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KLA-Tencor 10-Q 2011
KLAC 10Q 9/30/11
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
T
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2011
or
£
TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number 000-09992
KLA-Tencor Corporation
(Exact name of registrant as specified in its charter)
  
Delaware
 
04-2564110
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
One Technology Drive, Milpitas, California
 
95035
(Address of Principal Executive Offices)
 
(Zip Code)
(408) 875-3000
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  £
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
 
Accelerated filer £
  
Non-accelerated filer £
 
Smaller reporting company £
 
 
 
  
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes £    No  x
As of October 13, 2011, there were 166,664,427 shares of the registrant’s Common Stock, $0.001 par value, outstanding.


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


 

2


PART I. FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS
KLA-TENCOR CORPORATION
Condensed Consolidated Balance Sheets
(Unaudited)
 
(In thousands)
September 30,
2011
 
June 30,
2011
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
745,947

 
$
711,329

Marketable securities
1,354,204

 
1,327,206

Accounts receivable, net
461,640

 
583,270

Inventories, net
612,603

 
575,730

Deferred income taxes
290,372

 
331,397

Other current assets
132,153

 
147,078

Total current assets
3,596,919

 
3,676,010

Land, property and equipment, net
264,279

 
257,358

Goodwill
327,971

 
328,156

Purchased intangibles, net
77,949

 
85,902

Other non-current assets
298,199

 
328,095

Total assets
$
4,565,317

 
$
4,675,521

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
114,575

 
$
142,945

Deferred system profit
136,122

 
192,338

Unearned revenue
47,311

 
44,264

Other current liabilities
436,211

 
499,314

Total current liabilities
734,219

 
878,861

Non-current liabilities:
 
 
 
Long-term debt
746,425

 
746,290

Income tax payable
37,978

 
78,337

Unearned revenue
38,857

 
34,905

Other non-current liabilities
73,243

 
76,235

Total liabilities
1,630,722

 
1,814,628

Commitments and contingencies (Note 12 and Note 13)

 

Stockholders’ equity:
 
 
 
Common stock and capital in excess of par value
1,031,157

 
1,010,659

Retained earnings
1,910,403

 
1,852,633

Accumulated other comprehensive income (loss)
(6,965
)
 
(2,399
)
Total stockholders’ equity
2,934,595

 
2,860,893

Total liabilities and stockholders’ equity
$
4,565,317

 
$
4,675,521

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

3


KLA-TENCOR CORPORATION
Condensed Consolidated Statements of Operations
(Unaudited)
 
 
Three months ended
 
September 30,
(In thousands, except per share data)
2011
 
2010
Revenues:
 
 
 
Product
$
650,256

 
$
550,609

Service
146,220

 
131,733

Total revenues
796,476

 
682,342

Costs and operating expenses:
 
 
 
Costs of revenues
340,349

 
263,969

Engineering, research and development
107,762

 
94,720

Selling, general and administrative
94,076

 
88,037

Total costs and operating expenses
542,187

 
446,726

Income from operations
254,289

 
235,616

Interest income and other, net
6,866

 
1,225

Interest expense
13,893

 
13,529

Income before income taxes
247,262

 
223,312

Provision for income taxes
55,267

 
69,116

Net income
$
191,995

 
$
154,196

Net income per share:
 
 
 
Basic
$
1.15

 
$
0.92

Diluted
$
1.13

 
$
0.91

Cash dividends declared per share
$
0.35

 
$
0.25

Weighted average number of shares:
 
 
 
Basic
166,684

 
167,187

Diluted
169,835

 
169,839

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

4


KLA-TENCOR CORPORATION
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 
Three months ended
September 30,
(In thousands)
2011
 
2010
Cash flows from operating activities:
 
 
 
Net income
$
191,995

 
$
154,196

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
23,184

 
20,783

Non-cash stock-based compensation expense
20,496

 
24,213

Net gain on sale of marketable securities and other investments
(662
)
 
(1,047
)
Changes in assets and liabilities:
 
 
 
Decrease (increase) in accounts receivable, net
129,227

 
(50,342
)
Increase in inventories, net
(43,699
)
 
(63,450
)
Decrease in other assets
91,789

 
10,870

Increase (decrease) in accounts payable
(28,558
)
 
30,096

Decrease in deferred system profit
(56,216
)
 
(3,101
)
Decrease in other liabilities
(108,571
)
 
(26,690
)
Net cash provided by operating activities
218,985

 
95,528

Cash flows from investing activities:
 
 
 
Capital expenditures, net
(12,128
)
 
(11,163
)
Purchase of available-for-sale securities
(303,101
)
 
(228,951
)
Proceeds from sale and maturity of available-for-sale securities
268,931

 
239,650

Purchase of trading securities
(18,586
)
 
(16,004
)
Proceeds from sale of trading securities
16,176

 
30,623

Net cash provided by (used in) investing activities
(48,708
)
 
14,155

Cash flows from financing activities:
 
 
 
Issuance of common stock
9,702

 
2,953

Tax withholding payments related to vested and released restricted stock units
(17,930
)
 
(9,517
)
Common stock repurchases
(66,392
)
 
(62,156
)
Payment of dividends to stockholders
(58,460
)
 
(41,785
)
Net cash used in financing activities
(133,080
)
 
(110,505
)
Effect of exchange rate changes on cash and cash equivalents
(2,579
)
 
9,288

Net increase in cash and cash equivalents
34,618

 
8,466

Cash and cash equivalents at beginning of period
711,329

 
529,918

Cash and cash equivalents at end of period
$
745,947

 
$
538,384

Supplemental cash flow disclosures:
 
 
 
Income taxes paid, net
$
37,391

 
$
46,060

Interest paid
$
611

 
$
352

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

5


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, 2011, filed with the SEC on August 5, 2011.
The condensed consolidated financial statements include the accounts of KLA-Tencor and its majority-owned subsidiaries. All significant intercompany balances and transactions have been eliminated.
The results of operations for the three months ended September 30, 2011 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, 2012.
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.
Revenue Recognition. KLA-Tencor recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable, and collectability is reasonably assured. 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, 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 also allows for multiple element revenue arrangements in cases where certain elements of a sales arrangement are not delivered and accepted in one reporting period. In such cases, the Company defers the relative fair value of the undelivered elements until that element is delivered to the customer. To be considered a separate element, the product or service in question must represent a separate unit of accounting and fulfill the following criteria: (a) the delivered item(s) has value to the customer on a stand-alone basis; (b) there is objective and reliable evidence of the fair value of the undelivered item(s); and (c) if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the Company. If the arrangement does not meet all the above criteria, the entire amount of the sales contract is deferred until all elements are accepted by the customer.
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 vendor-specific objective evidence ("VSOE") or third-party evidence ("TPE") to allocate the selling price to each deliverable. The Company determines TPE based on historical prices charged for products and services when sold on a stand-alone basis.

6


When the Company is unable to establish relative selling price using VSOE or TPE, the Company uses estimated selling price ("ESP") in its allocation of arrangement consideration. The objective of ESP is to determine the price at which the Company would transact a sale if the product or service were to be 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.
Recent Accounting Pronouncements. In September 2011, the FASB amended its guidance through the issuance of a revised accounting standard intended to simplify testing goodwill for impairment. The amendments allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity will no longer be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that the fair value of the reporting unit is less than its carrying amount. Prior to the amendment, entities were required to test goodwill for impairment, on at least an annual basis, by first comparing the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit is calculated as being less than its carrying amount, then the second step of the quantitative test is to be performed to measure the amount of impairment loss, if any. The amendment becomes effective for annual and interim goodwill impairment tests performed for the Company's fiscal year ending June 30, 2013. Early adoption is permitted. The Company is currently evaluating the impact of the guidance on its financial position, results of operations and cash flows.
In June 2011, the FASB amended its guidance on the presentation of comprehensive income. Under the amended guidance, an entity has the option to present comprehensive income in either one continuous statement or two consecutive financial statements. A single statement must present the components of net income and total net income, the components of other comprehensive income and total other comprehensive income, and a total for comprehensive income. In a two-statement approach, an entity must present the components of net income and total net income in the first statement. That statement must be immediately followed by a financial statement that presents the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. The option under current guidance that permits the presentation of components of other comprehensive income as part of the statement of changes in stockholders' equity has been eliminated. The amendment becomes effective during the first quarter of the Company's fiscal year ending June 30, 2013. Early adoption is permitted. 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.
In May 2011, the FASB amended its guidance to converge fair value measurement and disclosure guidance about fair value measurement under U.S. GAAP with International Financial Reporting Standards ("IFRS"). IFRS is a comprehensive series of accounting standards published by the International Accounting Standards Board. The amendment changes the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the FASB does not intend for the amendment to result in a change in the application of the requirements in the current authoritative guidance. The amendment becomes effective prospectively for the Company's interim reporting period ending March 31, 2012. Early application is not permitted. The Company does not expect the amendment to have a material impact on its 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 was effective for the Company’s interim reporting period ended September 30, 2011. The amendment did not have an impact on the Company's 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 of that guidance 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 was effective for the Company’s interim reporting period ended September 30, 2011, and the implementation of that guidance did not have an impact on the Company's financial position, results of operations or cash flows as it is disclosure-only in nature.

7



NOTE 2 – FAIR VALUE MEASUREMENTS
The Company’s financial assets and liabilities 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 land, property and equipment, are recorded at cost and are assessed for impairment when an event or circumstance indicates that an other-than-temporary decline in value may have occurred.
Fair Value Hierarchy. The authoritative guidance for fair value measurements establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:
Level 1
  
Valuations based on quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.
 
 
 
Level 2
  
Valuations based on quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities.
 
 
 
Level 3
  
Valuations based on inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
All of the Company’s financial instruments were classified within Level 1 or Level 2 of the fair value hierarchy as of September 30, 2011, 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 certain U.S. Government agency securities, U.S. Treasury securities and sovereign 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 commercial paper, corporate debt securities, municipal securities and certain U.S. Government agency securities, U.S. Treasury securities and sovereign securities. The market inputs used to value these instruments generally consist of market yields, reported trades and broker/dealer quotes. Such instruments are generally classified within Level 2 of the fair value hierarchy.
The principal market in which the Company executes its foreign currency contracts is the institutional market in an over-the-counter environment with a relatively high level of price transparency. The market participants usually are large 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 included the auction rate securities that were held by the Company as of and prior to June 30, 2010. Such instruments were 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.

8


Financial assets (excluding cash held in operating accounts and time deposits) and liabilities measured at fair value on a recurring basis were presented on the Company’s Condensed Consolidated Balance Sheet as of September 30, 2011 as follows:
(In thousands)
Total
 
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
 
Significant Other
Observable Inputs
(Level 2)
Assets
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
Money market and other
$
578,442

 
$
578,442

 
$

Marketable securities:
 
 
 
 
 
U.S. Treasury securities
71,186

 
65,387

 
5,799

U.S. Government agency securities
344,132

 
342,734

 
1,398

Municipal securities
40,338

 

 
40,338

Corporate debt securities
831,721

 

 
831,721

Sovereign securities
32,411

 
13,385

 
19,026

Total cash equivalents and marketable securities(1)
1,898,230

 
999,948

 
898,282

Other current assets:
 
 
 
 
 
Derivative assets
845

 

 
845

Other non-current assets:
 
 
 
 
 
Executive Deferred Savings Plan:
 
 
 
 
 
Money market and other
4,967

 
4,967

 

Mutual funds
110,923

 
85,709

 
25,214

Executive Deferred Savings Plan total
115,890

 
90,676

 
25,214

Total financial assets(1)
$
2,014,965

 
$
1,090,624

 
$
924,341

Other current liabilities:
 
 
 
 
 
Derivative liabilities
$
(6,054
)
 
$

 
$
(6,054
)
Total financial liabilities
$
(6,054
)
 
$

 
$
(6,054
)
________________
(1) Excludes cash of $156.8 million held in operating accounts and time deposits of $45.1 million as of September 30, 2011.


9


Financial assets (excluding cash held in operating accounts and time deposits) and liabilities measured at fair value on a recurring basis were presented on the Company’s Condensed Consolidated Balance Sheet as of June 30, 2011 as follows:  
(In thousands)
Total
 
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
 
Significant Other
Observable Inputs
(Level 2)
Assets
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
U.S. Treasury securities
$
4,400

 
$

 
$
4,400

U.S. Government agency securities
6,010

 
6,010

 

Corporate debt securities
21,982

 

 
21,982

Money market and other
481,770

 
481,770

 

Marketable securities:
 
 
 
 
 
U.S. Treasury securities
54,496

 
52,396

 
2,100

U.S. Government agency securities
314,173

 
314,173

 

Municipal securities
38,957

 

 
38,957

Corporate debt securities
853,403

 

 
853,403

Sovereign securities
32,086

 
14,696

 
17,390

Total cash equivalents and marketable securities(1)
1,807,277

 
869,045

 
938,232

Other current assets:
 
 
 
 
 
Derivative assets
1,970

 

 
1,970

Other non-current assets:
 
 
 
 
 
Executive Deferred Savings Plan:
 
 
 
 
 
Money market and other
1,806

 
1,806

 

Mutual funds
126,227

 
95,971

 
30,256

Executive Deferred Savings Plan total
128,033

 
97,777

 
30,256

Total financial assets(1)
$
1,937,280

 
$
966,822

 
$
970,458

Other current assets:
 
 
 
 
 
Derivative liabilities
$
(2,127
)
 
$

 
$
(2,127
)
Total financial liabilities
$
(2,127
)
 
$

 
$
(2,127
)
________________
(1) Excludes cash of $165.9 million held in operating accounts and time deposits of $65.4 million as of June 30, 2011.
Changes in the Company’s Level 3 securities for the three months ended September 30, 2011 and 2010 were as follows:
 
Three months ended
September 30,
(In thousands)
2011
 
2010
Beginning aggregate fair value of Level 3 securities
$

 
$
16,825

Net settlements

 
(16,825
)
Ending aggregate fair value of Level 3 securities
$

 
$

During the fiscal year ended June 30, 2010 (and in prior fiscal years), the Company’s investment portfolio included auction rate securities, which were investments with contractual maturities generally between 20 to 30 years. 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. 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 with UBS on November 11, 2008. On June 30, 2010 UBS repurchased the Company's $16.8 million then-remaining auction rate securities at par value, and the repurchase was subsequently settled in July 2010.

10



NOTE 3 – BALANCE SHEET COMPONENTS
(In thousands)
As of
September 30, 2011
 
As of
June 30, 2011
Accounts receivable, net:
 
 
 
Accounts receivable, gross
$
484,028

 
$
605,376

Allowance for doubtful accounts
(22,388
)
 
(22,106
)
 
$
461,640

 
$
583,270

Inventories, net:
 
 
 
Customer service parts
$
155,425

 
$
148,466

Raw materials
230,855

 
235,605

Work-in-process
158,834

 
131,804

Finished goods
67,489

 
59,855

 
$
612,603

 
$
575,730

Other current assets:
 
 
 
Prepaid expenses
$
52,601

 
$
61,796

Income tax related receivables
58,866

 
59,774

Other current assets
20,686

 
25,508

 
$
132,153

 
$
147,078

Land, property and equipment, net:
 
 
 
Land
$
41,872

 
$
41,956

Buildings and leasehold improvements
234,512

 
234,173

Machinery and equipment
457,103

 
447,772

Office furniture and fixtures
20,527

 
19,645

Construction in process
8,689

 
6,979

 
762,703

 
750,525

Less: accumulated depreciation and amortization
(498,424
)
 
(493,167
)
 
$
264,279

 
$
257,358

Other non-current assets:
 
 
 
Executive Deferred Savings Plan(1)
$
115,890

 
$
128,033

Deferred tax assets – long-term
156,619

 
173,788

Other
25,690

 
26,274

 
$
298,199

 
$
328,095

Other current liabilities:
 
 
 
Warranty
$
43,603

 
$
41,528

Executive Deferred Savings Plan(1)
115,467

 
128,088

Compensation and benefits
123,802

 
186,761

Income taxes payable
12,313

 
16,364

Interest payable
21,706

 
8,769

Accrued litigation costs
2,600

 
4,824

Other accrued expenses
116,720

 
112,980

 
$
436,211

 
$
499,314


11


________________
(1)
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, except in cases where such distributions are required to be delayed in order to avoid a prohibited distribution under Internal Revenue Code Section 409A. As of September 30, 2011, the Company had a deferred compensation plan related asset and liability included as a component of other non-current assets and other current liabilities on its Condensed Consolidated Balance Sheet.
NOTE 4 – MARKETABLE SECURITIES
The amortized cost and fair value of marketable securities as of September 30, 2011 and June 30, 2011 were as follows:
As of September 30, 2011 (In thousands)
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
U.S. Treasury securities
$
70,916

 
$
306

 
$
(36
)
 
$
71,186

U.S. Government agency securities
343,721

 
749

 
(338
)
 
344,132

Municipal securities
40,075

 
266

 
(3
)
 
40,338

Corporate debt securities
830,229

 
3,688

 
(2,196
)
 
831,721

Money market and other
578,442

 

 

 
578,442

Sovereign securities
32,283

 
132

 
(4
)
 
32,411

Subtotal
1,895,666

 
5,141

 
(2,577
)
 
1,898,230

Add: Time deposits(1)
45,117

 

 

 
45,117

Less: Cash equivalents
589,143

 

 

 
589,143

Marketable securities
$
1,351,640

 
$
5,141

 
$
(2,577
)
 
$
1,354,204

As of June 30, 2011 (In thousands)
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
U.S. Treasury securities
$
58,754

 
$
165

 
$
(23
)
 
$
58,896

U.S. Government agency securities
319,375

 
931

 
(123
)
 
320,183

Municipal securities
38,688

 
275

 
(6
)
 
38,957

Corporate debt securities
870,591

 
5,162

 
(368
)
 
875,385

Money market and other
481,770

 

 

 
481,770

Sovereign securities
31,932

 
179

 
(25
)
 
32,086

Subtotal
1,801,110

 
6,712

 
(545
)
 
1,807,277

Add: Time deposits(1)
65,402

 

 

 
65,402

Less: Cash equivalents
545,475

 

 
(2
)
 
545,473

Marketable securities
$
1,321,037

 
$
6,712

 
$
(543
)
 
$
1,327,206

________________
(1)
Time deposits excluded from fair value measurements.

12


KLA-Tencor’s investment portfolio consists of both corporate and government securities that have a maximum maturity of three years. The longer the duration of these securities, the more susceptible they are to changes in market interest rates and bond yields. As yields increase, those securities with a lower yield-at-cost show a mark-to-market unrealized loss. All unrealized losses are due to changes in market interest rates, bond yields and/or credit ratings. The Company has the ability to realize the full value of all of these investments upon maturity. The following table summarizes the fair value and gross unrealized losses of the Company’s investments that were in an unrealized loss position as of September 30, 2011:
 
(In thousands)
Fair Value
 
Gross
Unrealized
Losses(1)
U.S. Treasury securities
$
25,868

 
$
(36
)
U.S. Government agency securities
134,278

 
(338
)
Municipal securities
1,443

 
(3
)
Corporate debt securities
280,339

 
(2,196
)
Sovereign securities
2,497

 
(4
)
Total
$
444,425

 
$
(2,577
)
__________________ 
(1)
As of September 30, 2011, the amount of total gross unrealized losses that had been in a continuous loss position for 12 months or more was immaterial.

The contractual maturities of securities classified as available-for-sale as of September 30, 2011, regardless of their classification on the Company's Condensed Consolidated Balance Sheet, were as follows:
(In thousands)
Amortized
Cost
 
Fair Value
Due within one year
$
320,316

 
$
321,151

Due after one year through three years
1,031,324

 
1,033,053

 
$
1,351,640

 
$
1,354,204

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 on the Company's investments for the three months ended September 30, 2011 and 2010 were $0.7 million and $1.0 million, respectively.
NOTE 5 – GOODWILL AND PURCHASED INTANGIBLE ASSETS
Goodwill
The following table presents goodwill balances as of September 30, 2011 and June 30, 2011:
(In thousands)
As of
September 30, 2011
 
As of
June 30, 2011
Gross goodwill balance
$
604,557

 
$
604,742

Accumulated impairment losses
(276,586
)
 
(276,586
)
Net goodwill balance
$
327,971

 
$
328,156

The changes in the gross goodwill balance since June 30, 2011 resulted primarily from foreign currency translation adjustments.
Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in each business combination. The Company performs an annual evaluation of goodwill as of November 30 each year, as well as upon the occurrence of significant events or circumstances that impact the valuation of goodwill. There have been no significant events or circumstances affecting the valuation of goodwill subsequent to the impairment test performed in the three months ended December 31, 2010. The next annual evaluation of the goodwill by reporting unit will be performed in the three months ending December 31, 2011.

13


Purchased Intangible Assets
The components of purchased intangible assets as of September 30, 2011 and June 30, 2011 were as follows:
(In thousands)
 
 
As of
September 30, 2011
 
As of
June 30, 2011
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

 
$
98,603

 
$
35,958

 
$
134,561

 
$
94,172

 
$
40,389

Patents
6-13 years
 
57,648

 
42,185

 
15,463

 
57,648

 
40,591

 
17,057

Trade name/Trademark
4-10 years
 
19,893

 
13,303

 
6,590

 
19,893

 
12,907

 
6,986

Customer relationships
6-7 years
 
54,823

 
35,056

 
19,767

 
54,823

 
33,565

 
21,258

Other
0-1 year
 
16,200

 
16,029

 
171

 
16,200

 
15,988

 
212

Total
 
 
$
283,125

 
$
205,176

 
$
77,949

 
$
283,125

 
$
197,223

 
$
85,902

For the three months ended September 30, 2011 and 2010, amortization expense for other intangible assets was $8.0 million and $8.4 million, respectively. Based on the intangible assets recorded as of September 30, 2011, 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)
2012 (remaining 9 months)
$
22,276

2013
20,957

2014
15,537

2015
12,771

2016
5,582

2017 and thereafter
826

Total
$
77,949

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 of September 30, 2011.
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 on September 30, 2011 and June 30, 2011, the fair value of the debt as of September 30, 2011 and June 30, 2011 was $857.4 million and $863.5 million, respectively.

14



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.
The following table summarizes the combined activity under the Company's equity incentive plans for the indicated period:
(In thousands)
Available
For Grant
Balances as of June 30, 2011(1)
11,554

Restricted stock units granted(2)(3)
(3,877
)
Restricted stock units canceled(2)
145

Options canceled/expired/forfeited
196

Plan shares expired(4)
(187
)
Balances as of September 30, 2011(1)
7,831

__________________ 
(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 members of the Board of Directors. As of September 30, 2011, 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)
Includes 0.2 million restricted stock units granted to senior management during the three months ended September 30, 2011 with performance-based vesting criteria (in addition to service-based vesting criteria for any of such restricted stock units that are deemed to have been earned). As of September 30, 2011, it had not yet been determined the extent to which (if at all) the performance-based vesting criteria of such restricted stock units had been satisfied. Therefore, this line item includes all such performance-based restricted stock units, reported at the maximum possible number of shares that may ultimately be issuable under such restricted stock units if all applicable performance-based and service-based criteria are fully satisfied.
(4)
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 plans do not result in additional shares being available to the Company for future grant.
Except for options granted to non-employee Board members 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 previously disclosed 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.
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 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.

15


The following table shows pre-tax stock-based compensation expense for the indicated periods: 
(In thousands)
Three months ended
September 30,
2011
 
2010
Stock-based compensation expense by:
 
 
 
Costs of revenues
$
3,838

 
$
4,168

Engineering, research and development
5,821

 
7,618

Selling, general and administrative
10,837

 
12,427

Total stock-based compensation expense
$
20,496

 
$
24,213

The following table shows stock-based compensation capitalized as inventory as of September 30, 2011 and June 30, 2011: 
(In thousands)
As of
September 30, 2011
 
As of
June 30, 2011
Inventory
$
7,006

 
$
6,701

Stock Options
The following table summarizes the activity and weighted-average exercise price for stock options under all plans during the three months ended September 30, 2011: 
Stock Options
Shares
(In thousands)
 
Weighted-Average
Exercise Price
Outstanding stock options as of June 30, 2011
7,675

 
$
45.38

Granted

 
$

Exercised
(309
)
 
$
31.39

Canceled/expired/forfeited
(196
)
 
$
47.51

Outstanding stock options as of September 30, 2011
7,170

 
$
45.93

Vested and exercisable as of September 30, 2011
7,167

 
$
45.93

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 September 30, 2011, were 2.1 years and 1.9 years, respectively. The aggregate intrinsic values for total options outstanding under all plans and for total options vested and exercisable under all plans as of September 30, 2011 were each $2.0 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 assumptions, including the option’s expected life and the expected price volatility of the underlying stock. The expected stock price volatility assumption was based on the market-based implied volatility from traded options of the Company’s common stock.
The following table shows the 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
September 30,
2011
 
2010
Total intrinsic value of options exercised
$
2,760

 
$
563

Total cash received from employees as a result of employee stock option exercises
$
9,702

 
$
2,953

Tax benefits realized in connection with these exercises
$
939

 
$
202

As of September 30, 2011, the unrecognized stock-based compensation balance related to stock options was immaterial.

16


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 three months ended September 30, 2011 and restricted stock units outstanding as of September 30, 2011 and June 30, 2011: 
Restricted Stock Units
Shares
(In thousands) (1)
 
Weighted-Average
Grant Date
Fair Value
Outstanding restricted stock units as of June 30, 2011
6,540

 
$
21.28

Granted(2)
2,154

 
$
25.37

Vested and released
(905
)
 
$
22.56

Withheld for taxes
(479
)
 
$
22.54

Forfeited
(80
)
 
$
21.15

Outstanding restricted stock units as of September 30, 2011(2)
7,230

 
$
22.25

__________________ 
(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.
(2)
Includes 0.2 million restricted stock units granted to senior management during the three months ended September 30, 2011 with performance-based vesting criteria (in addition to service-based vesting criteria for any of such restricted stock units that are deemed to have been earned). As of September 30, 2011, it had not yet been determined the extent to which (if at all) the performance-based vesting criteria of such restricted stock units had been satisfied. Therefore, this line item includes all such performance-based restricted stock units, reported at the maximum possible number of shares that may ultimately be issuable under such restricted stock units, if all applicable performance-based and service-based criteria are fully satisfied.
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 indicated periods: 
(In thousands, except for weighted-average grant date fair value)
Three months ended
September 30,
2011
 
2010
Grant date fair value after estimated forfeitures
$
54,637

 
$
40,705

Weighted-average grant date fair value per unit
$
25.37

 
$
19.52

Tax benefits realized in connection with vested and released restricted stock units
$
16,773

 
$
10,094

As of September 30, 2011, the unrecognized stock-based compensation expense balance related to restricted stock units was $138.8 million and will be recognized over an estimated weighted-average amortization period of 2.0 years.

17


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).
Effective January 1, 2010, the offering period (or length of the look-back period) under the ESPP has a duration of six months, and the purchase price with respect to each offering period beginning on or after such date is, until otherwise amended, equal to 85% of the lesser of (i) the fair market value of the Company’s common stock at the commencement of the applicable six-month offering period or (ii) the fair market value of the Company’s common stock on the purchase date.
The Company estimates the fair value of purchase rights under the ESPP using a Black-Scholes valuation model. The fair value of each purchase right under the ESPP was estimated on the date of grant using the Black-Scholes option valuation model and the straight-line attribution approach with the following weighted-average assumptions: 
 
Three months ended
September 30,
 
2011
 
2010
Stock purchase plan:
 
 
 
Expected stock price volatility
33.0
%
 
41.0
%
Risk-free interest rate
0.1
%
 
0.2
%
Dividend yield
3.4
%
 
3.7
%
Expected life of options (in years)
0.50

 
0.50

 The following table shows the tax benefits realized by the Company in connection with the disqualifying dispositions of shares purchased under the ESPP and the weighted-average fair value per share for the indicated periods: 
(In thousands, except for weighted-average fair value per share)
Three months ended
September 30,
2011
 
2010
Tax benefits realized in connection with the disqualifying dispositions of shares purchased under the ESPP
$
475

 
$
356

Weighted-average fair value per share based on Black-Scholes model
$
9.16

 
$
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 be issued under the ESPP during the forthcoming fiscal year. During the fiscal year ended June 30, 2011, a total of 2.0 million additional shares were reserved under the ESPP. To date, no additional shares have been reserved under the ESPP with respect to the fiscal year ending June 30, 2012. As of September 30, 2011, a total of 3.5 million shares were reserved and available for issuance under the ESPP.
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 72.8 million shares of its common stock under a repurchase program, including 10.0 million shares authorized in February 2011. 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. As of September 30, 2011, 7.3 million shares were available for repurchase under the Company’s repurchase program.

18


Share repurchases for the three months ended September 30, 2011 and 2010 were as follows:
 
Three months ended
September 30,
(In thousands)
2011
 
2010
Number of shares of common stock repurchased
1,763

 
1,972

Total cost of repurchases
$
66,982

 
$
59,323

As of September 30, 2011, $3.3 million of the total cost of repurchases set forth above remained unpaid and was recorded in other current liabilities. The $2.7 million which was accrued as of June 30, 2011 was paid during the three months ended September 30, 2011.
NOTE 9 – NET INCOME PER SHARE
Basic net income per share is calculated by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted net income per share is calculated by using the weighted-average number of common shares outstanding during the period, increased to include the number of additional shares of common stock that would have been outstanding if the shares of common stock underlying the Company’s outstanding dilutive stock options and restricted stock units had been issued. The dilutive effect of outstanding options and restricted stock units is reflected in diluted net income per share by application of the treasury stock method. Under the treasury stock method, the amount the employee must pay for exercising stock options, the amount of compensation cost for future service that the Company has not yet recognized, and the amount of tax benefits that 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
September 30,
2011
 
2010
Numerator:
 
 
 
Net income
$
191,995

 
$
154,196

Denominator:
 
 
 
Weighted-average shares-basic, excluding unvested restricted stock units
166,684

 
167,187

Effect of dilutive options and restricted stock units
3,151

 
2,652

Weighted-average shares-diluted
169,835

 
169,839

Basic net income per share
$
1.15

 
$
0.92

Diluted net income per share
$
1.13

 
$
0.91

Anti-dilutive securities excluded from the computation of diluted net income per share
6,635

 
10,340

The total amount of dividends paid during the three months ended September 30, 2011 and 2010 was $58.5 million and $41.8 million, respectively. On July 12, 2011, the Company announced that its Board of Directors had authorized an increase in the level of the Company's quarterly dividend from $0.25 to $0.35 per share. The increase in the amount of dividends paid during the three months ended September 30, 2011 reflects that increase in the level of the Company's quarterly dividend.

19



NOTE 10 – COMPREHENSIVE INCOME
The components of comprehensive income, net of tax, are as follows: 
 
Three months ended
September 30,
(In thousands)
2011
 
2010
Net income
$
191,995

 
$
154,196

Other comprehensive income (loss):
 
 
 
Currency translation adjustments
(1,787
)
 
13,522

Gains (losses) on cash flow hedging instruments
(626
)
 
840

Change in unrecognized losses and transition obligation related to pension and post-retirement plans
103

 
80

Unrealized gains (losses) on investments
(2,256
)
 
1,750

Other comprehensive income (loss)
(4,566
)
 
16,192

Total comprehensive income
$
187,429

 
$
170,388

NOTE 11 – INCOME TAXES
The following table provides details of income taxes:
(Dollar amounts in thousands)
Three months ended
September 30,
2011
 
2010
Income before income taxes
$
247,262

 
$
223,312

Provision for taxes
55,267

 
69,116

Effective tax rate
22.4
%
 
31.0
%
The Company’s estimated annual effective tax rate for the fiscal year ending June 30, 2012 is approximately 25.0%.
The difference between the actual effective tax rate of 22.4% during the quarter and the estimated annual effective tax rate of 25.0% is primarily due to the tax impact of the following items during the three months ended September 30, 2011:
Tax benefit of $18.3 million was recognized related to the settlement of a United States federal income tax examination for the fiscal years ended June 30, 2007 through June 30, 2009. During the three months ended September 30, 2011, the Company received acceptance from the Joint Committee of Taxation for the settlement of the U.S. federal income tax examination. As a result of the settlement, the Company reduced its unrecognized tax benefits by $22.0 million.
Tax benefit of $18.0 million was recognized related to a decrease in reserves for uncertain tax positions taken in prior years.
Tax expense of $23.6 million was recognized related to an inter-company licensing agreement in connection with the migration of a portion of the Company's manufacturing to Singapore.
Tax expense of $5.2 million was recognized related to a non-deductible decrease in the value of the assets held within the Company’s Executive Deferred Savings Plan.

20


Tax expense was lower as a percentage of income during the three months ended September 30, 2011 compared to the three months ended September 30, 2010 primarily due to:
A tax benefit of $18.3 million recognized during the three months ended September 30, 2011 resulting from a decrease in the Company's unrecognized tax benefits due to the settlement of a U.S. federal income tax examination;
A tax benefit of $18.0 million recognized during the three months ended September 30, 2011 resulting from a decrease in reserves for uncertain tax positions taken in prior years;
A decrease in tax expense of $6.9 million during the three months ended September 30, 2011 related to state income taxes; and
A decrease in tax expense of $7.7 million during the three months ended September 30, 2011 related to an increase in the proportion of the Company's earnings generated in jurisdictions with tax rates lower than the U.S. statutory tax rate; partially offset by
An increase in tax expense of $23.6 million during the three months ended September 30, 2011 related to a migration of a portion of the Company's manufacturing to Singapore.
In the normal course of business, the Company is subject to examination by taxing authorities throughout the world. The Company is subject to federal income tax examination for all years beginning from the year ended June 30, 2010.  The Company is subject to state income tax examinations for all years beginning from the fiscal year ended June 30, 2007. The Company is also subject to examinations in other major foreign jurisdictions, including Singapore, for all years beginning from the fiscal year ended June 30, 2007. 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 $1.1 million of its existing unrecognized tax benefits within the next twelve months as a result of the lapse of statutes of limitations and the resolution of examinations with various tax authorities.
NOTE 12 – LITIGATION AND OTHER LEGAL MATTERS
Indemnification Obligations. As a result of the Company's indemnification obligations in connection with the litigation and government inquiries related to the Company's historical stock option practices, the Company is currently paying defense costs for one former officer and employee facing an SEC civil action to which the Company is not a party, and the Company is also obligated to pay the attorneys' fees and expenses incurred by former employees in connection with discovery undertaken in that case. The Company is further incurring costs associated with retaining counsel to respond to discovery requests and otherwise representing the Company in that litigation. Although the maximum potential amount of future payments the Company could be required to make under these arrangements 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 condensed consolidated financial statements are adequate in light of the probable and estimated liabilities. However, because such matters are subject to many uncertainties, the ultimate outcomes are not predictable, and there can be no assurances that the actual amounts required to satisfy alleged liabilities from the matters described above will not exceed the amounts reflected in the Company's condensed consolidated financial statements or will not have a material adverse effect on its results of operations, financial condition or cash flows.
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.

21


The following table shows total receivables sold under factoring agreements and proceeds from sales of LCs for the three months ended September 30, 2011 and 2010:
 
 
Three months ended
(In thousands)
September 30,
2011
 
September 30,
2010
Receivables sold under factoring agreements
$
168,724

 
$
60,025

Proceeds from sales of LCs
$
4,510

 
$
50,831

Factoring and LC fees for the sale of certain trade receivables were recorded in interest income and other, net and were not material for the periods presented.
Facilities. KLA-Tencor leases certain of its facilities under arrangements that are accounted for as operating leases. Rent expense was $2.3 million and $2.0 million for the three months ended September 30, 2011 and 2010, respectively.
The following is a schedule of expected operating lease payments:
Fiscal year ending June 30,
Amount
(In thousands)
2012 (remaining 9 months)
$
6,430

2013
6,394

2014
4,003

2015
2,161

2016
1,931

2017 and thereafter
3,113

Total minimum lease payments
$
24,032

Purchase Commitments. KLA-Tencor maintains certain open inventory purchase commitments with its suppliers to ensure a smooth and continuous supply for key components. The Company’s liability under these purchase commitments is generally restricted to a forecasted time-horizon as mutually agreed upon between the parties. This forecasted time-horizon can vary among different suppliers. The Company’s open inventory purchase commitments were approximately $337.6 million as of September 30, 2011 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.

22


The following table provides the changes in the product warranty accrual for the three months ended September 30, 2011 and 2010:
(In thousands)
Three months ended
September 30,
2011
 
2010
Beginning balance
$
41,528

 
$
21,109

Accruals for warranties issued during the period
11,292

 
9,486

Changes in liability related to pre-existing warranties
2,390

 
159

Settlements made during the period
(11,607
)
 
(5,198
)
Ending balance
$
43,603

 
$
25,556

The Company maintains guarantee arrangements available through various financial institutions for up to $20.8 million, of which $18.7 million had been issued as of September 30, 2011, primarily to fund guarantees to customs authorities for VAT and other operating requirements of the Company’s subsidiaries in Europe and Asia.
KLA-Tencor is a party to a variety of agreements pursuant to which it may be obligated to indemnify the other party with respect to certain matters. Typically, these obligations arise in connection with contracts and license agreements or the sale of assets, under which the Company customarily agrees to hold the other party harmless against losses arising from, or provides customers with other remedies to protect against, bodily injury or damage to personal property caused by the Company's products, non-compliance with the Company's product performance specifications, infringement by the Company's products of third-party intellectual property rights and a breach of warranties, representations and covenants related to 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.
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.
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.
NOTE 14 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The authoritative guidance requires companies to recognize all derivative instruments and hedging activities, including foreign currency exchange contracts, as either assets or liabilities at fair value on the balance sheet. Changes in the fair value of derivatives that do not qualify for hedge treatment, as well as the ineffective portion of any hedges, are reflected in the Condensed Consolidated Statement of Operations. In accordance with the guidance, the Company designates foreign currency forward exchange and option contracts as cash flow hedges of certain forecasted foreign currency denominated sales and purchase transactions.

23


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 counterparty to any of the Company’s hedging arrangements experiences financial difficulties or is otherwise unable to honor the terms of the foreign currency hedge, the Company may experience material losses.
For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the 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 Company uses foreign currency forward contracts to hedge certain foreign currency denominated assets or liabilities. The gains and losses on these derivatives are largely offset by the changes in the fair value of the assets or liabilities being hedged.
Derivatives in Cash Flow Hedging Relationships: Foreign Exchange Contracts
The location and amounts of designated and non-designated derivative instruments’ gains and losses reported in the condensed consolidated financial statements for the three months ended September 30, 2011 and 2010 are as follows:
 
 
Three months ended
September 30,
(In thousands)
Location in Financial Statements
2011
 
2010
Derivatives Designated as Hedging Instruments
 
 
 
 
Gains (losses) in accumulated OCI on derivatives (effective portion)
Accumulated OCI
$
(1,194
)
 
$
414

Gains (losses) reclassified from accumulated OCI into income (effective portion):
Revenues
$
(284
)
 
$
(793
)
 
Costs of revenues
61

 
(142
)
 
Total losses reclassified from accumulated OCI into income (effective portion)
$
(223
)
 
$
(935
)
Gains (losses) recognized in income on derivatives (ineffective portion and amount excluded from effectiveness testing)
Interest income and other, net
$
43

 
$
(119
)
Derivatives Not Designated as Hedging Instruments
 
 
 
 
Losses recognized in income
Interest income and other, net
$
(12,568
)
 
$
(1,356
)

24


The U.S. dollar equivalent of all outstanding notional amounts of hedge contracts, with maximum maturity of 13 months, as of September 30, 2011 and June 30, 2011 was as follows: 
(In thousands)
As of
September 30, 2011
 
As of
June 30, 2011
Cash flow hedge contracts
 
 
 
Purchase
$
3,222

 
$
3,381

Sell
$
54,855

 
$
30,133

Other foreign currency hedge contracts
 
 
 
Purchase
$
117,439

 
$
174,499

Sell
$
171,968

 
$
216,738

The location and fair value amounts of the Company’s derivative instruments reported in its Condensed Consolidated Balance Sheets as of September 30, 2011 and June 30, 2011 were as follows: 
 
Asset Derivatives
 
Liability Derivatives
 
Balance Sheet Location
 
September 30,
2011
 
June 30,
2011
 
Balance Sheet Location
 
September 30,
2011
 
June 30,
2011
(In thousands)
 
Fair Value
 
 
 
Fair Value
Derivatives designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
Other current assets
 
$
161

 
$
145

 
Other current liabilities
 
$
721

 
$
475

Total derivatives designated as hedging instruments
 
 
$
161

 
$
145

 
 
 
$
721

 
$
475

Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
Other current assets
 
$
684

 
$
1,825

 
Other current liabilities
 
$
5,333

 
$
1,652

Total derivatives not designated as hedging instruments
 
 
$
684

 
$
1,825

 
 
 
$
5,333

 
$
1,652

Total derivatives
 
 
$
845

 
$
1,970

 
 
 
$
6,054

 
$
2,127

The following table provides the balances and changes in the accumulated other comprehensive income (loss) related to derivative instruments for the three months ended September 30, 2011 and 2010:
 
Three months ended
September 30,
(In thousands)
2011
 
2010
Beginning balance
$
12

 
$
(1,995
)
Amount reclassified to income
223

 
935

Net change
(1,194
)
 
414

Ending balance
$
(959
)
 
$
(646
)

25



NOTE 15 – RELATED PARTY TRANSACTIONS
During the three months ended September 30, 2011 and 2010, 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 months ended September 30, 2011 and 2010, the following table provides the transactions with these parties (for the portion of such period that they were considered related):
(In thousands)
Three months ended
September 30,
2011
 
2010
Total revenues
$
37

 
$
200

Total purchases
$
2,092

 
$
882

The Company's receivable balance from these parties was immaterial as of September 30, 2011 and was $0.2 million as of June 30, 2011. Management believes that such transactions are at arm’s length and on similar terms as would have been obtained from unaffiliated third parties.
NOTE 16 – 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.
The Company 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 the Company operates in one segment, all financial segment information required by the authoritative guidance can be found in the condensed consolidated financial statements.
The Company’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 regions. 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 months ended September 30, 2011 and 2010 (as a percentage of total revenues):
  
Three months ended
September 30,
(Dollar amounts in thousands)
2011
 
2010
Revenues:
 
 
 
 
 
 
 
United States
$
198,243

 
25
%
 
$
86,519

 
12
%
Taiwan
223,289

 
28
%
 
188,541

 
28
%
Japan
134,815

 
17
%
 
93,888

 
14
%
Europe & Israel
92,996

 
12
%
 
39,246

 
6
%
Korea
79,598

 
10
%
 
162,091

 
24
%
Rest of Asia
67,535

 
8
%
 
112,057

 
16
%
Total
$
796,476

 
100
%
 
$
682,342

 
100
%

26


The following is a summary of revenues by major products for the three months ended September 30, 2011 and 2010 (as a percentage of total revenues):
  
Three months ended
September 30,
(Dollar amounts in thousands)
2011
 
2010
Revenues:
 
 
 
 
 
 
 
Defect inspection
$
443,633

 
56
%
 
$
410,113

 
60
%
Metrology
182,012

 
23
%
 
119,554

 
18
%
Service
146,220

 
18
%
 
131,733

 
19
%
Other
24,611