KLAC 10Q 09/30/12
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark one)
T
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2012
or
£
TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number 000-09992
KLA-Tencor Corporation
(Exact name of registrant as specified in its charter)
  
Delaware
 
04-2564110
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
One Technology Drive, Milpitas, California
 
95035
(Address of Principal Executive Offices)
 
(Zip Code)
(408) 875-3000
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  £
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
 
Accelerated filer £
 
Non-accelerated filer £
 
Smaller reporting company £
 
 
 
 
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes £    No  x
As of October 11, 2012, there were 166,515,564 shares of the registrant’s Common Stock, $0.001 par value, outstanding.

Table of Contents

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


 

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Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS
KLA-TENCOR CORPORATION
Condensed Consolidated Balance Sheets
(Unaudited)
 
(In thousands)
September 30,
2012
 
June 30,
2012
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
709,942

 
$
751,294

Marketable securities
1,928,135

 
1,783,150

Accounts receivable, net
537,460

 
701,280

Inventories
689,713

 
650,802

Deferred income taxes
168,241

 
184,670

Other current assets
107,466

 
92,847

Total current assets
4,140,957

 
4,164,043

Land, property and equipment, net
288,876

 
277,686

Goodwill
326,848

 
327,716

Purchased intangibles, net
48,081

 
55,636

Other non-current assets
260,714

 
275,227

Total assets
$
5,065,476

 
$
5,100,308

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
116,247

 
$
139,183

Deferred system profit
141,925

 
147,218

Unearned revenue
57,494

 
63,095

Other current liabilities
471,435

 
513,411

Total current liabilities
787,101

 
862,907

Non-current liabilities:
 
 
 
Long-term debt
746,968

 
746,833

Income tax payable
52,855

 
50,839

Unearned revenue
35,815

 
34,899

Other non-current liabilities
90,425

 
89,235

Total liabilities
1,713,164

 
1,784,713

Commitments and contingencies (Note 11 and Note 12)

 

Stockholders’ equity:
 
 
 
Common stock and capital in excess of par value
1,108,465

 
1,089,480

Retained earnings
2,256,958

 
2,247,258

Accumulated other comprehensive income (loss)
(13,111
)
 
(21,143
)
Total stockholders’ equity
3,352,312

 
3,315,595

Total liabilities and stockholders’ equity
$
5,065,476

 
$
5,100,308

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

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KLA-TENCOR CORPORATION
Condensed Consolidated Statements of Operations
(Unaudited)
 
 
Three months ended
 
September 30,
(In thousands, except per share data)
2012
 
2011
Revenues:
 
 
 
Product
$
574,078

 
$
650,256

Service
146,631

 
146,220

Total revenues
720,709

 
796,476

Costs and operating expenses:
 
 
 
Costs of revenues
317,225

 
340,349

Engineering, research and development
119,742

 
107,762

Selling, general and administrative
97,185

 
94,076

Total costs and operating expenses
534,152

 
542,187

Income from operations
186,557

 
254,289

Interest income and other, net
3,488

 
6,866

Interest expense
13,503

 
13,893

Income before income taxes
176,542

 
247,262

Provision for income taxes
41,175

 
55,267

Net income
$
135,367

 
$
191,995

Net income per share:
 
 
 
Basic
$
0.81

 
$
1.15

Diluted
$
0.80

 
$
1.13

Cash dividends declared per share
$
0.40

 
$
0.35

Weighted average number of shares:
 
 
 
Basic
166,531

 
166,684

Diluted
169,824

 
169,835

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

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

 
Three months ended
 
September 30,
(In thousands)
2012
 
2011
Net income
$
135,367

 
$
191,995

Other comprehensive income (loss):
 
 
 
Currency translation adjustments:
 
 
 
Change in currency translation adjustments
6,622

 
(4,438
)
Change in income tax benefit (expense)
(1,677
)
 
2,651

Net change related to currency translation adjustments
4,945

 
(1,787
)
Cash flow hedges:
 
 
 
Change in net unrealized losses
(241
)
 
(1,194
)
Reclassification adjustments for losses included in net income
1,092

 
223

Change in income tax benefit (expense)
(303
)
 
345

Net change related to cash flow hedges
548

 
(626
)
Net change related to unrecognized losses and transition obligations in connection with defined benefit plans
157

 
103

Available-for-sale investments:
 
 
 
Change in net unrealized gains
3,917

 
(2,941
)
Reclassification adjustments for gains included in net income
(309
)
 
(662
)
Change in income tax benefit (expense)
(1,226
)
 
1,347

Net change related to available-for-sale securities
2,382

 
(2,256
)
Other comprehensive income (loss)
8,032

 
(4,566
)
Total comprehensive income
$
143,399

 
$
187,429


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

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KLA-TENCOR CORPORATION
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 
Three months ended
September 30,
(In thousands)
2012
 
2011
Cash flows from operating activities:
 
 
 
Net income
$
135,367

 
$
191,995

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
24,016

 
23,184

Asset impairment charges
1,327

 
—

Non-cash stock-based compensation expense
18,984

 
20,496

Excess tax benefit from equity awards
(7,026
)
 
—

Net gain on sale of marketable securities and other investments
(309
)
 
(662
)
Changes in assets and liabilities:
 
 
 
Decrease in accounts receivable, net
166,855

 
129,227

Increase in inventories
(39,289
)
 
(43,699
)
Decrease in other assets
19,676

 
91,789

Decrease in accounts payable
(23,104
)
 
(28,558
)
Decrease in deferred system profit
(5,292
)
 
(56,216
)
Decrease in other liabilities
(45,812
)
 
(108,571
)
Net cash provided by operating activities
245,393

 
218,985

Cash flows from investing activities:
 
 
 
Capital expenditures, net
(20,272
)
 
(12,128
)
Purchase of available-for-sale securities
(410,031
)
 
(303,101
)
Proceeds from sale and maturity of available-for-sale securities
265,028

 
268,931

Purchase of trading securities
(11,168
)
 
(18,586
)
Proceeds from sale of trading securities
9,322

 
16,176

Net cash used in investing activities
(167,121
)
 
(48,708
)
Cash flows from financing activities:
 
 
 
Issuance of common stock
23,250

 
9,702

Tax withholding payments related to vested and released restricted stock units
(18,961
)
 
(17,930
)
Common stock repurchases
(68,317
)
 
(66,392
)
Payment of dividends to stockholders
(66,629
)
 
(58,460
)
Excess tax benefit from equity awards
7,026

 
—

Net cash used in financing activities
(123,631
)
 
(133,080
)
Effect of exchange rate changes on cash and cash equivalents
4,007

 
(2,579
)
Net increase (decrease) in cash and cash equivalents
(41,352
)
 
34,618

Cash and cash equivalents at beginning of period
751,294

 
711,329

Cash and cash equivalents at end of period
$
709,942

 
$
745,947

Supplemental cash flow disclosures:
 
 
 
Income taxes paid, net
$
27,909

 
$
37,391

Interest paid
$
233

 
$
611

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

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KLA-TENCOR CORPORATION
Notes to Condensed Consolidated Financial Statements
(Unaudited)

NOTE 1 – BASIS OF PRESENTATION
Basis of Presentation. The condensed consolidated financial statements have been prepared by KLA-Tencor Corporation (“KLA-Tencor” or the “Company”) pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the unaudited interim financial statements reflect all adjustments (consisting only of normal, recurring adjustments) necessary for a fair statement of the financial position, results of operations and cash flows for the periods indicated. These financial statements and notes, however, should be read in conjunction with Item 8, “Financial Statements and Supplementary Data” included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2012, filed with the SEC on August 6, 2012.
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, 2012 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, 2013.
Certain reclassifications have been made to the prior year’s Condensed Consolidated Balance Sheet and notes to conform to the current year presentation. The reclassifications had no effect on the Condensed Consolidated Statements of Operations or Cash Flows.
Management Estimates. The preparation of the condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Recent Accounting Pronouncements. In September 2011, the Financial Accounting Standards Board (“FASB”) issued an accounting standard update intended to simplify testing goodwill for impairment. The amendments allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity will no longer be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that the fair value of the reporting unit is less than its carrying amount. The amendment becomes effective for annual and interim goodwill impairment tests performed for the Company's fiscal year ending June 30, 2013, and early adoption is permitted. The Company elected to early adopt this accounting guidance at the beginning of the three months ended December 31, 2011 (see Note 5, “Goodwill and Purchased Intangible Assets,” for a detailed description).
In June 2011, the FASB issued an accounting standard update requiring an increase in the prominence of items reported in other comprehensive income. The amendment eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders' equity and requires that the total of comprehensive income, the components of net income, and the components of other comprehensive income be presented in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendment also required presentation of adjustments for items that are reclassified from other comprehensive income in the statement where the components of net income and the components of other comprehensive income are presented, which was indefinitely deferred by the FASB in December 2011. The amendment (other than the portion regarding the presentation of reclassification adjustments which, as noted above, has been deferred indefinitely) became effective for the Company's interim period ended September 30, 2012. The amendment did not have an impact on the Company's financial position, results of operations or cash flows as it is disclosure-only in nature.
NOTE 2 – FAIR VALUE MEASUREMENTS
The Company’s financial assets and liabilities are measured and recorded at fair value, except for equity investments in privately-held companies. These equity investments are generally accounted for under the cost method of accounting and are periodically assessed for other-than-temporary impairment when an event or circumstance indicates that an other-than-temporary decline in value may have occurred. The Company’s non-financial assets, such as goodwill, intangible assets, and

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land, property and equipment, are recorded at cost and are assessed for impairment when an event or circumstance indicates that an other-than-temporary decline in value may have occurred.
Fair Value Hierarchy. The authoritative guidance for fair value measurements establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:
Level 1
  
Valuations based on quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.
 
 
 
Level 2
  
Valuations based on quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities.
 
 
 
Level 3
  
Valuations based on inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
All of the Company’s financial instruments were classified within Level 1 or Level 2 of the fair value hierarchy as of September 30, 2012, because they were valued using quoted market prices, broker/dealer quotes or alternative pricing sources with reasonable levels of price transparency. The types of instruments valued based on quoted market prices in active markets include money market funds, U.S. Government agency securities and certain U.S. Treasury securities and sovereign securities. Such instruments are generally classified within Level 1 of the fair value hierarchy.
The types of instruments valued based on other observable inputs include corporate debt securities, municipal securities and certain U.S. Treasury securities and sovereign securities. The market inputs used to value these instruments generally consist of market yields, reported trades and broker/dealer quotes. Such instruments are generally classified within Level 2 of the fair value hierarchy.
The principal market in which the Company executes its foreign currency contracts is the institutional market in an over-the-counter environment with a relatively high level of price transparency. The market participants usually are large commercial banks. The Company’s foreign currency contracts’ valuation inputs are based on quoted prices and quoted pricing intervals from public data sources and do not involve management judgment. These contracts are typically classified within Level 2 of the fair value hierarchy.

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Financial assets (excluding cash held in operating accounts and time deposits) and liabilities measured at fair value on a recurring basis as of the date indicated below were presented on the Company’s Condensed Consolidated Balance Sheet as follows:
As of September 30, 2012 (In thousands)
Total
 
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
 
Significant Other
Observable Inputs
(Level 2)
Assets
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
Corporate debt securities
$
43,998

 
$
—

 
$
43,998

Money market and other
538,499

 
538,499

 
—

Marketable securities:
 
 
 
 
 
U.S. Treasury securities
77,301

 
77,301

 
—

U.S. Government agency securities
654,477

 
654,477

 
—

Municipal securities
66,792

 
—

 
66,792

Corporate debt securities
1,061,528

 
—

 
1,061,528

Sovereign securities
27,591

 
8,584

 
19,007

Total cash equivalents and marketable securities(1)
2,470,186

 
1,278,861

 
1,191,325

Other current assets:
 
 
 
 
 
Derivative assets
1,133

 
—

 
1,133

Other non-current assets:
 
 
 
 
 
Executive Deferred Savings Plan:
 
 
 
 
 
Money market and other
4,079

 
4,079

 
—

Mutual funds
128,111

 
96,049

 
32,062

Executive Deferred Savings Plan total
132,190

 
100,128

 
32,062

Total financial assets(1)
$
2,603,509

 
$
1,378,989

 
$
1,224,520

Other current liabilities:
 
 
 
 
 
Derivative liabilities
$
(1,779
)
 
$
—

 
$
(1,779
)
Total financial liabilities
$
(1,779
)
 
$
—

 
$
(1,779
)
________________
(1) Excludes cash of $111.4 million held in operating accounts and time deposits of $56.5 million as of September 30, 2012.


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Financial assets (excluding cash held in operating accounts and time deposits) and liabilities measured at fair value on a recurring basis as of the date indicated below were presented on the Company’s Condensed Consolidated Balance Sheet as follows:  
As of June 30, 2012 (In thousands)
Total
 
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
 
Significant Other
Observable Inputs
(Level 2)
Assets
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
Money market and other
$
607,038

 
$
607,038

 
$
—

Marketable securities:
 
 
 
 
 
U.S. Treasury securities
91,438

 
88,014

 
3,424

U.S. Government agency securities
634,492

 
634,492

 
—

Municipal securities
66,543

 
—

 
66,543

Corporate debt securities
917,392

 
—

 
917,392

Sovereign securities
29,145

 
10,129

 
19,016

Equity securities
10

 
10

 
—

Total cash equivalents and marketable securities(1)
2,346,058

 
1,339,683

 
1,006,375

Other current assets:
 
 
 
 
 
Derivative assets
1,407

 
—

 
1,407

Other non-current assets:
 
 
 
 
 
Executive Deferred Savings Plan:

 

 

Money market and other
732

 
732

 
—

Mutual funds
124,622

 
94,572

 
30,050

Executive Deferred Savings Plan total
125,354

 
95,304

 
30,050

Total financial assets(1)
$
2,472,819

 
$
1,434,987

 
$
1,037,832

Other current liabilities:
 
 
 
 
 
Derivative liabilities
$
(1,909
)
 
$
—

 
$
(1,909
)
Total financial liabilities
$
(1,909
)
 
$
—

 
$
(1,909
)
________________
(1) Excludes cash of $126.0 million held in operating accounts and time deposits of $62.4 million as of June 30, 2012.
There were no transfers in and out of Level 1 and Level 2 fair value measurements during the three months ended September 30, 2012 or June 30, 2012. The Company did not have any assets or liabilities measured at fair value on a recurring basis within Level 3 fair value measurements as of September 30, 2012 or June 30, 2012.



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NOTE 3 – BALANCE SHEET COMPONENTS
(In thousands)
As of
September 30, 2012
 
As of
June 30, 2012
Accounts receivable, net:
 
 
 
Accounts receivable, gross
$
559,862

 
$
723,607

Allowance for doubtful accounts
(22,402
)
 
(22,327
)
 
$
537,460

 
$
701,280

Inventories:
 
 
 
Customer service parts
$
213,041

 
$
197,013

Raw materials
276,319

 
234,549

Work-in-process
142,197

 
170,254

Finished goods
58,156

 
48,986

 
$
689,713

 
$
650,802

Other current assets:
 
 
 
Prepaid expenses
$
40,068

 
$
53,472

Income tax related receivables
51,422

 
22,943

Other current assets
15,976

 
16,432

 
$
107,466

 
$
92,847

Land, property and equipment, net:
 
 
 
Land
$
41,895

 
$
41,397

Buildings and leasehold improvements
246,379

 
244,807

Machinery and equipment
456,260

 
443,668

Office furniture and fixtures
19,122

 
19,493

Construction in process
19,329

 
11,765

 
782,985

 
761,130

Less: accumulated depreciation and amortization
(494,109
)
 
(483,444
)
 
$
288,876

 
$
277,686

Other non-current assets:
 
 
 
Executive Deferred Savings Plan(1)
$
132,190

 
$
125,354

Deferred tax assets – long-term
107,080

 
128,738

Other
21,444

 
21,135

 
$
260,714

 
$
275,227

Other current liabilities:
 
 
 
Warranty
$
46,192

 
$
46,496

Executive Deferred Savings Plan(1)
132,350

 
125,329

Compensation and benefits
130,196

 
175,007

Income taxes payable
11,679

 
11,251

Interest payable
21,706

 
8,769

Accrued litigation costs
1,120

 
1,080

Other accrued expenses
128,192

 
145,479

 
$
471,435

 
$
513,411


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________________
(1)
KLA-Tencor has a non-qualified deferred compensation plan whereby certain executives and non-employee directors may defer a portion of their compensation. Participants are credited with returns based on their allocation of their account balances among measurement funds. The Company controls the investment of these funds, and the participants remain general creditors of KLA-Tencor. Distributions from the plan commence the quarter following a participant’s retirement or termination of employment, except in cases where such distributions are required to be delayed in order to avoid a prohibited distribution under Internal Revenue Code Section 409A. As of September 30, 2012, the Company had a deferred compensation plan related asset and liability included as a component of other non-current assets and other current liabilities on the Condensed Consolidated Balance Sheet.
NOTE 4 – MARKETABLE SECURITIES
The amortized cost and fair value of marketable securities as of the dates indicated below were as follows:
As of September 30, 2012 (In thousands)
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
U.S. Treasury securities
$
77,149

 
$
152

 
$
—

 
$
77,301

U.S. Government agency securities
653,108

 
1,385

 
(16
)
 
654,477

Municipal securities
66,685

 
124

 
(17
)
 
66,792

Corporate debt securities
1,099,330

 
6,357

 
(161
)
 
1,105,526

Money market and other
538,499

 
—

 
—

 
538,499

Sovereign securities
27,497

 
95

 
(1
)
 
27,591

Subtotal
2,462,268

 
8,113

 
(195
)
 
2,470,186

Add: Time deposits(1)
56,534

 
—

 
—

 
56,534

Less: Cash equivalents
598,585

 
—

 
—

 
598,585

Marketable securities
$
1,920,217

 
$
8,113

 
$
(195
)
 
$
1,928,135

As of June 30, 2012 (In thousands)
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
U.S. Treasury securities
$
91,387

 
$
67

 
$
(16
)
 
$
91,438

U.S. Government agency securities
633,587

 
981

 
(76
)
 
634,492

Municipal securities
66,538

 
107

 
(102
)
 
66,543

Corporate debt securities
914,134

 
3,826

 
(568
)
 
917,392

Money market and other
607,038

 
—

 
—

 
607,038

Sovereign securities
29,056

 
89

 
—

 
29,145

Equity securities
10

 
—

 
—

 
10

Subtotal
2,341,750

 
5,070

 
(762
)
 
2,346,058

Add: Time deposits(1)
62,431

 
—

 
—

 
62,431

Less: Cash equivalents
625,339

 
—

 
—

 
625,339

Marketable securities
$
1,778,842

 
$
5,070

 
$
(762
)
 
$
1,783,150

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

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KLA-Tencor’s investment portfolio consists of both corporate and government securities that have a maximum maturity of three years. The longer the duration of these securities, the more susceptible they are to changes in market interest rates and bond yields. As yields increase, those securities with a lower yield-at-cost show a mark-to-market unrealized loss. All unrealized losses are due to changes in market interest rates, bond yields and/or credit ratings. The Company has the ability to realize the full value of all of these investments upon maturity. The following table summarizes the fair value and gross unrealized losses of the Company’s investments that were in an unrealized loss position as of the date indicated below:
 
As of September 30, 2012 (In thousands)
Fair Value
 
Gross
Unrealized
Losses(1)
U.S. Treasury securities
$
2,038

 
$
—

U.S. Government agency securities
40,356

 
(16
)
Municipal securities
16,472

 
(17
)
Corporate debt securities
120,448

 
(161
)
Sovereign securities
3,000

 
(1
)
Total
$
182,314

 
$
(195
)
__________________ 
(1)
Of the total gross unrealized losses, there were no amounts that, as of September 30, 2012, had been in a continuous loss position for 12 months or more.

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, 2012 (In thousands)
Amortized Cost
 
Fair Value
Due within one year
$
457,709

 
$
458,759

Due after one year through three years
1,462,508

 
1,469,376

 
$
1,920,217

 
$
1,928,135

Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Net realized gains for the three months ended September 30, 2012 and 2011 were $0.3 million and $0.7 million, respectively.
NOTE 5 – GOODWILL AND PURCHASED INTANGIBLE ASSETS
Goodwill
The following table presents goodwill balances as of the dates indicated below:
(In thousands)
As of
September 30, 2012
 
As of
June 30, 2012
Gross goodwill balance
$
604,418

 
$
604,302

Accumulated impairment losses
(277,570
)
 
(276,586
)
Net goodwill balance
$
326,848

 
$
327,716

The changes in the gross goodwill balance since June 30, 2012 resulted from foreign currency translation adjustments. In September 2012, the Company decided to exit the solar inspection business due to adverse market conditions in that industry and recognized a goodwill impairment charge of $1.0 million.

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Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in each business combination. In September 2011, the FASB amended its guidance to simplify testing goodwill for impairment, allowing an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test.
The Company performed a qualitative assessment of the goodwill by reporting unit as of November 30, 2011 during the three months ended December 31, 2011 and concluded that it was more likely than not that the fair value of each of the reporting units exceeded its carrying amount. As of December 31, 2011, the Company's assessment indicated that goodwill in the reporting units was not impaired. There have been no significant events or circumstances affecting the valuation of goodwill subsequent to the qualitative assessment performed in the second quarter of the fiscal year ended June 30, 2012. As noted above, the Company recognized a goodwill impairment charge of $1.0 million during the three months ended September 30, 2012 in connection with the Company's decision to exit the solar inspection business. The next annual assessment of the goodwill by reporting unit will be performed in the second quarter of the fiscal year ending June 30, 2013.
Purchased Intangible Assets
The components of purchased intangible assets as of the dates indicated below were as follows:
(In thousands)
 
 
As of
September 30, 2012
 
As of
June 30, 2012
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
 
$
133,659

 
$
113,494

 
$
20,165

 
$
134,561

 
$
110,370

 
$
24,191

Patents
6-13 years
 
57,648

 
48,559

 
9,089

 
57,648

 
46,966

 
10,682

Trade name/Trademark
4-10 years
 
19,893

 
14,803

 
5,090

 
19,893

 
14,428

 
5,465

Customer relationships
6-7 years
 
54,680

 
40,943

 
13,737

 
54,823

 
39,525

 
15,298

Other
0-1 year
 
16,200

 
16,200

 
—

 
16,200

 
16,200

 
—

Total
 
 
$
282,080

 
$
233,999

 
$
48,081

 
$
283,125

 
$
227,489

 
$
55,636

Intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable.
For the three months ended September 30, 2012 and 2011, amortization expense for other intangible assets was $7.2 million and $8.0 million, respectively. Based on the intangible assets recorded as of September 30, 2012, and assuming no subsequent additions to, or impairment of, the underlying assets, the remaining estimated amortization expense is expected to be as follows:
Fiscal year ending June 30:
Amortization
(In thousands)
2013 (remaining 9 months)
$
13,566

2014
15,368

2015
12,752

2016
5,564

2017
806

2018 and thereafter
25

Total
$
48,081


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NOTE 6 – LONG-TERM DEBT
In April 2008, the Company issued $750 million aggregate principal amount of 6.90% senior, unsecured long-term debt due in 2018 with an effective interest rate of 7.00%. The discount on the debt amounted to $5.4 million and is being amortized over the life of the debt using the straight-line method as opposed to the interest method due to immateriality. Interest is payable semi-annually on November 1 and May 1. The debt indenture includes covenants that limit the Company’s ability to grant liens on its facilities and to enter into sale and leaseback transactions, subject to significant allowances under which certain sale and leaseback transactions are not restricted. The Company was in compliance with all of its covenants as of September 30, 2012.
In certain circumstances involving a change of control followed by a downgrade of the rating of the Company’s senior notes, the Company will be required to make an offer to repurchase the senior notes at a purchase price equal to 101% of the aggregate principal amount of the notes, plus accrued and unpaid interest. The Company’s ability to repurchase the senior notes in such event may be limited by law, by the indenture associated with the senior notes, by the Company’s then-available financial resources or by the terms of other agreements to which the Company may be party at such time. If the Company fails to repurchase the senior notes as required by the indenture, it would constitute an event of default under the indenture governing the senior notes which, in turn, may also constitute an event of default under other obligations.
Based on the trading prices of the debt on the applicable dates, the fair value of the debt as of September 30, 2012 and June 30, 2012 was $909.0 million and $902.2 million, respectively.
NOTE 7 – EQUITY AND LONG-TERM INCENTIVE COMPENSATION PLANS
Equity Incentive Program
Under the Company’s current equity incentive program, the Company issues equity awards from its 2004 Equity Incentive Plan (the “2004 Plan”), which provides for the grant of options to purchase shares of its common stock, stock appreciation rights, restricted stock units, performance shares, performance units and deferred stock units to its employees, consultants and members of its Board of Directors. The 2004 Plan permits the issuance of up to 32.0 million shares of common stock. Any 2004 Plan awards of restricted stock units, performance shares, performance units or deferred stock units with a per share or unit purchase price lower than 100% of fair market value on the grant date are counted against the total number of shares issuable under the 2004 Plan as 1.8 shares for every one share subject thereto.
The following table summarizes the combined activity under the equity incentive plans for the indicated period:
(In thousands)
Available
For Grant
Balances as of June 30, 2012(1)
7,969

Restricted stock units granted(2)(3)
(1,400
)
Restricted stock units canceled(2)
120

Options canceled/expired/forfeited
144

Plan shares expired(4)
(4
)
Balances as of September 30, 2012(1)
6,829

__________________ 
(1)
Includes shares available for issuance under the 2004 Plan, as well as under the Company’s 1998 Outside Director Option Plan (the “Outside Director Plan”), which only permits the issuance of stock options to the Company’s non-employee members of the Board of Directors. As of September 30, 2012, 1.7 million shares were available for grant under the Outside Director Plan.
(2)
The number of restricted stock units provided in this row reflects the application of the 1.8x multiple described above.
(3)
Includes 0.3 million restricted stock units (reflected as 0.6 million shares in this table due to the application of the 1.8x multiple described above) granted to senior management during the three months ended September 30, 2012 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, 2012, it had not yet been determined the extent to which (if at all) the performance-based vesting criteria of such restricted stock units had been satisfied. Therefore, this line item includes all such performance-based restricted stock units, reported at the maximum possible number of shares that may ultimately be issuable under such restricted stock units if all applicable performance-based criteria are achieved at their maximum and all applicable service-based criteria are fully satisfied.

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(4)
Represents the portion of shares listed as “Options canceled/expired/forfeited” above that were issued under the Company’s equity incentive plans other than the 2004 Plan or the Outside Director Plan. Because the Company is only currently authorized to issue equity awards under the 2004 Plan and the Outside Director Plan, any equity awards that are canceled, expire or are forfeited under any other Company equity incentive plans do not result in additional shares being available to the Company for future grant.
Except for stock options granted to non-employee Board members as part of their regular compensation package for service through the end of the first quarter of fiscal year 2008, the Company has granted only restricted stock units under its equity incentive program since September 2006. For the preceding several years until September 30, 2006, stock options were granted at the market price of the Company’s common stock on the date of grant (except for the previously disclosed retroactively priced options which were granted primarily prior to the fiscal year ended June 30, 2002), generally with a vesting period of five years and an exercise period not to exceed seven years (ten years for options granted prior to July 1, 2005) from the date of issuance. Restricted stock units may be granted with varying criteria such as service-based and/or performance-based vesting.
The fair value of stock-based awards is measured at the grant date and is recognized as an expense over the employee’s requisite service period. The fair value is determined using a Black-Scholes valuation model for purchase rights under the Company’s Employee Stock Purchase Plan and using the closing price of the Company’s common stock on the grant date for restricted stock units.
The following table shows pre-tax stock-based compensation expense for the indicated periods: 
 
Three months ended
September 30,
(In thousands)
2012
 
2011
Stock-based compensation expense by:
 
 
 
Costs of revenues
$
3,275

 
$
3,838

Engineering, research and development
5,463

 
5,821

Selling, general and administrative
10,246

 
10,837

Total stock-based compensation expense
$
18,984

 
$
20,496

The following table shows stock-based compensation capitalized as inventory as of the dates indicated below: 
(In thousands)
As of
September 30, 2012
 
As of
June 30, 2012
Inventory
$
8,093

 
$
7,692

Stock Options
The following table summarizes the activity and weighted-average exercise price for stock options under all plans during the three months ended September 30, 2012: 
Stock Options
Shares
(In thousands)
 
Weighted-Average
Exercise Price
Outstanding stock options as of June 30, 2012
3,844

 
$
47.36

Granted
—

 
$
—

Exercised
(522
)
 
$
44.55

Canceled/expired/forfeited
(144
)
 
$
48.28

Outstanding stock options as of September 30, 2012
3,178

 
$
47.79

Vested and exercisable as of September 30, 2012
3,178

 
$
47.79

The Company has not issued any stock options since November 1, 2007. The weighted-average remaining contractual terms for total options outstanding under all plans, and for total options vested and exercisable under all plans, as of September 30, 2012 were each 1.4 years. The aggregate intrinsic values for total options outstanding under all plans, and for total options vested and exercisable under all plans, as of September 30, 2012 were each $10.5 million.

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The authoritative guidance on stock-based compensation permits companies to select the option-pricing model used to estimate the fair value of their stock-based compensation awards. The Black-Scholes option-pricing model requires the input of assumptions, including the option’s expected term and the expected price volatility of the underlying stock. For purposes of the fair value estimates presented in this report, the Company has based its expected stock price volatility assumption on the market-based implied volatility from traded options of the Company’s common stock. As of September 30, 2012, the unrecognized stock-based compensation balance related to stock options was immaterial.
The following table shows the total intrinsic value of options exercised, total cash received from employees and non-employee Board members as a result of stock option exercises and tax benefits realized by the Company in connection with these stock option exercises for the indicated periods: 
 
Three months ended
September 30,
(In thousands)
2012
 
2011
Total intrinsic value of options exercised
$
3,927

 
$
2,760

Total cash received from employees and non-employee Board members as a result of stock option exercises
$
23,252

 
$
9,702

Tax benefits realized by the Company in connection with these exercises
$
1,294

 
$
939

The Company generally settles employee stock option exercises with newly issued common shares, except in certain tax jurisdictions where settling such exercises with treasury shares provides the Company or one of its subsidiaries with a tax benefit.
Restricted Stock Units
The following table shows the applicable number of restricted stock units and weighted-average grant date fair value for restricted stock units granted, vested and released, withheld for taxes, and forfeited during the three months ended September 30, 2012 and restricted stock units outstanding as of September 30, 2012 and June 30, 2012: 
Restricted Stock Units
Shares
(In thousands) (1)
 
Weighted-Average
Grant Date
Fair Value
Outstanding restricted stock units as of June 30, 2012
6,418

 
$
32.66

Granted(2)
778

 
$
51.65

Vested and released
(745
)
 
$
31.13

Withheld for taxes
(362
)
 
$
31.41

Forfeited
(67
)
 
$
34.92

Outstanding restricted stock units as of September 30, 2012(2)
6,022

 
$
35.35

__________________ 
(1)
Share numbers reflect actual shares subject to awarded restricted stock units. Under the terms of the 2004 Plan, each of the share numbers presented in this column is multiplied by 1.8 to calculate the impact on the share reserve under the 2004 Plan.
(2)
Includes 0.3 million restricted stock units granted to senior management during the three months ended September 30, 2012 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, 2012, it had not yet been determined the extent to which (if at all) the performance-based vesting criteria of such restricted stock units had been satisfied. Therefore, this line item includes all such performance-based restricted stock units, reported at the maximum possible number of shares that may ultimately be issuable under such restricted stock units if all applicable performance-based criteria are achieved at their maximum and all applicable service-based criteria are fully satisfied.
The restricted stock units granted by the Company since the beginning of the fiscal year ending June 30, 2013 generally vest (a) with respect to awards with only service-based vesting criteria, in four equal installments on the first, second, third and fourth anniversaries of the grant date and (b) with respect to awards with both performance-based and service-based vesting criteria, in two equal installments on the third and fourth anniversaries of the grant date, in each case subject to the recipient remaining employed by the Company as of the applicable vesting date. The restricted stock units granted by the Company from the beginning of the fiscal year ended June 30, 2007 through June 30, 2012 generally vest in two equal installments on the second and fourth anniversaries of the grant date, subject to the recipient remaining employed by the Company as of the applicable vesting date. The value of the restricted stock units is based on the closing market price of the Company’s common stock on the grant date. The restricted stock units have been awarded under the Plan, and each unit will entitle the recipient to one share of common stock when the applicable vesting requirements for that unit are satisfied. However, for each share

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actually issued under the awarded restricted stock units, the share reserve under the 2004 Plan will be reduced by 1.8 shares, as provided under the terms of the 2004 Plan.
The Company has adopted a cash-based long-term incentive program in fiscal year 2013 for many of its employees as part of the Company's employee compensation program. In October 2012, the Company approved cash-based long-term incentive (“Cash LTI”) awards of $59.5 million under the Company's Cash Long-Term Incentive Plan (“Cash LTI Plan”). Cash LTI awards issued to employees under the Cash LTI Plan will vest in four equal installments, with 25% of the aggregate amount of the Cash LTI award vesting on each yearly anniversary of the grant date over a four-year period. In order to receive payments under the Cash LTI Plan, participants must remain employed by the Company as of the applicable award vesting date. Although executives and non-employee Board members are not participating in this program, the adoption of the Cash LTI Plan will reduce the Company's overall share usage going forward. In the first quarter of fiscal year 2013, as referenced in the table above, the Company issued restricted stock units covering up to 0.8 million shares, of the Company's common stock, compared to issuances of awards covering up to 2.2 million shares in the comparable quarter during fiscal year 2012.
The following table shows the grant date fair value after estimated forfeitures and weighted-average grant date fair value per unit for the restricted stock units granted, as well as the tax benefits realized by the Company in connection with vested and released restricted stock units for the indicated periods: 
(In thousands, except for weighted-average grant date fair value)
Three months ended
September 30,
2012
 
2011
Grant date fair value after estimated forfeitures
$
26,439

 
$
54,637

Weighted-average grant date fair value per unit
$
51.65

 
$
35.74

Tax benefits realized by the Company in connection with vested and released restricted stock units
$
17,871

 
$
16,773

As of September 30, 2012, the unrecognized stock-based compensation expense balance, net of estimated forfeitures, related to restricted stock units was $115.4 million and will be recognized over an estimated weighted-average amortization period of 2.1 years.
Employee Stock Purchase Plan
KLA-Tencor’s Employee Stock Purchase Plan (“ESPP”) provides that eligible employees may contribute up to 10% of their eligible earnings toward the semi-annual purchase of KLA-Tencor’s common stock. The ESPP is qualified under Section 423 of the Internal Revenue Code. The employee’s purchase price is derived from a formula based on the closing price of the common stock on the first day of the offering period versus the closing price on the date of purchase (or, if not a trading day, on the immediately preceding trading day).
Effective January 1, 2010, the offering period (or length of the look-back period) under the ESPP has a duration of six months, and the purchase price with respect to each offering period beginning on or after such date is, until otherwise amended, equal to 85% of the lesser of (i) the fair market value of the Company’s common stock at the commencement of the applicable six-month offering period or (ii) the fair market value of the Company’s common stock on the purchase date.
The Company estimates the fair value of purchase rights under the ESPP using a Black-Scholes valuation model. The fair value of each purchase right under the ESPP was estimated on the date of grant using the Black-Scholes option valuation model and the straight-line attribution approach with the following weighted-average assumptions: 
 
Three months ended
September 30,
 
2012
 
2011
Stock purchase plan:
 
 
 
Expected stock price volatility
30.2
%
 
33.0
%
Risk-free interest rate
0.1
%
 
0.1
%
Dividend yield
3.3
%
 
3.4
%
Expected life of options (in years)
0.5

 
0.5

 

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No shares were purchased under the ESPP during the three months ended September 30, 2012 or 2011. 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,
2012
 
2011
Tax benefits realized by the Company in connection with the disqualifying dispositions of shares purchased under the ESPP
$
606

 
$
475

Weighted-average fair value per share based on Black-Scholes model
$
10.54

 
$
9.16

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, 2012, a total of 2.6 million shares were reserved and available for issuance under the ESPP. As of the date of this report, no additional shares have been added to the ESPP with respect to the fiscal year ending June 30, 2013.
NOTE 8 – STOCK REPURCHASE PROGRAM
Since July 1997, the Board of Directors has authorized the Company to systematically repurchase in the open market up to 72.8 million shares of its common stock under a repurchase program, including 10.0 million shares authorized in February 2011. The intent of this program is to offset the dilution from KLA-Tencor’s equity incentive plans and employee stock purchase plan, as well as to return excess cash to the Company’s stockholders. Subject to market conditions, applicable legal requirements and other factors, the repurchases will be made from time to time in the open market in compliance with applicable securities laws, including the Securities Exchange Act of 1934 and the rules promulgated thereunder such as Rule 10b-18. As of September 30, 2012, 1.9 million shares were available for repurchase under the Company’s repurchase program.
Share repurchases for the indicated periods (based on the settlement date of the applicable repurchase) were as follows:
 
Three months ended
September 30,
(In thousands)
2012
 
2011
Number of shares of common stock repurchased
1,361

 
1,763

Total cost of repurchases
$
68,317

 
$
66,982


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NOTE 9 – NET INCOME PER SHARE
Basic net income per share is calculated by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted net income per share is calculated by using the weighted-average number of common shares outstanding during the period, increased to include the number of additional shares of common stock that would have been outstanding if the shares of common stock underlying the Company’s outstanding dilutive stock options and restricted stock units had been issued. The dilutive effect of outstanding options and restricted stock units is reflected in diluted net income per share by application of the treasury stock method. Under the treasury stock method, the amount the employee must pay for exercising stock options, the amount of compensation cost for future service that the Company has not yet recognized, and the amount of tax benefits that is to be recorded in additional paid-in capital when the award becomes deductible are assumed to be used to repurchase shares. The following table sets forth the computation of basic and diluted net income per share:
(In thousands, except per share amounts)
Three months ended
September 30,
2012
 
2011
Numerator:
 
 
 
Net income
$
135,367

 
$
191,995

Denominator:
 
 
 
Weighted-average shares-basic, excluding unvested restricted stock units
166,531

 
166,684

Effect of dilutive options and restricted stock units
3,293

 
3,151

Weighted-average shares-diluted
169,824

 
169,835

Basic net income per share
$
0.81

 
$
1.15

Diluted net income per share
$
0.80

 
$
1.13

Anti-dilutive securities excluded from the computation of diluted net income per share
1,717

 
6,635

The total amount of dividends paid during the three months ended September 30, 2012 and 2011 was $66.6 million and $58.5 million, respectively. On July 10, 2012, the Company announced that its Board of Directors had authorized an increase in the level of the Company's quarterly dividend from $0.35 to $0.40 per share. The increase in the amount of dividends paid during the three months ended September 30, 2012 reflects that increase in the level of the Company's quarterly dividend.
NOTE 10 – INCOME TAXES
The following table provides details of income taxes:
(Dollar amounts in thousands)
Three months ended September 30,
 
2012
 
2011
Income before income taxes
$
176,542

 
$
247,262

Provision for income taxes
$
41,175

 
$
55,267

Effective tax rate
23.3
%
 
22.4
%
The Company’s estimated annual effective tax rate for the fiscal year ending June 30, 2013 is approximately 24.7%.
The difference between the actual effective tax rate of 23.3% during the quarter and the estimated annual effective tax rate of 24.7% is primarily due to a decrease in tax expense of $1.8 million as a result of a non-taxable increase in the value of the assets held within the Company’s Executive Deferred Savings Plan during the three months ended September 30, 2012.
Tax expense was higher as a percentage of income during the three months ended September 30, 2012 compared to the three months ended September 30, 2011 primarily due to the expiration of the federal research credit which occurred on December 31, 2011. The federal research credit decreased tax expense by $2.7 million during the three months ended September 30, 2011.
In the normal course of business, the Company is subject to examination by tax authorities throughout the world. The Company is subject to U.S. federal income tax examination for all years beginning from the fiscal year ended June 30, 2010.  The Company is subject to state income tax examinations for all years beginning from the fiscal year ended June 30, 2007. The

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Company is also subject to examinations in other major foreign jurisdictions, including Singapore, for all years beginning from the fiscal year ended June 30, 2007. It is possible that certain examinations may be concluded in the next twelve months. The Company believes it is possible that it may recognize up to $1.7 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 11 – 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 investigation (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 12 – 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.
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)
2012
 
2011
Receivables sold under factoring agreements
$
48,534

 
$
168,724

Proceeds from sales of LCs
$
—

 
$
4,510

Factoring and LC fees for the sale of certain trade receivables were recorded in interest income and other, net and were not material for the periods presented.

Facilities. KLA-Tencor leases certain of its facilities under arrangements that are accounted for as operating leases. Rent expense was $2.2 million and $2.3 million for the three months ended September 30, 2012 and 2011, respectively.
The following is a schedule of expected operating lease payments:
Fiscal year ending June 30,
Amount
(In thousands)
2013 (remaining 9 months)
$
6,680

2014
6,232

2015
3,475

2016
2,887

2017
2,387

2018 and thereafter
2,462

Total minimum lease payments
$
24,123

Purchase Commitments. KLA-Tencor maintains certain open inventory purchase commitments with its suppliers to ensure a smooth and continuous supply for key components. The Company’s liability under these purchase commitments is generally restricted to a forecasted time-horizon as mutually agreed upon between the parties. This forecasted time-horizon can

21
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vary among different suppliers. The Company’s open inventory purchase commitments were approximately $287.2 million as of September 30, 2012 and are primarily due within the next 12 months. Actual expenditures will vary based upon the volume of the transactions and length of contractual service provided. In addition, the amounts paid under these arrangements may be less in the event that the arrangements are renegotiated or canceled. Certain agreements provide for potential cancellation penalties.
Cash Long-Term Incentive Plan. The Company has committed $59.5 million to future payment obligations under its Cash LTI program. The calculation of compensation expense related to the Cash LTI Plan will include estimated forfeiture rate assumptions. Cash LTI awards issued to employees under the Cash LTI Plan will vest in four equal installments, with 25% of the aggregate amount of the Cash LTI award vesting on each yearly anniversary of the grant date over a four-year period. In order to receive payments under the Cash LTI Plan, participants must remain employed by the Company as of the applicable award vesting date.
Guarantees. KLA-Tencor provides standard warranty coverage on its systems for 40 hours per week for 12 months, providing labor and parts necessary to repair the systems during the warranty period. The Company accounts for the estimated warranty cost as a charge to costs of revenues when revenue is recognized. The estimated warranty cost is based on historical product performance and field expenses. Utilizing actual service records, the Company calculates the average service hours and parts expense per system and applies the actual labor and overhead rates to determine the estimated warranty charge. The Company updates these estimated charges on a quarterly basis. The actual product performance and/or field expense profiles may differ, and in those cases the Company adjusts its warranty accruals accordingly.
The following table provides the changes in the product warranty accrual for the indicated periods:
 
Three months ended September 30,
(In thousands)
2012
 
2011
Beginning balance
$
46,497

 
$
41,528

Accruals for warranties issued during the period
10,646

 
11,292

Changes in liability related to pre-existing warranties
2,352

 
2,390

Settlements made during the period
(13,303
)
 
(11,607
)
Ending balance
$
46,192

 
$
43,603

The Company maintains guarantee arrangements available through various financial institutions for up to $24.8 million, of which $22.7 million had been issued as of September 30, 2012, 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 such matters as title to assets sold, validity of certain intellectual property rights, non-infringement of third-party rights, and certain income tax-related matters. In each of these circumstances, payment by the Company is typically subject to the other party making a claim to and cooperating with the Company pursuant to the procedures specified in the particular contract. This usually allows the Company to challenge the other party's claims or, in case of breach of intellectual property representations or covenants, to control the defense or settlement of any third-party claims brought against the other party. Further, the Company's obligations under these agreements may be limited in terms of amounts, activity (typically at the Company's option to replace or correct the products or terminate the agreement with a refund to the other party), and duration. In some instances, the Company may have recourse against third parties and/or insurance covering certain payments made by the Company.
Subject to certain limitations, the Company is obligated to indemnify its current and former directors, officers and employees with respect to certain litigation matters and investigations that arise in connection with their service to the Company. These obligations arise under the terms of 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.

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It is not possible to predict the maximum potential amount of future payments under these or similar agreements due to the conditional nature of the Company's obligations and the unique facts and circumstances involved in each particular agreement. Historically, payments made by the Company under these agreements have not had a material effect on its business, financial condition, results of operations or cash flows.
NOTE 13 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The authoritative guidance requires companies to recognize all derivative instruments and hedging activities, including foreign currency exchange contracts, as either assets or liabilities at fair value on the balance sheet. Changes in the fair value of derivatives that do not qualify for hedge treatment, as well as the ineffective portion of any hedges, are reflected in the Condensed Consolidated Statement of Operations. In accordance with the guidance, the Company designates foreign currency forward exchange and option contracts as cash flow hedges of certain forecasted foreign currency denominated sales and purchase transactions.
KLA-Tencor’s foreign subsidiaries operate and sell KLA-Tencor’s products in various global markets. As a result, KLA-Tencor is exposed to risks relating to changes in foreign currency exchange rates. KLA-Tencor utilizes foreign currency forward exchange contracts and option contracts to hedge against future movements in foreign exchange rates that affect certain existing and forecasted foreign currency denominated sales and purchase transactions, such as the Japanese yen, the euro and the Israeli new shekel. KLA-Tencor does not use derivative financial instruments for speculative or trading purposes. The Company routinely hedges its exposures to certain foreign currencies with various financial institutions in an effort to minimize the impact of certain currency exchange rate fluctuations. These currency forward exchange contracts and options, designated as cash flow hedges, generally have maturities of less than 18 months. Cash flow hedges are evaluated for effectiveness monthly, based on changes in total fair value of the derivatives. If a financial counterparty to any of the Company’s hedging arrangements experiences financial difficulties or is otherwise unable to honor the terms of the foreign currency hedge, the Company may experience material losses.
For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the 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.
For derivative instruments that are not designated as accounting hedges, gains and losses are recognized in interest income and other, net. The Company uses foreign currency forward contracts to hedge certain foreign currency denominated assets or liabilities. The gains and losses on these derivatives are largely offset by the changes in the fair value of the assets or liabilities being hedged.

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Table of Contents

Derivatives in Cash Flow Hedging Relationships: Foreign Exchange 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
2012
 
2011
Derivatives Designated as Hedging Instruments
 
 
 
 
Losses in accumulated OCI on derivatives (effective portion)
Accumulated OCI
$
(241
)
 
$
(1,194
)
Gains (losses) reclassified from accumulated OCI into income (effective portion):
Revenues
$
(491
)
 
$
(284
)
 
Costs of revenues
(601
)
 
61

 
Total losses reclassified from accumulated OCI into income (effective portion)
$
(1,092
)
 
$
(223
)
Gains recognized in income on derivatives (ineffectiveness portion and amount excluded from effectiveness testing)
Interest income and other, net
$
51

 
$
43

Derivatives Not Designated as Hedging Instruments
 
 
 
 
Gains (losses) recognized in income
Interest income and other, net
$
673

 
$
(12,568
)
The U.S. dollar equivalent of all outstanding notional amounts of hedge contracts, with maximum maturity of 13 months, as of the dates indicated below was as follows: 
(In thousands)
As of
September 30, 2012
 
As of
June 30, 2012
Cash flow hedge contracts
 
 
 
Purchase
$
6,162

 
$
14,689

Sell
$
28,420

 
$
29,362

Other foreign currency hedge contracts
 
 
 
Purchase
$
122,507

 
$
121,965

Sell
$
137,524

 
$
126,827

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, 2012
 
As of
June 30, 2012
 
Balance Sheet Location
 
As of
September 30, 2012
 
As of
June 30, 2012
(In thousands)
 
Fair Value
 
 
 
Fair Value
Derivatives designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
Other current assets
 
$
324

 
$
128

 
Other current liabilities
 
$
130

 
$
736

Total derivatives designated as hedging instruments
 
 
$
324

 
$
128

 
 
 
$
130

 
$
736

Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
Other current assets
 
$
809

 
$
1,279

 
Other current liabilities
 
$
1,649

 
$
1,173

Total derivatives not designated as hedging instruments
 
 
$
809

 
$
1,279

 
 
 
$
1,649

 
$
1,173

Total derivatives
 
 
$
1,133

 
$
1,407

 
 
 
$
1,779

 
$
1,909


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Table of Contents

The following table provides the balances and changes in accumulated other comprehensive income (loss) related to derivative instruments for the indicated periods:
 
Three months ended
September 30,
(In thousands)
2012
 
2011
Beginning balance
$
(962
)
 
$
12

Amount reclassified to income
1,092

 
223

Net change
(241
)
 
(1,194
)
Ending balance
$
(111
)
 
$
(959
)
NOTE 14 – RELATED PARTY TRANSACTIONS
During the three months ended September 30, 2012 and 2011, the Company purchased from, or sold to, several entities, where one or more executive officers of the Company or members of the Company’s Board of Directors, or their immediate family members, also serves as an executive officer or board member, including JDS Uniphase Corporation, Cisco Systems, Inc., Freescale Semiconductor, Inc. and Avago Technologies Ltd. The following table provides the transactions with these parties for the indicated periods (for the portion of such period that they were considered related):
 
Three months ended
September 30,
(In thousands)
2012
 
2011
Total revenues
$
2,872

 
$
37

Total purchases
$
2,384

 
$
2,092

The Company had a receivable balance from these parties of $2.8 million and $1.9 million as of September 30, 2012 and June 30, 2012, respectively. Management believes that such transactions are at arm’s length and on similar terms as would have been obtained from unaffiliated third parties.
NOTE 15 – SEGMENT REPORTING AND GEOGRAPHIC INFORMATION
KLA-Tencor reports one reportable segment in accordance with the provisions of the authoritative guidance for segment reporting. Operating segments are defined as components of an enterprise about which separate financial information is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. KLA-Tencor’s chief operating decision maker is the Chief Executive Officer.
The Company is engaged primarily in designing, manufacturing, and marketing process control and yield management solutions for the semiconductor and related nanoelectronics industries. All operating segments have been aggregated due to their inter-dependencies, commonality of long-term economic characteristics, products and services, the production processes, class of customer and distribution processes. The Company’s service products are an extension of the system product portfolio and provide customers with spare parts and fab management services (including system preventive maintenance and optimization services) to improve yield, increase production uptime and throughput, and lower the cost of ownership. Since the Company operates in one segment, all financial segment information required by the authoritative guidance can be found in the condensed consolidated financial statements.
The Company’s significant operations outside the United States include manufacturing facilities in Israel and Singapore, and sales, marketing and service offices in Western Europe, Japan and the Asia Pacific regions. For geographical revenue reporting, revenues are attributed to the geographic location in which the customer is located. Long-lived assets consist primarily of net property and equipment and are attributed to the geographic region in which they are located.

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Table of Contents

The following is a summary of revenues by geographic region, based on ship-to location, for the indicated periods (as a percentage of total revenues):
  
Three months ended September 30,
(Dollar amounts in thousands)
2012
 
2011
Revenues:
 
 
 
 
 
 
 
United States
$
149,988

 
21
%
 
$
198,243

 
25
%
Taiwan
276,299

 
38
%
 
223,289

 
28
%
Japan
88,715

 
12
%
 
134,815

 
17
%
Europe & Israel
59,160

 
8
%
 
92,996

 
12
%
Korea
70,247

 
10
%
 
79,598

 
10
%
Rest of Asia
76,300

 
11
%
 
67,535

 
8
%
Total
$
720,709

 
100
%
 
$
796,476

 
100
%
The following is a summary of revenues by major products for the indicated periods (as a percentage of total revenues):
  
Three months ended September 30,
(Dollar amounts in thousands)
2012
 
2011
Revenues:
 
 
 
 
 
 
 
Defect inspection
$
396,941

 
55
%
 
$
443,633

 
56
%
Metrology
134,029

 
19
%
 
182,012

 
23
%
Service
146,631

 
20
%
 
146,220

 
18
%
Other
43,108

 
6
%
 
24,611

 
3
%
Total
$
720,709

 
100
%
 
$
796,476

 
100
%
Four customers accounted for greater than 10% of total revenues for the three months ended September 30, 2012. Two customers accounted for greater than 10% of total revenues for the three months ended September 30, 2011. One customer accounted for greater than 10% of net accounts receivable as of September 30, 2012. Two customers accounted for greater than 10% of net accounts receivable as of June 30, 2012.
Long-lived assets by geographic region as of the dates indicated below were as follows: 
(In thousands)
As of
September 30, 2012
 
As of
June 30, 2012
Long-lived assets:
 
 
 
United States
$
210,957

 
$
211,315

Taiwan
1,097

 
696

Japan
3,925

 
3,570

Europe & Israel
79,086

 
77,292

Korea
3,133

 
2,773

Rest of Asia
47,837

 
46,719

Total
$
346,035

 
$
342,365


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Table of Contents


ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical fact may be forward-looking statements. You can identify these and other forward-looking statements by the use of words such as “may,” “will,” “could,” “would,” “should,” “expects,” “plans,” “anticipates,” “relies,” “believes,” “estimates,” “predicts,” “intends,” “potential,” “continue,” “thinks,” “seeks,” or the negative of such terms, or other comparable terminology. Forward-looking statements also include the assumptions underlying or relating to any of the foregoing statements. Such forward-looking statements include, among others, forecasts of the future results of our operations; orders for our products and capital equipment generally; sales of semiconductors; the allocation of capital spending by our customers (and, in particular, the percentage of spending that our customers allocate to process control); growth of revenue in the semiconductor industry, the semiconductor capital equipment industry and our business; technological trends in the semiconductor industry; future developments or trends in the global capital and financial markets; our future product offerings and product features; the success and market acceptance of new products; timing of shipment of backlog; the future of our product shipments and our product and service revenues; our future gross margins; our future research and development expenses and selling, general and administrative expenses; our ability to successfully maintain cost discipline; international sales and operations; our ability to maintain or improve our existing competitive position; success of our product offerings; creation and funding of programs for research and development; attraction and retention of employees; results of our investment in leading edge technologies; the effects of hedging transactions; the effect of the sale of trade receivables and promissory notes from customers; our future income tax rate; future payments of dividends to our stockholders; the completion of any acquisitions of third parties, or the technology or assets thereof; benefits received from any acquisitions and development of acquired technologies; sufficiency of our existing cash balance, investments and cash generated from operations to meet our operating and working capital requirements; and the adoption of new accounting pronouncements.
Our actual results may differ significantly from those projected in the forward-looking statements in this report. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in Part II, Item 1A, “Risk Factors” in this report as well as in Item 1, “Business” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended June 30, 2012, filed with the Securities and Exchange Commission on August 6, 2012. You should carefully review these risks and also review the risks described in other documents we file from time to time with the Securities and Exchange Commission. You are cautioned not to place undue reliance on these forward-looking statements, and we expressly assume no obligation and do not intend to update the forward-looking statements in this report after the date hereof.
EXECUTIVE SUMMARY
KLA-Tencor Corporation is a leading supplier of process control and yield management solutions for the semiconductor and related nanoelectronics industries. Our broad portfolio of products and services primarily supports integrated circuit (“IC” or “chip”) manufacturers throughout the entire semiconductor fabrication process, from research and development to final volume production. We provide leading-edge equipment, software and support that enable IC manufacturers to identify, resolve and manage significant advanced technology manufacturing process challenges and obtain higher finished product yields at lower overall cost. In addition to serving the semiconductor industry, we also provide a range of technology solutions to a number of other high technology industries, including the light emitting diode (“LED”) and data storage industries, as well as general materials research.
Our products and services are used by the vast majority of bare wafer, IC, lithography reticle (“reticle” or “mask”) and disk manufacturers in the world. Our products, services and expertise are used by our customers to measure and control nanometric-level manufacturing processes, and to detect, analyze and resolve critical product defects that arise in that environment. Our revenues are driven largely by our customers' spending on capital equipment and related maintenance services necessary to support key transitions in their underlying product technologies, or to increase their production volumes in response to market demand. Our semiconductor customers generally operate in one or more of the three major semiconductor markets - memory, foundry and logic. All three of these markets are characterized by rapid technological changes and sudden shifts in end-user demand, which influence the level and pattern of our customers' spending on our products and services. Although capital spending in all three semiconductor markets has historically been very cyclical, the demand for more advanced and lower cost chips used in a growing number of consumer electronics, communications, data processing, and industrial and automotive products has resulted in favorable long-term revenue growth rates for our process control and yield management solutions.

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Table of Contents

As a supplier to the global semiconductor and semiconductor-related industries, we are subject to the cyclical capital spending that characterizes these industries. The timing, length, intensity and volatility of capacity-oriented capital spending cycles of our customers are unpredictable. In addition, our customer base continues to become more highly concentrated over time, thereby increasing the potential impact of a sudden change in capital spending by a major customer on our revenues and profitability.
The growing use of increasingly sophisticated semiconductor devices has caused many of our customers to invest in additional semiconductor manufacturing capabilities and capacity. These investments have included process control and yield management equipment and services, which have had a significant favorable impact on our revenues over the long term.
During the three months ended September 30, 2012, our customers reduced their purchases of process control and yield management equipment, primarily in response to the cyclical industry factors affecting our foundry and logic customers and the challenging demand environment for our memory customers. In the current environment, as our customer base become increasingly more concentrated, large orders from a relatively limited number of customers account for a substantial portion of our sales, which potentially exposes us to more new order volatility. The low level of demand for process control and yield management equipment in the September quarter, and the resulting negative impact on our new orders in the quarter, will result in lower levels of total revenues until market conditions improve and demand for our products recovers. We believe that, over the long term, our customers will continue to invest in advanced technologies and new materials to enable smaller design rules and new process technologies to deliver higher performance semiconductor capability at lower costs. We expect that these dynamics will drive long-term increased adoption of process control equipment and services that reduce semiconductor defectivity and improve manufacturing yields, leaving the longer-term drivers underlying growth in our industry intact.
During the three months ended September 30, 2012, we decided to exit the solar inspection business due to deteriorating solar industry fundamentals and declining near-term business opportunities in that market. We have recognized expenses of $3.1 million during the three months ended September 30, 2012 as a consequence of our decision.
The following table sets forth some of the key quarterly unaudited financial information that we use to manage our business: 
(In thousands, except net income per share)
Three months ended
September 30,
2012
 
June 30,
2012
 
March 31,
2012
 
December 31,
2011
 
September 30,
2011
Total revenues
$
720,709

 
$
892,465

 
$
840,521

 
$
642,482

 
$
796,476

Total costs and operating expenses
$
534,152

 
$
574,166

 
$
556,247

 
$
483,019

 
$
542,187

Gross margin
$
403,484

 
$
530,802

 
$
485,372

 
$
369,627

 
$
456,127

Income from operations
$
186,557

 
$
318,299

 
$
284,274

 
$
159,463

 
$
254,289

Net income
$
135,367

 
$
247,877

 
$
205,346

 
$
110,797

 
$
191,995

Net income per share:
 
 
 
 
 
 
 
 
 
Basic (1)
$
0.81

 
$
1.48

 
$
1.23

 
$
0.67

 
$
1.15

Diluted (1)
$
0.80

 
$
1.46

 
$
1.21

 
$
0.66

 
$
1.13

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

28
Table of Contents

CRITICAL ACCOUNTING ESTIMATES AND POLICIES
The preparation of our Condensed Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions in applying our accounting policies that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Note 1 to the Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended June 30, 2012 describes the significant accounting policies and methods used in preparation of the Consolidated Financial Statements. We base these estimates and assumptions on historical experience, and evaluate them on an on-going basis to ensure that they remain reasonable under current conditions. Actual results could differ from those estimates. We discuss the development and selection of the critical accounting estimates with the Audit Committee of our Board of Directors on a quarterly basis, and the Audit Committee has reviewed our related disclosure in this Quarterly Report on Form 10-Q. The accounting policies that reflect our more significant estimates, judgments and assumptions and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:
•
Revenue Recognition
•
Inventories
•
Warranty
•
Allowance for Doubtful Accounts
•
Equity and Long-Term Incentive Compensation Plans
•
Contingencies and Litigation
•
Goodwill and Intangible Assets
•
Income Taxes
There were no significant changes in our critical accounting estimates and policies during the three months ended September 30, 2012. Please refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for our fiscal year ended June 30, 2012 for a more complete discussion of our critical accounting policies and estimates.
Valuation of Goodwill and Intangible Assets
We performed a qualitative assessment of the goodwill by reporting unit as of November 30, 2011 during the three months ended December 31, 2011 and concluded that there was no impairment. We assess goodwill for impairment annually as well as whenever events or changes in circumstances indicate that the carrying amount of goodwill in any reporting unit may not be recoverable. Long-lived assets are tested for recoverability whenever events or changes in circumstances indicate that the assets' carrying amount may not be recoverable.
Our next annual evaluation of the goodwill by reporting unit will be performed during the three months ending December 31, 2012. If we were to encounter challenging economic conditions, such as a decline in our operating results, an unfavorable industry or macroeconomic environment, a substantial decline in our stock price, or any other adverse change in market conditions, we may be required to perform the two-step quantitative goodwill impairment analysis. In addition, if such conditions have the effect of changing one of the critical assumptions or estimates we use to calculate the value of our goodwill or intangible assets, we may be required to record goodwill and/or intangible asset impairment charges in future periods, whether in connection with our next annual impairment assessment in the second quarter of fiscal year 2013 or prior to that, if any triggering event occurs outside of the quarter during which the annual goodwill impairment assessment is performed. It is not possible at this time to determine if any such future impairment charge would result or, if it does, whether such charge would be material to our results of operations.

29
Table of Contents

Revenue Recognition
We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable, and collectibility is reasonably assured.  We enter into arrangements that may consist of multiple deliverables of our products and services where certain elements of the sales arrangement are not delivered and accepted in one reporting period. Judgment is required to properly identify the accounting units of the multiple deliverable transactions and to determine the manner in which revenue should be allocated among the accounting units.  Additionally, judgment is required to interpret various commercial terms and to determine when all criteria of revenue recognition have been met in order for revenue recognition to occur in the appropriate accounting period. While changes in the allocation of the estimated sales price between the accounting units will not affect the amount of total revenue recognized for a particular arrangement, any material changes in these allocations could impact the timing of revenue recognition, which could have a material effect on our financial position and results of operations. 
Recent Accounting Pronouncements
In September 2011, the Financial Accounting Standards Board (“FASB”) issued an accounting standard update intended to simplify testing goodwill for impairment. The amendments allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity will no longer be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that the fair value of the reporting unit is less than its carrying amount. The amendment becomes effective for annual and interim goodwill impairment tests performed for our fiscal year ending June 30, 2013, and early adoption is permitted. We elected to early adopt this accounting guidance at the beginning of the three months ended December 31, 2011 (see Note 5, “Goodwill and Purchased Intangible Assets,” to the Condensed Consolidated Financial Statements for a detailed description).
In June 2011, the FASB issued an accounting standard update requiring an increase in the prominence of items reported in other comprehensive income. The amendment eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders' equity and requires that the total of comprehensive income, the components of net income, and the components of other comprehensive income be presented in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendment also required presentation of adjustments for items that are reclassified from other comprehensive income in the statement where the components of net income and the components of other comprehensive income are presented, which was indefinitely deferred by the FASB in December 2011. The amendment (other than the portion regarding the presentation of reclassification adjustments which, as noted above, has been deferred indefinitely) became effective for our interim period ended September 30, 2012. The amendment did not have an impact on our financial position, results of operations or cash flows as it is disclosure-only in nature.

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Table of Contents


RESULTS OF OPERATIONS
Revenues and Gross Margin
 
Three months ended
 
 
 
 
(Dollar amounts in thousands)
September 30,
2012
 
June 30,
2012
 
September 30,
2011
 
Q1 FY13 vs.
Q4 FY12
 
Q1 FY13 vs.
Q1 FY12
Revenues:
 
 
 
 
 
 
 
 
 
 
 
Product
$
574,078

 
$
745,662

 
$
650,256

 
$
(171,584
)
 
(23
)%
 
$
(76,178
)
 
(12
)%
Service
146,631

 
146,803

 
146,220

 
(172
)
 
—
 %
 
411

 
—
 %
Total revenues
$
720,709

 
$
892,465

 
$
796,476

 
$
(171,756
)
 
(19
)%
 
$
(75,767
)
 
(10
)%
Costs of revenues
$
317,225

 
$
361,663

 
$
340,349

 
$
(44,438
)
 
(12
)%
 
$
(23,124
)
 
(7
)%
Gross margin percentage
56
%
 
59
%
 
57
%
 
 
 
 
 
 
 
 
Product revenues
Our business is cyclical with respect to the capital equipment procurement practices of semiconductor manufacturers, with revenues impacted by the investment patterns of such manufacturers.
Product revenues decreased during the three months ended September 30, 2012 compared to the three months ended June 30, 2012 as a result of the challenging demand environment for the semiconductor capital equipment industry, as customers revised their expansion plans in response to end-customer product demand levels and their need to absorb recent significant capital equipment purchases, as well as macro-economic uncertainty.
Product revenues decreased during the three months ended September 30, 2012 compared to the three months ended September 30, 2011, primarily due to lower levels of revenue backlog of $286 million at the start of the three months ended September 30, 2012 compared to $382 million at the start of the three months ended September 30, 2011.
Service revenues
Service revenues are generated from maintenance contracts, as well as billable time and material service calls made to our customers after the expiration of the warranty period. The amount of service revenues is typically a function of the number of post-warranty systems installed at our customers’ sites and the utilization of those systems. Service revenues during the three months ended September 30, 2012 remained flat compared to the three months ended June 30, 2012 and September 30, 2011.
Revenues by region
Revenues by region for the periods indicated were as follows: 
(Dollar amounts in thousands)
Three months ended
September 30, 2012
 
June 30, 2012
 
September 30, 2011
United States
$
149,988

 
21
%
 
$
131,112

 
15
%
 
$
198,243

 
25
%
Taiwan
276,299

 
38
%
 
270,507

 
30
%
 
223,289

 
28
%
Japan
88,715

 
12
%
 
77,969

 
9
%
 
134,815

 
17
%
Europe & Israel
59,160

 
8
%
 
72,520

 
8
%
 
92,996

 
12
%
Korea
70,247

 
10
%
 
271,511

 
30
%
 
79,598

 
10
%
Rest of Asia
76,300

 
11
%
 
68,846

 
8
%
 
67,535

 
8
%
Total
$
720,709

 
100
%
 
$
892,465

 
100
%
 
$
796,476

 
100
%
A significant portion of our revenues continues to be generated in Asia, where a substantial portion of the world’s semiconductor manufacturing capacity is located, and we expect that trend to continue.

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Gross margin
Our gross margin fluctuates with revenue levels and product mix and is affected by variations in costs related to manufacturing and servicing our products, including our ability to scale our operations efficiently and effectively in response to prevailing business conditions. Over the past several years, we have embarked on various advanced product development, customer satisfaction improvement and globalization initiatives to improve our competitiveness and gross margins.
The following tables summarize the major factors that contributed to the changes in gross margin percentage for the periods indicated:
 
Gross Margin Percentage
 
 
Gross Margin Percentage
Three months ended June 30, 2012
59.5
 %
 
Three months ended September 30, 2011
57.3
 %
Revenue volume of products and service
(1.2
)%
 
Revenue volume of products and service
0.1
 %
Mix of products and services sold
(0.1
)%
 
Mix of products and services sold
(1.0
)%
Manufacturing labor, overhead and efficiencies
(1.3
)%
 
Manufacturing labor, overhead and efficiencies
—
 %
Other service and manufacturing costs
(0.9
)%
 
Other service and manufacturing costs
(0.4
)%
Three months ended September 30, 2012
56.0
 %
 
Three months ended September 30, 2012
56.0
 %
Changes in gross margin percentage driven by revenue volume reflect our ability to leverage existing infrastructure in operating our business. It also includes the effect of fluctuations in average customer pricing and foreign exchange rates. Changes in gross margin percentage from mix of products and services sold reflect the impact of changes in the composition within product and service offerings, as well as differences in transaction-specific revenue realization. Changes in gross margin percentage from manufacturing labor, overhead and efficiencies reflect our ability to manage costs and drive productivity as we scale our manufacturing activity to respond to customer requirements; this includes the impact of capacity utilization, use of overtime and variability of cost structure. Changes in gross margin percentage from other service and manufacturing costs include the impact of customer support costs, including the efficiencies with which we deliver services to our customers, and the effectiveness with which we manage our production plans and inventory risk.
Our gross margin declined to 56.0% during the three months ended September 30, 2012 from 59.5% during the three months ended June 30, 2012 primarily due to lower revenue volume and lower factory utilization as a result of lower shipments.
Our gross margin declined to 56.0% during the three months ended September 30, 2012 from 57.3% during the three months ended September 30, 2011 primarily due to a less favorable mix of products sold.
Engineering, Research and Development (“R&D”)
(Dollar amounts in thousands)
Three months ended
 
 
 
 
 
 
 
 
September 30,
2012
 
June 30,
2012
 
September 30,
2011
 
Q1 FY13 vs.
Q4 FY12
 
Q1 FY13 vs.
Q1 FY12
R&D expenses
$
119,742

 
$
118,710

 
$
107,762

 
$
1,032

 
1
%
 
$
11,980

 
11
%
R&D expenses as a percentage of total revenues
17
%
 
13
%
 
14
%
 
 
 
 
 
 
 
 
R&D expenses during the three months ended September 30, 2012 increased compared to the three months ended June 30, 2012, primarily due to an increase in employee-related expenses of $1.6 million as a result of additional engineering headcount and an increase in engineering material costs of $1.9 million related to our next-generation products, offset by a benefit to R&D expense from external funding.
R&D expenses during the three months ended September 30, 2012 increased compared to the three months ended September 30, 2011, primarily due to an increase in engineering material costs of $7.5 million related to our next-generation products, an increase in employee-related expenses of $1.9 million as a result of annual compensation adjustments and additional engineering headcount and an increase in depreciation of fixed assets of $1.3 million.

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R&D expenses include the benefit of $4.0 million, $0.1 million and $3.6 million of external funding received during the three months ended September 30, 2012, June 30, 2012 and September 30, 2011, respectively, for certain strategic development programs from government grants.
Our future operating results will depend significantly on our ability to produce products and provide services that have a competitive advantage in our marketplace. To do this, we believe that we must continue to make substantial investments in our research and development. We remain committed to product development in new and emerging technologies as we address the yield challenges our customers face at future technology nodes.
Selling, General and Administrative (“SG&A”)
  
Three months ended
 
 
 
 
 
 
 
 
(Dollar amounts in thousands)
September 30,
2012
 
June 30,
2012