KLA CORP - FORM 10-Q - October 31, 2018

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EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER UNDER RULE 13A-14(A)/15D-14(A) - KLA CORPklac10qex311093018.htm
EX-32 - CERTIFICATION OF CEO AND CFO PURSUANT TO 18 U.S.C. SECTION 1350 - KLA CORPklac10qex32093018.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER UNDER RULE 13A-14(A)/15D-14(A) - KLA CORPklac10qex312093018.htm

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 September 30, 2018
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, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
 
 
 
Accelerated filer ¨
Non-accelerated filer ¨
 
(Do not check if a smaller reporting company)
 
Smaller reporting company ¨
 
 
 
 
Emerging growth company ¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
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 19, 2018, there were 153,075,310 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,
2018
 
June 30,
2018
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,649,514

 
$
1,404,382

Marketable securities
1,130,794

 
1,475,936

Accounts receivable, net
602,210

 
651,678

Inventories
993,527

 
931,845

Other current assets
144,999

 
85,159

Total current assets
4,521,044

 
4,549,000

Land, property and equipment, net
291,232

 
286,306

Goodwill
360,428

 
354,698

Deferred income taxes
222,107

 
193,200

Intangible assets, net
25,129

 
19,333

Other non-current assets
225,169

 
216,819

Total assets
$
5,645,109

 
$
5,619,356

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
154,930

 
$
169,354

Deferred system revenue
216,427

 
—

Deferred service revenue
166,254

 
69,255

Deferred system profit
—

 
279,581

Other current liabilities
773,319

 
699,893

Total current liabilities
1,310,930

 
1,218,083

Non-current liabilities:
 
 
 
Long-term debt
2,237,890

 
2,237,402

Deferred service revenue
80,936

 
71,997

Other non-current liabilities
447,984

 
471,363

Total liabilities
4,077,740

 
3,998,845

Commitments and contingencies (Note 13 and Note 14)

 

Stockholders’ equity:
 
 
 
Common stock and capital in excess of par value
596,166

 
617,999

Retained earnings
1,027,370

 
1,056,445

Accumulated other comprehensive income (loss)
(56,167
)
 
(53,933
)
Total stockholders’ equity
1,567,369

 
1,620,511

Total liabilities and stockholders’ equity
$
5,645,109

 
$
5,619,356

 
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 amounts)
2018
 
2017
Revenues:
 
 
 
Product
$
829,227

 
$
760,787

Service
264,033

 
208,794

Total revenues
1,093,260

 
969,581

Costs and expenses:
 
 
 
Costs of revenues
381,387

 
353,117

Research and development
153,530

 
146,687

Selling, general and administrative
114,438

 
107,432

Interest expense
26,362

 
30,576

Other expense (income), net
(10,025
)
 
(4,383
)
Income before income taxes
427,568

 
336,152

Provision for income taxes
31,624

 
55,216

Net income
$
395,944

 
$
280,936

Net income per share:
 
 
 
Basic
$
2.55

 
$
1.79

Diluted
$
2.54

 
$
1.78

Cash dividends declared per share
$
0.75

 
$
0.59

Weighted-average number of shares:
 
 
 
Basic
155,221

 
156,826

Diluted
156,083

 
157,846


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

4

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

 
Three months ended
 
September 30,
(In thousands)
2018
 
2017
Net income
$
395,944

 
$
280,936

Other comprehensive income (loss):
 
 
 
Currency translation adjustments:
 
 
 
Change in currency translation adjustments
(3,082
)
 
1,558

Change in income tax benefit or expense
—

 
(503
)
Net change related to currency translation adjustments
(3,082
)
 
1,055

Cash flow hedges:
 
 
 
Change in net unrealized gains or losses
13,794

 
444

Reclassification adjustments for net gains or losses included in net income
(1,037
)
 
(2,118
)
Change in income tax benefit or expense
(3,295
)
 
598

Net change related to cash flow hedges
9,462

 
(1,076
)
Net change related to unrecognized losses and transition obligations in connection with defined benefit plans
142

 
(34
)
Available-for-sale securities:
 
 
 
Change in net unrealized gains or losses
2,110

 
667

Reclassification adjustments for net gains or losses included in net income
481

 
(6
)
Change in income tax benefit or expense
(502
)
 
(64
)
Net change related to available-for-sale securities
2,089

 
597

Other comprehensive income (loss)
8,611

 
542

Total comprehensive income
$
404,555

 
$
281,478


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

5

KLA-TENCOR CORPORATION
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 
Three months ended
September 30,
(In thousands)
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
395,944

 
$
280,936

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
16,087

 
15,282

(Gain) loss on unrealized foreign exchange
3,005

 
2,291

Other
890

 
980

Stock-based compensation expense
16,138

 
14,031

Changes in assets and liabilities, net of assets acquired and liabilities assumed in business combination:
 
 
 
Accounts receivable
36,079

 
(95,621
)
Inventories
(55,738
)
 
(20,194
)
Other assets
(16,853
)
 
(4,222
)
Accounts payable
(14,765
)
 
(8,877
)
Deferred system revenue
(79,810
)
 
—

Deferred service revenue
(13,325
)
 
—

Deferred system profit
—

 
28,406

Other liabilities
93,753

 
160,617

Net cash provided by operating activities
381,405

 
373,629

Cash flows from investing activities:
 
 
 
Acquisition of a business, net of cash acquired
(11,787
)
 
(710
)
Capital expenditures
(22,330
)
 
(15,756
)
Purchases of available-for-sale securities
—

 
(191,744
)
Proceeds from sale of available-for-sale securities
91,238

 
50,095

Proceeds from maturity of available-for-sale securities
254,757

 
268,665

Purchases of trading securities
(4,619
)
 
(11,876
)
Proceeds from sale of trading securities
7,612

 
14,320

Net cash provided by investing activities
314,871

 
112,994

Cash flows from financing activities:
 
 
 
Repayment of debt
—

 
(156,250
)
Tax withholding payments related to vested and released restricted stock units
(26,961
)
 
(23,628
)
Common stock repurchases
(299,974
)
 
(39,927
)
Payment of dividends to stockholders
(122,757
)
 
(100,327
)
Net cash used in financing activities
(449,692
)
 
(320,132
)
Effect of exchange rate changes on cash and cash equivalents
(1,452
)
 
1,155

Net increase in cash and cash equivalents
245,132

 
167,646

Cash and cash equivalents at beginning of period
1,404,382

 
1,153,051

Cash and cash equivalents at end of period
$
1,649,514

 
$
1,320,697

Supplemental cash flow disclosures:
 
 
 
Income taxes paid
$
24,962

 
$
23,858

Interest paid
$
537

 
$
3,005

Non-cash activities:
 
 
 
Business acquisition holdback amounts - investing activities
$
440

 
$
4,780

Contingent consideration payable - financing activities
$
3,102

 
$
—

Accrued purchases of land, property and equipment - investing activities
$
9,242

 
$
4,734

Unsettled common stock repurchase - financing activities
$
7,812

 
$
848

Dividends payable - financing activities
$
4,783

 
$
7,011

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

6

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 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 presentation of the financial position, results of operations, comprehensive income, and cash flows for the periods indicated. These financial statements and notes, however, should be read in conjunction with Item 8, “Financial Statements and Supplementary Data” included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2018, filed with the SEC on August 6, 2018.
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, 2018 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, 2019.
Certain reclassifications have been made to the prior year’s Condensed Consolidated Financial Statements to conform to the current year presentation. The reclassifications did not have material effects on the prior year’s Condensed Consolidated Balance Sheets, Statements of Operations, Comprehensive Income and Cash Flows.
Proposed Merger with Orbotech, Ltd.
On March 18, 2018, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Orbotech, Ltd. (“Orbotech”) under which KLA-Tencor will acquire Orbotech for $38.86 in cash and 0.25 of a share of KLA-Tencor common stock in exchange for each ordinary share of Orbotech, which at the time of announcement valued Orbotech at $3.2 billion in enterprise value. The merger contemplated by the Merger Agreement (the “Orbotech Merger”) is subject to receipt of required regulatory approvals and satisfaction of the other customary closing conditions.
Management Estimates. The preparation of the condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions in applying the Company’s accounting policies that affect the reported amounts of assets and liabilities (and related disclosure of contingent assets and liabilities) at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Comparability. Effective on the first day of fiscal 2019, the Company adopted Accounting Standards Update 2014-09, Revenue from Contracts with Customers (“ASC 606”). Prior periods were not retrospectively restated, and accordingly, the consolidated balance sheet as of June 30, 2018, and the condensed consolidated statements of operations for the three months ended September 30, 2017 were prepared using accounting standards that were different than those in effect for the three months ended September 30, 2018.
Recent Accounting Pronouncements.
Recently Adopted
In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASC 606, which supersedes the guidance in ASC 605, Revenue Recognition (“ASC 605”). Under ASC 606, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, ASC 606 requires enhanced disclosures, including disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The Company adopted the ASC 606 as of July 1, 2018, using the modified retrospective transition approach. For additional details, refer to Note 2 “Revenue.”

7

In January 2016, the FASB issued an accounting standard update that changes the accounting for financial instruments primarily related to equity investments (other than those accounted for under the equity method of accounting or those that result in consolidation of the investee), financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. The Company adopted this update beginning in the first quarter of its fiscal year ending June 30, 2019 on a prospective basis and the adoption had no material impact on its condensed consolidated financial statements.
In October 2016, the FASB issued an accounting standard update to recognize the income tax consequences of intra-entity transfers of assets other than inventory when they occur. This eliminates the exception to postpone recognition until the asset has been sold to an outside party. The Company adopted this update beginning in the first quarter of its fiscal year ending June 30, 2019 on a modified retrospective basis and the adoption had no material impact on its condensed consolidated financial statements.
In January 2017, the FASB issued an accounting standard on clarifying the definition of a business, with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The Company adopted this update beginning in the first quarter of its fiscal year ending June 30, 2019 on a prospective basis.
In January 2017, the FASB issued an accounting standard update to simplify the subsequent measurement of goodwill by removing the second step of the two-step impairment test, which requires an entity to determine the fair value of assets and liabilities similar to what is required in a purchase price allocation. Under the update, goodwill impairment will be calculated as the amount by which a reporting unit’s carrying value exceeds its fair value. The Company early adopted this update in the first quarter of its fiscal year ending June 30, 2019 on a prospective basis.
In March 2017, the FASB issued an accounting standard update that changes the statements of operation classification of net periodic benefit cost related to defined benefit pension and/or other post-retirement benefit plans. Under the update, employers will present the service cost component of net periodic benefit cost in the same statements of operations line item(s) as other employee compensation costs arising from services rendered during the period. Only the service cost component will be eligible for capitalization in assets. Employers will present the other components of the net periodic benefit costs separately from the line item(s) that includes the service cost and outside of any subtotal of operating income, if one is presented. The Company adopted this update beginning in the first quarter of its fiscal year ending June 30, 2019 on a retrospective basis and the adoption had no material impact on its condensed consolidated financial statements.
In May 2017, the FASB issued an accounting standard update regarding stock compensation that provides guidance about which changes to the terms and conditions of a share-based payment award require an entity to apply modification accounting in order to reduce diversity in practice and reduce complexity. The Company adopted this update beginning in the first quarter of its fiscal year ending June 30, 2019 on a prospective basis and the adoption had no material impact on its condensed consolidated financial statements.
In February 2018, the FASB issued an accounting standard update that provides an option to reclassify disproportional tax effects and other income tax effects (“stranded tax effects”) caused by the Tax Cuts and Jobs Act (“the Act”) from accumulated other comprehensive income (“AOCI”) to retained earnings. The Company early adopted this update in the first quarter of its fiscal year ending June 30, 2019 and applied this update in the period of adoption. As a result of the adoption, the Company made a reclassification from AOCI to beginning retained earnings of approximately $10.7 million related to the stranded tax effects.
Updates Not Yet Effective
In February 2016, the FASB issued an accounting standard update which amends the existing accounting standards for leases. Consistent with current guidance, the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification. Under the new guidance, a lessee will be required to recognize assets and liabilities for all leases with lease terms of more than 12 months using a modified retrospective transition method. In July 2018, the FASB issued an amendment to the standard which provide the Company an option to apply the practical expedient allowed in the standard retrospectively with the cumulative effect recognized as of the date of adoption. The update is effective for the Company beginning in the first quarter of its fiscal year ending June 30, 2020. Early adoption is permitted. The Company is currently evaluating the impact of this accounting standard update on its condensed consolidated financial statements.

8

In June 2016, the FASB issued an accounting standard update that changes the accounting for recognizing impairments of financial assets. Under the update, credit losses for certain types of financial instruments will be estimated based on expected losses. The update also modifies the impairment models for available-for-sale debt securities and for purchased financial assets with credit deterioration since their origination. The update is effective for the Company beginning in the first quarter of its fiscal year ending June 30, 2021, with early adoption permitted starting in the first quarter of fiscal year ending June 30, 2020. The Company is currently evaluating the impact of this accounting standard update on its condensed consolidated financial statements.
In August 2017, the FASB issued an accounting standard update to hedge accounting to better align the Company’s risk management activities by refining financial and non-financial hedging strategy eligibilities. This update also amends the presentation and disclosure requirements to increase transparency to better understand an entity’s risk exposures and how hedging strategies are used to manage those exposures. This standard update is effective for the Company beginning in the first quarter of its fiscal year ending June 30, 2020, and early adoption is permitted. The Company is currently evaluating the impact of this accounting standard update on its condensed consolidated financial statements.
In August 2018, the FASB issued an accounting standard update which modifies the existing accounting standards for fair value measurement disclosure. This update eliminates the amount of and reasons for transfers between level 1 and level 2 of the fair value hierarchy, and the policy for timing of transfers between levels. This standard update is effective for the Company beginning in the first quarter of its fiscal year ending June 30, 2021, and early adoption is permitted. The Company is currently evaluating the impact of this accounting standard update on its condensed consolidated financial statements.
In August 2018, the FASB issued an accounting standard update to amend the disclosure requirements related to defined benefit pension and other post-retirement plans. Some of the changes include adding a disclosure requirement for significant gains and losses related to changes in the benefit obligation for the period, and removing the amounts in accumulated other comprehensive income expected to be recognized as components of net periodic benefit cost over the next fiscal year. This standard update is effective for the Company for the fiscal year ending June 30, 2021, and early adoption is permitted. The Company is currently evaluating the impact of this accounting standard update on its condensed consolidated financial statements.
In August 2018, the FASB issued an accounting standard update to align the requirements for capitalizing implementation costs incurred in a cloud computing arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The guidance clarifies which costs should be capitalized including the cost to acquire the license and the related implementation costs. This standard update is effective for the Company beginning in the first quarter of its fiscal year ending June 30, 2021, with an option to be adopted either prospectively or retrospectively. Early adoption is permitted. The Company is currently evaluating the impact of this accounting standard update on its condensed consolidated financial statements.
Significant Accounting Policies. Except for the accounting policy for revenue recognition, which was updated as a result of adopting ASC 606, and Global Intangible Low-Taxed Income (“GILTI”), there have been no material changes to our significant accounting policies in Note 1 “Description of Business and Summary of Significant Accounting Policies,” of the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2018.
Revenue Recognition. The Company primarily derives revenue from the sale of process control and yield management solutions for the semiconductor and related nanoelectronics industries, maintenance and support of all these products, installation and training services and the sale of spare parts. The Company’s solutions provide a comprehensive portfolio of inspection, metrology and data analytics products, which are accompanied by a flexible portfolio of services to enable its customers to maintain the performance and productivity of the solutions purchased. The Company’s solutions are generally not sold with a right of return, nor has the Company experienced significant returns from or refunds to its customers.
The Company accounts for a contract with a customer when there is approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectibility of consideration is probable.
The Company’s revenues are measured based on consideration stipulated in the arrangement with each customer, net of any sales incentives and amounts collected on behalf of third parties, such as sales taxes. The revenues are recognized as separate performance obligations that are satisfied by transferring control of the product or service to the customer.

9

The Company’s arrangements with its customers include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. A product or service is considered distinct if it is separately identifiable from other deliverables in the arrangement and if a customer can benefit from it on its own or with other resources that are readily available to the customer.
The transaction consideration, including any sales incentives, is allocated between separate performance obligations of an arrangement based on the stand-alone selling prices (“SSP”) for each distinct product or service. Management considers a variety of factors to determine the SSP, such as, historical standalone sales of products and services, discounting strategies and other observable data.
From time to time, the Company’s contracts are modified to account for additional, or to change existing, performance obligations. The Company’s contract modifications are generally accounted for prospectively.
Product revenue
The Company recognizes revenue from product sales at a point in time when the Company has satisfied its performance obligation by transferring control of the product to the customer. The Company uses judgment to evaluate whether the control has transferred by considering several indicators, including:

•
whether the Company has a present right to payment;
•
the customer has legal title;
•
the customer has physical possession;
•
the customer has significant risk and rewards of ownership; and
•
the customer has accepted the product, or whether customer acceptance is considered a formality based on history of acceptance of similar products (for example, when the customer has previously accepted the same tool, with the same specifications, and when we can objectively demonstrate that the tool meets all of the required acceptance criteria, and when the installation of the system is deemed perfunctory).
Not all of the indicators need to be met for the Company to conclude that control has transferred to the customer. In circumstances in which revenue is recognized prior to the product acceptance, the portion of revenue associated with its performance obligations to install product is deferred and recognized upon acceptance.
The Company enters into volume purchase agreements with some of its customers. The Company adjusts the transaction consideration for estimated credits earned by its customers for such incentives. These credits are estimated based upon the forecasted and actual product sales for any given period, and agreed-upon incentive rate. The estimate is updated at each reporting period.
The Company offers perpetual and term licenses for defects and data analysis software. The primary difference between perpetual and term licenses is the duration over which the customer can benefits from the use of the software, while the functionality and the features of the software are the same. The software is generally bundled with the post-contract customer support (“PCS”), which includes unspecified software updates that are made available throughout the entire term of the arrangement. Revenue from software licenses is recognized at a point in time, when the software is made available to the customer. Revenue from PCS is deferred at contract inception and recognized ratably over the service period, or as services are performed.
Services and spare parts revenue
The majority of product sales include a standard 12-month warranty that is not separately paid for by the customers. The customers may also purchase extended warranty for periods beyond the initial year as part of the initial product sale. The Company has concluded that the standard 12-month warranty as well as any extended warranty periods included in the initial product sales are separate performance obligations. The estimated fair value of warranty services is deferred and recognized ratably as revenue over the warranty period, as the customer simultaneously receives and consumes the benefits of warranty services provided by the Company.
Additionally, the Company offers product maintenance and support services, which the customer may purchase separately from the standard and extended warranty offered as part of the initial product sale. Revenue from separately negotiated maintenance and support service contracts is also recognized over time based on the terms of the applicable service period. Revenue from services performed in the absence of a maintenance contract, including training revenue, is recognized when the related services are performed. The Company also sells spare parts, revenue from which is recognized when control over the spare parts is transferred to the customer.

10

Installation services include connecting and validating configuration of the product. In addition, several testing protocols are completed to confirm the equipment is performing to customer specifications. Revenue from product installation are deferred and recognized at a point in time, once installation is complete.
Significant Judgments
The Company’s contracts with its customers often include promises to transfer multiple products and services. Each product and service is generally capable of being distinct and represents a separate performance obligation. Determining the SSP for each distinct performance obligation and allocation of consideration from an arrangement to the individual performance obligations and the appropriate timing of revenue recognition are significant judgments with respect to these arrangements. The Company typically estimates the SSP of products and services based on observable transactions when the products and services are sold on a standalone basis and those prices fall within a reasonable range. The Company typically has more than one SSP for individual products and services due to the stratification of these products by customers and circumstances. In these instances, the Company uses information such as the size of the customer, geographic region, as well as customization of the products in determining the SSP. In instances where the SSP is not directly observable, the Company determines the SSP using information that includes market conditions, entity-specific factors, including discounting strategies, information about the customer or class of customer that is reasonably available and other observable inputs. While changes in the allocation of SSP between performance obligations will not affect the amount of total revenue recognized for a particular contract, any material changes could impact the timing of revenue recognition, which could have a material effect on the Company’s financial position and result of operations.
Although the products are generally not sold with a right of return, the Company may provide other credits or sales incentives, which are accounted for either as variable consideration or material right, depending on the specific terms and conditions of the arrangement. These credits and incentives are estimated at contract inception and updated at the end of each reporting period if and when additional information becomes available.
As outlined above, the Company uses judgment to evaluate whether or not the customer has obtained control of the product and considers the several indicators in evaluating whether or not control has transferred to the customer. Not all of the indicators need to be met for the Company to conclude that control has transferred to the customer.
Contract Assets/Liabilities
The timing of revenue recognition, billings and cash collections may result in accounts receivable, contract assets, and contract liabilities (deferred revenue) on the Company’s condensed consolidated balance sheet. A receivable is recorded in the period the Company delivers products or provides services when the Company has an unconditional right to payment. Contract assets primarily relate to the value of products and services transferred to the customer for which the right to payment is not just dependent on the passage of time. Contract assets are transferred to receivable when rights to payment become unconditional.
A contract liability is recognized when the Company receives payment or has an unconditional right to payment in advance of the satisfaction of performance. The contract liabilities represent (1) Deferred product revenue relates to the value of products that have been shipped and billed to customers and for which the control has not been transferred to the customers, and (2) Deferred service revenue, which is recorded when the Company receives consideration, or such consideration is unconditionally due, from a customer prior to transferring services to the customer under the terms of a sales contract. Deferred service revenue typically results from warranty services, and maintenance and other service contracts.
Contract assets and liabilities related to rights and obligations in a contract are recorded net in the condensed consolidated balance sheets. Upon the adoption of ASC 606, deferred costs of revenue is included in other current assets while under the legacy guidance deferred costs of revenue was included in deferred system profit.
NOTE 2 – REVENUE
New Revenue Accounting Standard
Method and Impact of Adoption
The Company adopted ASC 606 on July 1, 2018 using the modified retrospective transition approach for all contracts completed and not completed as of the date of adoption. Under the modified retrospective transition approach, periods prior to the adoption date were not adjusted and continue to be reported in accordance with ASC 605. A cumulative effect of applying ASC 606 was recorded to beginning retained earnings to reflect the impact of all existing arrangements under ASC 606.

11

The net decrease to retained earnings of $21.0 million as of July 1, 2018 due to the adoption of ASC 606 was primarily related to the following items:
•
A decrease of approximately $97.0 million in retained earnings related to the deferral of estimated fair value of the warranty services provided with the Company’s products for which revenue will be recognized in future periods under ASC 606. Further, upon adoption of ASC 606, the Company will recognize the standard warranty for a majority of products as a separate performance obligation, while in prior periods, the Company accounted for the estimated warranty cost as a charge to costs of sales when revenue was recognized. This was partially offset by an increase in retained earnings of approximately $37.0 million related to reversal of standard warranty expense, which was charged to cost of revenues in prior periods.
•
An increase in retained earnings of approximately $26.0 million as a result of a change in the timing of transfer of control over products to the customers. Revenue under ASC 606 is expected to be recognized earlier than it would have been under legacy guidance primarily due to the Company’s assessment of timing of transfer of control.
The following table summarizes the effects of adopting ASC 606 on the Company’s condensed consolidated balance sheet as of September 30, 2018:
September 30, 2018 (In thousands)
As reported under
ASC 606
 
Prior to
adoption of
ASC 606
 
Effect of changes
ASSETS
 
 
 
 
 
Accounts receivable, net
$
602,210

 
$
614,476

 
$
(12,266
)
Other current assets
144,999

 
115,863

 
29,136

Deferred income taxes
222,107

 
199,326

 
22,781

LIABILITIES
 
 
 
 
 
Deferred system revenue
$
216,427

 
$
—

 
$
216,427

Deferred service revenue
166,254

 
58,984

 
107,270

Deferred system profit
—

 
330,622

 
(330,622
)
Other current liabilities
773,319

 
820,159

 
(46,840
)
Deferred service revenue, non-current
80,936

 
73,741

 
7,195

STOCKHOLDERS’ EQUITY
 
 
 
 
 
Retained earnings
$
1,027,370

 
$
941,162

 
$
86,208

Accumulated other comprehensive income (loss)
(56,167
)
 
(56,182
)
 
15


The following table summarizes the effects of adopting ASC 606 on the Company’s condensed consolidated statements of operations for the three months ended September 30, 2018:
Three months ended September 30, 2018 (In thousands, except per share amounts)
As reported under
ASC 606
 
Prior to
adoption of
ASC 606
 
Effect of changes
Revenues:
 
 
 
 
 
Product
$
829,227

 
$
700,673

 
$
128,554

Service
264,033

 
229,960

 
34,073

Costs and expenses:
 
 
 
 
 
Costs of revenues
381,387

 
341,874

 
39,513

Other expense (income), net
(10,025
)
—

(10,026
)
 
1

Provision for income taxes
31,624

 
15,934

 
15,690

Net income
$
395,944

 
$
288,521

 
$
107,423

Net income per share:
 
 
 
 
 
Basic
$
2.55

 
$
1.86

 
$
0.69

Diluted
$
2.54

 
$
1.85

 
$
0.69



12

Revenue recognized under ASC 606 is higher than it would have been under legacy guidance. This is primarily driven by the changes related to the accounting of standard warranty and our assessment of transfer of control.
Under ASC 606, revenue is recognized earlier than it would have been recognized under legacy guidance primarily due to the Company's assessment of timing of transfer of control. Additionally, the Company renders standard warranty coverage on its products for 12 months, providing labor and parts necessary to repair and maintain the products during the warranty period. Prior to adoption of ASC 606, the Company accounted for the estimated warranty cost as a charge to costs of sales when revenue was recognized. Upon adoption of ASC 606, the standard warranty for the majority of products is recognized as a separate performance obligation.

Contract Balances
 
As of
 
As of
 
 
 
 
(In thousands, except for percentage)
September 30, 2018
 
July 1, 2018
 
$ Change
 
% Change
Accounts receivable, net
$
602,210

 
$
635,878

 
$
(33,668
)
 
(5.29
)%
Contract assets
$
15,373

 
$
14,727

 
$
646

 
4.39
 %
Contract liabilities
$
463,617

 
$
556,691

 
$
(93,074
)
 
(16.72
)%
The Company’s payment terms and conditions vary by contract type, although terms generally include a requirement of payment of 70% to 90% of total contract consideration within 30 to 60 days of shipment, with the remainder payable within 30 days of acceptance. In instances where the timing of revenue recognition differs from the timing of invoicing, the Company has determined that its contracts generally do not include a significant financing component.
The change in contract assets during the three months ended September 30, 2018 is mainly due to $13.7 million of revenue recognized in excess of the amounts billed to the customers, partially offset by $13.0 million of contract assets reclassified to accounts receivable as the Company’s right to consideration for these contract assets became unconditional. Contract assets are included in Other current assets on the Company's condensed consolidated balance sheet.
During the three months ended September 30, 2018, the Company recognized revenue of $279.0 million that was included in contract liabilities as of July 1, 2018. This was partially offset by the value of products and services billed to customers for which control of the products and service has not transferred to the customers. Contract liabilities are included in current and non-current liabilities on the Company's condensed consolidated balance sheets.

Remaining Performance Obligations
As of September 30, 2018, the Company had $1.41 billion of remaining performance obligations, which represents the Company’s obligation to deliver products and services, and consists primarily of sales orders where written customer requests have been received. The Company expects to recognize approximately 5% to 15% of these performance obligations as revenue beyond the next twelve months, subject to risk of delays, pushouts, and cancellation by the customer, usually with limited or no penalties.
Refer to Note 17 “Segment Reporting and Geographic Information” for further information, including revenue by geographic region as well as significant product and service offering.
Practical expedient
The Company applies the following practical expedients:
•
The Company accounts for shipping and handling costs as activities to fulfill the promise to transfer the goods, instead of a promised service to its customer.
•
The Company has elected to not adjust the promised amount of consideration for the effects of a significant financing component as the Company expects, at contract inception, that the period between when the entity transfers a promised good or service to a customer and when the customer pays for that good or service will generally be one year or less.
•
The Company has elected to adopt the practical expedient for contract costs, specifically in relation to incremental costs of obtaining a contract. Costs to obtain a contract are not material, and the Company generally expenses such costs as incurred because the amortization period is one year or less.

13

•
The Company has elected to adopt the practical expedient for contract modifications, specifically to reflect the aggregate effect of all modifications that occur before July 1, 2018 in determining the transaction price, identifying the satisfied and unsatisfied performance obligations, and allocating the transaction price to the performance obligations.
NOTE 3 – FAIR VALUE MEASUREMENTS
The Company’s financial assets and liabilities are measured and recorded at fair value, except for its debt and certain equity investments in privately-held companies. Prior to July 1, 2018, the equity investments were generally accounted for under the cost method of accounting and were periodically assessed for other-than-temporary impairment when an event or circumstance indicated that an other-than-temporary decline in value may have occurred. Effective July 1, 2018, equity investments without a readily available fair value are accounted for using the measurement alternative. The measurement alternative is calculated as cost minus impairment, if any, plus or minus changes resulting from observable price changes.
The Company’s non-financial assets, such as goodwill, intangible assets, and land, property and equipment, are recorded at cost and are assessed for impairment when an event or circumstance indicates that an other-than-temporary decline in value may have occurred.
Fair Value of Financial Instruments. The Company has evaluated the estimated fair value of financial instruments using available market information and valuations as provided by third-party sources. The use of different market assumptions and/or estimation methodologies could have a significant effect on the estimated fair value amounts. The fair value of the Company’s cash equivalents, accounts receivable, accounts payable and other current assets and liabilities approximate their carrying amounts due to the relatively short maturity of these items.
Fair Value Hierarchy. The authoritative guidance for fair value measurements establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:
Level 1
  
Valuations based on quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.
 
 
 
Level 2
  
Valuations based on quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities.
 
 
 
Level 3
  
Valuations based on inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
As of September 30, 2018, the types of instruments valued based on quoted market prices in active markets included money market funds, certain U.S. Treasury securities and U.S. Government agency securities. Such instruments are generally classified within Level 1 of the fair value hierarchy. The types of instruments valued based on other observable inputs included corporate debt securities, sovereign securities, certain U.S. Treasury securities and U.S. Government agency 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 generally are large financial institutions. The Company’s foreign currency contracts’ valuation inputs are based on quoted prices and quoted pricing intervals from public data sources and do not involve management judgment. These contracts are typically classified within Level 2 of the fair value hierarchy.
The fair value of contingent consideration payable, which relates to the acquisitions of privately-held companies, was classified as Level 3 and estimated using significant inputs that were not observable in the market.

14

Financial assets (excluding cash held in operating accounts and time deposits) and liabilities measured at fair value on a recurring basis, as of the date indicated below, were presented on the Company’s Condensed Consolidated Balance Sheet as follows:
As of September 30, 2018 (In thousands)
Total
 
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Little or no market activity
Inputs
(Level 3)
Assets
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
U.S. Treasury securities
$
17,357

 
$
—

 
$
17,357

 
$
—

Money market funds and other
1,118,051

 
1,118,051

 
—

 
—

U.S. Government agency securities
22,354

 
—

 
22,354

 
—

Marketable securities:
 
 
 
 
 
 
 
Corporate debt securities
595,096

 
—

 
595,096

 
—

U.S. Government agency securities
245,228

 
245,228

 
—

 
—

Sovereign securities
17,205

 
—

 
17,205

 
—

U.S. Treasury securities
271,554

 
271,554

 
—

 
—

Total cash equivalents and marketable securities(1)
2,286,845

 
1,634,833

 
652,012

 
—

Other current assets:
 
 
 
 
 
 
 
Derivative assets
9,988

 
—

 
9,988

 
—

Other non-current assets:
 
 
 
 
 
 
 
Executive Deferred Savings Plan
203,370

 
146,388

 
56,982

 
—

Total financial assets(1)
$
2,500,203

 
$
1,781,221

 
$
718,982

 
$
—

Liabilities
 
 
 
 
 
 
 
Other current liabilities:
 
 
 
 
 
 
 
Derivative liabilities
$
(1,393
)
 
$
—

 
$
(1,393
)
 
$
—

Contingent consideration payable

(3,102
)
 
—

 
—

 
(3,102
)
Total financial liabilities
$
(4,495
)
 
$
—

 
$
(1,393
)
 
$
(3,102
)
________________
(1) Excludes cash of $467.6 million held in operating accounts and time deposits of $25.8 million as of September 30, 2018.


15

Financial assets (excluding cash held in operating accounts and time deposits) and liabilities measured at fair value on a recurring basis, as of the date indicated below, were presented on the Company’s Condensed Consolidated Balance Sheet as follows:  
As of June 30, 2018 (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
$
1,996

 
$
—

 
$
1,996

Corporate debt securities
4,995

 
—

 
4,995

Money market funds and other
863,115

 
863,115

 
—

U.S. Government agency securities
7,675

 
—

 
7,675

Marketable securities:
 
 
 
 
 
Corporate debt securities
735,408

 
—

 
735,408

Sovereign securities
17,142

 
—

 
17,142

U.S. Government agency securities
316,022

 
299,501

 
16,521

U.S. Treasury securities
405,654

 
364,574

 
41,080

Total cash equivalents and marketable securities(1)
2,352,007

 
1,527,190

 
824,817

Other current assets:
 
 
 
 
 
Derivative assets
5,385

 
—

 
5,385

Other non-current assets:
 
 
 
 
 
Executive Deferred Savings Plan
197,213

 
143,580

 
53,633

Total financial assets(1)
$
2,554,605

 
$
1,670,770

 
$
883,835

Liabilities
 
 
 
 
 
Other current liabilities:
 
 
 
 
 
Derivative liabilities
$
(6,828
)
 
$
—

 
$
(6,828
)
Total financial liabilities
$
(6,828
)
 
$
—

 
$
(6,828
)
________________
(1) Excludes cash of $473.8 million held in operating accounts and time deposits of $54.5 million as of June 30, 2018.
There were no transfers between Level 1 and Level 2 fair value measurements during the three months ended September 30, 2018. The Company generally did not have any assets or liabilities measured at fair value on a recurring basis within Level 3 fair value measurements as of June 30, 2018.



16

NOTE 4 – FINANCIAL STATEMENT COMPONENTS
Consolidated Balance Sheets
(In thousands)
As of
September 30, 2018
 
As of
June 30, 2018
Accounts receivable, net:
 
 
 
Accounts receivable, gross
$
613,847

 
$
663,317

Allowance for doubtful accounts
(11,637
)
 
(11,639
)
 
$
602,210

 
$
651,678

Inventories:
 
 
 
Customer service parts
$
265,849

 
$
253,639

Raw materials
349,300

 
331,065

Work-in-process
297,606

 
280,208

Finished goods
80,772

 
66,933

 
$
993,527

 
$
931,845

Other current assets:
 
 
 
Contract assets
$
15,373

 
$
—

Deferred costs of revenue(1)
47,843

 
—

Prepaid expenses
57,947

 
47,088

Prepaid income tax and other taxes
3,295

 
23,452

Other current assets
20,541

 
14,619

 
$
144,999

 
$
85,159

Land, property and equipment, net:
 
 
 
Land
$
40,582

 
$
40,599

Buildings and leasehold improvements
333,224

 
335,647

Machinery and equipment
583,682

 
577,077

Office furniture and fixtures
22,272

 
22,171

Construction-in-process
15,085

 
9,180

 
994,845

 
984,674

Less: accumulated depreciation
(703,613
)
 
(698,368
)
 
$
291,232

 
$
286,306

Other non-current assets:
 
 
 
Executive Deferred Savings Plan(2)
$
203,370

 
$
197,213

Other non-current assets
21,799

 
19,606

 
$
225,169

 
$
216,819

Other current liabilities:
 
 
 
Executive Deferred Savings Plan(2)
$
203,989

 
$
199,505

Compensation and benefits
243,874

 
177,587

Other accrued expenses
93,357

 
123,869

Customer credits and advances
119,655

 
116,440

Warranty
347

 
42,258

Income taxes payable
69,822

 
23,287

Interest payable
42,275

 
16,947

 
$
773,319

 
$
699,893

Other non-current liabilities:
 
 
 
Income taxes payable
$
348,282

 
$
371,665

Pension liabilities
66,431

 
66,786

Other non-current liabilities
33,271

 
32,912

 
$
447,984

 
$
471,363

____________
(1)
Deferred costs of revenue were previously included under deferred system profit prior to the adoption of ASC 606.

17

(2)
KLA-Tencor has a non-qualified deferred compensation plan (known as “Executive Deferred Savings Plan” or “EDSP”) under which certain employees and non-employee directors may defer a portion of their compensation. The expense associated with changes in the EDSP liability included in selling, general and administrative expense was $7.5 million and $6.8 million during the three months ended September 30, 2018 and 2017, respectively. The amount of net gains associated with changes in the EDSP assets included in selling, general and administrative expense was $7.4 million and $6.9 million during the three months ended September 30, 2018 and 2017, respectively. For additional details, refer to Note 1, “Description of Business and Summary of Significant Accounting Policies,” of the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2018.
Accumulated Other Comprehensive Income (Loss)
The components of accumulated other comprehensive income (loss) (“OCI”) as of the dates indicated below were as follows:
(In thousands)
Currency Translation Adjustments
 
Unrealized Gains (Losses) on Available-for-Sale Securities
 
Unrealized Gains (Losses) on Cash Flow Hedges
 
Unrealized Gains (Losses) on Defined Benefit Plans
 
Total
Balance as of September 30, 2018
$
(42,050
)
 
$
(9,277
)
 
$
11,841

 
$
(16,681
)
 
$
(56,167
)
 
 
 
 
 
 
 
 
 
 
Balance as of June 30, 2018
$
(29,974
)
 
$
(11,032
)
 
$
1,932

 
$
(14,859
)
 
$
(53,933
)
The effects on net income of amounts reclassified from accumulated OCI to the Condensed Consolidated Statement of Operations for the indicated period were as follows (in thousands):
 
 
Location in the Condensed Consolidated
 
Three months ended
September 30,
Accumulated OCI Components
 
Statements of Operations
 
2018
 
2017
Unrealized gains (losses) on cash flow hedges from foreign exchange and interest rate contracts
 
Revenues
 
$
983

 
$
968

 
 
Costs of revenues
 
(134
)
 
961

 
 
Interest expense
 
188

 
189

 
 
Net gains (losses) reclassified from accumulated OCI
 
$
1,037

 
$
2,118

Unrealized gains (losses) on available-for-sale securities
 
Other expense (income), net
 
$
(481
)
 
$
6

The amounts reclassified out of accumulated OCI related to the Company’s defined benefit pension plans, which were recognized as a component of net periodic cost for the three months ended September 30, 2018 and 2017 were $0.2 million, respectively. For additional details, refer to Note 11, “Employee Benefit Plans” of the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2018.
NOTE 5 – MARKETABLE SECURITIES
The amortized cost and fair value of marketable securities as of the dates indicated below were as follows:
As of September 30, 2018 (In thousands)
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Corporate debt securities
$
600,825

 
$
137

 
$
(5,866
)
 
$
595,096

Money market funds and other
1,118,051

 
—

 
—

 
1,118,051

Sovereign securities
17,352

 
—

 
(147
)
 
17,205

U.S. Government agency securities
269,824

 
10

 
(2,252
)
 
267,582

U.S. Treasury securities
292,203

 
—

 
(3,292
)
 
288,911

Subtotal
2,298,255

 
147

 
(11,557
)
 
2,286,845

Add: Time deposits(1)
25,842

 
—

 
—

 
25,842

Less: Cash equivalents
1,181,895

 
—

 
(2
)
 
1,181,893

Marketable securities
$
1,142,202

 
$
147

 
$
(11,555
)
 
$
1,130,794


18

As of June 30, 2018 (In thousands)
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Corporate debt securities
$
747,763

 
$
148

 
$
(7,508
)
 
$
740,403

Money market funds and other
863,115

 
—

 
—

 
863,115

Sovereign securities
17,293

 
—

 
(151
)
 
17,142

U.S. Government agency securities
326,508

 
16

 
(2,827
)
 
323,697

U.S. Treasury securities
411,329

 
3

 
(3,682
)
 
407,650

Subtotal
2,366,008

 
167

 
(14,168
)
 
2,352,007

Add: Time deposits(1)
54,537

 
—

 
—

 
54,537

Less: Cash equivalents
930,608

 
—

 
—

 
930,608

Marketable securities
$
1,489,937

 
$
167

 
$
(14,168
)
 
$
1,475,936

________________
(1) Time deposits excluded from fair value measurements.
KLA-Tencor’s investment portfolio consists of both corporate and government securities that have a maximum maturity of three years. The longer the duration of these securities, the more susceptible they are to changes in market interest rates and bond yields. As yields increase, those securities with a lower yield-at-cost show a mark-to-market unrealized loss. Most of the Company’s unrealized losses are due to changes in market interest rates and bond yields. The Company believes that it has the ability to realize the full value of all of these investments upon maturity. The following table summarizes the fair value and gross unrealized losses of the Company’s investments that were in an unrealized loss position as of the date indicated below: 
As of September 30, 2018 (In thousands)
Fair Value
 
Gross
Unrealized
Losses(1)
Corporate debt securities
$
518,894

 
$
(5,866
)
U.S. Treasury securities
271,554

 
(3,291
)
U.S. Government agency securities
238,564

 
(2,251
)
Sovereign securities
17,205

 
(147
)
Total
$
1,046,217

 
$
(11,555
)
__________________ 
(1) As of September 30, 2018, the amount of total gross unrealized losses related to investments that had been in a continuous loss position for 12 months or more was $7.3 million.

The contractual maturities of securities classified as available-for-sale, regardless of their classification on the Company’s Condensed Consolidated Balance Sheet, as of the date indicated below were as follows:
As of September 30, 2018 (In thousands)
Amortized Cost
 
Fair Value
Due within one year
$
650,451

 
$
645,992

Due after one year through three years
491,751

 
484,802

 
$
1,142,202

 
$
1,130,794

Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Realized gains and losses on available-for-sale securities for the three months ended September 30, 2018 and 2017 were immaterial.

NOTE 6 - BUSINESS COMBINATIONS

During the three months ended September 30, 2018, the Company acquired certain assets and assumed certain liabilities of a privately-held company for a total purchase consideration of $4.1 million, which includes a promise to pay an additional consideration of up to $1.5 million contingent on the achievement of certain milestones. As of September 30, 2018, the estimated fair value of the additional consideration was $1.5 million, which is classified as a current liability on the condensed consolidated balance sheet.


19

On July 11, 2018, the Company acquired the outstanding shares of a privately-held company for a total purchase consideration of $11.3 million, including the fair value of the promise to pay an additional consideration of up to $4.5 million contingent on the achievement of certain revenue milestones. As of September 30, 2018, the estimated fair value of the additional consideration was $1.6 million, which is classified as a current liability on the condensed consolidated balance sheet.
    
The Company has included the financial results of the acquisitions completed during the first quarter of the fiscal year 2019 in its condensed consolidated financial statements from the date of acquisition. These results were not individually or in aggregate material to our condensed consolidated financial statements.

For the fiscal year ended June 30, 2018, the Company acquired a product line from Keysight Technologies, Inc., a related party, for a total purchase consideration of $12.1 million, of which $5.2 million was allocated to goodwill based on the fair value at the acquisition date. Goodwill recognized was deductible for income tax purposes. For additional details, refer to Note 8 “Business Combinations,” of the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2018.

NOTE 7 – GOODWILL AND PURCHASED INTANGIBLE ASSETS
Goodwill
The Company has four reporting units: Wafer Inspection, Patterning, Global Service and Support (“GSS”), and Others. The following table presents goodwill balances and the movements by reporting unit during the three months ended September 30, 2018:
(In thousands)
 
Wafer Inspection
 
Patterning
 
GSS
 
Others
 
Total
Balance as of June 30, 2018
 
$
281,005

 
$
53,255

 
$
8,039

 
$
12,399

 
$
354,698

Acquired goodwill
 
—

 
—

 
4,631

 
1,176

 
5,807

Foreign currency and other adjustments
 
(77
)
 
—

 
—

 
—

 
(77
)
Balance as of September 30, 2018
 
$
280,928

 
$
53,255

 
$
12,670

 
$
13,575

 
$
360,428

The acquired goodwill during the three months ended September 30, 2018 resulted primarily from the acquisition of certain assets and liabilities of privately-held companies. See Note 6 “Business Combinations” for additional details.
As of September 30, 2018, there have been no significant events or circumstances affecting the valuation of goodwill subsequent to the qualitative assessment performed in the third quarter of the fiscal year ended June 30, 2018. For additional details, refer to Note 6 “Goodwill and Purchased Intangible Assets,” of the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2018. The next annual assessment of goodwill by reporting unit is scheduled to be performed in the third quarter of the fiscal year ending June 30, 2019.
Purchased Intangible Assets
The components of purchased intangible assets as of the dates indicated below were as follows:
(In thousands)
 
 
As of
September 30, 2018
 
As of
June 30, 2018
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
 
$
166,029

 
$
145,093

 
$
20,936

 
$
160,859

 
$
144,202

 
$
16,657

Trade name/Trademark
5-7 years
 
21,073

 
20,100

 
973

 
20,993

 
20,060

 
933

Customer relationships
7 years
 
58,050

 
55,234

 
2,816

 
56,680

 
55,136

 
1,544

Other
<1-5 years
 
1,270

 
866

 
404

 
660

 
461

 
199

Total
 
 
$
246,422

 
$
221,293

 
$
25,129

 
$
239,192

 
$
219,859

 
$
19,333

Purchased intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable.

20

For the three months ended September 30, 2018 and 2017, amortization expense for purchased intangible assets was $1.4 million and $1.2 million, respectively. The increase in the gross carrying value resulted primarily from the acquisition of certain assets and liabilities of privately-held companies. See Note 6 “Business Combinations” for additional details. Based on the purchased intangible assets recorded as of September 30, 2018, and assuming no subsequent additions to, or impairment of, the underlying assets, the remaining estimated annual amortization expense is expected to be as follows:
Fiscal year ending June 30:
Amortization
(In thousands)
2019 (remaining 9 months)
$
3,523

2020
4,438

2021
4,438

2022
4,438

2023
4,244

Thereafter
4,048

Total
$
25,129

NOTE 8 – DEBT
The following table summarizes the debt of the Company as of September 30, 2018 and June 30, 2018:
 
As of September 30, 2018
 
As of June 30, 2018
 
Amount
(In thousands)
 
Effective
Interest Rate
 
Amount
(In thousands)
 
Effective
Interest Rate
Fixed-rate 3.375% Senior Notes due on November 1, 2019
$
250,000

 
3.377
%
 
$
250,000

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

 
4.128
%
 
500,000

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

 
4.682
%
 
1,250,000

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

 
5.670
%
 
250,000

 
5.670
%
    Total debt
2,250,000

 
 
 
2,250,000

 
 
Unamortized discount
(2,433
)
 
 
 
(2,523
)
 
 
Unamortized debt issuance costs
(9,677
)
 
 
 
(10,075
)
 
 
    Total debt
$
2,237,890

 
 
 
$
2,237,402

 
 
Reported as:
 
 
 
 
 
 
 
Long-term debt
2,237,890

 
 
 
2,237,402

 
 
    Total debt
$
2,237,890

 
 
 
$
2,237,402

 
 
__________________ 
(1)
The effective interest rate disclosed above for this series of Senior Notes excludes the impact of the treasury rate lock hedge discussed below. The effective interest rate including the impact of the treasury rate lock hedge was 4.626%.
As of September 30, 2018, future principal payments for the long-term debt are $250.0 million in fiscal year 2020; $500.0 million in fiscal year 2022; and $1.50 billion after fiscal year 2023.
Senior Notes:
In November 2014, the Company issued $2.50 billion aggregate principal amount of senior, unsecured long-term notes (collectively referred to as “Senior Notes”). The Company issued the Senior Notes as part of the leveraged recapitalization plan under which the proceeds from the Senior Notes in conjunction with the proceeds from the term loans and cash on hand were used (x) to fund a special cash dividend of $16.50 per share, aggregating to approximately $2.76 billion, (y) to redeem $750.0 million of Senior Notes, including associated redemption premiums, accrued interest and other fees and expenses and (z) for other general corporate purposes, including repurchases of shares pursuant to the Company’s stock repurchase program.

21

The interest rate specified for each series of the Senior Notes will be subject to adjustments from time to time if Moody’s Investor Service, Inc. (“Moody’s”) or Standard & Poor’s Ratings Services (“S&P”) or, under certain circumstances, a substitute rating agency selected by us as a replacement for Moody’s or S&P, as the case may be (a “Substitute Rating Agency”), downgrades (or subsequently upgrades) its rating assigned to the respective series of Senior Notes such that the adjusted rating is below investment grade. If the adjusted rating of any series of Senior Notes from Moody’s (or, if applicable, any Substitute Rating Agency) is decreased to Ba1, Ba2, Ba3 or B1 or below, the stated interest rate on such series of Senior Notes as noted above will increase by 25 bps, 50 bps, 75 bps or 100 bps, respectively (“bps” refers to Basis Points and 1% is equal to 100 bps). If the rating of any series of Senior Notes from S&P (or, if applicable, any Substitute Rating Agency) with respect to such series of Senior Notes is decreased to BB+, BB, BB- or B+ or below, the stated interest rate on such series of Senior Notes as noted above will increase by 25 bps, 50 bps, 75 bps or 100 bps, respectively. The interest rates on any series of Senior Notes will permanently cease to be subject to any adjustment (notwithstanding any subsequent decrease in the ratings by any of Moody’s, S&P and, if applicable, any Substitute Rating Agency) if such series of Senior Notes becomes rated “Baa1” (or its equivalent) or higher by Moody’s (or, if applicable, any Substitute Rating Agency) and “BBB+” (or its equivalent) or higher by S&P (or, if applicable, any Substitute Rating Agency), or one of those ratings if rated by only one of Moody’s, S&P and, if applicable, any Substitute Rating Agency, in each case with a stable or positive outlook. In October 2014, the Company entered into a series of forward contracts to lock the 10-year treasury rate (“benchmark rate”) on a portion of the Senior Notes with a notional amount of $1.00 billion in aggregate. For additional details, refer to Note 15, “Derivative Instruments and Hedging Activities.”
The original discount on the Senior Notes amounted to $4.0 million and is being amortized over the life of the debt. Interest is payable semi-annually on May 1 and November 1 of each year. The debt indenture (the “Indenture”) includes covenants that limit the Company’s ability to grant liens on its facilities and enter into sale and leaseback transactions, subject to certain allowances under which certain sale and leaseback transactions are not restricted.
In certain circumstances involving a change of control followed by a downgrade of the rating of a series of Senior Notes by at least two of Moody’s, S&P and Fitch Inc., unless the Company has exercised its right to redeem the Senior Notes of such series, the Company will be required to make an offer to repurchase all or, at the holder’s option, any part, of each holder’s Senior Notes of that series pursuant to the offer described below (the “Change of Control Offer”). In the Change of Control Offer, the Company will be required to offer payment in cash equal to 101% of the aggregate principal amount of Senior Notes repurchased plus accrued and unpaid interest, if any, on the Senior Notes repurchased, up to, but not including, the date of repurchase.
Based on the trading prices of the Senior Notes on the applicable dates, the fair value of the Senior Notes as of September 30, 2018 and June 30, 2018 was approximately $2.31 billion and $2.33 billion, respectively. While the Senior Notes are recorded at cost, the fair value of the long-term debt was determined based on quoted prices in markets that are not active; accordingly, the long-term debt is categorized as Level 2 for purposes of the fair value measurement hierarchy.
As of September 30, 2018, the Company was in compliance with all of its covenants under the Indenture associated with the Senior Notes.
Revolving Credit Facility:
In November 2017, the Company entered into a Credit Agreement (the “Credit Agreement”) providing for a $750.0 million five-year unsecured Revolving Credit Facility (the “Revolving Credit Facility”), which replaced its prior Credit Facility. Subject to the terms of the Credit Agreement, the Revolving Credit Facility may be increased in an amount up to $250.0 million in the aggregate.
The Company may borrow, repay and reborrow funds under the Revolving Credit Facility until its maturity on November 30, 2022 (the “Maturity Date”), at which time such Revolving Credit Facility will terminate, and all outstanding loans under such facility, together with all accrued and unpaid interest, must be repaid. The Company may prepay outstanding borrowings under the Revolving Credit Facility at any time without a prepayment penalty.
Borrowings under the Revolving Credit Facility will bear interest, at the Company’s option, at either: (i) the Alternative Base Rate (“ABR”) plus a spread, which ranges from 0 bps to 75 bps, or (ii) the London Interbank Offered Rate (“LIBOR”) plus a spread, which ranges from 100 bps to 175 bps. The spreads under ABR and LIBOR are subject to adjustment in conjunction with credit rating downgrades or upgrades. The Company is also obligated to pay an annual commitment fee on the daily undrawn balance of the Revolving Credit Facility, which ranges from 10 bps to 25 bps, subject to an adjustment in conjunction with changes to the Company’s credit rating. As of September 30, 2018, the Company pays an annual commitment fee of 12.5 bps on the daily undrawn balance of the Revolving Credit Facility.

22

The Revolving Credit Facility requires the Company to maintain an interest expense coverage ratio as described in the Credit Agreement, on a quarterly basis, covering the trailing four consecutive fiscal quarters of no less than 3.50 to 1.00. In addition, the Company is required to maintain the maximum leverage ratio as described in the Credit Agreement, on a quarterly basis of 3.00 to 1.00, covering the trailing four consecutive fiscal quarters for each fiscal quarter, which can be increased to 4.00 to 1.00 for a period of time in connection with a material acquisition or a series of material acquisitions.
The Company was in compliance with all covenants under the Credit Agreement as of September 30, 2018 and had no outstanding borrowings under the unfunded Revolving Credit Facility.
NOTE 9 – EQUITY AND LONG-TERM INCENTIVE COMPENSATION PLANS
Equity Incentive Program
As of September 30, 2018, the Company had two equity incentive plans under which the Company was able to issue equity incentive awards, such as restricted stock units and stock options, to its employees, consultants and members of its Board of Directors: the 2004 Equity Incentive Plan (the “2004 Plan”) and the 1998 Director Plan (the “Outside Director Plan”) with 1.4 million and 1.7 million shares available for issuance, respectively.
For details of the 2004 Plan and the Outside Director Plan, refer to Note 8 “Equity and Long-Term Incentive Compensation Plans,” of the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2018.
Equity Incentive Plans - General Information
The following table summarizes the combined activity under the Company’s equity incentive plans for the indicated periods:
(In thousands)
Available
For Grant(1)
Balance as of June 30, 2018
3,680

Restricted stock units granted (2)
(637
)
Restricted stock units granted adjustment (3)
5

Restricted stock units canceled
4

Balance as of September 30, 2018
3,052

__________________ 
(1)
The number of restricted stock units reflects the application of the award multiplier (1.8x or 2.0x depending on the grant date of the applicable award).
(2)
Includes restricted stock units granted to senior management during the three months ended September 30, 2018 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, 2018, it had not yet been determined the extent to which (if at all) the performance-based vesting criteria had been satisfied. Therefore, this line item includes all such performance-based restricted stock units granted during the three months ended September 30, 2018, reported at the maximum possible number of shares that may ultimately be issuable if all applicable performance-based criteria are achieved at their maximum levels and all applicable service-based criteria are fully satisfied (0.4 million shares for the three months ended September 30, 2018 reflects the application of the multiplier described above).
(3)
Represents the portion of restricted stock units granted with performance-based vesting criteria and reported at the actual number of shares issued upon achievement of the performance vesting criteria during the three months ended September 30, 2018.
The fair value of stock-based awards is measured at the grant date and is recognized as an expense over the employee’s requisite service period. For restricted stock units granted without “dividend equivalent” rights, fair value is calculated using the closing price of the Company’s common stock on the grant date, adjusted to exclude the present value of dividends which are not accrued on those restricted stock units. The fair value for restricted stock units granted with “dividend equivalent” rights is determined using the closing price of the Company’s common stock on the grant date. As of September 30, 2018, the Company accrued $4.8 million of dividends payable, which included both a special cash dividend and regular quarterly cash dividends for the unvested restricted stock units outstanding as of the dividend record date. The fair value for purchase rights under the Company’s Employee Stock Purchase Plan is determined using a Black-Scholes model.

23

The following table shows pre-tax stock-based compensation expense for the indicated periods: 
 
Three months ended
September 30,
(In thousands)
2018
 
2017
Stock-based compensation expense by:
 
 
 
Costs of revenues
$
1,831

 
$
1,416

Research and development
2,519

 
2,171

Selling, general and administrative
11,788

 
10,444

Total stock-based compensation expense
$
16,138

 
$
14,031

The following table shows stock-based compensation capitalized as inventory as of the dates indicated below: 
(In thousands)
As of
September 30, 2018
 
As of
June 30, 2018
Inventory
$
4,817

 
$
4,580

Restricted Stock Units
The following table shows the activity and weighted-average grant date fair value for restricted stock units during the three months ended September 30, 2018:
Restricted Stock Units
Shares(1)
(In thousands)
 
Weighted-Average
Grant Date
Fair Value
Outstanding restricted stock units as of June 30, 2018(2)
2,014

 
$
76.50

Granted(2)
318

 
$
118.47

Granted adjustments(3)
(2
)
 
$
50.88

Vested and released
(332
)
 
$
63.72

Withheld for taxes
(234
)
 
$
63.72

Forfeited
(2
)
 
$
87.87

Outstanding restricted stock units as of September 30, 2018(2)
1,762

 
$
88.21

__________________ 
(1)
Share numbers reflect actual shares subject to awarded restricted stock units. Under the terms of the 2004 Plan, the number of shares subject to each award reflected in this number is multiplied by either 1.8x or 2.0x (depending on the grant date of the award) to calculate the impact of the award on the share reserve under the 2004 Plan.
(2)
Includes restricted stock units granted to senior management 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, 2018, it had not yet been determined the extent to which (if at all) the performance-based vesting criteria had been satisfied. Therefore, this line item includes all such performance-based restricted stock units, reported at the maximum possible number of shares (42 thousand shares for the fiscal year ended June 30, 2017, 0.2 million shares for the fiscal year ended June 30, 2018 and 0.2 million shares for the three months ended September 30, 2018) that may ultimately be issuable if all applicable performance-based criteria are achieved at their maximum and all applicable service-based criteria are fully satisfied.
(3)
Represents the portion of restricted stock units granted with performance-based vesting criteria and reported at the actual number of shares issued upon achievement of the performance vesting criteria during three months ended September 30, 2018.

The restricted stock units granted by the Company generally vest (a) with respect to awards with only service-based vesting criteria, in three or four equal installments and (b) with respect to awards with both performance-based and service-based vesting criteria, in two equal installments on the third and fourth anniversaries of the grant date, in each case subject to the recipient remaining employed by the Company as of the applicable vesting date. The restricted stock units granted to the independent members of the Board of Directors' vest annually. 

24

The following table shows the weighted-average grant date fair value per unit for the restricted stock units granted and the restricted stock units vested and tax benefits realized by the Company in connection with vested and released restricted stock units for the indicated periods: 
 
Three months ended
September 30,
(In thousands, except for weighted-average grant date fair value)
2018
 
2017
Weighted-average grant date fair value per unit
$
118.47

 
$
88.96

Grant date fair value of vested restricted stock units
$
36,072

 
$
36,534

Tax benefits realized by the Company in connection with vested and released restricted stock units
$
6,918

 
$
18,412

As of September 30, 2018, the unrecognized stock-based compensation expense balance related to restricted stock units was $128.4 million, excluding the impact of estimated forfeitures, and will be recognized over a weighted-average remaining contractual term and an estimated weighted-average amortization period of 1.7 years. The intrinsic value of outstanding restricted stock units as of September 30, 2018 was $179.2 million.
Cash-Based Long-Term Incentive Compensation
The Company has adopted a cash-based long-term incentive (“Cash LTI Plan”) program for many of its employees as part of the Company’s employee compensation program. During the three months ended September 30, 2018 and 2017, the Company approved Cash LTI awards of $2.8 million and $2.1 million, respectively. Cash LTI awards issued to employees under the Cash LTI Plan will vest in three or four equal installments, with one-third or one-fourth of the aggregate amount of the Cash LTI award vesting on each anniversary of the grant date over a three or four-year period. In order to receive payments under a Cash LTI award, participants must remain employed by the Company as of the applicable award vesting date. Executives and non-employee Board of Directors' members are not participating in this program. During the three months ended September 30, 2018 and 2017, the Company recognized $15.2 million and $14.8 million, respectively, in compensation expense under the Cash LTI Plan. As of September 30, 2018, the unrecognized compensation balance (excluding the impact of estimated forfeitures) related to the Cash LTI Plan was $116.4 million.
Employee Stock Purchase Plan
KLA-Tencor’s Employee Stock Purchase Plan (“ESPP”) provides, effective January 2, 2018, that eligible employees may contribute up to 15% of their eligible earnings toward the semi-annual purchase of KLA-Tencor’s common stock. Prior to January 2, 2018, eligible employees could contribute up to 10% of their eligible earnings. The ESPP is qualified under Section 423 of the Internal Revenue Code. The employee’s purchase price is derived from a formula based on the closing price of the common stock on the first day of the offering period versus the closing price on the date of purchase (or, if not a trading day, on the immediately preceding trading day).
The offering period (or length of the look-back period) under the ESPP has a duration of six months, and the purchase price with respect to each offering period beginning on or after such date is, until otherwise amended, equal to 85% of the lesser of (i) the fair market value of the Company’s common stock at the commencement of the applicable six-month offering period or (ii) the fair market value of the Company’s common stock on the purchase date. The Company estimates the fair value of purchase rights under the ESPP using a Black-Scholes model.
The fair value of each purchase right under the ESPP was estimated on the date of grant using the Black-Scholes model and the straight-line attribution approach with the following weighted-average assumptions: 
 
Three months ended
September 30,
 
2018
 
2017
Stock purchase plan:
 
 
 
Expected stock price volatility
30.0
%
 
25.9
%
Risk-free interest rate
1.9
%
 
0.9
%
Dividend yield
2.9
%
 
2.6
%
Expected life (in years)
0.5

 
0.5


25

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,
2018
 
2017
Tax benefits realized by the Company in connection with the disqualifying dispositions of shares purchased under the ESPP
$
511

 
$
847

Weighted-average fair value per share based on Black-Scholes model
$
22.73

 
$
19.04

The ESPP shares are replenished annually on the first day of each fiscal year by virtue of an evergreen provision. The provision allows for share replenishment equal to the lesser of 2.0 million shares or the number of shares which KLA-Tencor estimates will be required to be issued under the ESPP during the forthcoming fiscal year. As of September 30, 2018, a total of 2.0 million shares were reserved and available for issuance under the ESPP.
Quarterly cash dividends
On August 2, 2018, the Company’s Board of Directors declared a regular quarterly cash dividend of $0.75 per share on the outstanding shares of the Company’s common stock, which was paid on August 31, 2018 to the stockholders of record as of the close of business on August 15, 2018. The total amount of regular quarterly cash dividends and dividend equivalents paid by the Company during the three months ended September 30, 2018 and 2017 was $119.9 million and $94.1 million, respectively. The amount of accrued dividends payable for regular quarterly cash dividends on unvested restricted stock units with dividend equivalent rights as of September 30, 2018 and June 30, 2018 was $4.8 million and $6.7 million, respectively. These accrued cash dividends will be paid upon vesting of the underlying restricted stock units.
Special cash dividend
On November 19, 2014, the Company’s Board of Directors declared a special cash dividend of $16.50 per share on our outstanding common stock, which was paid on December 9, 2014 to the stockholders of record as of the close of business on December 1, 2014. The declaration and payment of the special cash dividend was part of the Company’s leveraged recapitalization transaction under which the special cash dividend was financed through a combination of existing cash and proceeds from the debt financing disclosed in Note 8 “Debt” that was completed during the three months ended December 31, 2014. As of the declaration date, the total amount of the special cash dividend accrued by the Company was approximately $2.76 billion, substantially all of which was paid out during the three months ended December 31, 2014, except for the aggregate special cash dividend of $43.0 million that was accrued for the unvested restricted stock units. As of September 30, 2018 and June 30, 2018, the Company had a total of $37.5 thousand and $2.8 million, respectively, of accrued dividends payable for the special cash dividend with respect to outstanding unvested restricted stock units, which will be paid when such underlying unvested restricted stock units vest. During the three months ended September 30, 2018 and 2017, the total special cash dividends paid with respect to vested restricted stock units were $2.8 million and $6.2 million, respectively.
NOTE 10 – STOCK REPURCHASE PROGRAM
The Company’s Board of Directors has authorized a program which permits the Company to repurchase up to $1.00 billion of its common stock, or up to $2.00 billion if the Orbotech Merger closes. The intent of this program is to offset the dilution from KLA-Tencor’s equity incentive plans, employee stock purchase plan, the issuance of shares in the merger involving Orbotech, as well as to return excess cash to the Company’s stockholders. Subject to market conditions, applicable legal requirements and other factors, the repurchases were made in the open market in compliance with applicable securities laws, including the Securities Exchange Act of 1934 and the rules promulgated thereunder, such as Rule 10b-18 and Rule 10b5-1. This stock repurchase program has no expiration date and may be suspended at any time. As of September 30, 2018, an aggregate of approximately $654.1 million was available for repurchase under the Company’s repurchase program.
Share repurchases for the indicated periods (based on the trade date of the applicable repurchase) were as follows:
 
Three months ended
September 30,
(In thousands)
2018
 
2017
Number of shares of common stock repurchased
2,781

 
433

Total cost of repurchases
$
307,786

 
$
40,775


26

As of September 30, 2018, the Company had repurchased 0.1 million shares for $7.8 million, which repurchases had not settled prior to September 30, 2018. The amount was recorded as a component of other current liabilities for the period presented.
NOTE 11 – NET INCOME PER SHARE
Basic net income per share is calculated by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted net income per share is calculated by using the weighted-average number of common shares outstanding during the period, increased to include the number of additional shares of common stock that would have been outstanding if the shares of common stock underlying the Company’s outstanding dilutive restricted stock units had been issued. The dilutive effect of outstanding restricted stock units is reflected in diluted net income per share by application of the treasury stock method.
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,
2018
 
2017
Numerator:
 
 
 
Net income
$
395,944

 
$
280,936

Denominator:
 
 
 
Weighted-average shares-basic, excluding unvested restricted stock units
155,221

 
156,826

Effect of dilutive restricted stock units and options
862

 
1,020

Weighted-average shares-diluted
156,083

 
157,846

Basic net income per share
$
2.55

 
$
1.79

Diluted net income per share
$
2.54

 
$
1.78

Anti-dilutive securities excluded from the computation of diluted net income per share
207

 
—

NOTE 12 – INCOME TAXES
The following table provides details of income taxes:

Three months ended
September 30,
(Dollar amounts in thousands)
2018
 
2017
Income before income taxes
$
427,568

 
$
336,152

Provision for income taxes
$
31,624

 
$
55,216

Effective tax rate
7.4
%
 
16.4
%

The Company’s effective tax rate during the three months ended September 30, 2018 was impacted by the Tax Cuts and Jobs Act (the “Act”), which was enacted into law on December 22, 2017. Income tax effects resulting from changes in tax laws are accounted for by the Company in accordance with the authoritative guidance, which requires that these tax effects be recognized in the period in which the law is enacted and the effects are recorded as a component of provision for income taxes from continuing operations. The Company has not fully completed its accounting for the tax effects of the enactment of the Act. As a result, the Company made an additional provision for income tax during the three months ended September 30, 2018 relating to the transaction tax due to enactment of the Act.

The Act includes significant changes to the U.S. corporate income tax system which reduces the Company's U.S. federal corporate tax rate from 35.0% to 21.0% as of January 1, 2018; shifts to a modified territorial tax regime which requires companies to pay a transition tax on earnings of certain foreign subsidiaries that were previously tax deferred; and creates new taxes on certain foreign-sourced earnings.

27

As of September 30, 2018, the Company had not fully completed its accounting for the tax effects of the enactment of the Act. The Company’s provision for income taxes for the three months ended September 30, 2018 is based in part on a reasonable estimate of the effects on its transition tax and existing deferred tax balances. For the amounts which the Company was able to reasonably estimate, the Company recognized a provisional tax benefit amount of $19.8 million for the three months ended September 30, 2018. The provisional tax benefit amount is included as a component of provision for income taxes from continuing operations. The component of the provisional tax benefit amount is as follows:
•
The Company recorded a provisional tax benefit adjustment of $19.8 million for the transition tax liability. The Company has not yet completed the calculation of the total post-1986 foreign E&P and the income tax pools for all foreign subsidiaries. Further, the transition tax is based in part on the amount of those earnings held in cash and other specified assets. This amount may change when the Company finalizes the calculation of post-1986 foreign E&P previously deferred from U.S. federal taxation and finalizes the amounts held in cash or other specified assets. In addition, further interpretations from U.S. federal and state governments and regulatory organizations may change the provisional tax liability or the accounting treatment of the provisional tax liability.
The Act also includes provisions for GILTI wherein taxes on foreign income are imposed in excess of a deemed return on tangible assets of foreign corporations. This income will effectively be taxed at a 10.5% tax rate in general. As a result, the Company’s deferred tax assets and liabilities were being evaluated if the deferred tax assets and liabilities should be recognized for the basis differences expected to reverse as a result of GILTI provisions that are effective for the Company after the fiscal year ending June 30, 2018, or should the tax on GILTI provisions be recognized in the period the Act was signed into law. The Company has elected to account for GILTI as a component of current period tax expense for the fiscal year ending June 30, 2019.
In the normal course of business, the Company is subject to examination by tax authorities throughout the world. The Company is subject to United States federal income tax examination for all years beginning from the fiscal year ended June 30, 2015. The Company is subject to state income tax examinations for all years beginning from the fiscal year ended June 30, 2014. 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, 2014.
It is possible that certain examinations may be concluded in the next twelve months. The Company believes that it may recognize up to $10.0 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 13 – LITIGATION AND OTHER LEGAL MATTERS
The Company is named from time to time as a party to lawsuits and other types of legal proceedings and claims in the normal course of its business. Actions filed against the Company include commercial, intellectual property, customer, and labor and employment related claims, including complaints of alleged wrongful termination and potential class action lawsuits regarding alleged violations of federal and state wage and hour and other laws. In general, legal proceedings and claims, regardless of their merit, and associated internal investigations (especially those relating to intellectual property or confidential information disputes) are often expensive to prosecute, defend or conduct and may divert management’s attention and other company resources. Moreover, the results of legal proceedings are difficult to predict, and the costs incurred in litigation can be substantial, regardless of outcome. The Company believes the amounts provided in its condensed consolidated financial statements are adequate in light of the probable and estimated liabilities. However, because such matters are subject to many uncertainties, the ultimate outcomes are not predictable, and there can be no assurances that the actual amounts required to satisfy alleged liabilities from the matters described above will not exceed the amounts reflected in the Company’s condensed consolidated financial statements or will not have a material adverse effect on its results of operations, financial condition or cash flows.
NOTE 14 – COMMITMENTS AND CONTINGENCIES
Factoring. KLA-Tencor has agreements (referred to as “factoring agreements”) with financial institutions to sell certain of its trade receivables and promissory notes from customers without recourse. The Company does not believe it is at risk for any material losses as a result of these agreements. In addition, the Company periodically sells certain letters of credit (“LCs”), without recourse, received from customers in payment for goods and services.

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The following table shows total receivables sold under factoring agreements and proceeds from sales of LCs for the indicated periods:
 
Three months ended
September 30,
(In thousands)
2018
 
2017
Receivables sold under factoring agreements
$
61,540

 
$
31,901

Proceeds from sales of LCs
$
10,892

 
$
5,571

Factoring and LC fees for the sale of certain trade receivables were recorded in other expense (income), 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 $2.5 million for the three months ended September 30, 2018 and 2017, respectively.
The following is a schedule of expected operating lease payments:
Fiscal year ending June 30,
Amount
(In thousands)
2019 (remaining 9 months)
$
6,303

2020
6,695

2021
4,925

2022
2,483

2023
1,831

2024 and thereafter
2,703

Total minimum lease payments
$
24,940

Purchase Commitments. KLA-Tencor maintains commitments to purchase inventory from its suppliers as well as goods and services in the ordinary course of business. The Company’s liability under these purchase commitments is generally restricted to a forecasted time-horizon as mutually agreed upon between the parties. This forecasted time-horizon can vary among different suppliers. The Company’s estimate of its significant purchase commitments is approximately $476.6 million as of September 30, 2018, which are primarily due within the next 12 months. Actual expenditures will vary based upon the volume of the transactions and length of contractual service provided. In addition, the amounts paid under these arrangements may be less in the event that the arrangements are renegotiated or canceled. Certain agreements provide for potential cancellation penalties.
Cash Long-Term Incentive Plan. As of September 30, 2018, the Company had committed $161.1 million for future payment obligations under its Cash LTI Plan. The calculation of compensation expense related to the Cash LTI Plan includes estimated forfeiture rate assumptions. Cash LTI awards issued to employees under the Cash LTI Plan vest in three or four equal installments, with one-third or one-fourth of the aggregate amount of the Cash LTI award vesting on each anniversary of the grant date over a three or four-year period. In order to receive payments under a Cash LTI award, participants must remain employed by the Company as of the applicable award vesting date.
Guarantees and Contingencies. The Company maintains guarantee arrangements available through various financial institutions for up to $22.0 million, of which $15.5 million had been issued as of September 30, 2018, primarily to fund guarantees to customs authorities for value-added tax (“VAT”) and other operating requirements of the Company’s subsidiaries in Europe and Asia.
KLA-Tencor is a party to a variety of agreements pursuant to which it may be obligated to indemnify the other party with respect to certain matters. Typically, these obligations arise in connection with contracts and license agreements or the sale of assets, under which the Company customarily agrees to hold the other party harmless against losses arising from, or provides customers with other remedies to protect against, bodily injury or damage to personal property caused by the Company’s products, non-compliance with the Company’s product performance specifications, infringement by the Company’s products of third-party intellectual property rights and a breach of warranties, representations and covenants related to matters such as title to assets sold, validity of certain intellectual property rights, non-infringement of third-party rights, and certain income tax-related matters. In each of these circumstances, payment by the Company is typically subject to the other party making a claim to and cooperating with the Company pursuant to the procedures specified in the particular contract.

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This usually allows the Company to challenge the other party’s claims or, in case of breach of intellectual property representations or covenants, to control the defense or settlement of any third-party claims brought against the other party. Further, the Company’s obligations under these agreements may be limited in terms of amounts, activity (typically at the Company’s option to replace or correct the products or terminate the agreement with a refund to the other party), and duration. In some instances, the Company may have recourse against third parties and/or insurance covering certain payments made by the Company.
Subject to certain limitations, the Company is obligated to indemnify its current and former directors, officers and employees with respect to certain litigation matters and investigations that arise in connection with their service to the Company. These obligations arise under the terms of the Company’s certificate of incorporation, its bylaws, applicable contracts, and Delaware and California law. The obligation to indemnify generally means that the Company is required to pay or reimburse the individuals’ reasonable legal expenses and possibly damages and other liabilities incurred in connection with these matters.
In addition, the Company may in limited circumstances enter into agreements that contain customer-specific commitments on pricing, tool reliability, spare parts stocking levels, response time and other commitments. Furthermore, the Company may give these customers limited audit or inspection rights to enable them to confirm that the Company is complying with these commitments. If a customer elects to exercise its audit or inspection rights, the Company may be required to expend significant resources to support the audit or inspection, as well as to defend or settle any dispute with a customer that could potentially arise out of such audit or inspection. To date, the Company has made no significant accruals in its condensed consolidated financial statements for this contingency. While the Company has not in the past incurred significant expenses for resolving disputes regarding these types of commitments, the Company cannot make any assurance that it will not incur any such liabilities in the future.
It is not possible to predict the maximum potential amount of future payments under these or similar agreements due to the conditional nature of the Company’s obligations and the unique facts and circumstances involved in each particular agreement. Historically, payments made by the Company under these agreements have not had a material effect on its business, financial condition, results of operations or cash flows.
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 and interest rate lock agreements, as either assets or liabilities at fair value on the balance sheet. Changes in the fair value of derivatives that do not qualify for hedge treatment, as well as the ineffective portion of any hedges, are recognized in other expense (income), net in the Condensed Consolidated Statements of Operations. In accordance with the guidance, the Company designates foreign currency exchange contracts and interest rate lock agreements as cash flow hedges of certain forecasted foreign currency denominated sales and purchase transactions, and the benchmark interest rate of the intended debt financing, respectively.
KLA-Tencor’s foreign subsidiaries operate and sell KLA-Tencor’s products in various global markets. As a result, KLA-Tencor is exposed to risks relating to changes in foreign currency exchange rates. KLA-Tencor utilizes foreign currency forward exchange contracts and option contracts to hedge against future movements in foreign exchange rates that affect certain existing and forecasted foreign currency denominated sales and purchase transactions, such as the Japanese yen, the euro, the New Taiwan dollar and the Israeli new shekel. The Company routinely hedges its exposures to certain foreign currencies with various financial institutions in an effort to minimize the impact of certain currency exchange rate fluctuations. These currency forward exchange contracts and options, designated as cash flow hedges, generally have maturities of less than 18 months. Cash flow hedges are evaluated for effectiveness monthly, based on changes in total fair value of the derivatives. If a financial counterparty to any of the Company’s hedging arrangements experiences financial difficulties or is otherwise unable to honor the terms of the foreign currency hedge, the Company may experience material losses.
For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gains or losses on the derivative is reported as a component of accumulated other comprehensive income (loss) (“OCI”) and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Changes in the fair value of currency forward exchange and option contracts due to changes in time value are excluded from the assessment of effectiveness. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.

30

For derivative instruments that are not designated as accounting hedges, gains and losses are recognized in other expense (income), net. The Company uses foreign currency forward contracts to hedge certain foreign currency denominated assets or liabilities. The gains and losses on these derivatives are largely offset by the changes in the fair value of the assets or liabilities being hedged.
In October 2014, the Company entered into a series of forward contracts (“Rate Lock Agreements”) to lock the benchmark rate on a portion of the Senior Notes. The Rate Lock Agreements had a notional amount of $1.00 billion in aggregate which matured in the second quarter of the fiscal year ended June 30, 2015. The Rate Lock Agreements were terminated on the date of pricing of the $1.25 billion of 4.650% Senior Notes due in 2024 and the Company recorded the fair value of $7.5 million as a gain within accumulated other comprehensive income (loss) as of December 31, 2014. The Company recognized $0.2 million for each of the three months ended September 30, 2018 and 2017 for the amortization of the gain recognized in accumulated other comprehensive income (loss), which amount reduced the interest expense. As of September 30, 2018, the unamortized portion of the fair value of the forward contracts for the Rate Lock Agreements was $4.6 million.
During the three months ended June 30, 2018, the Company entered into a series of forward contracts (the “2018 Rate Lock Agreements”) to lock the benchmark interest rate prior to expected debt issuances. The objective of the 2018 Rate Lock Agreements was to hedge the risk associated with the variability in interest rates due to the changes in the benchmark rate leading up to the closing of the intended financing, on the notional amount being hedged. The 2018 Rate Lock Agreement had a notional amount of $500.0 million in aggregate with contract maturity dates in the first half of the fiscal year ending June 30, 2019. Each forward contract will be closed on the earlier of the completion date of pricing of the portion of the intended debt being hedged or the expiration date. The Company designated each of the 2018 Rate Lock Agreements as a qualifying hedging instrument to be accounted for as a cash flow hedge, under which the effective portion of the gain or loss on the derivative is reported as a component of accumulated other comprehensive income (loss), and subsequently amortized into earnings as a component of interest expense over the term of the underlying debt. The ineffective portion, if any, will be recognized in earnings immediately. During the three months ended September 30, 2018, the 2018 Rate Lock Agreements were extended with a maturity date in the quarter ending December 31, 2018 and the realized gain of $4.5 million was recorded in OCI. As of September 30, 2018, the fair value of the outstanding forward contracts for the 2018 Rate Lock Agreements was $3.1 million.
Derivatives in Cash Flow Hedging Relationships: Foreign Exchange and Interest Rate Contracts
The locations and amounts of designated and non-designated derivative instruments’ gains and losses reported in the condensed consolidated financial statements for the indicated periods were as follows:
 
 
Three months ended
September 30,
(In thousands)
Location in Financial Statements
2018
 
2017
Derivatives Designated as Hedging Instruments
 
 
 
 
Gains (losses) in accumulated OCI on derivatives (effective portion)
Accumulated OCI
$
13,794

 
$
444

Gains (losses) reclassified from accumulated OCI into income (effective portion):
Revenues
$
983

 
$
968

 
Costs of revenues
(134
)
 
961

 
Interest expense
188

 
189

 
Net gains (losses) reclassified from accumulated OCI into income (effective portion)
$
1,037

 
$
2,118

Gains (losses) recognized in income on derivatives (ineffective portion and amount excluded from effectiveness testing)
Other expense (income), net
$
229

 
$
(71
)
Derivatives Not Designated as Hedging Instruments
 
 
 
 
Gains (losses) recognized in income
Other expense (income), net
$
3,763

 
$
439



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The U.S. dollar equivalent of all outstanding notional amounts of foreign currency hedge contracts, with maximum remaining maturities of approximately seven months as of September 30, 2018 and ten months as of June 30, 2018, were as follows:
(In thousands)
As of
September 30, 2018
 
As of
June 30, 2018
Cash flow hedge contracts- foreign currency
 
 
 
Purchase
$
6,073

 
$
8,116

Sell
$
90,410

 
$
115,032

Other foreign currency hedge contracts
 
 
 
Purchase
$
182,026

 
$
130,442

Sell
$
169,899

 
$
154,442

The locations and fair value amounts of the Company’s derivative instruments reported in its Condensed Consolidated Balance Sheets as of the dates indicated below were as follows: 
<
 
Asset Derivatives
 
Liability Derivatives
 
Balance Sheet 
Location
 
As of
September 30, 2018
 
As of
June 30, 2018
 
Balance Sheet 
Location
 
As of
September 30, 2018
 
As of
June 30, 2018
(In thousands)
 
Fair Value
 
 
Fair Value
Derivatives designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Rate lock contracts
Other current assets
 
$
3,071

 
$
219

 
Other current liabilities
 
$
—

 
$
5,158

Foreign exchange contracts
Other current assets
 
1,856

 
3,259

 
Other current liabilities
 
159

 
312

Total derivatives designated as hedging instruments
 
 
4,927

 
3,478

 
 
 
159

 
5,470

Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
Other current assets
 
5,061

 
1,907

 
Other current liabilities
 
1,234

 
1,358

Total derivatives not designated as hedging instruments
 
 
5,061

 
1,907

 
 
 
1,234

 
1,358

Total derivatives
 
 
$
9,988