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, 2015
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 and posted on its corporate website, if any, 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 and post such files).   Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
 
Accelerated filer ¨
 
Non-accelerated filer ¨
 
Smaller reporting company ¨
 
 
 
 
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨    No  x
As of April 10, 2015, there were 159,921,055 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
 
 
 
 
 
 


 

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PART I. FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS
KLA-TENCOR CORPORATION
Condensed Consolidated Balance Sheets
(Unaudited)
 
(In thousands)
March 31,
2015
 
June 30,
2014
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
621,892

 
$
630,861

Marketable securities
1,717,893

 
2,521,776

Accounts receivable, net
631,608

 
492,863

Inventories
632,353

 
656,457

Deferred income taxes
236,563

 
215,676

Other current assets
126,802

 
69,197

Total current assets
3,967,111

 
4,586,830

Land, property and equipment, net
321,081

 
330,263

Goodwill
335,291

 
335,355

Purchased intangibles, net
15,548

 
27,697

Other non-current assets
263,189

 
258,519

Total assets
$
4,902,220

 
$
5,538,664

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
103,189

 
$
103,422

Deferred system profit
146,355

 
147,923

Unearned revenue
58,295

 
59,176

Current portion of long-term debt
37,500

 

Other current liabilities
631,276

 
585,090

Total current liabilities
976,615

 
895,611

Non-current liabilities:
 
 
 
Long-term debt
3,199,299

 
747,919

Unearned revenue
52,500

 
57,500

Other non-current liabilities
179,865

 
168,288

Total liabilities
4,408,279

 
1,869,318

Commitments and contingencies (Note 12 and Note 13)

 

Stockholders’ equity:
 
 
 
Common stock and capital in excess of par value
534,330

 
1,220,504

Retained earnings (accumulated deficit)
(2,582
)
 
2,479,113

Accumulated other comprehensive income (loss)
(37,807
)
 
(30,271
)
Total stockholders’ equity
493,941

 
3,669,346

Total liabilities and stockholders’ equity
$
4,902,220

 
$
5,538,664

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

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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)
2015
 
2014
 
2015
 
2014
Revenues:
 
 
 
 
 
 
 
Product
$
565,181

 
$
670,083

 
$
1,545,663

 
$
1,716,006

Service
173,278

 
161,516

 
512,054

 
479,059

Total revenues
738,459

 
831,599

 
2,057,717

 
2,195,065

Costs and operating expenses:
 
 
 
 
 
 
 
Costs of revenues
320,282

 
342,826

 
891,962

 
906,297

Engineering, research and development
124,583

 
134,161

 
401,777

 
401,021

Selling, general and administrative
98,608

 
93,449

 
305,125

 
288,691

Total costs and operating expenses
543,473

 
570,436

 
1,598,864

 
1,596,009

Income from operations
194,986

 
261,163

 
458,853

 
599,056

Interest income and other, net
1,976

 
3,479

 
7,339

 
9,168

Interest expense
30,508

 
13,396

 
75,330

 
40,369

Loss on extinguishment of debt and other, net

 

 
131,669

 

Income before income taxes
166,454

 
251,246

 
259,193

 
567,855

Provision for income taxes
34,816

 
47,665

 
35,054

 
113,831

Net income
$
131,638

 
$
203,581

 
$
224,139

 
$
454,024

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.81

 
$
1.22

 
$
1.37

 
$
2.73

Diluted
$
0.81

 
$
1.21

 
$
1.36

 
$
2.70

Cash dividends declared per share (including a special
cash dividend of $16.50 per share declared during the three
   months ended December 31, 2014)
$
0.50

 
$
0.45

 
$
18.00

 
$
1.35

Weighted-average number of shares:
 
 
 
 
 
 
 
Basic
161,559

 
166,253

 
163,494

 
166,184

Diluted
162,794

 
167,989

 
164,930

 
168,355


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

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

 
Three months ended
 
Nine months ended
 
March 31,
 
March 31,
(In thousands)
2015
 
2014
 
2015
 
2014
Net income
$
131,638

 
$
203,581

 
$
224,139

 
$
454,024

Other comprehensive income (loss):
 
 
 
 
 
 
 
Currency translation adjustments:
 
 
 
 
 
 
 
Change in currency translation adjustments
(4,687
)
 
(13
)
 
(21,756
)
 
3,908

Change in income tax benefit or expense
2,370

 
113

 
8,343

 
(661
)
Net change related to currency translation adjustments
(2,317
)
 
100

 
(13,413
)
 
3,247

Cash flow hedges:
 
 
 
 
 
 
 
Change in net unrealized gains or losses
(1,309
)
 
(1,752
)
 
12,648

 
1,821

Reclassification adjustments for net gains or losses included in net income
(3,920
)
 
(934
)
 
(5,732
)
 
(3,472
)
Change in income tax benefit or expense
1,885

 
962

 
(2,492
)
 
591

Net change related to cash flow hedges
(3,344
)
 
(1,724
)
 
4,424

 
(1,060
)
Net change related to unrecognized losses and transition obligations in connection with defined benefit plans
1,212

 
142

 
2,525

 
542

Available-for-sale securities:
 
 
 
 
 
 
 
Change in net unrealized gains or losses
3,277

 
844

 
153

 
5,641

Reclassification adjustments for gains or losses included in net income
(60
)
 
(281
)
 
(1,976
)
 
(1,728
)
Change in income tax benefit or expense
(822
)
 
(183
)
 
751

 
(1,346
)
Net change related to available-for-sale securities
2,395

 
380

 
(1,072
)
 
2,567

Other comprehensive income (loss)
(2,054
)
 
(1,102
)
 
(7,536
)
 
5,296

Total comprehensive income
$
129,584

 
$
202,479

 
$
216,603

 
$
459,320


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

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KLA-TENCOR CORPORATION
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 
Nine months ended
March 31,
(In thousands)
2015
 
2014
Cash flows from operating activities:
 
 
 
Net income
$
224,139

 
$
454,024

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
60,570

 
61,062

Asset impairment charges
1,698

 
1,374

Loss on extinguishment of debt and other, net
131,669

 

Non-cash stock-based compensation expense
43,098

 
46,812

Excess tax benefit from equity awards
(15,186
)
 
(20,187
)
Net gain on sale of marketable securities and other investments
(1,976
)
 
(1,728
)
Changes in assets and liabilities, net of impact of acquisition of business:
 
 
 
Increase in accounts receivable, net
(162,234
)
 
(34,193
)
Decrease (increase) in inventories
11,002

 
(47,481
)
Decrease (increase) in other assets
(62,492
)
 
8,470

Increase in accounts payable
700

 
5,121

Increase (decrease) in deferred system profit
(1,569
)
 
15,630

Increase in other liabilities
59,008

 
41,342

Net cash provided by operating activities
288,427

 
530,246

Cash flows from investing activities:
 
 
 
Acquisition of non-marketable securities

 
(1,345
)
Acquisition of business

 
(18,000
)
Capital expenditures, net
(36,554
)
 
(54,436
)
Purchase of available-for-sale securities
(1,433,856
)
 
(1,156,107
)
Proceeds from sale of available-for-sale securities
1,664,898

 
723,225

Proceeds from maturity of available-for-sale securities
564,283

 
110,924

Purchase of trading securities
(48,949
)
 
(53,046
)
Proceeds from sale of trading securities
50,558

 
53,400

Net cash provided by (used in) investing activities
760,380

 
(395,385
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of debt, net of issuance costs
3,224,906

 

Repayment of debt
(886,742
)
 

Issuance of common stock
29,578

 
92,100

Tax withholding payments related to vested and released restricted stock units
(29,790
)
 
(51,556
)
Common stock repurchases
(435,030
)
 
(180,686
)
Payment of dividends to stockholders
(2,961,402
)
 
(224,405
)
Excess tax benefit from equity awards
15,186

 
20,187

Net cash used in financing activities
(1,043,294
)
 
(344,360
)
Effect of exchange rate changes on cash and cash equivalents
(14,482
)
 
332

Net decrease in cash and cash equivalents
(8,969
)
 
(209,167
)
Cash and cash equivalents at beginning of period
630,861

 
985,390

Cash and cash equivalents at end of period
$
621,892

 
$
776,223

Supplemental cash flow disclosures:
 
 
 
Income taxes paid, net
$
65,830

 
$
76,877

Interest paid
$
37,569

 
$
26,436

Non-cash activities:
 
 
 
Purchase of land, property and equipment - investing activities
$
2,255

 
$
4,103

Dividends payable - financing activities
$
41,412

 
$

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

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

NOTE 1 – BASIS OF PRESENTATION
Basis of Presentation. The condensed consolidated financial statements have been prepared by KLA-Tencor Corporation (“KLA-Tencor” or the “Company”) 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, 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 the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2014, filed with the SEC on August 8, 2014.
The condensed consolidated financial statements include the accounts of KLA-Tencor and its majority-owned subsidiaries. All significant intercompany balances and transactions have been eliminated.
The results of operations for the nine months ended March 31, 2015, which include a pre-tax net loss of $131.7 million incurred during the second quarter of the fiscal year ending June 30, 2015 as a result of the pre-tax net loss on extinguishment of debt (described in further detail below), 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, 2015. The Company classified such pre-tax net loss on extinguishment of debt as an adjustment to reconcile net income to net cash provided by operating activities and the gross redemption payments for the prepayment of the 6.900% senior, unsecured long-term notes due in 2018 (the “2018 Senior Notes”) as a cash outflow from financing activities in the condensed consolidated statements of cash flows for the nine months ended March 31, 2015.
Certain reclassifications have been made to the prior year’s Condensed Consolidated Balance Sheet and notes to conform to the current year presentation. The reclassifications had no effect on the prior year’s Condensed Consolidated Statements of Operations or Cash Flows.
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 the Company’s 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.
Revenue Recognition. KLA-Tencor recognizes 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. The Company derives revenue from three sources—sales of systems, spare parts and services. In general, the Company recognizes revenue for systems when the system has been installed, is operating according to predetermined specifications and is accepted by the customer. When the Company has demonstrated a history of successful installation and acceptance, the Company recognizes revenue upon delivery and customer acceptance. Under certain circumstances, however, the Company recognizes revenue prior to acceptance from the customer, as follows:
When the customer fab has previously accepted the same tool, with the same specifications, and when the Company can objectively demonstrate that the tool meets all of the required acceptance criteria.
When system sales to independent distributors have no installation requirement, contain no acceptance agreement, and 100% payment is due based upon shipment.
When the installation of the system is deemed perfunctory.
When the customer withholds acceptance due to issues unrelated to product performance, in which case revenue is recognized when the system is performing as intended and meets predetermined specifications.
In circumstances in which the Company recognizes revenue prior to installation, the portion of revenue associated with installation is deferred based on estimated fair value, and that revenue is recognized upon completion of the installation.

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In many instances, products are sold in stand-alone arrangements. Services are sold separately through renewals of annual maintenance contracts. The Company has multiple element revenue arrangements in cases where certain elements of a sales arrangement are not delivered and accepted in one reporting period. To determine the relative fair value of each element in a revenue arrangement, the Company allocates arrangement consideration based on the selling price hierarchy. For substantially all of the arrangements with multiple deliverables pertaining to products and services, the Company uses vendor-specific objective evidence (“VSOE”) or third-party evidence (“TPE”) to allocate the selling price to each deliverable. The Company determines TPE based on historical prices charged for products and services when sold on a stand-alone basis. When the Company is unable to establish relative selling price using VSOE or TPE, the Company uses estimated selling price (“ESP”) in its allocation of arrangement consideration. The objective of ESP is to determine the price at which the Company would transact a sale if the product or service were sold on a stand-alone basis. ESP could potentially be used for new or customized products. The Company regularly reviews relative selling prices and maintains internal controls over the establishment and updates of these estimates.
In a multiple element revenue arrangement, the Company defers revenue recognition associated with the relative fair value of each undelivered element until that element is delivered to the customer. To be considered a separate element, the product or service in question must represent a separate unit of accounting, which means that such product or service must fulfill the following criteria: (a) the delivered item(s) has value to the customer on a stand-alone basis; and (b) if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the Company. If the arrangement does not meet all the above criteria, the entire amount of the sales contract is deferred until all elements are accepted by the customer.
Trade-in rights are occasionally granted to customers to trade in tools in connection with subsequent purchases. The Company estimates the value of the trade-in right and reduces the revenue recognized on the initial sale. This amount is recognized at the earlier of the exercise of the trade-in right or the expiration of the trade-in right.
 Spare parts revenue is recognized when the product has been shipped, risk of loss has passed to the customer and collection of the resulting receivable is probable.
Service and maintenance contract revenue is recognized ratably over the term of the maintenance contract. Revenue from services performed in the absence of a maintenance contract, including consulting and training revenue, is recognized when the related services are performed and collectibility is reasonably assured.
The Company sells stand-alone software that is subject to the software revenue recognition guidance. The Company periodically reviews selling prices to determine whether VSOE exists, and in situations where the Company is unable to establish VSOE for undelivered elements such as post-contract service, revenue is recognized ratably over the term of the service contract.
The Company also defers the fair value of non-standard warranty bundled with equipment sales as unearned revenue. Non-standard warranty includes services incremental to the standard 40-hour per week coverage for 12 months. Non-standard warranty is recognized ratably as revenue when the applicable warranty term period commences.
The deferred system profit balance equals the amount of deferred system revenue that was invoiced and due on shipment, less applicable product and warranty costs. Deferred system revenue represents the value of products that have been shipped and billed to customers which have not met the Company’s revenue recognition criteria. Deferred system profit does not include the profit associated with product shipments to certain customers in Japan, to whom title does not transfer until customer acceptance. Shipments to such customers in Japan are classified as inventory at cost until the time of acceptance.
Recent Accounting Pronouncements.
Recently Adopted
In July 2013, the Financial Accounting Standards Board (“FASB”) issued an accounting standard update that provides guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss or a tax credit carryforward exists. Under the new standard, in most circumstances, an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the Company’s financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward. This accounting standard update became effective for the Company’s interim period ended September 30, 2014, and the adoption did not have a material impact on the Company’s condensed consolidated financial statements.


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In June 2014, the FASB issued an accounting standard update regarding stock-based compensation that clarifies the accounting treatment when terms of an award provide that a performance target could be achieved after the requisite service period ends. The update requires that a performance target that affects vesting that could be achieved after the requisite service period ends be treated as a performance condition. The update is effective for the Company beginning in the first quarter of the Company’s fiscal year ending June 30, 2017, with early adoption permitted. The Company early adopted this accounting standard update and the adoption did not have a material impact on the Company’s condensed consolidated financial statements.

Updates Not Yet Effective
In April 2015, the FASB issued accounting standards update regarding simplification of the presentation of debt issuance costs, which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The update is effective for the Company beginning in the first quarter of the fiscal year ending June 30, 2017. Earlier adoption is permitted for financial statements that have not been previously issued and the Company is required to apply the guidance on a retrospective basis with additional disclosure requirements upon transition. The Company does not expect this adoption to have a material impact on its condensed consolidated financial statements.
In May 2014, the FASB issued an accounting standard update regarding revenue from customer contracts to transfer goods and services or non-financial assets unless the contracts are covered by other standards (for example, insurance or lease contracts). Under the new guidance, an entity should recognize revenue in connection with the transfer of promised goods or services to customers in an amount that reflects the consideration that the entity expects to be entitled to receive in exchange for those goods or services. In addition, the new standard requires that reporting companies disclose the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The updates are effective for the Company beginning in the first quarter of the fiscal year ending June 30, 2018. In April 2015, the FASB announced a deferral of the effective date by one year, with early adoption on the original effective date permitted. The new revenue standard may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption. The Company is currently evaluating the impact of this accounting standard update on its condensed consolidated financial statements.

NOTE 2 – FAIR VALUE MEASUREMENTS
The Company’s financial assets and liabilities are measured and recorded at fair value, except for certain equity investments in privately-held companies. These equity investments are generally accounted for under the cost method of accounting and are periodically assessed for other-than-temporary impairment when an event or circumstance indicates that an other-than-temporary decline in value may have occurred. The Company’s non-financial assets, such as goodwill, intangible assets, and land, property and equipment, are recorded at cost and 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. KLA-Tencor has 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 the Company’s cash equivalents, accounts receivable, accounts payable and other current 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.

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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.
The Company’s financial instruments were classified within Level 1 or Level 2 of the fair value hierarchy as of March 31, 2015, because they were valued using quoted market prices, broker/dealer quotes or alternative pricing sources with reasonable levels of price transparency. As of March 31, 2015, the types of instruments valued based on quoted market prices in active markets included money market funds, U.S. Treasury securities, certain sovereign securities and certain U.S. Government agency securities. Such instruments are generally classified within Level 1 of the fair value hierarchy.
As of March 31, 2015, the types of instruments valued based on other observable inputs included corporate debt securities, municipal securities and certain U.S. Government agency 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 the Company executes its foreign currency contracts is the institutional market in an over-the-counter environment with a relatively high level of price transparency. The market participants usually are large financial institutions. The Company’s 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.
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 the Company’s Condensed Consolidated Balance Sheet as follows:
As of March 31, 2015 (In thousands)
Total
 
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
 
Significant Other
Observable Inputs
(Level 2)
Assets
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
U.S. Government agency securities
$
23,233

 
$
23,233

 
$

Corporate debt securities
15,998

 

 
15,998

Money market and other
406,337

 
406,337

 

Marketable securities:
 
 
 
 
 
U.S. Treasury securities
331,740

 
331,740

 

U.S. Government agency securities
649,703

 
611,969

 
37,734

Municipal securities
33,059

 

 
33,059

Corporate debt securities
647,144

 

 
647,144

Sovereign securities
49,345

 
8,975

 
40,370

Total cash equivalents and marketable securities(1)
2,156,559

 
1,382,254

 
774,305

Other current assets:
 
 
 
 
 
Derivative assets
5,822

 

 
5,822

Other non-current assets:
 
 
 
 
 
Executive Deferred Savings Plan
167,859

 
93,539

 
74,320

Total financial assets(1)
$
2,330,240

 
$
1,475,793

 
$
854,447

Liabilities
 
 
 
 
 
Other current liabilities:
 
 
 
 
 
Derivative liabilities
$
(3,725
)
 
$

 
$
(3,725
)
Total financial liabilities
$
(3,725
)
 
$

 
$
(3,725
)
________________
(1) Excludes cash of $158.8 million held in operating accounts and time deposits of $24.7 million as of March 31, 2015.


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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 the Company’s Condensed Consolidated Balance Sheet as follows:  
As of June 30, 2014 (In thousands)
Total
 
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
 
Significant Other
Observable Inputs
(Level 2)
Assets
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
U.S. Government agency securities
$
28,000

 
$
8,000

 
$
20,000

Municipal securities
2,891

 

 
2,891

Corporate debt securities
68,992

 

 
68,992

Money market and other
397,517

 
397,517

 

Marketable securities:
 
 
 
 
 
U.S. Treasury securities
384,400

 
365,401

 
18,999

U.S. Government agency securities
839,843

 
811,841

 
28,002

Municipal securities
93,325

 

 
93,325

Corporate debt securities
1,155,176

 

 
1,155,176

Sovereign securities
42,264

 
9,253

 
33,011

Total cash equivalents and marketable securities(1)
3,012,408

 
1,592,012

 
1,420,396

Other current assets:
 
 
 
 
 
Derivative assets
666

 

 
666

Other non-current assets:
 
 
 
 
 
Executive Deferred Savings Plan
159,995

 
105,311

 
54,684

Total financial assets(1)
$
3,173,069

 
$
1,697,323

 
$
1,475,746

Liabilities
 
 
 
 
 
Other current liabilities:
 
 
 
 
 
Derivative liabilities
$
(898
)
 
$

 
$
(898
)
Total financial liabilities
$
(898
)
 
$

 
$
(898
)
________________
(1) Excludes cash of $106.7 million held in operating accounts and time deposits of $33.5 million as of June 30, 2014.
There were no transfers in and out of Level 1 and Level 2 fair value measurements during the three and nine months ended March 31, 2015. The Company did not have significant assets or liabilities measured at fair value on a recurring basis within Level 3 fair value measurements as of March 31, 2015 or June 30, 2014.



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NOTE 3 – FINANCIAL STATEMENT COMPONENTS
Balance Sheet Components
(In thousands)
As of
March 31, 2015
 
As of
June 30, 2014
Accounts receivable, net:
 
 
 
Accounts receivable, gross
$
653,261

 
$
514,690

Allowance for doubtful accounts
(21,653
)
 
(21,827
)
 
$
631,608

 
$
492,863

Inventories:
 
 
 
Customer service parts
$
203,473

 
$
203,194

Raw materials
226,797

 
221,612

Work-in-process
153,447

 
171,249

Finished goods
48,636

 
60,402

 
$
632,353

 
$
656,457

Other current assets:
 
 
 
Prepaid expenses
$
44,008

 
$
35,478

Income tax related receivables
69,874

 
27,452

Other current assets
12,920

 
6,267

 
$
126,802

 
$
69,197

Land, property and equipment, net:
 
 
 
Land
$
40,403

 
$
41,848

Buildings and leasehold improvements
313,500

 
302,537

Machinery and equipment
507,446

 
491,167

Office furniture and fixtures
21,279

 
20,945

Construction-in-process
5,411

 
8,945

 
888,039

 
865,442

Less: accumulated depreciation and amortization
(566,958
)
 
(535,179
)
 
$
321,081

 
$
330,263

Other non-current assets:
 
 
 
Executive Deferred Savings Plan(1)
$
167,858

 
$
159,996

Deferred tax assets – long-term
63,840

 
75,138

Other non-current assets
31,491

 
23,385

 
$
263,189

 
$
258,519

Other current liabilities:
 
 
 
Warranty
$
35,429

 
$
37,746

Executive Deferred Savings Plan(1)
169,431

 
160,527

Compensation and benefits
170,495

 
203,990

Income taxes payable
12,933

 
15,283

Interest payable
44,719

 
8,769

Customer credits and advances
91,490

 
79,373

Other accrued expenses
106,779

 
79,402

 
$
631,276

 
$
585,090

Other non-current liabilities:
 
 
 
Pension liabilities
$
54,302

 
$
59,908

Income taxes payable
66,615

 
59,575

Other non-current liabilities
58,948

 
48,805

 
$
179,865

 
$
168,288



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________________
(1)
KLA-Tencor has a non-qualified deferred compensation plan under which certain executives and non-employee directors may defer a portion of their compensation. Participants are credited with returns based on their allocation of their account balances among measurement funds. The Company controls the investment of these funds, and the participants remain general creditors of KLA-Tencor. Distributions from the plan commence following a participant’s retirement or termination of employment or on a specified date allowed per the plan provisions, except in cases where such distributions are required to be delayed in order to avoid a prohibited distribution under Internal Revenue Code Section 409A. Participants can generally elect the distributions to be paid in lump sum or quarterly cash payments over a scheduled period for up to 15 years and are allowed to make subsequent changes to their existing elections as permissible under the plan provisions. The liability associated with deferred compensation plan is included as a component of other current liabilities. The Company also has a deferred compensation asset that corresponds to the liability under the deferred compensation plan and it is included as a component of other non-current assets. The plan assets are classified as trading securities.
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, 2015
$
(30,684
)
 
$
1,728

 
$
4,412

 
$
(13,263
)
 
$
(37,807
)
 
 
 
 
 
 
 
 
 
 
Balance as of June 30, 2014
$
(17,271
)
 
$
2,800

 
$
(12
)
 
$
(15,788
)
 
$
(30,271
)
The effects on net income 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
 
2015
 
2014
 
2015
 
2014
Unrealized gains (losses) on cash flow hedges from foreign exchange and interest rate contracts
 
Revenues
 
$
4,306

 
$
895

 
$
6,508

 
$
3,217

 
 
Costs of revenues
 
(575
)
 
39

 
(1,091
)
 
255

 
 
Interest expense
 
189

 

 
315

 

 
 
Net gains reclassified from accumulated OCI
 
$
3,920

 
$
934

 
$
5,732

 
$
3,472

 
 
 
 
 
 
 
 
 
 
 
Unrealized gains on available-for-sale securities
 
Interest income and other, net
 
$
60

 
$
281

 
$
1,976

 
$
1,728

The amounts reclassified out of accumulated OCI related to the Company’s defined pension plans, which were recognized as a component of net periodic cost for the three and nine months ended March 31, 2015 were $1.3 million and $2.8 million, respectively. The amounts reclassified out of accumulated OCI related to the Company’s defined pension plans, which were recognized as a component of net periodic cost for the three and nine months ended March 31, 2014, were $0.3 million and $0.9 million, respectively. For additional details, refer to Note 11, “Employee Benefit Plans” in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2014.



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NOTE 4 – MARKETABLE SECURITIES
The amortized cost and fair value of marketable securities as of the dates indicated below were as follows:
As of March 31, 2015 (In thousands)
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
U.S. Treasury securities
$
331,075

 
$
690

 
$
(25
)
 
$
331,740

U.S. Government agency securities
672,200

 
789

 
(53
)
 
672,936

Municipal securities
33,089

 
6

 
(36
)
 
33,059

Corporate debt securities
662,163

 
1,173

 
(194
)
 
663,142

Money market and other
406,337

 

 

 
406,337

Sovereign securities
49,321

 
32

 
(8
)
 
49,345

Subtotal
2,154,185

 
2,690

 
(316
)
 
2,156,559

Add: Time deposits(1)
24,663

 

 

 
24,663

Less: Cash equivalents
463,330

 
1

 
(2
)
 
463,329

Marketable securities
$
1,715,518

 
$
2,689

 
$
(314
)
 
$
1,717,893

As of June 30, 2014 (In thousands)
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
U.S. Treasury securities
$
384,165

 
$
287

 
$
(52
)
 
$
384,400

U.S. Government agency securities
867,309

 
651

 
(117
)
 
867,843

Municipal securities
96,198

 
93

 
(75
)
 
96,216

Corporate debt securities
1,220,794

 
3,526

 
(152
)
 
1,224,168

Money market and other
397,517

 

 

 
397,517

Sovereign securities
42,227

 
46

 
(9
)
 
42,264

Subtotal
3,008,210

 
4,603

 
(405
)
 
3,012,408

Add: Time deposits(1)
33,509

 

 

 
33,509

Less: Cash equivalents
524,149

 

 
(8
)
 
524,141

Marketable securities
$
2,517,570

 
$
4,603

 
$
(397
)
 
$
2,521,776

________________
(1)
Time deposits excluded from fair value measurements.
KLA-Tencor’s 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. All unrealized losses are due to changes in market interest rates, bond yields and/or credit ratings. The Company believes that it has the ability to realize the full value of all of these investments upon maturity. The following table summarizes the fair value and gross unrealized losses of the Company’s investments that were in an unrealized loss position as of the date indicated below:
 
As of March 31, 2015 (In thousands)
Fair Value
 
Gross
Unrealized
Losses(1)
U.S. Treasury securities
$
131,732

 
$
(25
)
U.S. Government agency securities
85,554

 
(52
)
Municipal securities
22,429

 
(36
)
Corporate debt securities
139,007

 
(193
)
Sovereign securities
19,360

 
(8
)
Total
$
398,082

 
$
(314
)
__________________ 
(1)
Of the total gross unrealized losses, the amount of total gross unrealized losses related to investments that had been in a continuous loss position for 12 months or more was immaterial.

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The contractual maturities of securities classified as available-for-sale, regardless of their classification on the Company’s Condensed Consolidated Balance Sheet, as of the date indicated below were as follows:
As of March 31, 2015 (In thousands)
Amortized Cost
 
Fair Value
Due within one year
$
625,908

 
$
626,235

Due after one year through three years
1,089,610

 
1,091,658

 
$
1,715,518

 
$
1,717,893

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 on available-for-sale securities for the three months ended March 31, 2015 and 2014 were $0.2 million and $0.3 million, respectively. Realized gains on available-for-sale securities for the nine months ended March 31, 2015 and 2014 were $2.3 million and $1.8 million, respectively. Realized losses on available-for-sale securities for the three and nine months ended March 31, 2015 and 2014 were immaterial.
NOTE 5 – BUSINESS COMBINATION
On March 28, 2014, the Company acquired certain assets and liabilities of a privately-held company that developed and sold software to mask manufacturers, semiconductor fabs and mask inspection and review equipment manufacturers, for a total purchase consideration of $18 million in cash.
The following table represents the purchase price allocation and summarizes the aggregate estimated fair values of the net assets acquired on the closing date of the acquisition:
(In thousands)
Purchase Price Allocation
Intangibles
$
9,400

Goodwill
8,730

Liabilities assumed
(130
)
Cash consideration paid
$
18,000

Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired. The $8.7 million of goodwill was assigned to the Defect Inspection reporting unit.
NOTE 6 – GOODWILL AND PURCHASED INTANGIBLE ASSETS
Goodwill
The following table presents goodwill balances and the movements during the nine months ended March 31, 2015:
(In thousands)
 
As of June 30, 2014
$
335,355

Adjustments
(64
)
As of March 31, 2015
$
335,291

The changes in the gross goodwill balance since June 30, 2014 resulted from foreign currency translation adjustments.
Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in prior business combinations. The Company has four reporting units: Defect Inspection, Metrology, Service and Other. As of March 31, 2015, substantially all of the goodwill balance resided within the Defect Inspection reporting unit.

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The Company performed a qualitative assessment of the goodwill by reporting unit as of November 30, 2014 during the three months ended December 31, 2014 and concluded that it was more likely than not that the fair value of each of the reporting units exceeded its carrying amount. As of December 31, 2014, the Company’s assessment indicated that goodwill in the reporting units was not impaired. There have been no significant events or circumstances affecting the valuation of goodwill subsequent to the qualitative assessment performed in the second quarter of the fiscal year ending June 30, 2015. The next annual assessment of the goodwill by reporting unit will be performed in the second quarter of the fiscal year ending June 30, 2016.
Purchased Intangible Assets
The components of purchased intangible assets as of the dates indicated below were as follows:
(In thousands)
 
 
As of
March 31, 2015
 
As of
June 30, 2014
Category
Range of
Useful Lives
 
Gross
Carrying
Amount
 
Accumulated
Amortization
and
Impairment
 
Net
Amount
 
Gross
Carrying
Amount
 
Accumulated
Amortization
and
Impairment
 
Net
Amount
Existing technology
4-7 years
 
$
141,659

 
$
132,668

 
$
8,991

 
$
141,659

 
$
126,567

 
$
15,092

Patents
6-13 years
 
57,648

 
56,348

 
1,300

 
57,648

 
54,398

 
3,250

Trade name/Trademark
4-10 years
 
19,893

 
18,538

 
1,355

 
19,893

 
17,427

 
2,466

Customer relationships
6-7 years
 
54,980

 
51,078

 
3,902

 
54,980

 
48,915

 
6,065

Other
0-1 year
 
17,299

 
17,299

 

 
17,299

 
16,475

 
824

Total
 
 
$
291,479

 
$
275,931

 
$
15,548

 
$
291,479

 
$
263,782

 
$
27,697

Intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable.
For the three months ended March 31, 2015 and 2014, amortization expense for intangible assets was $4.0 million and $3.5 million, respectively. For the nine months ended March 31, 2015 and 2014, amortization expense for intangible assets was $12.1 million and $11.9 million, respectively. Based on the intangible assets recorded as of March 31, 2015, and assuming no subsequent additions to, or impairment of, the underlying assets, the remaining estimated amortization expense is expected to be as follows:
Fiscal year ending June 30:
Amortization
(In thousands)
2015 (remaining 3 months)
$
3,653

2016
7,564

2017
2,806

2018
1,525

Total
$
15,548


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NOTE 7 – DEBT
The following table summarizes the debt of the Company as of March 31, 2015 and June 30, 2014:
 
As of March 31, 2015
 
As of June 30, 2014
 
Amount
(in thousands)
 
Effective
Interest Rate
 
Amount
(in thousands)
 
Effective
Interest Rate
Fixed-rate 6.900% Senior notes due on May 1, 2018
$

 
 
 
$
750,000

 
7.001
%
Fixed-rate 2.375% Senior notes due on November 1, 2017
250,000

 
2.396
%
 

 
 
Fixed-rate 3.375% Senior notes due on November 1, 2019
250,000

 
3.377
%
 

 
 
Fixed-rate 4.125% Senior notes due on November 1, 2021
500,000

 
4.128
%
 

 
 
Fixed-rate 4.650% Senior notes due on November 1, 2024(1)
1,250,000

 
4.682
%
 

 
 
Fixed-rate 5.650% Senior notes due on November 1, 2034
250,000

 
5.670
%
 

 
 
Term loans
740,625

 
 
 

 
 
Total debt
3,240,625

 
 
 
750,000

 
 
Unamortized discount
(3,826
)
 
 
 
(2,081
)
 
 
Total debt
$
3,236,799

 
 
 
$
747,919

 
 
 
 
 
 
 
 
 
 
Reported as:
 
 
 
 
 
 
 
Current portion of long-term debt
$
37,500

 
 
 
$

 
 
Long-term debt
3,199,299

 
 
 
747,919

 
 
Total debt
$
3,236,799

 
 
 
$
747,919

 
 
__________________ 
(1)
The effective interest rate disclosed above for this series of Senior Notes excludes the impact of the treasury rate lock hedge discussed below. The effective interest rate including the impact of the treasury rate lock hedge was 4.626%.
Debt Issuance - Senior Notes:
In November 2014, the Company issued $2.5 billion aggregate principal amount of senior, unsecured long-term notes (collectively referred to as “Senior Notes”). The Company issued the Senior Notes as part of the leveraged recapitalization plan under which the proceeds from the Senior Notes in conjunction with the proceeds from the term loans (described below) and cash on hand were used (x) to fund a special cash dividend of $16.50 per share, aggregating to approximately $2.76 billion, (y) to redeem $750 million of 2018 Senior Notes, including associated redemption premiums, accrued interest and other fees and expenses and (z) for other general corporate purposes, including repurchases of shares pursuant to the Company’s stock repurchase program. The interest rate specified for each series of the Senior Notes will be subject to adjustments from time to time if Moody’s Investor Service, Inc. (“Moody’s”) or Standard & Poor’s Ratings Services (“S&P”) or, under certain circumstances, a substitute rating agency selected by us as a replacement for Moody’s or S&P, as the case may be (a “Substitute Rating Agency”), downgrades (or subsequently upgrades) its rating assigned to the respective series of Senior Notes such that the adjusted rating is below investment grade. If the adjusted rating of any series of Senior Notes from Moody’s (or, if applicable, any Substitute Rating Agency) is decreased to Ba1, Ba2, Ba3 or B1 or below, the stated interest rate on such series of Senior Notes as noted above will increase by 25 bps, 50 bps, 75 bps or 100 bps, respectively (“bps” refers to Basis Points and 1% is equal to 100 bps). If the rating of any series of Senior Notes from S&P (or, if applicable, any Substitute Rating Agency) with respect to such series of Senior Notes is decreased to BB+, BB, BB- or B+ or below, the stated interest rate on such series of Senior Notes as noted above will increase by 25 bps, 50 bps, 75 bps or 100 bps, respectively. The interest rates on any series of Senior Notes will permanently cease to be subject to any adjustment (notwithstanding any subsequent decrease in the ratings by any of Moody’s, S&P and, if applicable, any Substitute Rating Agency) if such series of Senior Notes becomes rated “Baa1” (or its equivalent) or higher by Moody’s (or, if applicable, any Substitute Rating Agency) and “BBB+” (or its equivalent) or higher by S&P (or, if applicable, any Substitute Rating Agency), or one of those ratings if rated by only one of Moody’s, S&P and, if applicable, any Substitute Rating Agency, in each case with a stable or positive outlook. In October 2014, the Company entered into a series of forward contracts to lock the 10-year treasury rate (“benchmark rate”) on a portion of the Senior Notes with a notional amount of $1 billion in aggregate. For additional details, refer to Note 14, “Derivative Instruments and Hedging Activities.”

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Table of Contents

The original discount on the Senior Notes amounted to $4.0 million and is being amortized over the life of the debt. Interest is payable semi-annually on May 1 and November 1 of each year, beginning, May 1, 2015. The debt indenture (the “Indenture”) includes covenants that limit the Company’s ability to grant liens on its facilities and enter into sale and leaseback transactions, subject to certain allowances under which certain sale and leaseback transactions are not restricted. As of March 31, 2015, the Company was in compliance with all of its covenants under the Indenture associated with the Senior Notes.
In certain circumstances involving a change of control followed by a downgrade of the rating of a series of Senior Notes by at least two of Moody’s, S&P and Fitch Inc., unless the Company has exercised its right to redeem the Senior Notes of such series, the Company will be required to make an offer to repurchase all or, at the holder’s option, any part, of each holder’s Senior Notes of that series pursuant to the offer described below (the “Change of Control Offer”). In the Change of Control Offer, the Company will be required to offer payment in cash equal to 101% of the aggregate principal amount of Senior Notes repurchased plus accrued and unpaid interest, if any, on the Senior Notes repurchased, up to, but not including, the date of repurchase.
Based on the trading prices of the Senior Notes on the applicable dates, the fair value of the Senior Notes as of March 31, 2015 and June 30, 2014 was $2.6 billion and $893.7 million, respectively. While the Senior Notes are recorded at cost, the fair value of the long-term debt was determined based on quoted prices in markets that are not active; accordingly, the long-term debt is categorized as Level 2 for purposes of the fair value measurement hierarchy. Refer to Contractual Obligations under Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” showing future payments of long-term debt at face value as well as payment of associated interest.
Debt Issuance - Credit Facility (Term Loans and Unfunded Revolving Credit Facility):
In November 2014, the Company entered into $750 million of five-year senior unsecured prepayable term loans and a $500 million unfunded revolving credit facility (collectively, the “Credit Facility”) under the Credit Agreement (the “Credit Agreement”). The interest under the Credit Facility will be payable on the borrowed amounts at the London Interbank Offered Rate (“LIBOR”) plus a spread, which is currently 125 bps, and this spread is subject to adjustment in conjunction with the Company’s credit rating downgrades or upgrades. The spread ranges from 100 bps to 175 bps based on the then effective credit rating. The Company is also obligated to pay an annual commitment fee of 15 bps on the daily undrawn balance of the revolving credit facility, which is also subject to an adjustment in conjunction with the Company’s credit rating downgrades or upgrades by Moody’s and S&P. The annual commitment fee ranges from 10 bps to 25 bps on the daily undrawn balance of the revolving credit facility, depending upon the then effective credit rating. Principal payments with respect to the term loans will be made on the last day of each calendar quarter, which commenced as of March 31, 2015, and any unpaid principal balance of the term loans, including accrued interest, shall be payable on November 14, 2019 (the “Maturity Date”). The Company may prepay the term loans and unfunded revolving credit facility at any time without a prepayment penalty.
Future principal payments for the Company’s term loans as of March 31, 2015, are as follows:
Fiscal Quarters Ending
 
Quarterly Payment
(in thousands)
March 31, 2015 through December 31, 2016
 
$
9,375

March 31, 2017 through December 31, 2017
 
$
14,063

March 31, 2018 through September 30, 2019
 
$
18,750

December 31, 2019
 
$
487,500

The Credit Facility requires the Company to maintain an interest expense coverage ratio as described in the Credit Agreement, on a quarterly basis, covering the trailing four consecutive fiscal quarters of no less than 3.50 to 1.00. In addition, the Company is required to maintain the maximum leverage ratio as described in the Credit Agreement, on a quarterly basis, covering the trailing four consecutive fiscal quarters for the fiscal quarters as described below.
Fiscal Quarters Ending
 
Maximum Leverage Ratio
March 31, 2015 and June 30, 2015
 
4.25:1.00
September 30, 2015 and December 31, 2015
 
4.00:1.00
March 31, 2016 through September 30, 2016
 
3.75:1.00
December 31, 2016 and March 31, 2017
 
3.50:1.00
Thereafter
 
3.00:1.00

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The Company was in compliance with the financial covenants under the Credit Agreement as of March 31, 2015 and had no outstanding borrowings under the unfunded revolving credit facility. Refer to Liquidity and Capital Resources under Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional details. Also, refer to Contractual Obligations under Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” showing future payments of term loans as well as payments of associated interest.
Debt Redemption:
In December 2014, the Company redeemed the $750 million aggregate principal amount of the 2018 Senior Notes. The redemption resulted in a pre-tax net loss on extinguishment of debt of $131.7 million for the three months ended December 31, 2014 after an offset of a $1.2 million gain upon the termination of the non-designated forward contract entered by the Company in November 2014. The objective of entering into the non-designated forward contract was to lock the treasury rate used to determine the redemption amount of the 2018 Senior Notes. The notional amount of the non-designated forward contract was $750 million. Refer to Note 14, “Derivative Instruments and Hedging Activities.”
NOTE 8 – EQUITY AND LONG-TERM INCENTIVE COMPENSATION PLANS
Equity Incentive Program
As of March 31, 2015, the Company had two plans under which the Company was able to issue equity incentive awards, such as restricted stock units and stock options, to its employees, consultants and members of its Board of Directors: the 2004 Equity Incentive Plan (the “2004 Plan”) and the 1998 Director Plan (the “Outside Director Plan”).
2004 Plan:
The 2004 Plan provides for the grant of options to purchase shares of the Company’s common stock, stock appreciation rights, restricted stock units, performance shares, performance units and deferred stock units to the Company’s employees, consultants and members of its Board of Directors. As of March 31, 2015, 6.1 million shares were available for issuance under the 2004 Plan.
Any 2004 Plan awards of restricted stock units, performance shares, performance units or deferred stock units with a per share or unit purchase price lower than 100% of fair market value on the grant date are counted against the total number of shares issuable under the 2004 Plan as follows, based on the grant date of the applicable award: (a) for any such awards granted before November 6, 2013, the awards counted against the 2004 Plan share reserve as 1.8 shares for every one share subject thereto; and (b) for any such awards granted on or after November 6, 2013, the awards count against the 2004 Plan share reserve as 2.0 shares for every one share subject thereto.
In addition, in November 2013, the Company’s stockholders also approved amendments to the 2004 Plan that included, among other things, giving the plan administrator the ability to grant “dividend equivalent” rights in connection with awards of restricted stock units, performance shares, performance units and deferred stock units before they are fully vested. It allows the plan administrator, at its discretion, to grant a right to receive dividends on the aforementioned awards which may be settled in cash or Company stock at the discretion of the plan administrator subject to meeting the vesting requirement of the underlying awards.
Outside Director Plan
The Outside Director Plan only permits the issuance of stock options to the non-employee members of the Board of Directors. As of March 31, 2015, 1.7 million shares were available for grant under the Outside Director Plan.

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Table of Contents

Equity Incentive Plans - General Information
The following table summarizes the combined activity under the Company’s equity incentive plans for the indicated periods:
(In thousands)
Available
For Grant
Balances as of June 30, 2014
8,804

Restricted stock units granted(1)(3)
(1,191
)
Restricted stock units canceled(1)
181

Options granted/canceled/expired/forfeited
11

Plan shares expired(2)
(10
)
Balances as of March 31, 2015(4)
7,795

__________________ 
(1)
The number of restricted stock units provided in this row reflects the application of the award multiplier as described above (1.8x or 2.0x depending on the grant date of the applicable award).
(2)
Represents the portion of shares listed as “Options canceled/expired/forfeited” above that were issued under the Company’s equity incentive plans other than the 2004 Plan and the Outside Director Plan. Because the Company is only currently authorized to issue equity awards under the 2004 Plan and the Outside Director Plan, any equity awards that are canceled, expired or forfeited under any other Company equity incentive plan do not result in additional shares being available to the Company for future grant.
(3)
Includes restricted stock units granted to senior management during the nine months ended March 31, 2015 with performance-based vesting criteria (in addition to service-based vesting criteria for any of such restricted stock units that are deemed to have been earned). As of March 31, 2015, it had not yet been determined the extent to which (if at all) the performance-based vesting criteria of such restricted stock units had been satisfied. Therefore, this line item includes all such performance-based restricted stock units granted during the nine months ended March 31, 2015, reported at the maximum possible number of shares that may ultimately be issuable under such restricted stock units if all applicable performance-based criteria are achieved at their maximum levels and all applicable service-based criteria are fully satisfied (i.e., 0.6 million shares for the nine months ended March 31, 2015 after the application of 2.0x multiplier described above). The Company has granted only restricted stock units under its equity incentive program since October 2007, except the number of shares subject to outstanding options under the 2004 Plan was adjusted during the three months ended December 31, 2014 due to a proportionate and equitable adjustment under the 2004 Plan provisions as discussed below. For the preceding several years until October 31, 2007, stock options were granted at the market price of the Company’s common stock on the date of grant generally with vesting period terms ranging from one to five years. Restricted stock units may be granted with varying criteria such as service-based and/or performance-based vesting.
(4)
During the three months ended December 31, 2014, the Company adjusted the number of shares subject to outstanding options under the 2004 Plan by an aggregate of 4,245 shares pursuant to a proportionate and equitable adjustment for the effect of the special cash dividend, as required by the 2004 Plan. The total number of outstanding options under the 2004 Plan as well as the associated exercise prices were adjusted to ensure the aggregate intrinsic value remained the same after considering the effect of the special cash dividend. As the adjustment was required by the 2004 Plan, under the authoritative guidance, the adjustment to the outstanding awards did not result in any incremental compensation expense. Additionally, the adjustment did not have an impact on the shares available for future issuance under the 2004 Plan.
The fair value of stock-based awards is measured at the grant date and is recognized as an expense over the employee’s requisite service period. The fair value for purchase rights under the Company’s Employee Stock Purchase Plan is determined using a Black-Scholes valuation model and for restricted stock units granted without “dividend equivalent” rights using the closing price of the Company’s common stock on the grant date, adjusted to exclude the present value of dividends which are not accrued on those restricted stock units. In November 2013, the Company’s stockholders approved amendments to the 2004 Plan that included, among other things, giving the plan administrator the ability to grant “dividend equivalent” rights in connection with awards of restricted stock units, performance shares, performance units and deferred stock units before they are fully vested as discussed above. The fair value for restricted stock units granted with “dividend equivalent” rights is determined using the closing price of the Company’s common stock on the grant date. As of March 31, 2015, the Company accrued $41.4 million of dividends payable, substantially all of which is related to the special cash dividend for the unvested restricted stock units outstanding as of the dividend record date as well as restricted stock units granted with dividend equivalent rights during the nine months ended March 31, 2015, which entitle the holders of such equity awards to the same dividend value per share as holders of common stock subject to meeting the vesting requirements of the underlying equity awards.

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The following table shows pre-tax stock-based compensation expense for the indicated periods: 
 
Three months ended
March 31,
 
Nine months ended
March 31,
(In thousands)
2015
 
2014
 
2015
 
2014
Stock-based compensation expense by:
 
 
 
 
 
 
 
Costs of revenues
$
1,642

 
$
1,688

 
$
5,842

 
$
7,186

Engineering, research and development
2,941

 
3,512

 
10,016

 
12,797

Selling, general and administrative
8,184

 
7,523

 
27,240

 
26,829

Total stock-based compensation expense
$
12,767

 
$
12,723

 
$
43,098

 
$
46,812

The following table shows stock-based compensation capitalized as inventory as of the dates indicated below: 
(In thousands)
As of
March 31, 2015
 
As of
June 30, 2014
Inventory
$
3,294

 
$
8,278

Stock Options
The following table summarizes the activity and weighted-average exercise price for stock options under all plans during the nine months ended March 31, 2015: 
Stock Options
Shares
(In thousands)
 
Weighted-Average
Exercise Price
Outstanding stock options as of June 30, 2014
141

 
$
40.70

Granted
4

 
$
32.11

Exercised
(118
)
 
$
40.42

Canceled/expired/forfeited
(11
)
 
$
39.97

Outstanding stock options as of March 31, 2015 (all outstanding and all vested and exercisable)
16

 
$
31.28

The Company has not issued any stock options since October 2007. However, during the three months ended December 31, 2014, the Company adjusted the number of shares subject to outstanding options under the 2004 Plan by an aggregate of 4,245 shares pursuant to a proportionate and equitable adjustment for the effect of the special cash dividend, as required by the 2004 Plan. The total number of outstanding options under the 2004 Plan as well as the associated exercise prices were adjusted to ensure the aggregate intrinsic value remained the same after considering the effect of the special cash dividend. As the adjustment was required by the 2004 Plan, the adjustment to the outstanding awards did not result in any incremental compensation expense due to modification of such awards, under the authoritative guidance. Additionally, the adjustment did not have an impact on the shares available for future issuance under the 2004 Plan. As of March 31, 2015, the Company had no unrecognized stock-based compensation balance related to outstanding stock options. The weighted-average remaining contractual term for total options outstanding under all plans all of which were vested and exercisable as of March 31, 2015 was 0.1 years. The aggregate intrinsic value for total options outstanding under all plans (all of which were vested and exercisable as of March 31, 2015) was $0.4 million.
The following table shows the total intrinsic value of options exercised, total cash received from employees and non-employee Board members as a result of stock option exercises and tax benefits realized by the Company in connection with these stock option exercises for the indicated periods: 
 
Three months ended
March 31,
 
Nine months ended
March 31,
(In thousands)
2015
 
2014
 
2015
 
2014
Total intrinsic value of options exercised
$
171

 
$
4,626

 
$
4,090

 
$
15,940

Total cash received from employees and non-employee Board members as a result of stock option exercises
$
175

 
$
13,334

 
$
5,392

 
$
70,065

Tax benefits realized by the Company in connection with these exercises
$
59

 
$
1,147

 
$
1,828

 
$
4,825


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The Company generally settles employee stock option exercises with newly issued common shares, except in certain tax jurisdictions where settling such exercises with treasury shares provides the Company or one of its subsidiaries with a tax benefit.
Restricted Stock Units
The following table shows the applicable number of restricted stock units and weighted-average grant date fair value for restricted stock units granted, vested and released, withheld for taxes, and forfeited during the nine months ended March 31, 2015 and restricted stock units outstanding as of March 31, 2015 and June 30, 2014: 
Restricted Stock Units
Shares
(In thousands) (1)
 
Weighted-Average
Grant Date
Fair Value
Outstanding restricted stock units as of June 30, 2014
3,356

 
$
38.95

Granted(2)
596

 
$
74.48

Vested and released
(751
)
 
$
33.08

Withheld for taxes
(397
)
 
$
33.08

Forfeited
(100
)
 
$
39.26

Outstanding restricted stock units as of March 31, 2015
2,704

 
$
49.28

__________________ 
(1)
Share numbers reflect actual shares subject to awarded restricted stock units. As described above, under the terms of the 2004 Plan, the number of shares subject to each award reflected in this number is multiplied by either 1.8 or 2.0 (depending on the grant date of the award) to calculate the impact of the award on the share reserve under the 2004 Plan.
(2)
Includes restricted stock units granted to senior management during the nine months ended March 31, 2015 with performance-based vesting criteria (in addition to service-based vesting criteria for any of such restricted stock units that are deemed to have been earned). As of March 31, 2015, it had not yet been determined the extent to which (if at all) the performance-based vesting criteria of such restricted stock units had been satisfied. Therefore, this line item includes all such performance-based restricted stock units, reported at the maximum possible number of shares that may ultimately be issuable under such restricted stock units if all applicable performance-based criteria are achieved at their maximum and all applicable service-based criteria are fully satisfied (i.e., 0.3 million shares during the nine months ended March 31, 2015).

The restricted stock units granted by the Company since the beginning of the fiscal year ended June 30, 2013 generally vest (a) with respect to awards with only service-based vesting criteria, in four equal installments on the first, second, third and fourth anniversaries of the grant date and (b) with respect to awards with both performance-based and service-based vesting criteria, in two equal installments on the third and fourth anniversaries of the grant date, in each case subject to the recipient remaining employed by the Company as of the applicable vesting date. The restricted stock units granted by the Company from the beginning of the fiscal year ended June 30, 2007 through the fiscal year ended June 30, 2012 generally vest in two equal installments on the second and fourth anniversaries of the grant date, subject to the recipient remaining employed by the Company as of the applicable vesting date.
The following table shows the weighted-average grant date fair value per unit for the restricted stock units granted and tax benefits realized by the Company in connection with vested and released restricted stock units for the indicated periods: 
 
Three months ended
March 31,
 
Nine months ended
March 31,
(In thousands, except for weighted-average grant date fair value)
2015
 
2014
 
2015
 
2014
Weighted-average grant date fair value per unit
$
63.16

 
$
56.48

 
$
74.48

 
$
53.28

Tax benefits realized by the Company in connection with vested and released restricted stock units
$
1,511

 
$
1,793

 
$
25,830

 
$
43,884

As of March 31, 2015, the unrecognized stock-based compensation expense balance related to restricted stock units was $79.7 million, excluding the impact of estimated forfeitures, and will be recognized over a weighted-average remaining contractual term and an estimated weighted-average amortization period of 1.2 years. The intrinsic value of outstanding restricted stock units as of March 31, 2015 was $157.6 million.

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Table of Contents

Cash-Based Long-Term Incentive Compensation
Starting in the fiscal year ended June 30, 2013, the Company adopted a cash-based long-term incentive (“Cash LTI”) program for many of its employees as part of the Company’s employee compensation program. During the nine months ended March 31, 2015, the Company approved Cash LTI awards of $66.7 million under the Company’s Cash Long-Term Incentive Plan (“Cash LTI Plan”). Cash LTI awards issued to employees under the Cash LTI Plan will vest in four equal installments, with 25% of the aggregate amount of the Cash LTI award vesting on each yearly anniversary of the grant date over a four-year period. In order to receive payments under a Cash LTI award, participants must remain employed by the Company as of the applicable award vesting date. Executives and non-employee Board members are not participating in this program. During the three months ended March 31, 2015 and 2014, the Company recognized $10.5 million and $7.3 million, respectively, in compensation expense under the Cash LTI Plan. During the nine months ended March 31, 2015 and 2014, the Company recognized $29.0 million and $18.7 million, respectively, in compensation expense under the Cash LTI Plan. As of March 31, 2015, the unrecognized compensation balance (excluding the impact of estimated forfeitures) related to the Cash LTI Plan was $112.4 million.
Employee Stock Purchase Plan
KLA-Tencor’s Employee Stock Purchase Plan (“ESPP”) provides that eligible employees may contribute up to 10% of their eligible earnings toward the semi-annual purchase of KLA-Tencor’s common stock. The ESPP is qualified under Section 423 of the Internal Revenue Code. The employee’s purchase price is derived from a formula based on the closing price of the common stock on the first day of the offering period versus the closing price on the date of purchase (or, if not a trading day, on the immediately preceding trading day).
The offering period (or length of the look-back period) under the ESPP has a duration of six months, and the purchase price with respect to each offering period beginning on or after such date is, until otherwise amended, equal to 85% of the lesser of (i) the fair market value of the Company’s common stock at the commencement of the applicable six-month offering period or (ii) the fair market value of the Company’s common stock on the purchase date. The Company estimates the fair value of purchase rights under the ESPP using a Black-Scholes valuation model.
The fair value of each purchase right under the ESPP was estimated on the date of grant using the Black-Scholes option valuation model and the straight-line attribution approach with the following weighted-average assumptions: 
 
Three months ended
March 31,
 
Nine months ended
March 31,
 
2015
 
2014
 
2015
 
2014
Stock purchase plan:
 
 
 
 
 
 
 
Expected stock price volatility
25.5
%
 
25.8
%
 
24.5
%
 
27.5
%
Risk-free interest rate
0.1
%
 
0.1
%
 
0.1
%
 
0.1
%
Dividend yield
2.9
%
 
2.8
%
 
2.8
%
 
2.9
%
Expected life (in years)
0.5

 
0.5

 
0.5

 
0.5

The following table shows total cash received from employees for the issuance of shares under the ESPP, the number of shares purchased by employees through the ESPP, the tax benefits realized by the Company in connection with the disqualifying dispositions of shares purchased under the ESPP and the weighted-average fair value per share for the indicated periods: 
(In thousands, except for weighted-average fair value per share)
Three months ended
March 31,
 
Nine months ended
March 31,
2015
 
2014
 
2015
 
2014
Total cash received from employees for the issuance of shares under the ESPP
$

 
$

 
$
24,186

 
$
22,035

Number of shares purchased by employees through the ESPP

 

 
405

 
469

Tax benefits realized by the Company in connection with the disqualifying dispositions of shares purchased under the ESPP
$
411

 
$
1,150

 
$
1,600

 
$
2,023

Weighted-average fair value per share based on Black-Scholes model
$
14.40

 
$
13.04

 
$
14.55

 
$
12.29


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The ESPP shares are replenished annually on the first day of each fiscal year by virtue of an evergreen provision. The provision allows for share replenishment equal to the lesser of 2.0 million shares or the number of shares which KLA-Tencor estimates will be required to be issued under the ESPP during the forthcoming fiscal year. In August 2014, the Company added 2.0 million additional shares to the ESPP pursuant to the plan’s share replenishment provision with respect to the fiscal year ending June 30, 2015. As of March 31, 2015, a total of 2.5 million shares were reserved and available for issuance under the ESPP.
Quarterly cash dividends
On February 5, 2015, the Company’s Board of Directors declared a regular quarterly cash dividend of $0.50 per share on the outstanding shares of the Company’s common stock, which was paid on March 2, 2015 to the stockholders of record as of the close of business on February 17, 2015. Under the authoritative guidance, a dividend when declared is recognized as a reduction of retained earnings, to the extent available, with any excess recognized as a reduction of additional paid-in-capital. The quarterly cash dividend declared for the three months ended March 31, 2015 was recorded as a reduction of additional paid-in capital as the Company did not have retained earnings balance available as of the declaration date due to the balance being absorbed by the activity under our stock repurchase program. The total amount of regular quarterly cash dividends paid by the Company during the three months ended March 31, 2015 and 2014 was $80.8 million and $74.8 million, respectively. The total amount of regular quarterly cash dividends paid by the Company during the nine months ended March 31, 2015 and 2014 was $245.5 million and $224.4 million, respectively. The amount of accrued dividends for quarterly cash dividends for unvested restricted stock units with dividend equivalent rights was $0.6 million as of March 31, 2015.
Special cash dividend
On November 19, 2014, the Company’s Board of Directors declared a special cash dividend of $16.50 per share, which was paid on December 9, 2014 to the stockholders of record as of the close of business on December 1, 2014. Additionally, in connection with the special cash dividend, the Company’s Board of Directors and the Compensation Committee of the Board of Directors approved a proportionate and equitable adjustment to outstanding equity awards (restricted stock units and stock options), as required under the 2004 Plan, subject to the vesting requirements of the underlying awards. As the adjustment was required by the 2004 Plan, the adjustment to the outstanding awards did not result in any incremental compensation expense due to modification of such awards, under the authoritative guidance. Under the authoritative guidance, the dividend when declared is recognized as a reduction of retained earnings, to the extent available, with any excess recognized as a reduction of additional paid-in-capital. The special cash dividend reduced the retained earnings by $2.1 billion as of the special cash dividend declaration date, reducing the retained earnings amount to zero and the excess amount of the special cash dividend of $646.5 million was charged against additional paid-in capital. The declaration and payment of the special cash dividend are part of the Company’s leveraged recapitalization transaction under which the special cash dividend was financed through a combination of existing cash and proceeds from the debt financing disclosed in Note 7, “Debt” that was completed during the three months ended December 31, 2014. The total amount of the special cash dividend accrued by the Company during the three months ended December 31, 2014 was approximately $2.76 billion, substantially all of which was paid out during the three months ended December 31, 2014. As of March 31, 2015, the Company accrued a total of $40.8 million of dividends payable for special cash dividend with respect to outstanding unvested restricted stock units, which will be paid when such underlying unvested restricted stock units vest. Other than the special cash dividend declared during the three months ended December 31, 2014, the Company historically has not declared any special cash dividends. For additional details on accrued dividends, refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations, “Liquidity and Capital Resources,” in Part I, Item 2.
NOTE 9 – STOCK REPURCHASE PROGRAM
The Company’s Board of Directors has authorized a program for the Company to repurchase shares of the Company’s common stock. The intent of this program is to offset the dilution from KLA-Tencor’s equity incentive plans and employee stock purchase plan, as well as to return excess cash to the Company’s stockholders. Subject to market conditions, applicable legal requirements and other factors, the repurchases will be made from time to time in the open market in compliance with applicable securities laws, including the Securities Exchange Act of 1934, as amended, and the rules promulgated thereunder, such as Rule 10b-18. On July 8, 2014, the Company’s Board of Directors authorized KLA-Tencor to repurchase up to 13 million additional shares of the Company’s common stock. On October 23, 2014, as part of the leveraged recapitalization transaction announcement, the Board of Directors authorized an increase to the existing stock repurchase program of 3.6 million additional shares of the Company’s common stock. As of March 31, 2015, an aggregate of approximately 12.1 million shares were available for repurchase under the Company’s repurchase program.

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Table of Contents

Share repurchases for the indicated periods (based on the trade date of the applicable repurchase) were as follows:
 
Three months ended
March 31,
 
Nine months ended
March 31,
(In thousands)
2015
 
2014
 
2015
 
2014
Number of shares of common stock repurchased
2,644

 
930

 
6,506

 
2,927

Total cost of repurchases
$
168,943

 
$
59,880

 
$
447,892

 
$
180,686

As of March 31, 2015, the Company had repurchased 218,600 shares for $12.9 million, which repurchases had not settled prior to March 31, 2015 and were recorded as a component of other current liabilities.
NOTE 10 – NET INCOME PER SHARE
Basic net income per share is calculated by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted net income per share is calculated by using the weighted-average number of common shares outstanding during the period, increased to include the number of additional shares of common stock that would have been outstanding if the shares of common stock underlying the Company’s outstanding dilutive stock options and restricted stock units had been issued. The dilutive effect of outstanding options and restricted stock units is reflected in diluted net income per share by application of the treasury stock method. Under the treasury stock method, the amount the employee must pay for exercising stock options, the amount of compensation cost for future service that the Company has not yet recognized, and the amount of tax benefits that is to be recorded in additional paid-in capital when the award becomes deductible are assumed to be used to repurchase shares.
The following table sets forth the computation of basic and diluted net income per share:
(In thousands, except per share amounts)
Three months ended
March 31,
 
Nine months ended
March 31,
2015
 
2014
 
2015
 
2014
Numerator:
 
 
 
 
 
 
 
Net income
$
131,638

 
$
203,581

 
$
224,139

 
$
454,024

Denominator:
 
 
 
 
 
 
 
Weighted-average shares-basic, excluding unvested restricted stock units
161,559

 
166,253

 
163,494

 
166,184

Effect of dilutive options and restricted stock units
1,235

 
1,736

 
1,436

 
2,171

Weighted-average shares-diluted
162,794

 
167,989

 
164,930

 
168,355

Basic net income per share
$
0.81

 
$
1.22

 
$
1.37

 
$
2.73

Diluted net income per share
$
0.81

 
$
1.21

 
$
1.36

 
$
2.70

Anti-dilutive securities excluded from the computation of diluted net income per share
245

 

 
32

 

NOTE 11 – INCOME TAXES
The following table provides details of income taxes:

Three months ended
March 31,
 
Nine months ended
March 31,
(Dollar amounts in thousands)
2015
 
2014
 
2015
 
2014
Income before income taxes
$
166,454

 
$
251,246

 
$
259,193

 
$
567,855

Provision for income taxes
$
34,816

 
$
47,665

 
$
35,054

 
$
113,831

Effective tax rate
20.9
%
 
19.0
%
 
13.5
%
 
20.0
%
The Company’s estimated annual effective tax rate for the fiscal year ending June 30, 2015 is forecasted to be approximately 17% after considering the tax benefit on the pre-tax net loss of $131.7 million due to the redemption of the 2018 Senior Notes. The Company estimates an effective tax rate of approximately 22% for the remainder of the fiscal year ending June 30, 2015.

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Table of Contents

The difference between the actual tax expense during the three months ended March 31, 2015 and the estimated annual tax expense is primarily due to the impact of the following items:
Tax expense was decreased by $2.1 million during the three months ended March 31, 2015 related to a non-taxable increase in the value of the assets held within the Company’s Executive Deferred Savings Plan; and
Tax expense was decreased by $3.8 million during the three months ended March 31, 2015 related to the tax effect of an intercompany dividend.
Tax expense was higher as a percentage of income before taxes during the three months ended March 31, 2015 compared to the three months ended March 31, 2014 primarily due to the impact of the following items:
Tax expense was decreased by $5.5 million during the three months ended March 31, 2014 related to a decrease in the Company’s unrecognized tax benefits from the expiration of the statute of limitations; and
Tax expense was decreased by $2.1 million during the three months ended March 31, 2014 related to an increase in the proportion of the Company’s earnings generated in jurisdictions with tax rates lower than the U.S. statutory rate; offset by
Tax expense was decreased by $1.3 million during the three months ended March 31, 2015 related to a non-taxable increase in the value of the assets held within the Company’s Executive Deferred Savings Plan; and
Tax expense was decreased by $3.8 million during the three months ended March 31, 2015 related to the tax effect of an intercompany dividend.
Tax expense was lower as a percentage of income before taxes during the nine months ended March 31, 2015 compared to the nine months ended March 31, 2014, primarily due to the impact of the following items:
Tax expense was decreased by $45.2 million during the nine months ended March 31, 2015 related to a pre-tax net loss of $131.7 million due to the redemption of the 2018 Senior Notes; offset by
Tax expense was decreased by $5.5 million during the nine months ended March 31, 2014 related to a decrease in the Company’s unrecognized tax benefits from the expiration of the statute of limitations;
Tax expense was decreased by $3.2 million during the nine months ended March 31, 2014 related to a non-taxable increase in the value of the assets held within the Company’s Executive Deferred Savings Plan; and
Tax expense was decreased by $4.9 million during the nine months ended March 31, 2014 related to an increase in the proportion of the Company’s earnings generated in jurisdictions with tax rates lower than the U.S. statutory rate;

In the normal course of business, the Company is subject to examination by tax authorities throughout the world. The Company is subject to U.S. federal income tax examination for all years beginning from the fiscal year ended June 30, 2011. The Company is subject to state income tax examinations for all years beginning from the fiscal year ended June 30, 2010. The Company is also subject to examinations in other major foreign jurisdictions, including Singapore, for all years beginning from the fiscal year ended June 30, 2010. It is possible that certain examinations may be concluded in the next twelve months. The Company believes it is possible that it may recognize up to $22.9 million of its existing unrecognized tax benefits within the next twelve months as a result of the lapse of statutes of limitations and the resolution of examinations with various tax authorities.
NOTE 12 – LITIGATION AND OTHER LEGAL MATTERS
The Company is named from time to time as a party to lawsuits and other types of legal proceedings and claims in the normal course of its business. Actions filed against the Company include commercial, intellectual property, customer, and labor and employment related claims, including complaints of alleged wrongful termination and potential class action lawsuits regarding alleged violations of federal and state wage and hour and other laws. In general, legal proceedings and claims, regardless of their merit, and associated internal investigations (especially those relating to intellectual property or confidential information disputes) are often expensive to prosecute, defend or conduct and may divert management’s attention and other company resources. Moreover, the results of legal proceedings are difficult to predict, and the costs incurred in litigation can be substantial, regardless of outcome. The Company believes the amounts provided in its condensed consolidated financial statements are adequate in light of the probable and estimated liabilities. However, because such matters are subject to many uncertainties, the ultimate outcomes are not predictable, and there can be no assurances that the actual amounts required to satisfy alleged liabilities from the matters described above will not exceed the amounts reflected in the Company’s condensed consolidated financial statements or will not have a material adverse effect on its results of operations, financial condition or cash flows.

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Table of Contents

NOTE 13 – COMMITMENTS AND CONTINGENCIES
Factoring. KLA-Tencor has agreements (referred to as “factoring agreements”) with financial institutions to sell certain of its trade receivables and promissory notes from customers without recourse. The Company does not believe it is at risk for any material losses as a result of these agreements. In addition, the Company periodically sells certain letters of credit (“LCs”), without recourse, received from customers in payment for goods.
The following table shows total receivables sold under factoring agreements and proceeds from sales of LCs for the indicated periods:
 
Three months ended
March 31,
 
Nine months ended
March 31,
(In thousands)
2015
 
2014
 
2015
 
2014
Receivables sold under factoring agreements
$
15,614

 
$
27,195

 
$
88,832

 
$
83,489

Proceeds from sales of LCs
$

 
$

 
$
6,920

 
$

Factoring and LC fees for the sale of certain trade receivables were recorded in interest income and other, net and were not material for the periods presented.
Facilities. KLA-Tencor leases certain of its facilities under arrangements that are accounted for as operating leases. Rent expense was $2.2 million and $2.1 million for the three months ended March 31, 2015 and 2014, respectively. Rent expense was $6.8 million and $6.5 million for the nine months ended March 31, 2015 and 2014, respectively.
The following is a schedule of expected operating lease payments:
Fiscal year ending June 30,
Amount
(In thousands)
2015 (remaining 3 months)
$
2,149

2016
7,752

2017
5,508

2018
3,851

2019
1,788

2020 and thereafter
1,753

Total minimum lease payments
$
22,801

Purchase Commitments. KLA-Tencor maintains commitments to purchase inventory from its suppliers as well as goods and services in the ordinary course of business. The Company’s liability under these purchase commitments is generally restricted to a forecasted time-horizon as mutually agreed upon between the parties. This forecasted time-horizon can vary among different suppliers. The Company’s estimate of its significant purchase commitments is approximately $300.8 million as of March 31, 2015 which are primarily due within the next 12 months. Actual expenditures will vary based upon the volume of the transactions and length of contractual service provided. In addition, the amounts paid under these arrangements may be less in the event that the arrangements are renegotiated or canceled. Certain agreements provide for potential cancellation penalties.
Cash Long-Term Incentive Plan. As of March 31, 2015, the Company had committed $133.7 million for future payment obligations under its Cash LTI Plan. The calculation of compensation expense related to the Cash LTI Plan includes estimated forfeiture rate assumptions. Cash LTI awards issued to employees under the Cash LTI Plan vest in four equal installments, with 25% of the aggregate amount of the Cash LTI award vesting on each yearly anniversary of the grant date over a four-year period. In order to receive payments under a Cash LTI award, participants must remain employed by the Company as of the applicable award vesting date.
Warranties, Guarantees and Contingencies. KLA-Tencor provides standard warranty coverage on its systems for 40 hours per week for 12 months, providing labor and parts necessary to repair the systems during the warranty period. The Company accounts for the estimated warranty cost as a charge to costs of revenues when revenue is recognized. The estimated warranty cost is based on historical product performance and field expenses. Utilizing actual service records, the Company calculates the average service hours and parts expense per system and applies the actual labor and overhead rates to determine the estimated warranty charge. The Company updates these estimated charges on a quarterly basis. The actual product performance and/or field expense profiles may differ, and in those cases the Company adjusts its warranty accruals accordingly.

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The following table provides the changes in the product warranty accrual for the indicated periods:
 
Three months ended
March 31,
 
Nine months ended
March 31,
(In thousands)
2015
 
2014
 
2015
 
2014
Beginning balance
$
34,410

 
$
41,599

 
$
37,746

 
$
42,603

Accruals for warranties issued during the period
11,289

 
10,799

 
28,480

 
36,096

Changes in liability related to pre-existing warranties
76

 
(841
)
 
(690
)
 
(6,650
)
Settlements made during the period
(10,346
)
 
(10,408
)
 
(30,107
)
 
(30,900
)
Ending balance
$
35,429

 
$
41,149

 
$
35,429

 
$
41,149

The Company maintains guarantee arrangements available through various financial institutions for up to $21.6 million, of which $18.4 million had been issued as of March 31, 2015, primarily to fund guarantees to customs authorities for value-added tax (“VAT”) and other operating requirements of the Company’s subsidiaries in Europe and Asia.
KLA-Tencor is a party to a variety of agreements pursuant to which it may be obligated to indemnify the other party with respect to certain matters. Typically, these obligations arise in connection with contracts and license agreements or the sale of assets, under which the Company customarily agrees to hold the other party harmless against losses arising from, or provides customers with other remedies to protect against, bodily injury or damage to personal property caused by the Company’s products, non-compliance with the Company’s product performance specifications, infringement by the Company’s products of third-party intellectual property rights and a breach of warranties, representations and covenants related to matters such as title to assets sold, validity of certain intellectual property rights, non-infringement of third-party rights, and certain income tax-related matters. In each of these circumstances, payment by the Company is typically subject to the other party making a claim to and cooperating with the Company pursuant to the procedures specified in the particular contract.
This usually allows the Company to challenge the other party’s claims or, in case of breach of intellectual property representations or covenants, to control the defense or settlement of any third-party claims brought against the other party. Further, the Company’s obligations under these agreements may be limited in terms of amounts, activity (typically at the Company’s option to replace or correct the products or terminate the agreement with a refund to the other party), and duration. In some instances, the Company may have recourse against third parties and/or insurance covering certain payments made by the Company.
Subject to certain limitations, the Company is obligated to indemnify its current and former directors, officers and employees with respect to certain litigation matters and investigations that arise in connection with their service to the Company. These obligations arise under the terms of the Company’s certificate of incorporation, its bylaws, applicable contracts, and Delaware and California law. The obligation to indemnify generally means that the Company is required to pay or reimburse the individuals’ reasonable legal expenses and possibly damages and other liabilities incurred in connection with these matters.
In addition, the Company may in limited circumstances enter into agreements that contain customer-specific pricing, discount, rebate or credit commitments. Furthermore, the Company may give these customers limited audit or inspection rights to enable them to confirm that the Company is complying with these commitments. If a customer elects to exercise its audit or inspection rights, the Company may be required to expend significant resources to support the audit or inspection, as well as to defend or settle any dispute with a customer that could potentially arise out of such audit or inspection. To date, the Company has made no significant accruals in its condensed consolidated financial statements for this contingency. While the Company has not in the past incurred significant expenses for resolving disputes regarding these types of commitments, the Company cannot make any assurance that it will not incur any such liabilities in the future.
It is not possible to predict the maximum potential amount of future payments under these or similar agreements due to the conditional nature of the Company’s obligations and the unique facts and circumstances involved in each particular agreement. Historically, payments made by the Company under these agreements have not had a material effect on its business, financial condition, results of operations or cash flows.

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NOTE 14 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The authoritative guidance requires companies to recognize all derivative instruments and hedging activities, including foreign currency exchange contracts, as either assets or liabilities at fair value on the balance sheet. Changes in the fair value of derivatives that do not qualify for hedge treatment, as well as the ineffective portion of any hedges, are recognized in interest income and other, net in the Condensed Consolidated Statements of Operations. In accordance with the guidance, the Company designates foreign currency forward exchange and option contracts as cash flow hedges of certain forecasted foreign currency denominated sales and purchase transactions.
KLA-Tencor’s foreign subsidiaries operate and sell KLA-Tencor’s products in various global markets. As a result, KLA-Tencor is exposed to risks relating to changes in foreign currency exchange rates. KLA-Tencor utilizes foreign currency forward exchange contracts and option contracts to hedge against future movements in foreign exchange rates that affect certain existing and forecasted foreign currency denominated sales and purchase transactions, such as the Japanese yen, the euro, the New Taiwan dollar and the Israeli new shekel. The Company routinely hedges its exposures to certain foreign currencies with various financial institutions in an effort to minimize the impact of certain currency exchange rate fluctuations. These currency forward exchange contracts and options, designated as cash flow hedges, generally have maturities of less than 18 months. Cash flow hedges are evaluated for effectiveness monthly, based on changes in total fair value of the derivatives. If a financial counterparty to any of the Company’s hedging arrangements experiences financial difficulties or is otherwise unable to honor the terms of the foreign currency hedge, the Company may experience material losses.
For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gains or losses on the derivative is reported as a component of accumulated other comprehensive income (loss) (“OCI”) and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Changes in the fair value of currency forward exchange and option contracts due to changes in time value are excluded from the assessment of effectiveness. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.
For derivative instruments that are not designated as accounting hedges, gains and losses are recognized in interest income and other, net. The Company uses foreign currency forward contracts to hedge certain foreign currency denominated assets or liabilities. The gains and losses on these derivatives are largely offset by the changes in the fair value of the assets or liabilities being hedged.
In October 2014, in anticipation of the issuance of the Senior Notes, the Company entered into a series of forward contracts (“Rate Lock Agreements”) to lock the benchmark rate on a portion of the Senior Notes. The objective of the Rate Lock Agreements was to hedge the risk associated with the variability in interest rates due to the changes in the benchmark rate leading up to the closing of the intended financing, on the notional amount being hedged. The Rate Lock Agreements had a notional amount of $1 billion in aggregate, with contract maturity dates in the second quarter of the fiscal year ending June 30, 2015. The Company designated each of the Rate Lock Agreements as a qualifying hedging instrument to be accounted for as a cash flow hedge, under which the effective portion of the gain or loss on the close out of the Rate Lock Agreements was initially recognized in accumulated other comprehensive income (loss) as a reduction of total stockholders’ equity and subsequently amortized into earnings as a component of interest expense over the term of the underlying debt. The ineffective portion, if any, was recognized in earnings immediately. The Rate Lock Agreements were terminated on the date of pricing of the $1.25 billion of 4.650% Senior Notes due in 2024 and the Company recorded the fair value of a $7.5 million receivable as a gain within accumulated other comprehensive income (loss) as of December 31, 2014. For the three months and nine months ended March 31, 2015, the Company recognized $0.2 million and $0.3 million, respectively for the amortization of the gain recognized in accumulated other comprehensive income (loss), which amount reduced the interest expense. The Company did not record any ineffectiveness for the three months and nine months ended March 31, 2015. The cash proceeds of $7.5 million from the settlement of the Rate Lock Agreements were included in the cash flows from operating activities in the condensed consolidated statements of cash flows for the nine months ended March 31, 2015 because the designated hedged item was classified as interest expense in the cash flows from operating activities in the condensed consolidated statements of cash flows.

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In addition, in November 2014, the Company entered into a non-designated forward contract to lock the treasury rate used to determine the redemption amount of the 2018 Senior Notes that occurred during the three months ended December 31, 2014. The objective of the forward contract was to hedge the risk associated with the variability of the redemption amount due to changes in interest rates through the redemption of the existing 2018 Senior Notes. The forward contract had a notional amount of $750 million. The forward contract was terminated in December 2014 and the resulting fair value of $1.2 million receivable was included in the loss on extinguishment of debt and other, net line in the condensed consolidated statements of operations, partially offsetting the loss on redemption of the debt during the three months December 31, 2014. The cash proceeds from the forward contract were included in the cash flows from financing activities in the condensed consolidated statements of cash flows for the nine months ended March 31, 2015, partially offsetting the cash outflows for the redemption of the 2018 Senior Notes.
Derivatives in Cash Flow Hedging Relationships: Foreign Exchange and Interest Rate Contracts
The locations and amounts of designated and non-designated derivative instruments’ gains and losses reported in the condensed consolidated financial statements for the indicated periods were as follows:
 
 
Three months ended
March 31,