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KLA-Tencor 10-K 2010
Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

   For the Fiscal Year Ended June 30, 2010

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 No. 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 Number)

One Technology Drive, Milpitas, California   95035
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s Telephone Number, Including Area Code: (408) 875-3000

Securities Registered Pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Stock, $0.001 par value per share   The NASDAQ Stock Market LLC
Common Stock Purchase Rights   The NASDAQ Stock Market LLC

 

 

Securities Registered Pursuant to Section 12(g) of the Act:

None

(Title of Class)

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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  ¨    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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  ¨ (Do not check if a smaller reporting  company)    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

The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant based upon the closing price of the registrant’s stock, as of December 31, 2009, was $6.2 billion. Shares of common stock held by each officer and director and by each person or group who owns 10% or more of the outstanding common stock have been excluded in that such persons or groups may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

The registrant had 167,831,465 shares of common stock outstanding as of July 22, 2010.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2010 Annual Meeting of Stockholders to be held on November 3, 2010 (“Proxy Statement”), and to be filed pursuant to Regulation 14A within 120 days after the registrant’s fiscal year ended June 30, 2010, are incorporated by reference into Part III of this report.

 

 

 


Table of Contents

INDEX

 

  

Special Note Regarding Forward-Looking Statements

   ii
PART I
Item 1.   

Business

   1
Item 1A.   

Risk Factors

   15
Item 1B.   

Unresolved Staff Comments

   28
Item 2.   

Properties

   28
Item 3.   

Legal Proceedings

   29
Item 4.   

(Removed and Reserved)

   30
PART II
Item 5.   

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   31
Item 6.   

Selected Financial Data

   33
Item 7.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   34
Item 7A.   

Quantitative and Qualitative Disclosures About Market Risk

   56
Item 8.   

Financial Statements and Supplementary Data

   57
  

Consolidated Balance Sheets as of June 30, 2010 and June 30, 2009

   58
  

Consolidated Statements of Operations for each of the three years in the period ended June 30, 2010

   59
  

Consolidated Statements of Stockholders’ Equity for each of the three years in the period ended June 30, 2010

   60
  

Consolidated Statements of Cash Flows for each of the three years in the period ended June 30, 2010

   61
  

Notes to Consolidated Financial Statements

   62
  

Report of Independent Registered Public Accounting Firm

   109
Item 9.   

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   110
Item 9A.   

Controls and Procedures

   110
Item 9B.   

Other Information

   111
PART III
Item 10.   

Directors, Executive Officers and Corporate Governance

   112
Item 11.   

Executive Compensation

   112
Item 12.   

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   112
Item 13.   

Certain Relationships and Related Transactions, and Director Independence

   112
Item 14.   

Principal Accounting Fees and Services

   112
PART IV
Item 15.   

Exhibits, Financial Statement Schedule

   113
  

Signatures

   118
  

Schedule II Valuation and Qualifying Accounts

   119
  

Exhibit Index

   120

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical fact may be forward-looking statements. You can identify these and other forward-looking statements by the use of words such as “may,” “will,” “could,” “would,” “should,” “expects,” “plans,” “anticipates,” “relies,” “believes,” “estimates,” “predicts,” “intends,” “potential,” “continue,” “thinks,” “seeks,” or the negative of such terms, or other comparable terminology. Forward-looking statements also include the assumptions underlying or relating to any of the foregoing statements. Such forward-looking statements include, among others, forecasts of the future results of our operations; the percentage of spending that our customers allocate to process control; orders for our products and capital equipment generally; sales of semiconductors; the allocation of capital spending by our customers; growth of revenue in the semiconductor industry, the semiconductor capital equipment industry and our business; technological trends in the semiconductor industry; future developments or trends in the global capital and financial markets; the future impact or outcome of litigation or government investigations or audits; our future product offerings and product features; the success and market acceptance of new products; timing of shipment of backlog; the future of our product shipments and our product and service revenues; our future gross margins; our future research and development expenses and selling, general and administrative expenses; the future cost savings to be realized from our recent cost reduction efforts; international sales and operations; our ability to maintain or improve our existing competitive position; success of our product offerings; creation and funding of programs for research and development; attraction and retention of employees; results of our investment in leading edge technologies; the effects of hedging transactions; the effect of the sale of trade receivables and promissory notes from customers; our future income tax rate; dividends; the completion of any acquisitions of third parties, or the technology or assets thereof; benefits received from any acquisitions and development of acquired technologies; sufficiency of our existing cash balance, investments and cash generated from operations to meet our operating and working capital requirements; and the adoption of new accounting pronouncements.

Our actual results may differ significantly from those projected in the forward-looking statements in this report. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in Item 1A, “Risk Factors” in this Annual Report on Form 10-K, as well as in Item 1, “Business” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this report. You should carefully review these risks and also review the risks described in other documents we file from time to time with the Securities and Exchange Commission, including the Quarterly Reports on Form 10-Q that we will file in the fiscal year ending June 30, 2011. You are cautioned not to place undue reliance on these forward-looking statements, and we expressly assume no obligation to update the forward-looking statements in this report after the date hereof.

 

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PART I

 

ITEM 1. BUSINESS

The Company

KLA-Tencor Corporation (“KLA-Tencor” or the “Company” and also referred to as “we” or “our”) is a leading supplier of process control and yield management solutions for the semiconductor and related nanoelectronics industries. Our products are also used in a number of other industries, including the high brightness light emitting diode (“HBLED”), data storage and photovoltaic industries, as well as general materials research.

Within our primary area of focus, our comprehensive portfolio of products, services, software and expertise helps integrated circuit (“IC” or “chip”) manufacturers manage yield throughout the entire semiconductor fabrication process—from research and development to final volume production. These products and solutions are designed to help customers accelerate their development and production ramp cycles, to achieve higher and more stable semiconductor die yields, and to improve overall profitability.

KLA-Tencor’s products and services are used by the vast majority of wafer, IC, reticle and disk manufacturers in the world. These customers turn to us for inline wafer and IC defect monitoring, review and classification; reticle defect inspection and metrology; packaging and interconnect inspection; critical dimension (“CD”) metrology; pattern overlay metrology; film thickness, surface topography and composition measurements; measurement of in-chamber process conditions, wafer shape and stress metrology; computational lithography tools; and overall yield and fab-wide data management and analysis systems. Our advanced products, coupled with our unique yield management services, allow us to deliver the solutions our customers need to accelerate their yield learning rates and significantly reduce their risks and costs.

Certain industry and technical terms used in this section are defined in the subsection entitled “Glossary” found at the end of this Item 1.

KLA-Tencor Corporation was formed in April 1997 through the merger of KLA Instruments Corporation and Tencor Instruments, two long-time leaders in the semiconductor equipment industry that had originally begun operations in 1975 and 1976, respectively.

Additional information about KLA-Tencor is available on our Web site at www.kla-tencor.com. We make available free of charge on our Web site our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file them with or furnish them to the Securities and Exchange Commission (“SEC”). Information contained on our Web site is not part of this Annual Report on Form 10-K or our other filings with the SEC. Additionally, these filings may be obtained through the SEC’s Web site (www.sec.gov), which contains reports, proxy and information statements, and other information regarding issuers that file electronically. Documents that are not available through the SEC’s Web site may also be obtained by mailing a request to the U.S. Securities and Exchange Commission, Office of FOIA/PA Operations, 100 F Street N.E., Washington, DC 20549-2736, by submitting an online request form at the SEC’s Web site or by sending a fax to the SEC at 1-202-772-9337.

Industry

General Background

The semiconductor industry is KLA-Tencor’s core focus. The semiconductor fabrication process begins with a bare silicon wafer—a round disk that is six, eight or twelve inches in diameter, about as thick as a credit card and gray in color. The process of manufacturing wafers is itself highly sophisticated, involving the creation of large ingots of silicon by pulling them out of a vat of molten silicon. The ingots are then sliced into wafers and polished to a mirror finish.

 

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The manufacturing cycle of an IC is grouped into three phases: design, fabrication and testing. IC design involves the architectural layout of the circuit, as well as design verification and reticle generation. The fabrication of a chip is accomplished by depositing a series of film layers that act as conductors, semiconductors or insulators on bare wafers. The deposition of these film layers is interspersed with numerous other process steps that create circuit patterns, remove portions of the film layers, and perform other functions such as heat treatment, measurement and inspection. Most advanced chip designs require hundreds of individual steps, many of which are performed multiple times. Most chips consist of two main structures: the lower structure, typically consisting of transistors or capacitors which perform the “smart” functions of the chip; and the upper “interconnect” structure, typically consisting of circuitry which connects the components in the lower structure. When all of the layers on the wafer have been fabricated, each chip on the wafer is tested for functionality. The wafer is then cut into individual devices, and those chips that passed functional testing are packaged. Final testing is performed on all packaged chips.

Current Trends

Companies that anticipate future market demands by developing and refining new technologies and manufacturing processes are better positioned to lead in the semiconductor market. Accelerating the yield ramp and maximizing production yields of high-performance devices are key goals of modern semiconductor manufacturing. Ramping to high-volume production ahead of competitors can dramatically increase the revenue an IC manufacturer realizes for a given product. During past industry cycles, semiconductor manufacturers generally contended with a few key new technologies or market trends, such as a specific design rule shrink. In today’s market, driven by consumer demand for low-cost electronic goods from smart phones and MP3 players to laptops and portable devices, the leading semiconductor manufacturers are investing in bringing a multitude of new process technologies into production at the same time, some requiring new substrate and film materials, new geometries and advanced lithography techniques.

While many of these technologies have been adopted at the development and pilot production stages of chip manufacturing, significant challenges and risks associated with each technology have affected their adoption into full-volume production. For example, as design rules decrease, yields become more sensitive to the size and density of defects, while device performance characteristics (namely speed, capacity or power management) become more sensitive to such parameters as linewidth and film thickness variation. New process materials, such as high-k dielectrics, silicon-on-insulator (“SOI”) wafers and immersion lithography-capable photoresists, require extensive characterization before they can be used in the manufacturing process. Moving several of these advanced technologies into production at once only adds to the risks that chipmakers face.

The continuing evolution of semiconductor devices to smaller geometries and more complex multi-level circuitry has significantly increased the performance and cost requirements of the capital equipment used to manufacture these devices. Construction of an advanced wafer fabrication facility today can cost over $5 billion, substantially more than previous generation facilities. In addition, chipmakers are demanding increased productivity and higher returns from their manufacturing equipment and are also seeking ways to extend the performance of their existing equipment.

By developing new process control and yield management tools that help chipmakers accelerate the adoption of these new technologies into volume production, we enable our customers to better leverage these increasingly expensive facilities and significantly improve their return on investment (“ROI”). Once customers’ production lines are operating at high volume, our tools help ensure that yields are stable and process excursions are identified for quick resolution. In addition, the move to each new generation’s smaller design rules, coupled with new materials and device innovation, has increased in-process variability, which requires an increase in inspection and metrology sampling.

KLA-Tencor systems not only analyze defectivity and metrology issues at critical points in the wafer, reticle and IC manufacturing processes, but also provide information to our customers so that they can identify and address the underlying process problems. The ability to locate the source of defects and resolve the underlying

 

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process issues enables our customers to improve control over their manufacturing processes. This helps them increase their yield of high-performance parts and deliver their products to market ahead of their competitors—thus maximizing their profit. With our broad portfolio of application-focused technologies and our dedicated yield technology expertise, we are in position to be a key supplier of comprehensive yield management solutions for customers’ next-generation products, including those required for the 32nm chip generation and beyond.

Products

KLA-Tencor is engaged primarily in the design, manufacture and marketing of process control and yield management solutions for the semiconductor and related nanoelectronics industries.

KLA-Tencor’s offerings can be broadly categorized into the following groups: Chip Manufacturing, Wafer Manufacturing, Reticle Manufacturing, Complementary Metal-Oxide-Semiconductor (CMOS) Image Sensors Manufacturing, Data Storage Media/Head Manufacturing, Solar Manufacturing, HBLED Manufacturing and Other Technologies, Microelectromechanical Systems (MEMS) Manufacturing, and General Purpose/Lab Applications. We also provide refurbished KLA-Tencor Certified™ tools for our customers manufacturing larger design-rule devices, as well as comprehensive service and support for our products.

Chip Manufacturing

KLA-Tencor’s comprehensive portfolio of defect inspection, review, metrology, in-situ process monitoring and lithography modeling tools help chip manufacturers manage yield throughout the entire fabrication process—from research and development to final volume production. These products and solutions are designed to help fabs accelerate their development and production ramp cycles, to achieve higher and more stable semiconductor die yields, and to improve overall profitability.

Front-End Defect Inspection

KLA-Tencor’s front-end defect inspection tools cover a broad range of yield applications within the IC manufacturing environment, including research and development, incoming wafer qualification, reticle qualification, and tool, process and line monitoring. Patterned and unpatterned wafer inspectors find particles, pattern defects and electrical issues on the front surface, back surface and edge of the wafer, allowing engineers to detect and monitor critical yield excursions. Fabs rely on our high sensitivity reticle inspection systems to identify defects in reticles at an early stage, to prevent reticle defects from printing on production wafers. The defect data generated by our inspectors is compiled and reduced to relevant root-cause and yield-analysis information with our suite of data management tools. By implementing our front-end defect inspection and analysis systems, chipmakers are able to take quick corrective action, resulting in faster yield improvement and better time to market.

In fiscal year 2010, we launched two families of front-end defect inspection products that help accelerate yield for 32nm design node devices. Our 2830 Series broadband wafer inspection platform uses a high-power plasma light source to illuminate defect types whose size or location previously made them very difficult to consistently detect. In addition, the Puma™ 9500 Series narrowband wafer inspection platform incorporates new optics and image acquisition technology that improve the tool’s resolution and speed compared to its predecessor.

The products that we launched during fiscal year 2010 further strengthened our broad range of offerings that support the front-end defect inspection market. In the field of patterned wafer inspection, for example, we offer our 2367, 2810 Series, 2820 Series and 2830 Series systems (for broadband optical defect inspection); our Puma 9100 Series and 9500 Series systems (for narrowband optical defect inspection); and our eS35 system (for e-beam defect inspection). In the field of unpatterned wafer and surface inspection, our primary offering is our Surfscan® SP Series (a series of wafer defect inspection systems for process tool qualification and monitoring using blanket films and bare wafers), to which our SURFmonitorTM module

 

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may be added to enable capture of low-contrast defects. For reticle inspection, we offer our TeraFabTM products, which are photomask inspection systems that allow IC fabs to qualify incoming reticles and inspect production reticles for contaminants. In addition, we offer a number of other products for the front-end defect inspection market, as reflected in the product table at the conclusion of this “Products” section.

Back-End Defect Inspection

KLA-Tencor offers a series of standalone inspection systems for various applications in the field of semiconductor packaging (i.e., at the back-end of the semiconductor manufacturing process). Our Component Inspector (“CI”) products inspect various semiconductor components that are handled in a tray, such as microprocessors or memory chips. Component inspection capability includes 3D coplanarity inspection, measurement of the evenness of the contacts, and 2D surface inspection. Our Wafer Inspector (“WI”) products inspect either undiced wafers or diced wafers mounted on film frame carriers. They inspect the surface quality of the wafers, the quality of the wafer cutting or wafer bumps.

Defect Review

KLA-Tencor’s defect review systems capture high resolution images of the defects detected by inspection tools. These images enable defect classification, helping chipmakers to identify and resolve yield issues. Our complete line of defect review and classification tools spans optical and electron-beam technologies, from bench-top research systems to production-worthy tools having full factory automation. KLA-Tencor’s suite of defect inspectors, defect review and classification tools and data management systems form a broad solution for finding, identifying and tracking yield-critical defects and process issues.

In July 2009 we introduced the eDRTM-5210, an e-beam review and classification system that features second-generation electromagnetic-field immersion technology, engineered to deliver very high quality images and, consequently, accurate defect classification results.

Metrology

KLA-Tencor’s array of metrology solutions addresses integrated circuit, substrate, photovoltaic solar cell and medical device manufacturing, as well as scientific research and other applications. Precise metrology and control of pattern dimensions, film thicknesses, layer-to-layer alignment, pattern placement, surface topography and electro-optical properties are growing in importance in many industries as critical dimensions narrow, film thicknesses shrink to countable numbers of atomic layers and devices become more complex. In June 2010, we announced the Archer® 300 LCM overlay metrology system. With smaller device CDs and the advent of innovative patterning technologies, tolerances for proper alignment of successive patterned layers have become more stringent. The new overlay metrology system has increased precision and introduces the capability for overlay control at the sub-die level in order to meet industry requirements.

In-Situ Process Monitoring

KLA-Tencor’s SensArray® SensorWafers series provides a unique way, not available from conventional equipment monitors, to capture the effect of the process environment on production wafers. Measurements, such as temperature and radio frequency voltage, are used by both chipmakers and process equipment manufacturers to visualize, diagnose and control their processes and process tools. SensArray products are used in many semiconductor and flat panel display fabrication processes, including lithography, etch and deposition.

 

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Lithography Modeling

KLA-Tencor’s PROLITH™ product line provides researchers at advanced IC manufacturers, lithography hardware suppliers, track companies and material providers with virtual lithography software to explore critical-feature designs, manufacturability and process-limited yield of proposed lithographic technologies without the time and expense of printing hundreds of test wafers using experimental materials and prototype process equipment.

In February 2010, we launched PROLITH X3.1, which enables researchers at leading-edge chipmakers, consortia and equipment makers to quickly and cost-effectively troubleshoot challenging issues in EUV and double patterning lithography (DPL) processes.

Wafer Manufacturing

KLA-Tencor’s wafer manufacturing tools include inspection, metrology and data management systems. Specialized inspection tools assess surface quality and detect, count and bin defects during the wafer manufacturing process and as a critical part of outgoing inspection. Wafer geometry tools ensure the wafer is extremely flat and uniform in thickness, with precisely controlled surface topography. Specifications for wafer defectivity, geometry and surface quality are tightening as the dimensions of transistors become so small that the properties of the substrate can substantially affect transistor performance.

Key products in the wafer manufacturing field include our Surfscan SP series systems, which offer defect and surface quality inspection for polished wafers, epi wafers and engineered substrates, as well as SURFmonitor, an optional module for Surfscan SP2 and Surfscan SP2XP systems that performs both surface and defect inspection (by monitoring process drift and capturing low-contrast defects) as well as wafer geometry and nanotopography metrology (by indicating sub-Angstrom surface topography variation on bare substrates). Other products that we offer for the wafer manufacturing market are highlighted in the product table at the conclusion of this “Products” section.

Reticle Manufacturing

Error-free reticles, or masks, are the first step in achieving high semiconductor device yields, since reticle defects can be replicated on production wafers. KLA-Tencor offers high sensitivity reticle inspection and metrology systems for mask shops, designed to help them manufacture reticles that are free of any relevant defects and meet mask metrology requirements. The reticle inspection systems use optical imaging and multiple inspection modes to find numerous types of reticle defects prior to printing on the wafer. The metrology systems enable quality reticle manufacturing by providing outstanding precision for reticle pattern placement and accurate measurement of reticles’ critical dimensions.

In September 2009, we launched a new reticle inspection platform for mask shop applications, the TeronTM 600 Series. Addressing a major transition in mask design below the 32nm node, our Teron 600 Series introduces programmable scanner-illumination capability and improved sensitivity and computational lithography power over its predecessor. These advances are necessary to enable development and manufacturing of the innovative reticles used at sub-32nm nodes.

The new Teron 600 Series adds to our existing reticle inspection portfolio, which includes our TeraScanTM XR system (for mask shop production of reticles for the 32nm node and above) and our TeraFab products.

CMOS Image Sensors Manufacturing

Image sensors are devices that convert light into electrical signal, for use primarily in cameras. As yield-limiting defects can occur at any step in the assembly process, inspecting the filter or micro-lens layers can help reduce materials waste and cycle time.

 

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In October 2009, we launched the 8900 defect inspection system, a new tool for the CMOS Image Sensor market. The 8900 is designed to enable capture of a wide variety of defect types, with adjustable sensitivity and throughput settings for cost-effective defect management from initial product development through volume production of color filter arrays.

Data Storage Media/Head Manufacturing

Growth in data storage is being driven by a wave of innovative consumer electronics with small form factors and immense storage capacities, as well as an increasing need for high-volume storage options to back up new methods of remote computing and networking (such as cloud computing). Our process control and yield management solutions are designed to enable customers to rapidly understand and resolve complex manufacturing problems, which can help improve time to market and product yields. In the front-end and back-end of thin-film head wafer manufacturing, we offer the same process control equipment that we serve to the semiconductor industry. In addition, we offer an extensive range of test equipment and surface profilers with particular strength in photolithography and magnetics control. In substrate and media manufacturing, we offer metrology and defect inspection solutions with KLA-Tencor’s optical surface analyzers and magneto-optical mappers.

Solar Manufacturing

Photovoltaic or “solar” cells are used to produce electrical power from light. The continuing growth of the solar industry is closely related to the production cost of solar cells, as economic viability increases with lowering prices. To address our customers’ needs in this important industry, KLA-Tencor offers both surface profilers and solar wafer and cell inspection modules which are integrated in different stages of the solar wafer and cell production lines to increase yield and lower production costs.

KLA-Tencor’s ICOS® PVI inspection modules are designed for high speed, automated, optical in-line inspection of both the front and backside of monocrystalline and polycrystalline solar wafers and cells, as well as optical classification of solar cells at the final stage of the production flow. The P-6TM surface profiling system provides stylus profiling and analysis of surface topography for issues such as roughness, film stress and curvature for solar cell samples up to 150mm.

HBLED Manufacturing and Other Technologies

HBLEDs are becoming more commonly used in solid-state lighting, television and notebook backlighting, and automotive applications. As HBLED device makers target aggressive cost and performance targets, they place significant emphasis on improved process control and yield during the manufacturing process.

In December 2009, we launched the ICOS WI-2250 wafer inspector, which allows defect inspection of patterned whole and diced wafers up to 200mm, with macro inspection sensitivity in the pre- and post-dice inspection (i.e., front- and back-end) of HBLED and MEMS products.

In addition, Candela® technology is used by industry leaders in HBLED, single-crystalline thin film, silicon carbide and semiconductor industries to monitor production lines, identify mission critical defects of interest, and create process-specific recipes to detect and classify killer defects (including pits, cracks and stains from epi and substrate processes that impact yield and field reliability) while ignoring nuisance defects. Our Candela Optical Surface Analyzer inspection technology is being used by leaders in the HBLED manufacturing industry to optimize epi productivity through improved process control.

MEMS Manufacturing

The increasing demand for MEMS technology is coming from diverse industries such as automotive, space and consumer electronics. MEMS have the potential to revolutionize nearly every product category by bringing

 

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together silicon-based microelectronics with micromachining technology, making possible the realization of complete systems-on-a-chip. KLA-Tencor offers the tools and techniques, first developed for the integrated circuit industry, for this emerging market.

General Purpose/Lab Applications

A range of industries, including general scientific and materials research and optoelectronics require measurements of surface topography to either control their processes or research new material characteristics. Typical measurement parameters that our tools address include flatness, roughness, curvature, peak-to-valley, asperity, waviness, texture, volume, sphericity, slope, density, stress, bearing ratio and distance (mainly in the micron to nanometer range).

K-T CertifiedTM

K-T Certified is our certified refurbished tools program that delivers fully refurbished and tested tools to our customers with guaranteed performance. In addition to high-quality pre-owned 300mm and <200mm tools for the integrated circuit, reticle, substrate, MEMS and data storage markets, K-T Certified also offers system software and hardware performance upgrades to extend the capabilities of existing equipment. When a customer needs to move to the next manufacturing node, K-T Certified can help maximize existing assets through its repurchase, trade-in and redeployment services.

K-T ServicesTM

Our K-T Services program enables our customers in all business sectors to maintain the high performance and productivity of our products through a flexible portfolio of services. Whether a manufacturing site is producing integrated circuits, wafers or reticles, K-T Services delivers yield management expertise spanning advanced technology nodes, including collaboration with customers to determine the best products and services to meet technology requirements and optimize cost of ownership. Our comprehensive services include: proactive management of tools to identify and improve performance; expertise in optics, image processing and motion control with worldwide service engineers, 24/7 technical support teams and knowledge management systems; and an extensive parts network to ensure worldwide availability of parts.

 

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Product Table

The following table presents a representative list of the products that we offered during the course of the fiscal year ended June 30, 2010:

 

MARKETS    APPLICATIONS    PRODUCTS

Chip Manufacturing

       

Front-End Defect Inspection

   Patterned Wafer   

2367, 2810 Series, 2820 Series,

2830 Series

PumaTM 9100 and 9500 Series

eS35

   Macro and Edge   

VisEdge®

LDS

8900

   Unpatterned Wafer/Surface   

Surfscan® SP1 and SP2 Series

SURFmonitorTM

   Reticle    TeraFab TM
   Data Management    Klarity ® product family

Back-End Defect Inspection

   Component Inspection    ICOS® CI product family
   Wafer Inspection    ICOS® WI product family

Defect Review

   e-beam    eDR TM-5210 Series
   Optical    INM, INS & IRIS product families

Metrology

   Overlay    Archer®
   Optical CD    SpectraCD TM
   Film Thickness/Index   

AlerisTM

SpectraFxTM

   Wafer Geometry and Topography   

WaferSight TM

SURFmonitorTM

   Ion Implant and Anneal    Therma-Probe ®
   Surface Metrology   

HRP®-350

P-Series product family

   Resistivity    RS product family
   Data Management    K-T Analyzer®
     Lithography    SensArray ® product family

In-Situ Process Monitoring

   Plasma Etch    SensArray ® product family
   Implant and Wet    SensArray ® PlasmaSuite

Lithography Modeling

        PROLITH TM and related product families

 

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APPLICATIONS    PRODUCTS

Wafer Manufacturing

    

Surface and Defect Inspection

  

Surfscan® SP1 and SP2 Series

SURFmonitorTM

VisEdge®

Wafer Geometry and Nanotopography Metrology

  

WaferSightTM

SURFmonitorTM

Data Management

   FabVisionTM

Reticle Manufacturing

    

Defect Inspection

  

TeraScanTMXR

TeronTM Series

Pattern Placement Metrology

   LMS IPRO4

CMOS Image Sensors Manufacturing

    

Defect Inspection

   8900

Data Storage Media/Head Manufacturing

    

Wafer and Slider Test

  

AlerisTM

HRP®-250

PROLITHTM product family

RS product family

SpectraCD TM 200

Media Test

   Candela® product family

Defect Review

   INM product family

Solar Manufacturing

    

Surface Metrology

   P-Series product family

Optical Inspection

   PVI-6

HBLED Manufacturing

    

Wafer Inspection

   ICOS® WI product family

Defect Inspection

   Candela® product family

Surface Metrology

   P-Series product family

MEMS Manufacturing

    

Stylus ProfilingSurface Metrology

   P-Series product family

Sealing Inspection

   IRIS

Defect Review

   INM & IRIS product families

General Purpose, Labs

    

Stylus ProfilingSurface Metrology

  

P-Series product family

Alpha-Step® product family

Optical Profiling

   MicroXAM-100

Process Chamber Conditions

   SensArray® product family

 

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Customers

To support our growing global customer base, we maintain a significant presence throughout Asia, the United States and Europe, staffed with local sales and applications engineers, customer and field service engineers and yield management consultants. We count among our largest customers the leading semiconductor manufacturers in each of these regions. For the fiscal year ended June 30, 2010, two customers, Taiwan Semiconductor Manufacturing Company Limited and Intel Corporation, each accounted for more than 10% of our total revenues. For the fiscal year ended June 30, 2009, two customers, Intel Corporation and Samsung Electronics Co., Ltd., each accounted for more than 10% of our total revenues. In the fiscal year ended June 30, 2008, no customer accounted for more than 10% of our total revenues.

Our business depends upon the capital expenditures of semiconductor manufacturers, which in turn is driven by the current and anticipated market demand for ICs and products utilizing ICs. We do not consider our business to be seasonal in nature, but it is cyclical with respect to the capital equipment procurement practices of semiconductor manufacturers, and it is impacted by the investment patterns of such manufacturers in different global markets. Downturns in the semiconductor industry or slowdowns in the worldwide economy could have a material adverse effect on our future business and financial results.

Sales, Service and Marketing

Our sales, service and marketing efforts are aimed at building long-term relationships with our customers. We focus on providing a single and comprehensive resource for the full breadth of process control and yield management products and services. Customers benefit from the simplified planning and coordination, as well as the increased equipment compatibility, that are realized as a result of dealing with a single supplier. Our revenues are derived primarily from product sales, mostly through our direct sales force.

We believe that the size and location of our field sales, service and applications engineering, and marketing organizations represent a competitive advantage in our served markets. We have direct sales forces in Asia, the United States and Europe. We maintain an export compliance program that is designed to meet the requirements of the United States Departments of Commerce and State.

As of June 30, 2010, we employed approximately 2,030 sales and related personnel, service engineers and applications engineers. In addition to sales and service offices in the United States, we conduct sales, marketing and services out of wholly-owned subsidiaries or branches in other countries, including Belgium, China, France, Germany, Hong Kong, India, Israel, Italy, Japan, Singapore, South Korea, Taiwan and the United Kingdom. International revenues accounted for approximately 81%, 76% and 79% of our total revenues in the fiscal years ended June 30, 2010, 2009 and 2008, respectively. Additional information regarding our revenues from foreign operations for our last three fiscal years can be found in Note 17, “Segment Reporting and Geographic Information” to the Consolidated Financial Statements.

We believe that sales outside the United States will continue to be a significant percentage of our total revenues. Our future performance will depend, in part, on our ability to continue to compete successfully in Asia, one of the largest markets for our equipment. Our ability to compete in this area is dependent upon the continuation of favorable trading relationships between countries in the region and the United States, and our continuing ability to maintain satisfactory relationships with leading semiconductor companies in the region.

International sales and operations may be adversely affected by the imposition of governmental controls, restrictions on export technology, political instability, trade restrictions, changes in tariffs and the difficulties associated with staffing and managing international operations. In addition, international sales may be adversely affected by the economic conditions in each country. The revenues from our international business may also be affected by fluctuations in currency exchange rates. Although we attempt to manage some of the currency risk inherent in non-dollar product sales through hedging activities, there can be no assurance that such efforts will be

 

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adequate. These factors, as well as any of the other risk factors related to our international business and operations that are described in Item 1A, “Risk Factors,” could have a material adverse effect on our future business and financial results.

Backlog

Our shipment backlog for systems and associated warranty totaled $992 million and $332 million as of June 30, 2010 and 2009, respectively, and includes sales orders where written customer requests have been received and the delivery is anticipated within the next 12 months. Orders for service contracts and unreleased products are excluded from shipment backlog. All orders are subject to cancellation or delay by the customer, often with limited or no penalties. We make adjustments for shipment backlog obtained from acquired companies, sales order cancellations, customer delivery date changes and currency adjustments. Our shipment backlog is not subject to our normal accounting controls for information that is either reported in or derived from our basic financial statements. In addition, the concept of shipment backlog is not defined in the accounting literature, making comparisons between periods and with other companies difficult and potentially misleading.

Our revenue backlog, which includes sales orders where deliveries have been completed, but for which revenue has not been recognized pursuant to our policy for revenue recognition, totaled $343 million and $186 million as of June 30, 2010 and 2009, respectively. Orders for service contracts are excluded from revenue backlog.

Because customers can potentially change delivery schedules or delay or cancel orders, and because some orders are received and shipped within the same quarter, our shipment backlog at any particular date is not necessarily indicative of business volumes or actual sales for any succeeding periods. The cyclicality of the semiconductor industry combined with the lead times from our suppliers sometimes result in timing disparities between, on the one hand, our ability to manufacture, deliver and install products and, on the other, the requirements of our customers. In our efforts to balance the requirements of our customers with the availability of resources, management of our operating model and other factors, we often must exercise discretion and judgment as to the timing and prioritization of manufacturing, deliveries, and installations of products, which may impact the timing of revenue recognition with respect to such products.

Research and Development

The market for yield management and process monitoring systems is characterized by rapid technological development and product innovation. These technical innovations are inherently complex and require long development cycles and appropriate professional staffing. We believe that continued and timely development of new products and enhancements to existing products are necessary to maintain our competitive position. Accordingly, we devote a significant portion of our human and financial resources to research and development programs and seek to maintain close relationships with customers to remain responsive to their needs. In addition, we may enter into certain strategic development and engineering programs whereby certain government agencies or other third parties fund a portion of our research and development costs. As of June 30, 2010, we employed approximately 1,100 research and development personnel.

Our key research and development activities during fiscal year 2010 involved the development of process control and yield management equipment for sub-65nm processing. For information regarding our research and development expenses during the last three fiscal years, including costs offset by our strategic development and engineering programs, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Annual Report on Form 10-K.

The strength of our competitive positions in many of our existing markets is largely due to our leading technology, which is the result of our continuing significant investments in product research and development. Even during the recent down cycles in the semiconductor industry, we have remained committed to significant engineering efforts toward both product improvement and new product development in order to contribute to the

 

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continuing developments in our industries. New product introductions, however, may contribute to fluctuations in operating results, since customers may defer ordering existing products, and, if new products have reliability or quality problems, those problems may result in reduced orders, higher manufacturing costs, delays in acceptance of and payment for new products, and additional service and warranty expenses. There can be no assurance that we will successfully develop and manufacture new products, or that new products introduced by us will be accepted in the marketplace. If we do not successfully introduce new products, our results of operations will be adversely affected.

Manufacturing, Raw Materials and Supplies

We perform system design, assembly and testing in-house and utilize an outsourcing strategy for the manufacture of components and major subassemblies. Our in-house manufacturing activities consist primarily of assembling and testing components and subassemblies that are acquired through third-party vendors and integrating those subassemblies into our finished products. Our principal manufacturing activities take place in the United States (Milpitas, California), Singapore, Israel, Belgium and Germany. As of June 30, 2010, we employed approximately 800 manufacturing personnel.

Some critical parts, components and subassemblies (collectively, “parts”) that we use are designed by us and manufactured by suppliers in accordance with our specifications, while other parts are standard commercial products. We use numerous vendors to supply parts for the manufacture and support of our products. Although we make reasonable efforts to ensure that these parts are available from multiple suppliers, this is not always possible, and certain parts included in our systems may be obtained only from a single supplier or a limited group of suppliers. We endeavor to minimize the risk of production interruption by selecting and qualifying alternative suppliers for key parts, by monitoring the financial condition of key suppliers, and by ensuring adequate inventories of key parts are available to maintain manufacturing schedules.

Although we seek to reduce our dependence on sole and limited source suppliers, in some cases the partial or complete loss of certain of these sources could disrupt scheduled deliveries to customers, damage customer relationships and have a material adverse effect on our results of operations.

Competition

The worldwide market for process control and yield management systems is highly competitive. In each of our product markets, we face competition from established and potential competitors, some of which may have greater financial, research, engineering, manufacturing and marketing resources than we have, such as Applied Materials, Inc. and Hitachi Electronics Engineering Co., Ltd. We may also face future competition from new market entrants from other overseas and domestic sources. We expect our competitors to continue to improve the design and performance of their current products and processes and to introduce new products and processes with improved price and performance characteristics. We believe that, to remain competitive, we will require significant financial resources to offer a broad range of products, to maintain customer service and support centers worldwide, and to invest in product and process research and development.

We believe that, while price and delivery are important competitive factors, the customers’ overriding requirement is for systems that easily and effectively incorporate automated and highly accurate inspection and metrology capabilities into their existing manufacturing processes to enhance productivity. Significant competitive factors in the market for process control and yield management systems include system performance, ease of use, reliability, installed base and technical service and support.

Management believes that we are well positioned in the market with respect to both our products and services. However, any loss of competitive position could negatively impact our prices, customer orders, revenues, gross margins and market share, any of which would negatively impact our operating results and financial condition.

 

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Acquisitions and Alliances

We continuously evaluate strategic acquisitions and alliances to expand our technologies, product offerings and distribution capabilities. Acquisitions involve numerous risks, including management issues and costs in connection with integration of the operations, technologies and products of the acquired companies, and the potential loss of key employees of the acquired companies. The inability to manage these risks effectively could negatively impact our operating results and financial condition.

Patents and Other Proprietary Rights

We protect our proprietary technology through reliance on a variety of intellectual property laws, including patent, copyright and trade secret. We have filed and obtained a number of patents in the United States and abroad and intend to continue pursuing the legal protection of our technology through intellectual property laws. In addition, from time to time we acquire license rights under United States and foreign patents and other proprietary rights of third parties, and we attempt to protect our trade secrets and other proprietary information through confidentiality and other agreements with our customers, suppliers, employees and consultants and through other security measures.

Although we consider patents and other intellectual property significant to our business, due to the rapid pace of innovation within the process control and yield management systems industry, we believe that our protection through patent and other intellectual property rights is less important than factors such as our technological expertise, continuing development of new systems, market penetration, installed base and the ability to provide comprehensive support and service to customers worldwide.

No assurance can be given that patents will be issued on any of our applications, that license assignments will be made as anticipated, or that our patents, licenses or other proprietary rights will be sufficiently broad to protect our technology. No assurance can be given that any patents issued to or licensed by us will not be challenged, invalidated or circumvented or that the rights granted thereunder will provide us with a competitive advantage. In addition, there can be no assurance that we will be able to protect our technology or that competitors will not be able to independently develop similar or functionally competitive technology.

Employees

As of June 30, 2010, we employed approximately 5,000 people. None of our employees are represented by a labor union; however, our employees in France (pursuant to French industrial relations law) and in the German operations of our MIE business unit are represented by employee work councils. We have not experienced work stoppages and believe that our employee relations are good.

Competition is intense in the recruiting of personnel in the semiconductor and semiconductor equipment industry. We believe that our future success will depend, in part, on our continued ability to hire and retain qualified management, marketing and technical employees.

Glossary

This section provides definitions for certain industry and technical terms commonly used in our business, which are used elsewhere in this Item 1:

 

back-end

   Process steps that make up the second half of the semiconductor manufacturing process, from contact through completion of the wafer prior to electrical test.

broadband

   An illumination source with a wide spectral bandwidth.

critical dimension (CD)

   The dimension of a specified geometry (such as the width of a patterned line or the distance between two lines) that must be within design tolerances in order to maintain semiconductor device performance consistency.

 

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design rules

   Rules that set forth the allowable dimensions of particular features used in the design and layout of integrated circuits.

die

   The term for a single semiconductor chip on a wafer.

electron-beam

   An illumination source comprised of a stream of electrons emitted by a single source.

excursion

   For a manufacturing step or process, a deviation from normal operating conditions that can lead to decreased performance or yield of the final product.

front-end

   The processes that make up the first half of the semiconductor manufacturing process, from wafer start through final contact window processing.

In-situ

   Refers to processing steps or tests that are done without moving the wafer. Latin for “in original position.”

interconnect

   A highly conductive material, usually aluminum or polysilicon, that carries electrical signals to different parts of a die.

lithography

   A process in which a masked pattern is projected onto a photosensitive coating that covers a substrate.

mask shop

   A manufacturer that produces the reticles used by semiconductor manufacturers.

metrology

   The science of measurement to determine dimensions, quantity or capacity. In the semiconductor industry, typical measurements include critical dimension, overlay and film thickness.

microelectromechanical
systems (MEMS)

   Micron-sized mechanical devices powered by electricity, created using processes similar to those used to manufacture IC devices.

micron

   A metric unit of linear measure that equals 1/1,000,000 meter (10-6m), or 10,000 angstroms (the diameter of a human hair is approximately 75 microns).

nanometer (nm)

   One billionth (10-9) of a meter.

narrowband

   An illumination source with a narrow spectral bandwidth, such as a laser.

patterned

   For semiconductor manufacturing and industries using similar processing technologies, refers to substrates that have electronic circuits (transistors, interconnects, etc.) fabricated on the surface.

photoresist

   A radiation-sensitive material that, when properly applied to a variety of substrates and then properly exposed and developed, masks portions of the substrate with a high degree of integrity.

process control

   The ability to maintain specifications of product and equipment during manufacturing operations.

reticle

   A very flat glass plate that contains the patterns to be reproduced on a wafer.

substrate

   The substrate is a wafer on which layers of various materials are added during the process of manufacturing semiconductor devices or circuits.

unpatterned

   For semiconductor manufacturing and industries using similar processing technologies, refers to substrates that do not have electronic circuits (transistors, interconnects, etc.) fabricated on the surface. These can include bare silicon wafers, other bare substrates or substrates on which blanket films have been deposited.

yield management

   The ability of a semiconductor manufacturer to oversee, manage and control its manufacturing processes so as to maximize the percentage of manufactured wafers or die that conform to pre-determined specifications.

The definitions above are from internal sources, as well as SEMATECH Dictionary of Semiconductor Terms.

 

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ITEM 1A. RISK FACTORS

A description of factors that could materially affect our business, financial condition or operating results is provided below.

Risks Associated with Our Industry and Market Conditions

The semiconductor equipment industry is highly cyclical. The purchasing decisions of our customers are highly dependent on the economies of both the local markets in which they are located and the semiconductor industry worldwide. If we fail to respond to industry cycles, our business could be seriously harmed.

The timing, length and severity of the up-and-down cycles in the semiconductor equipment industry are difficult to predict. The cyclical nature of the primary industry in which we operate is largely a function of our customers’ capital spending patterns and need for expanded manufacturing capacity, which in turn are affected by factors such as capacity utilization, consumer demand for products, inventory levels and our customers’ access to capital. This cyclicality affects our ability to accurately predict future revenue and, in some cases, future expense levels. In the current environment, our ability to accurately predict our future operating results is particularly limited. During down cycles in our industry, the financial results of our customers may be negatively impacted, which could result not only in a decrease in, or cancellation or delay of, orders (which are generally subject to cancellation or delay by the customer with limited or no penalty) but also a weakening of their financial condition that could impair their ability to pay for our products or our ability to recognize revenue from certain customers. When cyclical fluctuations result in lower than expected revenue levels, operating results may be adversely affected and cost reduction measures may be necessary in order for us to remain competitive and financially sound. During periods of declining revenues, as was experienced during fiscal year 2009, we must be in a position to adjust our cost and expense structure to prevailing market conditions and to continue to motivate and retain our key employees. If we fail to respond, or if our attempts to respond fail to accomplish our intended results, then our business could be seriously harmed. Furthermore, any workforce reductions and cost reduction actions that we adopt in response to down cycles may result in additional restructuring charges, disruptions in our operations and loss of key personnel. In addition, during periods of rapid growth, we must be able to increase manufacturing capacity and personnel to meet customer demand. We can provide no assurance that these objectives can be met in a timely manner in response to industry cycles. Each of these factors could adversely impact our operating results and financial condition.

In addition, the semiconductor equipment industry and other industries that we serve are constantly developing and changing over time. These changes currently, or in the future may, include the increasing cost of building and operating fabrication facilities and the impact of such increases on our customers’ investment decisions; the variability of future growth rates in the semiconductor and related industries; the ever-increasing cost and complexity involved in the adoption by our customers of technology advances and the potential impact that may have on their rate of adoption; pricing trends in the end-markets for consumer electronics and other products, which places a growing emphasis on our customers’ cost of ownership; overall changes in capital spending patterns by our customers; and demand by semiconductor manufacturers for shorter cycle times for developing, manufacturing and installing capital equipment. Further, many semiconductor manufacturers have recently experienced decreased profitability, causing them to enter into collaboration or sharing arrangements for capacity, cost or risk with other manufacturers, outsource manufacturing activities, focus only on specific markets or applications, or purchase less manufacturing equipment. Any of the changes described in this paragraph may, particularly during periods of challenging macroeconomic conditions, negatively affect our customers’ rate of investment in capital equipment, which could result in downward pressure on our prices, customer orders, revenues and gross margins. If we do not successfully manage the risks resulting from any of these or other potential changes in our industries, our business, financial condition and operating results could be adversely impacted.

 

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We are exposed to risks associated with a weakening in the condition of the financial markets and the global economy.

The severe tightening of the credit markets, turmoil in the financial markets and weakening of the global economy that were experienced during the fiscal year ended June 30, 2009 contributed to slowdowns in the industries in which we operate, which slowdowns could recur or worsen if economic conditions were to deteriorate again.

The markets for semiconductors, and therefore our business, are ultimately driven by the global demand for electronic devices by consumers and businesses. Economic uncertainty frequently leads to reduced consumer and business spending, which, in the recent economic slowdown, caused our customers to decrease, cancel or delay their equipment and service orders from us. In addition, the tightening of credit markets and concerns regarding the availability of credit that accompanied that slowdown made it more difficult for our customers to raise capital, whether debt or equity, to finance their purchases of capital equipment, including the products we sell. Reduced demand, combined with delays in our customers’ ability to obtain financing (or the unavailability of such financing), has in recent periods adversely affected our product and service sales and revenues and therefore has harmed our business and operating results, and our operating results and financial condition may again be adversely impacted if economic conditions decline from their current levels.

In addition, a decline in the condition of the global financial markets could adversely impact the market values or liquidity of our investments. Our investment portfolio includes corporate and government securities, auction rate securities, money market funds and other types of debt and equity investments. Although we believe our portfolio continues to be comprised of sound investments due to the quality and (where applicable) credit ratings and government guarantees of the underlying investments, a decline in the capital and financial markets would adversely impact the market values of our investments and their liquidity. If the market value of such investments were to decline, or if we were to have to sell some of our investments under illiquid market conditions, we may be required to recognize an impairment charge on such investments or a loss on such sales, either of which could have an adverse effect on our financial condition and operating results.

If we are unable to timely and appropriately adapt to changes resulting from difficult macroeconomic conditions, our business, financial condition or results of operations may be materially and adversely affected.

Our future performance depends, in part, upon our ability to continue to compete successfully worldwide.

Our industry includes large manufacturers with substantial resources to support customers worldwide. Some of our competitors are diversified companies with greater financial resources and more extensive research, engineering, manufacturing, marketing, and customer service and support capabilities than we possess. We face competition from companies whose strategy is to provide a broad array of products and services, some of which compete with the products and services that we offer. These competitors may bundle their products in a manner that may discourage customers from purchasing our products, including pricing such competitive tools significantly below our product offerings. In addition, we face competition from smaller emerging semiconductor equipment companies whose strategy is to provide a portion of the products and services that we offer, using innovative technology to sell products into specialized markets. The strength of our competitive positions in many of our existing markets is largely due to our leading technology, which is the result of continuing significant investments in product research and development. However, we may enter new markets, whether through acquisitions or new internal product development, in which competition is based primarily on product pricing, not technological superiority. Further, some new growth markets that emerge may not require leading technologies. Loss of competitive position in any of the markets we serve, or an inability to sell our products on favorable commercial terms in new markets we may enter, could negatively affect our prices, customer orders, revenues, gross margins and market share, any of which would negatively affect our operating results and financial condition.

 

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We are exposed to risks associated with a highly concentrated customer base.

Our customer base, particularly in the semiconductor industry, historically has been, and is becoming increasingly, highly concentrated. In this environment, orders from a relatively limited number of manufacturers have accounted for, and are expected to continue to account for, a substantial portion of our sales. In addition, the mix and type of customers, and sales to any single customer, may vary significantly from quarter to quarter and from year to year. If customers do not place orders, or they delay or cancel orders, we may not be able to replace the business. Furthermore, because our products are configured to customer specifications, any changes, delays or cancellations of orders may result in significant, non-recoverable costs. As a result of the consolidation within our customer base, the customers that survive that consolidation represent a greater portion of our sales. Those surviving customers may have more aggressive policies regarding engaging alternative, second-source suppliers for the products we serve and, in addition, may seek, and on occasion receive, pricing, payment, intellectual property-related, or other commercial terms that are less favorable to us. Any of these changes could negatively impact our prices, customer orders, revenues and gross margins. Also, certain customers have undergone significant ownership changes, experienced management changes or have outsourced manufacturing activities, any of which may result in additional complexities in managing customer relationships and transactions. As a result of the recent challenging economic environment, we have been exposed to additional risks related to the continued financial viability of certain of our customers. To the extent our customers experience liquidity issues, we may be required to incur additional bad debt expense with respect to receivables owed to us by those customers. In addition, customers with liquidity issues may be forced to discontinue operations or may be acquired by one of our customers, and in either case such event would have the effect of further consolidating our customer base. Any of these factors could have a material adverse effect on our business, financial condition and operating results.

Risks Related to Our Business

If we do not develop and introduce new products and technologies in a timely manner in response to changing market conditions or customer requirements, our business could be seriously harmed.

Success in the semiconductor equipment industry depends, in part, on continual improvement of existing technologies and rapid innovation of new solutions. For example, the size of semiconductor devices continues to shrink, and the industry is currently transitioning to the use of new materials and innovative fab processes. While we expect these trends will increase our customers’ reliance on diagnostic products such as ours, we cannot be sure that these trends will directly improve our business. These and other evolving customer needs require us to respond with continued development programs and to cut back or discontinue older programs, which may no longer have industry-wide support. Technical innovations are inherently complex and require long development cycles and appropriate staffing of highly qualified employees. Our competitive advantage and future business success depend on our ability to accurately predict evolving industry standards, to develop and introduce new products that successfully address changing customer needs, to win market acceptance of these new products and to manufacture these new products in a timely and cost-effective manner.

In this environment, we must continue to make significant investments in research and development in order to enhance the performance, features and functionality of our products, to keep pace with competitive products and to satisfy customer demands. Substantial research and development costs typically are incurred before we confirm the technical feasibility and commercial viability of a new product, and not all development activities result in commercially viable products. There can be no assurance that revenues from future products or product enhancements will be sufficient to recover the development costs associated with such products or enhancements. In addition, we cannot be sure that these products or enhancements will receive market acceptance or that we will be able to sell these products at prices that are favorable to us. Our business will be seriously harmed if we are unable to sell our products at favorable prices or if the market in which we operate does not accept our products.

 

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Our business would be harmed if we do not receive parts sufficient in number and performance to meet our production requirements and product specification in a timely and cost-effective manner.

We use a wide range of materials in the production of our products, including custom electronic and mechanical components, and we use numerous suppliers to supply these materials. We generally do not have guaranteed supply arrangements with our suppliers. Because of the variability and uniqueness of customers’ orders, we do not maintain an extensive inventory of materials for manufacturing. We seek to minimize the risk of production and service interruptions and/or shortages of key parts by selecting and qualifying alternative suppliers for key parts, monitoring the financial stability of key suppliers and maintaining appropriate inventories of key parts. Although we make reasonable efforts to ensure that parts are available from multiple suppliers, key parts may be available only from a single supplier or a limited group of suppliers. Also, key parts we obtain from some of our suppliers incorporate the suppliers’ proprietary intellectual property; in those cases we are increasingly reliant on third parties for high-performance, high-technology components, which reduces the amount of control we have over the availability and protection of the technology and intellectual property that is used in our products. In addition, if certain of our key suppliers experience liquidity issues and are forced to discontinue operations, which is a heightened risk during economic downturns, that would affect their ability to deliver parts and could result in delays for our products. Our operating results and business may be adversely impacted if we are unable to obtain parts to meet our production requirements and product specifications, or if we are only able to do so on unfavorable terms.

Disruption of our manufacturing facilities or other operations, or in the operations of our customers, due to earthquake, flood, other natural catastrophic events, health epidemics or terrorism could result in cancellation of orders, delays in deliveries or other business activities, or loss of customers and could seriously harm our business.

We have significant manufacturing operations in the United States, Singapore, Israel, Belgium and Germany. In addition, our business is international in nature, with our sales, service and administrative personnel and our customers located in numerous countries throughout the world. Operations at our manufacturing facilities and our assembly subcontractors, as well as our other operations and those of our customers, are subject to disruption for a variety of reasons, including work stoppages, acts of war, terrorism, health epidemics, fire, earthquake, volcanic eruptions, energy shortages, flooding or other natural disasters. Such disruption could cause delays in, among other things, shipments of products to our customers, our ability to perform services requested by our customers, or the installation and acceptance of our products at customer sites. We cannot ensure that alternate means of conducting our operations (whether through alternate production capacity or service providers or otherwise) would be available if a major disruption were to occur or that, if such alternate means were available, they could be obtained on favorable terms.

As part of our cost-cutting actions, we have consolidated several operating facilities. Our California operations are now primarily centralized in our Milpitas facility. The consolidation of our California operations into a single campus could further concentrate the risks related to any of the disruptive events described in the preceding paragraph, such as acts of war or terrorism, earthquakes, fires or other natural disasters, if any such event were to impact our Milpitas facility.

We outsource a number of services to third-party service providers, which decreases our control over the performance of these functions. Disruptions or delays at our third-party service providers could adversely impact our operations.

We outsource a number of services, including our transportation and logistics management of spare parts and certain accounting functions, to domestic and overseas third-party service providers. While outsourcing arrangements may lower our cost of operations, they also reduce our direct control over the services rendered. It is uncertain what effect such diminished control will have on the quality or quantity of products delivered or services rendered, on our ability to quickly respond to changing market conditions, or on our ability to ensure compliance with all applicable domestic and foreign laws and regulations. Disruptions or delays at our third-

 

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party service providers due to events such as regional economic, business, environmental or political events, information technology system failures or military actions could adversely impact our operations and our ability to ship products, manage our product inventory or record and report financial and management information on a timely and accurate basis.

Our success is dependent in part on our technology and other proprietary rights. If we are unable to maintain our lead or protect our proprietary technology, we may lose valuable assets.

Our success is dependent in part on our technology and other proprietary rights. We own various United States and international patents and have additional pending patent applications relating to some of our products and technologies. The process of seeking patent protection is lengthy and expensive, and we cannot be certain that pending or future applications will actually result in issued patents or that issued patents will be of sufficient scope or strength to provide meaningful protection or commercial advantage to us. Other companies and individuals, including our larger competitors, may develop technologies and obtain patents relating to our business that are similar or superior to our technology or may design around the patents we own, adversely affecting our business. In addition, we at times engage in collaborative technology development efforts with our customers and suppliers, and these collaborations may constitute a key component of certain of our ongoing technology and product research and development projects. The termination of any such collaboration, or delays caused by disputes or other unanticipated challenges that may arise in connection with any such collaboration, could significantly impair our research and development efforts, which could have a material adverse impact on our business and operations.

We also maintain trademarks on certain of our products and services and claim copyright protection for certain proprietary software and documentation. However, we can give no assurance that our trademarks and copyrights will be upheld or successfully deter infringement by third parties.

While patent, copyright and trademark protection for our intellectual property is important, we believe our future success in highly dynamic markets is most dependent upon the technical competence and creative skills of our personnel. We attempt to protect our trade secrets and other proprietary information through confidentiality and other agreements with our customers, suppliers, employees and consultants and through other security measures. We also maintain exclusive and non-exclusive licenses with third parties for strategic technology used in certain products. However, these employees, consultants and third parties may breach these agreements, and we may not have adequate remedies for wrongdoing. In addition, the laws of certain territories in which we develop, manufacture or sell our products may not protect our intellectual property rights to the same extent as do the laws of the United States. In any event, the extent to which we can protect our trade secrets through the use of confidentiality agreements is limited, and our success will depend to a significant extent on our ability to innovate ahead of our competitors.

We might be involved in intellectual property disputes or other intellectual property infringement claims that may be costly to resolve, prevent us from selling or using the challenged technology and seriously harm our operating results and financial condition.

As is typical in the semiconductor equipment industry, from time to time we have received communications from other parties asserting the existence of patent rights, copyrights, trademark rights or other intellectual property rights which they believe cover certain of our products, processes, technologies or information. In addition, we occasionally receive notification from customers who believe that we owe them indemnification or other obligations related to intellectual property claims made against such customers by third parties. Litigation tends to be expensive and requires significant management time and attention and could have a negative effect on our results of operations or business if we lose or have to settle a case on significantly adverse terms. Our customary practice is to evaluate such infringement assertions and to consider whether to seek licenses where appropriate. However, we cannot ensure that licenses can be obtained or, if obtained, will be on acceptable terms

 

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or that costly litigation or other administrative proceedings will not occur. The inability to obtain necessary licenses or other rights on reasonable terms, or the instigation of litigation or other administrative proceedings, could seriously harm our operating results and financial condition.

We depend on key personnel to manage our business effectively, and if we are unable to attract, retain and motivate our key employees, our sales and product development could be harmed.

Our employees are vital to our success, and our key management, engineering and other employees are difficult to replace. We generally do not have employment contracts with our key employees. Further, we do not maintain key person life insurance on any of our employees. The expansion of high technology companies worldwide has increased demand and competition for qualified personnel. If we are unable to retain key personnel, or if we are not able to attract, assimilate or retain additional highly qualified employees to meet our needs in the future, our business and operations could be harmed.

If we fail to operate our business in accordance with our business plan, our operating results, business and stock price may be significantly and adversely impacted.

We attempt to operate our business in accordance with a business plan that is established annually, revised frequently (generally quarterly), and reviewed by management even more frequently (at least monthly). Our business plan is developed based on a number of factors, many of which require estimates and assumptions, such as our expectations of the economic environment, future business levels, our customers’ willingness and ability to place orders, lead-times, and future revenue and cash flow. Our budgeted operating expenses, for example, are based in part on our future revenue expectations. However, our ability to achieve our anticipated revenue levels is a function of numerous factors, including the volatile and cyclical nature of our industry, customer order cancellations, macroeconomic changes, operational matters regarding particular agreements, our ability to manage customer deliveries and resources for the installation and acceptance of our products (for products where customer acceptance is required before we can recognize revenue from such sales), our ability to manage delays or accelerations by customers in taking deliveries and the acceptance of our products (for products where customer acceptance is required before we can recognize revenue from such sales), our ability to operate our business and sales processes effectively, and a number of the other risk factors set forth in this Item 1A.

Because our expenses are in most cases relatively fixed in the short term, any revenue shortfall below expectations could have an immediate and significant adverse effect on our operating results. Similarly, if we fail to manage our expenses effectively or otherwise fail to maintain rigorous cost controls, we could experience greater than anticipated expenses during an operating period, which would also negatively affect our results of operations. If we fail to operate our business consistent with our business plan, our operating results in any period may be significantly and adversely impacted. Such an outcome could cause customers, suppliers or investors to view us as less stable, or could cause us to fail to meet financial analysts’ revenue or earnings estimates, any of which could have a material adverse impact on our business, financial condition or stock price.

Acquisitions are an important element of our strategy but, because of the uncertainties involved, we may not find suitable acquisition candidates and we may not be able to successfully integrate and manage acquired businesses. We are also exposed to risks in connection with strategic alliances into which we may enter.

In addition to our efforts to develop new technologies from internal sources, part of our growth strategy is to pursue acquisitions and acquire new technologies from external sources. As part of this effort, we may make acquisitions of, or significant investments in, businesses with complementary products, services and/or technologies. There can be no assurance that we will find suitable acquisition candidates or that acquisitions we complete will be successful. In addition, we may use equity to finance future acquisitions, which would increase our number of shares outstanding and be dilutive to current stockholders.

If we are unable to successfully integrate and manage acquired businesses or if acquired businesses perform poorly, then our business and financial results may suffer. It is possible that the businesses we have acquired, as

 

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well as businesses that we may acquire in the future, may perform worse than expected or prove to be more difficult to integrate and manage than expected. In addition, we may lose key employees of the acquired companies. As a result, risks associated with acquisition transactions may give rise to a material adverse effect on our business and financial results for a number of reasons, including:

 

   

we may have to devote unanticipated financial and management resources to acquired businesses;

 

   

the combination of businesses may cause the loss of key personnel or an interruption of, or loss of momentum in, the activities of our company and/or the acquired business;

 

   

we may not be able to realize expected operating efficiencies or product integration benefits from our acquisitions;

 

   

we may experience challenges in entering into new market segments for which we have not previously manufactured and sold products;

 

   

we may face difficulties in coordinating geographically separated organizations, systems and facilities;

 

   

the customers, distributors, suppliers, employees and others with whom the companies we acquire have business dealings may have a potentially adverse reaction to the acquisition;

 

   

we may have to write-off goodwill or other intangible assets; and

 

   

we may incur unforeseen obligations or liabilities in connection with acquisitions.

At times, we may also enter into strategic alliances with customers, suppliers or other business partners with respect to development of technology and intellectual property. These alliances typically require significant investments of capital and exchange of proprietary, highly sensitive information. The success of these alliances depends on various factors over which we may have limited or no control and requires ongoing and effective cooperation with our strategic partners. Mergers and acquisitions and strategic alliances are inherently subject to significant risks, and the inability to effectively manage these risks could materially and adversely affect our business, financial condition and operating results.

Compliance with federal securities laws, rules and regulations, as well as NASDAQ requirements, is becoming increasingly complex, and the significant attention and expense we must devote to those areas may have an adverse impact on our business.

Federal securities laws, rules and regulations, as well as NASDAQ rules and regulations, require companies to maintain extensive corporate governance measures, impose comprehensive reporting and disclosure requirements, set strict independence and financial expertise standards for audit and other committee members and impose civil and criminal penalties for companies and their chief executive officers, chief financial officers and directors for securities law violations. These laws, rules and regulations have increased, and in the future are expected to continue to increase, the scope, complexity and cost of our corporate governance, reporting and disclosure practices, which could harm our results of operations and divert management’s attention from business operations.

We are predominantly uninsured for losses and interruptions caused by terrorist acts and acts of war. If international political instability continues or increases, our business and results of operations could be harmed.

The threat of terrorism targeted at the regions of the world in which we do business increases the uncertainty in our markets. Any act of terrorism which affects the economy or the semiconductor industry could adversely affect our business. Increased international political instability in various parts of the world, disruption in air transportation and further enhanced security measures as a result of terrorist attacks may hinder our ability to do business and may increase our costs of operations. Such continuing instability could cause us to incur increased costs in transportation, make such transportation unreliable, increase our insurance costs, and cause international currency markets to fluctuate. This same instability could have the same effects on our suppliers and their ability

 

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to timely deliver their products. If international political instability continues or increases, our business and results of operations could be harmed. We are predominantly uninsured for losses and interruptions caused by terrorist acts and acts of war.

We self insure certain risks including earthquake risk. If one or more of the uninsured events occurs, we could suffer major financial loss.

We purchase insurance to help mitigate the economic impact of certain insurable risks; however, certain other risks are uninsurable or are insurable only at significant cost or cannot be mitigated with insurance. An earthquake could significantly disrupt our manufacturing operations, a significant portion of which are conducted in California, an area highly susceptible to earthquakes. It could also significantly delay our research and engineering efforts on new products, much of which is also conducted in California. We take steps to minimize the damage that would be caused by an earthquake, but there is no certainty that our efforts will prove successful in the event of an earthquake. We self insure earthquake risks because we believe this is a prudent financial decision based on our large cash reserves and the high cost and limited coverage available in the earthquake insurance market. Certain other risks are also self-insured either based on a similar cost-benefit analysis, or based on the unavailability of insurance. If one or more of the uninsured events occurs, we could suffer major financial loss.

A change in accounting standards or practices or a change in existing taxation rules or practices (or changes in interpretations of such standards, practices or rules) can have a significant effect on our reported results and may even affect reporting of transactions completed before the change is effective.

New accounting pronouncements and taxation rules and varying interpretations of accounting pronouncements and taxation rules have occurred and may occur in the future. Changes to (or revised interpretations of) existing tax or accounting rules or the questioning of current or past practices may adversely affect our reported financial results or the way we conduct our business.

For example, the adoption of the authoritative guidance for stock-based compensation, which required us to measure all employee stock-based compensation awards using a fair value method beginning in fiscal year 2006 and record such expense in our consolidated financial statements, has had a material impact on our consolidated financial statements, as reported under accounting principles generally accepted in the United States of America.

A change in our effective tax rate can have a significant adverse impact on our business.

A number of factors may adversely impact our future effective tax rates, such as the jurisdictions in which our profits are determined to be earned and taxed; the resolution of issues arising from tax audits with various tax authorities; changes in the valuation of our deferred tax assets and liabilities; adjustments to estimated taxes upon finalization of various tax returns; increases in expenses not deductible for tax purposes, including write-offs of acquired in-process research and development and impairment of goodwill in connection with acquisitions; changes in available tax credits; changes in stock-based compensation expense; changes in tax laws or the interpretation of such tax laws (for example, proposals for fundamental U.S. international tax reform, such as the recent proposal by President Obama’s Administration, if enacted); changes in generally accepted accounting principles; and the repatriation of non-U.S. earnings for which we have not previously provided for U.S. taxes. A change in our effective tax rate can adversely impact our results from operations.

We are exposed to various risks related to the legal, regulatory and tax environments in which we perform our operations and conduct our business.

We are subject to various risks related to compliance with new, existing, different, inconsistent or even conflicting laws, rules and regulations enacted by legislative bodies and/or regulatory agencies in the countries in which we operate and with which we must comply, including environmental, safety, antitrust and export control regulations. For example, we are subject to environmental and safety regulations in connection with our global business operations, including regulations related to the development, manufacture and use of our products,

 

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recycling and disposal of materials used in our products or in producing our products, the operation of our facilities, and the use of our real property. Our failure or inability to comply with existing or future laws, rules or regulations, or changes to existing laws, rules or regulations, including changes that result in inconsistent or conflicting laws, rules or regulations, in the countries in which we operate could result in violations of contractual or regulatory obligations that may adversely affect our reported financial results or our ability to conduct our business.

In addition, we may from time to time be involved in legal proceedings or claims regarding employment, contracts, product performance, product liability, antitrust, environmental regulations, securities, unfair competition and other matters (in addition to proceedings and claims related to intellectual property matters, which are separately discussed elsewhere in this Item 1A). These legal proceedings and claims, regardless of their merit, may be time-consuming and expensive to prosecute or defend, divert management’s attention and resources, and/or inhibit our ability to sell our products. There can be no assurance regarding the outcome of current or future legal proceedings or claims, which could adversely affect our operating results, financial condition and our ability to operate our business.

We are also exposed to additional risks related to our receipt of external funding for certain strategic development programs from various governments and government agencies, both domestically and internationally. Governments and government agencies typically have the right to terminate funding programs at any time in their sole discretion, so there is no assurance that these sources of external funding will continue to be available to us in the future. In addition, under the terms of these government grants, the applicable granting agency typically has the right to audit the costs that we incur, directly and indirectly, in connection with such programs. Any such audit could result in modifications to, or even termination of, the applicable government funding program. For example, if an audit were to identify any costs as being improperly allocated to the applicable program, those costs would not be reimbursed, and any such costs that had already been reimbursed would have to be refunded. We do not know the outcome of any future audits. Any adverse finding resulting from any such audit could lead to penalties (financial or otherwise), termination of funding programs, suspension of payments, fines and suspension or prohibition from receiving future government funding from the applicable government or government agency, any of which could adversely impact our operating results, financial condition and our ability to operate our business.

Furthermore, we are subject to tax audits in various jurisdictions, and such jurisdictions may assess additional income or other taxes against us. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different from our historical income tax provisions and accruals. The results of an audit or litigation could have a material adverse effect on our operating results or cash flows in the period or periods for which that determination is made.

A majority of our annual revenues are derived from outside the United States, and we maintain significant operations outside the United States. We are exposed to numerous risks as a result of the international nature of our business and operations.

A majority of our annual revenues are derived from outside the United States, and we maintain significant operations outside the United States. We expect that these conditions will continue in the foreseeable future. Managing global operations and sites located throughout the world presents challenges associated with, among other things, cultural diversity and organizational alignment. Moreover, each region in the global semiconductor equipment market exhibits unique characteristics that can cause capital equipment investment patterns to vary significantly from period to period. Periodic local or international economic downturns, trade balance issues, tariffs or other trade barriers, political instability, legal or regulatory changes or terrorism in regions where we have operations or where we do business, along with fluctuations in interest and currency exchange rates, could negatively affect our business and results of operations. Although we attempt to manage near-term currency risks through the use of hedging instruments, there can be no assurance that such efforts will be adequate.

 

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We are exposed to foreign currency exchange rate fluctuations; although we hedge certain currency risks, we may still be adversely affected by changes in foreign currency exchange rates or declining economic conditions in these countries.

We have some exposure to fluctuations in foreign currency exchange rates, primarily the Euro and the Japanese Yen. We have international subsidiaries that operate and sell our products globally. In addition, an increasing proportion of our manufacturing activities are conducted outside of the United States, and many of the costs associated with such activities are denominated in foreign currencies. We routinely hedge our exposures to certain foreign currencies with various financial institutions in an effort to minimize the impact of certain currency exchange rate fluctuations, but these hedges may be inadequate to protect us from currency exchange rate fluctuations. To the extent that these hedges are inadequate, or if there are significant currency exchange rate fluctuations in currencies for which we do not have hedges in place, our reported financial results or the way we conduct our business could be adversely affected. Furthermore, if a financial counter-party to our hedges experiences financial difficulties or is otherwise unable to honor the terms of the foreign currency hedge, we may experience material financial losses.

We are exposed to risks related to our financial arrangements with respect to receivables factoring and banking arrangements.

We enter into factoring arrangements with financial institutions to sell certain of our trade receivables and promissory notes from customers without recourse. In addition, we maintain bank accounts with several domestic and foreign financial institutions, any of which may prove not to be financially viable. If we were to stop entering into these factoring arrangements, our operating results, financial condition and cash flows could be adversely impacted by delays or failures in collecting trade receivables. However, by entering into these arrangements, and by engaging these financial institutions for banking services, we are exposed to additional risks. If any of these financial institutions experiences financial difficulties or is otherwise unable to honor the terms of our factoring or deposit arrangements, we may experience material financial losses due to the failure of such arrangements or a lack of access to our funds, any of which could have an adverse impact upon our operating results, financial condition and cash flows.

There are risks associated with our outstanding indebtedness.

As of June 30, 2010, we had $750 million aggregate principal amount of outstanding indebtedness represented by our senior notes that will mature in 2018, and we may incur additional indebtedness in the future. Our ability to pay interest and repay the principal for our indebtedness is dependent upon our ability to manage our business operations and the other risk factors discussed in this section. There can be no assurance that we will be able to manage any of these risks successfully.

In addition, changes by any rating agency to our outlook or credit rating could negatively affect the value and liquidity of both our debt and equity securities. Factors that can affect our credit rating include changes in our operating performance, the economic environment, conditions in the semiconductor and semiconductor equipment industries, our financial position, and changes in our business strategy.

In certain circumstances involving a change of control followed by a downgrade of the rating of our senior notes, we will be required to make an offer to repurchase the senior notes at a purchase price equal to 101% of the aggregate principal amount of the notes repurchased, plus accrued and unpaid interest. We cannot make any assurance that we will have sufficient financial resources at such time or will be able to arrange financing to pay the repurchase price of the senior notes. Our ability to repurchase the senior notes in such event may be limited by law, by the indenture associated with the senior notes, or by the terms of other agreements to which we may be party at such time. If we fail to repurchase the senior notes as required by the indenture, it would constitute an event of default under the indenture governing the senior notes which, in turn, may also constitute an event of default under other of our obligations.

 

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There can be no assurance that we will continue to declare cash dividends at all or in any particular amounts.

Our Board of Directors first instituted a quarterly dividend during the fiscal year ended June 30, 2005. Since that time, we have announced two increases in the amount of our quarterly dividend level. We intend to continue to pay quarterly dividends subject to capital availability and periodic determinations by our Board of Directors that cash dividends are in the best interest of our stockholders and are in compliance with all laws and agreements applicable to the declaration and payment of cash dividends by us. Future dividends may be affected by, among other factors: our views on potential future capital requirements for investments in acquisitions and the funding of our research and development; legal risks; stock repurchase programs; changes in federal and state income tax laws or corporate laws; and changes to our business model. Our dividend payments may change from time to time, and we cannot provide assurance that we will continue to declare dividends at all or in any particular amounts. A reduction in our dividend payments could have a negative effect on our stock price.

We are exposed to fluctuations in the market values of our portfolio investments and in interest rates; impairment of our investments could harm our earnings. In addition, we and our stockholders are exposed to risks related to the volatility of the market for our common stock.

Our investment portfolio consists of both corporate and government securities that have a maximum effective maturity of 10 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. We have the ability to realize the full value of all these investments upon maturity. Unrealized losses are due to changes in interest rates and bond yields.

In addition, the market price for our common stock is volatile and has fluctuated significantly during recent years. The trading price of our common stock could continue to be highly volatile and fluctuate widely in response to various factors, including without limitation conditions in the semiconductor industry and other industries in which we operate, fluctuations in the global economy or capital markets, our operating results or other performance metrics, or adverse consequences experienced by us as a result of any of the risks described elsewhere in this Item 1A. Volatility in the market price of our common stock could cause an investor in our common stock to experience a loss on the value of their investment in us and could also adversely impact our ability to raise capital through the sale of our common stock or to use our common stock as consideration to acquire other companies.

We have recorded significant restructuring, inventory write-off and asset impairment charges in the past and may do so again in the future, which could have a material negative impact on our business.

During the fiscal year ended June 30, 2009, we recorded material restructuring charges of $38.7 million related to our global workforce reduction, large excess inventory write-offs of $85.6 million, and material impairment charges of $446.7 million related to our goodwill and purchased intangible assets. If we were to encounter challenging economic conditions once again, we may implement additional cost reduction actions, which would require us to take additional, potentially material, restructuring charges related to, among other things, employee terminations or exit costs. We may also be required to write off additional inventory if our product build plans or usage of service inventory decline, and such additional write-offs could constitute material charges.

As noted above, we recorded a material charge during the fiscal year ended June 30, 2009 related to the impairment of our goodwill and purchased intangible assets. Goodwill represents the excess of costs over the net fair value of net assets acquired in a business combination. Goodwill is not amortized, but is instead tested for impairment at least annually in accordance with authoritative guidance for goodwill. Purchased intangible assets with estimable useful lives are amortized over their respective estimated useful lives using the straight-line method, and are reviewed for impairment in accordance with authoritative guidance for long-lived assets. The valuation of goodwill and intangible assets requires assumptions and estimates of many critical factors, including

 

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revenue and market growth, operating cash flows, market multiples, and discount rates. A substantial decline in our stock price, or any other adverse change in market conditions, particularly if such change has the effect of changing one of the critical assumptions or estimates we used to calculate the amount of such impairment charge, could result in a change to the estimation of fair value that could result in an additional impairment charge.

Any such additional material charges, whether related to restructuring or goodwill or purchased intangible asset impairment, may have a material negative impact on our operating results and related financial statements.

We are exposed to risks related to our commercial terms and conditions, including our indemnification of third parties, as well as the performance of our products.

Although our standard commercial documentation sets forth the terms and conditions that we intend to apply to commercial transactions with our business partners, counterparties to such transactions may not explicitly agree to our terms and conditions. In situations where we engage in business with a third party without an explicit master agreement regarding the applicable terms and conditions, or where the commercial documentation applicable to the transaction is subject to varying interpretations, we may have disputes with those third parties regarding the applicable terms and conditions of our business relationship with them. Such disputes could lead to a deterioration of our commercial relationship with those parties, costly and time-consuming litigation, or additional concessions or obligations being offered by us to resolve such disputes, or could impact our revenue or cost recognition. Any of these outcomes could materially and adversely affect our business, financial condition and results of operations.

In addition, in our commercial agreements, from time to time in the normal course of business we indemnify third parties with whom we enter into contractual relationships, including customers and lessors, with respect to certain matters. We have agreed, under certain conditions, to hold these third parties harmless against specified losses, such as those arising from a breach of representations or covenants, other third party claims that our products when used for their intended purposes infringe the intellectual property rights of such other third parties, or other claims made against certain parties. We may be compelled to enter into or accrue for probable settlements of alleged indemnification obligations or subject to potential liability arising from our customers’ involvements in legal disputes. In addition, notwithstanding the provisions related to limitations on our liability that we seek to include in our business agreements, the counter-parties to such agreements may dispute our interpretation or application of such provisions, and a court of law may not interpret or apply such provisions in our favor, any of which could result in an obligation for us to pay material damages to third parties and engage in costly legal proceedings. It is difficult to determine the maximum potential amount of liability under any indemnification obligations, whether or not asserted, due to our limited history of prior indemnification claims and the unique facts and circumstances that are likely to be involved in any particular claim. Our business, financial condition and results of operations in a reported fiscal period could be materially adversely affected if we expend significant amounts in defending or settling any purported claims, regardless of their merit or outcomes.

We are also exposed to potential costs associated with unexpected product performance issues. Our products and production processes are extremely complex and thus could contain unexpected product defects, especially when products are first introduced. Unexpected product performance issues could result in significant costs being incurred by us, including increased service or warranty costs, providing product replacements for (or modifications to) defective products, litigation related to defective products, product recalls, or product write-offs or disposal costs. These costs could be substantial and could have an adverse impact upon our business, financial condition and operating results. In addition, our reputation with our customers could be damaged as a result of such product defects, which could reduce demand for our products and negatively impact our business.

 

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We rely upon certain critical information systems for our daily business operation. Our inability to use or access these information systems at critical points in time could unfavorably impact the timeliness and efficiency of our business operations.

Our global operations are linked by information systems, including telecommunications, the internet, our corporate intranet, network communications, email and various computer hardware and software applications. Despite our implementation of network security measures, our tools and servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems and tools located at customer sites, or could be subject to system failures or malfunctions for other reasons. System failures or malfunctioning, such as difficulties with our customer relationship management (“CRM”) system, could disrupt our operations and our ability to timely and accurately process and report key components of our financial results. In addition, any disruptions or difficulties that may occur in connection with our enterprise resource planning (“ERP”) system or other systems (whether in connection with the regular operation of such systems or as a result of the integration of our acquired businesses into such systems) could adversely affect our ability to complete important business processes, such as the evaluation of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act of 2002. Any such event could have an adverse effect on our business, operating results and financial condition.

We are subject to the risks of additional government actions in the event we were to breach the terms of any settlement arrangement into which we have entered.

In connection with the settlement of certain government actions and other legal proceedings related to our historical stock option practices, we have explicitly agreed as a condition to such settlements that we will comply with certain laws, such as the books and records provisions of the federal securities laws. If we were to violate any such law, we might not only be subject to the significant penalties applicable to such violation, but our past settlements may also be impacted by such violation, which could give rise to additional government actions or other legal proceedings. Any such additional actions or proceedings may require us to expend significant management time and incur significant accounting, legal and other expenses, and may divert attention and resources from the operation of our business. These expenditures and diversions, as well as an adverse resolution of any such action or proceeding, could have a material adverse effect on our business, financial condition and results of operations.

 

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ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

ITEM 2. PROPERTIES

Information regarding our principal properties as of June 30, 2010 is set forth below:

 

Location

   Type   

Principal Use

   Square
Footage
   Ownership

Fremont, CA(1)

   Office and plant   

Research, Engineering, Marketing, Manufacturing, Service and Sales Administration

   101,882    Leased

Milpitas, CA

   Office, plant and
warehouse
  

Principal Executive Offices, Research, Engineering, Marketing, Manufacturing, Service and Sales Administration

   727,302    Owned

San Jose, CA(1)(3)

   Office, plant and
warehouse
  

Research, Engineering, Marketing, Manufacturing, Service and Sales Administration

   434,653    Owned

Santa Clara, CA

   Office, plant and
warehouse
  

Research, Engineering, Marketing, Manufacturing and Service

   58,559    Leased

Westwood, MA(1)

   Office and plant   

Research, Engineering, Marketing, Manufacturing and Service

   116,908    Leased

Leuven, Belgium(1)

   Office, plant and
warehouse
  

Research, Engineering, Marketing, Manufacturing and Service and Sales Administration

   99,315    Owned

Shenzhen, China

   Office and plant   

Sales, Service and Manufacturing

   33,571    Leased

Weilburg, Germany

   Office and plant   

Research, Engineering, Marketing, Manufacturing, Service and Sales Administration

   159,732    Leased

Chennai, India(3)

   Office   

Engineering

   79,668    Owned

Migdal Ha’Emek, Israel

   Office and plant   

Research, Engineering, Marketing, Manufacturing, Service and Sales Administration

   67,788    Owned

Yokohama, Japan

   Office and
warehouse
  

Sales, Service and Warehouse

   39,764    Leased

Serangoon, Singapore(2)

   Office and plant   

Manufacturing

   185,809    Owned

Hsinchu, Taiwan

   Office   

Sales and Service

   73,676    Leased

  

 

(1) Portions of certain properties are sublet, are vacant and marketed to sublease, or leased to third parties.
(2) The land on which the Serangoon, Singapore building resides is leased.
(3) All or portions of certain properties are being made available for sale.

As of June 30, 2010, we owned or leased a total of approximately 2.5 million square feet of space worldwide, including the locations listed above and office space for smaller sales and service offices in several locations throughout the world. Our operating leases expire at various times through July 31, 2018 with renewal

 

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options at the fair market value for additional periods up to five years. Additional information regarding these leases is incorporated herein by reference from Note 13, “Commitments and Contingencies” to the Consolidated Financial Statements. We believe our properties are adequately maintained and suitable for their intended use and that our production facilities have capacity adequate for our current needs, even after giving effect to the sale of certain properties as noted above.

 

ITEM 3. LEGAL PROCEEDINGS

Government Inquiries and SEC Settlement Relating to Historical Stock Option Practices

Several government agencies previously conducted investigations beginning in May 2006 concerning the Company’s past stock options grants and related accounting matters, including investigations by the SEC and United States Attorney’s Office (“USAO”), an examination of our 401(k) Savings Plan (“Plan”) by the U.S. Department of Labor (“DOL”), and an audit covering calendar year 2006 by the Internal Revenue Service (“IRS”). As previously reported, the SEC investigation was resolved with respect to the Company by a non-monetary settlement in July 2007, the USAO advised us that it had closed its investigation and determined not to take any action against the Company in July 2008, the IRS concluded its audit with a payment by the Company of $0.1 million in July 2008, and the DOL closed its examination on the basis of the Plan’s election to participate in our previously announced shareholder class action settlement, at no additional cost to the Company, and our separate settlement with the Plan’s independent fiduciary under which we paid the Plan $25,000 and denied all liability. These matters are now closed.

Litigation Relating to Historical Stock Option Practices

Beginning on May 22, 2006, several shareholder derivative actions were filed on behalf of and in the name of the Company against several of our current and former directors and officers relating to our historical stock options and related accounting from 1994 to 2006, consisting of a consolidated action in the U.S. District Court for the Northern District of California (the “Federal Derivative Action”); an action in the California Superior Court for Santa Clara County (“California Action”); and one in the Delaware Chancery Court (“Delaware Action”).

As previously reported, on March 15, 2010, we entered into a Stipulation of Settlement (the “Stipulation”) with all parties to the Federal Derivative Action to resolve the Federal Derivative Action in its entirety, subject to approval by the Federal District Court (the “Settlement”). By Addendum to the Stipulation filed on May 17, 2010, the plaintiffs in the California Action and in the Delaware Action joined in the Settlement. The Federal District Court approved the Settlement and entered its final judgment and order dismissing the Federal Derivative Action with prejudice on May 26, 2010. Thereafter, the California Action was dismissed with prejudice on June 1, 2010, and the Delaware Action was dismissed with prejudice on June 2, 2010. The Settlement became final and effective by its terms on June 28, 2010.

As set forth more fully in the Stipulation, under the Settlement, among other things, (i) we received cash payments totaling $24 million from insurers; (ii) we received additional cash payments of approximately $9.2 million from certain of the settling defendants; (iii) certain of the settling defendants relinquished compensation and other benefits of approximately $9.4 million; (iv) we paid attorneys’ fees to plaintiffs’ counsel in the amount of $8 million in cash, in addition to $8 million in shares of our common stock; (v) the Federal Derivative Action was dismissed with prejudice; (vi) the Company, settling defendants, related parties, and plaintiffs and their counsel have been released from claims related to the Federal Derivative Action and the matters that were or could have been alleged therein, and further litigation on such claims is barred; and (vii) we committed to maintain certain corporate governance enhancements, including certain previously implemented policies, procedures and guidelines relating to our board of directors composition, stock option granting practices and procedures, and internal controls and procedures. This summary of the terms of the Stipulation is qualified entirely by reference to the copy of the Stipulation filed as Exhibit 99.1 to the Current Report on Form 8-K filed by the Company with the SEC on March 26, 2010, the content of which is incorporated by reference herein. Under the Addendum to the Stipulation, the California Action and Delaware Action were also dismissed with

 

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prejudice. During the year ended June 30, 2010, we recorded a charge of $1.3 million to selling, general and administrative expenses, reflecting the anticipated net amount to be paid by the Company in connection with the Settlement and the Company’s settlements during such period of separate matters with Kenneth Schroeder and Kenneth Levy, as also previously reported and further described below. As a result of the Settlement, the shareholder derivative litigation arising from our historical stock options grants and related practices is now concluded.

The Company was also previously named as a defendant along with various of its current and former officers in putative securities class actions arising from its historical stock options grants and related matters in state and federal court beginning in June 2006. Those actions were resolved by settlement or dismissal, as previously reported.

Finally, we entered into settlements of litigation and arbitration claims filed by our former CEO Kenneth Schroeder in connection with the termination of his employment and cancellation of certain of his stock options and restricted stock units in 2006, and also settled claims asserted by our former CEO and Chairman of the Board Kenneth Levy relating to our alleged refusal to permit the exercise of certain stock options in 2007 and 2008. We recorded the expenses associated with these settlements in our selling, general and administrative expenses during the three months ended March 31, 2010. The settlements have been performed and are now final.

As a result of the foregoing, all litigation matters to which we were a party arising from our historical stock option grants and related practices are now closed.

Indemnification Obligations

Subject to certain limitations, we are obligated to indemnify our current and former directors, officers and employees with respect to certain litigation matters and investigations that arise in connection with their service to us. These obligations arise under the terms of our certificate of incorporation, our bylaws, applicable contracts, and Delaware and California law. The obligation to indemnify generally means that we are required to pay or reimburse the individuals’ reasonable legal expenses and possibly damages and other liabilities incurred in connection with these matters. We paid or reimbursed legal expenses incurred in connection with the investigation of our historical stock option practices and the related litigation and government inquiries by a number of our current and former directors, officers and employees. We are also paying defense costs to two former officers and employees facing SEC civil actions to which we are not a party. Although the maximum potential amount of future payments we could be required to make under these agreements is theoretically unlimited, we believe the fair value of this liability, to the extent estimable, is appropriately considered within the reserve we have established for currently pending legal proceedings.

Other Legal Matters

We are named from time to time as a party to lawsuits in the normal course of its business. Actions filed against us 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. Litigation, in general, and intellectual property and securities litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the results of legal proceedings are difficult to predict, and the costs incurred in litigation can be substantial, regardless of outcome. We believe the amounts provided in our 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 our financial statements or will not have a material adverse effect on our results of operations, financial condition or cash flows.

 

ITEM 4. (Removed and Reserved)

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is listed and traded on the NASDAQ Global Select Market under the symbol “KLAC.”

The prices per share reflected in the following table represent the high and low closing prices for our common stock on the NASDAQ Global Select Market for the periods indicated.

 

         Year ended June 30, 2010          Year ended June 30, 2009
         High            Low              High            Low    

First Fiscal Quarter

   $ 35.86    $ 25.13      $ 41.54    $ 30.92

Second Fiscal Quarter

   $ 37.40    $ 31.24      $ 31.00    $ 15.19

Third Fiscal Quarter

   $ 37.12    $ 28.09      $ 24.11    $ 15.54

Fourth Fiscal Quarter

   $ 35.30    $ 27.88      $ 29.45    $ 20.34

We paid dividends to holders of our common stock during each of the quarters in the fiscal years ended June 30, 2010 and 2009. The total amount of dividends paid during the fiscal years ended June 30, 2010 and 2009 was $102.4 million and $102.1 million, respectively. On July 13, 2010, we announced that our Board of Directors had authorized an increase in the level of our quarterly dividend from $0.15 to $0.25 per share. Following such announcement, during the first quarter of the fiscal year ending June 30, 2011, our Board of Directors authorized a quarterly cash dividend of $0.25 per share, which was declared on August 5, 2010 and will be paid on September 1, 2010 to our stockholders of record on August 16, 2010.

As of July 22, 2010, there were 622 holders of record of our common stock.

Recent Sales of Unregistered Securities

As described under Item 3 of Part I, “Legal Proceedings,” on March 15, 2010 we entered into a Stipulation of Settlement with respect to the derivative lawsuits related to the Company’s historical stock option practices. In connection with such settlement, which was approved by the U.S. District Court for the Northern District of California on May 26, 2010, we became obligated as of June 28, 2010 (the effective date of the settlement, per the terms of the Stipulation) to, among other things, issue $8 million in shares of our common stock to plaintiffs’ counsel within ten business days following such effective date. On July 12, 2010, without using an underwriter, we issued 263,106 shares of our common stock to plaintiffs’ counsel in connection with such settlement, with the number of shares determined by dividing $8 million by the average daily closing price of our common stock for the ten trading days immediately preceeding June 28, 2010. Because the U.S. District Court approved the terms of the settlement, which included the issuance of these securities, the securities were issued pursuant to the exemption from registration provided by Section 3(a)(10) of the Securities Act of 1933, as amended. As of June 30, 2010, we accrued approximately $7.3 million to account for the issuance of 263,106 shares based on the closing share price of our common stock as of June 30, 2010.

Equity Repurchase Plans

The following is a summary of stock repurchases for each month during the fourth quarter of the fiscal year ended June 30, 2010: (1)

 

Period

   Total Number of
Shares
Purchased(2)
   Average Price Paid
per Share
   Maximum Number of
Shares that May
Yet Be Purchased Under
the Plans  or Programs(3)

April 1, 2010 to April 30, 2010

   680,000    $ 32.61    7,161,000

May 1, 2010 to May 31, 2010

   805,000    $ 31.26    6,356,000

June 1, 2010 to June 30, 2010

   1,150,000    $ 29.83    5,206,000
          

Total

   2,635,000    $ 30.99   
          

 

(1)

In July 1997, the Board of Directors authorized us to systematically repurchase up to 17.8 million shares of our common stock in the open market. This plan was put into place to reduce the dilution from our employee benefit and incentive

 

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plans, such as our stock option and employee stock purchase plans, and to return excess cash to our stockholders. The Board of Directors has authorized us to repurchase additional shares of our common stock under the repurchase program in February 2005 (up to 10.0 million shares), February 2007 (up to 10.0 million shares), August 2007 (up to 10.0 million shares) and June 2008 (up to 15.0 million shares), in each case in addition to the originally authorized 17.8 million shares described in the first sentence of this footnote.

(2) All shares were purchased pursuant to the publicly announced repurchase programs described in footnote 1 above.
(3) The stock repurchase programs have no expiration date. Future repurchases of our common stock under our repurchase programs may be effected through various different repurchase transaction structures, including isolated open market transactions or systematic repurchase plans.

Stock Performance Graph and Cumulative Total Return

The following graph compares the cumulative 5-year total return attained by shareholders on our common stock relative to the cumulative total returns of the S&P 500 Index (as required by SEC regulations) and the Philadelphia Semiconductor Index. The graph tracks the performance of a $100 investment in our common stock and in each of the indices (with the reinvestment of all dividends) from June 30, 2005 to June 30, 2010.

LOGO

 

     6/05    6/06    6/07    6/08    6/09    6/10

KLA-Tencor Corporation

   100.00    96.09    128.29    96.23    61.39    69.08

S&P 500

   100.00    108.63    131.00    113.81    83.98    96.09

PHLX Semiconductor

   100.00    96.53    114.59    97.83    74.93    91.76

 

* Assumes $100 invested on June 30, 2005 in stock or index-including reinvestment of dividends.

Our fiscal year ends June 30. The comparisons in the graph above are based upon historical data and are not necessarily indicative of, nor intended to forecast, future stock price performance.

 

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ITEM 6. SELECTED FINANCIAL DATA

The following tables include selected consolidated summary financial data for each of our last five fiscal years. This data should be read in conjunction with Item 8, “Financial Statements and Supplementary Data,” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Annual Report on Form 10-K.

 

(In thousands, except per share data)                          

Year ended June 30,

   2010    2009     2008    2007    2006

Consolidated Statements of Operations:

             

Revenues

   $ 1,820,760    $ 1,520,216      $ 2,521,716    $ 2,731,229    $ 2,070,627

Income (loss) from operations

   $ 314,166    $ (577,941   $ 499,376    $ 589,868    $ 309,791

Net income (loss)

   $ 212,300    $ (523,368   $ 359,083    $ 528,098    $ 380,452

Cash dividend paid per share

   $ 0.60    $ 0.60      $ 0.60    $ 0.48    $ 0.48

Net income (loss) per share:

             

Basic

   $ 1.24    $ (3.07   $ 1.99    $ 2.68    $ 1.92

Diluted

   $ 1.23    $ (3.07   $ 1.95    $ 2.61    $ 1.86

As of June 30,

   2010    2009     2008    2007    2006

Consolidated Balance Sheets:

             

Cash, cash equivalents and marketable securities

   $ 1,534,044    $ 1,329,884      $ 1,579,383    $ 1,710,629    $ 2,325,796

Working capital

   $ 2,063,678    $ 1,851,635      $ 2,085,432    $ 2,247,209    $ 2,594,512

Total assets

   $ 3,907,056    $ 3,609,538      $ 4,848,390    $ 4,623,249    $ 4,575,911

Long-term debt(1)

   $ 745,747    $ 745,204      $ 744,661    $ —      $ —  

Stockholders’ equity

   $ 2,246,611    $ 2,184,392      $ 2,981,730    $ 3,550,042    $ 3,567,991

 

(1) In April 2008, we issued $750 million aggregate principal amount of senior notes due in 2018.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and the related notes included in Item 8, “Financial Statements and Supplementary Data,” in this Annual Report on Form 10-K. This discussion contains forward-looking statements, which involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of certain factors, including but not limited to those discussed in Item 1A, “Risk Factors” and elsewhere in this Annual Report on Form 10-K. (See “Special Note Regarding Forward-Looking Statements.”)

CRITICAL ACCOUNTING ESTIMATES AND POLICIES

The preparation of our Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions in applying our accounting policies that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We based these estimates and assumptions on historical experience, and evaluate them on an on-going basis to ensure that they remain reasonable under current conditions. Actual results could differ from those estimates. We discuss the development and selection of the critical accounting estimates with the Audit Committee of our Board of Directors on a quarterly basis, and the Audit Committee has reviewed the Company’s related disclosure in this Annual Report on Form 10-K. The items in our financial statements requiring significant estimates and judgments are as follows:

Revenue Recognition. We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable, and collectibility is reasonably assured. We derive revenue from three sources—sales of systems, spare parts and services. We typically recognize revenue for system sales upon acceptance by the customer that the system has been installed and is operating according to predetermined specifications. Under certain circumstances, however, we recognize revenue prior to written acceptance from the customer, as follows:

 

   

When system sales to independent distributors have no installation requirement, contain no acceptance agreement, and 100% payment is due upon shipment, revenue is recognized upon shipment.

 

   

When the installation of the system is deemed perfunctory, revenue is recognized upon shipment. The portion of revenue associated with installation is deferred based on estimated fair value, and that revenue is recognized upon completion of the installation.

 

   

When the customer fab has already accepted the same tool, with the same specifications, and it can be objectively demonstrated that the tool meets all of the required acceptance criteria upon shipment, revenue is recognized upon shipment. The portion of revenue associated with installation is deferred based on estimated fair value, and that revenue is recognized upon completion of the installation.

 

   

When the customer withholds signature on our acceptance document due to issues unrelated to product performance, revenue is recognized when the system is performing as intended and meets all published and contractually agreed specifications.

 

   

When the system is damaged during transit and title has passed to the customer, revenue is recognized upon receipt of cash payment from the customer.

Total revenue recognized without a written acceptance from the customer was approximately 24%, 14% and 16% of total revenues for the fiscal years ended June 30, 2010, 2009 and 2008, respectively. The increase in revenue recognized without a written acceptance for the fiscal year ended June 30, 2010 compared to the fiscal year ended June 30, 2009 was primarily driven by higher shipments of the same tools with same specifications that have previously been accepted at the applicable customer fabs. The decrease in revenue recognized without a written acceptance for the fiscal year ended June 30, 2009 compared to the fiscal year ended June 30, 2008 was

 

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primarily driven by lower shipments of tools that had already met the required acceptance criteria at those customer fabs. Shipping charges billed to customers are included in system revenue, and the related shipping costs are included in costs of revenues.

Trade-in rights are occasionally granted to customers to trade in tools in connection with subsequent purchases. We estimate the value of the trade-in right and reduce the revenue of 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. Services performed in the absence of a contract, such as consulting and training revenue, are recognized when the related services are performed, and collectibility is reasonably assured.

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 has not met the revenue recognition criteria of the Company. Deferred system profit does not include the profit associated with product shipments to customers in Japan, to whom title does not transfer until customer acceptance. Shipments to customers in Japan are classified as inventory at cost until the time of acceptance.

We also defer 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 twelve months. Non-standard warranty is recognized ratably as revenue when the applicable warranty term period commences.

Revenue Recognition for Certain Arrangements with Software Elements and/or Multiple Deliverables. In October 2009, the Financial Accounting Standards Board (“FASB”) amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry-specific software revenue recognition guidance. In October 2009, the FASB also amended the accounting standards for multiple-deliverable revenue arrangements to:

 

   

provide updated guidance on how the deliverables in an arrangement should be separated, and how the consideration should be allocated;

 

   

eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method; and

 

   

require an entity to allocate revenue in an arrangement using estimated selling prices (“ESP”) of deliverables if it does not have vendor-specific objective evidence (“VSOE”) or third-party evidence (“TPE”) of selling price. Valuation terms are defined as follows:

 

   

VSOE—the price at which we sell the element in a separate stand-alone transaction.

 

   

TPE—evidence from us or other companies of the value of a largely interchangeable element in a transaction.

 

   

ESP—our best estimate of the selling price of an element in a transaction.

We elected to early adopt this accounting guidance at the beginning of our second quarter of the fiscal year ending June 30, 2010 and have applied the adoption retrospectively to the beginning of the fiscal year to apply the guidance to transactions originating or materially modified after June 30, 2009. The implementation resulted in additional qualitative disclosures that are included in the footnotes to the Consolidated Financial Statements but did not have a material impact on our financial position, results of operations or cash flows.

 

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For transactions entered into through June 30, 2009, we primarily recognized revenue based on the guidance in Staff Accounting Bulletin No. 104. During the period, for the majority of our arrangements involving multiple deliverables, the entire amount of the sales contract was allocated to each respective element based on its relative selling price, using fair value. In the limited circumstances when we were not able to determine fair value for the deliverables in the arrangement, but were able to obtain fair value for the undelivered elements, revenue was allocated using the residual method. Under the residual method, the amount of revenue allocated to delivered elements equaled the total arrangement consideration less the aggregate selling price of any undelivered elements, and no revenue was recognized until all elements without fair value had been delivered. If fair value of any undelivered elements did not exist, the entire amount of the sales contract was deferred until all elements were accepted by the customer.

Inventories. Inventories are stated at the lower of cost (on a first-in, first-out basis) or market. Demonstration units are stated at their manufacturing cost, and written down to their net realizable value.

We review and set standard costs semi-annually at current manufacturing costs in order to approximate actual costs. Our manufacturing overhead standards for product costs are calculated assuming full absorption of forecasted spending over projected volumes, adjusted for excess capacity. Abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage) are recognized as current period charges.

We write down product inventory based on forecasted demand and technological obsolescence and parts inventory based on past usage. These factors are impacted by market and economic conditions, technology changes, new product introductions and changes in strategic direction and require estimates that may include uncertain elements. Actual demand may differ from forecasted demand, and such differences may have a material effect on recorded inventory values.

Warranty. We provide standard warranty coverage on our systems for 40 hours per week for twelve months, providing labor and parts necessary to repair the systems during the warranty period. We account 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, we calculate the average service hours and parts expense per system and apply the actual labor and overhead rates to determine the estimated warranty charge. We update these estimated charges on a quarterly basis. The actual product performance and/or field expense profiles may differ, and in those cases we adjust our warranty accruals accordingly. See Note 13, “Commitments and Contingencies” to the Consolidated Financial Statements for a detailed description.

Allowance for Doubtful Accounts. A majority of our trade receivables are derived from sales to large multinational semiconductor manufacturers throughout the world. In order to monitor potential credit losses, we perform ongoing credit evaluations of our customers’ financial condition. An allowance for doubtful accounts is maintained for probable credit losses based upon our assessment of the expected collectibility of all accounts receivable. The allowance for doubtful accounts is reviewed on a quarterly basis to assess the adequacy of the allowance. We take into consideration (1) any circumstances of which we are aware of a customer’s inability to meet its financial obligations; and (2) our judgments as to prevailing economic conditions in the industry and their impact on our customers. If circumstances change, such that the financial conditions of our customers are adversely affected and they are unable to meet their financial obligations to us, we may need to take additional allowances, which would result in a reduction of our net income.

Stock-Based Compensation. We account for stock-based awards exchanged for employee services based on the fair value of those awards. The fair value of stock-based awards is measured at the grant date and is recognized as expense over the employee’s requisite service period. The fair value is determined using a Black-Scholes valuation model for stock options and for purchase rights under our Employee Stock Purchase Plan and using the closing price of our common stock on the grant date for restricted stock units. The Black-Scholes

 

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option-pricing model requires the input of subjective assumptions, including the option’s expected life and the expected price volatility of the underlying stock. The expected stock price volatility assumption is based on the market-based implied volatility from traded options of our common stock.

Contingencies and Litigation. We are subject to the possibility of losses from various contingencies. Considerable judgment is necessary to estimate the probability and amount of any loss from such contingencies. An accrual is made when it is probable that a liability has been incurred or an asset has been impaired and the amount of loss can be reasonably estimated. We accrue a liability and charge operations for the estimated costs expected to be incurred over the next twelve months of adjudication or settlement of asserted and unasserted claims existing as of the balance sheet date. See Item 3, “Legal Proceedings” and Note 13, “Commitments and Contingencies” to the Consolidated Financial Statements for a detailed description.

Goodwill and Intangible Assets. We assess goodwill for impairment annually as well as whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Long-lived intangible assets are tested for recoverability whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. See Note 6, “Goodwill and Purchased Intangible Assets” to the Consolidated Financial Statements for a detailed description. Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in each business combination. We conducted our annual evaluation of goodwill by reporting unit during the quarter ended December 31, 2009 and concluded that there was no impairment. There have been no significant events or circumstances affecting the valuation of goodwill subsequent to the impairment test performed in the second quarter of the fiscal year ended June 30, 2010.

Income Taxes. We account for income taxes in accordance with the authoritative guidance that requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. The guidance also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that a portion of the deferred tax asset will not be realized. We have determined that a valuation allowance was necessary against a portion of the deferred tax assets, but our future taxable income will be sufficient to recover the remainder of our deferred tax assets. However, should there be a change in our ability to recover our deferred tax assets, we could be required to record a valuation allowance against our deferred tax assets. This would result in an increase to our tax provision in the period in which we determined that the recovery was not probable.

On a quarterly basis, we provide for income taxes based upon an estimated annual effective income tax rate. The effective tax rate is highly dependent upon the geographic composition of worldwide earnings, tax regulations governing each region, availability of tax credits and the effectiveness of our tax planning strategies. We carefully monitor the changes in many factors and adjust our effective income tax rate on a timely basis. If actual results differ from these estimates, this could have a material effect on our financial condition and results of operations.

In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. In accordance with the authoritative guidance on accounting for uncertainty in income taxes, we recognize liabilities for uncertain tax positions based on the two-step process prescribed within the interpretation. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement. We reevaluate these uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit, and new audit activity. Any change in these factors could result in the recognition of a tax benefit or an additional charge to the tax provision.

 

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Valuation of Marketable Securities. Our investments in available-for-sale securities are reported at fair value. Unrealized gains related to increases in the fair value of investments and unrealized losses related to decreases in the fair value are included in accumulated other comprehensive income (loss), net of tax, as reported on our Consolidated Statements of Stockholders’ Equity. However, changes in the fair value of investments impact our net income only when such investments are sold or impairment is recognized. Realized gains and losses on the sale of securities are determined by specific identification of the security’s cost basis. We periodically review our investment portfolio to determine if any investment is other-than-temporarily impaired due to changes in credit risk or other potential valuation concerns, which would require us to record an impairment charge in the period any such determination is made. In making this judgment, we evaluate, among other things, the duration of the investment, the extent to which the fair value of an investment is less than its cost, the credit rating and any changes in credit rating for the investment, and our ability and intent to hold the investment until the earlier of market price recovery or maturity. Our assessment that an investment is not other-than-temporarily impaired could change in the future due to new developments or changes in our strategies or assumptions related to any particular investment.

Fair Value Measurements. We adopted authoritative guidance for fair value measurements as of the beginning of fiscal year 2009. In February 2008, the FASB issued a provision that allowed companies to elect a one-year delay in applying the fair value measurements guidance to certain fair value measurements, primarily related to non-financial assets and liabilities. We elected the delayed adoption date for our non-financial assets and liabilities impacted by the guidance. This guidance defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and enhances disclosures about fair value measurements. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The adoption of the guidance relating to the fair value measurement of non-financial assets and liabilities on July 1, 2009 did not have a material impact on our consolidated results of operations or financial condition. See Note 2, “Fair Value Measurements,” to the Consolidated Financial Statements.

Concurrently with the adoption of the fair value measurement and disclosure provisions, we adopted authoritative guidance that permits entities to elect, at specified election dates, to measure eligible financial instruments at fair value. See Note 2, “Fair Value Measurements,” to the Consolidated Financial Statements.

Effects of Recent Accounting Pronouncements.

In April 2010, the FASB amended its guidance on share-based payment awards denominated in certain currencies. The amendment clarifies that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. This amendment becomes effective for our interim period ending September 30, 2011. We do not expect the implementation to have a material impact on our financial position, results of operations or cash flows.

In April 2010, the FASB amended the authoritative guidance addressing accounting for arrangements in which a vendor satisfies its performance obligations over time, with all or a portion of the consideration contingent on future events, referred to as “milestones.” The scope of the new guidance is limited to milestones in arrangements that involve research or development activities, such as the successful completion of a drug study phase. The amendment provides guidance on the criteria that should be met for determining whether the milestone method of revenue recognition is appropriate. A vendor can recognize consideration that is contingent upon achievement of a milestone in its entirety as revenue in the period in which the milestone is achieved only if the milestone meets all criteria to be considered substantive. A vendor that is affected by the amendments is required to provide a description of the overall arrangement, a description of each milestone and related contingent consideration, a determination of whether each milestone is considered substantive, the factors that

 

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the entity considered in determining whether the milestone or milestones are substantive, and the amount of consideration recognized during the period for the milestone or milestones. This amendment becomes effective for our interim period ending September 30, 2010, and we do not expect the amendment to have a material impact on our financial position, results of operations or cash flows.

In March 2010, the FASB amended the authoritative guidance on derivatives and hedging. The amendment addresses the scope exception related to embedded credit derivatives to clarify when analysis of an embedded credit derivative for bifurcation from the host contract is not required. It specifies that embedded credit derivatives not qualifying for the scope exception, such as an embedded derivative related to a credit default swap on a referenced credit, would be subject to a bifurcation analysis even if their effects are allocated to interests in subordinated tranches of securitized financial instruments. The amended guidance requires that an entity separately disclose, on an instrument-by-instrument basis, the gross gains and gross losses that comprise the cumulative-effect adjustment that results from adopting the amended guidance. The amended guidance becomes effective for our interim period ending September 30, 2010. We currently do not hold such derivatives, and do not expect the amendment to have a material impact on our financial position, results of operations or cash flows.

In February 2010, the SEC issued a policy statement and staff work plan regarding the potential use by U.S. issuers of financial statements prepared in accordance with International Financial Reporting Standards (“IFRS”). IFRS is a comprehensive series of accounting standards published by the International Accounting Standards Board. Under the proposed timeline set forth by the SEC, we could be required in fiscal year 2015 to prepare financial statements in accordance with IFRS, and the SEC is expected to make a determination in 2011 regarding the mandatory adoption of IFRS. We are currently assessing the impact that this potential change would have on our consolidated financial statements, and we will continue to monitor the development of the potential implementation of IFRS.

In February 2010, the FASB amended its guidance on subsequent events. The amendment states that entities that are required to file or furnish their financial statements with the SEC are no longer required to disclose the date through which the entity has evaluated subsequent events. This amendment was effective for our interim reporting period ended March 31, 2010, and the implementation did not have an impact on our financial position, results of operations or cash flows as it is disclosure-only in nature.

In January 2010, the FASB issued authoritative guidance for fair value measurements. This guidance now requires a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and also to describe the reasons for these transfers. This authoritative guidance also requires enhanced disclosure of activity in Level 3 fair value measurements. The guidance for Level 1 and Level 2 fair value measurements was effective for our interim reporting period ended March 31, 2010. The implementation did not have an impact on our financial position, results of operations or cash flows as it is disclosure-only in nature. The guidance for Level 3 fair value measurements disclosures becomes effective for our interim reporting period ending September 30, 2011, and we do not expect that this guidance will have an impact on our financial position, results of operations or cash flows as it is disclosure-only in nature.

In October 2009, the FASB amended its Emerging Issues Task Force (“EITF”) authoritative guidance addressing revenue arrangements with multiple deliverables. The guidance requires revenue to be allocated to multiple elements using relative fair value based on vendor-specific objective evidence, third-party evidence or estimated selling price. The residual method also becomes obsolete under this guidance. This guidance is effective for our interim reporting period ending September 30, 2010, and allows for early adoption. We elected to early adopt the accounting guidance at the beginning of the second quarter of our fiscal year ending June 30, 2010 and have applied the adoption retrospectively to the beginning of the fiscal year to apply the guidance to transactions originating or materially modified after June 30, 2009. The implementation resulted in additional qualitative disclosures but did not have a material impact on our financial position, results of operations or cash flows.

 

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In October 2009, the FASB amended the authoritative guidance addressing certain revenue arrangements that include software elements. This guidance states that tangible products with hardware and software components that work together to deliver the product functionality are considered non-software products, and the accounting guidance for revenue arrangements with multiple deliverables is to be followed with respect to such products. This guidance is effective for our interim reporting period ending September 30, 2010, and allows for early adoption. We elected to early adopt the accounting guidance at the beginning of the second quarter of our fiscal year ending June 30, 2010 and have applied the adoption retrospectively to the beginning of the fiscal year to apply the guidance to transactions originating or materially modified after June 30, 2009. The implementation resulted in additional qualitative disclosures but did not have a material impact on our financial position, results of operations or cash flows.

In August 2009, the FASB issued authoritative guidance for measuring liabilities at fair value that reaffirms the previously existing definition of fair value and reintroduces the concept of entry value into the determination of fair value of liabilities. Entry value is the amount an entity would receive to enter into an identical liability. The guidance was effective for our interim reporting period ended December 31, 2009. The implementation did not have a material impact on our financial position, results of operations or cash flows.

In June 2009, the FASB issued authoritative guidance for consolidations that changes how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. This guidance was effective for our interim reporting period ending September 30, 2010. We are currently evaluating the impact of the guidance on our financial position, results of operations and cash flows.

In June 2009, the FASB issued authoritative guidance to establish the FASB Accounting Standards Codification as the source of authoritative accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States. This guidance was effective for our interim reporting period ended September 30, 2009 and only impacted references for accounting guidance.

In April 2009, the FASB issued authoritative guidance for business combinations that amends the provisions related to the initial recognition and measurement, subsequent measurement and disclosure of assets and liabilities arising from contingencies in a business combination. This guidance will require such contingencies to be recognized at fair value on the acquisition date if fair value can be reasonably estimated during the allocation period. Otherwise, entities would typically account for the acquired contingencies in accordance with authoritative guidance for contingencies. The guidance became effective for our business combinations for which the acquisition date is on or after July 1, 2009. The implementation did not have a material impact on our financial position, results of operations or cash flows during the fiscal year ended June 30, 2010, and the effect of this guidance, if any, on our financial position, results of operations and cash flows in future periods will depend on the nature and significance of business combinations subject to this guidance.

In April 2009, the FASB issued authoritative guidance to increase the frequency of fair value disclosures of financial instruments, thereby enhancing consistency in financial reporting. The guidance relates to fair value disclosures for any financial instruments that are not currently reflected on a company’s balance sheet at fair value. Prior to the effective date of this guidance, fair values for these types of financial assets and liabilities had only been disclosed once a year. The guidance requires these disclosures on a quarterly basis, providing qualitative and quantitative information about fair value estimates for all those financial instruments not measured on the balance sheet at fair value. The disclosure requirement under this guidance was effective for our interim reporting period ended September 30, 2009. The implementation did not have an impact on our financial position, results of operations or cash flows as it is disclosure-only in nature.

 

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In December 2008, the FASB issued authoritative guidance for an employer’s disclosures about plan assets of a defined benefit pension or other post-retirement plan. The guidance requires annual disclosures surrounding how investment allocation decisions are made, including the factors that are pertinent to an understanding of investment policies and strategies. The annual disclosure requirement under this guidance was effective for our fiscal year ending June 30, 2010. The implementation resulted in additional qualitative disclosures, but did not change the accounting treatment for postretirement benefit plans.

In April 2008, the FASB issued authoritative guidance for general intangibles other than goodwill, amending the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. This guidance is effective for intangible assets acquired on or after July 1, 2009. The adoption did not have a material impact on our financial position, results of operations or cash flows.

 

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EXECUTIVE SUMMARY

KLA-Tencor Corporation is a leading supplier of process control and yield management solutions for the semiconductor and related nanoelectronics industries. Within our primary area of focus, our comprehensive portfolio of products, services, software and expertise helps integrated circuit (“IC” or “chip”) manufacturers manage yield throughout the entire semiconductor fabrication process – from research and development to final volume production. In addition to the semiconductor industry, our technologies serve a number of other industries, including the high brightness light emitting diode (“HBLED”), data storage, and photovoltaic industries, as well as general materials research.

Our products and services are used by the vast majority of wafer, IC, reticle and disk manufacturers in the world. Our revenues are driven largely by capital spending by our customers who operate in one or more of several key semiconductor markets, including the memory, foundry and logic markets. Our customers purchase our products either in response to the need to drive advances in process technologies or to ramp up production to satisfy demand from industries such as communication, data processing, consumer electronics, automotive and aerospace. We believe that, over the long term, our customers will continue to invest in advanced technologies and new materials to enable smaller design rules and higher density applications, as well as reduced cost, which in turn will drive increased adoption of process control to reduce defectivity.

As a supplier to the global semiconductor and semiconductor-related industries, we are subject to business cycles, the timing, length and volatility of which can be difficult to predict. The industries we serve have historically been cyclical due to sudden changes in demand and manufacturing capacity. Our ability to predict future capacity-related capital spending by our customers is extremely limited, as such spending is very closely connected to the unpredictable business cycles within their industries. While our customer base, particularly in the semiconductor industry, historically has been, and is becoming increasingly, highly concentrated, we expect capital spending of our customers on process control to increase over the long term, driven by the demand for more precise diagnostics capabilities to address new defects as a result of shrinking device feature sizes, the transition to new materials, new device and circuit architecture, new lithography challenges and fab process innovation.

The demand for our products is generally affected by the profitability of our customers, which is driven by capacity and market supply for their products, as well as the willingness and ability of our customers to invest in new technologies. The increase in the semiconductor content in communication, data processing, consumer electronics, automotive and aerospace products, combined with the improving global economic environment during the fiscal year ended June 30, 2010, favorably impacted our customers and consequently accelerated the demand for our products. As our customers accelerate capital investments, we have started to increase production volumes to support anticipated customer demand. However, we cannot predict the duration and sustainability of the improving business conditions. As we increase production volumes and make commitments to increase our capacity in anticipation of improved business conditions, we remain at risk of incurring inventory-related and other restructuring charges if the recent improved business conditions do not continue.

The following table sets forth some of our key consolidated financial information for each of our last three fiscal years:

 

     Year ended June 30,  

(Dollar amounts in thousands)

   2010     2009     2008  

Total revenues

   $ 1,820,760      $ 1,520,216      $ 2,521,716   

Costs of revenues

   $ 815,662      $ 864,824      $ 1,134,856   

Gross margin percentage

     55     43     55

Net income (loss)

   $ 212,300      $ (523,368   $ 359,083   

Diluted income (loss) per share

   $ 1.23      $ (3.07   $ 1.95   

 

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The results for the fiscal year ended June 30, 2010 reflected improved fundamentals in the semiconductor industry driven by improvement in the economic environment, and strong demand from our foundry customers. Sales of our products and demand for our services improved as our customers ramped up their operations in response to improved market conditions. Even as we increased our business activity levels and shipped more products to our customers during the fiscal year ended June 30, 2010, we maintained tight controls over costs, which resulted in strong gross margins as well as net income.

The results for the fiscal year ended June 30, 2009 indicated the weak demand for semiconductor capital equipment and service due to the unfavorable global economic and industry conditions. The macroeconomic uncertainty led our customers to significantly reduce their factory operations and spending. While we took actions to restructure our operations and reduce our cost structure in response to the deteriorating market conditions, the rapid decline in revenues resulted in a significant deterioration in gross margins and a net loss. In the fiscal year ended June 30, 2009, we completed the acquisition of the Microelectronic Inspection Equipment business unit (“MIE business unit”) of Vistec Semiconductor Systems for net cash consideration of approximately $141.4 million. The acquired MIE business unit is a provider of mask registration measurement tools, Scanning Electron Microscope (“SEM”) based tools for mask critical dimension measurement and macro defect inspection systems. Our financial results for the fiscal year ended June 30, 2009 also included significant charges associated with impairment of goodwill, purchased intangible assets and other long-lived assets, as well as restructuring programs.

The results for the fiscal year ended June 30, 2008 reflected the culmination of a period of improved conditions in the semiconductor industry that began with the industry recovery in the fiscal year ended June 30, 2006. While the semiconductor market, and overall economic conditions, had started to weaken throughout the fiscal year ended June 30, 2008, our backlog position driven by demand from dynamic random access memory (DRAM) and flash memory chip manufacturers enabled us to generate strong revenue, gross margin and net income. In the fiscal year ended June 30, 2008, we completed the acquisition of ICOS Vision Systems Corporation for net cash consideration of approximately $488.8 million primarily to expand our product portfolio in semiconductor packaging inspection and to gain entry into the solar cell inspection and HBLED inspection markets.

Revenues and Gross Margin

 

     Year ended June 30,                          

(Dollar amounts in thousands)

   2010     2009     2008     FY10 vs. FY09     FY09 vs. FY08  

Revenues:

              

Product

   $ 1,324,270      $ 1,062,126      $ 2,030,224      $ 262,144      25   $ (968,098   -47

Service

     496,490        458,090        491,492        38,400      8     (33,402   -7
                                            

Total revenues

   $ 1,820,760      $ 1,520,216      $ 2,521,716      $ 300,544        $ (1,001,500  
                                            

Costs of revenues

   $ 815,662      $ 864,824      $ 1,134,856      $ (49,162   -6   $ (270,032   -24

Stock-based compensation expense included in costs of revenues

   $ 14,275      $ 19,932      $ 22,041      $ (5,657   -28   $ (2,109   -10

Gross margin percentage

     55     43     55     12       -12  

Product revenues

Product revenues increased in the fiscal year ended June 30, 2010 compared to the fiscal year ended June 30, 2009 as a result of increased capital spending by customers for both technology and capacity related investments of process control equipment, in response to strong semiconductor electronics end market demand.

 

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New semiconductor manufacturing products targeted towards the most advanced production nodes were significant contributors to this increase in revenue, as customers added advanced production capacity, particularly those serving the foundry market. These factors contributed to an increase in the number of tools that we sold during the fiscal year ended June 30, 2010, as compared to the fiscal year ended June 30, 2009. The increase in tool sales over our prior fiscal year was primarily driven by an increase in our sales of defect inspection equipment.

Product revenues decreased in the fiscal year ended June 30, 2009 compared to the fiscal year ended June 30, 2008 as a result of a reduction in capital spending by our customers due to the weakness in the semiconductor industry and a deteriorating macroeconomic environment, which resulted in customers delaying their purchases and installations of our products. The decline in revenues reflected the slowdown in worldwide demand for semiconductor equipment, as semiconductor manufacturers reduced capital spending and conserved cash in response to their business environment, even as their need for more precise diagnostics capabilities increased with technological advances. The weak macroeconomic and credit environments during the year adversely impacted the profitability of our customers, their access to capital and their capital spending.

For the fiscal year ended June 30, 2010, two customers, Taiwan Semiconductor Manufacturing Company Limited and Intel Corporation, each accounted for more than 10% of total revenues. For the fiscal year ended June 30, 2009, two customers, Intel Corporation and Samsung Electronics Co., Ltd., accounted for more than 10% of total revenues. For the fiscal year ended June 30, 2008, no customer accounted for more than 10% of total revenues. As of June 30, 2010, two customers, Samsung Electronics Co., Ltd. and Taiwan Semiconductor Manufacturing Company Limited, each accounted for more than 10% of net accounts receivable. As of June 30, 2009, two customers, Taiwan Semiconductor Manufacturing Company Limited and Intel Corporation, each accounted for more than 10% of net accounts receivable.

Service revenues

Service revenues are generated from maintenance contracts, as well as time and material billable service calls made to our customers after the expiration of the warranty period. The amount of service revenues generated is generally a function of the number of post-warranty systems installed at our customers’ sites and the utilization of those systems. Service revenues increased in the fiscal year ended June 30, 2010 compared to the fiscal year ended June 30, 2009 as the increase in wafer processing activity by semiconductor manufacturing customers drove higher system utilization of our previously installed equipment. This higher utilization level led to an increase in demand for service. Service revenues decreased in the fiscal year ended June 30, 2009 compared to the fiscal year ended June 30, 2008 as customers idled their under-utilized production equipment in response to the weakness in the semiconductor industry and the deteriorating macroeconomic environment.

Revenues by region

Revenues by region for the periods indicated were as follows (in thousands):

 

     Year ended June 30,  
     2010     2009     2008  

United States

   $ 341,079    19   $ 372,887    24   $ 518,851    21

Europe & Israel

     111,497    6     162,665    11     305,350    12

Japan

     239,393    13     437,081    29     617,214    24

Taiwan

     688,089    38     181,411    12     570,904    23

Korea

     151,198    8     187,624    12     225,119    9

Rest of Asia

     289,504    16     178,548    12     284,278    11
                                       

Total

   $ 1,820,760    100   $ 1,520,216    100   $ 2,521,716    100
                                       

 

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A significant portion of our revenues continue to be generated in Asia, where a substantial portion of the world’s semiconductor manufacturing capacity is located, and we expect that will continue to be the case.

Gross margin

Our gross margin fluctuates with revenue levels and product mix, and is affected by variations in costs related to manufacturing and servicing our products. Our gross margin percentage increased to 55% during the fiscal year ended June 30, 2010 from 43% during the fiscal year ended June 30, 2009 primarily due to demand for new high value products, significant volume efficiencies in manufacturing operations worldwide, lower inventory obsolescence, as well as a lower overall manufacturing cost structure as a result of our outsourcing and globalization initiatives. In addition, productivity improvements resulting from better utilization of field service resources contributed to the gross margin improvement.

Our gross margin percentage decreased to 43% during the fiscal year ended June 30, 2009 from 55% during the fiscal year ended June 30, 2008 primarily due to lower product and service revenues, higher intangible assets amortization expense as a result of our acquisitions of ICOS and the MIE business unit, decreased manufacturing capacity utilization, and excess inventory write-downs.

Engineering, Research and Development (“R&D”)

 

     Year ended June 30,                          

(Dollar amounts in thousands)

   2010     2009     2008     FY10 vs. FY09     FY09 vs. FY08  

R&D expenses

   $ 329,560      $ 371,463      $ 409,973      $ (41,903   -11   $ (38,510   -9

Stock-based compensation expense included in R&D expenses

   $ 27,289      $ 33,127      $ 32,623      $ (5,838   -18   $ 504      2

R&D expenses as a percentage of total revenues

     18     24     16     -6       8  

R&D expenses during the fiscal year ended June 30, 2010 decreased compared to the fiscal year ended June 30, 2009, even as we continued significant investments in product research and development. The decrease during the fiscal year ended June 30, 2010 was primarily attributable to cost reduction activities initiated during fiscal year ended June 30, 2009, the benefits of which were fully realized in the fiscal year ended June 30, 2010. In addition, no in-process R&D expense associated with acquisitions that we completed during that year was recorded during the fiscal year ended June 30, 2010, compared to $8.6 million of in-process R&D expense recorded during the fiscal year ended June 30, 2009. Furthermore, development material costs and consulting services related to R&D product development decreased compared to the fiscal year ended June 30, 2009 as certain significant new products completed the product development cycle during the fiscal year ended June 30, 2009 and came to market in the fiscal year ended June 30, 2010. The following are expenses that were recorded in the fiscal year ended June 30, 2010 compared to the fiscal year ended June 30, 2009:

 

   

$209.6 million for employee-related expenses, compared to $220.8 million during the fiscal year ended June 30, 2009,

 

   

$83.8 million for engineering material costs, compared to $97.9 million in the fiscal year ended June 30, 2009,

 

   

$26.5 million for outside services such as consulting, compared to $31.6 million during the fiscal year ended June 30, 2009,

 

   

$15.6 million for depreciation of fixed assets, amortization of intangibles and expensed in-process R&D (“IPR&D”), compared to $31.1 million during the fiscal year ended June 30, 2009, and

 

   

$13.7 million of benefit to R&D expense from external funding, compared to $21.7 million in the fiscal year ended June 30, 2009.

 

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R&D expenses during the fiscal year ended June 30, 2009 decreased compared to the fiscal year ended June 30, 2008. The decrease is primarily attributable to reduced employee-related expenses as a result of a number of cost reduction activities that we have undertaken, as well as reduced engineering material costs during the fiscal year ended June 30, 2009. These decreases were partially offset by additional R&D spending as a result of our acquisitions of ICOS and the MIE business unit. The following are expenses that were recorded in the fiscal year ended June 30, 2009 compared to the fiscal year ended June 30, 2008:

 

   

$220.8 million for employee-related expenses, compared to $226.5 million during the fiscal year ended June 30, 2008,

 

   

$97.9 million for engineering material costs, compared to $112.7 million in the fiscal year ended June 30, 2008,

 

   

$31.6 million for outside services such as consulting, compared to $36.8 million during the fiscal year ended June 30, 2008,

 

   

$31.1 million for depreciation of fixed assets, amortization of intangibles and expensed IPR&D, compared to $47.4 million during the fiscal year ended June 30, 2008, and

 

   

$21.7 million of benefit to R&D expense from external funding, compared to $20.4 million in the fiscal year ended June 30, 2008.

During the fiscal years ended June 30, 2009 and 2008, we expensed IPR&D of $8.6 million and $22.7 million, respectively, upon the completion of the acquisitions during the applicable fiscal year in connection with acquired intellectual property for which, as of the acquisition date, technological feasibility had not been established and no future alternative uses existed. The fair value of the purchased IPR&D was determined using the income approach, which discounts expected future cash flows from projects to their net present value. Future cash flows were estimated, taking into account the expected life cycles of the products and the underlying technology, relevant market sizes and industry trends. We determined a discount rate for each project based on the relative risks inherent in the project’s development horizon, the estimated costs of development, and the level of technological change in the project and the industry, among other factors. IPR&D was expensed upon acquisition because technological feasibility had not been achieved and no future alternative uses existed. The development of these technologies remains a risk due to the remaining efforts to achieve technological feasibility, rapidly changing customer markets, uncertain standards for new products, and significant competitive threats. The nature of the efforts to develop these technologies into commercially viable products consists primarily of planning, designing, experimenting, and testing activities necessary to determine that the technologies can meet market expectations, including functionality and technical requirements.

R&D expenses include the benefit of $13.7 million, $21.7 million and $20.4 million of external funding received during the fiscal years ended June 30, 2010, 2009 and 2008, respectively, for certain strategic development programs primarily from government grants. We expect our R&D expenses to increase with increases in our business activity levels as we accelerate our investments in critical programs focusing on new technologies and enhancements to existing products.

Our future operating results will depend significantly on our ability to produce products and provide services that have a competitive advantage in our marketplace. To do this, we believe that we must continue to make substantial investments in our research and development. We remain committed to product development in new and emerging technologies as we address the yield challenges our customers face at future technology nodes.

 

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Selling, General and Administrative (“SG&A”)

 

     Year ended June 30,                          

(Dollar amounts in thousands)

   2010     2009     2008     FY10 vs. FY09     FY09 vs. FY08  

SG&A expenses

   $ 361,372      $ 415,126      $ 464,890      $ (53,754   -13   $ (49,764   -11

Stock-based compensation expense included in SG&A expenses

   $ 44,418      $ 52,476      $ 51,806      $ (8,058   -15   $ 670      1

SG&A expenses as a percentage of total revenues

     20     27     18     -7       9  

SG&A expenses during the fiscal year ended June 30, 2010 were lower compared to the fiscal year ended June 30, 2009 primarily due to cost reduction activities initiated during the fiscal year ended June 30, 2009, the benefits of which were fully realized in the fiscal year ended June 30, 2010. In addition, $2.9 million of bad debt recovery was recorded during the fiscal year ended June 30, 2010, compared to $23.2 million of bad debt expense recorded during the fiscal year ended June 30, 2009. The following are expenses that were recorded in the fiscal year ended June 30, 2010 compared to the fiscal year ended June 30, 2009:

 

   

$306.7 million for employee-related expenses, compared to $328.0 million during the fiscal year ended June 30, 2009,

 

   

$2.9 million of bad debt recovery, compared to $23.2 million of bad debt expense during the fiscal year ended June 30, 2009,

 

   

$48.7 million for depreciation of fixed assets and amortization of intangibles, compared to $59.2 million during the fiscal year ended June 30, 2009, and

 

   

$16.9 million for expenses and settlements, net, related to the shareholder litigation relating to our historical stock option practices, compared to $13.9 million during the fiscal year ended June 30, 2009.

SG&A expenses during the fiscal year ended June 30, 2009 were lower compared to the fiscal year ended June 30, 2008 primarily due to lower expenses related to the shareholder litigation relating to our historical stock option practices and reduced employee-related expenses as a result of a number of cost reduction activities that we have undertaken, which are partially offset by additional SG&A spending and higher intangible assets amortization expense as a result of our acquisitions of ICOS and the MIE business unit, additional bad debt expense and lower gain on sale of real estate assets. The following are expenses that were recorded in the fiscal year ended June 30, 2009 compared to the fiscal year ended June 30, 2008:

 

   

$328.0 million for employee-related expenses, compared to $378.2 million during the fiscal year ended June 30, 2008,

 

   

$23.2 million for bad debt expense, compared to $0.2 million during the fiscal year ended June 30, 2008,

 

   

$59.2 million for depreciation of fixed assets and amortization of intangibles, compared to $34.3 million during the fiscal year ended June 30, 2008,

 

   

$13.9 million for expenses related to the shareholder litigation relating to our historical stock option practices, compared to $76.9 million during the fiscal year ended June 30, 2008, and

 

   

$4.1 million in net gains recorded on the sale of real estate assets, compared to $20.1 million recorded in the fiscal year ended June 30, 2008.

Impairment of Goodwill and Purchased Intangible Assets

For the three months ended December 31, 2009, we performed our annual evaluation of goodwill by reporting unit and concluded that there was no impairment as of December 31, 2009. As of December 31, 2009, our assessment indicated that the fair value of our reporting units was substantially in excess of their estimated

 

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carrying values, and therefore goodwill in the reporting units was not impaired. There have been no significant events or circumstances affecting the valuation of goodwill subsequent to the impairment test performed in the second quarter of the fiscal year ended June 30, 2010.

For the three months ended December 31, 2008, we performed our annual evaluation of goodwill by reporting unit and concluded that, as of December 31, 2008, the carrying value of our Metrology reporting unit exceeded its estimated fair value. As a result of the global economic downturn, reductions to our revenue and operating forecasts and a significant reduction in our market capitalization, we determined that the goodwill related to our Metrology reporting unit was fully impaired. As a result, we recorded a goodwill impairment charge of $272.1 million during the three months ended December 31, 2008.

As a result of the aforementioned impairment indicators for the three months ended December 31, 2008 and in accordance with the authoritative guidance on impairment of long-lived assets, we performed an analysis utilizing discounted future cash flows related to the long-lived and intangible assets to determine the fair value of each of our asset groups. Based on the assessment, we recorded an intangible asset impairment charge of $162.8 million related to existing technology, patents, customer relationships and trademarks, as well as an additional $2.0 million impairment charge related to long-lived assets during the three months ended December 31, 2008.

Restructuring Charges

In March 2009, we announced a plan to further reduce our global workforce by approximately 10%, which followed our announcement in November 2008 of a global workforce reduction of approximately 15%. We have undertaken a number of cost reduction activities, including these workforce reductions, in an effort to lower our quarterly operating expense run rate. The program in the United States is accounted for in accordance with the authoritative guidance related to compensation for nonretirement post-employment benefits, whereas the programs in the international locations are accounted for in accordance with the authoritative guidance for contingencies. During the fiscal year ended June 30, 2010, we recorded a $4.5 million net restructuring charge, of which $2.2 million was recorded to costs of revenues, $0.4 million to engineering, research and development expense and $1.9 million to selling, general and administrative expense. These charges represent the estimated minimum liability associated with expected termination benefits to be provided to employees.

The following table shows the activity primarily related to severance and benefits expense for the fiscal years ended June 30, 2010 and 2009:

 

(In thousands)

   Year ended
June 30, 2010
    Year ended
June 30, 2009
 

Beginning Balance

   $ 8,086      $ 1,333   

Restructuring costs

     5,580        40,596   

Adjustments

     (1,045     (1,912

Cash payments

     (12,174     (31,931
                

Ending Balance

   $ 447      $ 8,086   
                

Substantially all of the remaining accrued restructuring balance as of June 30, 2010 related to our workforce reductions is expected to be paid out by the end of calendar year 2010.

Interest Income and Other, Net

 

     Year ended June 30,  

(Dollar amounts in thousands)

   2010     2009     2008  

Interest income and other, net

   $ 31,532      $ 30,749      $ 71,625   

Interest expense

   $ 54,517      $ 55,339      $ 10,767   

Interest income and other, net as a percentage of total revenues

     2     2     3

Interest expense as a percentage of total revenues

     3     4     0

 

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Interest income and other, net is comprised primarily of interest income earned on our investment and cash portfolio, realized gains or losses on sales of marketable securities, as well as gains or losses recorded upon settlement of certain foreign currency contracts. Interest income and other, net during the fiscal year ended June 30, 2010 compared to the fiscal year ended June 30, 2009 remained flat. The decrease in interest income and other, net during the fiscal year ended June 30, 2009 compared to the fiscal year ended June 30, 2008 was primarily the result of lower interest income from our investment and cash portfolio due to lower market interest rates, as well as lower foreign currency transaction gain.

Interest expense in the fiscal year ended June 30, 2010 compared to the fiscal year ended June 30, 2009 remained flat. The increase in interest expense in the fiscal year ended June 30, 2009 compared to the fiscal year ended June 30, 2008 was primarily due to additional interest expense as a result of the issuance of $750 million aggregate principal amount of senior notes in the fourth quarter of the fiscal year ended June 30, 2008.

Provision for Income Taxes

The following table provides details of income taxes:

 

(In thousands)

   Year ended June 30,  
     2010     2009     2008  

Income (loss) before income taxes

   $ 291,181      $ (602,531   $ 560,234   

Provision for (benefit from) taxes

     78,881        (79,163     201,151   
                        

Effective tax rate

     27.1     13.1     35.9

Tax expense has decreased during the fiscal year ended June 30, 2010 due to a year-over-year increase in the proportion of our income earned outside the United States in countries with lower income tax rates.

We incurred $12.0 million in additional tax expense during the fiscal year ended June 30, 2010 due to shortfalls from employee stock activity. Windfall tax benefits arise when a company’s tax deduction for employee stock activity exceeds book compensation for the same activity. A shortfall arises when the tax deduction is less than book compensation. Windfalls are recorded as increases to capital in excess of par value. Shortfalls are recorded as decreases to capital in excess of par value to the extent that cumulative windfalls exceed cumulative shortfalls. Shortfalls in excess of cumulative windfalls are recorded as provision for income taxes.

We incurred $38.1 million in additional tax expense during the fiscal year ended June 30, 2009 due to a reduction in non-current deferred tax assets as a result of the adoption of California budget legislation, signed on February 20, 2009, which will allow a taxpayer to elect an alternative method to attribute taxable income to California for tax years beginning on or after January 1, 2011. We expect to make the election to use the alternative method to attribute taxable income to California for our fiscal year ending June 30, 2012. The expense included a reduction in non-current deferred tax assets of $9.7 million and a $28.4 million valuation allowance on excess California research and development credits that we believe will not be utilized due to the effect of the lower apportionment rate.

Tax expense was also increased during the fiscal year ended June 30, 2009 due to a goodwill impairment charge of $277.0 million related to certain business units, which was non-deductible for tax purposes.

We incurred $52.9 million in additional tax expense during the fiscal year ended June 30, 2008 due to the implementation of our global manufacturing strategy. The incremental U.S. tax expense was a result of an inter-company licensing agreement related to the migration of manufacturing to Singapore.

The additional tax expense was partially offset by a tax benefit of $14.4 million during the year ended June 30, 2008 that we realized due to the revision of prior year cumulative undistributed earnings of foreign subsidiaries considered to be permanently reinvested outside the United States.

 

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Our future effective income tax rate depends on various factors, such as tax legislation, the geographic composition of our pre-tax income, non-deductible expenses incurred in connection with acquisitions, research and development credits as a percentage of aggregate pre-tax income, the domestic manufacturing deduction, non-taxable or non-deductible increases or decreases in the assets held within our Executive Deferred Savings Plan, the tax effects of employee stock activity and the effectiveness of our tax planning strategies.

For the fiscal year ending June 30, 2011, cumulative shortfalls from employee stock activity may continue to exceed cumulative windfalls from employee stock activity, and we may therefore report higher provision for income taxes as a result. Because we cannot determine all of the factors that will enter into our income tax expense computation for the fiscal year ended June 30, 2011, we cannot currently estimate this impact on our tax rate for the next fiscal year.

In the normal course of business, we are subject to tax audits in various jurisdictions, and such jurisdictions may assess additional income or other taxes against us. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different from our historical income tax provisions and accruals. The results of an audit or litigation could have a material adverse effect on our operating results or cash flows in the period or periods for which that determination is made.

We are under United States federal income tax examination for the fiscal years ended June 30, 2007 through June 30, 2009, which represents all years for which tax returns have been filed and the statute of limitations has not expired. We are subject to state income tax examinations for all years beginning from the fiscal year ended June 30, 2006. We are also subject to examinations in major foreign jurisdictions, including Japan, Israel and Singapore, for all years beginning from the fiscal year ended June 30, 2006 and are currently under tax examinations in various other foreign tax jurisdictions. It is possible that certain examinations may be concluded in the next twelve months. We believe it is possible that we may recognize up to $3.6 million of our existing unrecognized tax benefits within the next twelve months as a result of the lapse of statutes of limitations, and the resolution of agreements with various foreign tax authorities.

Liquidity and Capital Resources

 

     As of June 30,  

(Dollar amounts in thousands)

   2010     2009     2008  

Cash and cash equivalents

   $ 529,918      $ 524,967      $ 1,128,106   

Marketable securities

     1,004,126        804,917        451,277   
                        

Total cash, cash equivalents and marketable securities

   $ 1,534,044      $ 1,329,884      $ 1,579,383   
                        

Percentage of total assets

     39     37     33
     Year ended June 30,  

(In thousands)

   2010     2009     2008  

Net cash provided by operating activities

   $ 447,800      $ 195,684      $ 662,611   

Net cash provided by (used in) investing activities

     (227,964     (484,900     58,063   

Net cash used in financing activities

     (216,331     (299,117     (318,938

Effect of exchange rate changes on cash and cash equivalents

     1,446        (14,806     3,859   
                        

Net increase (decrease) in cash and cash equivalents

   $ 4,951      $ (603,139   $ 405,595   
                        

At June 30, 2010, our cash, cash equivalents and marketable securities totaled $1.5 billion, an increase of $204 million from June 30, 2009. We have historically financed our operations through cash generated from operations. Cash provided by operating activities was $448 million and $196 million for the fiscal years ended June 30, 2010 and 2009, respectively.

 

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Cash provided by operating activities during the fiscal year ended June 30, 2010 increased compared to the fiscal year ended June 30, 2009 from $196 million to $448 million primarily as a result of the following key factors:

 

   

Lower operating expenses during the fiscal year ended June 30, 2010, reduced by approximately $165 million as compared to the fiscal year ended June 30, 2009, resulting primarily from our cost cutting measures initiated during the fiscal year ended June 30, 2009, the benefits of which were fully realized in the fiscal year ended June 30, 2010,

 

   

No material cash payments in the settlement of litigation during the fiscal year ended June 30, 2010, as compared to a cash payment of $65 million during the fiscal year ended June 30, 2009 in connection with the settlement of the shareholder class action litigation related to our historical stock option practices,

 

   

Increase in customer collections by approximately $58 million during the fiscal year ended June 30, 2010 as compared to the fiscal year ended June 30, 2009, and

 

   

Increase in taxes paid of approximately $26 million during the fiscal year ended June 30, 2010 as compared to the fiscal year ended June 30, 2009.

Cash used in investing activities during the fiscal year ended June 30, 2010 declined compared to the fiscal year ended June 30, 2009 from $485 million to $228 million primarily as a result of the following key factors:

 

   

Decrease of $140 million in acquisitions, primarily driven by the acquisition of the MIE business unit during the fiscal year ended June 30, 2009,

 

   

Decrease in the use of cash for purchases of available-for-sale and trading securities, net of sales and maturities, of approximately $141 million during the fiscal year ended June 30, 2010 as compared to the fiscal year ended June 30, 2009, partially offset by

 

   

Decrease in cash collections by approximately $16 million during the fiscal year ended June 30, 2010 from sale of assets, as compared to the fiscal year ended June 30, 2009.

Cash used in financing activities during the fiscal year ended June 30, 2010 declined compared to the fiscal year ended June 30, 2009 from $299 million to $216 million as a result of lower common stock repurchases. We repurchased $136 million of our common stock during the fiscal year ended June 30, 2010, as compared to $227 million in stock repurchases during the fiscal year ended June 30, 2009.

Cash provided by operating activities during the fiscal year ended June 30, 2009 decreased compared to the fiscal year ended June 30, 2008 from $663 million to $196 million primarily as a result of the following key factors:

 

   

Lower customer collections as a result of a decline in revenue during the fiscal year ended June 30, 2009, reduced by approximately $862 million as compared to the fiscal year ended June 30, 2008,

 

   

Decrease of $78 million in interest income during the fiscal year ended June 30, 2009 as compared to fiscal year ended June 30, 2008, primarily due to lower market interest rates,

 

   

Cash payments of $65 million in the settlement of litigation in connection with the settlement of the shareholder class action litigation related to our historical stock option practices during the fiscal year ended June 30, 2009, as compared to no such payments during the fiscal year ended June 30, 2008,

 

   

Interest payments of $52 million on the $750 million of our outstanding senior notes during the fiscal year ended June 30, 2009, as compared to no such payments during the fiscal year ended June 30, 2008, partially offset by

 

   

Reduced operating expenses by approximately $346 million during the fiscal year ended June 30, 2009 as compared to the fiscal year ended June 30, 2008, primarily from our cost reduction measures, and

 

   

Lower tax payments of $238 million during the fiscal year ended June 30, 2009, as compared to the fiscal year ended June 30, 2008.

 

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Cash flow from investing activities during the fiscal year ended June 30, 2009 declined compared to the fiscal year ended June 30, 2008 from $58 million of cash provided by investing activities to $485 million of cash used in investing activities, primarily as a result of the following key factors:

 

   

Increase in the use of cash for purchases of available-for-sale and trading securities, net of sales and maturities, of approximately $884 million during the fiscal year ended June 30, 2009 as compared to the fiscal year ended June 30, 2008,

 

   

Decrease in cash collections by approximately $47 million during the fiscal year ended June 30, 2009 from sale of real estate assets, as compared to the fiscal year ended June 30, 2008, partially offset by

 

   

Decrease of $353 million in acquisition expenses during the fiscal year ended June 30, 2009 as compared to the fiscal year ended June 30, 2008, primarily driven by our acquisition of ICOS for net cash consideration of approximately $489 million during the fiscal year ended June 30, 2008 and our acquisition of the MIE business unit of Vistec Semiconductor Systems for net cash consideration of approximately $141 million during the fiscal year ended June 30, 2009, and

 

   

Lower capital expenditures during the fiscal year ended June 30, 2009 by approximately $35 million, as compared to the fiscal year ended June 20, 2008.

Cash used in financing activities during the fiscal year ended June 30, 2009 declined compared to the fiscal year ended June 30, 2008 from $319 million to $299 million as a result of lower common stock repurchases, largely offset by cash proceeds from the issuance of long-term debt. We repurchased $227 million of our common stock during the fiscal year ended June 30, 2009, as compared to $1.1 billion in stock repurchases during the fiscal year ended June 30, 2008.

During the fiscal year ended June 30, 2009, we announced plans to reduce our global workforce by approximately 15% and 10% in November 2008 and March 2009, respectively. We recorded $4.5 million and $38.7 million in net restructuring charges during the fiscal years ended June 30, 2010 and 2009, respectively. As of June 30, 2010, we have paid out approximately $44.1 million in restructuring payments. The remaining balance will be paid out by the end of calendar year 2010.

The total amount of dividends paid during the fiscal years ended June 30, 2010, 2009 and 2008 was $102.4 million, $102.1 million and $108.5 million, respectively.

The shares repurchased under our share repurchase program have decreased our basic and diluted weighted-average shares outstanding. The decrease was partially offset by additional shares issued upon the exercise of employee stock options and in connection with stock purchases under our Employee Stock Purchase Plan. In October 2008, we suspended our stock repurchase program, and we subsequently restarted the program in February 2010.

Contractual Obligations

The following is a schedule summarizing our significant obligations to make future payments under contractual obligations as of June 30, 2010:

 

    Fiscal year ending June 30,

(In thousands)

  Total   2011   2012   2013   2014   2015   Thereafter   Other

Long-term debt obligations(1)

  $ 750,000   $ —     $ —     $ —     $ —     $ —     $ 750,000     —  

Interest expense associated with long-term debt obligations

    405,375     51,750     51,750     51,750     51,750     51,750     146,625     —  

Purchase commitments

    338,097     334,050     2,700     603     491     253     —       —  

Non-current income tax payable(2)

    58,982     —       —       —       —       —       —       58,982

Operating leases

    28,505     8,779     5,848     3,970     2,876     1,849     5,183     —  

Pension obligations

    24,240     1,735     1,572     1,960     1,927     2,541     14,505     —  
                                               

Total contractual cash obligations

  $ 1,605,199   $ 396,314   $ 61,870   $ 58,283   $ 57,044   $ 56,393   $ 916,313   $ 58,982
                                               

 

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(1) In April 2008, we issued $750 million aggregate principal amount of senior notes due in 2018.
(2) Represents the non-current tax payable obligation. We are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months due to uncertainties in the timing of tax audit outcomes.

We have agreements with financial institutions to sell certain of our trade receivables and promissory notes from customers without recourse. In addition, from time to time we will discount, without recourse, letters of credit (“LCs”) received from customers in payment for goods.

The following table shows total receivables sold under factoring agreements and proceeds from sales of LCs and related discounting fees paid during the years ended June 30, 2010, 2009 and 2008:

 

     Year ended June 30,

(In thousands)

   2010    2009    2008

Receivables sold under factoring agreements

   $ 107,666    $ 262,998    $ 290,250

Proceeds from sales of LCs

   $ 37,226    $ 27,799    $ 39,379

Discounting fees paid on sales of LCs(1)

   $ 189    $ 145    $ 232

 

(1) Discounting fees were equivalent to interest expense and were recorded in interest income and other, net.

We maintain guarantee arrangements of $16.7 million in various locations to fund customs guarantees for VAT and LC needs of our subsidiaries in Europe and Asia. Approximately $14.4 million was outstanding under these arrangements as of June 30, 2010.

We maintain certain purchase commitments with our suppliers to ensure a smooth and continuous supply chain for key components. Our liability under these purchase commitments is generally restricted to a forecasted time-horizon as mutually agreed upon between the parties. This forecast time-horizon can vary among different suppliers. We estimate our purchase commitments as of June 30, 2010 to be approximately $338.1 million, most of which is 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 change in the event that the arrangements are renegotiated or canceled. Certain agreements provide for potential cancellation penalties.

We provide standard warranty coverage on our systems for 40 hours per week for twelve months, providing labor and parts necessary to repair the systems during the warranty period. We account 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. The actual product performance and/or field expense profiles may differ, and in those cases we adjust our warranty reserves accordingly. Non-standard warranty coverage generally includes services incremental to the standard 40-hour per week coverage for twelve months. See Note 13, “Commitments and Contingencies” to the Consolidated Financial Statements for a detailed description.

Working capital increased to $2.1 billion as of June 30, 2010, compared to $1.9 billion as of June 30, 2009. This increase is primarily due to cash generated from operations, offset by cash payments for the share repurchase program, cash payments of dividends to stockholders, and purchases of fixed assets. As of June 30, 2010, our principal sources of liquidity consisted of $1.5 billion of cash, cash equivalents and marketable securities. Our liquidity is affected by many factors, some of which are based on the normal ongoing operations of the business, and others of which relate to the uncertainties of global economies and the semiconductor and the semiconductor equipment industries. Although cash requirements will fluctuate based on the timing and extent of these factors, we believe that cash generated from operations, together with the liquidity provided by existing cash balances, will be sufficient to satisfy our liquidity requirements for at least the next twelve months.

 

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Our investment portfolio included auction rate securities, which are investments with contractual maturities generally between 20 to 30 years. They are typically issued in the form of municipal bonds, preferred stock, a pool of student loans, or collateralized debt obligations whose interest rates are reset. The reset typically occurs every seven to forty-nine days, through an auction process. At the end of each reset period, investors can sell or continue to hold the securities at par. The auction rate securities held by us are backed by student loans and are collateralized, insured and guaranteed by the United States Federal Department of Education. In addition, all auction rate securities held by us are rated by the major independent rating agencies as either AAA or Aaa. In February 2008, auctions failed for approximately $48.2 million in par value of municipal auction rate securities that we held because sell orders exceeded buy orders. These failures are not believed to be a credit issue, but rather caused by a lack of liquidity. The funds associated with these failed auctions may not be accessible until the issuer calls the security, a successful auction occurs, a buyer is found outside of the auction process, or the security matures.

By letter dated August 8, 2008, we received notification from UBS AG (“UBS”), in connection with a settlement entered into between UBS and certain regulatory agencies, offering to repurchase all of our auction rate security holdings at par value. We formally accepted the settlement offer and entered into a repurchase agreement (“Agreement”) with UBS on November 11, 2008 (“Acceptance Date”). By accepting the Agreement, we (1) received the right (“Put Option”) to sell our auction rate securities at par value to UBS between June 30, 2010 and June 30, 2012 and (2) gave UBS the right to purchase the auction rate securities from us any time after the Acceptance Date as long as we receive the par value. As of June 30, 2009, we had $40.7 million par value of auction rate securities. During the fiscal year ended June 30, 2010, $23.9 million of the auction rate securities were called at par by the issuers. The Put Option was exercised on June 30, 2010 to sell the remaining auction rate securities of $16.8 million at par value and was subsequently settled. As of June 30, 2010, those remaining auction rate securities that had been sold but had not yet been settled as of such date are included in marketable securities and valued at par.

We accounted for the Put Option as a freestanding financial instrument, and during the three months ended December 31, 2008, we made an election to transfer these auction rate securities from available for sale to trading securities.

In April 2008, we issued $750 million aggregate principal amount of 6.90% senior, unsecured long-term debt due in 2018 with an effective interest rate of 7.00%. The discount on the debt amounted to $5.4 million and is being amortized over the life of the debt using the straight-line method as opposed to the interest method due to immateriality. Interest is payable semi-annually on November 1 and May 1. The debt indenture includes covenants that limit our ability to grant liens on our facilities and to enter into sale and leaseback transactions, subject to significant allowances under which certain sale and leaseback transactions are not restricted. We are in compliance with all of our covenants as at June 30, 2010.

Our credit ratings and outlooks as of July 22, 2010 are summarized below.

 

Rating Agency

   Rating    Outlook

Fitch

   BBB    Stable

Moody’s

   Baa1    Stable

Standard & Poor’s

   BBB    Negative

Factors that can affect our credit ratings include changes in our operating performance, the economic environment, conditions in the semiconductor and semiconductor equipment industries, our financial position, and changes in our business strategy.

Off-Balance Sheet Arrangements

Under our foreign currency risk management strategy, we utilize derivative instruments to protect our interests from unanticipated fluctuations in earnings and cash flows caused by volatility in currency exchange rates. This financial exposure is monitored and managed as an integral part of our overall risk management

 

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program, which focuses on the unpredictability of financial markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on our operating results. We continue our policy of hedging our current and forecasted foreign currency exposures with hedging instruments having tenors of up to 18 months (see Note 16, “Derivative Instruments and Hedging Activities” to the Consolidated Financial Statements for a detailed description). Our outstanding hedge contracts, with maximum maturity of 18 months, were as follows:

 

     As of June 30,  

(In thousands)

   2010     2009  

Cash flow hedge contracts

    

Purchase

   $ 15,835      $ —     

Sell

     (32,853     (36,938

Other foreign currency hedge contracts

    

Purchase

     82,535        73,914   

Sell

     (104,414     (106,080
                

Net

   $ (38,897   $ (69,104
                

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to financial market risks, including changes in interest rates, foreign currency exchange rates and marketable equity security prices. To mitigate these risks, we utilize derivative financial instruments, such as foreign currency hedges. We do not use derivative financial instruments for speculative or trading purposes. All of the potential changes noted below are based on sensitivity analyses performed on our financial position as of June 30, 2010. Actual results may differ materially.

As of June 30, 2010, we had an investment portfolio of fixed income securities of $1.0 billion, excluding those classified as cash and cash equivalents. These securities, as with all fixed income instruments, are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10% from levels as of June 30, 2010, the fair value of the portfolio would decline by $1.3 million.

As of June 30, 2010, we had net forward and option contracts to sell $38.9 million in foreign currency in order to hedge certain currency exposures (detail of these contracts and hedging activities is included in Note 16, “Derivative Instruments and Hedging Activities” to the Consolidated Financial Statements). If we had entered into these contracts on June 30, 2010, the U.S. dollar equivalent would have been $44.4 million. A 10% adverse move in all currency exchange rates affecting the contracts would decrease the fair value of the contracts by $21.5 million. However, if this occurred, the fair value of the underlying exposures hedged by the contracts would increase by a similar amount. Accordingly, we believe that, as a result of the hedging of certain of our foreign currency exposure, changes in most relevant foreign currency exchange rates should have no material impact on our income or cash flows.

In April 2008, we issued $750 million aggregate principal amount of 6.90% senior unsecured notes due in 2018. The fair market value of long-term fixed interest rate debt is subject to interest rate risk. Generally, the fair market value of fixed interest rate debt will increase as interest rates fall and decrease as interest rates rise. At June 30, 2010, the book value and the fair value of our fixed rate debt were $745.7 million and $834.4 million, respectively. At June 30, 2009, the book value and the fair value of our fixed rate debt were $745.2 million and $702.0 million, respectively.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

Consolidated Balance Sheets as of June 30, 2010 and 2009

   58

Consolidated Statements of Operations for each of the three years in the period ended June 30, 2010

   59

Consolidated Statements of Stockholders’ Equity for each of the three years in the period ended June 30, 2010

   60

Consolidated Statements of Cash Flows for each of the three years in the period ended June 30, 2010

   61

Notes to Consolidated Financial Statements

   62

Report of Independent Registered Public Accounting Firm

   109

 

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KLA-TENCOR CORPORATION

Consolidated Balance Sheets

 

     As of June 30,  

(In thousands, except per share data)

   2010     2009  

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 529,918      $ 524,967   

Marketable securities

     1,004,126        804,917   

Accounts receivable, net

     440,125        210,143   

Inventories, net

     401,730        370,206   

Deferred income taxes

     328,522        261,121   

Other current assets

     131,044        227,263   
                

Total current assets

     2,835,465        2,398,617   

Land, property and equipment, net

     236,752        291,878   

Goodwill

     328,006        329,379   

Purchased intangibles, net

     117,336        149,080   

Other non-current assets

     389,497        440,584   
                

Total assets

   $ 3,907,056      $ 3,609,538   
                

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Current liabilities:

    

Accounts payable

   $ 107,938      $ 63,485   

Deferred system profit

     204,764        95,820   

Unearned revenue

     37,026        46,236   

Other current liabilities

     422,059        341,441   
                

Total current liabilities

     771,787        546,982   

Non-current liabilities:

    

Long-term debt

     745,747        745,204   

Income tax payable

     53,492        49,738   

Unearned revenue

     20,354        23,059   

Other non-current liabilities

     69,065        60,163   
                

Total liabilities

     1,660,445        1,425,146   

Commitments and contingencies (Notes 13 and 14)

    

Stockholders’ equity:

    

Preferred stock, $0.001 par value, 1,000 shares authorized, none outstanding

     —          —     

Common stock, $0.001 par value, 500,000 shares authorized, 239,132 and 237,714 shares issued, 168,043 and 170,669 shares outstanding, as of June 30, 2010 and June 30, 2009, respectively

     168        171   

Capital in excess of par value

     921,292        835,306   

Retained earnings

     1,356,454        1,370,132   

Accumulated other comprehensive income (loss)

     (31,303     (21,217
                

Total stockholders’ equity

     2,246,611        2,184,392   
                

Total liabilities and stockholders’ equity

   $ 3,907,056      $ 3,609,538   
                

See accompanying notes to consolidated financial statements.

 

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KLA-TENCOR CORPORATION

Consolidated Statements of Operations

 

     Year ended June 30,

(In thousands, except per share data)

   2010    2009     2008

Revenues:

       

Product

   $ 1,324,270    $ 1,062,126      $ 2,030,224

Service

     496,490      458,090        491,492
                     

Total revenues

     1,820,760      1,520,216        2,521,716
                     

Costs and operating expenses:

       

Costs of revenues

     815,662      864,824        1,134,856

Engineering, research and development

     329,560      371,463        409,973

Selling, general and administrative

     361,372      415,126        464,890

Goodwill and purchased intangible assets impairment

     —        446,744        12,621
                     

Total costs and operating expenses

     1,506,594      2,098,157        2,022,340
                     

Income (loss) from operations

     314,166      (577,941     499,376

Interest income and other, net

     31,532      30,749        71,625

Interest expense

     54,517      55,339        10,767
                     

Income (loss) before income taxes

     291,181      (602,531     560,234

Provision for (benefit from) income taxes

     78,881      (79,163     201,151
                     

Net income (loss)

   $ 212,300    $ (523,368   $ 359,083
                     

Net income (loss) per share:

       

Basic

   $ 1.24    $ (3.07   $ 1.99
                     

Diluted

   $ 1.23    $ (3.07   $ 1.95
                     

Cash dividend paid per share

   $ 0.60    $ 0.60      $ 0.60
                     

Weighted-average number of shares:

       

Basic

     170,652      170,253        180,594
                     

Diluted

     173,034      170,253        184,259
                     

See accompanying notes to consolidated financial statements.

 

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KLA-TENCOR CORPORATION

Consolidated Statements of Stockholders’ Equity

 

     Common Stock and
Capital in Excess of
Par Value
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Total
Stockholders’
Equity
 

(In thousands)

   Shares     Amount        

Balances at June 30, 2007

   191,364        967,886        2,570,751        11,405        3,550,042   

Components of comprehensive income:

          

Net income

   —          —          359,083        —          359,083   

Change in unrealized loss on defined benefit plan assets, net of tax

   —          —          —          (498     (498

Change in unrealized gain on investments

   —          —          —          180        180   

Currency translation adjustments

   —          —          —          46,134        46,134   

Deferred losses on cash flow hedging instruments

   —          —          —          (9,537     (9,537
                

Total comprehensive income

             395,362   
                

Cumulative effect of adoption of income tax guidance

   —          —          (8,455     —          (8,455

Net issuance under employee stock plans

   4,170        155,635        —          —          155,635   

Repurchase of common stock

   (21,496     (510,554     (608,441     —          (1,118,995

Cash dividends paid ($0.60 per share)

   —          —          (108,521     —          (108,521

Stock-based compensation

   —          106,013        —          —          106,013   

Tax benefits of stock option transactions

   —          10,649        —          —          10,649   
                                      

Balances at June 30, 2008

   174,038        729,629        2,204,417        47,684        2,981,730   

Components of comprehensive loss:

          

Net loss

   —          —          (523,368     —          (523,368

Change in unrealized loss on defined benefit plan assets, net of tax

   —          —          —          2,467        2,467   

Change in unrealized gain on investments, net of tax

   —          —          —          4,829        4,829   

Currency translation adjustments

   —          —          —          (79,463     (79,463

Deferred gains on cash flow hedging instruments, net of tax

   —          —          —          3,266        3,266   
                

Total comprehensive loss

             (592,269
                

Net issuance under employee stock plans

   3,041        27,856        —          —          27,856   

Repurchase of common stock

   (6,410     (9,930     (208,768     —          (218,698

Cash dividends paid ($0.60 per share)

   —          —          (102,149     —          (102,149

Stock-based compensation

   —          105,535        —          —          105,535   

Tax charges for stock option transactions

   —          (17,613     —          —          (17,613
                                      

Balances at June 30, 2009

   170,669        835,477        1,370,132      $ (21,217     2,184,392   

Components of comprehensive income:

          

Net income

   —          —          212,300        —          212,300   

Change in unrealized loss on defined benefit plan assets, net of tax

   —          —          —          (4,446     (4,446

Change in unrealized gain on investments, net of tax

   —          —          —          36        36   

Currency translation adjustments

   —          —          —          (5,439     (5,439

Deferred losses on cash flow hedging instruments, net of tax

   —          —          —          (237     (237
                

Total comprehensive income

             202,214   
                

Net issuance under employee stock plans

   1,999        22,353        —          —          22,353   

Repurchase of common stock

   (4,625     (17,341     (123,569     —          (140,910

Cash dividends paid ($0.60 per share)

   —          —          (102,409     —          (102,409

Stock-based compensation

   —          85,982        —          —          85,982   

Tax charges for stock option transactions

   —          (5,011 )     —          —          (5,011 )
                                      

Balances at June 30, 2010

   168,043      $ 921,460      $ 1,356,454      $ (31,303   $ 2,246,611   
                                      

See accompanying notes to consolidated financial statements.

 

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Consolidated Statements of Cash Flows

 

     Year Ended June 30,  

(In thousands)

   2010     2009     2008  

Cash flows from operating activities:

      

Net income (loss)

   $ 212,300      $ (523,368   $ 359,083   

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

      

Depreciation and amortization

     87,348        135,848        126,376   

Goodwill, purchased intangible asset and long-lived asset impairment charges

     15,149        452,620        13,685   

Net gain on sale of real estate assets

     (2,984     (4,071     (20,163

Non-cash stock-based compensation

     85,982        105,535        106,468   

Provision for doubtful accounts

     (2,888     23,279        —     

Net loss (gain) on sale of marketable securities and other investments

     (5,077     635        (7,993

Deferred income taxes

     (19,865     59,697        16,644   

Tax benefit (charge) from equity awards

     (5,133     (17,880     10,649   

Excess tax benefit from equity awards

     —          (1,691     (7,899

Changes in assets and liabilities, net of assets acquired and liabilities assumed in business combinations:

      

Decrease (increase) in accounts receivable, net

     (220,857     277,331        149,309   

Decrease (increase) in inventories

     (27,715     120,249        100,168   

Decrease (increase) in other assets

     102,033        17,729        (94,787

Increase (decrease) in accounts payable

     44,381        (46,796     7,162   

Increase (decrease) in deferred system profit

     108,943        (54,978     (50,950

Increase (decrease) in other liabilities

     76,183        (348,455     (45,141
                        

Net cash provided by operating activities

     447,800        195,684        662,611   
                        

Cash flows from investing activities:

      

Acquisitions of businesses, net of cash received

     (1,500     (141,399     (494,036

Capital expenditures, net

     (30,202     (22,226     (57,323

Proceeds from sale of assets

     5,878        21,814        68,787   

Purchase of available-for-sale securities

     (1,080,412     (1,008,905     (1,129,522

Proceeds from sale of available-for-sale securities

     702,826        554,958        1,647,728   

Proceeds from maturity of available-for-sale securities

     152,144        98,333        16,865   

Purchase of trading securities

     (77,295     (67,240     (91,236

Proceeds from sale of trading securities

     100,597        79,765        96,800   
                        

Net cash provided by (used in) investing activities

     (227,964     (484,900     58,063   
                        

Cash flows from financing activities:

      

Issuance of long-term debt, net of discounts

     —          —          744,570   

Issuance of common stock

     35,867        40,108        155,635   

Tax withholding payments related to vested and released restricted stock units

     (13,514     (12,252     —     

Payment of dividends to stockholders

     (102,409     (102,149     (108,521

Excess tax benefit from equity awards

     —          1,691        7,899   

Common stock repurchases

     (136,275     (226,515     (1,111,170

Debt issuance costs

     —          —          (7,351
                        

Net cash used in financing activities

     (216,331     (299,117     (318,938
                        

Effect of exchange rate changes on cash and cash equivalents

     1,446        (14,806     3,859   
                        

Net increase (decrease) in cash and cash equivalents

     4,951        (603,139     405,595   

Cash and cash equivalents at beginning of period

     524,967        1,128,106        722,511   
                        

Cash and cash equivalents at end of period

   $ 529,918      $ 524,967      $ 1,128,106   
                        

Supplemental cash flow disclosures:

      

Income taxes paid (refund received), net

   $ (13,989   $ (23,144   $ 250,327   

Interest paid

   $ 52,438      $ 56,021      $ 3,195   

See accompanying notes to consolidated financial statements.

 

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KLA-TENCOR CORPORATION

Notes to Consolidated Financial Statements

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of Operations and Principles of Consolidation. 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. Headquartered in Milpitas, California, KLA-Tencor has subsidiaries both in the United States and in key markets throughout the world.

The Consolidated Financial Statements include the accounts of KLA-Tencor and its majority-owned subsidiaries. All significant intercompany balances and transactions have been eliminated.

Management Estimates. The preparation of the Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

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 KLA-Tencor’s cash, cash equivalents, accounts receivable, accounts payable and other current liabilities approximate their carrying amounts due to the relatively short maturity of these items.

Cash Equivalents and Marketable Securities. All highly liquid debt instruments with original or remaining maturities of less than three months at the date of purchase are considered to be cash equivalents. Marketable securities are generally classified as available-for-sale for use in current operations if required and are reported at fair value, with unrealized gains and losses, net of tax, presented as a separate component of stockholders’ equity under the caption “Accumulated other comprehensive income (loss).” All realized gains and losses and unrealized losses resulting from declines in fair value that are other than temporary are recorded in earnings in the period of occurrence. The specific identification method is used to determine the realized gains and losses on investments.

Non-Marketable Equity Securities and Other Investments. KLA-Tencor acquires certain equity investments for the promotion of business and strategic objectives, and to the extent these investments continue to have strategic value, KLA-Tencor typically does not attempt to reduce or eliminate the inherent market risks. Non-marketable equity securities and other investments are recorded at historical cost. Non-marketable equity securities and other investments are included in “Other non-current assets” on the balance sheet. Non-marketable equity securities are subject to a periodic impairment review; however, there are no open-market valuations, and the impairment analysis requires significant judgment. This analysis includes assessment of the investee’s financial condition, the business outlook for its products and technology, its projected results and cash flow, the likelihood of obtaining subsequent rounds of financing and the impact of any relevant contractual equity preferences held by KLA-Tencor or others.

Variable Interest Entities. The Financial Accounting Standards Board (“FASB”) requires that if the Company is the primary beneficiary of a variable interest entity, the assets, liabilities and results of operations of the variable interest entity should be included in the Company’s consolidated financial statements. KLA-Tencor has concluded that none of the Company’s equity investments are material to the Company’s financial position and do not require consolidation as they are either not variable interest entities or, of the equity investments that are variable interest entities, KLA-Tencor is not considered to be the primary beneficiary based on an assessment performed by management.

 

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KLA-TENCOR CORPORATION

Notes to Consolidated Financial Statements—(Continued)

 

Inventories. Inventories are stated at the lower of cost (on a first-in, first-out basis) or market. Demonstration units are stated at their manufacturing cost, and written down to state the demonstration units at their net realizable value. The Company reviews and sets standard costs semi-annually at current manufacturing costs in order to approximate actual costs. The Company’s manufacturing overhead standards for product costs are calculated assuming full absorption of forecasted spending over projected volumes, adjusted for excess capacity. Abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage) are recognized as current period charges. The Company writes down product inventory based on forecasted demand and technological obsolescence and parts inventory based on past usage. These factors are impacted by market and economic conditions, technology changes, new product introductions and changes in strategic direction and require estimates that may include uncertain elements. Actual demand may differ from forecasted demand, and such differences may have a material effect on recorded inventory values.

Allowance for Doubtful Accounts. A majority of the Company’s trade receivables are derived from sales to large multinational semiconductor manufacturers throughout the world. In order to monitor potential credit losses, the Company performs ongoing credit evaluations of its customers’ financial condition. An allowance for doubtful accounts is maintained for probable credit losses based upon the Company’s assessment of the expected collectibility of all accounts receivable. The allowance for doubtful accounts is reviewed on a quarterly basis to assess the adequacy of the allowance.

Property and Equipment. Property and equipment are recorded at cost, net of accumulated depreciation. Depreciation of property and equipment is based on the straight-line method over the estimated useful lives of the assets, which are generally thirty to thirty-five years for buildings, ten to fifteen years for leasehold improvements, five to seven years for furniture and fixtures, and two to five years for machinery and equipment. Leasehold improvements are amortized by the straight-line method over the shorter of the life of the related asset or the term of the underlying lease. Construction in process assets are not depreciated until the assets are placed in service. Depreciation expense for the fiscal years ended June 30, 2010, 2009 and 2008 was $43.5 million, $54.7 million and $60.6 million, respectively.

Goodwill and Intangible Assets. The Company assesses goodwill for impairment annually as well as whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Long-lived intangible assets are tested for recoverability whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. See Note 6, “Goodwill and Purchased Intangible Assets” for a detailed description. Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in each business combination. The Company conducted its annual evaluation of goodwill by reporting unit during the quarter ended December 31, 2009 and concluded that there was no impairment. There have been no significant events or circumstances affecting the valuation of goodwill subsequent to the impairment test performed in the second quarter of the fiscal year ended June 30, 2010.

Impairment of Long-Lived Assets. KLA-Tencor evaluates the carrying value of its long-lived assets whenever events or changes in circumstances indicate that the carrying value of the asset may be impaired. An impairment loss is recognized when estimated future cash flows expected to result from the use of the asset, including disposition, is less than the carrying value of the asset. Such an impairment charge would be measured as the excess of the carrying value of the asset over its fair value.

Software Development Costs. KLA-Tencor capitalizes certain internal and external costs incurred to acquire and create internal use software. Capitalized software is included in property and equipment when development is complete and is depreciated over three to five years when placed in service.

Concentration of Credit Risk. Financial instruments that potentially subject KLA-Tencor to significant concentrations of credit risk consist primarily of cash equivalents, short-term and non-current marketable

 

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KLA-TENCOR CORPORATION

Notes to Consolidated Financial Statements—(Continued)

 

securities, trade accounts receivable and derivative financial instruments used in hedging activities. KLA-Tencor invests in a variety of financial instruments, such as, but not limited to, certificates of deposit, corporate and municipal bonds, United States Treasury and agency securities, and equity securities and, by policy, limits the amount of credit exposure with any one financial institution or commercial issuer. KLA-Tencor has not experienced any material credit losses on its investments.

A majority of KLA-Tencor’s trade receivables are derived from sales to large multinational semiconductor manufacturers located throughout the world, with a majority located in Asia. Concentration of credit risk with respect to trade receivables is considered to be limited due to the Company’s customer base and the diversity of its geographic sales areas. KLA-Tencor performs ongoing credit evaluations of its customers’ financial condition and generally requires no collateral to secure accounts receivable. KLA-Tencor maintains an allowance for potential credit losses based upon expected collectibility of all accounts receivable. In addition, KLA-Tencor may utilize letters of credit or non-recourse factoring to mitigate credit risk when considered appropriate.

KLA-Tencor is exposed to credit loss in the event of nonperformance by counterparties on the foreign exchange contracts that the Company uses in hedging activities and in certain factoring transactions. These counterparties are large international financial institutions, and to date no such counterparty has failed to meet its financial obligations under such contracts.

Foreign Currency. The functional currencies of KLA-Tencor’s foreign subsidiaries are the local currencies, except as described below. Accordingly, all assets and liabilities of these foreign operations are translated to U.S. dollars at current period end exchange rates, and revenues and expenses are translated to U.S. dollars using average exchange rates in effect during the period. The gains and losses from foreign currency translation of these subsidiaries’ financial statements are recorded directly into a separate component of stockholders’ equity under the caption “Accumulated other comprehensive income (loss).”

KLA-Tencor’s manufacturing subsidiaries in Germany, Israel, Belgium, Hong Kong and Singapore use the U.S. dollar as their functional currency. Accordingly, assets and liabilities of these subsidiaries are remeasured using exchange rates in effect at the end of the period, except for non-monetary assets, such as inventories and property, plant and equipment that are remeasured using historical exchange rates. Revenues and costs are translated using average exchange rates for the period, except for costs related to those balance sheet items that are translated using historical exchange rates. The resulting remeasurement gains and losses are included in the Consolidated Statements of Operations as incurred.

Derivative Financial Instruments. KLA-Tencor uses financial instruments, such as forward exchange contracts and currency options, to hedge a portion of, but not all, existing and forecasted foreign currency denominated transactions expected to occur within twelve months. The purpose of KLA-Tencor’s foreign currency program is to manage the effect of exchange rate fluctuations on certain foreign currency denominated revenues, costs and eventual cash flows. The effect of exchange rate changes on forward exchange contracts is expected to offset the effect of exchange rate changes on the underlying hedged items. KLA-Tencor believes these financial instruments do not subject the Company to speculative risk that would otherwise result from changes in currency exchange rates. KLA-Tencor does not use derivative financial instruments for speculative or trading purposes.

All of KLA-Tencor’s derivative financial instruments are recorded at fair value based upon quoted market prices for comparable instruments adjusted for risk of non-performance. For derivative instruments designated and qualifying as cash flow hedges of forecasted foreign currency denominated transactions, the effective portion of the gain or loss on these hedges is reported as a component of accumulated other comprehensive income (loss) in stockholders’ equity, and is reclassified into earnings when the hedged transaction affects earnings. If the transaction being hedged fails to occur, or if a portion of any derivative is ineffective, the gain or loss on the

 

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KLA-TENCOR CORPORATION

Notes to Consolidated Financial Statements—(Continued)

 

associated financial instrument is recorded immediately in earnings. For derivative instruments used to hedge existing foreign currency denominated assets or liabilities, the gain or loss on these hedges is recorded immediately in earnings to offset the changes in the fair value of the assets or liabilities being hedged.

Warranty. KLA-Tencor provides standard warranty coverage on its systems for 40 hours per week for twelve months, providing labor and parts necessary to repair the systems during the warranty period. KLA-Tencor 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, KLA-Tencor calculates the average service hours and parts expense per system and applies the actual labor and overhead rates to determine the estimated warranty charge. KLA-Tencor updates these estimated charges on a quarterly basis. The actual product performance and/or field expense profiles may differ, and in those cases KLA-Tencor adjusts its warranty accruals accordingly (see Note 13, “Commitments and Contingencies”).

Revenue Recognition. KLA-Tencor recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable, and collectibility is reasonably assured. KLA-Tencor derives revenue from three sources—sales of systems, spare parts and services. KLA-Tencor typically recognizes revenue for system sales upon acceptance by the customer that the system has been installed and is operating according to predetermined specifications. Under certain circumstances, however, KLA-Tencor recognizes revenue prior to written acceptance from the customer, as follows:

 

   

When system sales to independent distributors have no installation requirement, contain no acceptance agreement, and 100% payment is due upon shipment, revenue is recognized on shipment.

 

   

When the installation of the system is deemed perfunctory, revenue is recognized upon shipment. The portion of revenue associated with installation is deferred based on estimated fair value, and that revenue is recognized upon completion of the installation.

 

   

When the customer fab has already accepted the same tool, with the same specifications, and it can be objectively demonstrated that the tool meets all of the required acceptance criteria upon shipment, revenue is recognized upon shipment. The portion of revenue associated with installation is deferred based on estimated fair value, and that revenue is recognized upon completion of the installation.

 

   

When the customer withholds signature on the acceptance document due to issues unrelated to product performance, revenue is recognized when the system is performing as intended and meets all published and contractually agreed specifications.

 

   

When the system is damaged during transit and title has passed to the customer, revenue is recognized upon receipt of cash payment from the customer.

KLA-Tencor also allows for multiple element revenue arrangements in cases where certain elements of a sales contract are not delivered and accepted at the same time. In such cases, KLA-Tencor defers the relative fair value of the 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 and fulfill the following criteria: (a) the delivered item(s) has value to the customer on a standalone basis; (b) there is objective and reliable evidence of the fair value of the undelivered item(s); and (c) 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 of 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.

 

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KLA-TENCOR CORPORATION

Notes to Consolidated Financial Statements—(Continued)

 

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. If maintenance is included in an arrangement, that includes a software license agreement, amounts related to maintenance are allocated based on vendor specific objective evidence of fair value. Services performed in the absence of a contract, such as consulting and training revenue, are recognized when the related services are performed, and collectibility is reasonably assured.

The deferred system profit balance as of June 30, 2010 and 2009 was $204.8 million and $95.8 million, respectively, and 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 has not met the revenue recognition criteria of the Company. Deferred system profit does not include the profit associated with product shipments to customers in Japan, to whom title does not transfer until customer acceptance. Shipments to customers in Japan are classified as inventory at cost until the time of acceptance.

KLA-Tencor 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 twelve months. Non-standard warranty is recognized ratably as revenue when the applicable warranty term period commences. The unearned revenue balance was $57.4 million and $69.3 million as of June 30, 2010 and 2009, respectively.

Revenue Recognition for Certain Arrangements with Software Elements and/or Multiple Deliverables. In October 2009, the FASB amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry-specific software revenue recognition guidance. In October 2009, the FASB also amended the accounting standards for multiple-deliverable revenue arrangements to: