SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical fact may be forward-looking statements. You can identify these and other forward-looking statements by the use of words such as "may," "will," "could," "would," "should," "expects," "plans," "anticipates," "relies," "believes," "estimates," "predicts," "intends," "potential," "continue," "thinks," "seeks," or the negative of such terms, or other comparable terminology. Forward-looking statements also include the assumptions underlying or relating to any of the foregoing statements. Such forward-looking statements include, among others, forecasts of the future results of our operations; orders for our products and capital equipment generally; sales of semiconductors; the allocation of capital spending by our customers (and, in particular, the percentage of spending that our customers allocate to process control); growth of revenue in the semiconductor industry, the semiconductor capital equipment industry and our business; technological trends in the semiconductor industry; future developments or trends in the global capital and financial markets; our future product offerings and product features; the success and market acceptance of new products; timing of shipment of backlog; the future of our product shipments and our product and service revenues; our future gross margins; our future research and development expenses and selling, general and administrative expenses; our ability to successfully maintain cost discipline; international sales and operations; our ability to maintain or improve our existing competitive position; success of our product offerings; creation and funding of programs for research and development; attraction and retention of employees; results of our investment in leading edge technologies; the effects of hedging transactions; the effect of the sale of trade receivables and promissory notes from customers; our future income tax rate; future payments of dividends to our stockholders; the completion of any acquisitions of third parties, or the technology or assets thereof; benefits received from any acquisitions and development of acquired technologies; sufficiency of our existing cash balance, investments and cash generated from operations to meet our operating and working capital requirements; and the adoption of new accounting pronouncements. Our actual results may differ significantly from those projected in the forward-looking statements in this report. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in Part II, Item 1A, "Risk Factors" in this report as well as in Item 1, "Business" and Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended June 30, 2012, filed with the Securities and Exchange Commission on August 6, 2012. You should carefully review these risks and also review the risks described in other documents we file from time to time with the Securities and Exchange Commission. You are cautioned not to place undue reliance on these forward-looking statements, and we expressly assume no obligation and do not intend to update the forward-looking statements in this report after the date hereof.
EXECUTIVE SUMMARY
KLA-Tencor Corporation is a leading supplier of process control and yield management solutions for the semiconductor and related nanoelectronics industries. Our broad portfolio of inspection and metrology products and services primarily supports integrated circuit ("IC" or "chip") manufacturers throughout the entire semiconductor fabrication process, from research and development to final volume production. We provide leading-edge equipment, software and support that enable IC manufacturers to identify, resolve and manage significant advanced technology manufacturing process challenges and obtain higher finished product yields at lower overall cost. In addition to serving the semiconductor industry, we also provide a range of technology solutions to a number of other high technology industries, including the light emitting diode ("LED") and data storage industries, as well as general materials research.
Our products and services are used by the vast majority of bare wafer, IC, lithography reticle ("reticle" or "mask") and disk manufacturers in the world. Our products, services and expertise are used by our customers to measure and control nanometric-level manufacturing processes, and to detect, analyze and resolve critical product defects that arise in that environment. Our revenues are driven largely by our customers' spending on capital equipment and related maintenance services necessary to support key transitions in their underlying product technologies, or to increase their production volumes in response to market demand. Our semiconductor customers generally operate in one or more of the three major semiconductor markets - memory, foundry and logic. All three of these markets are characterized by rapid technological changes and sudden shifts in end-user demand, which influence the level and pattern of our customers' spending on our products and services. Although capital spending in all three semiconductor markets has historically been very cyclical, the demand for more advanced and lower cost chips used in a growing number of consumer electronics, communications, data processing, and industrial and automotive products has resulted over the long term in a favorable demand environment for our process control and yield management solutions.

As a supplier to the global semiconductor and semiconductor-related industries, we are subject to the cyclical capital spending that characterizes these industries. The timing, length, intensity and volatility of capacity-oriented capital spending cycles of our customers are unpredictable. In addition, our customer base continues to become more highly concentrated over time, thereby increasing the potential impact of a sudden change in capital spending by a major customer on our revenues and profitability. As our customer base becomes increasingly more concentrated, large orders from a relatively limited number of customers account for a substantial portion of our sales, which potentially exposes us to more volatility for new orders.
However, in addition to these trends of cyclicality and consolidation, the semiconductor industry has also been significantly impacted by constant technological innovation. The growing use of increasingly sophisticated semiconductor devices has caused many of our customers to invest in additional semiconductor manufacturing capabilities and capacity. These investments have included process control and yield management equipment and services, which have had a significant favorable impact on our revenues over the long term. During the three months ended December 31, 2012, our customers, particularly from the foundry market, resumed higher levels of purchases of process control and yield management equipment to achieve their technology and capacity plans, as the growth in the demand for mobile devices and new consumer products increases the demand for semiconductor products. While we expect that the resumption of higher levels of new orders in the three months ended December 31, 2012 is likely to generate increased revenue levels in the March quarter, revenues during the three months ended December 31, 2012 decreased compared to the prior quarter as a result of the low level of demand and new orders for process control and yield management equipment in the September quarter. We believe that, over the long term, our customers will continue to invest in advanced technologies and new materials to enable smaller design rules and new process technologies to deliver higher performance semiconductor capability at lower costs. We expect that these dynamics will drive long-term increased adoption of process control equipment and services that reduce semiconductor defectivity and improve manufacturing yields, leaving the longer-term drivers underlying growth in our industry intact.
The following table sets forth some of the key quarterly unaudited financial information that we use to manage our business:

                                                                      Three months ended
(In thousands, except net    December 31,       September 30,      June 30,      March 31,       December 31,       September 30,
income per share)                2012               2012             2012           2012             2011               2011
Total revenues             $      673,011     $       720,709     $ 892,465     $  840,521     $      642,482     $       796,476
Total costs and operating
expenses                   $      519,764     $       534,152     $ 574,166     $  556,247     $      483,019     $       542,187
Gross margin               $      369,096     $       403,484     $ 530,802     $  485,372     $      369,627     $       456,127
Income from operations     $      153,247     $       186,557     $ 318,299     $  284,274     $      159,463     $       254,289
Net income                 $      106,630     $       135,367     $ 247,877     $  205,346     $      110,797     $       191,995
Net income per share:
Basic (1)                  $         0.64     $          0.81     $    1.48     $     1.23     $         0.67     $          1.15
Diluted (1)                $         0.63     $          0.80     $    1.46     $     1.21     $         0.66     $          1.13


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CRITICAL ACCOUNTING ESTIMATES AND POLICIES
The preparation of our Condensed Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions in applying our accounting policies that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Note 1 to the Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended June 30, 2012 describes the significant accounting policies and methods used in preparation of the Consolidated Financial Statements. We base these estimates and assumptions on historical experience, and evaluate them on an on-going basis to ensure that they remain reasonable under current conditions. Actual results could differ from those estimates. We discuss the development and selection of the critical accounting estimates with the Audit Committee of our Board of Directors on a quarterly basis, and the Audit Committee has reviewed our related disclosure in this Quarterly Report on Form 10-Q. The accounting policies that reflect our more significant estimates, judgments and assumptions and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:

• Revenue Recognition

• Inventories

• Warranty

• Allowance for Doubtful Accounts

• Equity and Long-Term Incentive Compensation Plans

• Contingencies and Litigation

• Goodwill and Intangible Assets

• Income Taxes

There were no significant changes in our critical accounting estimates and policies during the three months ended December 31, 2012. Please refer to Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for our fiscal year ended June 30, 2012 for a more complete discussion of our critical accounting policies and estimates. Valuation of Goodwill and Intangible Assets We have four reporting units: Defect Inspection, Metrology, Service and Other. As of December 31, 2012, substantially all of the goodwill balance resided in the Defect Inspection reporting unit. The fair value of each of our reporting units was substantially in excess of its estimated carrying amount as of the most recent quantitative analysis of goodwill impairment performed in the three months ended December 31, 2010. There have been no triggering events or changes in circumstances since that quantitative analysis to indicate that the fair value of any of the Company's reporting units would be less than its carrying amount.
We performed a qualitative assessment of the goodwill by reporting unit as of November 30, 2012 during the three months ended December 31, 2012 and concluded that there was no impairment. We assess goodwill for impairment annually as well as whenever events or changes in circumstances indicate that the carrying amount of goodwill in any reporting unit may not be recoverable. Long-lived assets are tested for recoverability whenever events or changes in circumstances indicate that the assets' carrying amount may not be recoverable.
Our next annual evaluation of the goodwill by reporting unit will be performed during the three months ending December 31, 2013. If we were to encounter challenging economic conditions, such as a decline in our operating results, an unfavorable industry or macroeconomic environment, a substantial decline in our stock price, or any other adverse change in market conditions, we may be required to perform the two-step quantitative goodwill impairment analysis. In addition, if such conditions have the effect of changing one of the critical assumptions or estimates we use to calculate the value of our goodwill or intangible assets, we may be required to record goodwill and/or intangible asset impairment charges in future periods, whether in connection with our next annual impairment assessment in the second quarter of fiscal year 2014 or prior to that, if any triggering event occurs outside of the quarter during which the annual goodwill impairment assessment is performed. It is not possible at this time to determine if any such future impairment charge would result or, if it does, whether such charge would be material to our results of operations. Revenue Recognition
We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable, and collectibility is reasonably assured. We enter into arrangements that may consist of multiple deliverables of our products and services where certain elements of the sales arrangement are not delivered and accepted in one reporting period. Judgment is required to properly identify the accounting units of the multiple deliverable transactions and to determine the manner in which revenue should be allocated among the accounting units. Additionally, judgment is required to interpret various commercial terms and to determine when all criteria of revenue recognition have been met in order for revenue recognition to occur in the appropriate accounting period. While changes in the allocation of the estimated sales price between the accounting units will not affect the amount of total revenue recognized for a particular arrangement, any material changes in these allocations could impact the timing of revenue recognition, which could have a material effect on our financial position and results of operations.
Recent Accounting Pronouncements
In September 2011, the Financial Accounting Standards Board ("FASB") issued an accounting standard update intended to simplify testing goodwill for impairment. The amendments allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity is no longer required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that the fair value of the reporting unit is less than its carrying amount. The amendment, by its terms, became effective for annual and interim goodwill impairment tests performed for our fiscal year ending June 30, 2013, and early adoption was

permitted. We elected to early adopt this accounting guidance at the beginning of the three months ended December 31, 2011 (see Note 5, "Goodwill and Purchased Intangible Assets," to the Condensed Consolidated Financial Statements for a detailed description).
In June 2011, the FASB issued an accounting standard update requiring an increase in the prominence of items reported in other comprehensive income. The amendment eliminated the option to present components of other comprehensive income as part of the statement of changes in stockholders' equity and required that the total of comprehensive income, the components of net income, and the components of other comprehensive income be presented in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendment also required presentation of adjustments for items that are reclassified from other comprehensive income in the statement where the components of net income and the components of other comprehensive income are presented, but that requirement was indefinitely deferred by the FASB in December 2011. The amendment (other than the portion regarding the presentation of reclassification adjustments which, as noted above, has been deferred indefinitely) became effective for our interim period ended September 30, 2012. The amendment did not have an impact on our financial position, results of operations or cash flows as it is disclosure-only in nature.

RESULTS OF OPERATIONS
Revenues and Gross Margin
                                      Three months ended
(Dollar amounts in    December 31,      September 30,      December 31,          Q2 FY13 vs.            Q2 FY13 vs.
thousands)                2012               2012              2011                Q1 FY13                Q2 FY12
Revenues:
Product              $     523,023     $      574,078     $     500,659     $ (51,055 )     (9 )%   $  22,364        4 %
Service                    149,988            146,631           141,823         3,357        2  %       8,165        6 %
Total revenues       $     673,011     $      720,709     $     642,482     $ (47,698 )     (7 )%   $  30,529        5 %
Costs of revenues    $     303,915     $      317,225     $     272,855     $ (13,310 )     (4 )%   $  31,060       11 %
Gross margin
percentage                      55 %               56 %              58 %


                                     Six months ended
                               December 31,     December 31,      Q2 FY13 YTD vs.
(Dollar amounts in thousands)      2012             2011            Q2 FY12 YTD
Revenues:
Product                       $  1,097,101     $  1,150,915     $  (53,814 )   (5 )%
Service                            296,619          288,043          8,576      3  %
Total revenues                $  1,393,720     $  1,438,958     $  (45,238 )   (3 )%
Costs of revenues             $    621,140     $    613,204     $    7,936      1  %
Gross margin percentage                 55 %             57 %

Product revenues
Our business is cyclical with respect to the capital equipment procurement practices of semiconductor manufacturers, with revenues impacted by the investment patterns of such manufacturers. Our product revenues in any particular quarter are significantly impacted by the amount of new orders that we receive during that quarter and, due to the duration of manufacturing and installation cycles, in the preceding quarters.
Product revenues decreased during the three months ended December 31, 2012 compared to the three months ended September 30, 2012, as customers reduced their purchases of process control and yield management equipment during the three months ended September 30, 2012 in response to the cyclical industry factors affecting our foundry and logic customers and the challenging demand environment for our memory customers. The reduction in demand for process control and yield management equipment during the three months ended September 30, 2012, and the consequent decline in backlog at the beginning of the three months ended December 31, 2012 compared to the prior quarter, resulted in a lower level of product revenues during the three months ended December 31, 2012 compared to the three months ended September 30, 2012.

Product revenues increased during the three months ended December 31, 2012 compared to the three months ended December 31, 2011 as a result of strong foundry demand and higher level of products installed and accepted by customers in Taiwan during the three months ended December 31, 2012, as well as higher revenue deferrals associated with customers with liquidity challenges in the three months ended December 31, 2011.
Product revenues decreased during the six months ended December 31, 2012 compared to the six months ended December 31, 2011, primarily due to lower levels of revenue and shipment backlogs at the beginning of the period, as well as to a lower level of orders received within the period, as a result of a weaker demand environment.
Service revenues
Service revenues are generated from maintenance contracts, as well as billable time and material service calls made to our customers after the expiration of the warranty period. The amount of service revenues is typically a function of the number of post-warranty systems installed at our customers' sites and the utilization of those systems. Service revenues during the three and six months ended December 31, 2012 increased compared to the three months ended September 30, 2012 and three and six months ended December 31, 2011, respectively, primarily due to an increase in the number of post-warranty systems installed at our customers' sites. Revenues by region
The following is a summary of revenues by geographic region, based on ship-to location, for the indicated periods (as a percentage of total revenues):

                                                                Three months ended
(Dollar amounts in thousands)      December 31, 2012            September 30, 2012           December 31, 2011
United States                   $     169,629       25 %   $     149,988           21 %   $     160,484       25 %
Taiwan                                223,493       33 %         276,299           38 %         169,015       26 %
Japan                                  92,849       14 %          88,715           12 %         110,321       17 %
Europe & Israel                        59,753        9 %          59,160            8 %          69,270       11 %
Korea                                  57,259        9 %          70,247           10 %          61,979       10 %
Rest of Asia                           70,028       10 %          76,300           11 %          71,413       11 %

A significant portion of our revenues continues to be generated in Asia, where a substantial portion of the world's semiconductor manufacturing capacity is located, and we expect that trend to continue. Gross margin
Our gross margin fluctuates with revenue levels and product mix and is affected by variations in costs related to manufacturing and servicing our products, including our ability to scale our operations efficiently and effectively in response to prevailing business conditions. Over the past several years, we have embarked on various advanced product development, customer satisfaction improvement and globalization initiatives to improve our competitiveness and gross margins.
The following tables summarize the major factors that contributed to the changes in gross margin percentage for the periods indicated:

                      Gross Margin Percentage                                  Gross Margin Percentage
                        Three months ended                            Three months ended      Six months ended
September 30, 2012               56.0  %         December 31, 2011            57.5  %                 57.4  %
Revenue volume of                                Revenue volume of
products and service             (1.0 )%         products and service         (1.0 )%                 (0.5 )%
Mix of products and                              Mix of products and
services sold                     1.8  %         services sold                 0.1  %                 (0.7 )%
Manufacturing labor,                             Manufacturing labor,
overhead and                                     overhead and
efficiencies                      0.3  %         efficiencies                  0.7  %                  0.3  %
Other service and                                Other service and
manufacturing costs              (2.3 )%         manufacturing costs          (2.5 )%                 (1.1 )%
December 31, 2012                54.8  %         December 31, 2012            54.8  %                 55.4  %

Changes in gross margin percentage driven by revenue volume reflect our ability to leverage existing infrastructure in operating our business. It also includes the effect of fluctuations in average customer pricing and foreign exchange rates. Changes in gross margin percentage from mix of products and services sold reflect the impact of changes in the composition within product and service offerings, as well as differences in transaction-specific or customer-specific revenue realization. Changes in gross margin percentage from manufacturing labor, overhead and efficiencies reflect our ability to manage costs and drive productivity as we scale our manufacturing activity to respond to customer requirements; this includes the impact of capacity utilization, use of overtime and variability of cost structure. Changes in gross margin percentage from other service and manufacturing costs include the impact of customer support costs, including the efficiencies with which we deliver services to our customers, and the effectiveness with which we manage our production plans and inventory risk. Our gross margin declined to 54.8% during the three months ended December 31, 2012 from 56.0% during the three months ended September 30, 2012, primarily due to lower revenue volume and an increase in inventory reserves, partially offset by a more favorable mix of products sold. The increase in inventory reserves was attributable to the acceleration of certain product transitions and higher inventory levels associated with faster product delivery lead times and service response time commitments to customers.
Our gross margin declined to 54.8% during the three months ended December 31, 2012 from 57.5% during the three months ended December 31, 2011, primarily due to lower revenue volume, in the form of slightly lower manufacturing capacity utilization, as well as an increase in inventory reserves attributable to the acceleration of certain product transitions and higher inventory levels associated with faster product delivery lead times and service response time commitments to customers. . . .