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KLA-Tencor 10-Q 2011

Documents found in this filing:

  1. 10-Q
  2. Ex-10.46
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32
  6. Ex-32
Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended: December 31, 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 Number 000-09992

 

 

KLA-Tencor Corporation

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   04-2564110

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

One Technology Drive

Milpitas, California

95035

(Address of principal executive offices)

(Zip Code)

(408) 875-3000

(Registrant’s telephone number, including area code)

 

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

  Accelerated filer ¨    Non-accelerated filer ¨   Smaller reporting company ¨
     (Do not check if a smaller reporting company)  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of January 13, 2011, there were 167,221,198 shares of the registrant’s Common Stock, $0.001 par value, outstanding.

 

 

 


Table of Contents

INDEX

 

         Page
Number
 

PART I

  FINANCIAL INFORMATION   

Item 1

  Financial Statements (Unaudited)   
 

Condensed Consolidated Balance Sheets as of December 31, 2010 and June 30, 2010

     3   
 

Condensed Consolidated Statements of Operations for the Three Months and Six Months Ended December  31, 2010 and 2009

     4   
 

Condensed Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2010 and 2009

     5   
 

Notes to Condensed Consolidated Financial Statements

     6   

Item 2

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      28   

Item 3

  Quantitative and Qualitative Disclosures About Market Risk      40   

Item 4

  Controls and Procedures      41   

PART II

  OTHER INFORMATION   

Item 1

  Legal Proceedings      41   

Item 1A

  Risk Factors      41   

Item 2

  Unregistered Sales of Equity Securities and Use of Proceeds      51   

Item 3

  Defaults upon Senior Securities      51   

Item 4

  (Removed and Reserved)      51   

Item 5

  Other Information      51   

Item 6

  Exhibits      52   

SIGNATURES

     53   

EXHIBIT INDEX

     54   

 

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Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

KLA-TENCOR CORPORATION

Condensed Consolidated Balance Sheets

(Unaudited)

 

(In thousands)

   December 31,
2010
    June 30,
2010
 

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 596,104      $ 529,918   

Marketable securities

     1,040,296        1,004,126   

Accounts receivable, net

     531,453        440,125   

Inventories, net

     504,697        401,730   

Deferred income taxes

     333,410        328,522   

Other current assets

     120,351        131,044   
                

Total current assets

     3,126,311        2,835,465   

Land, property and equipment, net

     249,468        236,752   

Goodwill

     328,147        328,006   

Purchased intangibles, net

     101,900        117,336   

Other non-current assets

     362,635        389,497   
                

Total assets

   $ 4,168,461      $ 3,907,056   
                

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Current liabilities:

    

Accounts payable

   $ 123,166      $ 107,938   

Deferred system profit

     241,494        204,764   

Unearned revenue

     33,193        37,026   

Other current liabilities

     396,084        422,059   
                

Total current liabilities

     793,937        771,787   

Non-current liabilities:

    

Long-term debt

     746,018        745,747   

Income tax payable

     62,329        53,492   

Unearned revenue

     28,383        20,354   

Other non-current liabilities

     71,560        69,065   
                

Total liabilities

     1,702,227        1,660,445   

Commitments and contingencies (Note 12 and Note 13)

    

Stockholders’ equity:

    

Common stock and capital in excess of par value

     972,870        921,460   

Retained earnings

     1,506,747        1,356,454   

Accumulated other comprehensive income (loss)

     (13,383     (31,303
                

Total stockholders’ equity

     2,466,234        2,246,611   
                

Total liabilities and stockholders’ equity

   $ 4,168,461      $ 3,907,056   
                

 

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

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Table of Contents

KLA-TENCOR CORPORATION

Condensed Consolidated Statements of Operations

(Unaudited)

 

     Three months ended
December 31,
     Six months ended
December 31,
 

(In thousands, except per share data)

   2010     2009      2010     2009  

Revenues:

         

Product

   $ 627,857      $ 314,946       $ 1,178,466      $ 544,197   

Service

     138,470        125,409         270,203        238,845   
                                 

Total revenues

     766,327        440,355         1,448,669        783,042   
                                 

Costs and operating expenses:

         

Costs of revenues

     311,398        207,286         575,367        379,178   

Engineering, research and development

     94,897        83,301         189,617        161,510   

Selling, general and administrative

     91,166        102,673         179,203        180,309   
                                 

Total costs and operating expenses

     497,461        393,260         944,187        720,997   
                                 

Income from operations

     268,866        47,095         504,482        62,045   

Interest income and other, net

     (4,182     4,463         (2,957     25,762   

Interest expense

     13,493        13,542         27,022        26,999   
                                 

Income before income taxes

     251,191        38,016         474,503        60,808   

Provision for income taxes

     65,699        16,222         134,815        18,609   
                                 

Net income

   $ 185,492      $ 21,794       $ 339,688      $ 42,199   
                                 

Net income per share:

         

Basic

   $ 1.11      $ 0.13       $ 2.03      $ 0.25   
                                 

Diluted

   $ 1.09      $ 0.13       $ 2.00      $ 0.24   
                                 

Cash dividend paid per share

   $ 0.25      $ 0.15       $ 0.50      $ 0.30   
                                 

Weighted average number of shares:

         

Basic

     166,886        171,408         167,052        171,053   
                                 

Diluted

     169,513        173,808         169,685        173,292   
                                 

 

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

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Table of Contents

KLA-TENCOR CORPORATION

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

     Six months ended
December 31,
 

(In thousands)

   2010     2009  

Cash flows from operating activities:

    

Net income

   $ 339,688      $ 42,199   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     42,436        46,374   

Asset impairment charges

     6,800        10,592   

Gain on sale of real estate assets

     (1,372     (2,984

Non-cash stock-based compensation expense

     43,644        41,054   

Tax charge from equity awards

     —          (5,133

Net gain on sale of marketable securities and other investments

     (1,477     (2,874

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

    

Increase in accounts receivable, net

     (79,232     (83,843

Decrease (increase) in inventories

     (103,160     24,350   

Decrease (increase) in other assets

     (27,267     55,182   

Increase in accounts payable

     14,680        23,616   

Increase in deferred system profit

     36,730        51,758   

Increase in other liabilities

     17,983        36,559   
                

Net cash provided by operating activities

     289,453        236,850   
                

Cash flows from investing activities:

    

Capital expenditures, net

     (22,715     (14,370

Proceeds from sale of assets

     18,185        5,878   

Purchase of available-for-sale securities

     (418,312     (600,671

Proceeds from sale and maturity of available-for-sale securities

     363,327        404,387   

Purchase of trading securities

     (28,401     (38,574

Proceeds from sale of trading securities

     44,528        46,621   
                

Net cash used in investing activities

     (43,388     (196,729
                

Cash flows from financing activities:

    

Issuance of common stock

     31,723        23,462   

Tax withholding payments related to vested and released restricted stock units

     (20,251     (12,204

Common stock repurchases

     (119,173     —     

Payment of dividends to stockholders

     (83,594     (51,292 )
                

Net cash used in financing activities

     (191,295     (40,034
                

Effect of exchange rate changes on cash and cash equivalents

     11,416        6,390   
                

Net increase in cash and cash equivalents

     66,186        6,477   

Cash and cash equivalents at beginning of period

     529,918        524,967   
                

Cash and cash equivalents at end of period

   $ 596,104      $ 531,444   
                

Supplemental cash flow disclosures:

    

Income taxes paid (refund received), net

   $ 117,370      $ (57,900
                

Interest paid

   $ 26,447      $ 26,330   
                

 

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

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KLA-TENCOR CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

NOTE 1 – BASIS OF PRESENTATION

Basis of Presentation. The condensed consolidated financial statements have been prepared by KLA-Tencor Corporation (“KLA-Tencor” or the “Company”) pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the unaudited interim financial statements reflect all adjustments (consisting only of normal, recurring adjustments) necessary for a fair statement of the financial position, results of operations and cash flows for the periods indicated. These financial statements and notes, however, should be read in conjunction with Item 8, “Financial Statements and Supplementary Data” included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2010, filed with the SEC on August 6, 2010.

The condensed consolidated financial statements include the accounts of KLA-Tencor and its majority-owned subsidiaries. All significant intercompany balances and transactions have been eliminated.

References in this Quarterly Report on Form 10-Q to “authoritative guidance” are to the Accounting Standards Codification issued by the Financial Accounting Standards Board (“FASB”) in June 2009.

The results of operations for the three and six months ended December 31, 2010 are not necessarily indicative of the results that may be expected for any other interim period or for the full fiscal year ending June 30, 2011.

Certain reclassifications have been made to the prior year’s Condensed Consolidated Balance Sheet and notes to conform to the current year presentation. The reclassifications had no effect on the Condensed Consolidated Statements of Operations or Cash Flows.

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

Recent Accounting Pronouncements

In December 2010, the FASB amended its guidance on goodwill and other intangible assets. The amendment modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if there are qualitative factors indicating that it is more likely than not that a goodwill impairment exists. The qualitative factors are consistent with the existing guidance which requires goodwill of a reporting unit to be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. This amendment was effective for the Company’s interim period ending December 31, 2010. The amendment did not have an impact on the Company’s financial position, results of operations or cash flows.

In December 2010, the FASB amended its guidance on business combinations. Under the amended guidance, a public entity that presents comparative financial statements must disclose the revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the prior annual reporting period. The amendment is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The amendment did not have an impact on the Company’s financial position, results of operations or cash flows.

In April 2010, the FASB amended its guidance on share-based payment awards with an exercise price 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 the Company’s interim period ending September 30, 2011. The Company does not expect the implementation to have an impact on its financial position, results of operations or cash flows.

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 the Company’s interim reporting period ended March 31, 2010. The implementation did not have an impact on the Company’s 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 the Company’s interim reporting period ending September 30, 2011 and the Company does not expect that this guidance will have an impact on its financial position, results of operations or cash flows as it is disclosure-only in nature.

 

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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:

 

   

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 the Company sells the element in a separate stand-alone transaction.

 

   

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

 

   

ESP – the Company’s best estimate of the selling price of an element in a transaction.

The Company elected to early adopt this accounting guidance at the beginning of its second quarter of the fiscal year ended June 30, 2010 and 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 below but did not have a material impact on the Company’s financial position, results of operations or cash flows.

This guidance does not generally change the units of accounting for the Company’s revenue transactions. The Company 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, the Company recognizes revenue upon shipment, prior to acceptance by the customer. The portion of revenue associated with installation is deferred based on relative sales price and recognized upon completion of the installation. Spare parts revenue is recognized when the product has been shipped and risk of loss has passed to the customer, and collectability is reasonably assured. Service and maintenance contract revenue is recognized ratably over the term of the maintenance contract. Revenue from services performed in the absence of a contract, such as consulting and training revenue, is recognized when the related services are performed, and collectability is reasonably assured. The Company’s arrangements generally do not include any provisions for cancellation, termination or refunds that would significantly impact recognized revenue.

The Company enters into revenue arrangements that may consist of multiple deliverables of its products and services where certain elements of a sales contract are not delivered and accepted in one reporting period.

In many instances, products are sold in stand-alone arrangements. Services are sold separately through renewals of annual maintenance contracts. As a result, for substantially all of the arrangements with multiple deliverables pertaining to products and services, the Company uses VSOE or TPE to allocate the selling price to each deliverable. The Company determines TPE based on historical prices charged for products and services when sold on a stand-alone basis.

When the Company is unable to establish relative selling price using VSOE or TPE, the Company uses ESP in its allocation of arrangement consideration. The objective of ESP is to determine the price at which the Company would transact a sale if the product or service were sold on a stand-alone basis. ESP could potentially be used for new or customized products.

The Company regularly reviews relative selling prices and maintains internal controls over the establishment and updates of these estimates.

NOTE 2 – FAIR VALUE MEASUREMENTS

The Company’s financial assets are measured and recorded at fair value, except for equity investments in privately-held companies. These equity investments are generally accounted for under the cost method of accounting and are periodically assessed for other-than-temporary impairment when an event or circumstance indicates that an other-than-temporary decline in value may have occurred. The Company’s non-financial assets, such as goodwill, intangible assets, and property, plant and equipment, are recorded at cost and are assessed for impairment when an event or circumstance indicates that an other-than-temporary decline in value may have occurred.

Fair Value Hierarchy. The authoritative guidance for fair value measurements establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:

 

Level 1    Valuations based on quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.

 

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Level 2    Valuations based on quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities.
Level 3    Valuations based on inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

All of the Company’s financial instruments were classified within Level 1 or Level 2 of the fair value hierarchy at December 31, 2010, because they were valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. The types of instruments valued based on quoted market prices in active markets include money market funds and U.S. Treasury securities. Such instruments are generally classified within Level 1 of the fair value hierarchy.

The types of instruments valued based on other observable inputs include U.S. agency securities, commercial paper, U.S. corporate bonds, municipal obligations and sovereign securities. The market inputs used to value these instruments generally consist of market yields, reported trades and broker/dealer quotes. Such instruments are generally classified within Level 2 of the fair value hierarchy.

The principal market in which the Company executes its foreign currency contracts is the institutional market in an over-the-counter environment with a relatively high level of price transparency. The market participants usually are large commercial banks. The Company’s foreign currency contracts’ valuation inputs are based on quoted prices and quoted pricing intervals from public data sources and do not involve management judgment. These contracts are typically classified within Level 2 of the fair value hierarchy.

The types of instruments valued based on unobservable inputs include the auction rate securities that were held by the Company as of and prior to June 30, 2010. Such instruments were generally classified within Level 3 of the fair value hierarchy. The Company estimated the fair value of these auction rate securities using a discounted cash flow model incorporating assumptions that market participants would use in their estimates of fair value. Some of these assumptions included estimates for interest rates, timing and amount of cash flows and expected holding periods of the auction rate securities.

Financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2010 were as follows:

 

(In thousands)

   Total     Quoted Prices in
Active Markets
for Identical
Assets (Level  1)
     Significant Other
Observable Inputs
(Level 2)
    Significant
Unobservable Inputs
(Level 3)
 

U.S. Treasuries

   $ 60,706      $ 39,681       $ 21,025        —     

U.S. Government agency securities

     250,635        248,636         1,999        —     

Municipal bonds

     60,497        —           60,497        —     

Corporate debt securities

     621,883        —           621,883        —     

Money market, bank deposits and other

     401,010        401,010         —          —     

Sovereign securities

     43,587        10,385         33,202        —     
                                 

Total marketable securities and cash equivalents

     1,438,318        699,712         738,606        —     
                                 

Executive Deferred Savings Plan:

         

Money market and other

     720        720         —          —     

Mutual funds

     124,873        96,337         28,536        —     
                                 

Executive Deferred Savings Plan total

     125,593        97,057         28,536        —     
                                 

Derivative assets

     2,313        —           2,313        —     

Total financial assets

   $ 1,566,224      $ 796,769       $ 769,455      $ —     
                                 

Derivative liabilities

   $ (4,584   $ —         $ (4,584   $ —     
                                 

Total financial liabilities

   $ (4,584   $ —         $ (4,584   $ —     
                                 

 

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Financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2010 were as follows:

 

(In thousands)

  Total     Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
     Significant Other
Observable Inputs
(Level 2)
    Significant
Unobservable Inputs
(Level 3)
 

U.S. Treasuries

  $ 42,293      $ 35,194       $ 7,099        —     

U.S. Government agency securities

    250,280        243,144         7,136        —     

Municipal bonds

    55,459        —           55,459        —     

Corporate debt securities

    603,156        —           603,156        —     

Money market, bank deposits and other

    373,081        373,070         11        —     

Sovereign securities

    39,355        10,500         28,855        —     

Auction rate securities

    16,825        —           —          16,825   
                                

Total marketable securities and cash equivalents

    1,380,449        661,908         701,716        16,825   
                                

Executive Deferred Savings Plan:

        

Money market and other

    4        4         —          —     

Mutual funds

    109,226        85,254         23,972        —     
                                

Executive Deferred Savings Plan total

    109,230        85,258         23,972        —     
                                

Derivative assets

    296        —           296        —     

Total financial assets

  $ 1,489,975      $ 747,166       $ 725,984      $ 16,825   
                                

Derivative liabilities

  $ (5,824   $ —         $ (5,824   $ —     
                                

Total financial liabilities

  $ (5,824   $ —         $ (5,824   $ —     
                                

 

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Assets and liabilities measured at fair value on a recurring basis were presented on the Company’s Condensed Consolidated Balance Sheet as of December 31, 2010 as follows:

 

(In thousands)

   Total     Quoted Prices in
Active Markets
for Identical
Assets (Level  1)
     Significant Other
Observable Inputs
(Level 2)
    Significant
Unobservable Inputs
(Level 3)
 

Cash equivalents

   $ 398,022      $ 374,573       $ 23,449      $ —     

Marketable securities

     1,040,296        325,139         715,157        —     

Other current assets

     2,313        —           2,313        —     

Other non-current assets

     125,593        97,057         28,536        —     
                                 

Total financial assets

   $ 1,566,224      $ 796,769       $ 769,455      $ —     
                                 

Other current liabilities

   $ (4,584   $ —         $ (4,584   $ —     
                                 

Total financial liabilities

   $ (4,584   $ —         $ (4,584   $ —     
                                 

Assets and liabilities measured at fair value on a recurring basis were presented on the Company’s Condensed Consolidated Balance Sheet as of June 30, 2010 as follows:

 

(In thousands)

   Total     Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
     Significant Other
Observable Inputs
(Level 2)
    Significant
Unobservable Inputs
(Level 3)
 

Cash equivalents

   $ 376,323      $ 356,224       $ 20,099      $ —     

Marketable securities

     1,004,126        305,684         681,617        16,825  

Other current assets

     296        —           296        —     

Other non-current assets

     109,230        85,258         23,972        —     
                                 

Total financial assets

   $ 1,489,975      $ 747,166       $ 725,984      $ 16,825  
                                 

Other current liabilities

   $ (5,824   $ —         $ (5,824   $ —     
                                 

Total financial liabilities

   $ (5,824   $ —         $ (5,824   $ —     
                                 

Changes in the Company’s Level 3 securities for the three and six months ended December 31, 2010 and 2009 were as follows:

 

(In thousands)

   Three months ended
December 31,
    Six months ended
December 31,
 
   2010      2009     2010     2009  

Beginning aggregate estimated fair value of Level 3 securities

   $ —         $ 37,594      $ 16,825      $ 40,584   

Total realized and unrealized gains

         

Unrealized gain included in income

     —           21        —          56   

Net settlements

     —           (5,250     (16,825     (8,275
                                 

Ending aggregate estimated fair value of Level 3 securities

   $ —         $ 32,365      $ —        $ 32,365   
                                 

 

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NOTE 3 – BALANCE SHEET COMPONENTS

 

(In thousands)

   December 31,
2010
    June 30,
2010
 

Accounts receivable, net

    

Accounts receivable, gross

   $ 553,533      $ 471,999   

Allowance for doubtful accounts

     (22,080     (31,874
                
   $ 531,453      $ 440,125   
                

Inventories, net

    

Customer service parts

   $ 137,594      $ 131,951   

Raw materials

     197,164        123,301   

Work-in-process

     120,430        95,641   

Finished goods

     49,509        50,837   
                
   $ 504,697      $ 401,730   
                

Other current assets

    

Prepaid expenses

   $ 38,327      $ 39,121   

Income tax related receivables

     53,487        47,934   

Other current assets

     28,537        43,989   
                
   $ 120,351      $ 131,044   
                

Land, property and equipment, net

    

Land

   $ 41,952      $ 41,807   

Buildings and leasehold improvements

     230,227        224,403   

Machinery and equipment

     456,054        443,351   

Office furniture and fixtures

     22,624        23,345   

Construction in progress

     4,828        2,603   
                
     755,685        735,509   

Less: accumulated depreciation and amortization

     (506,217     (498,757
                
   $ 249,468      $ 236,752   
                

Other non-current assets

    

Long-term investments

   $ 143,347      $ 132,829   

Deferred tax assets – long-term

     208,631        244,927   

Other

     10,657        11,741   
                
   $ 362,635      $ 389,497   
                

Other current liabilities

    

Warranty

   $ 30,892      $ 21,109   

Compensation and benefits

     245,546        268,446   

Income taxes payable

     21,368        35,340   

Interest payable

     8,769        8,769   

Accrued litigation costs

     1,746        10,439   

Other accrued expenses

     87,763        77,956   
                
   $ 396,084      $ 422,059   
                

 

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NOTE 4 – MARKETABLE SECURITIES

The amortized costs and estimated fair value of marketable securities as of December 31, 2010 and June 30, 2010 are as follows:

 

As of December 31, 2010 (In thousands)

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 

U.S. Treasuries

   $ 60,669       $ 93       $ (56   $ 60,706   

U.S. Government agency securities

     250,116         686         (167     250,635   

Municipal bonds

     60,514         140         (157     60,497   

Corporate debt securities

     617,599         4,875         (591     621,883   

Money market, bank deposits and other

     401,010         —           —          401,010   

Sovereign securities

     43,328         272         (13     43,587   
                                  

Subtotal

     1,433,236         6,066         (984     1,438,318   

Less: Cash equivalents

     398,022         —           —          398,022   
                                  

Marketable securities

   $ 1,035,214       $ 6,066       $ (984   $ 1,040,296   
                                  

As of June 30, 2010 (In thousands)

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 

U.S. Treasuries

   $ 42,182       $ 112       $ (1   $ 42,293   

U.S. Government agency securities

     249,182         1,108         (10     250,280   

Municipal bonds

     55,171         368         (80     55,459   

Corporate debt securities

     599,118         5,314         (1,276     603,156   

Money market, bank deposits and other

     373,081         —           —          373,081   

Sovereign securities

     39,166         210         (21     39,355   

Auction rate securities

     16,825         —           —          16,825   
                                  

Subtotal

     1,374,725         7,112         (1,388     1,380,449   

Less: Cash equivalents

     376,316         7         —          376,323   
                                  

Marketable securities

   $ 998,409       $ 7,105       $ (1,388   $ 1,004,126   
                                  

KLA-Tencor’s investment portfolio consists of both corporate and government securities that have a maximum maturity of three years. The longer the duration of these securities, the more susceptible they are to changes in market interest rates and bond yields. As yields increase, those securities with a lower yield-at-cost show a mark-to-market unrealized loss. All unrealized losses are due to changes in interest rates and bond yields. The Company has the ability to realize the full value of all of these investments upon maturity. The following table summarizes the estimated fair value and gross unrealized losses of the Company’s investments, aggregated by investment instrument and length of time that the individual securities have been in an unrealized loss position as of December 31, 2010:

 

(In thousands)

   Estimated
Fair Value
     Gross
Unrealized
Losses(1)
 

U.S. Treasuries

   $ 15,701       $ (56

U.S. Government agency securities

     86,962         (167

Municipal bonds

     32,575         (157

Corporate debt securities

     151,322         (591

Sovereign securities

     10,063         (13
                 

Total

   $ 296,623       $ (984
                 

 

(1) Of the total gross unrealized losses, there were no amounts that have been in a continuous loss position for 12 months or more.

 

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The contractual maturities of securities classified as available-for-sale as of December 31, 2010, regardless of the consolidated balance sheet classification, are as follows:

 

(In thousands)

   Amortized
Cost
     Estimated
Fair Value
 

Due within one year

   $ 664,051       $ 668,680   

Due after one year through three years

     371,163         371,616   
                 
   $ 1,035,214       $ 1,040,296   
                 

Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Net realized gains for the three and six months ended December 31, 2010 were $0.4 million and $1.5 million, respectively.

During the fiscal years ended June 30, 2008, 2009 and 2010, the Company’s investment portfolio included auction rate securities, which are investments with contractual maturities generally between 20 to 30 years. They are usually found 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 that were held by the Company were backed by student loans and were collateralized, insured and guaranteed by the United States Federal Department of Education. In addition, all auction rate securities that were held by the Company were rated by the major independent rating agencies as either AAA or Aaa. In February 2008, because sell orders exceeded buy orders, auctions failed for approximately $48.2 million in par value of municipal auction rate securities that were then held by the Company. These failures were not believed to be a credit issue, but rather caused by a lack of liquidity. The funds associated with these failed auctions might not have been accessible until the issuer called the security, a successful auction occurred, a buyer was found outside of the auction process, or the security matured. By letter dated August 8, 2008, the Company received notification from UBS AG (“UBS”), in connection with a settlement entered into between UBS and certain regulatory agencies, offering to repurchase all of the Company’s auction rate security holdings at par value. The Company formally accepted the settlement offer and entered into a repurchase agreement (“Agreement”) with UBS on November 11, 2008 (“Acceptance Date”). By accepting the Agreement, the Company (1) received the right (“Put Option”) to sell its 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 the Company any time after the Acceptance Date as long as the Company receives the par value. The Put Option was exercised on June 30, 2010 to sell all $16.8 million of the Company’s remaining auction rate securities at par value and was subsequently settled in July 2010.

Executive Deferred Savings Plan

KLA-Tencor has a non-qualified deferred compensation plan whereby certain executives and non-employee directors may defer a portion of their compensation. Participants are credited with returns based on their allocation of their account balances among measurement funds. The Company controls the investment of these funds, and the participants remain general creditors of KLA-Tencor. Distributions from the plan commence the quarter following a participant’s retirement or termination of employment. As of December 31, 2010, the Company had a deferred compensation plan related asset and liability of $125.6 million and $126.8 million, respectively, included as a component of other non-current assets and other current liabilities on the Condensed Consolidated Balance Sheet. As of June 30, 2010, the Company had a deferred compensation plan related asset and liability of $109.2 million and $110.0 million, respectively, included as a component of other non-current assets and other current liabilities on the Condensed Consolidated Balance Sheet.

 

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NOTE 5 – GOODWILL AND PURCHASED INTANGIBLE ASSETS

Goodwill

The following table presents goodwill balances and the movements during the six months ended December 31, 2010 and 2009:

 

     Six months ended December 31,  

(In thousands)

   2010     2009  

Gross beginning balance as of beginning of fiscal year

   $ 604,592      $ 605,965   

Accumulated impairment losses

     (276,586     (276,586
                

Net beginning balance as of beginning of fiscal year

     328,006        329,379   

Net exchange differences

     141        4,605   
                

Net ending balance as of December 31

   $ 328,147      $ 333,984   
                

(In thousands)

   As of
December 31, 2010
    As of
December 31, 2009
 

Gross goodwill balance

   $ 604,733      $ 610,570   

Accumulated impairment losses

     (276,586     (276,586
                

Net goodwill balance

   $ 328,147      $ 333,984   
                

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 completed its annual evaluation of the goodwill by reporting unit during the three months ended December 31, 2009 and 2010 and concluded that there was no impairment as of December 31, 2009 and 2010. As of December 31, 2009 and 2010, the Company’s assessment of goodwill impairment indicated that the fair value of the Company’s reporting units were substantially in excess of their estimated carrying values, and therefore goodwill in the reporting units was not impaired.

Fair value of a reporting unit is determined by using a weighted combination of two market-based approaches and an income approach, as this combination is deemed to be the most indicative of the Company’s fair value in an orderly transaction between market participants and is consistent in principle with the methodology used for goodwill evaluation in the prior year. Under the market-based approach, the Company utilizes information regarding the Company as well as publicly available industry information to determine earnings multiples and sales multiples that are used to value the Company’s reporting units. The Company assigns an equal weighting to the discounted cash flow. Under the income approach, the Company determines fair value based on estimated future cash flows of each reporting unit, discounted by an estimated weighted-average cost of capital, which reflects the overall level of inherent risk of a reporting unit and the rate of return an outside investor would expect to earn. Determining the fair value of a reporting unit is judgmental in nature and requires the use of significant estimates and assumptions, including revenue growth rates and operating margins, discount rates and future market conditions, among others.

Adjustments to goodwill during the three and six months ended December 31, 2010 and 2009 resulted primarily from foreign currency translation adjustments.

 

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Purchased Intangible Assets

The components of purchased intangible assets as of December 31, 2010 and June 30, 2010 were as follows:

 

(Dollar amounts in thousands)

        As of December 31, 2010      As of June 30, 2010  

Category

  

Range of
Useful Lives

   Gross
Carrying
Amount
     Accumulated
Amortization
and
Impairment
     Net
Amount
     Gross
Carrying
Amount
     Accumulated
Amortization
and
Impairment
     Net
Amount
 

Existing technology

   4-7 years    $ 134,561       $ 85,234       $ 49,327       $ 133,066       $ 75,524       $ 57,542   

Patents

   6-13 years      57,648         37,403         20,245         57,648         34,217         23,431   

Trade name / Trademark

   4-10 years      19,893         12,099         7,794         19,893         11,130         8,763   

Customer relationships

   6-7 years      54,823         30,586         24,237         54,823         27,606         27,217   

Other

   0-1 year      16,199         15,902         297         16,200         15,817         383   
                                                        

Total

      $ 283,124       $ 181,224       $ 101,900       $ 281,630       $ 164,294       $ 117,336   
                                                        

For the three months ended December 31, 2010 and 2009, amortization expense for other intangible assets was $8.5 million and $8.4 million, respectively. For the six months ended December 31, 2010 and 2009, amortization expense for other intangible assets was $16.9 million and $16.7 million, respectively. Based on the intangible assets recorded as of December 31, 2010, and assuming no subsequent additions to, or impairment of the underlying assets, the remaining estimated amortization expense is expected to be as follows:

 

Fiscal year ending June 30:

   Amortization
(in thousands)
 

2011 (remaining 6 months)

   $ 15,999   

2012

     30,230   

2013

     20,957   

2014

     15,537   

2015

     12,771   

Thereafter

     6,406   
        

Total

   $ 101,900   
        

NOTE 6 – LONG-TERM DEBT

In April 2008, the Company 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 the Company’s ability to grant liens on its facilities and to enter into sale and leaseback transactions, subject to significant allowances under which certain sale and leaseback transactions are not restricted. The Company was in compliance with all of its covenants as at December 31, 2010.

In certain circumstances involving a change of control followed by a downgrade of the rating of the Company’s senior notes, the Company 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, plus accrued and unpaid interest. The Company’s ability to repurchase the senior notes in such event may be limited by law, by the indenture associated with the senior notes, by the Company’s then-available financial resources or by the terms of other agreements to which the Company may be party at such time. If the Company fails 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 obligations.

Based on the trading prices of the debt at December 31, 2010 and June 30, 2010, the estimated fair value of the debt at December 31, 2010 and June 30, 2010 was $829.1 million and $834.4 million, respectively.

NOTE 7 – STOCK-BASED COMPENSATION

Equity Incentive Program

Under the Company’s current equity incentive program, the Company issues equity awards from its 2004 Equity Incentive Plan (the “2004 Plan”), which provides for the grant of options to purchase shares of its common stock, stock appreciation rights, restricted stock units, performance shares, performance units and deferred stock units to its employees, consultants and members of its Board of Directors. The 2004 Plan permits the issuance of up to 32.0 million shares of common stock. Any 2004 Plan awards of restricted stock units, performance shares, performance units or deferred stock units with a per share or unit purchase price lower than 100% of fair market value on the grant date are counted against the total number of shares issuable under the 2004 Plan as 1.8 shares for every one share subject thereto. During the six months ended December 31, 2010, 0.3 million restricted stock units were granted to senior management with performance-based and service-based vesting criteria.

 

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The following table summarizes the combined activity under the equity incentive plans for the indicated period:

 

(In thousands)

   Available
For Grant
 

Balances at June 30, 2010(1)

     15,162   

Restricted stock units granted(2)

     (3,855

Restricted stock units canceled(2)

     142   

Options canceled/expired/forfeited

     889   

Plan shares expired(3)

     (838
        

Balances at December 31, 2010(1)

     11,500   
        

 

(1) Includes shares available for issuance under the 2004 Plan, as well as under the Company’s 1998 Outside Director Option Plan (the “Outside Director Plan”), which only permits the issuance of stock options to the Company’s non-employee directors. As of December 31, 2010, 1.6 million shares were available for grant under the Outside Director Plan.
(2) The number of restricted stock units provided in this row reflects the application of the 1.8x multiple described above.
(3) Represents the portion of shares listed as “Options canceled/expired/forfeited” above that were issued under the Company’s equity incentive plans other than the 2004 Plan or the Outside Director Plan. Because the Company is only currently authorized to issue equity awards under the 2004 Plan and the Outside Director Plan, any equity awards that are canceled, expire or are forfeited under any other Company equity incentive plan do not result in additional shares being available to the Company for future grant.

Except for options granted to non-employee directors as part of their regular compensation package for service through the end of the first quarter of fiscal year 2008, the Company has granted only restricted stock units under its equity incentive program since September 2006. For the preceding several years until June 30, 2006, stock options were granted at the market price of the Company’s common stock on the date of grant (except for the retroactively priced options which were granted primarily prior to the fiscal year ended June 30, 2002), generally with a vesting period of five years and an exercise period not to exceed seven years (ten years for options granted prior to July 1, 2005) from the date of issuance. Restricted stock units may be granted with varying criteria such as service-based and/or performance-based vesting.

 

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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 the Company’s Employee Stock Purchase Plan and using the closing price of the Company’s common stock on the grant date for restricted stock units.

The following table shows pre-tax stock-based compensation expense for the indicated periods:

 

(In thousands)

   Three months ended
December 31,
     Six months ended
December 31,
 
   2010      2009      2010      2009  

Stock-based compensation expense by:

           

Costs of revenues

   $ 3,439       $ 3,325       $ 7,607       $ 6,613   

Engineering, research and development

     5,814         6,667         13,432         13,270   

Selling, general and administrative

     10,178         10,863         22,605         21,171   
                                   

Total stock-based compensation expense

   $ 19,431       $ 20,855       $ 43,644       $ 41,054   
                                   

The following table shows stock-based compensation capitalized as inventory as of December 31, 2010 and June 30, 2010:

 

(In thousands)

  December 31,
2010
     June 30,
2010
 

Inventory

  $ 5,971       $ 6,687   

Stock Options

The following table summarizes the activity and weighted-average exercise price for stock options under all plans during the six months ended December 31, 2010:

 

Stock Options

   Shares
(In thousands)
    Weighted-Average
Exercise Price
 

Outstanding stock options as of June 30, 2010

     11,358      $ 43.72   

Granted

     —        $ —     

Exercised

     (516   $ 30.16   

Canceled/expired/forfeited

     (889   $ 45.52   
          

Outstanding stock options as of December 31, 2010

     9,953      $ 44.26   
          

Vested and exercisable as of December 31, 2010

     9,925      $ 44.21   
          

The Company has not issued any stock options since November 1, 2007. The weighted-average remaining contractual terms for total options outstanding under all plans and for total options vested and exercisable under all plans as of December 31, 2010 were each 2.5 years. The aggregate intrinsic values for total options outstanding under all plans and for total options vested and exercisable under all plans as of December 31, 2010 were each $8.2 million.

The authoritative guidance on stock-based compensation permits companies to select the option-pricing model used to estimate the fair value of their stock-based compensation awards. The Black-Scholes option-pricing model requires the input of highly subjective assumptions, including the option’s expected life and the price volatility of the underlying stock. The expected stock price volatility assumption was based on market-based implied volatility from traded options on the Company’s stock.

The following table shows total intrinsic value of options exercised, total cash received from employees as a result of employee stock option exercises, and tax benefits realized by the Company in connection with these stock option exercises for the indicated periods:

 

(In thousands)

   Three months ended
December 31,
     Six months ended
December 31,
 
   2010      2009      2010      2009  

Total intrinsic value of options exercised

     2,726         895         3,289         1,105   

Total cash received from employees as a result of employee stock option exercises

     12,594         11,661         15,547         14,577   

Tax benefits realized by the Company in connection with these exercises

     980         329         1,182         406   

 

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As of December 31, 2010, the unrecognized stock-based compensation balance related to stock options was $0.4 million and will be recognized over an estimated weighted-average amortization period of 0.7 years.

The Company settles employee stock option exercises with newly issued common shares except in certain tax jurisdictions where settling such exercises with treasury shares provides the Company or one of its subsidiaries with a tax benefit.

Restricted Stock Units

The following table shows the applicable number of restricted stock units and weighted-average grant date fair value after estimated forfeitures for restricted stock units granted, vested and released, withheld for taxes, and forfeited during the six months ended December 31, 2010 and restricted stock units outstanding as of December 31, 2010 and June 30, 2010:

 

Restricted Stock Units

   Shares
(In thousands) (1)
    Weighted-Average
Grant Date
Fair Value
 

Outstanding restricted stock units as of June 30, 2010

     6,470      $ 22.52   

Granted

     2,142      $ 19.73   

Vested and released

     (1,258   $ 23.46   

Withheld for taxes

     (597   $ 23.73   

Forfeited

     (79   $ 21.40   
          

Outstanding restricted stock units as of December 31, 2010

     6,678      $ 21.35   
          

 

(1) Share numbers reflect actual shares subject to awarded restricted stock units. Under the terms of the 2004 Plan, each of the share numbers presented in this column is multiplied by 1.8 to calculate the impact on the share reserve under the 2004 Plan.

The restricted stock units granted by the Company since the beginning of the fiscal year ended June 30, 2007 generally vest in two equal installments on the second and fourth anniversaries of the date of grant. Prior to the fiscal year ended June 30, 2007, the restricted stock units granted by the Company generally vested in two equal installments over four or five years from the date of the grant. The value of the restricted stock units is based on the closing market price of the Company’s common stock on the date of award. The restricted stock units have been awarded under the Company’s 2004 Plan, and each unit will entitle the recipient to one share of common stock when the applicable vesting requirements for that unit are satisfied. However, for each share actually issued under the awarded restricted stock units, the share reserve under the 2004 Plan will be reduced by 1.8 shares, as provided under the terms of the 2004 Plan.

The following table shows the grant date fair value after estimated forfeitures, weighted-average grant date fair value per unit, and tax benefits realized by the Company in connection with vested and released restricted stock units for the three and six months ended December 31, 2010 and 2009:

 

(In thousands. except for weighted-average grant date fair value)

   Three months ended
December 31,
     Six months ended
December 31,
 
   2010      2009      2010      2009  

Grant date fair value after estimated forfeitures

   $ 1,543       $ 921       $ 42,248       $ 63,391   

Weighted-average grant date fair value per unit

   $ 27.22       $ 26.31       $ 19.73       $ 22.21   

Tax benefits realized by the Company in connection with vested and released restricted stock units

   $ 12,245       $ 11,517       $ 22,339       $ 13,155   

As of December 31, 2010, the unrecognized stock-based compensation expense balance related to restricted stock units was $114.7 million and will be recognized over an estimated weighted-average amortization period of 2.6 years.

Employee Stock Purchase Plan

KLA-Tencor’s Employee Stock Purchase Plan (“ESPP”) provides that eligible employees may contribute up to 10% of their eligible earnings toward the semi-annual purchase of KLA-Tencor’s common stock. The ESPP is qualified under Section 423 of the Internal Revenue Code. The employee’s purchase price is derived from a formula based on the closing price of the common stock on the first day of the offering period versus the closing price on the date of purchase (or, if not a trading day, on the immediately preceding trading day).

During the three months ended March 31, 2009, the Company’s Board of Directors approved amendments to the ESPP as part of the Company’s efforts to reduce operating expenses in response to the then-current economic conditions. Those amendments to the ESPP (a) eliminated the look-back feature (i.e., the reference to the fair market value of the Company’s common stock at the commencement of the applicable six-month offering period) and (b) reduced the purchase price discount from 15% to 5%. These changes were effective July 1, 2009, such that the purchase price with respect to the six-month offering period that began on July 1, 2009 was 95% of the fair market value of the Company’s common stock on the purchase date, December 31, 2009.

 

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During the quarter ended December 31, 2009, in response to improvements in the business conditions within the industries that the Company serves, the Company’s Board of Directors approved amendments to the ESPP that (a) reinstated the six-month look-back feature and (b) increased the purchase price discount from 5% to 15%. These changes became effective January 1, 2010, such that the purchase price with respect to each offering period beginning on or after such date will be 85% of the lesser of (i) the fair market value of the Company’s common stock at the commencement of the applicable six-month offering period or (ii) the fair market value of the Company’s common stock on the purchase date.

The Company estimates the fair value of purchase rights under the ESPP using a Black-Scholes valuation model. The fair value of each purchase right under the ESPP was estimated on the date of grant using the Black-Scholes option valuation model and the straight-line attribution approach with the following weighted-average assumptions:

 

     Three months ended
December 31,
    Six months ended
December 31,
 
     2010     2009     2010     2009  

Stock purchase plan:

        

Expected stock price volatility

     41     ( *)      41     ( *) 

Risk-free interest rate

     0.2     ( *)      0.2     ( *) 

Dividend yield

     3.68     ( *)      3.68     ( *) 

Expected life of options (in years)

     0.50        ( *)      0.50        ( *) 

 

(*) There were no valuations recorded during the three and six months ended December 31, 2009. No compensation cost was recognized as the purchase price under the ESPP during that period was based solely on the market price of the shares at the purchase date and the discount on the purchase price was 5%.

The following table shows total cash received from employees for the issuance of shares under the ESPP, the number of shares purchased by employees through the ESPP, the tax benefits realized by the Company in connection with the disqualifying dispositions of shares purchased under the ESPP, and the weighted-average fair value per share:

 

(In thousands. except for weighted-average fair value)

   Three months ended
December 31,
     Six months ended
December 31,
 
   2010      2009      2010      2009  

Total cash received from employees for the issuance of shares under the ESPP

   $ 16,176       $ 8,885       $ 16,176       $ 8,885   

Number of shares purchased by employees through the ESPP

     701         259         701         259   

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

   $ 115       $ 154       $ 471       $ 867   

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

   $ 6.53       $ —         $ 6.53       $ —     

The ESPP shares are replenished annually on the first day of each fiscal year by virtue of an evergreen provision. The provision allows for share replenishment equal to the lesser of 2.0 million shares or the number of shares which KLA-Tencor estimates will be required to issue under the ESPP during the forthcoming fiscal year. During the fiscal year ended June 30, 2010, a total of 2.0 million additional shares were reserved under the ESPP, and an additional 2.0 million shares have been reserved under the ESPP with respect to the fiscal year ending June 30, 2011. As of December 31, 2010, after giving effect to the ESPP purchase that occurred on that date, a total of 3.9 million shares were reserved and available for issuance under the ESPP.

 

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NOTE 8 – STOCK REPURCHASE PROGRAM

Since July 1997, the Board of Directors has authorized the Company to systematically repurchase in the open market up to 62.8 million shares of its common stock under a repurchase program. This program was put into place to reduce the dilution from KLA-Tencor’s equity incentive plans and employee stock purchase plan, and to return excess cash to the Company’s stockholders. Subject to market conditions, applicable legal requirements and other factors, the repurchases will be made from time to time in the open market in compliance with applicable securities laws, including the Securities Exchange Act of 1934 and the rules promulgated thereunder such as Rule 10b-18. In October 2008, the Company suspended its stock repurchase program, and the Company subsequently restarted the program in February 2010. As of December 31, 2010, 1.7 million shares were available for repurchase under the Company’s repurchase program.

Share repurchases for the three and six months ended December 31, 2010 and 2009 were as follows:

 

(In thousands)

   Three months ended
December 31,
     Six months ended
December 31,
 
   2010      2009      2010      2009  

Number of shares of common stock repurchased

     1,559         —           3,531         —     

Total cost of repurchases

   $ 57,938         —         $ 117,261         —     

As of December 31, 2010, $2.7 million of the above total cost of repurchase amount remained unpaid and is recorded in other current liabilities. The $1.8 million which was accrued at September 30, 2010 was paid during the three months ended December 31, 2010.

NOTE 9 – NET INCOME PER SHARE

Basic net income per share is calculated by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is calculated by using the weighted-average number of common shares outstanding during the period, increased to include the number of additional shares of common stock that would have been outstanding if the shares of common stock underlying the Company’s outstanding dilutive stock options and restricted stock units had been issued. The dilutive effect of outstanding options and restricted stock units is reflected in diluted earnings per share by application of the treasury stock method. Under the treasury stock method, the amount the employee must pay for exercising stock options, the amount of compensation cost for future service that the Company has not yet recognized, and the amount of tax benefits that would be recorded in additional paid-in capital when the award becomes deductible are assumed to be used to repurchase shares. The following table sets forth the computation of basic and diluted net income per share:

 

(In thousands, except per share amounts)

   Three months ended
December 31,
     Six months ended
December 31,
 
   2010      2009      2010      2009  

Numerator:

           

Net income

   $ 185,492       $ 21,794       $ 339,688       $ 42,199   

Denominator:

           

Weighted average shares outstanding, excluding unvested restricted stock units

     166,886         171,408         167,052         171,053   

Effect of dilutive options and restricted stock units

     2,627         2,400         2,633         2,239   
                                   

Denominator for diluted income per share

     169,513         173,808         169,685         173,292   
                                   

Basic earnings per share

   $ 1.11       $ 0.13       $ 2.03       $ 0.25   

Diluted earnings per share

   $ 1.09       $ 0.13       $ 2.00       $ 0.24   

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

     8,622         10,948         9,602         12,483   

The total amount of dividends paid during the three months ended December 31, 2010 and 2009 was $41.8 million and $25.7 million, respectively. The total amount of dividends paid during the six months ended December 31, 2010 and 2009 was $83.6 million and $51.3 million, respectively.

 

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NOTE 10 – COMPREHENSIVE INCOME

The components of comprehensive income, net of tax, are as follows:

 

(In thousands)

   Three months ended
December 31,
    Six months ended
December 31,
 
   2010     2009     2010      2009  

Net income

   $ 185,492      $ 21,794      $ 339,688       $ 42,199   

Other comprehensive income (loss):

         

Currency translation adjustments

     4,455        (5,529     17,978         3,561   

Gain (loss) on cash flow hedging instruments, net

     (639    
558
  
    200         720   

Change in unrecognized losses and transition obligation related to pension and post-retirement plans

     91        19        171         37   

Unrealized loss on investments

     (2,179     (1,648     (428      (75
                                 

Other comprehensive income (loss)

     1,728        (6,600     17,921         4,243   

Total comprehensive income

   $ 187,220      $ 15,194      $ 357,609       $ 46,442   
                                 

NOTE 11 – INCOME TAXES

The following table provides details of income taxes:

 

(Dollar amounts in thousands)

   Three months ended
December 31,
    Six months ended
December 31,
 
   2010     2009     2010     2009  

Income before income taxes

   $ 251,191      $ 38,016      $ 474,503      $ 60,808   

Provision for taxes

     65,699        16,222        134,815        18,609   

Effective tax rate

     26.2     42.7     28.4     30.6

The Company’s estimated annual effective tax rate for the year is approximately 29%.

The difference between the actual effective tax rate of 26.2% during the quarter and the estimated annual effective tax rate of 29% is primarily due to the tax impact of the following items during the three months ended December 31, 2010:

 

   

Tax expense was decreased by $3.7 million due to windfalls from employee stock activity. A windfall arises when the tax deduction is more than book compensation. Windfalls are generally recorded as increases to capital in excess of par value. A shortfall arises when the tax deduction is less than book compensation. 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. When there are shortfalls recorded as provision for income taxes during an earlier quarter, windfalls arising in subsequent quarters within the same fiscal year are recorded as a reduction to income taxes to the extent of the shortfalls recorded.

 

   

Tax expense was decreased by $3.1 million related to a non-taxable increase in the assets held within the Company’s Executive Deferred Savings Plan.

 

   

Tax expense was decreased by $3.9 million related to the reinstatement of the U.S. Federal Research and Development Credit (the Federal R&D Credit), under The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, which was signed into law on December 17, 2010.

Tax expense was higher as a percentage of income during the three months ended December 31, 2009 compared to the three months ended December 31, 2010 primarily due to an increase in tax expense of $8.7 million resulting from shortfalls related to employee stock activity during the three months ended December 31, 2009. The shortfall expense during the three months ended December 31, 2009 had a significant impact on the Company’s effective tax rate due to the lower level of income generated during the three months ended December 31, 2009.

Tax expense was higher as a percentage of income during the six months ended December 31, 2009 compared to the six months ended December 31, 2010 due to a decrease in tax expense of $3.9 million resulting from the reinstatement of the Federal R&D Credit during the six months ended December 31, 2010 and an increase in tax expense of $8.7 million resulting from shortfalls related to employee stock activity during the six months ended December 31, 2009.

In the normal course of business, the Company is subject to examination by taxing authorities throughout the world. The Company is 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. The Company is subject to state income tax examinations for all years beginning from the fiscal year ended June 30, 2006. The Company is also

 

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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 is currently under tax examinations in various other foreign tax jurisdictions. It is possible that certain examinations may be concluded in the next twelve months. The Company believes it is possible that it may recognize up to $3.6 million of its existing unrecognized tax benefits within the next twelve months as a result of the lapse of statutes of limitations and the resolution of agreements with various foreign tax authorities.

NOTE 12 – LITIGATION AND OTHER LEGAL MATTERS

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

Other Legal Matters. The Company is named from time to time as a party to lawsuits in the normal course of its business. Actions filed against the Company include commercial, intellectual property, customer, and labor and employment related claims, including complaints of alleged wrongful termination and potential class action lawsuits regarding alleged violations of federal and state wage and hour and other laws. 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. The Company believes the amounts provided in its 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 its financial statements or will not have a material adverse effect on its results of operations, financial condition or cash flows.

NOTE 13 – COMMITMENTS AND CONTINGENCIES

Factoring. KLA-Tencor has agreements with financial institutions to sell certain of its trade receivables and promissory notes from customers without recourse. The Company does not believe it is at risk for any material losses as a result of these agreements. In addition, from time to time the Company 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, proceeds from sales of LCs and related discounting fees paid for the three and six months ended December 31, 2010 and 2009:

 

     Three months ended      Six months ended  

(In thousands)

   December 31,
2010
     December 31,
2009
     December 31,
2010
     December 31,
2009
 

Receivables sold under factoring agreements

   $ 96,586       $ 39,818       $ 156,611       $ 70,019   

Proceeds from sales of LCs

   $ 33,327       $ —         $ 84,263       $ 10,630   

Discounting fees paid on sales of LCs (1)

   $ 50       $ —         $ 155       $ 123   

 

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

 

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Facilities. KLA-Tencor leases certain of its facilities under arrangements that are accounted for as operating leases. Rent expense was $2.2 million and $2.3 million for the three months ended December 31, 2010 and 2009, respectively. Rent expense was $4.1 million and $4.9 million for the six months ended December 31, 2010 and 2009, respectively.

The following is a schedule of expected operating lease payments (in thousands):

 

Fiscal year ended June 30,

   Amount  

2011 (remaining 6 months)

   $ 4,445   

2012

     6,636   

2013

     4,398   

2014

     2,912   

2015

     1,721   

2016 and thereafter

     4,273   
        

Total minimum lease payments

   $ 24,385   
        

Purchase Commitments. KLA-Tencor maintains certain open inventory purchase commitments with its suppliers to ensure a smooth and continuous supply for key components. KLA-Tencor’s liability under these purchase commitments is generally restricted to a forecasted time-horizon as mutually agreed upon between the parties. This forecasted time-horizon can vary among different suppliers. The Company’s open inventory purchase commitments were $289.2 million as of December 31, 2010 and are primarily due within the next 12 months. Actual expenditures will vary based upon the volume of the transactions and length of contractual service provided. In addition, the amounts paid under these arrangements may be less in the event that the arrangements are renegotiated or canceled. Certain agreements provide for potential cancellation penalties.

Guarantees. 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. The Company accounts for the estimated warranty cost as a charge to costs of revenues when revenue is recognized. The estimated warranty cost is based on historical product performance and field expenses. Utilizing actual service records, the Company calculates the average service hours and parts expense per system and applies the actual labor and overhead rates to determine the estimated warranty charge. The Company updates these estimated charges on a quarterly basis. The actual product performance and/or field expense profiles may differ, and in those cases the Company adjusts its warranty accruals accordingly.

The following table provides the changes in the product warranty accrual for the three and six months ended December 31, 2010 and 2009:

 

(In thousands)

   Three months ended
December 31,
    Six months ended
December 31,
 
   2010     2009     2010     2009  

Beginning balance

   $ 25,556      $ 15,052      $ 21,109      $ 18,213   

Accruals for warranties issued during the period

     12,306        5,994        21,792        10,727   

Changes in liability related to pre-existing warranties

     (1,307     (654     (1,148     (2,579

Settlements made during the period

     (5,663     (4,666     (10,861     (10,635
                                

Ending balance

   $ 30,892      $ 15,726      $ 30,892      $ 15,726   
                                

Subject to certain limitations, KLA-Tencor indemnifies its current and former officers and directors for certain events or occurrences. Although the maximum potential amount of future payments the Company could be required to make under these agreements is theoretically unlimited, the Company believes the fair value of this liability, to the extent estimable, is appropriately considered within the reserve it has established for currently pending legal proceedings.

KLA-Tencor is a party to a variety of agreements pursuant to which it may be obligated to indemnify the other party with respect to certain matters. Typically, these obligations arise in connection with contracts and license agreements or the sale of assets, under which the Company customarily agrees to hold the other party harmless against losses arising from, or provides customers with other remedies to protect against, bodily injury or damage to personal property caused by the Company’s products, non-compliance with the Company’s product performance specifications, infringement by the Company’s products of third-party intellectual property rights and a breach of warranties, representations and covenants related to such matters as title to assets sold, validity of certain intellectual property rights, non-infringement of third-party rights, and certain income tax-related matters. In each of these circumstances, payment by the Company is typically subject to the other party making a claim to and cooperating with the Company pursuant to the procedures specified in the particular contract. This usually allows the Company to challenge the other party’s claims or, in case of breach of intellectual property representations or covenants, to control the defense or settlement of any third-party claims brought against the other party. Further, the Company’s obligations under these agreements may be limited in terms of amounts, activity (typically at the Company’s option to replace or correct the products or terminate the agreement with a refund to the other party), and duration. In some instances, the Company may have recourse against third parties and/or insurance covering certain payments made by the Company.

 

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It is not possible to predict the maximum potential amount of future payments under these or similar agreements due to the conditional nature of the Company’s obligations and the unique facts and circumstances involved in each particular agreement. Historically, payments made by the Company under these agreements have not had a material effect on its business, financial condition, results of operations or cash flows.

The Company maintains guarantee arrangements available through various financial institutions for up to $20.3 million, of which $18.2 million had been issued as of December 31, 2010, primarily to fund guarantees to customs authorities for VAT and other operating requirements of the Company’s subsidiaries in Europe and Asia.

NOTE 14 – RESTRUCTURING CHARGES

The Company has undertaken a number of cost reduction activities, including workforce reductions, in an effort to lower its quarterly operating expense run rate. The program in the United States is accounted for in accordance with the authoritative guidance related to compensation for non-retirement post-employment benefits, whereas the programs in the international locations are accounted for in accordance with the authoritative guidance for contingencies. During the three months ended December 31, 2010, the Company recorded a $1.1 million net restructuring charge, of which $0.2 million was recorded to costs of revenues, $0.1 million was recorded to engineering, research and development expense and $0.8 million was recorded to selling, general and administrative expense. These charges represent the estimated minimum liability associated with expected termination benefits to be provided to employees after employment.

The following table shows the activity primarily related to severance and benefits expense for the three and six months ended December 31, 2010 and 2009:

 

(In thousands)

   Three months ended
December 31,
    Six months ended
December 31,
 
   2010     2009     2010     2009  

Beginning balance

   $ 589      $ 4,304      $ 1,221      $ 8,086   

Restructuring costs

     1,065        3,262        1,430        3,845   

Adjustments

     (8     (149     (30     (685

Cash payments

     (771     (2,839     (1,746     (6,668
                                

Ending balance

   $ 875      $ 4,578      $ 875      $ 4,578   
                                

Substantially all of the remaining accrued restructuring balance as of December 31, 2010 related to the Company’s workforce reductions is expected to be paid out by June 30, 2011.

NOTE 15 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

The authoritative guidance requires companies to recognize all derivative instruments and hedging activities, including foreign currency exchange contracts, as either assets or liabilities at fair value on the balance sheet. Changes in the fair value of derivatives that do not qualify for hedge treatment, as well as the ineffective portion of any hedges, are reflected in the Condensed Consolidated Statement of Operations. In accordance with the guidance, the Company designates foreign currency forward exchange contracts as cash flow hedges of certain forecasted foreign currency denominated sales and purchase transactions.

KLA-Tencor’s foreign subsidiaries operate and sell KLA-Tencor’s products in various global markets. As a result, KLA-Tencor is exposed to risks relating to changes in foreign currency exchange rates. KLA-Tencor utilizes foreign currency forward exchange contracts and option contracts to hedge against future movements in foreign exchange rates that affect certain existing and forecasted foreign currency denominated sales and purchase transactions, such as the Japanese yen, the euro and the Israeli shekel. KLA-Tencor does not use derivative financial instruments for speculative or trading purposes. The Company routinely hedges its exposures to certain foreign currencies with various financial institutions in an effort to minimize the impact of certain currency exchange rate fluctuations. These currency forward exchange contracts and options, designated as cash flow hedges, generally have maturities of less than 18 months. Cash flow hedges are evaluated for effectiveness monthly, based on changes in total fair value of the derivatives. If a financial counter-party to any of the Company’s hedging arrangements experiences financial difficulties or is otherwise unable to honor the terms of the foreign currency hedge, the Company may experience material losses.

 

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For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of accumulated other comprehensive income (loss) (“OCI”) and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Changes in the fair value of currency forward exchange and option contracts due to changes in time value are excluded from the assessment of effectiveness. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.

For derivative instruments that are not designated as accounting hedges, gains and losses are recognized in interest income and other, net. The majority of such derivatives are foreign currency forward contracts to hedge certain foreign currency denominated assets or liabilities. The gains and losses on these derivatives are largely offset by the changes in the fair value of the assets or liabilities being hedged.

Derivatives in Cash Flow Hedging Relationships: Foreign Exchange Contracts

The location and amounts of designated and non-designated derivative instruments’ gains and losses in the condensed consolidated financial statements for the three and six months ended December 31, 2010 and 2009 are as follows:

 

     Location in Financial Statements  
     Three months ended December 31, 2010     Three months ended December 31, 2009  

(In thousands)

   Accumulated
OCI
    Revenues     Costs of
revenues
     Interest
income
and
other,
net
    Total     Accumulated
OCI
    Revenues     Costs of
revenues
     Interest
income
and

other,
net
    Total  

Derivatives Designated as Hedging Instruments

                      

Loss in accumulated OCI on derivative (effective portion)

   $ (1,653          $ (1,653   $ (200          $ (200
                                                                                  

Gain (loss) reclassified from accumulated OCI into income (effective portion)

     $ (534   $ 312         $ (222     $ (1,120   $ 24         $ (1,096
                                                                                  

Gain recognized in income on derivative (ineffectiveness portion and amount excluded from effectiveness testing)

          $ 266      $ 266             $ 202      $ 202   
                                                                                  

Derivatives Not Designated as Hedging Instruments

                      

Gain (loss) recognized in income

          $ (513   $ (513          $ 401      $ 401   
                                                                                  
     Six months ended December 31, 2010     Six months ended December 31, 2009  

(In thousands)

   Accumulated
OCI
    Revenues     Costs of
revenues
     Interest
income
and
other,
net
    Total     Accumulated
OCI
    Revenues     Costs of
revenues
     Interest
income
and
other,
net
    Total  

Derivatives Designated as Hedging Instruments

                      

Loss in accumulated OCI on derivative (effective portion)

   $ (1,240          $ (1,240   $ (402          $ (402
                                                                                  

Gain (loss) reclassified from accumulated OCI into income (effective portion)

     $ (1,327   $ 170         $ (1,157     $ (1,332   $ 24         $ (1,308
                                                                                  

Gain (loss) recognized in income on derivative (ineffectiveness portion and amount excluded from effectiveness testing)

          $ 147      $ 147             $ (319   $ (319
                                                                                  

Derivatives Not Designated as Hedging Instruments

                      

Loss recognized in income

          $ (1,869   $ (1,869          $ (2,112   $ (2,112
                                                                                  

 

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The U.S. dollar equivalent of all outstanding notional amounts of hedge contracts, with maximum maturity of 13 months, was as follows:

 

(In thousands)

   As of
December 31, 2010
    As of
June 30, 2010
 

Cash flow hedge contracts

    

Purchase

   $ 12,620      $ 15,835   

Sell

     (50,741     (32,853

Other foreign currency hedge contracts

    

Purchase

     83,156        82,535   

Sell

     (89,031     (104,414
                

Net

   $ (43,996   $ (38,897
                

The location and fair value amounts of the Company’s derivative instruments reported in its Condensed Consolidated Balance Sheets as of December 31, 2010 and June 30, 2010 were as follows:

 

     Asset Derivatives      Liability Derivatives  
     Balance Sheet Location      December 31,
2010
     June 30,
2010
     Balance Sheet Location      December 31,
2010
     June 30,
2010
 

(In thousands)

      Fair Value         Fair Value  

Derivatives designated as hedging instruments

                 

Foreign exchange contract

     Other current assets       $ 415       $ 125         Other current liabilities       $ 1,236       $ 2,033   
                                         

Total derivatives designated as hedging instruments

      $ 415       $ 125          $ 1,236       $ 2,033   
                                         

Derivatives not designated as hedging instruments

                 

Foreign exchange contract

     Other current assets       $ 1,898       $ 171         Other current liabilities       $ 3,348       $ 3,791   
                                         

Total derivatives not designated as hedging instruments

      $ 1,898       $ 171          $ 3,348       $ 3,791   
                                         

Total derivatives

      $ 2,313       $ 296          $ 4,584       $ 5,824   
                                         

The following table provides the balances and changes in accumulated other comprehensive income (loss) related to derivative instruments for the three and six months ended December 31, 2010 and 2009:

 

(In thousands)

   Three months ended
December 31,
    Six months ended
December 31,
 
   2010     2009     2010     2009  

Beginning balance

   $ (646   $ (1,353   $ (1,994   $ (1,613

Amount reclassified to income

     222        1,096        1,157        1,558   

Net change

     (1,653     (200     (1,240     (402
                                

Ending balance

   $ (2,077   $ (457   $ (2,077   $ (457
                                

NOTE 16 – SALE OF REAL ESTATE

During the three months ended December 31, 2010, the Company completed the sale of remaining real estate properties in San Jose, California. The Company had recorded asset impairment charges of $10.4 million, included in selling, general and administrative expenses, during the six months ended December 31, 2009. The real estate properties are non-financial assets subject to level 3 fair value measurement. The sale transaction, which closed on December 9, 2010, resulted in proceeds to the Company of $18.2 million and a gain on sale of $1.4 million as an offset to selling, general and administrative expenses.

 

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NOTE 17 – RELATED PARTY TRANSACTIONS

During the three and six months ended December 31, 2010 and 2009, the Company purchased from, or sold to, several entities, where one or more executive officers of the Company or members of the Company’s Board of Directors, or their immediate family members, also serves as an executive officer or board member, including JDS Uniphase Corporation and Cisco Systems, Inc. For the three and six months ended December 31, 2010 and 2009, the following table provides the transactions with these parties (for the portion of such period that they were considered related):

 

(Dollar amounts in thousands)

   Three months ended
December 31,
     Six months ended
December 31,
 
   2010      2009      2010      2009  

Total revenues

   $ 47       $ 1,347       $ 247       $ 3,938   

Total purchases

   $ 1,923       $ 1,450       $ 2,805       $ 2,392   

The Company had a receivable balance from these parties of $0.1 million and $2.0 million at December 31, 2010 and June 30, 2010, respectively. Management believes that such transactions are at arm’s length and on similar terms as would have been obtained from unaffiliated third parties.

NOTE 18 – SEGMENT REPORTING AND GEOGRAPHIC INFORMATION

KLA-Tencor reports one reportable segment in accordance with the provisions of the authoritative guidance for segment reporting. Operating segments are defined as components of an enterprise about which separate financial information is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. KLA-Tencor’s chief operating decision maker is the Chief Executive Officer.

KLA-Tencor is engaged primarily in designing, manufacturing, and marketing process control and yield management solutions for the semiconductor and related nanoelectronics industries. All operating units have been aggregated due to their inter-dependencies, commonality of long-term economic characteristics, products and services, the production processes, class of customer and distribution processes. The Company’s service products are an extension of the system product portfolio and provide customers with spare parts and fab management services (including system preventive maintenance and optimization services) to improve yield, increase production uptime and throughput, and lower the cost of ownership. Since KLA-Tencor operates in one segment, all financial segment information can be found in the condensed consolidated financial statements.

KLA-Tencor’s significant operations outside the United States include manufacturing facilities in Israel and Singapore, and sales, marketing and service offices in Western Europe, Japan and the Asia Pacific region. For geographical revenue reporting, revenues are attributed to the geographic location in which the customer is located. Long-lived assets consist primarily of net property and equipment and are attributed to the geographic region in which they are located.

The following is a summary of revenues by geographic region for the three and six months ended December 31, 2010 and 2009 (as a percentage of total revenues):

 

      Three months  ended
December 31,
    Six months  ended
December 31,
 

(Dollar amounts in thousands)

   2010     2009     2010     2009  

Revenues:

                    

United States

   $ 149,843         20   $ 105,489         24   $ 236,362         16   $ 180,046         23

Taiwan

     233,081         30     171,947         39     421,622         29     294,066         38

Japan

     59,813         8     56,140         13     153,701         11     115,492         15

Europe & Israel

     60,491         8     26,908         6     99,737         7     50,833         6

Korea

     123,154         16     19,437         4     285,245         20     48,949         6

Rest of Asia

     139,945         18     60,434         14     252,002         17     93,656         12
                                                                    

Total

   $ 766,327         100   $ 440,355         100   $ 1,448,669         100   $ 783,042         100
                                                                    

 

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The following is a summary of revenues by major products for the three and six months ended December 31, 2010 and 2009 (as a percentage of total revenues):

 

      Three months  ended
December 31,
    Six months  ended
December 31,
 

(Dollar amounts in thousands)

   2010     2009     2010     2009  

Revenues:

                    

Defect inspection

   $ 506,360         66   $ 259,483         59   $ 916,473         63   $ 430,571         55

Metrology

     104,041         14     54,080         12     223,595         15     98,758         13

Service

     138,470         18     125,409         29     270,203         19     238,845         31

Other

     17,456         2     1,383         0     38,398         3     14,868         2
                                                                    

Total

   $ 766,327         100   $ 440,355         100   $ 1,448,669         100   $ 783,042         100
                                                                    

For the three months ended December 31, 2010, three customers accounted for greater than 10% of total revenues. For the six months ended December 31, 2010, two customers accounted for greater than 10% of total revenues. For the three and six months ended December 31, 2009, two customers accounted for greater than 10% of total revenues. As of December 31, 2010 and June 30, 2010, two customers accounted for greater than 10% of net accounts receivable.

Long-lived assets by geographic region as of December 31, 2010 and June 30, 2010 were as follows:

 

(In thousands)

   December 31, 2010      June 30, 2010  

Long-lived assets:

     

United States

   $ 134,645       $ 174,033   

Taiwan

     843         714   

Japan

     4,353         3,985   

Europe & Israel

     128,111         127,474   

Korea

     2,879         3,482   

Rest of Asia

     53,875         56,141   
                 

Total

   $ 324,706       $ 365,829   
                 

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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; our future product offerings and product features; the success and market acceptance of new products; timing of shipment of backlog; the future of our product shipments and our product and service revenues; our future gross margins; our future research and development expenses and selling, general and administrative expenses; our ability to successfully maintain cost discipline; international sales and operations; our ability to maintain or improve our existing competitive position; success of our product offerings; creation and funding of programs for research and development; attraction and retention of employees; results of our investment in leading edge technologies; the effects of hedging transactions; the effect of the sale of trade receivables and promissory notes from customers; our future income tax rate; 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 Part II, Item 1A, “Risk Factors” in this report as well as in Item 1, “Business” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of

 

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Operations” in our Annual Report on Form 10-K for the year ended June 30, 2010, filed with the Securities and Exchange Commission on August 6, 2010. You should carefully review these risks and also review the risks described in other documents we file from time to time with the Securities and Exchange Commission. You are cautioned not to place undue reliance on these forward-looking statements, and we expressly assume no obligation to update the forward-looking statements in this report after the date hereof.

CRITICAL ACCOUNTING ESTIMATES AND POLICIES

The preparation of our Condensed Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions in applying our accounting policies that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Note 1 to the Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended June 30, 2010 describes the significant accounting policies and methods used in preparation of the Consolidated Financial Statements. 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 Quarterly Report on Form 10-Q. The accounting policies that reflect our more significant estimates, judgments and assumptions and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:

 

   

Revenue Recognition

 

   

Inventories

 

   

Warranty

 

   

Allowance for Doubtful Accounts

 

   

Stock-Based Compensation

 

   

Contingencies and Litigation

 

   

Goodwill and Intangible Assets

 

   

Income Taxes

System revenues recognized without an acceptance from the customer were 35%, 26% and 22% of total revenues for the three months ended December 31, 2010, September 30, 2010 and December 31, 2009, respectively. The percentage of system revenues recognized without an acceptance from customers increased during the three months ended December 31, 2010 as compared to the three months ended September 30, 2010 and December 31, 2009, primarily due to higher shipments of tools that have already met the required acceptance criteria at those customer fabs.

There were no significant changes in our critical accounting estimates and policies during the three months ended December 31, 2010. Please refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for our fiscal year ended June 30, 2010 for a more complete discussion of our critical accounting policies and estimates.

Valuation of 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 assets are tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. We completed our annual evaluation of goodwill by reporting unit during the three months ended December 31, 2010 and 2009 and concluded that there was no impairment as of December 31, 2010 and 2009.

 

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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 the second quarter of our fiscal year ended June 30, 2010 and 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 below but did not have a material impact on our financial position, results of operations or cash flows.

This guidance does not generally change the units of accounting for our revenue transactions. 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 upon shipment, prior to acceptance by the customer. The portion of revenue associated with installation is deferred based on relative sales price and recognized upon completion of the installation. Spare parts revenue is recognized when the product has been shipped and risk of loss has passed to the customer, and collectability is reasonably assured. Service and maintenance contract revenue is recognized ratably over the term of the maintenance contract. Revenue from services performed in the absence of a contract, such as consulting and training revenue, is recognized when the related services are performed, and collectability is reasonably assured. Our arrangements generally do not include any provisions for cancellation, termination or refunds that would significantly impact recognized revenue.

We enter into revenue arrangements that may consist of multiple deliverables of our products and services where certain elements of a sales contract are not delivered and accepted in one reporting period.

In many instances, products are sold in stand-alone arrangements. Services are sold separately through renewals of annual maintenance contracts. As a result, for substantially all of the arrangements with multiple deliverables pertaining to products and services, we use VSOE or TPE to allocate the selling price to each deliverable. We determine TPE based on historical prices charged for products and services when sold on a stand-alone basis.

When we are unable to establish relative selling price using VSOE or TPE, we use ESP in our allocation of arrangement consideration. The objective of ESP is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis. ESP could potentially be used for new or customized products.

We regularly review relative selling prices and maintain internal controls over the establishment and updates of these estimates.

Recent Accounting Pronouncements

In December 2010, the FASB amended its guidance on goodwill and other intangible assets. The amendment modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if there are qualitative factors indicating that it is more likely than not that a goodwill impairment exists. The qualitative factors are consistent with the existing guidance which requires goodwill of a reporting unit to be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. This amendment was effective for our interim period ending December 31, 2010. The amendment did not have an impact on our financial position, results of operations or cash flows.

In December 2010, the FASB amended its guidance on business combinations. Under the amended guidance, a public entity that presents comparative financial statements must disclose the revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the prior annual reporting period. The amendment is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The amendment did not have an impact on our financial position, results of operations or cash flows.

 

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In April 2010, the FASB amended its guidance on share-based payment awards with an exercise price 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 an impact on our financial position, results of operations or cash flows.

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.

EXECUTIVE SUMMARY

KLA-Tencor Corporation is a leading supplier of process control and yield management solutions for the semiconductor and related nanoelectronics industries. Our comprehensive portfolio of products, services, software and expertise helps integrated circuit (“IC” or “chip”) manufacturers manage yield throughout the entire wafer 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 light emitting diode (“LED”), data storage, photovoltaic, and general materials research and manufacturing.

Our products and services are used by virtually every major wafer, IC, reticle and disk manufacturer 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 because of their need to drive advances in their process and product technologies, or to ramp up production to satisfy demand from their customers for chips used in a growing number of consumer electronics, communications, data processing, and industrial products. 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 to reduce cost. This in turn will drive increased adoption of process control equipment and service that reduce semiconductor defectivity and improve manufacturing yields.

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 overall market 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 concentrated, we expect our customers’ capital spending on process control to increase over the long term. This increase is driven by the demand for more precise diagnostics capabilities to address new defects as a result of shrinking of device feature sizes, the transition to new materials, new device and circuit architecture, new lithography and other chip manufacturing challenges, and ongoing fab process innovation.

The demand for our products is ultimately affected by the profitability of our customers, which is driven by a number of factors including macroeconomic conditions, consumer and business demand for products that use their semiconductors, the successful development and introduction of new products and product applications, and the overall balance of manufacturing supply to customer demand in key market segments. While semiconductor content in consumer electronics, communications, data processing, and other industrial products continues to increase, the global economic weakness during the fiscal year ended June 30, 2009 adversely impacted many of our customers and consequently impacted the demand for our products. However, during the fiscal year ended June 30, 2010, economic conditions generally began to gradually improve, especially in some of the more rapidly developing economies in Asia. Demand for many technology-intensive products started to recover, and manufacturing capacity utilization in much of the semiconductor industry improved. As a result, several of our customers, particularly in the foundry market, began to increase their investments in manufacturing capacity and R&D, resulting in growing demand for our products and services throughout the year.

We continued to experience strong demand from our customers during the three months ended December 31, 2010, which, though lower than the preceding two quarters, was near historical highs. In response to this strong demand from our customers, we have been increasing our production volumes and customer support services. Our results for the three months ended December 31, 2010 reflect the sixth consecutive quarter of revenue growth.

We cannot predict the duration and sustainability of these business conditions. We remain at risk of incurring inventory or other capacity related charges if current favorable business conditions do not continue.

 

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The following table sets forth some of the key quarterly unaudited financial information that we use to manage our business:

 

(In thousands, except net income per share)

   Three months ended      Three months ended  
   December 31,
2010
     September 30,
2010
     June 30,
2010
     March 31,
2010
     December 31,
2009
     September 30,
2009
 

Total revenues

   $ 766,327       $ 682,342       $ 559,419       $ 478,299       $ 440,355       $ 342,687   

Total costs and operating expenses

   $ 497,461       $ 446,726       $ 398,577       $ 387,020       $ 393,260       $ 327,737   

Gross margin

   $ 454,929       $ 418,373       $ 331,500       $ 269,734       $ 233,069       $ 170,795   

Income from operations

   $ 268,866       $ 235,616       $ 160,842       $ 91,279       $ 47,095       $ 14,950   

Net income

   $ 185,492       $ 154,196       $ 113,085       $ 57,016       $ 21,794       $ 20,405   

Net income per share:

                 

Basic (1)

   $ 1.11       $ 0.92       $ 0.67       $ 0.33       $ 0.13       $ 0.12   

Diluted (1)

   $ 1.09       $ 0.91       $ 0.66       $ 0.33       $ 0.13       $ 0.12   

 

(1) Basic and diluted earnings per share are computed independently for each of the quarters presented based on the weighted average basic and fully diluted shares outstanding for each quarter. Therefore, the sum of quarterly basic and diluted per share information may not equal annual basic and diluted earnings per share.

RESULTS OF OPERATIONS

Revenues and Gross Margin

 

     Three months ended              

(Dollar amounts in thousands)

   December 31,
2010
    September  30,
2010
    December 31,
2009
    Q2 FY11 vs.
Q1 FY11
    Q2 FY11 vs.
Q2 FY10
 

Revenues:

        

Product

   $ 627,857      $ 550,609      $ 314,946      $ 77,248        14   $ 312,911         99

Service

   $ 138,470      $ 131,733      $ 125,409      $ 6,737        5   $ 13,061         10
                                             

Total revenues

   $ 766,327      $ 682,342      $ 440,355      $ 83,985        12   $ 325,972         74
                                             

Costs of revenues

   $ 311,398      $ 263,969      $ 207,286      $ 47,429        18   $ 104,112         50

Stock-based compensation expense included in costs of revenues

   $ 3,439      $ 4,168      $ 3,325      $ (729     -17