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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 December 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 January 15, 2016, there were 155,664,640 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)
December 31,
2015
 
June 30,
2015
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
886,591

 
$
838,025

Marketable securities
1,354,834

 
1,549,086

Accounts receivable, net
427,115

 
585,494

Inventories
691,786

 
617,904

Deferred income taxes
217,473

 
236,253

Other current assets
106,906

 
77,814

Total current assets
3,684,705

 
3,904,576

Land, property and equipment, net
292,393

 
314,591

Goodwill
335,205

 
335,263

Purchased intangibles, net
6,934

 
11,895

Other non-current assets
253,279

 
259,687

Total assets
$
4,572,516

 
$
4,826,012

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
122,314

 
$
103,342

Deferred system profit
131,848

 
148,691

Unearned revenue
63,587

 
71,335

Current portion of long-term debt

 
16,981

Other current liabilities
540,581

 
661,414

Total current liabilities
858,330

 
1,001,763

Non-current liabilities:
 
 
 
Long-term debt
3,131,676

 
3,173,435

Unearned revenue
49,360

 
47,145

Other non-current liabilities
167,525

 
182,230

Total liabilities
4,206,891

 
4,404,573

Commitments and contingencies (Note 11 and Note 12)

 

Stockholders’ equity:
 
 
 
Common stock and capital in excess of par value
416,144

 
474,374

Accumulated deficit

 
(12,362
)
Accumulated other comprehensive income (loss)
(50,519
)
 
(40,573
)
Total stockholders’ equity
365,625

 
421,439

Total liabilities and stockholders’ equity
$
4,572,516

 
$
4,826,012

 
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
 
Six months ended
 
December 31,
 
December 31,
(In thousands, except per share amounts)
2015
 
2014
 
2015
 
2014
Revenues:
 
 
 
 
 
 
 
Product
$
527,780

 
$
503,884

 
$
988,519

 
$
980,482

Service
182,465

 
172,473

 
364,370

 
338,776

Total revenues
710,245

 
676,357

 
1,352,889

 
1,319,258

Costs and expenses:
 
 
 
 
 
 
 
Costs of revenues
280,980

 
283,213

 
551,224

 
571,680

Engineering, research and development
118,272

 
133,557

 
238,215

 
277,194

Selling, general and administrative
96,532

 
104,873

 
188,195

 
206,517

Loss on extinguishment of debt and other, net

 
131,669

 

 
131,669

Interest expense
30,539

 
31,301

 
61,103

 
44,822

Other expense (income), net
(1,553
)
 
(1,988
)
 
(5,622
)
 
(5,363
)
Income (loss) before income taxes
185,475

 
(6,268
)
 
319,774

 
92,739

Provision for (benefit from) income taxes
33,268

 
(26,536
)
 
62,670

 
238

Net income
$
152,207

 
$
20,268

 
$
257,104

 
$
92,501

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.98

 
$
0.12

 
$
1.65

 
$
0.56

Diluted
$
0.98

 
$
0.12

 
$
1.64

 
$
0.56

Cash dividends declared per share (including a special cash
   dividend of $16.50 per share declared during the three
   months ended December 31, 2014)
$
0.52

 
$
17.00

 
$
1.04

 
$
17.50

Weighted-average number of shares:
 
 
 
 
 
 
 
Basic
155,252

 
164,036

 
156,036

 
164,440

Diluted
155,996

 
165,317

 
156,971

 
165,950


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
 
Six months ended
 
December 31,
 
December 31,
(In thousands)
2015
 
2014
 
2015
 
2014
Net income
$
152,207

 
$
20,268

 
$
257,104

 
$
92,501

Other comprehensive income (loss):
 
 
 
 
 
 
 
Currency translation adjustments:
 
 
 
 
 
 
 
Change in currency translation adjustments
(2,144
)
 
(9,333
)
 
(8,268
)
 
(17,069
)
Change in income tax benefit or expense
380

 
3,101

 
1,764

 
5,973

Net change related to currency translation adjustments
(1,764
)
 
(6,232
)
 
(6,504
)
 
(11,096
)
Cash flow hedges:
 
 
 
 
 
 
 
Change in net unrealized gains or losses
707

 
11,924

 
(1,154
)
 
13,957

Reclassification adjustments for net gains or losses included in net income
165

 
(1,584
)
 
(237
)
 
(1,812
)
Change in income tax benefit or expense
(314
)
 
(3,727
)
 
500

 
(4,377
)
Net change related to cash flow hedges
558

 
6,613

 
(891
)
 
7,768

Net change related to unrecognized losses and transition obligations in connection with defined benefit plans
576

 
580

 
806

 
1,313

Available-for-sale securities:
 
 
 
 
 
 
 
Change in net unrealized gains or losses
(4,715
)
 
(389
)
 
(4,234
)
 
(3,124
)
Reclassification adjustments for gains or losses included in net income
(26
)
 
(281
)
 
(43
)
 
(1,916
)
Change in income tax benefit or expense
989

 
158

 
920

 
1,573

Net change related to available-for-sale securities
(3,752
)
 
(512
)
 
(3,357
)
 
(3,467
)
Other comprehensive income (loss)
(4,382
)
 
449

 
(9,946
)
 
(5,482
)
Total comprehensive income
$
147,825

 
$
20,717

 
$
247,158

 
$
87,019


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

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KLA-TENCOR CORPORATION
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 
Six months ended
December 31,
(In thousands)
2015
 
2014
Cash flows from operating activities:
 
 
 
Net income
$
257,104

 
$
92,501

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
36,264

 
40,060

Asset impairment charges
358

 

Loss on extinguishment of debt and other, net

 
131,669

Non-cash stock-based compensation expense
23,573

 
30,331

Excess tax benefit from equity awards
(11,541
)
 
(14,788
)
Net gain on sales of marketable securities and other investments
(1,258
)
 
(1,916
)
Changes in assets and liabilities:
 
 
 
Decrease (increase) in accounts receivable, net
157,023

 
(161,021
)
Increase in inventories
(67,911
)
 
(12,743
)
Increase in other assets
(3,663
)
 
(82,588
)
Increase in accounts payable
19,205

 
5,754

Increase (decrease) in deferred system profit
(16,843
)
 
20,163

Decrease in other liabilities
(98,205
)
 
(1,412
)
Net cash provided by operating activities
294,106

 
46,010

Cash flows from investing activities:
 
 
 
Capital expenditures, net
(15,279
)
 
(26,228
)
Proceeds from sale of assets
1,215

 

Purchases of available-for-sale securities
(624,861
)
 
(1,094,276
)
Proceeds from sale of available-for-sale securities
485,087

 
1,441,460

Proceeds from maturity of available-for-sale securities
326,335

 
383,132

Purchases of trading securities
(35,005
)
 
(39,566
)
Proceeds from sale of trading securities
35,576

 
36,793

Net cash provided by investing activities
173,068

 
701,315

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

 
3,224,906

Repayment of debt
(60,000
)
 
(877,367
)
Issuance of common stock
21,908

 
29,403

Tax withholding payments related to vested and released restricted stock units
(22,021
)
 
(27,800
)
Common stock repurchases
(181,711
)
 
(266,360
)
Payment of dividends to stockholders
(183,054
)
 
(2,879,152
)
Excess tax benefit from equity awards
11,541

 
14,788

Net cash used in financing activities
(413,337
)
 
(781,582
)
Effect of exchange rate changes on cash and cash equivalents
(5,271
)
 
(11,739
)
Net increase (decrease) in cash and cash equivalents
48,566

 
(45,996
)
Cash and cash equivalents at beginning of period
838,025

 
630,861

Cash and cash equivalents at end of period
$
886,591

 
$
584,865

Supplemental cash flow disclosures:
 
 
 
Income taxes paid, net
$
59,475

 
$
57,729

Interest paid
$
59,860

 
$
33,228

Non-cash activities:
 
 
 
Purchase of land, property and equipment - investing activities
$
2,253

 
$
3,962

Unsettled common stock repurchase - financing activities
$

 
$
12,589

Dividends payable - financing activities
$
20,284

 
$
42,987

 
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 – DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Description of Business. KLA-Tencor Corporation (“KLA-Tencor” or the “Company”) is a leading supplier of process control and yield management solutions for the semiconductor and related nanoelectronics industries. KLA-Tencor’s broad portfolio of wafer inspection and patterning products, and related service, software and other offerings primarily supports integrated circuit, which is referred to as an “IC” or “chip,” manufacturers throughout the entire semiconductor fabrication process, from research and development to final volume production. KLA-Tencor provides leading-edge equipment, software and support that enable IC manufacturers to identify, resolve and manage significant advanced technology manufacturing process challenges and obtain higher finished product yields at lower overall cost. In addition to serving the semiconductor industry, KLA-Tencor also provides a range of technology solutions to a number of other high technology industries, including the LED and data storage industries, as well as general materials research.
On October 20, 2015, the Company entered into an Agreement and Plan of Merger and Reorganization (the “Merger Agreement”) with Lam Research Corporation (“Lam Research”), under which KLA-Tencor will, subject to the satisfaction or waiver of the conditions therein, ultimately become a direct or indirect wholly-owned subsidiary of Lam Research.
In accordance with the Merger Agreement, at the effective time of the Merger, each of the Company’s stockholder may elect to receive, for all shares of the Company’s common stock held at the closing of the transaction, and on a per share basis, one of the following: (i) mixed consideration, consisting of both 0.5 of a share of Lam Research common stock and $32.00 in cash; (ii) all-stock consideration, consisting of a number of shares of Lam Research common stock equal to 0.5 plus $32.00 divided by the volume weighted average price of Lam Research common stock over a five trading day period ending shortly before the closing of the transaction (“the five day VWAP”); or (iii) all-cash consideration, consisting of $32.00 plus 0.5 times the five-day VWAP. If no election was made by the Company’s stockholders, they will be deemed to have elected the mixed consideration. All-cash and all-stock elections will be subject to proration in accordance with the terms of the Merger Agreement.
The transaction is expected to close in mid-calendar year 2016, pending receipt of customary regulatory approvals and the satisfaction of other customary closing conditions, including the approval by the Company’s stockholders of the Merger Agreement and the approval by Lam Research’s stockholders of the issuance of shares in the transaction.
The Merger Agreement contains certain termination rights for both the Company and Lam Research, including if a governmental body prohibits the Mergers or if the Mergers are not consummated by July 20, 2016, subject to certain extension rights. Upon termination of the Merger Agreement under specified circumstances, the Company or Lam Research will be required to pay the other party a termination fee of $290.0 million.
For additional details on the transaction, refer to copy of the Merger Agreement attached as an Exhibit to the Form 8-K filed with the U.S. Securities and Exchange Commission (“SEC”) on October 21, 2015.
Basis of Presentation. The condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the 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, 2015, filed with the SEC on August 7, 2015.
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 three and six months ended December 31, 2015 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, 2016.
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, Comprehensive Income and Cash Flows.

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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. The Company 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% of the 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.
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 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.

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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 sales of inventory at cost until the time of acceptance.
Recent Accounting Pronouncements.
Updates Not Yet Effective
In May 2014, the Financial Accounting Standards Board (“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 August 2015, the FASB deferred the effective date of the update 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.
In April 2015, the FASB issued an accounting standard update for customer’s cloud based fees. The guidance changes what a customer must consider in determining whether a cloud computing arrangement contains a software license. If the arrangement contains a software license, the customer would account for the fees related to the software license element in accordance with guidance related to internal use software; if the arrangement does not contain a software license, the customer would account for the arrangement as a service contract. The update is effective for the Company beginning in the first quarter of the Company’s fiscal year ending June 30, 2017. Early adoption is permitted as of the beginning of an interim or annual reporting period. The Company is currently evaluating the impact of this accounting standard update on its condensed consolidated financial statements.
In July 2015, the FASB issued an accounting standard update for the subsequent measurement of inventory. The amended guidance requires entities to measure inventory at the lower of cost or net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. The requirement would replace the current lower of cost or market evaluation and the accounting guidance is unchanged for inventory measured using last-in, first-out (“LIFO”) or the retail inventory method. The update is effective for the Company beginning in the first quarter of the Company’s fiscal year ending June 30, 2018 and should be applied prospectively with early adoption permitted as of the beginning of an interim or annual reporting period. The Company is currently evaluating the impact of this accounting standard update on its condensed consolidated financial statements.
In November 2015, the FASB issued an accounting standard update for the presentation of deferred income taxes. Under this new guidance, deferred tax liabilities and assets should be classified as noncurrent in a classified balance sheet. The update is effective for the Company beginning in the first quarter of the Company’s fiscal year ending June 30, 2018 with early adoption permitted as of the beginning of an interim or annual reporting period. Additionally, this guidance may be applied either prospectively or retrospectively to all periods presented. The Company is currently evaluating the impact of this accounting standard update on its condensed consolidated financial statements.

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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.
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 December 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 December 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 December 31, 2015, the types of instruments valued based on other observable inputs included corporate debt securities, municipal securities, certain U.S. Government agency securities and certain 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.

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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 December 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
$
32,997

 
$

 
$
32,997

Corporate debt securities
53,320

 

 
53,320

Money market and other
470,811

 
470,811

 

Sovereign securities
17,736

 

 
17,736

Marketable securities:
 
 
 
 
 
U.S. Treasury securities
273,524

 
273,524

 

U.S. Government agency securities
371,319

 
371,319

 

Municipal securities
7,717

 

 
7,717

Corporate debt securities
652,433

 

 
652,433

Sovereign securities
42,779

 
6,427

 
36,352

Total cash equivalents and marketable securities(1)
1,922,636

 
1,122,081

 
800,555

Other current assets:
 
 
 
 
 
Derivative assets
1,028

 

 
1,028

Other non-current assets:
 
 
 
 
 
Executive Deferred Savings Plan
161,053

 
90,556

 
70,497

Total financial assets(1)
$
2,084,717

 
$
1,212,637

 
$
872,080

Liabilities
 
 
 
 
 
Other current liabilities:
 
 
 
 
 
Derivative liabilities
$
(4,092
)
 
$

 
$
(4,092
)
Total financial liabilities
$
(4,092
)
 
$

 
$
(4,092
)
________________
(1) Excludes cash of $251.1 million held in operating accounts and time deposits of $67.7 million as of December 31, 2015.


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Table of Contents

Financial assets (excluding cash held in operating accounts and time deposits) and liabilities measured at fair value on a recurring basis, as of the date indicated below, were presented on the Company’s Condensed Consolidated Balance Sheet as follows:  
As of June 30, 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
$
7,500

 
$
7,500

 
$

Corporate debt securities
13,099

 

 
13,099

Money market and other
611,385

 
611,385

 

Marketable securities:
 
 
 
 
 
U.S. Treasury securities
275,555

 
275,555

 

U.S. Government agency securities
564,768

 
556,019

 
8,749

Municipal securities
31,816

 

 
31,816

Corporate debt securities
612,862

 

 
612,862

Sovereign securities
57,093

 
8,976

 
48,117

Total cash equivalents and marketable securities(1)
2,174,078

 
1,459,435

 
714,643

Other current assets:
 
 
 
 
 
Derivative assets
3,064

 

 
3,064

Other non-current assets:
 
 
 
 
 
Executive Deferred Savings Plan
165,655

 
91,203

 
74,452

Total financial assets(1)
$
2,342,797

 
$
1,550,638

 
$
792,159

Liabilities
 
 
 
 
 
Other current liabilities:
 
 
 
 
 
Derivative liabilities
$
(3,106
)
 
$

 
$
(3,106
)
Total financial liabilities
$
(3,106
)
 
$

 
$
(3,106
)
________________
(1) Excludes cash of $183.1 million held in operating accounts and time deposits of $29.9 million as of June 30, 2015.
There were no transfers in and out of Level 1 and Level 2 fair value measurements during the three and six months ended December 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 December 31, 2015 or June 30, 2015.



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NOTE 3 – FINANCIAL STATEMENT COMPONENTS
Balance Sheet Components
(In thousands)
As of
December 31, 2015
 
As of
June 30, 2015
Accounts receivable, net:
 
 
 
Accounts receivable, gross
$
448,786

 
$
607,157

Allowance for doubtful accounts
(21,671
)
 
(21,663
)
 
$
427,115

 
$
585,494

Inventories:
 
 
 
Customer service parts
$
221,980

 
$
209,726

Raw materials
226,377

 
194,218

Work-in-process
186,359

 
156,820

Finished goods
57,070

 
57,140

 
$
691,786

 
$
617,904

Other current assets:
 
 
 
Prepaid expenses
$
38,625

 
$
37,006

Income tax related receivables
61,129

 
32,850

Other current assets
7,152

 
7,958

 
$
106,906

 
$
77,814

Land, property and equipment, net:
 
 
 
Land
$
40,385

 
$
40,397

Buildings and leasehold improvements
318,904

 
316,566

Machinery and equipment
508,578

 
510,642

Office furniture and fixtures
21,573

 
21,411

Construction-in-process
3,432

 
3,152

 
892,872

 
892,168

Less: accumulated depreciation and amortization
(600,479
)
 
(577,577
)
 
$
292,393

 
$
314,591

Other non-current assets:
 
 
 
Executive Deferred Savings Plan(1)
$
161,053

 
$
165,655

Deferred tax assets – long-term
77,288

 
78,648

Other non-current assets
14,938

 
15,384

 
$
253,279

 
$
259,687

Other current liabilities:
 
 
 
Warranty
$
36,148

 
$
36,413

Executive Deferred Savings Plan(1)
163,988

 
167,886

Compensation and benefits
130,394

 
196,682

Income taxes payable
18,880

 
15,582

Interest payable
19,398

 
19,395

Customer credits and advances
89,265

 
93,212

Other accrued expenses
82,508

 
132,244

 
$
540,581

 
$
661,414

Other non-current liabilities:
 
 
 
Pension liabilities
$
53,930

 
$
55,696

Income taxes payable
65,997

 
69,018

Other non-current liabilities
47,598

 
57,516

 
$
167,525

 
$
182,230



13

Table of Contents

________________
(1)
KLA-Tencor has a non-qualified deferred compensation plan (known as “Executive Deferred Savings 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 the Company. The Company invests these funds in certain mutual funds and such investments are classified as trading securities on the condensed consolidated balance sheets. Distributions from the Executive Deferred Savings Plan commence following a participant’s retirement or termination of employment or on a specified date allowed per the Executive Deferred Savings 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 Executive Deferred Savings Plan provisions. Changes in the Executive Deferred Savings Plan liability is recorded in selling, general and administrative expense in the condensed consolidated statements of operations. The expense (benefit) associated with changes in the liability included in selling, general and administrative expense were $6.8 million and $6.1 million for the three months ended December 31, 2015 and 2014, respectively. The expense (benefit) associated with changes in the liability included in selling, general and administrative expense were $(3.3) million and $4.2 million for the six months ended December 31, 2015 and 2014, respectively. Changes in the Executive Deferred Savings Plan assets are recorded as gains (losses), net in selling, general and administrative expense in the condensed consolidated statements of operations. The amount of gains (losses), net included in selling, general and administrative expense were $6.9 million and $6.2 million for the three months ended December 31, 2015 and 2014, respectively. The amount of gains (losses), net included in selling, general and administrative expense were $(3.1) million and $4.4 million for the six months ended December 31, 2015 and 2014, respectively.
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 December 31, 2015
$
(36,429
)
 
$
(2,623
)
 
$
3,662

 
$
(15,129
)
 
$
(50,519
)
 
 
 
 
 
 
 
 
 
 
Balance as of June 30, 2015
$
(29,925
)
 
$
734

 
$
4,553

 
$
(15,935
)
 
$
(40,573
)
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
December 31,
 
Six months ended
December 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
 
$
324

 
$
1,933

 
$
1,009

 
$
2,202

 
 
Costs of revenues
 
(678
)
 
(475
)
 
(1,150
)
 
(516
)
 
 
Interest expense
 
189

 
126

 
378

 
126

 
 
Net gains reclassified from accumulated OCI
 
$
(165
)
 
$
1,584

 
$
237

 
$
1,812

 
 
 
 
 
 
 
 
 
 
 
Unrealized gains on available-for-sale securities
 
Other expense (income), net
 
$
26

 
$
281

 
$
43

 
$
1,916

The amounts reclassified out of accumulated OCI related to the Company’s defined benefit pension plans, which were recognized as a component of net periodic cost for the three and six months ended December 31, 2015 were $0.7 million and $1.0 million, respectively. The amounts reclassified out of accumulated OCI related to the Company’s defined benefit pension plans, which were recognized as a component of net periodic cost for the three and six months ended December 31, 2014 were $0.7 million and $1.5 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, 2015.

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Table of Contents

NOTE 4 – MARKETABLE SECURITIES
The amortized cost and fair value of marketable securities as of the dates indicated below were as follows:
As of December 31, 2015 (In thousands)
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
U.S. Treasury securities
$
274,142

 
$
12

 
$
(630
)
 
$
273,524

U.S. Government agency securities
404,990

 
71

 
(745
)
 
404,316

Municipal securities
7,719

 
2

 
(4
)
 
7,717

Corporate debt securities
707,685

 
61

 
(1,993
)
 
705,753

Money market and other
470,811

 

 

 
470,811

Sovereign securities
60,555

 
4

 
(44
)
 
60,515

Subtotal
1,925,902

 
150

 
(3,416
)
 
1,922,636

Add: Time deposits(1)
67,733

 

 

 
67,733

Less: Cash equivalents
635,535

 
3

 
(3
)
 
635,535

Marketable securities
$
1,358,100

 
$
147

 
$
(3,413
)
 
$
1,354,834

As of June 30, 2015 (In thousands)
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
U.S. Treasury securities
$
274,965

 
$
605

 
$
(15
)
 
$
275,555

U.S. Government agency securities
571,843

 
551

 
(126
)
 
572,268

Municipal securities
31,819

 
7

 
(10
)
 
31,816

Corporate debt securities
625,965

 
511

 
(515
)
 
625,961

Money market and other
611,385

 

 

 
611,385

Sovereign securities
57,091

 
33

 
(31
)
 
57,093

Subtotal
2,173,068

 
1,707

 
(697
)
 
2,174,078

Add: Time deposits(1)
29,941

 

 

 
29,941

Less: Cash equivalents
654,933

 

 

 
654,933

Marketable securities
$
1,548,076

 
$
1,707

 
$
(697
)
 
$
1,549,086

________________
(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 December 31, 2015 (In thousands)
Fair Value
 
Gross
Unrealized
Losses(1)
U.S. Treasury securities
$
250,397

 
$
(630
)
U.S. Government agency securities
298,143

 
(745
)
Municipal securities
3,005

 
(4
)
Corporate debt securities
584,219

 
(1,990
)
Sovereign securities
35,752

 
(44
)
Total
$
1,171,516

 
$
(3,413
)
__________________ 
(1)
As of December 31, 2015, 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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Table of Contents

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 December 31, 2015 (In thousands)
Amortized Cost
 
Fair Value
Due within one year
$
379,750

 
$
379,437

Due after one year through three years
978,350

 
975,397

 
$
1,358,100

 
$
1,354,834

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 December 31, 2015 and 2014 were immaterial, respectively. Realized gains on available-for-sale securities for the six months ended December 31, 2015 was immaterial and for the six months ended December 31, 2014 was $2.1 million. Realized losses on available-for-sale securities for the three and six months ended December 31, 2015 and 2014 were immaterial, respectively.
NOTE 5 – GOODWILL AND PURCHASED INTANGIBLE ASSETS
Goodwill
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 made certain organizational changes and consolidated its product divisions effective in the first quarter of fiscal year 2016, in response to changing customer requirements in the industry. As required by the authoritative guidance, when an entity reorganizes its reporting structure in a manner that changes the composition of one or more of its reporting units, goodwill is reassigned to the affected reporting units using a relative fair value allocation approach. The fair value of each reporting unit is compared to the fair value of the business immediately prior to the reorganization. The fair value for the Company’s reporting units was determined using a weighted combination of market-based and income-based approach. The Company has four reporting units as of December 31, 2015: Wafer Inspection, Patterning, Global Service and Support, and Others. The goodwill balance by reporting units as of December 31, 2015 were as follows:
(In thousands)
 
Wafer Inspection
 
Patterning
 
Others
 
Total
Balance as of June 30, 2015
 
$
332,783

(1) 
$
2,480

(2) 
$

 
$
335,263

Goodwill allocation
 
(51,671
)
(3) 
50,775

(3) 
896

(3) 

Goodwill adjustment
 
(58
)
 

 

 
(58
)
Balance as of December 31, 2015
 
$
281,054

 
$
53,255

 
$
896

 
$
335,205

__________________ 
(1)
The balance as of June 30, 2015, reflects goodwill for the Defect Inspection reporting unit under the old reporting structure which was renamed as Wafer Inspection under the new reporting structure after certain components were allocated out.
(2)
The balance as of June 30, 2015, reflects goodwill for the Metrology reporting unit under the old reporting structure which was renamed as Patterning under the new reporting structure after certain components were allocated in.
(3)
The reorganization resulted in certain goodwill balances to be reallocated as noted above.
The changes in the gross goodwill balance during the six months ended December 31, 2015 resulted from foreign currency translation adjustments.
The Company performed a qualitative assessment of the goodwill by reporting unit as of November 30, 2015 during the three months ended December 31, 2015 as part of its annual goodwill impairment assessment and concluded that it was more likely than not that the fair value of each of the reporting units exceeded its carrying amount. In assessing the qualitative factors, the Company considered the impact of key factors including change in industry and competitive environment, market capitalization, stock price, earnings multiples, budgeted-to-actual revenue performance from prior year, gross margin and cash flow from operating activities. As such, it was not necessary to perform the two-step quantitative goodwill impairment test at this time. 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, 2016. The next annual assessment of the goodwill by reporting unit will be performed in the second quarter of the fiscal year ending June 30, 2017.

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Table of Contents

Purchased Intangible Assets
The components of purchased intangible assets as of the dates indicated below were as follows:
(In thousands)
 
 
As of
December 31, 2015
 
As of
June 30, 2015
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

 
$
137,160

 
$
4,499

 
$
141,659

 
$
134,664

 
$
6,995

Patents
6-13 years
 
57,648

 
57,648

 

 
57,648

 
56,998

 
650

Trade name/Trademark
4-10 years
 
19,893

 
19,422

 
471

 
19,893

 
18,899

 
994

Customer relationships
6-7 years
 
54,980

 
53,016

 
1,964

 
54,980

 
51,724

 
3,256

Total
 
 
$
274,180

 
$
267,246

 
$
6,934

 
$
274,180

 
$
262,285

 
$
11,895

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 December 31, 2015 and 2014, amortization expense for intangible assets was $1.3 million and $4.0 million, respectively. For the six months ended December 31, 2015 and 2014, amortization expense for intangible assets was $5.0 million and $8.1 million, respectively. Based on the intangible assets recorded as of December 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)
2016 (remaining 6 months)
$
2,603

2017
2,806

2018
1,525

Total
$
6,934

NOTE 6 – DEBT
The following table summarizes the debt of the Company as of December 31, 2015 and June 30, 2015:
 
As of December 31, 2015
 
As of June 30, 2015
 
Amount
(In thousands)
 
Effective
Interest Rate
 
Amount
(In thousands)
 
Effective
Interest Rate
Fixed-rate 2.375% Senior notes due on November 1, 2017
$
250,000

 
2.396
%
 
$
250,000

 
2.396
%
Fixed-rate 3.375% Senior notes due on November 1, 2019
250,000

 
3.377
%
 
250,000

 
3.377
%
Fixed-rate 4.125% Senior notes due on November 1, 2021
500,000

 
4.128
%
 
500,000

 
4.128
%
Fixed-rate 4.650% Senior notes due on November 1, 2024(1)
1,250,000

 
4.682
%
 
1,250,000

 
4.682
%
Fixed-rate 5.650% Senior notes due on November 1, 2034
250,000

 
5.670
%
 
250,000

 
5.670
%
Term loans
651,250

 
 
 
711,250

 
 
Total debt
3,151,250

 
 
 
3,211,250

 
 
Unamortized discount
(3,518
)
 
 
 
(3,723
)
 
 
Unamortized debt issuance costs
(16,056
)
 
 
 
(17,111
)
 
 
Total debt
$
3,131,676

 
 
 
$
3,190,416

 
 
 
 
 
 
 
 
 
 
Reported as:
 
 
 
 
 
 
 
Current portion of long-term debt
$

 
 
 
$
16,981

 
 
Long-term debt
3,131,676

 
 
 
3,173,435

 
 
Total debt
$
3,131,676

 
 
 
$
3,190,416

 
 
__________________ 
(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%.

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Table of Contents

As of December 31, 2015, future principal payments for the long-term debt are summarized as follows. For fiscal year ending 2016, there are no scheduled payments since the Company made $61.3 million of principal prepayments on the term loans as of December 31, 2015.
Fiscal year ending June 30:
Amount
(In thousands)
2016 (remaining 6 months)
$

2017 (remaining 3 months of scheduled payments)
4,375

2018
315,625

2019
75,000

2020
756,250

Thereafter
2,000,000

Total payments
$
3,151,250

Senior Notes:
In November 2014, the Company issued $2.50 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 $1.00 billion in aggregate. For additional details, refer to Note 14, “Derivative Instruments and Hedging Activities.”
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. 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 December 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 December 31, 2015 and June 30, 2015 was approximately $2.52 billion, 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.

18

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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, 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. During the second quarter of fiscal quarter ended December 31, 2015, the Company prepaid additional principal of $20.0 million for the term loans.
Future principal payments for the Company’s term loans (without giving effect to $61.3 million of principal prepayments as of December 31, 2015 that shall be applied to the future scheduled quarterly payments) as of December 31, 2015, are as follows:
Fiscal Quarters Ending
 
Quarterly Payment
(In thousands)
March 31, 2016 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
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
The Company was in compliance with the financial covenants under the Credit Agreement as of December 31, 2015 and had no outstanding borrowings under the unfunded revolving credit facility.
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 7 – EQUITY AND LONG-TERM INCENTIVE COMPENSATION PLANS
Equity Incentive Program
As of December 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”).

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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 December 31, 2015, 4.9 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 December 31, 2015, 1.7 million shares were available for grant under the Outside Director Plan.
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
Balance as of June 30, 2015(1)(2)
7,810

Restricted stock units granted(3)(2)
(1,541
)
Restricted stock units canceled(2)
360

Balance as of December 31, 2015(1)(2)
6,629

__________________ 
(1)
The Company has granted only restricted stock units under its equity incentive program since October 2007, except 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.
(2)
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).
(3)
Includes restricted stock units granted to senior management during the six months ended December 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 December 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 six months ended December 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.


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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. For restricted stock units granted without “dividend equivalent” rights, fair value is calculated 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 December 31, 2015, the Company accrued $20.3 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 six months ended December 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. The fair value for purchase rights under the Company’s Employee Stock Purchase Plan is determined using a Black-Scholes valuation model.
The following table shows pre-tax stock-based compensation expense for the indicated periods: 
 
Three months ended
December 31,
 
Six months ended
December 31,
(In thousands)
2015
 
2014
 
2015
 
2014
Stock-based compensation expense by:
 
 
 
 
 
 
 
Costs of revenues
$
1,266

 
$
1,963

 
$
2,730

 
$
4,200

Engineering, research and development
2,269

 
3,335

 
4,761

 
7,075

Selling, general and administrative
7,790

 
9,550

 
16,082

 
19,056

Total stock-based compensation expense
$
11,325

 
$
14,848

 
$
23,573

 
$
30,331

The following table shows stock-based compensation capitalized as inventory as of the dates indicated below: 
(In thousands)
As of
December 31, 2015
 
As of
June 30, 2015
Inventory
$
3,583

 
$
3,242

Stock Options
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 December 31, 2015, the outstanding stock options are immaterial (all vested and exercisable).
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
December 31,
 
Six months ended
December 31,
(In thousands)
2015
 
2014
 
2015
 
2014
Total intrinsic value of options exercised
$
1

 
$
441

 
$
1

 
$
3,919

Total cash received from employees and non-employee Board members as a result of stock option exercises
$
1

 
$
540

 
$
1

 
$
5,217

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

 
$
152

 
$

 
$
1,769

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.

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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 six months ended December 31, 2015 and restricted stock units outstanding as of December 31, 2015 and June 30, 2015: 
Restricted Stock Units
Shares(1)
(In thousands)
 
Weighted-Average
Grant Date
Fair Value
Outstanding restricted stock units as of June 30, 2015
2,674

 
$
49.36

Granted(2)
770

 
$
51.12

Vested and released
(805
)
 
$
38.57

Withheld for taxes
(440
)
 
$
38.57

Forfeited
(192
)
 
$
54.87

Outstanding restricted stock units as of December 31, 2015
2,007

 
$
56.21

__________________ 
(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 1.8x or 2.0x (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 six months ended December 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 December 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 (i.e., 0.3 million shares during the six months ended December 31, 2015) 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.

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 restricted stock units granted to members of the board of directors vest on the first anniversary of the date of grant.
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
December 31,
 
Six months ended
December 31,
(In thousands, except for weighted-average grant date fair value)
2015
 
2014
 
2015
 
2014
Weighted-average grant date fair value per unit
$
66.83

 
$
81.28

 
$
51.12

 
$
74.56

Tax benefits realized by the Company in connection with vested and released restricted stock units
$
2,165

 
$
1,018

 
$
25,682

 
$
24,319

As of December 31, 2015, the unrecognized stock-based compensation expense balance related to restricted stock units was $76.1 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 1.7 years. The intrinsic value of outstanding restricted stock units as of December 31, 2015 was $139.2 million.

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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 six months ended December 31, 2015 and 2014, the Company approved Cash LTI awards of $47.1 million and $65.7 million, respectively 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 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 December 31, 2015 and 2014, the Company recognized $11.5 million and $10.7 million, respectively, in compensation expense under the Cash LTI Plan. During the six months ended December 31, 2015 and 2014, the Company recognized $21.4 million and $18.5 million, respectively, in compensation expense under the Cash LTI Plan. As of December 31, 2015, the unrecognized compensation balance (excluding the impact of estimated forfeitures) related to the Cash LTI Plan was $113.4 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 proposed merger of KLA-Tencor and Lam Research could shorten the offering period at the time of the close of the merger. Refer to Note 1, “Description of Business and Basis of Presentation” for additional details regarding the merger.
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
December 31,
 
Six months ended
December 31,
 
2015
 
2014
 
2015
 
2014
Stock purchase plan:
 
 
 
 
 
 
 
Expected stock price volatility
23.9
%
 
23.5
%
 
23.9
%
 
23.5
%
Risk-free interest rate
0.1
%
 
0.1
%
 
0.1
%
 
0.1
%
Dividend yield
3.7
%
 
2.7
%
 
3.7
%
 
2.7
%
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
December 31,
 
Six months ended
December 31,
2015
 
2014
 
2015
 
2014
Total cash received from employees for the issuance of shares under the ESPP
$
21,908

 
$
24,186

 
$
21,908

 
$
24,186

Number of shares purchased by employees through the ESPP
454

 
405

 
454

 
405

Tax benefits realized by the Company in connection with the disqualifying dispositions of shares purchased under the ESPP
$
339

 
$
106

 
$
719

 
$
1,189

Weighted-average fair value per share based on Black-Scholes model
$
11.34

 
$
14.66

 
$
11.34

 
$
14.66


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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. As of December 31, 2015, a total of 1.7 million shares were reserved and available for issuance under the ESPP.
Quarterly cash dividends
On November 4, 2015, the Company’s Board of Directors declared a regular quarterly cash dividend of $0.52 per share on the outstanding shares of the Company’s common stock, which was paid on December 1, 2015 to the stockholders of record as of the close of business on November 16, 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 December 31, 2015 reduced retained earnings by $79.0 million and the excess amount was charged against additional paid-in capital by $1.7 million as the Company did not have enough retained earnings balance available as of the declaration date due to the balance being absorbed by the activity under its stock repurchase program. The total amount of regular quarterly cash dividends paid by the Company during the three months ended December 31, 2015 and 2014 was $80.8 million and $82.3 million, respectively. The total amount of regular quarterly cash dividends paid by the Company during the six months ended December 31, 2015 and 2014 was $162.5 million and $164.7 million, respectively. The amount of accrued dividends for quarterly cash dividends for unvested restricted stock units with dividend equivalent rights as of December 31, 2015 and 2014 was $1.6 million and $0.4 million, respectively.
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 6, “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 December 31, 2015, the Company accrued a total of $18.7 million of dividends payable for the special cash dividend with respect to outstanding unvested restricted stock units, which will be paid when such underlying unvested restricted stock units vest. During the three and six months ended December 31, 2015, the total special cash dividends paid with respect to fully vested restricted stock units with dividend equivalent rights was $0.6 million and $20.5 million, respectively. The total amount of the special cash dividend accrued by the Company during the three and six 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, except for the aggregate special cash dividend of $43.0 million that was accrued for the unvested restricted stock units. 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.

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NOTE 8 – 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 were made in the open market in compliance with applicable securities laws, including the Securities Exchange Act of 1934 and the rules promulgated thereunder, such as Rule 10b-18. As of December 31, 2015, an aggregate of approximately 5.9 million shares were available for repurchase under the Company’s repurchase program. In connection with entering into the Merger Agreement with Lam Research, the Company suspended further repurchases under its repurchase program effective October 21, 2015.
Share repurchases for the indicated periods (based on the trade date of the applicable repurchase) were as follows:
 
Three months ended
December 31,
 
Six months ended
December 31,
(In thousands)
2015
 
2014
 
2015
 
2014
Number of shares of common stock repurchased
568

 
2,120

 
3,445

 
3,862

Total cost of repurchases
$
29,509

 
$
148,266

 
$
175,743

 
$
278,949

As of December 31, 2015, the Company had no unsettled share repurchases. As of December 31, 2014, the Company had repurchased 176,123 shares for $12.6 million, which repurchases had not settled prior to December 31, 2014. The amount was recorded as a component of other current liabilities for the period presented.
NOTE 9 – 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 restricted stock units and stock options had been issued. The dilutive effect of outstanding restricted stock units and options 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
December 31,
 
Six months ended
December 31,
2015
 
2014
 
2015
 
2014
Numerator:
 
 
 
 
 
 
 
Net income
$
152,207

 
$
20,268

 
$
257,104

 
$
92,501

Denominator:
 
 
 
 
 
 
 
Weighted-average shares-basic, excluding unvested restricted stock units
155,252

 
164,036

 
156,036

 
164,440

Effect of dilutive options and restricted stock units
744

 
1,281

 
935

 
1,510

Weighted-average shares-diluted
155,996

 
165,317

 
156,971

 
165,950

Basic net income per share
$
0.98

 
$
0.12

 
$
1.65

 
$
0.56

Diluted net income per share
$
0.98

 
$
0.12

 
$
1.64

 
$
0.56

Anti-dilutive securities excluded from the computation of diluted net income per share
139

 
32

 
182

 
13


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NOTE 10 – INCOME TAXES
The following table provides details of income taxes:

Three months ended
December 31,
 
Six months ended
December 31,
(Dollar amounts in thousands)
2015
 
2014
 
2015
 
2014
Income (loss) before income taxes
$
185,475

 
$
(6,268
)
 
$
319,774

 
$
92,739

Provision for (benefit from) income taxes
$
33,268

 
$
(26,536
)
 
$
62,670

 
$
238

Effective tax rate
17.9
%
 
423.4
%
 
19.6
%
 
0.3
%
The Company recognized a tax expense during the three months ended December 31, 2015 compared to a tax benefit during the three months ended December 31, 2014 primarily due to the impact of the following items:
Tax expense was decreased by $45.8 million during the three months ended December 31, 2014 related to a pre-tax net loss of $131.7 million due to the redemption of the 2018 Senior Notes;
Tax expense was decreased by $1.2 million during the three months ended December 31, 2014 compared to the three months ended December 31, 2015 due to the reinstatement of the U.S. federal research credit during the three months ended December 31, 2014 and during the three months ended December 31, 2015. Tax expense was decreased by $10.4 million during the three months ended December 31, 2014 when the Tax Increase Prevention Act of 2014 reinstated the research credit on December 19, 2014 retroactively to January 1, 2014 through December 31, 2014. Tax expense was decreased by $9.2 million during the three months ended December 31, 2015 when the Protecting Americans from Tax Hikes (PATH) Act of 2015 permanently reinstated the research credit on December 18, 2015 retroactively to January 1, 2015; and
Tax expense was decreased by $3.8 million during the three months ended December 31, 2014 related to a tax effect of a change in the tax accounting method.
Tax expense was higher as a percentage of income before taxes during the six months ended December 31, 2015 compared to the six months ended December 31, 2014 primarily due to the impact of the following items:
Tax expense was decreased by $45.8 million during the six months ended December 31, 2014 related to a pre-tax net loss of $131.7 million due to the redemption of the 2018 Senior Notes;
Tax expense was decreased by $1.2 million during the six months ended December 31, 2014 compared to the six months ended December 31, 2015 due to the reinstatement of the U.S. federal research credit during the six months ended December 31, 2014 and during the six months ended December 31, 2015. Tax expense was decreased by $10.4 million during the six months ended December 31, 2014 when the Tax Increase Prevention Act of 2014 reinstated the research credit on December 19, 2014 retroactively to January 1, 2014 through December 31, 2014. Tax expense was decreased by $9.2 million during the six months ended December 31, 2015 when the Protecting Americans from Tax Hikes (PATH) Act of 2015 permanently reinstated the research credit on December 18, 2015 retroactively to January 1, 2015;
Tax expense was decreased by $3.8 million during the six months ended December 31, 2014 related to a tax effect of a change in the tax accounting method; and
Tax expense was increased by $2.7 million during the six months ended December 31, 2015 related to a non-deductible decrease in the value of the assets held within the Company’s Executive Deferred Savings Plan.
In the normal course of business, the Company is subject to examination by tax authorities throughout the world. The Company is subject to United States federal income tax examination for all years beginning from the fiscal year ended June 30, 2012 and is under United States federal income tax examination for the fiscal year ended June 30, 2013. The Company is subject to state income tax examinations for all years beginning from the fiscal year ended June 30, 2011. 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, 2011. It is possible that certain examinations may be concluded in the next twelve months. The Company believes that it may recognize up to $19.1 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.

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NOTE 11 – LITIGATION AND OTHER LEGAL MATTERS
Litigation Related to Proposed Merger with Lam Research.
Hedgecock Lawsuit. On October 28, 2015, a complaint was filed in the California Superior Court for Santa Clara County against KLA-Tencor, the members of the KLA-Tencor Board, Lam Research, Merger Sub 1, and Merger Sub 2, which, together with Merger Sub 1 and Lam Research, are referred to as the “Lam Defendants.” The action, captioned Hedgecock v. KLA-Tencor Corp., et al., Case No. 115CV287329, was filed by a purported KLA-Tencor stockholder as a purported class action on behalf of all KLA-Tencor stockholders (excluding defendants and their affiliates) against all defendants. In the complaint, plaintiff alleges that the individual defendants (the KLA-Tencor Board) breached their fiduciary duties by, among other things, causing KLA-Tencor to agree to a merger transaction with the Lam Defendants at an unfair price and pursuant to an unfair process, and that the Lam Defendants aided and abetted such breaches. On December 21, 2015, plaintiff filed an amended complaint, in which plaintiff additionally alleges that the disclosures by KLA-Tencor and Lam Research concerning the transaction are materially misleading because they purportedly omit and/or misrepresent certain information. Plaintiff seeks to enjoin or rescind KLA-Tencor’s transaction with the Lam Defendants, as applicable, as well as an award of damages and attorney’s fees, in addition to other relief. KLA-Tencor believes this lawsuit has no merit and intend to defend against it vigorously. KLA-Tencor has determined a potential loss is reasonably possible however, based on its current knowledge, KLA-Tencor does not believe that the amount of such possible loss or a range of potential loss is reasonably estimable.
Karr Lawsuit. Also on October 28, 2015, another complaint was filed in the California Superior Court for Santa Clara County against KLA-Tencor, the members of the KLA-Tencor Board, Lam Research, Merger Sub 1, and Merger Sub 2. This action, captioned Karr v. KLA-Tencor Corporation, et al., Case No. 115CV287331, was filed by one of the same plaintiff’s law firms as in the Hedgecock action on behalf of a different purported KLA-Tencor stockholder, as a purported class action on behalf of all KLA-Tencor stockholders (excluding defendants and their affiliates) against all defendants. The allegations in the Karr complaint are similar to the allegations in the Hedgecock action. In the complaint, plaintiff alleges that the individual defendants (the KLA-Tencor Board) breached their fiduciary duties by, among other things, causing KLA-Tencor to agree to a merger transaction with the Lam Defendants at an unfair price and pursuant to an unfair process, and that KLA-Tencor and the Lam Defendants aided and abetted such breaches. On December 21, 2015, plaintiff filed an amended complaint, in which plaintiff additionally alleges that the disclosures by KLA-Tencor and Lam Research concerning the transaction are materially misleading because they purportedly omit and/or misrepresent certain information. Plaintiff seeks to enjoin or rescind KLA-Tencor’s transaction with the Lam Defendants, as applicable, as well as an award of attorney’s fees, in addition to other relief. KLA-Tencor believes this lawsuit has no merit and intend to defend against it vigorously. KLA-Tencor has determined a potential loss is reasonably possible however, based on its current knowledge, KLA-Tencor does not believe that the amount of such possible loss or a range of potential loss is reasonably estimable.
Rooney Lawsuit. On November 10, 2015, a complaint was filed in the Court of Chancery in the State of Delaware against the members of the KLA-Tencor Board. This action, captioned Rooney v. Wallace, et al., Case No. 11700, was filed on behalf of a purported KLA-Tencor stockholder, as a purported class action on behalf of all similarly-situated KLA-Tencor stockholders (excluding defendants and their affiliates) against all defendants. The allegations in the Rooney complaint are similar to the allegations in the Hedgecock and Karr actions. In the complaint, plaintiff alleges that the defendants (the KLA-Tencor Board) breached their fiduciary duties by, among other things, causing KLA-Tencor to agree to a merger transaction with Lam Research at an unfair price and pursuant to an unfair process. On December 23, 2015, plaintiff filed an amended complaint, in which plaintiff additionally alleges that the disclosures by KLA-Tencor and Lam Research concerning the transaction are materially misleading because they purportedly omit and/or misrepresent certain information. Plaintiff seeks to enjoin or rescind KLA-Tencor’s transaction with Lam Research, as applicable, as well as an award of attorney’s fees, in addition to other relief. KLA-Tencor believes this lawsuit has no merit and intend to defend against it vigorously. KLA-Tencor has determined a potential loss is reasonably possible however, based on its current knowledge, KLA-Tencor does not believe that the amount of such possible loss or a range of potential loss is reasonably estimable.

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Spoleto Lawsuit. On December 29, 2015, another complaint was filed in the California Superior Court for Santa Clara County against KLA-Tencor, the members of the KLA-Tencor Board, Lam Research, Merger Sub 1, and Merger Sub 2. This action, captioned Spoleto Corp. v. Wallace, et al., Case No. 115CV289552, was filed by another purported KLA-Tencor stockholder as a purported class action on behalf of all KLA-Tencor stockholders (excluding defendants and their affiliates) against all defendants. The allegations in the Spoleto complaint are similar to the allegations in the Hedgecock, Karr, and Rooney actions. In the complaint, plaintiff alleges that the individual defendants (the KLA-Tencor Board) breached their fiduciary duties by, among other things, causing KLA-Tencor to agree to a merger transaction with the Lam Defendants at an unfair price and pursuant to an unfair process, and making disclosures concerning the transaction that are materially misleading. Plaintiff alleges that the Lam Defendants aided and abetted such breaches. Plaintiff seeks to enjoin or rescind KLA-Tencor’s transaction with the Lam Defendants, as applicable, as well as an award of damages and attorney’s fees, in addition to other relief. KLA-Tencor believes this lawsuit has no merit and intend to defend against it vigorously. KLA-Tencor has determined a potential loss is reasonably possible however, based on its current knowledge, KLA-Tencor does not believe that the amount of such possible loss or a range of potential loss is reasonably estimable.
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.
For additional discussion of certain risks associated with legal proceedings, see Part II, Item 1A, “Risk Factors.”
NOTE 12 – COMMITMENTS AND CONTINGENCIES
Merger-related Commitment and Fees. KLA-Tencor has an agreement with a financial advisor in relation to the pending merger with Lam Research. KLA-Tencor has agreed to pay the third party a fee of approximately $58.0 million, $0.1 million of which was paid upon the execution of the engagement letter and $5.0 million of which was paid upon delivery of the fairness opinion, and the remaining portion of which will be paid upon, and subject to, consummation of the merger (provided that the final actual fee will be, in part, based on an average of the closing prices of Lam Research common stock over ten trading days approaching the closing of the merger). During the three months ended December 31, 2015, $5.1 million of the fees were recorded in selling, general and administrative line of the condensed consolidated statements of operations. In addition, the merger agreement contains certain termination rights for KLA-Tencor and further provides that KLA-Tencor, as applicable, may be required to pay a termination fee of $290.0 million to Lam Research.
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
December 31,
 
Six months ended
December 31,
(In thousands)
2015
 
2014
 
2015
 
2014
Receivables sold under factoring agreements
$
41,756

 
$
47,598

 
$
75,600

 
$
73,218

Proceeds from sales of LCs
$
4,062

 
$

 
$
4,062

 
$
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.

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Facilities. KLA-Tencor leases certain of its facilities under arrangements that are accounted for as operating leases. Rent expense was $2.2 million and $2.3 million for the three months ended December 31, 2015 and 2014, respectively. Rent expense was $4.3 million and $4.6 million for the six months ended December 31, 2015 and 2014, respectively.
The following is a schedule of expected operating lease payments:
Fiscal year ending June 30,
Amount
(In thousands)
2016 (remaining 6 months)
$
4,001

2017
6,354

2018
4,162

2019
1,983

2020
1,248

2021 and thereafter
549

Total minimum lease payments
$
18,297

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 $334.1 million as of December 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 December 31, 2015, the Company had committed $125.4 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 regular basis. The actual product performance and/or field expense profiles may differ, and in those cases the Company adjusts its warranty accruals accordingly.
The following table provides the changes in the product warranty accrual for the indicated periods:
 
Three months ended
December 31,
 
Six months ended
December 31,
(In thousands)
2015
 
2014
 
2015
 
2014
Beginning balance
$
35,892

 
$
33,059

 
$
36,413

 
$
37,746

Accruals for warranties issued during the period
10,733

 
10,212

 
19,772

 
17,191

Changes in liability related to pre-existing warranties
(3,411
)
 
704

 
(3,594
)
 
(766
)
Settlements made during the period
(7,066
)
 
(9,565
)
 
(16,443
)
 
(19,761
)
Ending balance
$
36,148

 
$
34,410

 
$
36,148

 
$
34,410

The Company maintains guarantee arrangements available through various financial institutions for up to $25.6 million, of which $22.2 million had been issued as of December 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.

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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