate long-term debt. We maintain a conservative investment policy, which focuses on the safety and preservation of our invested funds by limiting default risk, market risk, and reinvestment risk. The table below presents principal amounts and related weighted-average tax equivalent interest rates by year of maturity for our investment portfolio at June 25, 2006 and June 26, 2005: June 25, 2006 June 26, 2005 June 24, 2007 Cash equivalents Fiscal Year Ending June 28, 2009 June 29, 2008 June 27, 2010 June 26, 2011 There- After Total Fair Value Total (in thousands, except percentages) Variable rate . . . . . . $ 730,887 Average rate . . . . . . Fixed rate . . . . . . . . $ 113,566 Average rate . . . . . . Short-term investments 4.95% 5.10% — $ — $ — $ — $ — $ — $ — $ — $ — — — — — $ — $ 730,887 — — $ — $ 113,566 — — — 4.95% 5.10% $ 730,887 — $ 113,509 — $ — — $ 378,183 3.05% Fixed rate . . . . . . . . $ Average rate . . . . . . 42,125 $ 25,411 $31,346 $23,819 $ 3.86% 3.93% 4.43% 4.26% 6,760 5.14% $12,870 $ 142,331 4.37% 4.19% $ 139,524 — $ 328,846 3.99% Restricted cash and investments Variable rate . . . . . . $ Average rate . . . . . . Fixed rate . . . . . . . . $ 328,643 Average rate . . . . . . 70,575 5.08% 5.64% $ — $ — $ — $ — $14,968 — $25,395 — $ 4,552 $ 4.94% 5.27% 4.83% — $ — $ — 9,082 5.89% — $17,810 5.66% 70,575 5.64% $ 400,450 5.12% Total investment securities . . . . . . . . $1,285,796 $50,806 $46,314 $28,371 $ 15,842 $30,680 $1,457,809 Average rate . . . . . . . . . 4.68% 4.44% 4.70% 4.35% 5.57% 5.12% 4.41% $ 70,575 — $ 399,463 — $ — — $ 85,038 3.00% $1,453,958 — $ 792,067 3.43% Long-term debt . . . . . . . Variable rate . . . . . . $ Average rate . . . . . . — $ — $ — $ — $ 350,000 — — — — 5.65% $ — $ 350,000 — 5.65% $ 350,000 — $ — — We mitigate default risk by investing in high credit quality securities and by positioning our portfolio to respond appropriately to a significant reduction in a credit rating of any investment issuer or guarantor. The portfolio includes only marketable securities with active secondary or resale markets to achieve portfolio liquidity and maintain a prudent amount of diversification. We conduct business on a global basis in several major international currencies. As such, we are potentially exposed to adverse as well as beneficial movements in foreign currency exchange rates. The majority of our sales and expenses are denominated in U.S. dollars except for certain of our revenues in Japan that are denominated in Japanese Yen, certain of our spares and service contracts which are denominated in other currencies, and 33 expenses related to our non-U.S. sales and support offices which are denominated in these countries’ local currency. We currently enter into foreign currency forward contracts to minimize the short-term impact of the exchange rate fluctuations on Japanese Yen-denominated assets and forecasted Japanese Yen-denominated revenue where we currently believe our primary exposure to currency rate fluctuation lies. To protect against the reduction in value of forecasted Japanese Yen-denominated revenues, we enter into foreign currency forward exchange rate contracts that generally expire within 12 months, and no later than 24 months. These foreign currency forward exchange rate contracts are designated as cash flow hedges and are carried on our Balance Sheet at fair value with the effective portion of the contracts’ gains or losses included in accumulated other comprehensive income (loss) and subsequently recognized in earnings in the same period the hedged revenue is recognized. We also enter into foreign currency forward contracts to hedge the gains and losses generated by the remeasurement of Japanese Yen-denominated net receivable balances. The change in fair value of these balance sheet hedge contracts is recorded into earnings as a component of other income and expense and offsets the change in fair value of the foreign currency denominated intercompany and trade receivables, recorded in other income and expense, assuming the hedge contract fully covers the intercompany and trade receivable balances. On June 25, 2006, the notional amount of outstanding Japanese Yen forward contracts that are designated as balance sheet hedges was $23.5 million. The unrealized gain on the contracts on June 25, 2006, was $0.1 million. A 15% appreciation of the Japanese Yen would result in an unrealized loss of $4.1 million. Depreciation in the exchange rate of the Japanese Yen of approximately 15% would result in an unrealized gain of $3.1 million. These changes in fair values would be offset in other income and expense by corresponding change in fair values of the foreign currency denominated intercompany and trade receivables assuming the hedge contract fully covers the intercompany and trade receivable balances. On June 25, 2006, the notional amount of outstanding Japanese Yen forward contracts that are designated as cash flow hedges was $193.8 million. A 15% appreciation of the Japanese Yen would result in an unrealized loss of $34.2 million. Depreciation in the exchange rate of the Japanese Yen of approximately 15% would result in an unrealized gain of $25.3 million. Our outstanding long-term debt of $350.0 million bears interest at LIBOR plus a spread ranging from 0.10% to 0.50%, depending upon a consolidated leverage ratio, as defined in the Credit Agreement. The initial spread under the Credit Agreement is 0.10%. The principal payment of $350 million is due on June 19, 2011. The fair value of long-term debt approximates its carrying value due to the variable interest rate applicable to the debt. Item 8. Consolidated Financial Statements and Supplementary Data The Consolidated Financial Statements required by this Item are set forth on the pages indicated at Item 15(a). The unaudited quarterly results of our operations for our two most recent fiscal years are incorporated herein by reference under Item 6, “Selected Consolidated Financial Data”. 34 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. Item 9A. Controls and Procedures Disclosure Controls and Procedures As required by Exchange Act Rule 13a-15(b), as of the close of fiscal year June 25, 2006, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15(e). Based upon that evaluation, our Chief Executive Officer along with our Chief Financial Officer, concluded that our disclosure controls and procedures are effective at the reasonable assurance level. We intend to review and evaluate the design and effectiveness of our disclosure controls and procedures on an ongoing basis and to correct any material deficiencies that we may discover. Our goal is to ensure that our senior management has timely access to material information that could affect our business. Management’s Report on Internal Control Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Management has used the framework set forth in the report entitled “Internal Control—Integrated Framework” published by the Committee of Sponsoring Organizations of the Treadway Commission to evaluate the effectiveness of the Company’s internal control over financial reporting. Based on that evaluation, management has concluded that the Company’s internal control over financial reporting was effective as of June 25, 2006 at providing reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Ernst & Young LLP, an independent registered public accounting firm, has audited management’s assessment of the Company’s internal control over financial reporting, as stated in their report, which is included at the end of Part II, Item 8 of this Annual Report on Form 10-K. Changes in Internal Control Over Financial Reporting There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Effectiveness of Controls While we believe the present design of our disclosure controls and procedures and internal control over financial reporting is effective at the reasonable assurance level, future events affecting our business may cause us to modify our disclosure controls and procedures or internal control over financial reporting. The effectiveness of controls cannot be absolute because the cost to design and implement a control to identify errors or mitigate the risk of errors occurring should not outweigh the potential loss caused by the errors that would likely be detected by the control. Moreover, we believe that a control system cannot be guaranteed to be 100% effective all of the time. Accordingly, a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Item 9B. Other Information None 35 PART III We have omitted from this Report certain information required by Part III because we, as the Registrant, will file a definitive proxy statement with the Securities and Exchange Commission (SEC) within 120 days after the end of our fiscal year, pursuant to Regulation 14A, as promulgated by the SEC, for our Annual Meeting of Stockholders to be held November 2, 2006 (the Proxy Statement), and certain information included therein is incorporated herein by reference. (However, the Report of the Audit Committee, Compensation Committee and the Comparative Stock Performance graph of the Registrant’s Proxy Statement are expressly not incorporated by reference herein.) For information regarding our executive officers, see Part I of this Form 10-K under the caption “Executive Officers of the Company”, which information is incorporated herein by this reference. Item 10. Directors and Executive Officers of the Registrant The information concerning our directors required by this Item is incorporated by reference to our Proxy Statement under the heading “Proposal No. 1-Election of Directors.” Lam has adopted a Code of Ethics that applies to all employees, officers, and directors of the Company. Our Code of Ethics is publicly available on the investor relations page of our website at www.lamresearch.com. To the extent required by law, any amendments to, or waivers from, any provision of the Code of Ethics will promptly be disclosed to the public. To the extent permitted by such legal requirements, we intend to make such public disclosure by posting the relevant material on our website in accordance with SEC rules. Item 11. Executive Compensation The information required by this Item is incorporated by reference to our Proxy Statement under the heading “Executive Compensation and Other Information.” Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The information required by this Item is incorporated by reference to our Proxy Statement under the headings “Proposal No. 1-Election of Directors”, “Security Ownership of Certain Beneficial Owners and Management” and “Securities Authorized for Issuance Under Equity Compensation Plans.” Item 13. Certain Relationships and Related Transactions The information required by this Item is incorporated by reference to our Proxy Statement under the heading “Certain Relationships and Related Transactions”. Item 14. Principal Independent Registered Public Accounting Firm Fees and Services The information required by this Item is incorporated by reference to our Proxy Statement under the heading “Relationship with Independent Registered Public Accounting Firm.” 36 Item 15. Exhibits and Consolidated Financial Statement Schedules (a) 1. Index to Financial Statements PART IV Consolidated Balance Sheets — June 25, 2006 and June 26, 2005 . . . . . . . . . . . . . . . Consolidated Statements of Operations — Years Ended June 25, 2006, June 26, 2005, and June 27, 2004. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consolidated Statements of Cash Flows — Years Ended June 25, 2006, June 26, 2005, and June 27, 2004. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consolidated Statements of Stockholders’ Equity — Years Ended June 25, 2006, June 26, 2005, and June 27, 2004. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Report of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . . . Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2. Index to Financial Statement Schedules Schedule II — Valuation and Qualifying Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 38 39 40 41 42 63 64 66 Schedules, other than those listed above, have been omitted since they are not applicable/not required, or the information is included elsewhere herein. 3. See (c) of this Item 15, which is incorporated herein by reference. (c) The list of Exhibits follows page 67 of this Form 10-K and are incorporated herein by this reference. 37 LAM RESEARCH CORPORATION CONSOLIDATED BALANCE SHEETS (in thousands, except per share data) ASSETS Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Short-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accounts receivable, less allowance for doubtful accounts of $3,822 as of June 25, 2006 and $3,865 as of June 26, 2005 . . . . . . . . . . . . . . Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred income taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Prepaid expenses and other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Restricted cash and investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred income taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . LIABILITIES AND STOCKHOLDERS’ EQUITY Trade accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued expenses and other current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other long-term liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commitments and contingencies Stockholders’ equity: Preferred stock, at par value of $0.001 per share; authorized — 5,000 shares, none outstanding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Common stock, at par value of $0.001 per share; authorized — 400,000 shares; issued and outstanding — 141,785 shares at June 25, 2006 and 137,313 shares at June 26, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred stock-based compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Treasury stock, at cost, 13,532 shares at June 25, 2006 and 7,215 shares at June 26, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accumulated other comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total stockholders’ equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total liabilities and stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . June 25, 2006 June 26, 2005 $ 910,815 139,524 $ 482,250 327,003 407,347 168,714 53,625 26,344 1,706,369 49,893 470,038 38,533 48,511 $2,313,344 $ 108,504 317,637 140,085 566,226 350,000 969 917,195 232,005 110,051 76,660 16,867 1,244,836 41,082 85,038 43,224 34,635 $1,448,815 $ 60,218 229,207 89,708 379,133 — 2,786 381,919 — — 142 973,391 — 137 744,672 (1,225) (416,447) (11,205) 850,268 1,396,149 $2,313,344 (186,064) (10,789) 520,165 1,066,896 $1,448,815 See Notes to Consolidated Financial Statements 38 LAM RESEARCH CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) Total revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of goods sold — restructuring recoveries . . . . . . . . . . . . Total cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross margin. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Research and development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Selling, general and administrative. . . . . . . . . . . . . . . . . . . . . . . . Restructuring charges, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . Operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other income (expense): Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income before income taxes . . . . . . . . . . . . . . . . . . . . . . . . Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income per share: June 25, 2006 $1,642,171 814,777 — 814,777 827,394 228,891 192,238 — 421,129 406,265 38,189 (677) (2,490) 35,022 441,287 105,532 $ 335,755 YEAR ENDED June 26, 2005 $1,502,453 738,361 — 738,361 764,092 194,115 164,774 14,201 373,090 391,002 17,537 (1,413) (8,004) 8,120 399,122 99,781 $ 299,341 June 27, 2004 $935,946 506,548 (1,651) 504,897 431,049 170,479 146,063 8,327 324,869 106,180 9,915 (4,634) (811) 4,470 110,650 27,662 $ 82,988 Basic net income per share. . . . . . . . . . . . . . . . . . . . . . . . . . . . Diluted net income per share . . . . . . . . . . . . . . . . . . . . . . . . . . $ $ 2.42 2.34 $ $ 2.17 2.10 $ $ 0.63 0.59 Number of shares used in per share calculations: Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 138,581 143,732 137,727 142,417 131,776 144,928 See Notes to Consolidated Financial Statements 39 LAM RESEARCH CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Restructuring charges, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization of premiums on securities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Asset impairment charge. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loss on disposal of long-lived assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Equity-based compensation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net noncash gain on retirement of 4% Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income tax benefit on equity-based compensation plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . Excess tax benefit on equity-based compensation plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Changes in working capital accounts: Accounts receivable, net of allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Prepaid expenses and other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Trade accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued expenses and other liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net cash provided by operating activities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures and intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Purchases of available-for-sale securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sales and maturities of available-for-sale securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Transfer of restricted cash and investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net cash provided by / (used for) investing activities . . . . . . . . . . . . . . . . . . . . . . . CASH FLOWS FROM FINANCING ACTIVITIES: Principal payments on long-term debt and capital lease obligations . . . . . . . . . . . . . . . . . . . . . Net proceeds from issuance of long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from settlement of swap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Excess tax benefit on equity-based compensation plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Treasury stock purchases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reissuances of treasury stock. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from issuance of common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net cash provided by / (used for) financing activities . . . . . . . . . . . . . . . . . . . . . . . Effect of exchange rate changes on cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net increase in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash and cash equivalents at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash and cash equivalents at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . June 25, 2006 YEAR ENDED June 26, 2005 June 27, 2004 $ 335,755 $ 299,341 $ 82,988 22,000 27,726 — 2,683 — — 22,768 — 27,786 (17,805) (326) (178,542) (59,038) (9,270) 48,341 50,675 87,934 360,687 (42,080) (129,464) 312,252 (385,000) — (244,292) (112) 349,632 — 17,805 (251,211) 15,171 179,400 310,685 1,485 428,565 482,250 $ 910,815 25,517 89,352 14,201 3,285 — — 864 — 2,050 — (431) 13,470 (2,588) (455) (33,108) (18,936) 33,368 425,930 (22,849) (247,392) 184,083 27,430 — (58,728) — — — — (167,081) 458 114,304 (52,319) 3,964 318,847 163,403 $ 482,250 28,240 10,862 6,676 3,966 3,025 732 3,167 (7,505) 1,421 — (251) (138,361) 5,136 6,528 57,847 63,105 29,573 157,149 (24,026) (463,476) 530,406 6,000 (398) 48,506 (300,012) — 10,870 — — 13,242 64,152 (211,748) 2,153 (3,940) 167,343 $ 163,403 Schedule of noncash transactions Acquisition of leased equipment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,088 Supplemental disclosures: Cash payments for interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash payments for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 531 $ 11,873 $ $ $ — $ — 1,341 7,339 $ 13,600 4,165 $ See Notes to Consolidated Financial Statements 40 LAM RESEARCH CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (in thousands) COMMON STOCK SHARES 127,435 6,224 COMMON STOCK $127 7 ADDITIONAL PAID-IN CAPITAL $560,273 64,145 TREASURY STOCK $ (38,670) — DEFERRED STOCK- BASED COMPENSATION $(2,769) — ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) $ (13,694) — RETAINED EARNINGS $143,817 — TOTAL $ 649,084 64,152 Balance at June 29, 2003 . . . . . . . . . . . . Sale of common stock . . . . . . . . . . . . . . Income tax benefit from stock option transactions . . . . . . . . . . . . . . . . . . Reissuance of treasury stock . . . . . . . . Deferred stock-based compensation. . . Amortization of deferred compensation Components of comprehensive income: Net income . . . . . . . . . . . . . . . . . . . Foreign currency translation adjustment . . . . . . . . . . . . . . . . Unrealized loss on fair value of derivative financial instruments, net . . . . . . . . . . . . Unrealized loss on financial instruments, net . . . . . . . . . . . . Less: reclassification adjustment for gains included in earnings . . . . . Total comprehensive income . . Balance at June 27, 2004. . . . . . . . . . . . Sale of common stock . . . . . . . . . . . . . . Purchase of treasury stock . . . . . . . . . . Income tax benefit from stock option transactions . . . . . . . . . . . . . . . . . . Reissuance of treasury stock . . . . . . . . Deferred stock-based compensation. . . Amortization of deferred compensation Components of comprehensive income: Net income . . . . . . . . . . . . . . . . . . . Foreign currency translation adjustment . . . . . . . . . . . . . . . . Unrealized gain on fair value of derivative financial instruments, net . . . . . . . . . . . . Unrealized loss on financial instruments, net . . . . . . . . . . . . Less: reclassification adjustment for gains included in earnings . . . . . Total comprehensive income . . Balance at June 26, 2005. . . . . . . . . . . . Sale of common stock . . . . . . . . . . . . . . Purchase of treasury stock . . . . . . . . . . Income tax benefit on equity-based compensation plans . . . . . . . . . . . . Reissuance of treasury stock . . . . . . . . Equity-based compensation expense . . Deferred compensation adjustment . . . Exercise of warrant . . . . . . . . . . . . . . . . Components of comprehensive income: Net income . . . . . . . . . . . . . . . . . . . Foreign currency translation adjustment . . . . . . . . . . . . . . . . Unrealized gain on fair value of derivative financial instruments, net . . . . . . . . . . . . Unrealized loss on financial instruments, net . . . . . . . . . . . . Less: reclassification adjustment for gains included in earnings . . . . . Total comprehensive income . . Balance at June 25, 2006. . . . . . . . . . . . — 1,329 — — — — — — — 1 — — — — — — — 1,421 — 2,237 — — 18,928 — — — — (2,237) 3,167 — — — — — — — — — — — — — — — 134,988 8,155 (5,855) $135 8 (6) $628,076 114,296 — $ (19,742) — (167,075) $(1,839) — — — 25 — — — — — — — — — — — — — — — — 2,050 — (173) 423 — — — — — — 753 — — — — — — — 137,313 9,914 (6,979) $137 10 (6) $744,672 179,390 $(186,064) — (251,205) — 658 — — 879 — — — — — — 1 — — — — — — — 27,786 — 22,768 (1,225) — 20,822 — — — — — — — — — — — — — — 173 441 — — — — — $(1,225) — — — — — 1,225 — — — — — — — — — — 1,808 (293) (2,665) (439) $ (15,283) — — — — — — — 3,584 1,650 (379) (361) — — — — — 2,061 6,200 (916) (7,761) — (5,686) — — 82,988 — — — — $ $221,119 — — — (295) — — 1,421 13,243 — 3,167 82,988 1,808 (293) (2,665) (439) 81,399 812,466 114,304 (167,081) 2,050 458 — 864 299,341 299,341 — — — — — — — — 3,584 1,650 (379) (361) 303,835 $ 1,066,896 179,400 (251,211) 2,061 6,200 (916) (7,761) 335,339 $ 1,396,149 — (5,652) — — 27,786 15,171 22,768 — — 335,755 335,755 $ (10,789) — — $520,165 — — 141,785 $142 $973,391 $(416,447) $ — $ (11,205) $850,268 See Notes to Consolidated Financial Statements 41 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 25, 2006 Note 1: Company and Industry Information Lam Research Corporation (Lam or the Company) is a major provider of wafer fabrication equipment and services to the world’s semiconductor industry. The Company actively markets and sells product offerings that include single-wafer plasma etch systems with a wide range of applications and an array of services designed to optimize the utilization of these systems by its customers. The Company sells its products and services primarily to companies involved in the production of semiconductors in the United States, Europe, Japan, Korea, and Asia Pacific. The semiconductor industry is cyclical in nature and has historically experienced periodic downturns and upturns. Today’s leading indicators of changes in customer investment patterns may not be any more reliable than in prior years. Demand for the Company’s equipment can vary significantly from period to period as a result of various factors, including, but not limited to, economic conditions, supply, demand, and prices for semiconductors, customer capacity requirements, and the Company’s ability to develop and market competitive products. For these and other reasons, the Company’s results of operations for fiscal years 2006, 2005, and 2004 may not necessarily be indicative of future operating results. Note 2: Summary of Significant Accounting Policies The preparation of financial statements, in conformity with U.S. generally accepted accounting principles requires management to make 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. The Company based its estimates and assumptions on historical experience and on various other assumptions believed to be applicable, and evaluates them on an on-going basis to ensure they remain reasonable under current conditions. Actual results could differ significantly from those estimates. Revenue Recognition: The Company recognizes all revenue when persuasive evidence of an arrangement exists, delivery has occurred and title has passed or services have been rendered, the selling price is fixed or determinable, collection of the receivable is reasonably assured, and the Company has completed its system installation obligations, received customer acceptance or is otherwise released from its installation or customer acceptance obligations. In the event that terms of the sale provide for a lapsing customer acceptance period, the Company recognizes revenue upon the expiration of the lapsing acceptance period or customer acceptance, whichever occurs first. In circumstances where the practices of a customer do not provide for a written acceptance or the terms of sale do not include a lapsing acceptance provision, the Company recognizes revenue where it can be reliably demonstrated that the delivered system meets all of the agreed to customer specifications. In situations with multiple deliverables, revenue is recognized upon the delivery of the separate elements to the customer and when the Company receives customer acceptance or is otherwise released from its customer acceptance obligations. Revenue from multiple element arrangements is allocated among the separate elements based on their relative fair values, provided the elements have value on a stand alone basis, there is objective and reliable evidence of fair value, the arrangement does not include a general right of return relative to the delivered item and delivery or performance of the undelivered item(s) is considered probable and substantially in the Company’s control. The maximum revenue recognized on a delivered element is limited to the amount that is not contingent upon the delivery of additional items. Revenue related to sales of spare parts and system upgrade kits is generally recognized upon shipment. Revenue related to services is generally recognized upon completion of the services requested by a customer order. Revenue for extended maintenance service contracts with a fixed payment amount is recognized on a straight-line basis over the term of the contract. Inventory Valuation: Inventories are stated at the lower of cost or market using standard costs, which approximate actual costs on a first-in, first-out basis. The Company maintains a perpetual inventory system and continuously records the quantity on-hand and standard cost for each product, including purchased components, subassemblies and finished goods. The Company maintains the integrity of perpetual inventory records through periodic physical counts of quantities on hand. Finished goods are reported as inventories until the point of title transfer to the customer. Generally, title transfer is documented in the terms of sale. When the terms of sale 42 do not specify, the Company assumes title transfers when it completes physical transfer of the products to the freight carrier unless other customer practices prevail. Transfer of title for shipments to Japanese customers generally occurs at time of customer acceptance. Standard costs are re-assessed at least annually and reflect achievable acquisition costs, generally the most recent vendor contract prices for purchased parts, currently obtainable assembly and test labor performance levels, and overhead for internally manufactured products. Manufacturing labor and overhead costs are attributed to individual product standard costs at a level planned to absorb spending at average utilization volumes. All intercompany profits related to the sales and purchases of inventory between the Company’s legal entities are eliminated from its consolidated financial statements. Management evaluates the need to record adjustments for impairment of inventory at least quarterly. The Company’s policy is to assess the valuation of all inventories, including manufacturing raw materials, work- in-process, finished goods and spare parts in each reporting period. Obsolete inventory or inventory in excess of management’s estimated usage requirements over the next 12 to 36 months is written down to its estimated market value, if less than cost. Inherent in the estimates of market value are management’s forecasts related to the Company’s future manufacturing schedules, customer demand, technological and/or market obsolescence, general semiconductor market conditions, possible alternative uses and ultimate realization of excess inventory. If future customer demand or market conditions are less favorable than the Company’s projections, additional inventory write-downs may be required, and would be reflected in cost of sales in the period the revision is made. Warranty: Typically, the sale of semiconductor capital equipment includes providing parts and service warranty to customers as part of the overall price of the system. The Company offers standard warranties for its systems that run generally for a period of 12 months from system acceptance, not to exceed 14 months from shipment of the system to the customer. When appropriate, the Company records a provision for estimated warranty expenses to cost of sales for each system upon revenue recognition. The amount recorded is based on an analysis of historical activity, which uses factors such as type of system, customer, geographic region, and any known factors such as tool reliability trends. All actual parts and labor costs incurred in subsequent periods are charged to those established reserves through the application of detailed project record keeping. Actual warranty expenses are incurred on a system-by-system basis, and may differ from the Company’s original estimates. While the Company periodically monitors the performance and cost of warranty activities, if actual costs incurred are different than its estimates, the Company may recognize adjustments to provisions in the period in which those differences arise or are identified. The Company does not maintain general or unspecified reserves; all warranty reserves are related to specific systems. In addition to the provision of standard warranties, the Company offers customer-paid extended warranty services. Revenues for extended maintenance and warranty services with a fixed payment amount are recognized on a straight-line basis over the term of the contract. Related costs are recorded either as incurred or when related liabilities are determined to be probable and estimable. Equity-based Compensation — Employee Stock Purchase Plan and Employee Stock Plans: Beginning on June 27, 2005 the Company accounts for its employee stock purchase plan (ESPP) and stock plans under the provisions of SFAS No. 123R. SFAS No. 123R requires the recognition of the fair value of equity-based compensation in net income. The fair value of the Company’s restricted stock units was calculated based upon the fair market value of its stock at the date of grant. The fair value of the Company’s stock options and ESPP awards was estimated using a Black-Scholes option valuation model. This model requires the input of highly subjective assumptions and elections in adopting and implementing SFAS No. 123R, including expected stock price volatility and the estimated life of each award. The fair value of equity-based awards is amortized over the vesting period of the award and the Company has elected to use the straight-line method for awards granted after the adoption of SFAS No. 123R and continues to use a graded vesting method for awards granted prior to the adoption of SFAS No. 123R. The Company makes quarterly assessments of the adequacy of its tax credit pool to determine if there are any deficiencies which require recognition in its consolidated statements of operations. Prior to the adoption of SFAS No. 123R, the Company accounted for its ESPP and stock option plans under the provisions of Accounting Principles Board (APB) Opinion No. 25 “Accounting For Stock Issued to Employees” (APB No. 25) and Financial Accounting Standards Board (FASB) Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation — an Interpretation of APB Opinion No. 25” and made pro forma 43 footnote disclosures as required by Statement of Financial Accounting Standards (SFAS) No. 148, “Accounting For Stock-Based Compensation — Transition and Disclosure”, which amends SFAS No. 123, “Accounting For Stock-Based Compensation”. Pro forma net income and pro forma net income per share disclosed in the footnotes to the Company’s consolidated financial statements were estimated using a Black-Scholes option valuation model. As a result of the adoption of SFAS No. 123R, the Company will only recognize a benefit from stock-based compensation in paid-in-capital if an incremental tax benefit is realized after all other tax attributes currently available to the Company have been utilized. In addition, the Company has elected to account for the indirect benefits of stock-based compensation on the research tax credit and the extraterritorial income deduction through the income statement (continuing operations) rather than through paid-in-capital. The Company has also elected to net deferred tax assets and the associated valuation allowance related to net operating loss and tax credit carryforwards for the accumulated stock award tax benefits determined under APB No. 25 for income tax footnote disclosure purposes. The Company will track these stock award attributes separately and will only recognize these attributes through paid-in-capital in accordance with Footnote 82 of SFAS123(R). Income Taxes: Deferred income taxes reflect the net effect of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The Company records a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. Realization of the Company’s net deferred tax assets is dependent on future taxable income. The Company believes it is more likely than not that such assets will be realized; however, ultimate realization could be negatively impacted by market conditions and other variables not known or anticipated at this time. In the event that the Company determines that it would not be able to realize all or part of its net deferred tax assets, an adjustment would be charged to earnings in the period such determination is made. Likewise, if the Company later determines that it is more likely than not that the deferred tax assets would be realized, then the previously provided valuation allowance would be reversed. The Company calculates its current and deferred tax provision based on estimates and assumptions that could differ from the actual results reflected in income tax returns filed during the subsequent year. Adjustments based on filed returns are recorded when identified. The Company provides for income taxes on an interim basis on the basis of annual estimated effective income tax rates. The Company’s estimated effective income tax rate reflects the underlying profitability of the Company, the level of R&D spending, the regions where profits are recorded and the respective tax rates imposed. The Company carefully monitors these factors and adjusts the effective income tax rate, if necessary. If actual results differ from estimates, the Company could be required to record an additional valuation allowance on deferred tax assets or adjust its effective income tax rate, which could have a material impact on its business, results of operations, and financial condition. The calculation of the Company’s tax liabilities involves dealing with uncertainties in the application of complex tax laws. The Company’s estimate for the potential outcome of any uncertain tax issue is highly judgmental. Resolution of these uncertainties in a manner inconsistent with the Company’s expectations could have a material impact on the Company’s results of operation and financial condition. The Company accounts for the income tax contingencies in accordance with SFAS No. 5, “Accounting for Contingencies.” Fiscal Year: The Company follows a 52/53-week fiscal reporting calendar and its fiscal year ends on the last Sunday of June each year. The Company’s most recent fiscal year ended on June 25, 2006 and included 52 weeks. The fiscal years ended June 26, 2005 and June 27, 2004 also included 52 weeks. The Company’s next fiscal year, ending on June 24, 2007, will include 52 weeks. Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Cash Equivalents and Short-Term Investments: All investments purchased with an original final maturity of three months or less are considered to be cash equivalents. All of the Company’s short-term investments are classified as available-for-sale at the respective balance sheet dates. The Company accounts for its investment portfolio at fair value. The investments classified as available-for-sale are recorded at fair value based upon 44 quoted market prices, and any material temporary difference between the cost and fair value of an investment is presented as a separate component of accumulated other comprehensive income (loss.) The specific identification method is used to determine the realized gains and losses on investments. Property and Equipment: Property and equipment is stated at cost. Equipment is depreciated by the straight-line method over the estimated useful lives of the assets, generally three to seven years. Leasehold improvements are amortized by the straight-line method over the shorter of the life of the related asset or the term of the underlying lease. Impairment of Long-Lived Assets: The Company routinely considers whether indicators of impairment of long-lived assets are present. If such indicators are present, the Company determines whether the sum of the estimated undiscounted cash flows attributable to the assets in question is less than their carrying value. If the sum is less, the Company recognizes 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. If the assets determined to be impaired are to be held and used, the Company recognizes 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 the Company depreciates 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 less cost to sell. Derivative Financial Instruments: The Company carries derivative financial instruments (derivatives) on the balance sheet at their fair values in accordance with Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS No. 133). The Company has a policy that allows the use of derivative financial instruments, specifically foreign currency forward exchange rate contracts, to hedge foreign currency exchange rate fluctuations on forecasted revenue transactions denominated in Japanese Yen and other foreign currency denominated assets. The Company does not use derivatives for trading or speculative purposes. The Company’s policy is to attempt to minimize short-term business exposure to foreign currency exchange rate risks using an effective and efficient method to eliminate or reduce such exposures. In the normal course of business, the Company’s financial position is routinely subjected to market risk associated with foreign currency exchange rate fluctuations. To protect against the reduction in value of forecasted Japanese Yen-denominated revenues, the Company has instituted a foreign currency cash flow hedging program. The Company enters into foreign currency forward exchange rate contracts that generally expire within 12 months, and no later than 24 months. These foreign currency forward exchange contracts are designated as cash flow hedges and are carried on the Company’s balance sheet at fair value with the effective portion of the contracts’ gains or losses included in accumulated other comprehensive income (loss) and subsequently recognized in earnings in the same period the hedged revenue is recognized. Each period, hedges are tested for effectiveness, using the dollar offset method, by comparing the change in value of the derivative with the change in the value of the anticipated sales transactions. To qualify for hedge accounting, the hedge relationship must meet criteria relating both to the derivative instrument and the hedged item. These include identification of the hedging instrument, the hedged item, the nature of the risk being hedged and how the hedging instrument’s effectiveness in offsetting the exposure to changes in the hedged item’s fair value or cash flows will be measured. To receive hedge accounting treatment, all hedging relationships are formally documented at the inception of the hedge and the hedges must be highly effective in offsetting changes to future cash flows on hedged transactions. When derivative instruments are designated and qualify as effective cash flow hedges, the Company is able to defer changes in the fair value of the hedging instrument within accumulated other comprehensive income (loss) until the hedged exposure is realized. Consequently, with the exception of hedge ineffectiveness recognized, the Company’s results of operations are not subject to fluctuation as a result of changes in the fair value of the derivative instruments. If hedges are not highly effective or if the Company does not believe that the underlying hedged forecasted transactions would occur, the Company may not be able to account for its investments in derivative instruments as cash flow hedges. If this were to occur in a future period, changes in the fair values of the Company’s derivative instruments would be recognized in earnings without the benefits of offsets or deferrals of changes in fair value arising from hedge accounting treatment. 45 The Company also enters into foreign currency forward exchange rate contracts to hedge the gains and losses generated by the remeasurement of Japanese Yen-denominated net receivable balances. Under SFAS No. 133, these forward contracts are not designated for hedge accounting treatment. Therefore, the change in fair value of these derivatives is recorded into earnings as a component of other income and expense and offsets the change in fair value of the foreign currency denominated intercompany and trade receivables, recorded in other income and expense, assuming the hedge contract fully covers the intercompany and trade receivable balances. To hedge foreign currency risks, the Company uses foreign currency exchange forward contracts, where possible and practical. These forward contracts are valued using standard valuation formulas with assumptions about future foreign currency exchange rates derived from existing exchange rates and interest rates observed in the market. The Company considers its most current outlook in determining the level of foreign currency denominated intercompany revenues to hedge as cash flow hedges. The Company combines these forecasts with historical trends to establish the portion of its expected volume to be hedged. The revenues are hedged and designated as cash flow hedges to protect the Company from exposures to fluctuations in foreign currency exchange rates. In the event the underlying forecasted transaction does not occur, or it becomes probable that it will not occur, the related hedge gains and losses on the cash flow hedge are reclassified from accumulated other comprehensive income (loss) to interest and other income (expense) on the consolidated statement of operations at that time. The Company does not believe that it is or was exposed to more than a nominal amount of credit risk in its interest rate and foreign currency hedges, as counterparties are established and well-capitalized financial institutions. The Company’s exposures are in liquid currencies (Japanese Yen), so there is minimal risk that appropriate derivatives to maintain the Company’s hedging program would not be available in the future. Guarantees: The Company accounts for guarantees in accordance with FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34” (FIN No. 45). Accordingly, the Company evaluates its guarantees to determine whether (a) the guarantee is specifically excluded from the scope of FIN No. 45, (b) the guarantee is subject to FIN No. 45 disclosure requirements only, but not subject to the initial recognition and measurement provisions, or (c) the guarantee is required to be recorded in the financial statements at fair value. The Company has recorded a liability for certain guaranteed residual values related to specific facility lease agreements. The Company has evaluated its remaining guarantees and has concluded that they are either not within the scope of FIN No. 45 or do not require recognition in the financial statements. These guarantees generally include certain indemnifications to its lessors under operating lease agreements for environmental matters, potential overdraft protection obligations to financial institutions related to one of the Company’s subsidiaries, indemnifications to the Company’s customers for certain infringement of third-party intellectual property rights by its products and services, and the Company’s warranty obligations under sales of its products. Please see Note 16 for additional information on the Company’s guarantees. Foreign Currency Translation: The Company’s non-U.S. subsidiaries that operate in a local currency environment, where that local currency is the functional currency, primarily generate and expend cash in their local currency. Billings and receipts for their labor and services are primarily denominated in the local currency and the workforce is paid in local currency. Their individual assets and liabilities are primarily denominated in the local foreign currency and do not materially impact the Company’s cash flows. Accordingly, all balance sheet accounts of these local functional currency subsidiaries are translated at the fiscal period-end exchange rate, and income and expense accounts are translated using average rates in effect for the period, except for costs related to those balance sheet items that are translated using historical exchange rates. The resulting translation adjustments are recorded as cumulative translation adjustments, and are a component of accumulated other comprehensive income (loss). Translation adjustments are recorded in other income (expense), net, where the U.S. dollar is the functional currency. Reclassifications: Certain amounts presented in the comparative financial statements for prior years have been reclassified to conform to the fiscal year 2006 presentation. 46 Note 3: Recent Accounting Pronouncements In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation 48, “Accounting for Income Tax Uncertainties” (FIN 48). FIN 48 defines the threshold for recognizing the benefits of tax return positions in the financial statements as “more-likely-than-not” to be sustained by the taxing authority. The recently issued literature also provides guidance on the derecognition, measurement and classification of income tax uncertainties, along with any related interest and penalties. FIN 48 also includes guidance concerning accounting for income tax uncertainties in interim periods and increases the level of disclosures associated with any recorded income tax uncertainties. FIN 48 is effective for fiscal years beginning after December 15, 2006. Any differences between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption will be accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. The Company is currently in the process of determining the impact, if any, of adopting the provisions of FIN 48 on its financial position, results of operations and liquidity. Note 4: Financial Instruments Investments at June 25, 2006 and June 26, 2005 consist of the following: June 25, 2006 Cost Unrealized Gains Unrealized Losses Fair Value (in thousands) Cost June 26, 2005 Unrealized Gains Unrealized Losses Fair Value Available for sale: Institutional Money Market Funds . . . . . . . . . . . . . . . . . . $ 730,887 $— $ — $ 730,887 $ 366,672 $ — $ — $ 366,672 Securities held with original maturities less than or equal to 90 days. . . . . . . . . . . . . . . Amounts included in cash and cash equivalents . . . . . . . . . . Municipal Bonds and Notes . . . . Treasury and Agency Notes . . . . Bank and Corporate Notes . . . . . Amounts included in short-term investments . . . . . . . . . . . . . Certificates of deposit and interest bearing accounts . . . Auction Rate Securities . . . . . . . Municipal Bonds and Notes . . . . Amounts included in restricted 113,566 844,453 13,233 20,035 109,063 142,331 85,038 70,575 315,412 — — 1 — 13 14 — — 25 (57) 113,509 11,511 (57) (37) (510) (2,274) 844,396 13,197 19,525 106,802 378,183 102,118 50,362 176,366 (2,821) 139,524 328,846 — — (1,012) 85,038 70,575 314,425 85,038 — — — — 84 27 125 236 — — — — 11,511 — (686) (322) (1,071) 378,183 101,516 50,067 175,420 (2,079) 327,003 — — — 85,038 — — cash and investments . . . . . . Total Available-for-sale . . . . 471,025 $1,457,809 25 $39 (1,012) $(3,890) 470,038 85,038 $1,453,958 $ 792,067 — $236 — $(2,079) 85,038 $ 790,224 The Company accounts for its investment portfolio at fair value. Realized gains and (losses) from investments sold were approximately $0.1 million and $(0.5) million in fiscal year 2006 and approximately $0.1 million and $(0.9) million in fiscal year 2005. Realized gains and (losses) for investments sold are specifically identified. Management assesses the fair value of investments in debt securities that are not actively traded through consideration of interest rates and their impact on the present value of the cash flows to be received from the investments. The Company also considers whether changes in the credit ratings of the issuer could impact the assessment of fair value. The fair value of the Company’s investments in auction rate preferred securities is based upon par value, which approximates fair value due to the nature of the instruments. The Company’s available-for-sale securities are invested in financial instruments with a minimum rating of A2 / A, as rated by two of the following three rating agencies: Moody’s, Standard & Poor’s (S&P), or Fitch. 47 The amortized cost and fair value of cash equivalents and short-term investments and restricted cash and investments with contractual maturities is as follows: Due in less than one year . . . . . . . . . . . . . . . . . . . . . . . . Due one year through five years . . . . . . . . . . . . . . . . . . June 25, 2006 June 26, 2005 Cost Estimated Fair Value Estimated Fair Value Cost (in thousands) $ 1,215,221 172,013 $ 1,387,234 $ 1,214,558 168,825 $ 1,383,383 $631,200 160,867 $792,067 $630,596 159,628 $790,224 Management has the ability and intent, if necessary, to liquidate any of its investments in order to meet the Company’s liquidity needs in the next 12 months. Accordingly, those investments with contractual maturities greater than one year from the date of purchase have been classified as short-term on the accompanying consolidated balance sheets. On June 16, 2006, the Company’s wholly-owned subsidiary, Lam Research International SARL (LRI), as borrower, entered into a $350 million Credit Agreement (the Credit Agreement). Under the Credit Agreement, on June 19, 2006, LRI borrowed $350 million in principal amount. The loan under the Credit Agreement shall be fully repaid not later than five years following the closing date. The loan under the Credit Agreement will bear interest at LIBOR plus a spread ranging from 0.10% to 0.50%, depending upon a consolidated leverage ratio, as defined in the Credit Agreement. The initial spread under the Credit Agreement is 0.10%. LRI may prepay the loan under the Credit Agreement in whole or in part at any time without penalty, subject to reimbursement of lenders’ breakage and redeployment costs in certain cases. The fair value of long-term debt approximates its carrying value of $350.0 million due to the variable interest rate applicable to the debt. Concentrations of Credit Risk Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash equivalents, short-term investments, trade accounts receivable and derivative financial instruments used in hedging activities. As noted above, the Company’s available-for-sale securities are invested in financial instruments with a minimum rating of A2 / A, as rated by two of the following three rating agencies: Moody’s, Standard & Poor’s (S&P), or Fitch, respectively and its policy limits the amount of credit exposure with any one financial institution or commercial issuer. Credit risk evaluations, including trade references, bank references and Dun & Bradstreet ratings are performed on all new customers, and subsequent to credit application approval, the Company monitors its customers’ financial statements and payment performance. In general, the Company does not require collateral on sales. The fair value of the Company’s foreign currency forward contracts is estimated based upon the Japanese Yen exchange rates at June 25, 2006 and June 26, 2005, respectively. At June 25, 2006 and June 26, 2005, the notional amount of outstanding Japanese Yen forward contracts that are designated as cash flow hedges was $193.8 million and $66.2 million, respectively. At June 25, 2006 and June 26, 2005, the notional amount of Japanese Yen forward contracts that are designated as balance sheet hedges was $23.5 million and $32.6 million, respectively. Note 5: Derivative Financial Instruments and Hedging The Company carries derivative financial instruments (derivatives) on the balance sheet at their fair values in accordance with Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS No. 133). The Company has a policy that allows the use of derivative 48 financial instruments, specifically foreign currency forward exchange rate contracts, to hedge foreign currency exchange rate fluctuations on forecasted revenue transactions denominated in Japanese Yen and other foreign currency denominated assets. The Company does not use derivatives for trading or speculative purposes. The Company’s policy is to attempt to minimize short-term business exposure to foreign currency exchange rate risks using an effective and efficient method to eliminate or reduce such exposures. In the normal course of business, the Company’s financial position is routinely subjected to market risk associated with foreign currency exchange rate fluctuations. To protect against the reduction in value of forecasted Japanese Yen-denominated revenues, the Company has instituted a foreign currency cash flow hedging program. The Company enters into foreign currency forward exchange rate contracts that generally expire within 12 months, and no later than 24 months. These foreign currency forward exchange contracts are designated as cash flow hedges and are carried on the Company’s balance sheet at fair value with the effective portion of the contracts’ gains or losses included in accumulated other comprehensive income (loss) and subsequently recognized in earnings in the same period the hedged revenue is recognized. Each period, hedges are tested for effectiveness, using the dollar offset method, by comparing the change in value of the derivative with the change in the value of the anticipated sales transactions. There were no gains or losses during fiscal years 2006 and 2005 associated with forecasted transactions that failed to occur. To qualify for hedge accounting, the hedge relationship must meet criteria relating both to the derivative instrument and the hedged item. These include identification of the hedging instrument, the hedged item, the nature of the risk being hedged and how the hedging instrument’s effectiveness in offsetting the exposure to changes in the hedged item’s fair value or cash flows will be measured. To receive hedge accounting treatment, all hedging relationships are formally documented at the inception of the hedge and the hedges must be highly effective in offsetting changes to future cash flows on hedged transactions. When derivative instruments are designated and qualify as effective cash flow hedges, the Company is able to defer changes in the fair value of the hedging instrument within accumulated other comprehensive income (loss) until the hedged exposure is realized. Consequently, with the exception of hedge ineffectiveness recognized, the Company’s results of operations are not subject to fluctuation as a result of changes in the fair value of the derivative instruments. If hedges are not highly effective or if the Company does not believe that the underlying hedged forecasted transactions would occur, the Company may not be able to account for its investments in derivative instruments as cash flow hedges. If this were to occur in a future period, changes in the fair values of the Company’s derivative instruments would be recognized in earnings without the benefits of offsets or deferrals of changes in fair value arising from hedge accounting treatment. At June 25, 2006, the Company expects to reclassify the entire amount of $1.2 million of losses accumulated in other comprehensive income to earnings during the next 12 months due to the recognition in earnings of the hedged forecasted transactions. The Company also enters into foreign currency forward exchange rate contracts to hedge the gains and losses generated by the remeasurement of Japanese Yen-denominated receivable balances. Under SFAS No. 133, these forward contracts are not designated for hedge accounting treatment. Therefore, the change in fair value of these derivatives is recorded into earnings as a component of other income and expense and offsets the change in fair value of the foreign currency denominated intercompany and trade receivables, recorded in other income and expense, assuming the hedge contract fully covers the intercompany and trade receivable balances. Note 6: Inventories Inventories are stated at the lower of cost (first-in, first-out method) or market. Shipments to Japanese customers are classified as inventory and carried at cost until title transfers. Inventories consist of the following: Raw materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Work-in-process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Finished goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 June 25, 2006 June 26, 2005 (in thousands) $ 78,038 29,980 60,696 $168,714 $ 51,251 24,492 34,308 $110,051 Note 7: Property and Equipment Property and equipment, net, consist of the following: Manufacturing, engineering and office equipment . . . . . . . . . . . . . Computer equipment and software . . . . . . . . . . . . . . . . . . . . . . . . . Leasehold improvements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Furniture and fixtures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: accumulated depreciation and amortization . . . . . . . . . . . . . . June 25, 2006 June 26, 2005 (in thousands) $ 106,172 61,419 38,950 6,599 213,140 (163,247) $ 49,893 $ 98,947 63,839 41,574 5,045 209,405 (168,323) $ 41,082 Note 8: Accrued Expenses and Other Current Liabilities Accrued expenses and other current liabilities consist of the following: Accrued compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Warranty reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income and other taxes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . Restructuring reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . June 25, 2006 June 26, 2005 (in thousands) $116,455 34,701 83,955 1,590 80,936 $317,637 $ 96,006 35,802 30,518 3,317 63,564 $229,207 Note 9: Stockholders’ Equity In October, 2004, the Company announced that its Board of Directors had authorized the repurchase of up to $250 million of Company common stock from the public market or in private purchases. The terms of the repurchase program permit the Company to repurchase shares through September 30, 2007. In August, 2005, the Company announced that its Board of Directors had authorized the repurchase of an additional $500 million of the Company’s common stock from the public market or private purchase. The terms of the repurchase program permit the Company to repurchase shares through September 30, 2008. The Company plans to continue to execute the authorized repurchases. Share repurchases under the authorizations were as follows: Period As of June 26, 2005 . . . . . . . . . . . . . . . . . . . . . . . Additional authorization of $500 million — August 24, 2005 . . . . . . . . . . . . . . . . . . . . Quarter Ending September 25, 2005. . . . . . . . . . Quarter Ending December 25, 2005 . . . . . . . . . . Quarter Ending March 26, 2006 . . . . . . . . . . . . . Quarter Ending June 25, 2006. . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Number of Shares Repurchased Total Cost of Repurchase Average Price Paid Per Share Amount Available For Repurchase Under the Plan (in thousands, except per share data) 5,855 $167,081 $28.54 $ 82,919 2,644 1,848 1,698 788 12,833 78,690 61,917 73,602 37,002 $418,292 29.76 33.50 43.36 46.93 $32.59 $582,919 $504,229 $442,312 $368,710 $331,708 50 Note 10: Other Income (Expense), Net The significant components of other income (expense), net, are as follows: Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign exchange loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Debt issue cost amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net gain on settlement of swap and retirement of 4% Notes . . . . . . . . . Equity method investment losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Equity method investment impairment . . . . . . . . . . . . . . . . . . . . . . . . . Charitable contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . June 25, 2006 $38,189 (677) (1,458) (368) — — — (1,000) 336 $35,022 Year Ended June 26, 2005 (in thousands) $17,537 (1,413) (1,175) — — (205) (445) (5,500) (679) $ 8,120 June 27, 2004 $ 9,915 (4,634) (1,334) (1,593) 4,505 (426) — (1,000) (963) $ 4,470 Note 11: Net Income Per Share Basic net income per share is computed by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted net income per share is computed, using the treasury stock method, as though all potential common shares that are dilutive were outstanding during the period. The following table provides a reconciliation of the numerators and denominators of the basic and diluted computations for net income per share. Numerator: Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $335,755 $299,341 $ 82,988 Year Ended June 26, 2005 (in thousands, except per share data) June 25, 2006 June 27, 2004 Add: Interest expense on 4% Notes, net of income taxes . . . . . . . . . . Numerator for diluted net income per share. . . . . . . . . . . . . . . . Denominator: — 3,179 $335,755 $299,341 $ 86,167 — Basic average shares outstanding. . . . . . . . . . . . . . . . . . . . . . . . Effect of potential dilutive securities: 138,581 137,727 131,776 Employee stock plans and warrant . . . . . . . . . . . . . . . . . . . . Assumed conversion of 4% Notes . . . . . . . . . . . . . . . . . . . . Diluted average shares outstanding . . . . . . . . . . . . . . . . . . . Net income per share — Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income per share — Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,151 — 143,732 4,690 — 142,417 $ $ 2.42 $ 2.34 $ 2.17 $ 2.10 $ 6,897 6,255 144,928 0.63 0.59 For purposes of computing diluted net income per share, weighted-average common shares do not include potential dilutive securities that are anti-dilutive under the treasury stock method. The following potential dilutive securities were excluded: Number of potential dilutive securities excluded . . . . . . . . . . . . . . . 305 June 25, 2006 Year Ended June 26, 2005 (in thousands) 3,035 June 27, 2004 3,403 51 Note 12: Comprehensive Income The components of comprehensive income are as follows: Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $335,755 Foreign currency translation adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,061 Unrealized gain (loss) on fair value of derivative June 25, 2006 Year Ended June 26, 2005 (in thousands) $299,341 3,584 June 27, 2004 $82,988 1,808 6,200 financial instruments, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (916) Unrealized loss on financial instruments, net . . . . . . . . . . . . . . . . . . . . . . . Reclassification adjustment for loss (gain) included in earnings . . . . . . . . (7,761) Comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $335,339 1,650 (379) (361) $303,835 (293) (2,665) (439) $81,399 The balance of accumulated other comprehensive loss is as follows: June 25, 2006 June 26, 2005 (in thousands) Accumulated foreign currency translation adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . Accumulated unrealized (loss) gain on derivative financial instruments . . . . . . . . . . . . Accumulated unrealized (loss) on financial instruments . . . . . . . . . . . . . . . . . . . . . . . . Accumulated other comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (7,700) (1,177) (2,328) $(11,205) $ (9,761) 815 (1,843) $(10,789) Note 13: Equity-Based Compensation Plans The Company has adopted stock plans that provide for the grant to employees of equity-based awards, including stock options and restricted stock units, of Lam common stock. In addition, these plans permit the grant of nonstatutory equity-based awards to paid consultants and outside directors. According to the plans, the equity-based award price is determined by the Board of Directors or its designee, the plan administrator, but in no event will it be less than the fair market value of the Company’s Common Stock on the date of grant. Equity-based awards granted under the plans vest over a period determined by the Board of Directors or the plan administrator. The Company also has an employee stock purchase plan (ESPP) that allows employees to purchase its common stock. 52 A summary of stock plan transactions follows: Options Outstanding Restricted Stock Units June 29, 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additional amount authorized . . . . . . . . . . . . . . . . . Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canceled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . June 27, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additional amount authorized . . . . . . . . . . . . . . . . . Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canceled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Vested restricted stock . . . . . . . . . . . . . . . . . . . . . . . June 26, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additional amount authorized . . . . . . . . . . . . . . . . . Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Canceled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Vested restricted stock . . . . . . . . . . . . . . . . . . . . . . . June 25, 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Available For Grant 3,597,092 — (665,835) 1,602,440 (26,645) 4,507,052 6,000,000 (775,050) 1,286,953 — — 11,018,955 — (1,053,584) 263,696 (281,670) Number of Shares 30,701,795 — 583,985 — (6,146,637) (1,602,440) — 23,536,703 — 775,050 (7,405,002) (1,277,049) — — 15,629,702 — — (9,890,026) (211,738) — Weighted- Average Exercise Price $16.02 — $26.45 $10.32 $21.88 — $17.38 — $24.97 $13.57 $25.14 — — $18.91 — — $18.16 $24.37 — 9,947,397 5,527,938 $20.04 Number of Shares — — 81,850 — — — 81,850 — — — (9,904) — — 71,946 — 1,053,584 — (51,958) — (28,060) 1,045,512 Weighted- Average FMV at Grant $ — — $22.10 — — — $22.10 — — — $22.10 — — $22.10 — $33.90 — $29.07 — $22.97 $33.60 At June 25, 2006, 16,520,847 shares of Lam Common Stock were reserved for future issuance under the various stock plans. Outstanding and exercisable options presented by price range at June 25, 2006 are as follows: Options Outstanding Weighted- Average Remaining Life (Years) 2.53 2.81 3.98 4.84 2.69 4.37 4.02 5.24 3.72 3.75 3.55 Number of Options Outstanding 529,242 442,519 929,191 253,183 1,611,317 733,825 649,490 368,101 7,000 4,070 5,527,938 Weighted- Average Exercise Price $ 6.31 8.62 14.25 20.78 22.05 24.07 26.84 37.76 51.50 53.00 $20.04 Options Exercisable Number of Options Exercisable 529,242 434,853 540,262 81,333 1,579,417 434,480 626,440 368,101 7,000 4,070 4,605,198 Weighted- Average Exercise Price $ 6.31 8.61 13.36 20.27 22.05 24.68 26.87 37.76 51.50 53.00 $ 20.16 $ Range of Exercise Prices 3.33-6.33 6.38-9.67 9.96-18.46 18.58-21.97 22.00-22.05 22.07-25.66 25.72-28.04 28.06-50.46 51.50-51.50 53.00-53.00 $ 3.33-53.00 We awarded a total of 1,053,584 restricted stock units during fiscal year 2006. Certain of these restricted stock units contain Company-specific performance targets. 1,045,512 restricted stock units remain subject to vesting requirements as of June 25, 2006. 53 The 1997 Stock Incentive Plan and the 1999 Stock Option Plan provide for the grant of non-qualified equity- based awards to eligible employees, consultants and advisors, and non-employee directors of the Company and its subsidiaries. Initially, 9.0 million shares were reserved for issuance under each plan. During fiscal year 2005, an additional 6.0 million shares were reserved for issuance under the 1997 Stock Incentive Plan evergreen provision. There were no additional amounts reserved for issuance during fiscal years 2006 and 2004. The 1999 Employee Stock Purchase Plan (the 1999 ESPP) allows employees to designate a portion of their base compensation to be used to purchase the Company’s Common Stock at a purchase price per share of the lower of 85% of the fair market value of the Company’s Common Stock on the first or last day of the applicable offering period. Typically, each offering period lasts 12 months and comprises three interim purchase dates. The 1999 ESPP, approved by the Company’s stockholders at the Annual Meeting of Stockholders on November 5, 1998, replaced the existing 1984 Employee Stock Purchase Plan (1984 ESPP). At June 29, 2003 the Company had 9.0 million shares of Lam Common Stock reserved for issuance under the 1999 ESPP: 3.0 million shares may be issued at any time and additional shares (previously 6.0 million total additional shares) may be issued for each share of the Company’s Common Stock which the Company redeems in public-market or private purchases and designated for this purpose. In fiscal year 2004, the Company’s stockholders approved an amendment to the 1999 ESPP to (i) each year automatically increase the number of shares available for issuance under the Plan by a specific amount on a one-for-one basis with shares of Common Stock that the Company will redeem in public market and private purchases for such purpose and (ii) to authorize the Plan Administrator (the Compensation Committee of the Board) to set a limit on the number of shares a Plan participant can purchase on any single Plan exercise date. The automatic annual increase provides that the number of shares in the Plan reserve available for issuance shall be increased on the first business day of each calendar year commencing with 2004, on a one-for- one basis with each share of Common Stock that the Company redeems, in public-market or private purchases, and designates for this purpose, by a number of shares equal to the lesser of (i) 2,000,000, (ii) one and one-half percent (1.5%) of the number of shares of all classes of common stock of the Company outstanding on the first business day of such calendar year, or (iii) a lesser number determined by the Plan Administrator. During fiscal years 2004 and 2006, the number of shares of Lam Common Stock reserved for issuance under the 1999 ESPP increased by 2.0 million shares in each fiscal year, subject to repurchase of an equal number of shares in public market or private purchases. There were no increases to the reserve during fiscal year 2005. During fiscal year 2006, 657,490 shares of the Company’s Common Stock were sold to employees under the 1999 ESPP. A total of 9,680,601 shares of the Company’s Common Stock have been issued under the 1999 ESPP Plan through June 25, 2006, at prices ranging from $4.11 to $31.84 per share. At June 25, 2006, 3,313,227 shares were available for purchase under the 1999 ESPP Plan. Prior to June 27, 2005, the Company accounted for its stock plans under the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB No. 25) and FASB Interpretation (FIN) No. 44, “Accounting for Certain Transactions Involving Stock Compensation — an Interpretation of APB Opinion No. 25” (FIN No. 44). The Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123R), effective June 27, 2005 using the modified prospective transition method. Under that transition method, equity-based compensation expense recognized during fiscal year 2006 includes: (a) ESPP awards with offering periods commencing, and stock options and restricted stock units granted, prior to, but not yet vested as of June 27, 2005, based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) ESPP with offering periods commencing and restricted stock units granted, subsequent to June 27, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123R. Under the modified prospective transition method, results for prior periods are not restated. The Company analyzed its equity-based compensation strategies prior to the adoption of SFAS No. 123R and made the decision to grant restricted stock units rather than stock options during fiscal year 2006. The Company recognized equity-based compensation expense of $22.8 million during fiscal year 2006. Included in these amounts are expenses related to restricted stock units of $11.4 million during fiscal year 2006 which would have been included in the Company’s Consolidated Statements of Operations under the provisions of APB No. 25. As a result of adopting SFAS No. 123R, the company’s income before income taxes and net income for the year ended June 25, 2006, are $11.4 million and $9.3 million lower, respectively, than if it had continued 54 to account for equity-based compensation under APB No. 25. Basic and diluted earnings per share for the year ended June 25, 2006 are $.07 and $.06 lower, respectively, than if the Company had continued to account for equity-based compensation under APB No. 25. The income tax benefit recognized in the consolidated statements of operations related to equity-based compensation expense was $4.3 million during fiscal year 2006. The estimated fair value of the Company’s equity-based awards, less expected forfeitures, is amortized over the awards’ vesting period on a straight-line basis for awards granted after the adoption of SFAS No. 123R and on a graded vesting basis for awards granted prior to the adoption of SFAS No. 123R. The modified prospective transition method of SFAS No. 123R requires the presentation of pro forma information, for periods presented prior to the adoption of SFAS No. 123R, regarding net income (loss) and net income (loss) per share as if the Company had accounted for its stock plans under the fair value method of SFAS No. 123R. For pro forma purposes, fair value of stock options and ESPP awards was estimated using the Black- Scholes option valuation model and amortized on a graded vesting basis. The fair value of all of the Company’s equity-based awards was estimated assuming no expected dividends and estimates of expected life, volatility and risk-free interest rate at the time of grant. The following table illustrates the effect on net income and net income per share if the Company had accounted for its stock plans under the fair value method of accounting under SFAS No. 123R: June 25, 2006 Year Ended June 26, 2005 June 27, 2004 Net income — as reported . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $335,755 $299,341 — Add: compensation expense recorded under APB No. 25, net of tax . . . . . 648 Deduct: pro forma compensation expense, net of tax . . . . . . . . . . . . . . . . . — (18,749) Net income — pro forma . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $335,755 $281,240 2.17 Basic net income per share — as reported . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2.04 Basic net income per share — pro forma . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.10 Diluted net income per share — as reported . . . . . . . . . . . . . . . . . . . . . . . . 1.97 Diluted net income per share — pro forma . . . . . . . . . . . . . . . . . . . . . . . . . $ (in thousands, except per share data) $ 82,988 2,336 (27,128) $ 58,196 0.63 $ 0.44 0.59 0.42 2.42 $ 2.42 2.34 2.34 $ $ The fair value of the Company’s equity-based awards granted during fiscal years 2005 and 2004 was estimated using the following weighted-average assumptions: Expected life (years) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expected stock price volatility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Risk-free interest rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stock Options and Restricted Stock Units Options ESPP June 26, 2005 2.8 June 27, 2004 3.3 June 26, 2005 0.6 June 27, 2004 0.6 73.3% 74.1% 74.0% 74.1% 2.9% 2.3% 2.3% 2.8% The Company did not grant any stock options during fiscal year 2006. The fair value of the Company’s stock options issued prior to the adoption of SFAS No. 123R was estimated using a Black-Scholes option valuation model. This model requires the input of highly subjective assumptions, including expected stock price volatility and the estimated life of each award. Prior to the adoption of SFAS No. 123R, the Company used historical volatility as a basis for calculating expected volatility. The aggregate intrinsic value of options outstanding and options exercisable was $127.3 million and $105.6 million, respectively, as of June 25, 2006. The total intrinsic value of options exercised during fiscal year 2006 was $224.0 million. As of June 25, 2006, there was $1.9 million of total unrecognized compensation cost related to nonvested stock options granted and outstanding; that cost is expected to be recognized through fiscal year 2009, with a weighted average remaining period of 0.7 years. Cash received from stock option exercises was $179.4 million during fiscal year 2006. 55 The fair value of the Company’s restricted stock units was calculated based upon the fair market value of the Company’s stock at the date of grant. As of June 25, 2006, there was $20.9 million of total unrecognized compensation cost related to nonvested restricted stock units granted; that cost is expected to be recognized over a weighted average remaining period of 1.0 years. ESPP ESPP awards were valued using the Black-Scholes model. ESPP awards for offering periods subsequent to the adoption of SFAS No. 123R were valued using the Black-Scholes model with expected volatility calculated using implied volatility. Prior to the adoption of SFAS No. 123R, the Company used historical volatility in deriving its expected volatility assumption. The Company determined, for purposes of valuing ESPP awards, that implied volatility provides a more accurate reflection of market conditions and is a better indicator of expected volatility than historical volatility. During fiscal year 2006 ESPP was valued assuming no expected dividends and the following weighted-average assumptions: Expected life (years) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.68 Expected stock price volatility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34.5% Risk-free interest rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4% As of June 25, 2006, there was $0.8 million of total unrecognized compensation cost related to the ESPP that is expected to be recognized over a remaining period of two months. Note 14: Profit Sharing and Benefit Plans Profit sharing is awarded to certain employees based upon performance against specific corporate financial and operating goals. Distributions to employees by the Company are based upon a percentage of earned compensation, provided that a threshold level of the Company’s financial and performance goals are met. In addition to profit sharing the Company has other bonus plans based on achievement of profitability and other specific performance criteria. Charges to expense under these plans were $70.8 million, $63.1 million, and $30.9 million during fiscal years 2006, 2005, and 2004, respectively. The Company maintains a 401(k)-retirement savings plan for its full-time employees in North America. Each participant in the plan may elect to contribute from 2% to 20% of his or her annual salary to the plan, subject to statutory limitations. The Company makes matching employee contributions in cash to the plan at the rate of 50% of the first 6% of salary contributed. Employees participating in the 401(k)-retirement savings plan are 100% vested in the Company matching contributions and investments are directed by participants. The Company made matching contributions of approximately $3.5 million, $3.2 million, and $3.0 million in fiscal years 2006, 2005, and 2004, respectively. 56 Note 15: Commitments The Company has certain obligations, some of which are recorded on its balance sheet and some which are not, to make future payments under various contracts. Obligations are recorded on the Company’s balance sheet in accordance with U.S. generally accepted accounting principles. The obligations recorded on the Company’s consolidated balance sheet include restructuring liabilities and long-term debt which are outlined in the following table and are discussed below. The Company’s off-balance sheet arrangements include contractual relationships and are presented as operating leases and purchase obligations in the table below. The Company’s contractual cash obligations and commitments relating to these agreements, and its guarantees are included in the following table: Operating Leases Purchase Obligations Restructuring Liabilities Long-term Debt and Interest Expense Total (in thousands) Payments due by period: Less than 1 year . . . . . . . . . . . . . . . . . . . 1-3 years . . . . . . . . . . . . . . . . . . . . . . . . . 4-5 years . . . . . . . . . . . . . . . . . . . . . . . . . Over 5 years . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . $ 14,821 86,613 2,142 2,175 $105,751 $154,482 42,905 8,306 — $ 205,693 $1,590 — — — $1,590 $ 20,050 40,209 390,044 — $ 450,303 $190,943 169,727 400,492 2,175 $763,337 Operating Leases The Company leases most of its administrative, R&D and manufacturing facilities, regional sales/service offices and certain equipment under non-cancelable operating leases, which expire at various dates through 2021. Certain of the Company’s facility leases for buildings located at its Fremont, California headquarters and certain other facility leases provide the Company with an option to extend the leases for additional periods or to purchase the facilities. Certain of the Company’s facility leases provide for periodic rent increases based on the general rate of inflation. Included in the operating leases 1-3 years section of the table above is $75.0 million in guaranteed residual values for lease agreements relating to certain properties at the Company’s Fremont, California campus. As part of the lease agreements, the Company has the option to purchase the remaining buildings at any time for a total purchase price for all remaining properties related to these leases of approximately $85.0 million. The Company is required to guarantee the lessor a residual value on the properties of up to $75.0 million at the end of the lease terms in fiscal year 2008 (in the event that the leases are not renewed, the Company does not exercise the purchase options, the lessor sells the properties and the sale price is less than the lessor’s costs). The Company maintains cash collateral of $85.0 million as part of the lease agreements as of June 25, 2006 in separate, specified certificates of deposit and interest-bearing accounts which are recorded as restricted cash and investments in its Consolidated Balance Sheet. The lessor under the lease agreements is a substantive independent leasing company that does not have the characteristics of a variable interest entity (VIE) as defined by FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” and is therefore not consolidated by the Company. The remaining operating lease balances primarily relate to non-cancelable facility-related operating leases. Purchase Obligations Purchase obligations consist of significant contractual obligations either on an annual basis or over multi- year periods related to the Company’s outsourcing activities or other material commitments, including vendor- consigned inventories. The Company continues to enter into new agreements and maintain existing agreements to outsource certain activities, including elements of its manufacturing, warehousing, logistics, facilities maintenance, certain information technology functions, and certain transactional general and administrative functions. The contractual cash obligations and commitments table presented above contains the Company’s 57 minimum obligations at June 25, 2006 under these arrangements and others. Actual expenditures will vary based on the volume of transactions and length of contractual service provided. In addition to minimum spending commitments, certain of these agreements provide for potential cancellation charges. Consignment inventories, which are owned by vendors but located in the Company’s storage locations and warehouses, are not reported as the Company’s inventory until title is transferred to it or its purchase obligation is determined. At June 25, 2006, vendor-owned inventories held at the Company’s locations and not reported as its inventory increased to approximately $31.1 million as compared to $14.8 million at June 26, 2005, due to the increased volume of the Company’s business. Restructuring Liabilities The Company’s total restructuring reserves as of June 25, 2006 were $1.6 million, which consists primarily of lease payments on vacated buildings. Through cash generated from operations, the Company expects the remaining balance to be paid over the next twelve months. Long-Term Debt and Interest Expense On June 16, 2006, the Company’s wholly-owned subsidiary, Lam Research International SARL (LRI), as borrower, entered into a $350 million Credit Agreement (the Credit Agreement). Under the Credit Agreement, on June 19, 2006, LRI borrowed $350 million in principal amount. The loan under the Credit Agreement shall be fully repaid not later than five years following the closing date. The loan under the Credit Agreement will bear interest at LIBOR plus a spread ranging from 0.10% to 0.50%, depending upon a consolidated leverage ratio, as defined in the Credit Agreement. The initial spread under the Credit Agreement is 0.10%. LRI may prepay the loan under the Credit Agreement in whole or in part at any time without penalty, subject to reimbursement of lenders’ breakage and redeployment costs in certain cases. The amounts in the table above include the principal payment of $350 million due on June 19, 2011 and interest payments estimated based on the current LIBOR rate of 5.55% and initial spread of ten basis points. The fair value of long-term debt approximates its carrying value due to the variable interest rate applicable to the debt. The Company used the proceeds from the credit facility entered into by LRI to facilitate the repatriation of $500 million of foreign earnings in the June 2006 quarter under the provisions of the American Jobs Creation Act of 2004 (AJCA). The Company has now completed its repatriation of foreign earnings under the provisions of the AJCA. Note 16: Guarantees The Company accounts for its guarantees in accordance with Financial Accounting Standards Board (FASB) Interpretation No. 45 “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN No. 45). FIN No. 45 requires a company that is a guarantor to make specific disclosures about its obligations under certain guarantees that it has issued. FIN No. 45 also requires a company (the Guarantor) to recognize, at the inception of a guarantee, a liability for the obligations it has undertaken in issuing the guarantee. The Company leases several facilities at its headquarters location in Fremont, California. As part of certain of the lease agreements, the Company has the option to purchase the remaining buildings at any time for a total purchase price for all remaining properties related to these leases of approximately $85.0 million. The Company is required to guarantee the lessor a residual value on the properties of up to $75.0 million at the end of the lease terms in fiscal year 2008 (in the event that the leases are not renewed, the Company does not exercise the purchase options, the lessor sells the properties and the sale price is less than the lessor’s costs). The Company maintains cash collateral of $85.0 million as part of the lease agreements as of June 25, 2006 in separate, specified certificates of deposit and interest-bearing accounts which are recorded as restricted cash and investments in its Consolidated Balance Sheet. The lessor under the lease agreements is a substantive independent leasing company that does not have the characteristics of a variable interest entity (VIE) as defined by FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” and is therefore not consolidated by the Company. 58 The Company has issued certain indemnifications to its lessors under some of its agreements. The Company has entered into certain insurance contracts which may limit its exposure to such indemnifications. As of June 25, 2006, the Company has not recorded any liability on its financial statements in connection with these indemnifications, as it does not believe, based on information available, that it is probable that any amounts will be paid under these guarantees. In connection with the Credit Agreement entered into by LRI note above, the Company entered into a Guarantee Agreement (the Guarantee Agreement) guaranteeing the obligations of LRI under the Credit Agreement. The Company’s obligations under the Guarantee Agreement are collateralized by readily marketable securities in an amount equal to 110% of the outstanding balance of its obligations under the Guarantee Agreement, representing $385.0 million at June 25, 2006. This collateral is reflected in the balance of restricted cash and investments in the Company’s Consolidated Balance Sheet. Generally, the Company indemnifies, under pre-determined conditions and limitations, its customers for infringement of third-party intellectual property rights by the Company’s products or services. The Company seeks to limit its liability for such indemnity to an amount not to exceed the sales price of the products or services subject to its indemnification obligations. The Company does not believe, based on information available, that it is probable that any material amounts will be paid under these guarantees. The Company offers standard warranties on its systems that run generally for a period of 12 months from system acceptance, not to exceed 14 months from the date of shipment of the system to the customer. The liability amount is based on actual historical warranty spending activity by type of system, customer, and geographic region, modified for any known differences such as the impact of system reliability improvements. Changes in the Company’s product warranty reserves during fiscal years 2006 and 2005 were as follows: Balance at June 27, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Warranties issued during the period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Settlements made during the period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expirations and change in liability for pre-existing warranties during the period . . . . . . . . . . . . . Balance at June 26, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance at June 26, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Warranties issued during the period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Settlements made during the period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expirations and change in liability for pre-existing warranties during the period . . . . . . . . . . . . . Balance at June 25, 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Note 17: Income Taxes The components of income (loss) before income taxes are as follows: (in thousands) $ 28,401 40,066 (23,392) (9,273) $ 35,802 (in thousands) $ 35,802 39,394 (22,905) (17,590) $ 34,701 United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . June 25, 2006 $196,529 244,758 $441,287 Year Ended June 26, 2005 (in thousands) $223,880 175,242 $399,122 June 27, 2004 $108,950 1,700 $110,650 59 Significant components of the provision (benefit) for income taxes attributable to income before income taxes are as follows: Federal: Current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . State: Current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign: Current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . June 25, 2006 Year Ended June 26, 2005 (in thousands) June 27, 2004 $ 54,195 52,069 106,264 $ 2,235 78,353 80,588 $ 1,396 10,730 12,126 (1,264) (5,016) (6,280) 648 3,077 3,725 260 5,468 5,728 24,095 (18,547) 5,548 $105,532 14,577 891 15,468 $99,781 9,808 — 9,808 $27,662 Deferred income taxes reflect the net effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s net deferred tax assets are as follows: Deferred tax assets: Tax benefit carryforwards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accounting reserves and accruals deductible in different periods . . . . . . . . . . . . . Inventory valuation differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capitalized R&D expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Varian settlement-stock warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross deferred tax assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred tax liabilities: Temporary differences for capital assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . State cumulative temporary differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross deferred tax liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . June 25, 2006 June 26, 2005 (in thousands) $ 26,395 41,665 8,466 34,942 — 7,755 119,223 $ 69,438 37,611 5,498 13,021 8,665 7,837 142,070 (12,568) (14,497) (27,065) $ 92,158 (10,391) (11,795) (22,186) $119,884 Realization of the Company’s net deferred tax assets is based upon the weight of available evidence, including such factors as the recent earnings history and expected future taxable income. The Company believes it is more likely than not that such assets will be realized; however, ultimate realization could be negatively impacted by market conditions and other variables not known or anticipated at this time. Deferred tax assets relating to tax benefits of employee stock option grants have been reduced to reflect the exercises in fiscal year 2006. Some exercises resulted in tax deductions in excess of previously recorded benefits based on the option value at the time of grant (“windfalls”). Although these additional tax benefits are reflected in net operating loss carryforwards, pursuant to SFAS 123(R), the additional tax benefit associated with the windfall is not recognized until the deduction reduces cash taxes payable. When the tax benefit reduces cash taxes payable, the Company will credit equity. During fiscal year 2006, the Company recorded a credit 60 to equity of $27.8 million. The net operating loss and tax credit carryforwards related to these tax benefits of $125.2 million and $106.0 million are not reflected in the Company’s deferred tax assets for fiscal years 2006 and 2005, respectively. At June 25, 2006, the Company had federal tax loss carryforwards of approximately $188.4 million, non tax-effected, which will expire between fiscal years 2023 and 2026. The Company also has federal and state tax credit carryforwards of approximately $172.4 million of which approximately $119.6 million will expire in varying amounts between fiscal years 2011 and 2027. The remaining balance of $52.8 million of tax carryforwards may be carried forward indefinitely. A reconciliation of income tax expense provided at the federal statutory rate (35% in fiscal years 2006, 2005, and 2004) to actual income expense (benefit) is as follows: June 25, 2006 Year Ended June 26, 2005 June 27, 2004 Income tax expense computed at federal statutory rate . . . . . . . . . . . . . . . . $154,450 (6,281) State income taxes, net of federal tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (70,704) Foreign income taxes at different rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . (4,762) Tax credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,207 Provision related to repatriation under AJCA . . . . . . . . . . . . . . . . . . . . . . . 8,622 Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — Change in valuation allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $105,532 (in thousands) $139,692 648 (33,052) (5,726) — (1,781) $ 38,688 261 9,347 (6,604) — (1,341) — (12,689) $ 27,662 $ 99,781 Consistent with the proportion of earnings outside of the U.S., the Company has negotiated a tax holiday on certain of those foreign earnings which is effective from fiscal year 2003 through June 2013. The tax holiday is conditional upon the Company meeting certain employment and investment thresholds. The impact of the tax holiday decreased income taxes by approximately $73.4 million for fiscal year 2006 as compared to $12.4 million in fiscal year 2005. The benefit of the tax holiday on net income per share (diluted) was approximately $0.51 in fiscal year 2006 as compared to $0.09 in fiscal year 2005. On October 22, 2004, the American Jobs Creation Act of 2004 (“AJCA” or the “Act”) was enacted into law. The Act provided for a special one-time elective dividends received deduction of 85% for certain foreign earnings that are repatriated by the end of fiscal 2006. During the year ended June 25, 2006, the Company repatriated $526 million of foreign earnings of which $500 million represented an extraordinary dividend under the AJCA. As a result, the Company recorded an additional $24.2 million tax provision in fiscal 2006. The Company has recently reached a settlement on a transfer pricing dispute via a bilateral advance pricing agreement between the United States and Korea relating to fiscal years 1998 through 2005. The Company received the final closing letter from the Korean taxing authorities dated June 20, 2006. As such, the Company reversed its related tax reserve by a net $2.7 million in the fourth quarter of fiscal 2006. Note 18: Segment, Geographic Information and Major Customers The Company operates in one business segment: manufacturing and servicing of front-end wafer processing semiconductor manufacturing equipment. The Company’s material operating units qualify for aggregation under Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information,” due to their identical customer base and similarities in economic characteristics, nature of products and services, and processes for procurement, manufacturing and distribution. The Company operates in five geographic regions: the United States, Europe, Korea, Asia Pacific, and Japan. For geographical reporting, revenues are attributed to the geographic location in which the customers’ facilities are located while long-lived assets are attributed to the geographic locations in which the assets are located. 61 June 25, 2006 Year Ended June 26, 2005 (in thousands) Net sales: United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Asia Pacific . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Korea . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Japan. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total net sales . . . . . . . . . . . . . . . . . . . . . . . . . $ 238,009 208,369 470,912 366,939 357,942 $ 1,642,171 $ 234,112 184,014 582,033 280,605 221,689 $ 1,502,453 Long-lived assets: United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Asia Pacific . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Korea . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Japan. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total long-lived assets . . . . . . . . . . . . . . . . . . June 25, 2006 $86,408 4,955 1,645 2,553 1,031 $96,592 June 26, 2005 (in thousands) $62,390 7,191 2,483 1,858 252 $74,174 June 27, 2004 $164,528 177,380 397,681 92,063 104,294 $935,946 June 27, 2004 $68,398 10,180 554 1,622 318 $81,072 In fiscal year 2006, revenues from Samsung Electronics Company, Ltd., accounted for approximately 15% of total revenues and revenues from Toshiba Corporation accounted for approximately 12% of total revenues. In fiscal year 2005, revenues from Samsung Electronics Company, Ltd., accounted for approximately 13% of total revenues, and, in fiscal year 2004, revenues from ST Microelectronics accounted for approximately 15% of total revenues. Note 19: Legal Proceedings From time to time, the Company has received notices from third parties alleging infringement of such parties’ patent or other intellectual property rights by the Company’s products. In such cases it is the Company’s policy to defend the claims, or if considered appropriate, negotiate licenses on commercially reasonable terms. However, no assurance can be given that the Company will be able in the future to negotiate necessary licenses on commercially reasonable terms, or at all, or that any litigation resulting from such claims would not have a material adverse effect on the Company’s consolidated financial position or operating results. Note 20: Subsequent Events On July 12, 2006, the Supreme Court of California denied review of lower and appellate court judgments in favor of Lam with respect to a lawsuit filed by Lam alleging breach of purchase order contracts by one of its customers. As a result of the denied review, the prior rulings from the trial and appellate courts stand resulting in a judgment in favor of Lam of approximately $15.8 million, which includes approximately $2.0 million in post- judgment interest. The Company plans to record this amount in other income (expense), net during the quarter ending September 24, 2006. 62 Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders of Lam Research Corporation We have audited the accompanying consolidated balance sheets of Lam Research Corporation as of June 25, 2006 and June 26, 2005, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended June 25, 2006. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Lam Research Corporation at June 25, 2006 and June 26, 2005, and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 25, 2006, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Lam Research Corporation’s internal control over financial reporting as of June 25, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated August 14, 2006 expressed an unqualified opinion thereon. As discussed in Note 2 to the Notes to Consolidated Financial Statements, under the heading Equity- Based Compensation – Employee Stock Purchase Plan and Employee Stock Plans, in fiscal 2006 Lam Research Corporation changed its method of accounting for stock-based compensation. San Jose, California August 14, 2006 63 Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting The Board of Directors and Stockholders of Lam Research Corporation We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Lam Research Corporation maintained effective internal control over financial reporting as of June 25, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Lam Research Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management’s assessment that Lam Research Corporation maintained effective internal control over financial reporting as of June 25, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Lam Research Corporation maintained, in all material respects, effective internal control over financial reporting as of June 25, 2006, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Lam Research Corporation as of June 25, 2006 and June 26, 2005, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended June 25, 2006 of Lam Research Corporation and our report dated August 14, 2006 expressed an unqualified opinion thereon. San Jose, California August 14, 2006 64 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. SIGNATURES LAM RESEARCH CORPORATION By /s/ Stephen G. Newberry Stephen G. Newberry, President and Chief Executive Officer Dated: August 16, 2006 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Stephen G. Newberry and Martin B. Anstice, jointly and severally, his attorney-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report of Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorney-in-fact, or his substitute or substitutes, may do or cause to be done by virtue thereof. Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated. Signatures Title /s/ Stephen G. Newberry Stephen G. Newberry President and Chief Executive Officer, Director /s/ Martin B. Anstice Martin B. Anstice /s/ James W. Bagley James W. Bagley /s/ Dr. Seiichi Watanabe Dr. Seiichi Watanabe /s/ David G. Arscott David G. Arscott /s/ Robert M. Berdahl Robert M. Berdahl /s/ Richard J. Elkus, Jr. Richard J. Elkus, Jr. /s/ Jack R. Harris Jack R. Harris /s/ Grant M. Inman Grant M. Inman /s/ Catherine P. Lego Catherine P. Lego Group Vice President, Chief Financial Officer, and Chief Accounting Officer Executive Chairman Director Director Director Director Director Director Director 65 Date August 16, 2006 August 16, 2006 August 16, 2006 August 16, 2006 August 16, 2006 August 16, 2006 August 16, 2006 August 16, 2006 August 16, 2006 August 16, 2006 LAM RESEARCH CORPORATION SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS Description YEAR ENDED JUNE 25, 2006 Deducted from asset accounts: Additions Balance At Beginning Of Period Charged To Costs And Expenses Balance At End Of Period Deductions Describe Allowance for doubtful accounts . . . . . . . . . . . . . $ 3,865,000 $ 51,000 $ 94,000(1) $ 3,822,000 YEAR ENDED JUNE 26, 2005 Deducted from asset accounts: Allowance for doubtful accounts . . . . . . . . . . . . . $ 3,865,000 $ 83,000 $ 83,000(1) $ 3,865,000 YEAR ENDED JUNE 27, 2004 Deducted from asset accounts: Allowance for doubtful accounts . . . . . . . . . . . . . $ 3,789,000 $701,000 $625,000(1) $ 3,865,000 (1) $0.1 million, $0.1 million, and $0.6 million, of specific customer accounts written-off in fiscal 2006, 2005, and 2004, respectively. 66 LAM RESEARCH CORPORATION ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED JUNE 25, 2006 EXHIBIT INDEX Description Certificate of Incorporation of the Registrant, dated September 7, 1989; as amended by the Agreement and Plan of Merger, Dated February 28, 1990; the Certificate of Amendment dated October 28, 1993; the Certificate of Ownership and Merger dated December 15, 1994; the Certificate of Ownership and Merger dated June 25, 1999 and the Certificate of Amendment effective as March 7, 2000. Amended and Restated By Laws of the Registrant, dated June 27, 2005. Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Stock dated January 27, 1997. Amended 1984 Incentive Stock Option Plan and Forms of Stock Option Agreements. Amended 1991 Stock Option Plan and Forms of Stock Option Agreements. Exhibit 3.1(22) 3.2(33) 3.3(22) 4.2(1)* 4.4(5)* 4.8(35)* Amended and restated 1997 Stock Incentive Plan. 4.11(18)* Amended and restated 1996 Performance-Based Restricted Stock Plan. 4.12(34)* Amended and restated 1999 Stock Option Plan. 4.13(34)* Lam Research Corporation 1999 Employee Stock Purchase Plan, as amended. 4.14(35)* Lam Research Corporation 2004 Executive Incentive Plan, as amended. 10.3(2) 10.12(3) 10.16(4) 10.30(6) 10.35(7) 10.38(8) 10.46(9) 10.49(9) 10.50(10) 10.51(10) 10.52(11) Form of Indemnification Agreement. ECR Technology License Agreement and Rainbow Technology License Agreement by and between Registrant and Sumitomo Metal Industries, Ltd. License Agreement effective January 1, 1992 between the Registrant and Tokyo Electron Limited. 1996 Lease Agreement Between Lam Research Corporation and the Industrial Bank of Japan, Limited, dated March 27, 1996. Agreement and Plan of Merger by and among Lam Research Corporation, Omega Acquisition Corporation and OnTrak Systems, Inc., dated as of March 24, 1997. Consent and Waiver Agreement between Lam Research Corporation and IBJTC Leasing Corporation-BSC, The Industrial Bank of Japan, Limited, Wells Fargo Bank, N.A., The Bank of Nova Scotia, and the Nippon Credit Bank, Ltd., dated March 28, 1997. Receivables Purchase Agreement between Lam Research Co., Ltd. and ABN AMRO Bank N.V., Tokyo Branch, dated December 26, 1997. Guaranty to the Receivables Purchase Agreement between Lam Research Co., Ltd. and ABN AMRO Bank N.V., Tokyo Branch, dated December 26, 1997. License Agreement between Lam Research Corporation and Trikon Technologies, Inc., dated March 18, 1998. Loan Agreement between Lam Research Corporation and The Industrial Bank of Japan, Limited, dated March 30, 1998. Credit Agreement between Lam Research Corporation and Deutsche Bank AG, New York Branch and ABN AMRO Bank N.V., San Francisco Branch, dated April 13, 1998. 67 Exhibit Description 10.53(11) 10.58(12) 10.59(12) 10.61(13) 10.62(13) 10.63(13) 10.64(13) 10.66(14) 10.67(15) 10.68(15) 10.69(17) 10.70(19) 10.71(19) 10.73(20) 10.74(20) 10.75(21) 10.76(21) 10.77(23) 10.78(24) First Amendment to Credit Agreement between Lam Research Corporation and ABN AMRO Bank N.V., San Francisco Branch, dated August 10, 1998. Loan Agreement between Lam Research Co., Ltd. and ABN AMRO Bank N.V., dated September 30, 1998. Guaranty to Loan Agreement between Lam Research Co., Ltd and ABN AMRO Bank N.V., dated September 30, 1998. Second Amendment to Credit Agreement between ABN AMRO BANK, N.V. and Lam Research Corporation, dated December 18, 1998. First Amendment to Guaranty between ABN AMRO BANK, N.V. and Lam Research Corporation, dated December 25, 1998. Supplemental Agreement of Receivables Purchase Agreement dated December 26, 1997 between ABN AMRO BANK, N.V. and Lam Research Corporation, dated December 25, 1998. Supplemental Agreement of Loan Agreement dated September 30, 1998 between ABN AMRO BANK, N.V. and Lam Research Corporation, dated December 25, 1998. Substitution Certificate for Loan Agreement dated September 30, 1998 between ABN AMRO BANK, N.V. and Lam Research Corporation, dated March 19, 1999. OTS Issuer Stock Option Master Agreement between Lam Research Corporation and Goldman Sachs & Co., and Collateral Appendix thereto, dated June 1999. Form of ISDA Master Agreement and related documents between Lam Research Corporation and Credit Suisse Financial Products, dated June 1999. The First Amendment Agreement between Lam Research Corporation and Credit Suisse Financial Products, dated August 31, 1999. Lease Agreement between Lam Research Corporation and Scotiabanc Inc., dated January 10, 2000. Participation Agreement between Lam Research Corporation, Scotiabanc Inc., and The Bank of Nova Scotia, dated January 19, 2000. Lease Agreement Between Lam Research Corporation and Cushing 2000 Trust, dated December 6, 2000. Participation Agreement Between Lam Research Corporation and Cushing 2000 Trust, Dated December 6, 2000. Indenture between Lam Research Corporation and LaSalle Bank, National Association, as Trustee, dated May 22, 2001. Registration Rights Agreement among Lam Research Corporation, Credit Suisse First Boston Corporation and ABN Amro Rothschild LLC, dated May 22, 2001. Warrant to Purchase Common Stock of Lam Research Corporation, dated December 19, 2001, issued to Varian Semiconductor Equipment Associates, Inc. Promissory Note between Lam Research Corporation and Stephen G. Newberry dated May 8, 2001. 10.79(25) Amendment to Stock Option Grant for James W. Bagley dated October 16, 2002. 10.80(26) Amended and Restated Master Lease and Deed of Trust Between Lam Research Corporation and SELCO Service Corporation, dated March 25, 2003. 68 Exhibit Description 10.81(26) 10.82(26) 10.83(26) 10.84(26) Lease Supplement No. 1 Between Lam Research Corporation and SELCO Service Corporation, dated March 25, 2003. Participation Agreement Between Lam Research Corporation, SELCO Service Corporation and Key Corporate Capital Inc., dated March 25, 2003. Amendment to Participation Agreement Between Lam Research Corporation, Scotiabanc Inc. and The Bank of Nova Scotia, dated December 27, 2002. Amendment to Participation Agreement Between Lam Research Corporation, the Cushing 2000 Trust, Scotiabanc Inc, The Bank of Nova Scotia and Fleet National Bank, dated December 27, 2002. 10.85(26)* Employment Agreement for Stephen G. Newberry, dated January 1, 2003. 10.86(27)* Amended and Restated Master Lease and Deed of Trust Between Lam Research Corporation and SELCO Service Corporation, dated as of June 1, 2003. 10.87(27) 10.88(27) 10.89(27) 10.94(27) Lease Supplement No. 1 Between Lam Research Corporation and SELCO Service Corporation, dated as of June 1, 2003. Lease Supplement No. 2 Between Lam Research Corporation and SELCO Service Corporation, dated as of June 1, 2003. Lease Supplement No. 3 Between Lam Research Corporation and SELCO Service Corporation, dated as of June 1, 2003. Participation Agreement Between Lam Research Corporation and SELCO Service Corporation, and Key Corporate Capital Inc., dated as of June 1, 2003. 10.95(27)* Employment Agreement for Ernest Maddock, dated April 15, 2003. 10.96(28)* Employment Agreement for Nicolas J. Bright, dated August 1, 2003. 10.97(32) 10.98(32) 10.99(32) 10.100(31) 10.101(31) 10.102(36) 10.103(36) 10.104(37) Second Amendment to Second Amended and Restated Uncommitted Insured Trade Receivables Purchase Agreement between ABN Amro Bank, N.V. and Lam Research Corporation, dated June 2, 2004. Amended and Restated Guaranty between ABN Amro Bank, N.V. and Lam Research Corporation, dated June 2, 2004. Form of Nonstatutory Stock Option Agreement — Lam Research Corporation 1997 Stock Incentive Plan. Third Amended and Restated Uncommitted Insured Trade Receivables Purchase Agreement between Lam Research Corporation, Lam Research International SARL and ABN Amro Bank N.V., dated March 22, 2005. Third Amended and Restated Guaranty between Lam Research Corporation and ABN Amro Bank N.V., dated March 22, 2005. Form of Restricted Stock Unit Award Agreement (U.S. Agreement A) — Lam Research Corporation 1997 Stock Incentive Plan. Form of Restricted Stock Unit Award Agreement (non-U.S. Agreement I-A) — Lam Research Corporation 1997 Stock Incentive Plan. $350,000,000 Credit Agreement among Lam Research International SARL, as Borrower, The Several Lenders from Time to Time Parties Hereto, and ABN Amro Bank N.V., as Administrative Agent, dated June 16, 2006. 69 Exhibit Description 10.105(38) Guarantee Agreement made by Lam Research Corporation in favor of ABN Amro Bank N.V., as Administrative Agent for the Lenders, dated June 16, 2006. 21 23.1 24 31.1 31.2 32.1 32.2 (1) (2) (3) (4) (5) (6) (7) (8) (9) Subsidiaries of the Registrant. Consent of Independent Registered Public Accounting Firm. Power of Attorney (See Signature page) Rule 13a – 14(a) / 15d – 14(a) Certification (Principal Executive Officer) Rule 13a – 14(a) / 15d – 14(a) Certification (Principal Financial Officer) Section 1350 Certification — (Principal Executive Officer) Section 1350 Certification — (Principal Financial Officer) Incorporated by reference to Post Effective Amendment No. 1 to the Registrant’s Registration Statement on Form S-8 (No. 33-32160) filed with the Securities and Exchange Commission on May 10, 1990. Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended April 3, 1988. Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the quarter ended December 31, 1989. Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the quarter ended December 31, 1991. Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the quarter ended December 31, 1995. Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 1996. Incorporated by reference to Registrant’s Report on Form 8-K dated March 31, 1997. Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 1997. Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the quarter ended December 31, 1997. (10) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. (11) Incorporated by reference to Registrant’s Annual Report on Form 10-K for the fiscal year ended June 30, 1998. (12) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 1998. (13) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the quarter ended December 31, 1998. (14) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q/A for the quarter ended March 31, 1999. (15) Incorporated by reference to Registrant’s Report on Form 8-K dated June 22, 1999. (16) Incorporated by reference to Registrant’s Report on Form S-8 dated November 5, 1998. (17) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 26, 1999. (18) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the quarter ended December 26, 1999. (19) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 26, 2000. (20) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the quarter ended December 24, 2000. (21) Incorporated by reference to Registrant’s Registration Statement on Form S-3 dated July 27, 2001. 70 (22) Incorporated by reference to Registrant’s Amendment No. 2 to its Annual Report on Form 10K/A for the fiscal year ended June 25, 2000. (23) Incorporated by reference to Registrant’s Registration Statement on Form S-3 dated January 30, 2002. (24) Incorporated by reference to Registrant’s Annual Report on Form 10-K for the fiscal year ended June 30, 2002. (25) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the quarter ended December 29, 2002. (26) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 30, 2003. (27) Incorporated by reference to Registrant’s Annual Report on Form 10-K for the fiscal year ended June 29, 2003. (28) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 28, 2003. (29) Incorporated by reference to Appendix A of the Registrant’s Proxy Statement filed on October 14, 2003. (30) Incorporated by reference to Appendix B of the Registrant’s Proxy Statement filed on October 14, 2003. (31) Incorporated by reference to Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 27, 2005. (32) Incorporated by reference to Registrant’s Annual Report on Form 10-K for the fiscal year ended June 27, 2004. (33) Incorporated by reference to Registrant’s Report on Form 8-K dated June 26, 2005. (34) Incorporated by reference to Registrant’s Registration Statement on Form S-8 (No. 33-127936) filed with the Securities and Exchange Commission on August 28, 2005. (35) Incorporated by reference to Registrant’s Current Report on Form 8-K dated November 8, 2005. (36) Incorporated by reference to Registrant’s Current Report on Form 8-K dated February 6, 2006. (37) Incorporated by reference to Registrant’s Current Report on Form 8-K dated June 19, 2006. * Indicates management contract or compensatory plan or arrangement in which executive officers of the Company are eligible to participate. 71 EXHIBIT 31.1 RULE 13a-14(a)/15d-14(a) CERTIFICATION (PRINCIPAL EXECUTIVE OFFICER) I, Stephen G. Newberry, certify that: 1. I have reviewed this annual report on Form 10-K of Lam Research Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have: a) b) c) d) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this annual report based on such evaluation; and disclosed in this annual report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting. 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): a) b) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. August 16, 2006 /s/ Stephen G. Newberry Stephen G. Newberry President and Chief Executive Officer 72 EXHIBIT 31.2 RULE 13a-14(a)/15d-14(a) CERTIFICATION (PRINCIPAL FINANCIAL OFFICER) I, Martin B. Anstice, certify that: 1. I have reviewed this annual report on Form 10-K of Lam Research Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have: a) b) c) d) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this annual report based on such evaluation; and disclosed in this annual report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting. 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): a) b) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. August 16, 2006 /s/ Martin B. Anstice Martin B. Anstice Group Vice President, Chief Financial Officer and Chief Accounting Officer 73 EXHIBIT 32.1 SECTION 1350 CERTIFICATION (PRINCIPAL EXECUTIVE OFFICER) In connection with the Annual Report of Lam Research Corporation (the “Company”) on Form 10-K for the fiscal period ending June 25, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Stephen G. Newberry, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. August 16, 2006 /s/ Stephen G. Newberry Stephen G. Newberry President and Chief Executive Officer 74 EXHIBIT 32.2 SECTION 1350 CERTIFICATION (PRINCIPAL FINANCIAL OFFICER) In connection with the Annual Report of Lam Research Corporation (the “Company”) on Form 10-K for the fiscal period ending June 25, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Martin B. Anstice, Group Vice President, Chief Financial Officer and Chief Accounting Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. August 16, 2006 /s/ Martin B. Anstice Martin B. Anstice Group Vice President, Chief Financial Officer and Chief Accounting Officer 75 (This page is intentionally left blank.) (This page is intentionally left blank.) 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(cid:84)(cid:72)(cid:69)(cid:0)(cid:80)(cid:82)(cid:79)(cid:80)(cid:69)(cid:82)(cid:84)(cid:89)(cid:0)(cid:79)(cid:70)(cid:0)(cid:84)(cid:72)(cid:69)(cid:73)(cid:82)(cid:0)(cid:82)(cid:69)(cid:83)(cid:80)(cid:69)(cid:67)(cid:84)(cid:73)(cid:86)(cid:69)(cid:0)(cid:72)(cid:79)(cid:76)(cid:68)(cid:69)(cid:82)(cid:83)(cid:14)(cid:0) execute to the needs of our customers extend our leadership position in etch leverage our expertise into adjacent markets deliver best-in-class fi nancial performance BOARD OF DIRECTORS BOARD OF DIRECTORS James W. Bagley James W. Bagley Executive Chairman Executive Chairman EXECUTIVE MANAGEMENT EXECUTIVE MANAGEMENT Stephen G. Newberry Stephen G. Newberry President and Chief Executive Offi cer President and Chief Executive Offi cer Stephen G. Newberry Stephen G. Newberry President and Chief Executive Offi cer President and Chief Executive Offi cer James W. Bagley James W. Bagley Executive Chairman Executive Chairman David G. Arscott David G. Arscott President, Compass Technology Group President, Compass Technology Group Robert M. Berdahl Robert M. Berdahl President of the Association of President of the Association of American Universities American Universities Richard J. Elkus, Jr. Richard J. Elkus, Jr. Director, Scripps Research Institute, and Director, Scripps Research Institute, and Former Director, KLA-Tencor Former Director, KLA-Tencor Jack R. Harris Jack R. Harris Chairman, HT, Inc., and Chairman, HT, Inc., and Executive Chairman, Metara, Inc. Executive Chairman, Metara, Inc. Grant M. Inman Grant M. Inman General Partner, General Partner, Inman Investment Management Inman Investment Management Nicolas J. Bright Nicolas J. Bright Executive Vice President, Executive Vice President, Regional Business and Global Products Regional Business and Global Products Martin B. Anstice Martin B. Anstice Group Vice President, Chief Financial Offi cer Group Vice President, Chief Financial Offi cer and Chief Accounting Offi cer and Chief Accounting Offi cer Harold M. Goldstein Harold M. Goldstein Group Vice President, Group Vice President, Global Human Resources Global Human Resources Daniel Liao Daniel Liao Group Vice President, Asia Pacifi c Group Vice President, Asia Pacifi c Steven A. Lindsay Steven A. Lindsay Group Vice President, Corporate Marketing Group Vice President, Corporate Marketing and Corporate Communications and Corporate Communications Catherine P. Lego Catherine P. Lego General Partner, The Photonics Fund, LP General Partner, The Photonics Fund, LP Ernest E. Maddock Ernest E. Maddock Group Vice President, Global Operations Group Vice President, Global Operations Seiichi Watanabe Seiichi Watanabe Executive General Manager, Executive General Manager, Terumo Corporation Terumo Corporation Patricia S. Wolpert Patricia S. Wolpert Owner, Wolpert Consulting LLC Owner, Wolpert Consulting LLC Thomas J. Bondur Thomas J. Bondur Vice President, Business Development Vice President, Business Development Jean-Francois Deschamps Jean-Francois Deschamps Vice President, North America and Europe Vice President, North America and Europe Richard A. Gottscho, Ph.D. Richard A. Gottscho, Ph.D. Vice President and General Manager, Vice President and General Manager, Etch Products Etch Products Abdi Hariri Abdi Hariri Vice President and General Manager, Vice President and General Manager, Customer Support Business Group Customer Support Business Group Marc A. Haugen Marc A. Haugen Vice President, Global Business Operations Vice President, Global Business Operations David J. Hemker, Ph.D David J. Hemker, Ph.D Vice President, New Product Development Vice President, New Product Development Hwee Tong Lim Hwee Tong Lim Vice President, Southeast Asia Vice President, Southeast Asia Jeffrey Marks, Ph.D. Jeffrey Marks, Ph.D. Vice President, New Businesses Vice President, New Businesses Masayuki Mike Morita Masayuki Mike Morita Vice President, Japan Vice President, Japan Yang Pan, Ph.D. Yang Pan, Ph.D. Vice President, China Vice President, China Les Spencer Les Spencer Vice President and Chief Information Offi cer Vice President and Chief Information Offi cer Inhak Harry Suh Inhak Harry Suh Vice President, Korea Vice President, Korea James Wheat James Wheat Vice President, Corporate Controller Vice President, Corporate Controller Jeffrey Zellmer Jeffrey Zellmer Vice President, Business Finance Vice President, Business Finance ©2006 Lam Research Corporation. All rights reserved. ©2006 Lam Research Corporation. All rights reserved. 670017255-10/06 670017255-10/06 Lam Research Corporation 4650 Cushing Parkway Fremont, California 94538 Phone: 1.510.572.0200 www.lamresearch.com 2006 Annual Report