Document
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark one)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2019
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 000-09992
KLA-Tencor Corporation
(Exact name of registrant as specified in its charter)
  
Delaware
 
04-2564110
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
One Technology Drive, Milpitas, California
 
95035
(Address of Principal Executive Offices)
 
(Zip Code)
(408) 875-3000
(Registrant’s telephone number, including area code) 
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 whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).   Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
 
 
 
Accelerated filer ¨
Non-accelerated filer ¨
 
(Do not check if a smaller reporting company)
 
Smaller reporting company ¨
 
 
 
 
Emerging growth company ¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨    No  x
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.001 par value per share
KLAC
The Nasdaq Stock Market, LLC
 
 
The Nasdaq Global Select Market

As of April 19, 2019, there were 161,620,262 shares of the registrant’s Common Stock, $0.001 par value, outstanding.


Table of Contents

INDEX
 
 
 
Page
Number
 
 
 
PART I
FINANCIAL INFORMATION
 
Item 1
 
 
 
 
 
 
 
Item 2
Item 3
Item 4
 
 
 
PART II
OTHER INFORMATION
 
Item 1
Item 1A
Item 2
Item 3
Item 4
Item 5
Item 6
 
 
 
 
 
 


 

2

Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS
KLA-TENCOR CORPORATION
Condensed Consolidated Balance Sheets
(Unaudited)
 
(In thousands)
March 31,
2019
 
June 30,
2018
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,092,163

 
$
1,404,382

Marketable securities
805,105

 
1,475,936

Accounts receivable, net
958,021

 
651,678

Inventories
1,317,260

 
931,845

Other current assets
270,079

 
85,159

Total current assets
4,442,628

 
4,549,000

Land, property and equipment, net
411,852

 
286,306

Goodwill
2,172,902

 
354,698

Deferred income taxes
205,820

 
193,200

Purchased intangible assets, net
1,694,313

 
19,333

Other non-current assets
260,090

 
236,082

Total assets
$
9,187,605

 
$
5,638,619

LIABILITIES, NON-CONTROLLING INTEREST AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
206,248

 
$
169,354

Deferred system revenue
228,745

 

Deferred service revenue
182,119

 
69,255

Deferred system profit

 
279,581

Current portion of long-term debt
249,997

 

Other current liabilities
833,747

 
696,080

Total current liabilities
1,700,856

 
1,214,270

Non-current liabilities:
 
 
 
Long-term debt
3,172,649

 
2,237,402

Deferred tax liability
762,303

 
1,197

Deferred service revenue
90,610

 
71,997

Other non-current liabilities
575,599

 
493,242

Total liabilities
6,302,017

 
4,018,108

Commitments and contingencies (Note 13 and Note 14)

 

Stockholders’ equity:
 
 
 
Common stock and capital in excess of par value
1,989,914

 
617,999

Retained earnings
928,086

 
1,056,445

Accumulated other comprehensive income (loss)
(68,907
)
 
(53,933
)
Total KLA-Tencor stockholders’ equity
2,849,093

 
1,620,511

Non-controlling interest in consolidated subsidiaries
36,495

 

Total stockholders’ equity
2,885,588

 
1,620,511

Total liabilities and stockholders’ equity
$
9,187,605

 
$
5,638,619

 
See accompanying notes to condensed consolidated financial statements (unaudited).

3

Table of Contents

KLA-TENCOR CORPORATION
Condensed Consolidated Statements of Operations
(Unaudited)
 
 
Three months ended
 
Nine months ended
 
March 31,
 
March 31,
(In thousands, except per share amounts)
2019
 
2018
 
2019
 
2018
Revenues:
 
 
 
 
 
 
 
Product
$
793,224

 
$
797,797

 
$
2,474,652

 
$
2,320,171

Service
304,087

 
223,497

 
835,817

 
646,526

Total revenues
1,097,311

 
1,021,294

 
3,310,469

 
2,966,697

Costs and expenses:
 
 
 
 
 
 
 
Costs of revenues
486,945

 
368,356

 
1,276,592

 
1,068,475

Research and development
184,887

 
153,239

 
504,320

 
456,626

Selling, general and administrative
182,184

 
113,237

 
409,084

 
325,934

Interest expense
31,187

 
28,119

 
84,087

 
86,067

Other expense (income), net
(9,282
)
 
(7,640
)
 
(28,535
)
 
(19,847
)
Income before income taxes
221,390

 
365,983

 
1,064,921

 
1,049,442

Provision for income taxes
28,745

 
59,102

 
107,232

 
595,944

Net income
192,645

 
306,881

 
957,689

 
453,498

Less: Net loss attributable to non-controlling interest
(83
)
 

 
(83
)
 

Net income attributable to KLA-Tencor
$
192,728

 
$
306,881

 
$
957,772

 
$
453,498

Net income per share attributable to KLA-Tencor
 
 
 
 
 
 
 
Basic
$
1.23

 
$
1.96

 
$
6.20

 
$
2.90

Diluted
$
1.23

 
$
1.95

 
$
6.17

 
$
2.88

Weighted-average number of shares:
 
 
 
 
 
 
 
Basic
156,349

 
156,221

 
154,561

 
156,547

Diluted
157,182

 
157,201

 
155,310

 
157,539


See accompanying notes to condensed consolidated financial statements (unaudited).

4

Table of Contents

KLA-TENCOR CORPORATION
Condensed Consolidated Statements of Comprehensive Income
(Unaudited)

 
Three months ended
 
Nine months ended
 
March 31,
 
March 31,
(In thousands)
2019
 
2018
 
2019
 
2018
Net income
$
192,645

 
$
306,881

 
$
957,689

 
$
453,498

Other comprehensive income (loss):
 
 
 
 
 
 
 
Currency translation adjustments:
 
 
 
 
 
 
 
Change in currency translation adjustments
(1,031
)
 
4,238

 
(5,104
)
 
10,617

Change in income tax benefit or expense
442

 
(667
)
 
442

 
(3,006
)
Net change related to currency translation adjustments
(589
)
 
3,571

 
(4,662
)
 
7,611

Cash flow hedges:
 
 
 
 
 
 
 
Change in net unrealized gains or losses
(1,379
)
 
(581
)
 
(6,567
)
 
560

Reclassification adjustments for net gains or losses included in net income
(946
)
 
(694
)
 
(3,719
)
 
(3,775
)
Change in income tax benefit or expense
461

 
369

 
1,641

 
1,045

Net change related to cash flow hedges
(1,864
)
 
(906
)
 
(8,645
)
 
(2,170
)
Net change related to unrecognized losses and transition obligations in connection with defined benefit plans
438

 
(28
)
 
993

 
(121
)
Available-for-sale securities:
 
 
 
 
 
 
 
Change in net unrealized gains or losses
3,922

 
(5,723
)
 
8,681

 
(10,919
)
Reclassification adjustments for net gains or losses included in net income
313

 
(2
)
 
1,263

 
61

Change in income tax benefit or expense
(680
)
 
1,333

 
(1,759
)
 
2,584

Net change related to available-for-sale securities
3,555

 
(4,392
)
 
8,185

 
(8,274
)
Other comprehensive income (loss)
1,540

 
(1,755
)
 
(4,129
)
 
(2,954
)
Comprehensive loss attributable to non-controlling interest
(83
)
 

 
(83
)
 

Total comprehensive income attributable to KLA-Tencor
$
194,268

 
$
305,126

 
$
953,643

 
$
450,544


See accompanying notes to condensed consolidated financial statements (unaudited).

5

Table of Contents

KLA-TENCOR CORPORATION
Condensed Consolidated Statements of Stockholders’ Equity
(Unaudited)
 
Common Stock and
Capital in Excess of
Par Value
 
Retained
Earnings
(Accumulated Deficit)
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total KLA-Tencor
Stockholders’
Equity
 
Non-controlling interest
 
Total Stockholders' Equity
(In thousands, except per share amounts)
Shares
 
Amount
 
Balance as of June 30, 2018
156,048

 
$
617,999

 
$
1,056,445

 
$
(53,933
)
 
$
1,620,511

 
$

 
$
1,620,511

Adoption of ASC 606

 

 
(21,215
)
 
75

 
(21,140
)
 

 
(21,140
)
Reclassification of stranded tax effects

 

 
10,920

 
(10,920
)
 

 

 

Balance as of July 1, 2018
156,048

 
617,999

 
1,046,150

 
(64,778
)
 
1,599,371

 

 
1,599,371

Net income

 

 
395,944

 

 
395,944

 

 
395,944

Other comprehensive income

 

 

 
8,611

 
8,611

 

 
8,611

Net issuance under employee stock plans
332

 
(26,961
)
 

 

 
(26,961
)
 

 
(26,961
)
Repurchase of common stock
(2,781
)
 
(11,010
)
 
(296,777
)
 

 
(307,787
)
 

 
(307,787
)
Cash dividends ($0.75 per share) and dividend equivalents declared

 

 
(117,947
)
 

 
(117,947
)
 

 
(117,947
)
Stock-based compensation expense

 
16,138

 

 

 
16,138

 

 
16,138

Balance as of September 30, 2018
153,599

 
596,166

 
1,027,370

 
(56,167
)
 
1,567,369

 

 
1,567,369

Net income

 

 
369,100

 

 
369,100

 

 
369,100

Other comprehensive income

 

 

 
(14,280
)
 
(14,280
)
 
 
 
(14,280
)
Net issuance under employee stock plans
321

 
17,323

 

 

 
17,323

 

 
17,323

Repurchase of common stock
(2,556
)
 
(9,919
)
 
(232,482
)
 

 
(242,401
)
 

 
(242,401
)
Cash dividends ($0.75 per share) and dividend equivalents declared

 

 
(115,184
)
 

 
(115,184
)
 

 
(115,184
)
Stock-based compensation expense

 
15,695

 

 

 
15,695

 

 
15,695

Balance as of December 31, 2018
151,364

 
619,265

 
1,048,804

 
(70,447
)
 
1,597,622

 

 
1,597,622

Net income attributable to KLA-Tencor

 

 
192,728

 

 
192,728

 

 
192,728

Net loss attributable to non-controlling interest

 

 

 

 

 
(83
)
 
(83
)
Other comprehensive income

 

 

 
1,540

 
1,540

 

 
1,540

Assumption of stock-based compensation plan awards in connection with the acquisition of Orbotech

 
13,281

 

 

 
13,281

 

 
13,281

Common stock issued upon the acquisition of Orbotech
12,292

 
1,330,786

 

 

 
1,330,786

 

 
1,330,786

Net issuance under employee stock plans
26

 
(371
)
 

 

 
(371
)
 

 
(371
)
Repurchase of common stock
(1,770
)
 
(7,240
)
 
(198,777
)
 

 
(206,017
)
 

 
(206,017
)
Cash dividends ($0.75 per share) and dividend equivalents declared

 

 
(114,669
)
 

 
(114,669
)
 

 
(114,669
)
Non-controlling interest in connection with the acquisition of Orbotech

 

 

 

 

 
36,578

 
36,578

Stock-based compensation expense

 
34,193

 

 

 
34,193

 

 
34,193

Balance as of March 31, 2019
161,912

 
$
1,989,914

 
$
928,086

 
$
(68,907
)
 
$
2,849,093

 
$
36,495

 
$
2,885,588


See accompanying notes to condensed consolidated financial statements (unaudited).


6

Table of Contents



KLA-TENCOR CORPORATION
Condensed Consolidated Statements of Stockholders’ Equity
(Unaudited)

 
Common Stock and
Capital in Excess of
Par Value
 
Retained
Earnings
(Accumulated Deficit)
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total KLA-Tencor
Stockholders’
Equity
(In thousands, except per share amounts)
Shares
 
Amount
 
Balance as of June 30, 2017
156,840

 
$
529,283

 
$
848,457

 
$
(51,323
)
 
$
1,326,417

Net income

 

 
280,936

 

 
280,936

Other comprehensive income

 

 

 
542

 
542

Net issuance under employee stock plans
334

 
(23,628
)
 

 

 
(23,628
)
Repurchase of common stock
(433
)
 
(1,463
)
 
(39,312
)
 

 
(40,775
)
Cash dividends ($0.59 per share) and dividend equivalents declared

 

 
(93,567
)
 

 
(93,567
)
Stock-based compensation expense

 
14,031

 

 

 
14,031

Balance as of September 30, 2017
156,741

 
518,223

 
996,514

 
(50,781
)
 
1,463,956

Net loss

 

 
(134,319
)
 

 
(134,319
)
Other comprehensive income

 

 

 
(1,741
)
 
(1,741
)
Net issuance under employee stock plans
309

 
18,012

 

 

 
18,012

Repurchase of common stock
(388
)
 
(1,283
)
 
(39,585
)
 

 
(40,868
)
Cash dividends ($0.59 per share) and dividend equivalents declared

 

 
(93,154
)
 

 
(93,154
)
Stock-based compensation expense

 
13,739

 

 

 
13,739

Balance as of December 31, 2017
156,662

 
548,691

 
729,456

 
(52,522
)
 
1,225,625

Net income

 

 
306,881

 

 
306,881

Other comprehensive income

 

 

 
(1,755
)
 
(1,755
)
Net issuance under employee stock plans
6

 
(437
)
 

 

 
(437
)
Repurchase of common stock
(796
)
 
(2,787
)
 
(80,648
)
 

 
(83,435
)
Cash dividends ($0.59 per share) and dividend equivalents declared

 

 
(92,946
)
 

 
(92,946
)
Stock-based compensation expense

 
16,210

 

 

 
16,210

Balance as of March 31, 2018
155,872

 
$
561,677

 
$
862,743

 
$
(54,277
)
 
$
1,370,143



See accompanying notes to condensed consolidated financial statements (unaudited).


7

Table of Contents

KLA-TENCOR CORPORATION
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 
Nine months ended
March 31,
(In thousands)
2019
 
2018
Cash flows from operating activities:
 
 
 
Net income
$
957,689

 
$
453,498

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
105,338

 
47,695

Loss (gains) on unrealized foreign exchange and other
4,863

 
(1,221
)
Stock-based compensation expense
66,026

 
43,980

Changes in assets and liabilities, net of assets acquired and liabilities assumed in business acquisitions:
 
 
 
Accounts receivable
(92,586
)
 
(78,128
)
Inventories
(72,740
)
 
(104,921
)
Other assets
15,057

 
16,276

Accounts payable
(17,795
)
 
21,375

Deferred system revenue
(67,428
)
 

Deferred service revenue
(16,485
)
 

Deferred system profit

 
79,147

Other liabilities
(54,768
)
 
377,906

Net cash provided by operating activities
827,171

 
855,607

Cash flows from investing activities:
 
 
 
Acquisition of non-marketable securities
(630
)
 
(3,377
)
Business acquisitions, net of cash acquired
(1,818,283
)
 
(5,490
)
Capital expenditures
(74,652
)
 
(44,119
)
Purchases of available-for-sale securities
(2,686
)
 
(438,673
)
Proceeds from sale of available-for-sale securities
239,528

 
165,030

Proceeds from maturity of available-for-sale securities
443,107

 
489,569

Purchases of trading securities
(62,428
)
 
(65,160
)
Proceeds from sale of trading securities
64,623

 
67,063

Net cash (used in) provided by investing activities
(1,211,421
)
 
164,843

Cash flows from financing activities:
 
 
 
Proceeds from issuance of debt, net of issuance costs
1,186,263

 

Proceeds from revolving credit facility, net of debt issuance costs
900,000

 
248,693

Repayment of debt
(902,474
)
 
(721,250
)
Common stock repurchases
(750,216
)
 
(165,078
)
Payment of dividends to stockholders
(350,900
)
 
(285,030
)
Issuance of common stock
20,556

 
20,571

Tax withholding payments related to vested and released restricted stock units
(30,575
)
 
(26,623
)
Payment of contingent consideration payable
(513
)
 

Net cash provided by (used in) financing activities
72,141

 
(928,717
)
Effect of exchange rate changes on cash and cash equivalents
(110
)
 
10,898

Net (decrease) increase in cash and cash equivalents
(312,219
)
 
102,631

Cash and cash equivalents at beginning of period
1,404,382

 
1,153,051

Cash and cash equivalents at end of period
$
1,092,163

 
$
1,255,682

Supplemental cash flow disclosures:
 
 
 
Income taxes paid
$
164,701

 
$
221,797

Interest paid
$
55,529

 
$
61,028

Non-cash activities:
 
 
 
Issuance of common stock for the acquisition of Orbotech Ltd. - financing activities
$
1,330,786

 
$

Contingent consideration payable - financing activities
$
6,740

 
$

Dividends payable - financing activities
$
6,494

 
$
8,408

Unsettled common stock repurchase - financing activities
$
5,988

 
$

Accrued debt issuance costs - financing activities
$
2,530

 
$

Accrued purchases of land, property and equipment - investing activities
$
6,370

 
$
9,728

 See accompanying notes to condensed consolidated financial statements (unaudited).

8

Table of Contents

KLA-TENCOR CORPORATION
Notes to Condensed Consolidated Financial Statements
(Unaudited)

NOTE 1 – BASIS OF PRESENTATION
Basis of Presentation. For purposes of this report, “KLA,” “KLA-Tencor,” the “Company,” “we,” “our,” “us,” or similar references mean KLA-Tencor Corporation, and its majority-owned subsidiaries unless the context requires otherwise. The condensed consolidated financial statements have been prepared by us pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations.
In the opinion of management, the unaudited interim financial statements reflect all adjustments (consisting only of normal, recurring adjustments) necessary for a fair statement of the financial position, results of operations, comprehensive income, stockholders’ equity and cash flows for the periods indicated. These financial statements and notes, however, should be read in conjunction with Item 8, “Financial Statements and Supplementary Data” included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018, filed with the SEC on August 6, 2018.
The condensed consolidated financial statements include the accounts of KLA and its majority-owned subsidiaries. All significant intercompany balances and transactions have been eliminated.
The results of operations for the three and nine months ended March 31, 2019 are not necessarily indicative of the results that may be expected for any other interim period or for the full fiscal year ending June 30, 2019.
Certain reclassifications have been made to the prior year’s Condensed Consolidated Financial Statements to conform to the current year presentation. The reclassifications did not have material effects on the prior year’s Condensed Consolidated Balance Sheets, Statements of Operations, Comprehensive Income and Cash Flows.
Acquisition of Orbotech, Ltd. On February 20, 2019 (the “Closing Date” or “Acquisition Date”), we completed the acquisition of Orbotech, Ltd. (“Orbotech”) for $38.86 in cash and 0.25 of a share of our common stock in exchange for each ordinary share of Orbotech for a total consideration of $3.26 billion. The acquisition of Orbotech is referred to as the “Orbotech Acquisition”. The Orbotech Acquisition was accounted for by applying the acquisition method of accounting for business combinations. The unaudited condensed consolidated financial statements in this report include the financial results of Orbotech prospectively from the Acquisition Date. For additional details, refer to Note 6 “Business Combinations.”
Management Estimates. The preparation of the 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 and liabilities (and related disclosure of contingent assets and liabilities) at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Comparability. Effective on the first day of fiscal 2019, we adopted Accounting Standards Update 2014-09, Revenue from Contracts with Customers (“ASC 606”). Prior periods were not retrospectively restated, and accordingly, the consolidated balance sheet as of June 30, 2018, and the condensed consolidated statements of operations for the three and nine months ended March 31, 2018 were prepared using accounting standards that were different than those in effect for the three and nine months ended March 31, 2019.
Recent Accounting Pronouncements.
Recently Adopted
In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASC 606, which supersedes the guidance in ASC 605, Revenue Recognition (“ASC 605”). Under ASC 606, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, ASC 606 requires enhanced disclosures, including disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. We adopted the ASC 606 as of July 1, 2018 in our first quarter of our fiscal year ending June 30, 2019, using the modified retrospective transition approach. For additional detail, refer to Note 2 “Revenue.”

9

Table of Contents

In January 2016, the FASB issued an accounting standard update that changes the accounting for financial instruments primarily related to equity investments (other than those accounted for under the equity method of accounting or those that result in consolidation of the investee), financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. We adopted this update beginning in the first quarter of our fiscal year ending June 30, 2019 on a prospective basis and the adoption had no material impact on our condensed consolidated financial statements.
In August 2016, the FASB issued an accounting standard update intended to clarify how certain cash receipts and cash payments are presented and classified in the statement of cash flows. We adopted this update beginning in the first quarter of our fiscal year ending June 30, 2019 on a retrospective basis and the adoption had no material impact on our condensed consolidated financial statements.
In October 2016, the FASB issued an accounting standard update to recognize the income tax consequences of intra-entity transfers of assets other than inventory when they occur. This eliminates the exception to postpone recognition until the asset has been sold to an outside party. We adopted this update beginning in the first quarter of our fiscal year ending June 30, 2019 on a modified retrospective basis and the adoption had no material impact on our condensed consolidated financial statements.
In January 2017, the FASB issued an accounting standard on clarifying the definition of a business, with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. We adopted this update beginning in the first quarter of our fiscal year ending June 30, 2019 on a prospective basis and the adoption had no material impact on our condensed consolidated financial statements.
In January 2017, the FASB issued an accounting standard update to simplify the subsequent measurement of goodwill by removing the second step of the two-step impairment test, which requires an entity to determine the fair value of assets and liabilities similar to what is required in a purchase price allocation. Under the update, goodwill impairment will be calculated as the amount by which a reporting unit’s carrying value exceeds our fair value. We early adopted this update in the first quarter of our fiscal year ending June 30, 2019 on a prospective basis and the adoption had no material impact on our condensed consolidated financial statements.
In March 2017, the FASB issued an accounting standard update that changes the statements of operations classification of net periodic benefit cost related to defined benefit pension and/or other post-retirement benefit plans. Under the update, employers will present the service cost component of net periodic benefit cost in the same statements of operations line item(s) as other employee compensation costs arising from services rendered during the period. Only the service cost component will be eligible for capitalization in assets. Employers will present the other components of the net periodic benefit costs separately from the line item(s) that includes the service cost and outside of any subtotal of operating income, if one is presented. We adopted this update beginning in the first quarter of our fiscal year ending June 30, 2019 on a retrospective basis and the adoption had no material impact on our condensed consolidated financial statements.
In May 2017, the FASB issued an accounting standard update regarding stock compensation that provides guidance about which changes to the terms and conditions of a share-based payment award require an entity to apply modification accounting in order to reduce diversity in practice and reduce complexity. We adopted this update beginning in the first quarter of our fiscal year ending June 30, 2019 on a prospective basis and the adoption had no material impact on our condensed consolidated financial statements.
In August 2017, the FASB issued an accounting standard update to hedge accounting to better align risk management activities by refining financial and non-financial hedging strategy eligibilities. This update also amends the presentation and disclosure requirements to increase transparency to better understand an entity’s risk exposures and how hedging strategies are used to manage those exposures. We early adopted this update in the second quarter of our fiscal year ending June 30, 2019 under the modified retrospective approach. The cumulative effect adjustment for the elimination of the ineffectiveness was not material to our condensed consolidated financial statements. The presentation and disclosure have been amended on a prospective basis, as required by this update.
In February 2018, the FASB issued an accounting standard update that provides an option to reclassify disproportional tax effects and other income tax effects (“stranded tax effects”) caused by the Tax Cuts and Jobs Act (“the Act”) from accumulated other comprehensive income (“AOCI”) to retained earnings. We early adopted this update in the first quarter of our fiscal year ending June 30, 2019 and applied this update in the period of adoption. As a result of the adoption, we made a reclassification from AOCI to beginning retained earnings of approximately $10.9 million related to the stranded tax effects.

10

Table of Contents

Updates Not Yet Effective
In February 2016, the FASB issued an accounting standard update which amends the existing accounting standards for leases. Consistent with current guidance, the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on our classification. Under the new guidance, a lessee will be required to recognize assets and liabilities for all leases with lease terms of more than 12 months using a modified retrospective transition method. In July 2018, the FASB issued an amendment to the standard which provides us an option to apply the practical expedient allowed in the standard retrospectively with the cumulative effect recognized as of the date of adoption. The update is effective for us beginning in the first quarter of our fiscal year ending June 30, 2020. Early adoption is permitted. We are currently evaluating the impact of this accounting standard update on our condensed consolidated financial statements.
In June 2016, the FASB issued an accounting standard update that changes the accounting for recognizing impairments of financial assets. Under the update, credit losses for certain types of financial instruments will be estimated based on expected losses. The update also modifies the impairment models for available-for-sale debt securities and for purchased financial assets with credit deterioration since their origination. The update is effective for us beginning in the first quarter of our fiscal year ending June 30, 2021, with early adoption permitted starting in the first quarter of fiscal year ending June 30, 2020. We are currently evaluating the impact of this accounting standard update on our condensed consolidated financial statements.
In August 2018, the FASB issued an accounting standard update which modifies the existing accounting standards for fair value measurement disclosure. This update eliminates the disclosure of the amount of and reasons for transfers between level 1 and level 2 of the fair value hierarchy, and the policy for timing of transfers between levels. This standard update is effective for us beginning in the first quarter of our fiscal year ending June 30, 2021, and early adoption is permitted. We are currently evaluating the impact of this accounting standard update on our condensed consolidated financial statements.
In August 2018, the FASB issued an accounting standard update to amend the disclosure requirements related to defined benefit pension and other post-retirement plans. Some of the changes include adding a disclosure requirement for significant gains and losses related to changes in the benefit obligation for the period and removing the amounts in accumulated other comprehensive income expected to be recognized as components of net periodic benefit cost over the next fiscal year. This standard update is effective for us for the fiscal year ending June 30, 2021, and early adoption is permitted. We are currently evaluating the impact of this accounting standard update on our condensed consolidated financial statements.
In August 2018, the FASB issued an accounting standard update to align the requirements for capitalizing implementation costs incurred in a cloud computing arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The guidance clarifies which costs should be capitalized including the cost to acquire the license and the related implementation costs. This standard update is effective for us beginning in the first quarter of our fiscal year ending June 30, 2021, with an option to be adopted either prospectively or retrospectively. Early adoption is permitted. We are currently evaluating the impact of this accounting standard update on our condensed consolidated financial statements.
Significant Accounting Policies. We updated our accounting policies for Revenue Recognition, Business Combinations, Global Intangible Low-Taxed Income (“GILTI”), and Derivative Financial Instruments. There have been no other material changes to our significant accounting policies in Note 1 “Description of Business and Summary of Significant Accounting Policies,” of the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018.
Revenue Recognition. We primarily derive revenue from the sale of process control and yield management solutions for the semiconductor and related nanoelectronics industries, maintenance and support of all these products, installation and training services and the sale of spare parts. Our solutions provide a comprehensive portfolio of inspection, metrology and data analytics products, which are accompanied by a flexible portfolio of services to enable our customers to maintain the performance and productivity of the solutions purchased. The acquisition of Orbotech enabled us to broaden our portfolio to include the yield enhancement and production solutions used by manufacturers of printed circuit boards, flat panel displays, advanced packaging, micro-electro-mechanical systems and other electronic components.
Our solutions are generally not sold with a right of return, nor have we experienced significant returns from or refunds to our customers.
We account for a contract with a customer when there is approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectibility of consideration is probable.

11

Table of Contents

Our revenues are measured based on consideration stipulated in the arrangement with each customer, net of any sales incentives and amounts collected on behalf of third parties, such as sales taxes. The revenues are recognized as separate performance obligations that are satisfied by transferring control of the product or service to the customer.
Our arrangements with our customers include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. A product or service is considered distinct if it is separately identifiable from other deliverables in the arrangement and if a customer can benefit from it on its own or with other resources that are readily available to the customer.
The transaction consideration, including any sales incentives, is allocated between separate performance obligations of an arrangement based on the stand-alone selling prices (“SSP”) for each distinct product or service. Management considers a variety of factors to determine the SSP, such as, historical standalone sales of products and services, discounting strategies and other observable data.
From time to time, our contracts are modified to account for additional, or to change existing, performance obligations. Our contract modifications are generally accounted for prospectively.
Product revenue
We recognize revenue from product sales at a point in time when we have satisfied our performance obligation by transferring control of the product to the customer. We use judgment to evaluate whether the control has transferred by considering several indicators, including:

whether we have a present right to payment;
the customer has legal title;
the customer has physical possession;
the customer has significant risk and rewards of ownership; and
the customer has accepted the product, or whether customer acceptance is considered a formality based on history of acceptance of similar products (for example, when the customer has previously accepted the same tool, with the same specifications, and when we can objectively demonstrate that the tool meets all of the required acceptance criteria, and when the installation of the system is deemed perfunctory).
Not all of the indicators need to be met for us to conclude that control has transferred to the customer. In circumstances in which revenue is recognized prior to the product acceptance, the portion of revenue associated with our performance obligations to install product is deferred and recognized upon acceptance.
We enter into volume purchase agreements with some of our customers. We adjust the transaction consideration for estimated credits earned by our customers for such incentives. These credits are estimated based upon the forecasted and actual product sales for any given period and agreed-upon incentive rate. The estimate is updated at each reporting period.
We offer perpetual and term licenses for defects and data analysis software. The primary difference between perpetual and term licenses is the duration over which the customer can benefit from the use of the software, while the functionality and the features of the software are the same. With the acquisition of Orbotech we offer computer-aided manufacturing and engineering software solutions for the printed circuit boards production. Software is generally bundled with post-contract customer support (“PCS”), which includes unspecified software updates that are made available throughout the entire term of the arrangement. Revenue from software licenses is recognized at a point in time, when the software is made available to the customer. Revenue from PCS is deferred at contract inception and recognized ratably over the service period, or as services are performed.
Services and spare parts revenue
The majority of product sales include a standard 6 to 12-month warranty that is not separately paid for by the customers. The customers may also purchase extended warranty for periods beyond the initial year as part of the initial product sale. We have concluded that the standard 12-month warranty as well as any extended warranty periods included in the initial product sales are separate performance obligations. The estimated fair value of warranty services is deferred and recognized ratably as revenue over the warranty period, as the customer simultaneously receives and consumes the benefits of warranty services provided by us.

12

Table of Contents

Additionally, we offer product maintenance and support services, which the customer may purchase separately from the standard and extended warranty offered as part of the initial product sale. Revenue from separately negotiated maintenance and support service contracts is also recognized over time based on the terms of the applicable service period. Revenue from services performed in the absence of a maintenance contract, including training revenue, is recognized when the related services are performed. We also sell spare parts, revenue from which is recognized when control over the spare parts is transferred to the customer.
Installation services include connecting and validating configuration of the product. In addition, several testing protocols are completed to confirm the equipment is performing to customer specifications. Revenue from product installation are deferred and recognized at a point in time, once installation is complete.
Significant Judgments
Our contracts with our customers often include promises to transfer multiple products and services. Each product and service is generally capable of being distinct and represents a separate performance obligation. Determining the SSP for each distinct performance obligation and allocation of consideration from an arrangement to the individual performance obligations and the appropriate timing of revenue recognition are significant judgments with respect to these arrangements. We typically estimate the SSP of products and services based on observable transactions when the products and services are sold on a standalone basis and those prices fall within a reasonable range. We typically have more than one SSP for individual products and services due to the stratification of these products by customers and circumstances. In these instances, we use information such as the size of the customer, geographic region, as well as customization of the products in determining the SSP. In instances where the SSP is not directly observable, we determine the SSP using information that includes market conditions, entity-specific factors, including discounting strategies, information about the customer or class of customer that is reasonably available and other observable inputs. While changes in the allocation of SSP between performance obligations will not affect the amount of total revenue recognized for a particular contract, any material changes could impact the timing of revenue recognition, which could have a material effect on our financial position and result of operations.
Although the products are generally not sold with a right of return, we may provide other credits or sales incentives, which are accounted for either as variable consideration or material right, depending on the specific terms and conditions of the arrangement. These credits and incentives are estimated at contract inception and updated at the end of each reporting period if and when additional information becomes available.
As outlined above, we use judgments to evaluate whether or not the customer has obtained control of the product and considers the several indicators in evaluating whether or not control has transferred to the customer. Not all of the indicators need to be met for us to conclude that control has transferred to the customer.
Contract Assets/Liabilities
The timing of revenue recognition, billings and cash collections may result in accounts receivable, contract assets, and contract liabilities (deferred revenue) on our condensed consolidated balance sheet. A receivable is recorded in the period we deliver products or provide services when we have an unconditional right to payment. Contract assets primarily relate to the value of products and services transferred to the customer for which the right to payment is not just dependent on the passage of time. Contract assets are transferred to receivable when rights to payment become unconditional.
A contract liability is recognized when we receive payment or have an unconditional right to payment in advance of the satisfaction of performance. The contract liabilities represent (1) deferred product revenue related to the value of products that have been shipped and billed to customers and for which the control has not been transferred to the customers, and (2) deferred service revenue, which is recorded when we receive consideration, or such consideration is unconditionally due, from a customer prior to transferring services to the customer under the terms of a contract. Deferred service revenue typically results from warranty services, and maintenance and other service contracts.
Contract assets and liabilities related to rights and obligations in a contract are recorded net in the condensed consolidated balance sheets. Upon the adoption of ASC 606, deferred costs of revenue are included in other current assets while under the legacy guidance deferred costs of revenue was included in deferred system profit.







13

Table of Contents

Business Combinations. We allocate the fair value of the purchase price of our acquisitions to the tangible assets acquired, liabilities assumed, and intangible assets acquired, including in-process research and development (“IPR&D”), based on their estimated fair values. The excess of the fair value of the purchase price over the fair values of these net tangible and intangible assets acquired is recorded as goodwill. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but our estimates and assumptions are inherently uncertain and subject to refinement. As a result, during the measurement period, which will not exceed one year from the acquisition date, we record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the fair value of the purchase price of our acquisitions, whichever comes first, any subsequent adjustments are recorded to our condensed consolidated statements of operations.

The fair value of IPR&D is initially capitalized as an intangible asset with an indefinite life and assessed for impairment
thereafter. When an IPR&D project is completed, the IPR&D is reclassified as an amortizable purchased intangible asset and amortized over the asset’s estimated useful life. Acquisition-related expenses are recognized separately from the business combination and are expensed as incurred.

Derivative Financial Instruments. We use financial instruments, such as forward exchange contracts and currency options, to hedge a portion of, but not all, existing and forecasted foreign currency denominated transactions. The purpose of our foreign currency program is to manage the effect of exchange rate fluctuations on certain foreign currency denominated revenues, costs and eventual cash flows. The effect of exchange rate changes on forward exchange contracts is expected to offset the effect of exchange rate changes on the underlying hedged items. We also use interest rate lock agreements to hedge the risk associated with the variability of cash flows due to changes in the benchmark interest rate of the intended debt financing. We believe these financial instruments do not subject us to speculative risk that would otherwise result from changes in currency exchange rates or interest rates. All of our derivative financial instruments are recorded at fair value based upon quoted market prices for comparable instruments adjusted for risk of counterparty non-performance.
For derivative instruments designated and qualifying as cash flow hedges of forecasted foreign currency denominated transactions or debt financing expected to occur within twelve to eighteen months, the effective portion of the gains or losses is reported in accumulated other comprehensive income (loss) (“OCI”) and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Prior to adopting the new accounting guidance for hedge accounting, time value was excluded from the assessment of effectiveness for derivative instruments designated as cash flow hedges. Time value was amortized on a mark-to-market basis and recognized in earnings over the life of the derivative contract. For derivative contracts executed after adopting the new accounting guidance, the election to include time value for the assessment of effectiveness is made on all forward contracts designated as cash flow hedges. The change in fair value of the derivative are recorded in OCI until the hedged transaction is recognized in earnings. The assessment effectiveness of options contracts designated as cash flow hedges continue to exclude time value after adopting the new accounting guidance. The initial value of the component excluded from the assessment of effectiveness are recognized in earnings over the life of the derivative contracts. Any difference between change in the fair value of the excluded components and the amounts recognized in earnings are recorded in OCI. For derivative instruments that are not designated as a cash flow hedge, gains and losses are recognized in other expense (income), net. We use foreign currency forward contracts to hedge certain foreign currency denominated assets or liabilities. The gains and losses on these derivative instruments are largely offset by the changes in the fair value of the assets or liabilities being hedged.
Global Intangible Low-Taxed Income. The Tax Cuts and Jobs Act (the “Act”) includes provisions for Global Intangible Low-Taxed Income (“GILTI”) wherein taxes on foreign income are imposed in excess of a deemed return on tangible assets of foreign corporations. This income will effectively be taxed at a 10.5% tax rate in general. As a result, the Company’s deferred tax assets and liabilities were being evaluated to determine if the deferred tax assets and liabilities should be recognized for the basis differences expected to reverse as a result of GILTI provisions that are effective for the Company after the fiscal year ending June 30, 2018, or should the tax on GILTI provisions be recognized as period costs in each year incurred. The Company has elected to account for GILTI as a component of current period tax expense starting from the first quarter of the fiscal year ending June 30, 2019.

14

Table of Contents

NOTE 2 – REVENUE
New Revenue Accounting Standard
Method and Impact of Adoption
At the beginning of the fiscal year 2019, we adopted ASC 606 using the modified retrospective transition approach for all contracts completed and not completed as of the date of adoption. Under the modified retrospective transition approach, periods prior to the adoption date were not adjusted and continue to be reported in accordance with ASC 605. A cumulative effect of applying ASC 606 was recorded to the beginning retained earnings to reflect the impact of all existing arrangements under ASC 606.
The cumulative effect of applying ASC 606 represents a net decrease of $21.0 million as of July 1, 2018, which primarily related to the following:
A decrease of approximately $97.0 million in retained earnings related to the deferral of estimated fair value of the warranty services provided with our products for which revenue will be recognized in future periods under ASC 606. Further, upon adoption of ASC 606, we will recognize the standard warranty for a majority of products as a separate performance obligation, while in prior periods, we accounted for the estimated warranty cost as a charge to costs of sales when revenue was recognized. This was partially offset by an increase in retained earnings of approximately $37.0 million related to reversal of standard warranty expense, which was charged to cost of revenues in prior periods.
An increase in retained earnings of approximately $26.0 million due to a change in the timing of transfer of control over products to the customers.
Under ASC 606, revenue is recognized earlier than it would have been recognized under legacy guidance primarily due to our assessment of timing of transfer of control. Additionally, we render standard warranty coverage on our products for 12 months, providing labor and parts necessary to repair and maintain the products during the warranty period. Prior to adoption of ASC 606, we accounted for the estimated warranty cost as a charge to costs of sales when revenue was recognized. Upon adoption of ASC 606, the standard warranty for the majority of products is recognized as a separate performance obligation in service revenue.
Orbotech adopted ASC 606 on January 1, 2018, and the effect of adopting the ASC 606 on Orbotech’s revenues and operating income was not material. Orbotech’s contracts under ASC 606 supports the recognition of revenue at a point in time for the majority of its contracts, which is consistent with its legacy revenue recognition model. Revenue on the majority of Orbotech’s contracts will continue to be recognized upon delivery because this represents the point in time at which control is transferred to the customers. Revenues derived from performance obligations such as warranty and service contracts will continue to be recognized over the period of the service.
The following table, including the results from the acquisition of Orbotech, summarizes the effects of adopting ASC 606 on our condensed consolidated balance sheet as of March 31, 2019:
March 31, 2019 (In thousands)
As reported under
ASC 606
 
Prior to
adoption of
ASC 606
 
Effect of changes
ASSETS
 
 
 
 
 
Accounts receivable, net
$
958,021

 
$
1,064,002

 
$
(105,981
)
Other current assets
270,079

 
130,172

 
139,907

Deferred income taxes
205,820

 
197,392

 
8,428

LIABILITIES
 
 
 
 
 
Deferred system revenue
$
228,745

 
$

 
$
228,745

Deferred service revenue
182,119

 
97,190

 
84,929

Deferred system profit

 
323,107

 
(323,107
)
Other current liabilities
833,747

 
866,870

 
(33,123
)
Deferred service revenue, non-current
90,610

 
82,176

 
8,434

STOCKHOLDERS EQUITY
 
 
 
 
 
Retained earnings
$
928,086

 
$
851,740

 
$
76,346

Accumulated other comprehensive income (loss)
(68,907
)
 
(69,038
)
 
131


15

Table of Contents

The following table, including the results from the acquisition of Orbotech, summarizes the effects of adopting ASC 606 on our condensed consolidated statements of operations for the three months ended March 31, 2019:
Three months ended March 31, 2019 (In thousands, except per share amounts)
As reported under
ASC 606
 
Prior to
adoption of
ASC 606
 
Effect of changes
Revenues:
 
 
 
 
 
Product
$
793,224

 
$
854,393

 
$
(61,169
)
Service
304,087

 
266,333

 
37,754

Costs and expenses:
 
 
 
 
 
Costs of revenues
486,945

 
499,209

 
(12,264
)
Other expense (income), net
(9,282
)
 
(9,041
)
 
(241
)
Provision for income taxes
28,745

 
29,755

 
(1,010
)
Net income attributable to KLA-Tencor
192,728

 
202,627

 
(9,899
)
Net income per share attributable to KLA-Tencor
 
 
 
 
 
Basic
$
1.23

 
$
1.30

 
$
(0.07
)
Diluted
$
1.23

 
$
1.29

 
$
(0.06
)
The following table, including the results from the acquisition of Orbotech, summarizes the effects of adopting ASC 606 on our condensed consolidated statements of operations for the nine months ended March 31, 2019:
Nine months ended March 31, 2019 (In thousands, except per share amounts)
As reported under
ASC 606
 
Prior to
adoption of
ASC 606
 
Effect of changes
Revenues:
 
 
 
 
 
Product
$
2,474,652

 
$
2,430,481

 
$
44,171

Service
835,817

 
726,976

 
108,841

Costs and expenses:
 
 
 
 
 
Costs of revenues
1,276,592

 
1,233,999

 
42,593

Other expense (income), net
(28,535
)
 
(28,253
)
 
(282
)
Provision for income taxes
107,232

 
94,090

 
13,142

Net income attributable to KLA-Tencor
957,772

 
860,212

 
97,560

Net income per share attributable to KLA-Tencor:
 
 
 
 
 
Basic
$
6.20

 
$
5.57

 
$
0.63

Diluted
$
6.17

 
$
5.54

 
$
0.63


Contract Balances
 
As of
 
As of
 
 
 
 
(In thousands, except for percentage)
March 31, 2019
 
July 1, 2018
 
$ Change
 
% Change
Accounts receivable, net
$
958,021

 
$
635,878

 
$
322,143

 
51
 %
Contract assets
$
91,518

 
$
14,727

 
$
76,791

 
521
 %
Contract liabilities
$
501,474

 
$
556,691

 
$
(55,217
)
 
(10
)%
Our payment terms and conditions vary by contract type, although terms generally include a requirement of payment of 70% to 90% of total contract consideration within 30 to 60 days of shipment, with the remainder payable within 30 days of acceptance.
The change in contract assets during the nine months ended March 31, 2019 was mainly due to an increase in contract assets of $71.1 million from the Orbotech Acquisition in the third quarter of fiscal year 2019 and $19.4 million of revenue recognized in excess of the amounts billed to the customers, partially offset by $14.7 million of contract assets reclassified to net accounts receivable as our right to consideration for these contract assets became unconditional. Contract assets are included in Other current assets on our condensed consolidated balance sheet.

16

Table of Contents

During the nine months ended March 31, 2019, we recognized revenue of $422.3 million that was included in contract liabilities as of July 1, 2018. This was partially offset by an increase in contract liabilities of $28.8 million from the Orbotech Acquisition in the third quarter of fiscal year 2019, and the value of products and services billed to customers for which control of the products and service has not transferred to the customers. Contract liabilities are included in current and non-current liabilities on our condensed consolidated balance sheets.

Remaining Performance Obligations
As of March 31, 2019, we had $1.73 billion of remaining performance obligations, which represents our obligation to deliver products and services, and consists primarily of sales orders where written customer requests have been received. We expect to recognize approximately 5% to 15% of these performance obligations as revenue beyond the next twelve months, subject to risk of delays, pushouts, and cancellation by the customer, usually with limited or no penalties.
Refer to Note 17 “Segment Reporting and Geographic Information” for information related to revenue by geographic region as well as significant product and service offerings.
Practical expedients
We apply the following practical expedients:
We account for shipping and handling costs as activities to fulfill the promise to transfer the goods, instead of a promised service to our customer.
We have elected to not adjust the promised amount of consideration for the effects of a significant financing component as we expect, at contract inception, that the period between when the entity transfers a promised good or service to a customer and when the customer pays for that good or service will generally be one year or less.
We have elected to expense costs to obtain a contract as incurred because the expected amortization period is one year or less.
We have elected to reflect the aggregate effect of all modifications that occurred before July 1, 2018 in determining the transaction price, identifying the satisfied and unsatisfied performance obligations, and allocating the transaction price to the performance obligations.
NOTE 3 – FAIR VALUE MEASUREMENTS
Our financial assets and liabilities are measured and recorded at fair value, except for our debt and certain equity investments in privately-held companies. Prior to July 1, 2018, the equity investments were generally accounted for under the cost method of accounting and were periodically assessed for other-than-temporary impairment when an event or circumstance indicated that an other-than-temporary decline in value may have occurred. Effective July 1, 2018, equity investments without a readily available fair value are accounted for using the measurement alternative. The measurement alternative is calculated as cost minus impairment, if any, plus or minus changes resulting from observable price changes.
Our non-financial assets, such as goodwill, intangible assets, and land, property and equipment, are assessed for impairment when an event or circumstance indicates that an other-than-temporary decline in value may have occurred.
Fair Value of Financial Instruments. We have evaluated the estimated fair value of financial instruments using available market information and valuations as provided by third-party sources. The use of different market assumptions and/or estimation methodologies could have a significant effect on the estimated fair value amounts. The fair value of our cash equivalents, accounts receivable, accounts payable and other current assets and liabilities approximate their carrying amounts due to the relatively short maturity of these items.
Fair Value Hierarchy. The authoritative guidance for fair value measurements establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:
Level 1
  
Valuations based on quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.
 
 
 
Level 2
  
Valuations based on quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities.
 
 
 
Level 3
  
Valuations based on inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

17

Table of Contents

A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
As of March 31, 2019, the types of instruments valued based on quoted market prices in active markets included money market funds, certain U.S. Treasury securities and U.S. Government agency securities. Such instruments are generally classified within Level 1 of the fair value hierarchy. The types of instruments valued based on other observable inputs included corporate debt securities and sovereign securities. The market inputs used to value these instruments generally consist of market yields, reported trades and broker/dealer quotes. Such instruments are generally classified within Level 2 of the fair value hierarchy.
The principal market in which we execute our foreign currency contracts is the institutional market in an over-the-counter environment with a relatively high level of price transparency. The market participants generally are large financial institutions. Our foreign currency contracts’ valuation inputs are based on quoted prices and quoted pricing intervals from public data sources and do not involve management judgment. These contracts are typically classified within Level 2 of the fair value hierarchy.
The fair value of deferred payments and contingent consideration payable, the majority of which were recorded in connection with business combinations during the three months ended March 31, 2019, were classified as Level 3 and estimated using significant inputs that were not observable in the market. See Note 6 “Business Combinations” for additional information.
Financial assets (excluding cash held in operating accounts and time deposits) and liabilities measured at fair value on a recurring basis, as of the date indicated below, were presented on our Condensed Consolidated Balance Sheet as follows:
As of March 31, 2019 (In thousands)
Total
 
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant 
Other
Observable 
Inputs
(Level 2)
 
Little or no market activity
Inputs
(Level 3)
Assets
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds and other
$
592,141

 
$
592,141

 
$

 
$

U.S. Treasury securities

 

 

 

Marketable securities:
 
 
 
 
 
 
 
Corporate debt securities
439,246

 

 
439,246

 

Sovereign securities
10,991

 

 
10,991

 

U.S. Government agency securities
166,092

 
166,092

 

 

U.S. Treasury securities
187,080

 
187,080

 

 

Total cash equivalents and marketable securities(1)
1,395,550

 
945,313

 
450,237

 

Other current assets:
 
 
 
 
 
 
 
Derivative assets
4,246

 

 
4,246

 

Other non-current assets:
 
 
 
 
 
 
 
Executive Deferred Savings Plan
203,286

 
153,528

 
49,758

 

Total financial assets(1)
$
1,603,082

 
$
1,098,841

 
$
504,241

 
$

Liabilities
 
 
 
 
 
 
 
Derivative liabilities
$
(1,816
)
 
$

 
$
(1,816
)
 
$

Deferred payments
(8,800
)
 

 

 
(8,800
)
Contingent consideration payable

(13,840
)
 

 

 
(13,840
)
Total financial liabilities
$
(24,456
)
 
$

 
$
(1,816
)
 
$
(22,640
)
________________
(1) Excludes cash of $446.7 million held in operating accounts and time deposits of $55.0 million as of March 31, 2019.


18

Table of Contents

Financial assets (excluding cash held in operating accounts and time deposits) and liabilities measured at fair value on a recurring basis, as of the date indicated below, were presented on our Condensed Consolidated Balance Sheet as follows:  
As of June 30, 2018 (In thousands)
Total
 
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
 
Significant Other
Observable Inputs
(Level 2)
Assets
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
Corporate debt securities
$
4,995

 
$

 
$
4,995

Money market funds and other
863,115

 
863,115

 

U.S. Government agency securities
7,675

 

 
7,675

U.S. Treasury securities
1,996

 

 
1,996

Marketable securities:
 
 
 
 
 
Corporate debt securities
735,408

 

 
735,408

Sovereign securities
17,142

 

 
17,142

U.S. Government agency securities
316,022

 
299,501

 
16,521

U.S. Treasury securities
405,654

 
364,574

 
41,080

Total cash equivalents and marketable securities(1)
2,352,007

 
1,527,190

 
824,817

Other current assets:
 
 
 
 
 
Derivative assets
5,385

 

 
5,385

Other non-current assets:
 
 
 
 
 
Executive Deferred Savings Plan
197,213

 
143,580

 
53,633

Total financial assets(1)
$
2,554,605

 
$
1,670,770

 
$
883,835

Liabilities
 
 
 
 
 
Derivative liabilities
$
(6,828
)
 
$

 
$
(6,828
)
Total financial liabilities
$
(6,828
)
 
$

 
$
(6,828
)
________________
(1) Excludes cash of $473.8 million held in operating accounts and time deposits of $54.5 million as of June 30, 2018.
There were no transfers between Level 1 and Level 2 fair value measurements during the nine months ended March 31, 2019. We did not have any assets or liabilities measured at fair value on a recurring basis within Level 3 fair value measurements as of June 30, 2018. See Note 8 “Debt” for disclosure of the fair value of our Senior Notes.



19

Table of Contents

NOTE 4 – FINANCIAL STATEMENT COMPONENTS
Consolidated Balance Sheets
(In thousands)
As of
March 31, 2019
 
As of
June 30, 2018
Accounts receivable, net:
 
 
 
Accounts receivable, gross
$
970,291

 
$
663,317

Allowance for doubtful accounts
(12,270
)
 
(11,639
)
 
$
958,021

 
$
651,678

Inventories:
 
 
 
Customer service parts
$
337,720

 
$
253,639

Raw materials
466,133

 
331,065

Work-in-process
314,480

 
280,208

Finished goods
198,927

 
66,933

 
$
1,317,260

 
$
931,845

Other current assets:
 
 
 
Contract assets
$
91,518

 
$

Deferred costs of revenue(1)
48,389

 

Prepaid expenses
76,507

 
47,088

Prepaid income and other taxes
34,479

 
23,452

Other current assets
19,186

 
14,619

 
$
270,079

 
$
85,159

Land, property and equipment, net:
 
 
 
Land
$
41,422

 
$
40,599

Buildings and leasehold improvements
389,270

 
335,647

Machinery and equipment
662,025

 
577,077

Office furniture and fixtures
28,475

 
22,171

Construction-in-process
27,766

 
9,180

 
1,148,958

 
984,674

Less: accumulated depreciation
(737,106
)
 
(698,368
)
 
$
411,852

 
$
286,306

Other non-current assets:
 
 
 
Executive Deferred Savings Plan(2)
$
203,286

 
$
197,213

Other non-current assets
56,804

 
38,869

 
$
260,090

 
$
236,082

Other current liabilities:
 
 
 
Compensation and benefits
$
246,429

 
$
173,774

Executive Deferred Savings Plan(2)
204,349

 
199,505

Other accrued expenses
176,677

 
123,869

Customer credits and advances
148,389

 
116,440

Interest payable
44,046

 
16,947

Warranty
6,740

 
42,258

Income taxes payable
7,117

 
23,287

 
$
833,747

 
$
696,080

Other non-current liabilities:
 
 
 
Income taxes payable
$
390,904

 
$
371,665

Pension liabilities
67,103

 
66,786

Other non-current liabilities
117,592

 
54,791

 
$
575,599

 
$
493,242

________________
(1)
Deferred costs of revenue were previously included under deferred system profit prior to the adoption of ASC 606.

20

Table of Contents

(2)
We have a non-qualified deferred compensation plan (known as “Executive Deferred Savings Plan” or “EDSP”) under which certain employees and non-employee directors may defer a portion of their compensation. The expense (benefit) associated with changes in the EDSP liability included in selling, general and administrative expense was $19.3 million and $0.9 million during the three months ended March 31, 2019 and 2018, respectively and was $7.0 million and $14.7 million during the nine months ended March 31, 2019 and 2018, respectively. The amount of net gains (losses) associated with changes in the EDSP assets included in selling, general and administrative expense was $19.7 million and $0.5 million during the three months ended March 31, 2019 and 2018, respectively and was $7.7 million and $14.4 million the nine months ended March 31, 2019 and 2018, respectively. For additional details, refer to Note 1, “Description of Business and Summary of Significant Accounting Policies,” of the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018.
Accumulated Other Comprehensive Income (Loss)
The components of accumulated other comprehensive income (loss) (“OCI”) as of the dates indicated below were as follows:
(In thousands)
Currency Translation Adjustments
 
Unrealized Gains (Losses) on Available-for-Sale Securities
 
Unrealized Gains (Losses) on Cash Flow Hedges
 
Unrealized Gains (Losses) on Defined Benefit Plans
 
Total
Balance as of March 31, 2019
$
(43,630
)
 
$
(3,181
)
 
$
(6,266
)
 
$
(15,830
)
 
$
(68,907
)
 
 
 
 
 
 
 
 
 
 
Balance as of June 30, 2018
$
(29,974
)
 
$
(11,032
)
 
$
1,932

 
$
(14,859
)
 
$
(53,933
)
The effects on net income (loss) of amounts reclassified from accumulated OCI to the Condensed Consolidated Statement of Operations for the indicated period were as follows (in thousands):
 
 
Location in the Condensed Consolidated
 
Three months ended
March 31,
 
Nine months ended
March 31,
Accumulated OCI Components
 
Statements of Operations
 
2019
 
2018
 
2019
 
2018
Unrealized gains (losses) on cash flow hedges from foreign exchange and interest rate contracts(1)
 
Revenues
 
$
655

 
$
(65
)
 
$
3,343

 
$
1,300

 
 
Costs of revenues
 
(17
)
 
570

 
(309
)
 
1,908

 
 
Interest expense
 
150

 
189

 
527

 
567

 
 
Other expense (income), net
 
158

 

 
158

 

 
 
Net gains (losses) reclassified from accumulated OCI
 
$
946

 
$
694

 
$
3,719

 
$
3,775

Unrealized gains (losses) on available-for-sale securities
 
Other expense (income), net
 
$
(313
)
 
$
2

 
$
(1,263
)
 
$
(61
)
__________________ 
(1)
Reflects the adoption of the new accounting guidance for hedge accounting in the second quarter of fiscal year 2019. For additional details, refer to Note 15, “Derivative Instruments and Hedging Activities.”
The amounts reclassified out of accumulated OCI related to our defined benefit pension plans, which were recognized as a component of net periodic cost for the three and nine months ended March 31, 2019 were $0.2 million and $0.6 million, respectively. The amounts reclassified out of accumulated OCI related to our defined benefit pension plans, which were recognized as a component of net periodic cost for the three and nine months ended March 31, 2018 were $0.4 million and $1.2 million, respectively. For additional details, refer to Note 11, “Employee Benefit Plans” of the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018.

21

Table of Contents

NOTE 5 – MARKETABLE SECURITIES
The amortized cost and fair value of marketable securities as of the dates indicated below were as follows:
As of March 31, 2019 (In thousands)
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Corporate debt securities
$
441,279

 
$
43

 
$
(2,076
)
 
$
439,246

Money market funds and other
592,141

 

 

 
592,141

Sovereign securities
11,037

 

 
(46
)
 
10,991

U.S. Government agency securities
166,867

 
1

 
(776
)
 
166,092

U.S. Treasury securities
188,283

 

 
(1,203
)
 
187,080

Subtotal
1,399,607

 
44

 
(4,101
)
 
1,395,550

Add: Time deposits(1)
54,986

 

 

 
54,986

Less: Cash equivalents
645,431

 

 

 
645,431

Marketable securities
$
809,162

 
$
44

 
$
(4,101
)
 
$
805,105

As of June 30, 2018 (In thousands)
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Corporate debt securities
$
747,763

 
$
148

 
$
(7,508
)
 
$
740,403

Money market funds and other
863,115

 

 

 
863,115

Sovereign securities
17,293

 

 
(151
)
 
17,142

U.S. Government agency securities
326,508

 
16

 
(2,827
)
 
323,697

U.S. Treasury securities
411,329

 
3

 
(3,682
)
 
407,650

Subtotal
2,366,008

 
167

 
(14,168
)
 
2,352,007

Add: Time deposits(1)
54,537

 

 

 
54,537

Less: Cash equivalents
930,608

 

 

 
930,608

Marketable securities
$
1,489,937

 
$
167

 
$
(14,168
)
 
$
1,475,936

________________
(1) Time deposits excluded from fair value measurements.
Our investment portfolio consists of both corporate and government securities that have a maximum maturity of three years. The longer the duration of these securities, the more susceptible they are to changes in market interest rates and bond yields. As yields increase, those securities with a lower yield-at-cost show a mark-to-market unrealized loss. Most of our unrealized losses are due to changes in market interest rates and bond yields. We believe that we have the ability to realize the full value of all of these investments upon maturity. As of March 31, 2019, we had 296 investments in an unrealized loss position. The following table summarizes the fair value and gross unrealized losses of our investments that were in an unrealized loss position as of the date indicated below: 
As of March 31, 2019 (In thousands)
Fair Value
 
Gross
Unrealized
Losses(1)
Corporate debt securities
$
397,009

 
$
(2,076
)
U.S. Treasury securities
187,080

 
(1,203
)
U.S. Government agency securities
163,445

 
(776
)
Sovereign securities
10,991

 
(46
)
Total
$
758,525

 
$
(4,101
)
__________________ 
(1) As of March 31, 2019, we had investments in a continuous loss position for 12 months or more with a gross amount $4.1 million.


22

Table of Contents

The contractual maturities of securities classified as available-for-sale, regardless of their classification on our Condensed Consolidated Balance Sheet, as of the date indicated below were as follows:
As of March 31, 2019 (In thousands)
Amortized Cost
 
Fair Value
Due within one year
$
606,043

 
$
603,536

Due after one year through three years
203,119

 
201,569

 
$
809,162

 
$
805,105

Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Realized gains and losses on available-for-sale securities for the three and nine months ended March 31, 2019 and 2018 were immaterial.

NOTE 6 - BUSINESS COMBINATIONS
Orbotech Acquisition
On February 20, 2019, we completed the acquisition of 100% of the outstanding shares of Orbotech for aggregate purchase consideration of approximately $3.26 billion which was paid in part by cash of $1.90 billion, in part by KLA common shares with a fair value of $1.32 billion and the balance by the assumption of stock options and RSUs. Orbotech is a global supplier of yield-enhancing and process-enabling solutions for the manufacture of electronics products. KLA acquired Orbotech to extend and enhance its portfolio of products to address market opportunities in the printed circuit board, flat panel display, advanced packaging and semiconductor manufacturing areas.

Preliminary Purchase Price Allocation
The aggregate purchase consideration has been preliminarily allocated as follows (in thousands):
Purchase Price
 
Cash for outstanding Orbotech shares(1)
$
1,901,948

Fair value of KLA-Tencor common stock issued for outstanding Orbotech shares(2)
1,324,657

Cash for Orbotech equity awards(3)
9,543

Fair value of KLA-Tencor common stock issued to settle Orbotech equity awards(4)
6,129

Stock options and RSUs assumed (5)
13,281

Total purchase consideration
3,255,558

Less: cash acquired
(215,640
)
Total purchase consideration, net of cash acquired
$
3,039,918

 
 
Allocation
 
Total current assets
$
694,143

Property, plant and equipment
94,290

Goodwill
1,773,544

Intangible assets
1,629,070

Other non-current assets
77,780

Total current liabilities (6)
(301,090
)
Deferred tax liability
(825,341
)
Total non-current liabilities (6)
(65,896
)
Non-controlling interest
(36,582
)
 
$
3,039,918

________________
(1)
Represents the total cash paid to settle 48.9 million outstanding Orbotech Shares as of February 20, 2019 at $38.86 per Orbotech share.

23

Table of Contents

(2)
Represents the fair value of 12.2 million shares of our common stock issued to settle 48.9 million outstanding Orbotech shares. KLA issued 0.25 shares for each Orbotech share. The fair value of KLA’s common stock was $108.26 per share on the Acquisition Date.
(3)
Represents primarily cash consideration for the settlement of the vested stock options and restricted stock units for which services were rendered by the employees of Orbotech prior to the closing, and a small portion for the settlement of fractional shares.
(4)
Represents the fair value of share of 56,614 shares of KLA common stock issued to settle the vested Orbotech stock options. The fair value of KLA’s common stock was $108.26 per share on the Acquisition Date.
(5)
Represents the fair value of the assumed stock options and RSUs to the extent those related to services provided by the employee of Orbotech prior to closing. Also refer to Note 9, “Equity, Long-Term Incentive Compensation Plans and Non-Controlling Interest” for additional information about assumed stock options and RSUs.
(6)
On December 24, 2018, Orbotech, as part of its strategy to invest in the high growth area of the software business within the Printed Circuit Boards (“PCB”) industry, acquired the remaining 50% shares of Frontline, which was prior to that accounted as an equity investee, from Mentor Graphics Development Services (Israel) Ltd. Orbotech acquired all of the joint venture interests it did not previously own for $85.0 million in cash on hand and agreed to pay an additional $10.0 million in cash over four years plus a cash earn-out of not less than $5.0 million and up to $20.0 million. The earn out amounts are based on revenues from a Frontline product currently under development. As of February 20, 2019, the estimated fair market values of the four-year cash payment and the earn-out are $8.8 million and $7.1 million, respectively. As of February 20, 2019, these amounts have been included in current and non-current liabilities at $4.3 million and $11.6 million respectively.

KLA allocated the purchase price to tangible and identified intangible assets acquired and liabilities assumed based on the preliminary estimates of their estimated fair values, which were determined using generally accepted valuation techniques based on estimates and assumptions made by management at the time of the Orbotech Acquisition and are subject to change during the measurement period which is not expected to exceed one year. The primary tasks that are required to be completed include validation of business level forecasts, jurisdictional forecasts, customer attrition rates and synergies expected to be derived from the acquisition of Orbotech, including any related tax impacts. Any adjustments to our preliminary purchase price allocation identified during the measurement period will be recognized in the period in which the adjustments are determined.

The operating results of Orbotech have been included in our consolidated financial statements for the three and nine months ended March 31, 2019 from the Acquisition Date. The goodwill was primarily attributable to the assembled workforce of Orbotech, planned growth in new markets and synergies expected to be achieved from the combined operations of KLA-Tencor and Orbotech. None of the goodwill is deductible for income tax purposes. Goodwill arising from the Orbotech Acquisition has been allocated to Orbotech which KLA is treating as a separate component as of March 31, 2019. As disclosed in Note 17 "Segment Reporting and Geographic Informaion", KLA is still in the process of completing the analysis of its segment reporting structure and upon completion of that analysis, goodwill associated with the Orbotech acquisition will be assigned to the appropriate reporting units.