Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Consolidated Balance Sheets as of June 30, 2017 and 201659
Consolidated Statements of Operations for each of the three years in the period ended June 30, 201760
Consolidated Statements of Comprehensive Income for each of the three years in the period ended June 30, 201761
Consolidated Statements of Stockholders’ Equity for each of the three years in the period ended June 30, 201762
Consolidated Statements of Cash Flows for each of the three years in the period ended June 30, 201763
Notes to Consolidated Financial Statements64
Report of Independent Registered Public Accounting Firm103

KLA-TENCOR CORPORATION

Consolidated Balance Sheets

As of June 30,
(In thousands, except par value)20172016
ASSETS
Current assets:
Cash and cash equivalents$1,153,051$1,108,488
Marketable securities1,863,6891,382,806
Accounts receivable, net571,117613,233
Inventories732,988698,635
Other current assets71,22164,870
Total current assets4,392,0663,868,032
Land, property and equipment, net283,975278,014
Goodwill349,526335,177
Deferred income taxes291,967302,219
Purchased intangibles, net18,9634,331
Other non-current assets195,676174,659
Total assets$5,532,173$4,962,432
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable$147,380$106,517
Deferred system profit180,861174,551
Unearned revenue65,50759,147
Current portion of long-term debt249,983—
Other current liabilities649,431662,208
Total current liabilities1,293,1621,002,423
Non-current liabilities:
Long-term debt2,680,4743,057,936
Unearned revenue59,71356,336
Other non-current liabilities172,407156,623
Total liabilities4,205,7564,273,318
Commitments and contingencies (Notes 13 and 14)
Stockholders’ equity:
Preferred stock, $0.001 par value, 1,000 shares authorized, none outstanding——
Common stock, $0.001 par value, 500,000 shares authorized, 261,654 and 260,619 shares issued, 156,840 and 155,955 shares outstanding, as of June 30, 2017 and June 30, 2016, respectively157156
Capital in excess of par value529,126452,818
Retained earnings848,457284,825
Accumulated other comprehensive income (loss)(51,323)(48,685)
Total stockholders’ equity1,326,417689,114
Total liabilities and stockholders’ equity$5,532,173$4,962,432

See accompanying notes to consolidated financial statements.

KLA-TENCOR CORPORATION

Consolidated Statements of Operations

Year ended June 30,
(In thousands, except per share amounts)201720162015
Revenues:
Product$2,703,934$2,250,260$2,125,396
Service776,080734,233688,653
Total revenues3,480,0142,984,4932,814,049
Costs and expenses:
Costs of revenues1,287,5471,163,3911,215,229
Research and development526,870481,258530,616
Selling, general and administrative389,336379,399406,864
Loss on extinguishment of debt and other, net——131,669
Interest expense122,476122,887106,009
Other expense (income), net(19,461)(20,634)(10,469)
Income before income taxes1,173,246858,192434,131
Provision for income taxes247,170153,77067,973
Net income$926,076$704,422$366,158
Net income per share:
Basic$5.92$4.52$2.26
Diluted$5.88$4.49$2.24
Cash dividends declared per share (including a special cash dividend of $16.50 per share declared during the three months ended December 31, 2014)$2.14$2.08$18.50
Weighted-average number of shares:
Basic156,468155,869162,282
Diluted157,481156,779163,701

See accompanying notes to consolidated financial statements.

KLA-TENCOR CORPORATION

Consolidated Statements of Comprehensive Income

Year ended June 30,
(In thousands)201720162015
Net income$926,076$704,422$366,158
Other comprehensive income (loss):
Currency translation adjustments:
Change in currency translation adjustments2,332(3,898)(20,740)
Change in income tax benefit or expense(562)1,3998,086
Net change related to currency translation adjustments1,770(2,499)(12,654)
Cash flow hedges:
Change in net unrealized gains or losses10,138(9,622)13,745
Reclassification adjustments for net gains or losses included in net income(3,222)3,722(6,615)
Change in income tax benefit or expense(2,470)2,122(2,565)
Net change related to cash flow hedges4,446(3,778)4,565
Net change related to unrecognized losses and transition obligations in connection with defined benefit plans(1,534)(4,552)(147)
Available-for-sale securities:
Change in net unrealized gains or losses(8,568)3,549(1,069)
Reclassification adjustments for net gains or losses included in net income(191)(312)(2,119)
Change in income tax benefit or expense1,439(520)1,122
Net change related to available-for-sale securities(7,320)2,717(2,066)
Other comprehensive income (loss)(2,638)(8,112)(10,302)
Total comprehensive income$923,438$696,310$355,856

See accompanying notes to consolidated financial statements.

KLA-TENCOR CORPORATION

Consolidated Statements of Stockholders’ Equity

Common Stock and Capital in Excess of Par ValueRetained Earnings (Accumulated Deficit)Accumulated Other Comprehensive Income (Loss)Total Stockholders’ Equity
(In thousands, except per share amounts)SharesAmount
Balances as of June 30, 2014165,448$1,220,504$2,479,113$(30,271)$3,669,346
Net income——366,158—366,158
Other comprehensive loss———(10,302)(10,302)
Net issuance under employee stock plans1,65816,186——16,186
Repurchase of common stock(9,255)(26,891)(581,965)—(608,856)
Cash dividends ($18.50 per share including a special cash dividend of $16.50 per share declared during the three months ended December 31, 2014) and dividend equivalents declared—(807,391)(2,275,668)—(3,083,059)
Stock-based compensation expense—55,302——55,302
Tax benefit for equity awards—16,664——16,664
Balances as of June 30, 2015157,851474,374(12,362)(40,573)421,439
Net income——704,422—704,422
Other comprehensive loss———(8,112)(8,112)
Net issuance under employee stock plans1,58914,354——14,354
Repurchase of common stock(3,445)(10,049)(165,694)—(175,743)
Cash dividends ($2.08 per share) and dividend equivalents declared—(82,295)(241,541)—(323,836)
Stock-based compensation expense—45,050——45,050
Tax benefit for equity awards—11,540——11,540
Balances as of June 30, 2016155,995452,974284,825(48,685)689,114
Net income——926,076—926,076
Other comprehensive loss———(2,638)(2,638)
Net issuance under employee stock plans1,08826,132——26,132
Repurchase of common stock(243)(766)(24,236)—(25,002)
Cash dividends ($2.14 per share) and dividend equivalents declared——(338,208)—(338,208)
Stock-based compensation expense—50,943——50,943
Balances as of June 30, 2017156,840$529,283$848,457$(51,323)$1,326,417

See accompanying notes to consolidated financial statements.

KLA-TENCOR CORPORATION

Consolidated Statements of Cash Flows

Year Ended June 30,
(In thousands)201720162015
Cash flows from operating activities:
Net income$926,076$704,422$366,158
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization57,83666,93280,536
Asset impairment charges3581,3962,126
Loss on extinguishment of debt and other, net——131,669
Non-cash stock-based compensation expense50,94345,05055,302
Deferred income taxes4,00719,804(24,245)
Excess tax benefit from equity awards—(11,936)(15,403)
Net gain on sales of marketable securities and other investments(1,207)(5,887)(2,119)
Changes in assets and liabilities, net of business acquisition:
Decrease (increase) in accounts receivable, net39,898(8,292)(118,520)
Decrease (increase) in inventories(46,433)(67,579)27,500
Decrease (increase) in other assets(26,596)14,61311,135
Increase in accounts payable40,1003,109848
Increase in deferred system profit6,31025,860768
Increase (decrease) in other liabilities28,373(27,796)90,151
Net cash provided by operating activities1,079,665759,696605,906
Cash flows from investing activities:
Acquisition of non-marketable securities(3,430)——
Business acquisition, net of cash acquired(28,560)——
Capital expenditures, net(38,594)(31,741)(45,791)
Proceeds from sale of assets2,9477,076—
Purchases of available-for-sale securities(1,626,983)(1,175,720)(1,731,551)
Proceeds from sale of available-for-sale securities434,873737,8171,993,396
Proceeds from maturity of available-for-sale securities699,293602,446699,108
Purchases of trading securities(97,525)(68,378)(60,808)
Proceeds from sale of trading securities97,09373,18763,867
Net cash provided by (used in) investing activities(560,886)144,687918,221
Cash flows from financing activities:
Proceeds from issuance of debt, net of issuance costs——3,224,906
Repayment of debt(130,000)(135,000)(916,117)
Issuance of common stock45,35938,29847,008
Tax withholding payments related to vested and released restricted stock units(19,169)(23,942)(30,229)
Common stock repurchases(25,002)(181,711)(602,888)
Payment of dividends to stockholders(343,993)(346,283)(3,041,055)
Excess tax benefit from equity awards—11,93615,403
Net cash used in financing activities(472,805)(636,702)(1,302,972)
Effect of exchange rate changes on cash and cash equivalents(1,411)2,782(13,991)
Net increase in cash and cash equivalents44,563270,463207,164
Cash and cash equivalents at beginning of period1,108,488838,025630,861
Cash and cash equivalents at end of period$1,153,051$1,108,488$838,025
Supplemental cash flow disclosures:
Income taxes paid, net$234,053$105,187$69,681
Interest paid$119,998$120,433$92,982
Non-cash activities:
Purchase of land, property and equipment - investing activities$3,299$2,035$1,843
Business acquisition holdback amounts- investing activities$5,318$—$—
Unsettled common stock repurchase - financing activities$—$—$5,968
Dividends payable - financing activities$13,772$19,556$42,002

See accompanying notes to consolidated financial statements.

KLA-TENCOR CORPORATION

Notes to Consolidated Financial Statements

NOTE 1— DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of Business and Principles of Consolidation. KLA-Tencor Corporation (“KLA-Tencor” or the “Company”) is a leading supplier of process control and yield management solutions for the semiconductor and related nanoelectronics industries. KLA-Tencor’s broad portfolio of inspection and metrology products, and related service, software and other offerings primarily supports integrated circuit, which is referred to as an “IC” or “chip,” manufacturers throughout the entire semiconductor fabrication process, from research and development to final volume production. KLA-Tencor provides 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, KLA-Tencor also provides a range of technology solutions to a number of other high technology industries, including the advanced packaging, light emitting diode (“LED”), power devices, compound semiconductor, and data storage industries, as well as general materials research. Headquartered in Milpitas, California, KLA-Tencor has subsidiaries both in the United States and in key markets throughout the world.

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

Terminated Merger Agreement. On October 20, 2015, the Company entered into an Agreement and Plan of Merger and Reorganization (the “Merger Agreement” or “Merger”) with Lam Research Corporation (“Lam Research”) which was subject to regulatory approvals. On October 5, 2016, the parties mutually agreed to terminate the Merger Agreement and no termination fees were payable by either party.

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

Cash Equivalents and Marketable Securities. All highly liquid debt instruments with original or remaining maturities of less than three months at the date of purchase are considered to be cash equivalents. Marketable securities are generally classified as available-for-sale for use in current operations, if required, and are reported at fair value, with unrealized gains and losses, net of tax, presented as a separate component of stockholders’ equity under the caption “Accumulated other comprehensive income (loss).” All realized gains and losses and unrealized losses resulting from declines in fair value that are other than temporary are recorded in earnings in the period of occurrence. The specific identification method is used to determine the realized gains and losses on investments. For all investments in debt and equity securities, the Company assesses whether the impairment is other than temporary. If the fair value of a debt security is less than its amortized cost basis, an impairment is considered other than temporary if (i) the Company has the intent to sell the security or it is more likely than not that the Company will be required to sell the security before recovery of its entire amortized cost basis, or (ii) the Company does not expect to recover the entire amortized cost of the security. If an impairment is considered other than temporary based on condition (i), the entire difference between the amortized cost and the fair value of the security is recognized in earnings. If an impairment is considered other than temporary based on condition (ii), the amount representing credit losses, defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis of the debt security, will be recognized in earnings, and the amount relating to all other factors will be recognized in other comprehensive income (loss). The Company evaluates both qualitative and quantitative factors such as duration and severity of the unrealized losses, credit ratings, default and loss rates of the underlying collateral, structure and credit enhancements to determine if a credit loss may exist.

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

Variable Interest Entities. KLA-Tencor uses a qualitative approach in assessing the consolidation requirement for variable interest entities. The approach focuses on identifying which enterprise has the power to direct the activities that most significantly impact the variable interest entity’s economic performance and which enterprise has the obligation to absorb losses or the right to receive benefits from the variable interest entity. In the event that the Company is the primary beneficiary of a variable interest entity, the assets, liabilities, and results of operations of the variable interest entity will be included in the Company’s Consolidated Financial Statements. The Company has concluded that none of the Company’s equity investments require consolidation as per the Company’s most recent qualitative assessment.

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

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

Property and Equipment. Property and equipment are recorded at cost, net of accumulated depreciation. Depreciation of property and equipment is based on the straight-line method over the estimated useful lives of the assets. The following table sets forth the estimated useful life for various asset categories:

Asset CategoryRange of Useful Lives
Buildings30 to 35 years
Leasehold improvementsShorter of 15 years or lease term
Machinery and equipment2 to 5 years
Office furniture and fixtures7 years

Construction-in-process assets are not depreciated until the assets are placed in service. Depreciation expense for the fiscal years ended June 30, 2017, 2016 and 2015 was $49.1 million, $52.6 million and $55.8 million, respectively.

Goodwill and Purchased Intangible Assets. KLA-Tencor assesses goodwill for impairment annually as well as whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Long-lived purchased intangible assets are tested for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. See Note 6, “Goodwill and Purchased Intangible Assets” for additional details.

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

Concentration of Credit Risk. Financial instruments that potentially subject KLA-Tencor to significant concentrations of credit risk consist primarily of cash equivalents, short-term marketable securities, trade accounts receivable and derivative financial instruments used in hedging activities. The Company invests in a variety of financial instruments, such as, but not limited to, certificates of deposit, corporate debt and municipal securities, United States Treasury and Government agency securities, and equity securities and, by policy, limits the amount of credit exposure with any one financial institution or commercial issuer. The Company has not experienced any material credit losses on its investments.

A majority of the Company’s accounts receivable are derived from sales to large multinational semiconductor manufacturers located throughout the world, with a majority located in Asia. In recent years, the Company’s customer base has become increasingly concentrated due to corporate consolidations, acquisitions and business closures, and to the extent that these customers experience liquidity issues in the future, the Company may be required to incur additional bad debt expense

with respect to trade receivables. The Company performs ongoing credit evaluations of its customers’ financial condition and generally requires no collateral to secure accounts receivable. The Company maintains an allowance for potential credit losses based upon expected collectibility risk of all accounts receivable. In addition, the Company may utilize letters of credit or non-recourse factoring to mitigate credit risk when considered appropriate.

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

The following customers each accounted for more than 10% of total revenues for the indicated periods:

Year ended June 30,
201720162015
Samsung Electronics Co., Ltd.Micron Technology, Inc.Intel Corporation
Taiwan Semiconductor Manufacturing Company LimitedTaiwan Semiconductor Manufacturing Company LimitedSamsung Electronics Co., Ltd.
Taiwan Semiconductor Manufacturing Company Limited

The following customers each accounted for more than 10% of net accounts receivable as of the dates indicated below:

As of June 30,
20172016
Samsung Electronics Co., Ltd.SK Hynix, Inc.
Taiwan Semiconductor Manufacturing Company LimitedTaiwan Semiconductor Manufacturing Company Limited

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

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

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

All of the Company’s derivative financial instruments are recorded at fair value based upon quoted market prices for comparable instruments adjusted for risk of counterparty non-performance. For derivative instruments designated and qualifying as cash flow hedges of forecasted foreign currency denominated transactions expected to occur within twelve to eighteen months, the effective portion of the gain or loss on these hedges is reported as a component of “Accumulated other comprehensive income (loss)” in stockholders’ equity, and is reclassified into earnings when the hedged transaction affects earnings. If the transaction being hedged fails to occur, or if a portion of any derivative is (or becomes) ineffective, the gain or loss on the associated financial instrument is recorded immediately in earnings. For derivative instruments used to hedge existing foreign currency denominated assets or liabilities, the gains or losses on these hedges are recorded immediately in earnings to offset the changes in the fair value of the assets or liabilities being hedged.

Warranty. The Company provides standard warranty coverage on its systems for 40 hours per week for 12 months, providing labor and parts necessary to repair and maintain 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 regular basis. The actual product performance and/or field expense profiles may differ, and in those cases the Company adjusts its warranty accruals accordingly (see Note 13, “Commitments and Contingencies”).

Revenue Recognition. The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable, and collectibility is reasonably assured. The Company derives revenue from three sources—sales of systems, spare parts and services. In general, the Company recognizes revenue for systems when the system has been installed, is operating according to predetermined specifications and is accepted by the customer. When the Company has demonstrated a history of successful installation and acceptance, the Company recognizes revenue upon delivery and customer acceptance. Under certain circumstances, however, the Company recognizes revenue prior to acceptance from the customer, as follows:

•When the customer fab has previously accepted the same tool, with the same specifications, and when the Company can objectively demonstrate that the tool meets all of the required acceptance criteria.
•When system sales to independent distributors have no installation requirement, contain no acceptance agreement, and 100% of the payment is due based upon shipment.
•When the installation of the system is deemed perfunctory.
•When the customer withholds acceptance due to issues unrelated to product performance, in which case revenue is recognized when the system is performing as intended and meets predetermined specifications.

In circumstances in which the Company recognizes revenue prior to installation, the portion of revenue associated with installation is deferred based on estimated fair value, and that revenue is recognized upon completion of the installation.

In many instances, products are sold in stand-alone arrangements. Services are sold separately through renewals of annual maintenance contracts. The Company has multiple element revenue arrangements in cases where certain elements of a sales arrangement are not delivered and accepted in one reporting period. To determine the relative fair value of each element in a revenue arrangement, the Company allocates arrangement consideration based on the selling price hierarchy. For substantially all of the arrangements with multiple deliverables pertaining to products and services, the Company uses vendor-specific objective evidence (“VSOE”) or third-party evidence (“TPE”) to allocate the selling price to each deliverable. The Company determines TPE based on historical prices charged for products and services when sold on a stand-alone basis. When the Company is unable to establish relative selling price using VSOE or TPE, the Company uses estimated selling price (“ESP”) in its allocation of arrangement consideration. The objective of ESP is to determine the price at which the Company would transact a sale if the product or service were sold on a stand-alone basis. ESP could potentially be used for new or customized products. The Company regularly reviews relative selling prices and maintains internal controls over the establishment and updates of these estimates.

In a multiple element revenue arrangement, the Company defers revenue recognition associated with the relative fair value of each undelivered element until that element is delivered to the customer. To be considered a separate element, the product or service in question must represent a separate unit of accounting, which means that such product or service must fulfill the following criteria: (a) the delivered item(s) has value to the customer on a stand-alone basis; and (b) if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered

item(s) is considered probable and substantially in the control of the Company. If the arrangement does not meet all the above criteria, the entire amount of the sales contract is deferred until all elements are accepted by the customer.

Trade-in rights are occasionally granted to customers to trade in tools in connection with subsequent purchases. The Company estimates the value of the trade-in right and reduces the revenue recognized on the initial sale. This amount is recognized at the earlier of the exercise of the trade-in right or the expiration of the trade-in right.

The Company enters into volume purchase agreements with some of its customers. The Company accrues the estimated credits earned by its customers for such incentives, and in situations when the credit levels vary depending upon sales volume, the Company updates its accrual based on the amount that the Company estimates will be purchased pursuant to the volume purchase agreements. Accruals for customer credits are recorded as an offset to revenue or deferred revenue.

Spare parts revenue is recognized when the product has been shipped, risk of loss has passed to the customer and collection of the resulting receivable is probable.

Service and maintenance contract revenue is recognized ratably over the term of the maintenance contract. Revenue from services performed in the absence of a maintenance contract, including consulting and training revenue, is recognized when the related services are performed and collectibility is reasonably assured.

The Company sells stand-alone software that is subject to software revenue recognition guidance. The Company periodically reviews selling prices to determine whether VSOE exists, and in situations where the Company is unable to establish VSOE for undelivered elements such as post-contract service, revenue is recognized ratably over the term of the service contract.

The Company also defers the fair value of non-standard warranty bundled with equipment sales as unearned revenue. Non-standard warranty includes services incremental to the standard 40-hour per week coverage for 12 months. Non-standard warranty is recognized ratably as revenue when the applicable warranty term period commences.

The deferred system profit balance equals the value of products that have been shipped and billed to customers which have not met the Company’s revenue recognition criteria, less applicable product and warranty costs. Deferred system profit does not include the profit associated with product shipments to certain customers in Japan, to whom title does not transfer until customer acceptance. Shipments to such customers in Japan are classified as inventory at cost until the time of acceptance.

Research and Development Costs. Research and development costs are expensed as incurred.

Shipping and Handling Costs. Shipping and handling costs are included as a component of cost of sales.

Accounting for Stock-Based Compensation Plans. The Company accounts for stock-based awards granted to employees for services based on the fair value of those awards. The fair value of stock-based awards is measured at the grant date and is recognized as expense over the employee’s requisite service period. The fair value for restricted stock units granted without “dividend equivalent” rights is determined using the closing price of the Company’s common stock on the grant date, adjusted to exclude the present value of dividends which are not accrued on the restricted stock units. The fair value for restricted stock units granted with “dividend equivalent” rights is determined using the closing price of the Company’s common stock on the grant date. The award holder is not entitled to receive payments under dividend equivalent rights unless the associated restricted stock unit award vests (i.e., the award holder is entitled to receive credits, payable in cash or shares of the Company’s common stock, equal to the cash dividends that would have been received on the shares of common stock underlying the restricted stock units had the shares been issued and outstanding on the dividend record date, but such dividend equivalents are only paid subject to the recipient satisfying the vesting requirements of the underlying award). Additionally, the Company estimates forfeitures based on historical experience and revises those estimates in subsequent periods if actual forfeitures differ from the estimated amounts. The fair value is determined using a Black-Scholes valuation model for purchase rights under the Employee Stock Purchase Plan. 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. The expected stock price volatility assumption is based on the market-based historical implied volatility from traded options of the Company’s common stock.

Accounting for Cash-Based Long-Term Incentive Compensation. Cash-based long-term incentive (“Cash LTI”) awards issued to employees under the Company’s Cash LTI program vests in three or four equal installments, with one-third or one-fourth of the aggregate amount of the Cash LTI award vesting on each yearly anniversary of the grant date over a three or four-year period. In order to receive payments under a Cash LTI award, participants must remain employed by the Company as of the applicable award vesting date. Compensation expense related to the Cash LTI awards is recognized over the vesting term, which is adjusted for the impact of estimated forfeitures.

Accounting for Non-qualified Deferred Compensation Plan. The Company has a non-qualified deferred compensation plan (known as “Executive Deferred Savings Plan”) under which 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 the Company. The Company invests these funds in certain mutual funds and such investments are classified as trading securities in the consolidated balance sheets. Distributions from the Executive Deferred Savings Plan commence following a participant’s retirement or termination of employment or on a specified date allowed per the Executive Deferred Savings Plan provisions, except in cases where such distributions are required to be delayed in order to avoid a prohibited distribution under Internal Revenue Code Section 409A. Participants can generally elect the distributions to be paid in lump sum or quarterly cash payments over a scheduled period for up to 15 years and are allowed to make subsequent changes to their existing elections as permissible under the Executive Deferred Savings Plan provisions. The liability associated with the Executive Deferred Savings Plan is included as a component of other current liabilities in the consolidated balance sheets. Changes in the Executive Deferred Savings Plan liability is recorded in selling, general and administrative expense in the consolidated statements of operations. The expense (benefit) associated with changes in the liability included in selling, general and

administrative expense was $20.9 million, $(0.8) million and $10.4 million for the fiscal years ended June 30, 2017, 2016 and 2015, respectively. The Company also has a deferred compensation asset that corresponds to the liability under the Executive Deferred Savings Plan and it is included as a component of other non-current assets in the consolidated balance sheets. Changes in the Executive Deferred Savings Plan assets are recorded as gains (losses), net in selling, general and administrative expense in the consolidated statements of operations. The amount of net gains included in selling, general and administrative expense were $20.8 million, $0.1 million and $10.4 million for the fiscal years ended June 30, 2017, 2016 and 2015, respectively.

Income Taxes. The Company accounts for income taxes in accordance with the authoritative guidance, which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. The guidance also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that certain deferred tax asset will not be realized. The Company has determined that a valuation allowance is necessary against certain deferred tax assets, but it anticipates that its future taxable income will be sufficient to recover the remainder of its deferred tax assets. However, should there be a change in the Company’s ability to recover its deferred tax assets that are not subject to a valuation allowance, the Company could be required to record an additional valuation allowance against such deferred tax assets. This would result in an increase to the Company’s tax provision in the period in which the Company determines that the recovery is not probable.

The Company applies a two-step approach, based on authoritative guidance, to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained in audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement. The Company reevaluates these uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit and new audit activity. Any change in these factors could result in the recognition of a tax benefit or an additional charge to the tax provision.

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 dilutive potential shares of common stock had been issued. The dilutive effect of restricted stock units and options is reflected in diluted net income per share by application of the treasury stock method. The dilutive securities are excluded from the computation of diluted net loss per share when a net loss is recorded for the period as their effect would be anti-dilutive.

Contingencies and Litigation. The Company is subject to the possibility of losses from various contingencies. Considerable judgment is necessary to estimate the probability and amount of any loss from such contingencies. An accrual is made when it is probable that a liability has been incurred or an asset has been impaired and the amount of loss can be reasonably estimated. The Company accrues a liability and recognizes as expense the estimated costs expected to be incurred over the next twelve months to defend or settle asserted and unasserted claims existing as of the balance sheet date. See Note 13, “Commitments and Contingencies” and Note 14, “Litigation and Other Legal Matters” for additional details.

Reclassifications. Certain reclassifications have been made to prior year financial statements to conform to the current year presentation. The reclassifications had no effect on the Consolidated Statements of Operations, Comprehensive Income, Stockholder’s Equity and Cash Flows.

Recent Accounting Pronouncements

Recently Adopted

In April 2015, the Financial Accounting Standards Board (“FASB”) issued an accounting standard update for customer’s cloud based fees. The guidance changes what a customer must consider in determining whether a cloud computing arrangement contains a software license. If the arrangement contains a software license, the customer would account for the fees related to the software license element in accordance with guidance related to internal use software; if the arrangement does not contain a software license, the customer would account for the arrangement as a service contract. The Company adopted this update beginning in the first quarter of its fiscal year ended June 30, 2017 on a prospective basis and there was no impact of adoption on its consolidated financial statements.

In September 2015, the FASB issued an accounting standard update on simplifying the accounting for measurement-period adjustments for business combinations. This standard requires an acquirer in a business combination to recognize an impact of a measurement period adjustment in the reporting period in which the adjustment amounts are determined, rather than retrospectively adjusting previously reported amounts. The standard is effective for the Company beginning in the first quarter of its fiscal year ended June 30, 2017. The Company adopted the standard in the fiscal year ended June 30, 2017 and there was no impact of adoption on its consolidated financial statements.

In March 2016, the FASB issued an accounting standard update to simplify certain aspects of share-based payment awards to employees, including the accounting for income taxes, an option to recognize gross stock-based compensation expense with actual forfeitures recognized as they occur and statutory tax withholding requirements, as well as certain classifications in the statement of cash flows. The update is effective for the Company beginning in the first quarter of its fiscal year ending June 30, 2018, with early adoption permitted and all of the guidance must be adopted in the same period. However, the Company elected to early-adopt this standard update beginning in the first quarter of its fiscal year ended June 30, 2017.

Impact to Consolidated Statements of Operations

The primary impact of adopting the standard update is a change in the recording of the excess tax benefits or deficiencies from share-based payments. Before adoption, the Company recognized the excess tax benefits or deficiencies related to stock-based compensation as a credit or charge to additional paid-in capital (“APIC”) in the Company’s Consolidated Balance Sheets. Under the standard update, these excess tax benefits or deficiencies are recognized as a discrete tax benefit or discrete tax expense in the income tax provision in the Company’s Consolidated Statement of Operations. For the fiscal year ended June 30, 2017, the Company recognized a discrete tax benefit of $6.6 million related to net excess tax benefits mainly from stock-based compensation and dividend equivalents. The standard update requires companies to adopt the amendment related to accounting for excess tax benefits or deficiencies on a prospective basis only and as a result, prior periods were not retrospectively adjusted.

Impact to Consolidated Statements of Cash Flows

In addition to the income tax consequence as described above, the standard update for share-based payment requires that cash flows from excess tax benefits related to share-based payments be reported as operating activities in the Consolidated Statements of Cash Flows. Previously, cash flows from excess tax benefit related to share-based payments were reported as financing activities. The standard update allows for two methods of adoption which are prospective or retrospective application. The Company elected to adopt this amendment on a prospective basis and as a result, prior periods were not retrospectively adjusted.

Updates Not Yet Effective

In May 2014, the FASB issued an accounting standard update regarding revenue from customer contracts to transfer goods and services or non-financial assets unless the contracts are covered by other standards (for example, insurance or lease contracts). Under the new guidance, an entity should recognize revenue in connection with the transfer of promised goods or services to customers in an amount that reflects the consideration that the entity expects to be entitled to receive in exchange for those goods or services. In addition, the new standard requires that reporting companies disclose the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new standard is effective for the Company beginning in the first quarter of its fiscal year ending June 30, 2019 with early adoption permitted beginning in the first quarter of its fiscal year ending June 30, 2018. The new standard may be applied retrospectively to each prior period presented (“full retrospective transition method”) or retrospectively with the cumulative effect recognized as of the date of adoption (“modified retrospective transition method”). The FASB has also issued several amendments to the standard since its initial issuance. The Company intends to adopt the new standard in the first quarter of its fiscal year ending June 30, 2019 and elected a modified retrospective transition method to be applied to completed and incomplete contracts as of adoption date.

To address the significant implementation requirements of the accounting standard update, the Company has established a revenue project steering committee and cross-functional implementation team for the implementation of the standard, including a review of all significant revenue arrangements to identify any differences in the timing, measurement, presentation of revenue recognition including new disclosure requirements.

The Company has completed its preliminary assessment of the potential impact that the implementation of this new standard will have on its consolidated financial statements and believes the most significant impact may include the following:

•The Company will account for the standard 12-month warranty for a majority of its products that is not separately paid for by the customers as a performance obligation since the Company provides for necessary repairs as well as preventive maintenance services for such products. The estimated fair value of the service will be deferred and recognized ratably as revenue over the warranty period.
•The Company will generally recognize revenue for its products at a point of time based on judgment of whether or not the Company has satisfied its performance obligation by transferring control of the product to the customer. In evaluating whether or not control has been transferred to the customer, the Company will consider whether or not certain indicators have been met. Not all of the indicators need to be met for the Company to conclude that control has transferred to the customer. The Company will be required to use significant judgment to evaluate whether or not the factors indicate that the customer has obtained control of the product and the following factors will be considered in evaluating whether or not control has transferred to the customer: the Company has a present right to payment; the customer has legal title; the customer has physical possession; the customer has significant risk and rewards of ownership; and the customer has accepted the product, or whether customer acceptance is considered a formality based on history of acceptance of similar products.
•The Company will recognize revenue for software licenses at the time of delivery since the Vendor Specific Objective Evidence (“VSOE”) requirement for undelivered element such as post-contract support is eliminated and companies are allowed to use established or best estimate selling price for the undelivered element to allocate and defer the revenue. As a result, the Company will recognize as revenue a portion of the sales price upon delivery of the software, compared to the current practice of recognizing the entire sales price ratably over the term of the service contract due to the lack of VSOE.

The Company will continue to assess the impact of the new standard, including potential changes to the accounting policies, business processes, systems and internal controls over financial reporting and its preliminary assessment of the impact is subject to change.

In July 2015, the FASB issued an accounting standard update for the subsequent measurement of inventory. The amended guidance requires entities to measure inventory at the lower of cost or net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. The requirement would replace the current lower of cost or market evaluation and the accounting guidance is unchanged for inventory measured using last-in, first-out (“LIFO”) or the retail inventory method. The update is effective for the Company beginning in the first quarter of the Company’s fiscal year ending June 30, 2018 and should be applied prospectively with early adoption permitted as of the beginning of an interim or annual reporting period. The Company does not expect that this accounting standard update will have a material effect on its consolidated financial statements upon adoption.

In January 2016, the FASB issued an accounting standard update that changes the accounting for financial instruments primarily related to equity investments (other than those accounted for under the equity method of accounting or those that result in consolidation of the investee), financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. The accounting standard update is effective for the Company beginning in the first quarter of its fiscal year ending 2019, and early adoption is permitted. The Company is currently evaluating the impact of this accounting standard update on its consolidated financial statements.

In February 2016, the FASB issued an accounting standard update which amends the existing accounting standards for leases. Consistent with current guidance, the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification. Under the new guidance, a lessee will be required to recognize assets and liabilities for all leases with lease terms of more than 12 months. The update is effective for the Company beginning in the first quarter of its fiscal year ending June 30, 2020 using a modified retrospective transition method. Early adoption is permitted. The Company is currently evaluating the impact of this accounting standard update on its consolidated financial statements.

In June 2016, the FASB issued an accounting standard update that changes the accounting for recognizing impairments of financial assets. Under the update, credit losses for certain types of financial instruments will be estimated based on expected losses. The update also modifies the impairment models for available-for-sale debt securities and for purchased financial assets with credit deterioration since their origination. The update is effective for the Company beginning in the first quarter of its fiscal year ending June 30, 2021, with early adoption permitted starting in the first quarter of fiscal year ending 2020. The Company is currently evaluating the impact of this accounting standard update on its consolidated financial statements.

In October 2016, the FASB issued an accounting standard update to recognize the income tax consequences of intra-entity transfers of assets other than inventory when they occur. This eliminates the exception to postpone recognition until the asset has been sold to an outside party. This standard is effective for the Company beginning in the first quarter of its fiscal year ending 2019, and early adoption is permitted. It is required to be applied on a modified retrospective basis through a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The Company is currently evaluating the impact of this accounting standard update on its consolidated financial statements.

In January 2017, the FASB issued an accounting standard update to simplify the subsequent measurement of goodwill by removing the second step of the two-step impairment test, which requires an entity to determine the fair value of assets and liabilities similar to what is required in a purchase price allocation. Under the update, goodwill impairment will be calculated as the amount by which a reporting unit's carrying value exceeds its fair value. This standard is effective for the Company beginning in the first quarter of its fiscal year ending 2021 and requires a prospective approach to adoption. Early adoption is permitted. The Company is currently evaluating the impact of this accounting standard update on its consolidated financial statements.

In January 2017, the FASB issued an accounting standard on clarifying the definition of a business, with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The standard is effective for the Company for its fiscal year ending June 30, 2019. The Company is currently evaluating the impact of this accounting standard update on its consolidated financial statements.

In March 2017, the FASB issued an accounting standard update that changes the income statement classification of net periodic benefit cost related to defined benefit pension and/or other postretirement benefit plans. Under the update, employers will present the service cost component of net periodic benefit cost in the same statement of operations line item(s) as other employee compensation costs arising from services rendered during the period. Only the service cost component will be eligible for capitalization in assets. Employers will present the other components of the net periodic benefit costs separately from the line item(s) that includes the service cost and outside of any subtotal of operating income, if one is presented. The standard is effective for the Company beginning in the first quarter of its fiscal year ending June 30, 2019 and early adoption is permitted. It is required to be applied retrospectively, except for the provision regarding capitalization in assets which is required to be applied prospectively. The Company is currently evaluating the impact of this accounting standard update on its consolidated financial statements.

In May 2017, the FASB issued an accounting standard update regarding stock compensation that provides guidance about which changes to the terms and conditions of a share-based payment award require an entity to apply modification accounting in order to reduce diversity in practice and reduce complexity. The update is effective for the Company beginning in the first quarter of the Company’s fiscal year ending June 30, 2019 and should be applied prospectively with early adoption permitted as of the beginning of an interim or annual reporting period. The Company is currently evaluating the impact of this accounting standard update on its consolidated financial statements.

NOTE 2 — FAIR VALUE MEASUREMENTS

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

Fair Value of Financial Instruments. KLA-Tencor has evaluated the estimated fair value of financial instruments using available market information and valuations as provided by third-party sources. The use of different market assumptions and/or estimation methodologies could have a significant effect on the estimated fair value amounts. The fair value of the Company’s cash equivalents, accounts receivable, accounts payable and other current assets and liabilities approximate their carrying amounts due to the relatively short maturity of these items.

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

Level 1Valuations based on quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.
Level 2Valuations 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 3Valuations 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.

The Company’s financial instruments were classified within Level 1 or Level 2 of the fair value hierarchy as of June 30, 2017, because they were valued using quoted market prices, broker/dealer quotes or alternative pricing sources with observable levels of price transparency. As of June 30, 2017, the types of instruments valued based on quoted market prices in active markets included money market funds, U.S. Treasury securities and certain U.S. Government agency securities. Such instruments are generally classified within Level 1 of the fair value hierarchy.

As of June 30, 2017, the types of instruments valued based on other observable inputs included corporate debt securities, sovereign securities and certain U.S. Government agency securities . The market inputs used to value these instruments generally consist of market yields, reported trades and broker/dealer quotes. Such instruments are generally classified within Level 2 of the fair value hierarchy.

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

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 Consolidated Balance Sheet as follows:

As of June 30, 2017 (In thousands)TotalQuoted Prices in Active Markets for Identical Assets (Level 1)Significant Other Observable Inputs (Level 2)
Assets
Cash equivalents:
Corporate debt securities$76,472$—$76,472
Money market funds and other616,039616,039—
U.S. Government agency securities117,417—117,417
Sovereign securities10,050—10,050
Marketable securities:
Corporate debt securities1,042,723—1,042,723
Sovereign securities42,515—42,515
U.S. Government agency securities391,409368,12123,288
U.S. Treasury securities373,299373,299—
Total cash equivalents and marketable securities(1)2,669,9241,357,4591,312,465
Other current assets:
Derivative assets5,931—5,931
Other non-current assets:
Executive Deferred Savings Plan182,150136,14546,005
Total financial assets(1)$2,858,005$1,493,604$1,364,401
Liabilities
Other current liabilities:
Derivative liabilities$(1,275)$—$(1,275)
Total financial liabilities$(1,275)$—$(1,275)

(1) Excludes cash of $307.4 million held in operating accounts and time deposits of $39.4 million as of June 30, 2017.

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 Consolidated Balance Sheet as follows:

As of June 30, 2016 (In thousands)TotalQuoted Prices in Active Markets for Identical Assets (Level 1)Significant Other Observable Inputs (Level 2)
Assets
Cash equivalents:
Corporate debt securities$20,569$—$20,569
Money market funds and other626,156626,156—
U.S. Treasury securities68,74868,748—
Marketable securities:
Corporate debt securities657,905—657,905
Municipal securities5,016—5,016
Sovereign securities41,2576,42634,831
U.S. Government agency securities405,705385,73119,974
U.S. Treasury securities258,754258,754—
Total cash equivalents and marketable securities(1)2,084,1101,345,815738,295
Other current assets:
Derivative assets1,095—1,095
Other non-current assets:
Executive Deferred Savings Plan162,160106,14956,011
Total financial assets(1)$2,247,365$1,451,964$795,401
Liabilities
Other current liabilities:
Derivative liabilities$(11,647)$—$(11,647)
Total financial liabilities$(11,647)$—$(11,647)

(1) Excludes cash of $330.1 million held in operating accounts and time deposits of $77.1 million as of June 30, 2016.

There were no transfers between Level 1 and Level 2 fair value measurements during the fiscal year ended June 30, 2017 or 2016. 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 June 30, 2017 or 2016.

NOTE 3 — FINANCIAL STATEMENT COMPONENTS

Consolidated Balance Sheets

As of June 30,
(In thousands)20172016
Accounts receivable, net:
Accounts receivable, gross$592,753$634,905
Allowance for doubtful accounts(21,636)(21,672)
$571,117$613,233
Inventories:
Customer service parts$245,172$234,712
Raw materials240,389208,689
Work-in-process193,026187,733
Finished goods54,40167,501
$732,988$698,635
Other current assets:
Prepaid expenses$36,146$37,127
Income tax related receivables22,07118,190
Other current assets13,0049,553
$71,221$64,870
Land, property and equipment, net:
Land$40,617$40,603
Buildings and leasehold improvements319,306313,239
Machinery and equipment551,277507,378
Office furniture and fixtures21,32821,737
Construction-in-process4,5975,286
937,125888,243
Less: accumulated depreciation and amortization(653,150)(610,229)
$283,975$278,014
Other non-current assets:
Executive Deferred Savings Plan$182,150$162,160
Other non-current assets13,52612,499
$195,676$174,659
Other current liabilities:
Executive Deferred Savings Plan$183,603$162,289
Compensation and benefits172,707224,496
Customer credits and advances95,18881,994
Interest payable19,39619,395
Warranty45,45834,773
Income taxes payable17,04027,964
Other accrued expenses116,039111,297
$649,431$662,208
Other non-current liabilities:
Pension liabilities$72,801$69,418
Income taxes payable68,43950,365
Other non-current liabilities31,16736,840
$172,407$156,623

Accumulated Other Comprehensive Income (Loss)

The components of accumulated other comprehensive income (loss) (“OCI”) as of the dates indicated below were as follows:

(In thousands)Currency Translation AdjustmentsUnrealized Gains (Losses) on Available-for-Sale SecuritiesUnrealized Gains (Losses) on Cash Flow HedgesUnrealized Gains (Losses) on Defined Benefit PlansTotal
Balance as of June 30, 2017$(30,654)$(3,869)$5,221$(22,021)$(51,323)
Balance as of June 30, 2016$(32,424)$3,451$775$(20,487)$(48,685)

The effects on net income of amounts reclassified from accumulated OCI to the Consolidated Statements of Operations for the indicated periods were as follows (in thousands):

Location in the Consolidated Statements of OperationsYear ended June 30,
Accumulated OCI Components20172016
Unrealized gains (losses) on cash flow hedges from foreign exchange and interest rate contractsRevenues$2,846$(2,926)
Costs of revenues(378)(1,551)
Interest expense754755
Net gains reclassified from accumulated OCI$3,222$(3,722)
Unrealized gains (losses) on available-for-sale securitiesOther expense (income), net$191$312

The amounts reclassified out of accumulated OCI related to the Company’s defined benefit pension plans, which were recognized as a component of net periodic cost for the fiscal years ended June 30, 2017 and 2016 were $1.9 million and $1.4 million, respectively. For additional details, refer to Note 11, “Employee Benefit Plans.”

Consolidated Statements of Operations

Year ended June 30,
(In thousands)201720162015
Other expense (income), net:
Interest income$(23,270)$(14,507)$(12,545)
Foreign exchange losses, net6411,2351,764
Net realized gains on sale of investments(191)(311)(2,119)
Other3,359(7,051)2,431
$(19,461)$(20,634)$(10,469)

NOTE 4 — MARKETABLE SECURITIES

The amortized cost and fair value of marketable securities as of the dates indicated below were as follows:

As of June 30, 2017 (In thousands)Amortized CostGross Unrealized GainsGross Unrealized LossesFair Value
Corporate debt securities$1,120,548$598$(1,951)$1,119,195
Money market funds and other616,039——616,039
Sovereign securities52,621—(56)52,565
U.S. Government agency securities510,55362(1,789)508,826
U.S. Treasury securities374,67652(1,429)373,299
Subtotal2,674,437712(5,225)2,669,924
Add: Time deposits(1)39,389——39,389
Less: Cash equivalents845,639—(15)845,624
Marketable securities$1,868,187$712$(5,210)$1,863,689
As of June 30, 2016 (In thousands)Amortized CostGross Unrealized GainsGross Unrealized LossesFair Value
Corporate debt securities$676,259$2,372$(157)$678,474
Money market funds and other626,156——626,156
Municipal securities5,0142—5,016
Sovereign securities41,22438(5)41,257
U.S. Government agency securities404,889830(14)405,705
U.S. Treasury securities326,3211,181—327,502
Subtotal2,079,8634,423(176)2,084,110
Add: Time deposits(1)77,131——77,131
Less: Cash equivalents778,4511(17)778,435
Marketable securities$1,378,543$4,422$(159)$1,382,806

(1) Time deposits excluded from fair value measurements.

KLA-Tencor’s investment portfolio consists of both corporate and government securities that have a maximum maturity of three years. The longer the duration of these securities, the more susceptible they are to changes in market interest rates and bond yields. As yields increase, those securities with a lower yield-at-cost show a mark-to-market unrealized loss. All unrealized losses are due to changes in market interest rates, bond yields and/or credit ratings. The Company believes that it has the ability to realize the full value of all of these investments upon maturity. The following table summarizes the fair value and gross unrealized losses of the Company’s investments that were in an unrealized loss position as of the date indicated below:

As of June 30, 2017 (In thousands)Fair ValueGross Unrealized Losses(1)
Corporate debt securities$716,934$(1,940)
U.S. Government agency securities328,868(1,786)
U.S. Treasury securities324,555(1,429)
Sovereign securities42,515(55)
Total$1,412,872$(5,210)
(1)As of June 30, 2017, the amount of total gross unrealized losses related to investments that had been in a continuous loss position for 12 months or more was immaterial.

The contractual maturities of securities classified as available-for-sale, regardless of their classification on the Company’s Consolidated Balance Sheet, as of the date indicated below were as follows:

As of June 30, 2017 (In thousands)Amortized CostFair Value
Due within one year$661,679$661,184
Due after one year through three years1,206,5081,202,505
$1,868,187$1,863,689

Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Realized gains on available for sale securities for the fiscal years ended June 30, 2017, 2016 and 2015 were $0.4 million, $0.9 million and $2.4 million, respectively. Realized losses on available for sale securities were immaterial for all years presented.

NOTE 5 - BUSINESS COMBINATION

On June 9, 2017, the Company completed the acquisition of the outstanding shares of a privately-held company that designs and manufactures optical profilers and defect inspection systems for advanced semiconductor packaging, LED and data storage industries, for total purchase consideration of $36.9 million, including cash paid of $31.6 million at closing. The remaining acquisition holdback amount of $5.3 million will be paid before the end of calendar year 2017. The primary reason for the acquisition is to expand the Company’s portfolio of products.

The following table represents the preliminary purchase price allocation and summarizes the aggregate estimated fair value of the net assets acquired on the closing date of the acquisition:

(In thousands)Preliminary Purchase Price Allocation
Intangible assets$17,660
Goodwill14,280
Assets acquired (including cash and marketable securities of $3.2 million)6,294
Liabilities assumed(1,334)
Fair value of net assets acquired$36,900

The operating results of the acquired entity have been included in the Company’s consolidated financial statements for the fiscal year ending June 30, 2017. Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired. The $14.3 million of goodwill was assigned to the Global Service and Support (“GSS”), and the Other reporting units. None of the goodwill recognized is deductible for income tax purposes.

NOTE 6 — GOODWILL AND PURCHASED INTANGIBLE ASSETS

Goodwill

Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in the current and prior business combinations. The Company has four reporting units: Wafer Inspection, Patterning, GSS, and Others. The following table presents goodwill balances and the movements by reporting unit during the fiscal years ended June 30, 2017 and 2016:

(In thousands)Wafer InspectionPatterningGSSOthersTotal
Balance as of June 30, 2015$332,783(1)$2,480(2)$—$—$335,263
Goodwill reallocation(51,671)(3)50,775(3)—896(3)—
Foreign currency adjustment(86)———(86)
Balance as of June 30, 2016281,02653,255—896335,177
Acquired goodwill——2,85611,42414,280
Foreign currency adjustment69———69
Balance as of June 30, 2017$281,095$53,255$2,856$12,320$349,526
(1)The balance as of June 30, 2015, reflects goodwill for the Defect Inspection reporting unit under the old reporting structure which was renamed as Wafer Inspection under a new reporting structure after certain components were allocated out.
(2)The balance as of June 30, 2015, reflects goodwill for the Metrology reporting unit under the old reporting structure which was renamed as Patterning under a new reporting structure after certain components were allocated in.
(3)The Company made certain organizational changes and consolidated its product division effective in the first quarter of fiscal 2016. The reorganization resulted in the reallocation of certain goodwill balances as noted above.

Goodwill is net of accumulated impairment losses of $277.6 million, which were recorded prior to the fiscal year ended June 30, 2014. The acquired goodwill during the fiscal year ended June 30, 2017 resulted from the acquisition of certain assets and liabilities of a privately-held company. See Note 5 “Business Combination” for additional details.

The Company performed a qualitative assessment of the goodwill by reporting unit as of November 30, 2016 during the three months ended December 31, 2016 and concluded that it was more likely than not that the fair value of each of the reporting units exceeded its carrying amount. In assessing the qualitative factors, the Company considered the impact of key factors including change in industry and competitive environment, market capitalization, stock price, earnings multiples, budgeted-to-actual revenue performance from prior year, gross margin and cash flow from operating activities. As such, it was not necessary to perform the two-step quantitative goodwill impairment test at that time. In addition, 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, 2017. The next annual assessment of goodwill by reporting unit is scheduled to be performed in the second quarter of the fiscal year ending June 30, 2018.

Purchased Intangible Assets

The components of purchased intangible assets as of the dates indicated below were as follows:

(In thousands)As of June 30, 2017As of June 30, 2016
CategoryRange of Useful LivesGross Carrying AmountAccumulated Amortization and ImpairmentNet AmountGross Carrying AmountAccumulated Amortization and ImpairmentNet Amount
Existing technology4-7 years$157,259$140,346$16,913$141,659$138,160$3,499
Trade name/Trademark7 years20,99319,9021,09119,89319,743150
Customer relationships7-8 years55,68054,95972154,98054,298682
Backlog<1 year26022238———
Total$234,192$215,229$18,963$216,532$212,201$4,331

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 fiscal years ended June 30, 2017, 2016 and 2015, amortization expense for purchased intangible assets was $3.0 million, $7.6 million and $15.8 million, respectively. The increase in the gross carrying value resulted from the acquisition of a privately-held company. See Note 5 “Business Combination” for additional details. Based on the intangible assets recorded as of June 30, 2017, and assuming no subsequent additions to, or impairment of, the underlying assets, the remaining estimated annual amortization expense is expected to be as follows:

Fiscal year ending June 30:Amortization (In thousands)
2018$4,172
20192,409
20202,409
20212,409
20222,409
Thereafter5,155
Total$18,963

NOTE 7 — DEBT

The following table summarizes the debt of the Company as of June 30, 2017 and June 30, 2016:

As of June 30, 2017As of June 30, 2016
Amount (in thousands)Effective Interest RateAmount (in thousands)Effective Interest Rate
Fixed-rate 2.375% Senior notes due on November 1, 2017$250,0002.396%$250,0002.396%
Fixed-rate 3.375% Senior notes due on November 1, 2019250,0003.377%250,0003.377%
Fixed-rate 4.125% Senior notes due on November 1, 2021500,0004.128%500,0004.128%
Fixed-rate 4.650% Senior notes due on November 1, 2024(1)1,250,0004.682%1,250,0004.682%
Fixed-rate 5.650% Senior notes due on November 1, 2034250,0005.670%250,0005.670%
Term loans446,2502.137%576,2501.714%
Total debt2,946,2503,076,250
Unamortized discount(2,901)(3,312)
Unamortized debt issuance costs(12,892)(15,002)
Total debt$2,930,457$3,057,936
Reported as:
Current portion of long-term debt$249,983$—
Long-term debt2,680,4743,057,936
Total debt$2,930,457$3,057,936
(1)The effective interest rate disclosed above for this series of Senior Notes excludes the impact of the treasury rate lock hedge discussed below. The effective interest rate including the impact of the treasury rate lock hedge was 4.626%.

As of June 30, 2017, future principal payments for the long-term debt are summarized as follows.

Fiscal year ending June 30,Amount (In thousands)
2018$250,000
2019—
2020696,250
2021—
2022500,000
Thereafter1,500,000
Total payments$2,946,250

Senior Notes:

In November 2014, the Company issued $2.50 billion aggregate principal amount of senior, unsecured long-term notes (collectively referred to as “Senior Notes”). The Company issued the Senior Notes as part of the leveraged recapitalization plan under which the proceeds from the Senior Notes in conjunction with the proceeds from the term loans (described below) and cash on hand were used (x) to fund a special cash dividend of $16.50 per share, aggregating to approximately $2.76 billion, (y) to redeem $750.0 million of 2018 Senior Notes, including associated redemption premiums, accrued interest and other fees and expenses and (z) for other general corporate purposes, including repurchases of shares pursuant to the Company’s stock repurchase program. The interest rate specified for each series of the Senior Notes will be subject to adjustments from time to time if Moody’s Investor Service, Inc. (“Moody’s”) or Standard & Poor’s Ratings Services (“S&P”) or, under certain circumstances, a substitute rating agency selected by us as a replacement for Moody’s or S&P, as the case may be (a “Substitute Rating Agency”), downgrades (or subsequently upgrades) its rating assigned to the respective series of Senior Notes such that the adjusted rating is below investment grade. If the adjusted rating of any series of Senior Notes from Moody’s (or, if applicable, any Substitute Rating Agency) is decreased to Ba1, Ba2, Ba3 or B1 or below, the stated interest rate on such series of Senior Notes as noted above will increase by 25 bps, 50 bps, 75 bps or 100 bps, respectively (“bps” refers to Basis Points and 1% is equal to 100 bps). If the rating of any series of Senior Notes from S&P (or, if applicable, any Substitute Rating Agency) with respect to such series of Senior Notes is decreased to BB+, BB, BB- or B+ or below, the stated interest rate on such series of Senior Notes as noted above will increase by 25 bps, 50 bps, 75 bps or 100 bps, respectively. The interest rates on any series of Senior Notes will permanently cease to be subject to any adjustment (notwithstanding any subsequent decrease in the ratings by any of Moody’s, S&P and, if applicable, any Substitute Rating Agency) if such series of Senior Notes becomes rated “Baa1” (or its equivalent) or higher by Moody’s (or, if applicable, any Substitute Rating Agency) and “BBB+” (or its equivalent) or higher by S&P (or, if applicable, any Substitute Rating Agency), or one of those ratings if rated by only one of Moody’s, S&P and, if applicable, any Substitute Rating Agency, in each case with a stable or positive outlook. In October 2014, the Company entered into a series of forward contracts to lock the 10-year treasury rate (“benchmark rate”) on a portion of the Senior Notes with a notional amount of $1.00 billion in aggregate. For additional details, refer to Note 16, “Derivative Instruments and Hedging Activities.”

The original discount on the Senior Notes amounted to $4.0 million and is being amortized over the life of the debt. Interest is payable semi-annually on May 1 and November 1 of each year. The debt indenture (the “Indenture”) includes covenants that limit the Company’s ability to grant liens on its facilities and enter into sale and leaseback transactions, subject to certain allowances under which certain sale and leaseback transactions are not restricted. As of June 30, 2017, the Company was in compliance with all of its covenants under the Indenture associated with the Senior Notes.

In certain circumstances involving a change of control followed by a downgrade of the rating of a series of Senior Notes by at least two of Moody’s, S&P and Fitch Inc., unless the Company has exercised its right to redeem the Senior Notes of such series, the Company will be required to make an offer to repurchase all or, at the holder’s option, any part, of each holder’s Senior Notes of that series pursuant to the offer described below (the “Change of Control Offer”). In the Change of Control Offer, the Company will be required to offer payment in cash equal to 101% of the aggregate principal amount of Senior Notes repurchased plus accrued and unpaid interest, if any, on the Senior Notes repurchased, up to, but not including, the date of repurchase.

Based on the trading prices of the Senior Notes on the applicable dates, the fair value of the Senior Notes as of June 30, 2017 and June 30, 2016 was approximately $2.67 billion and $2.68 billion, respectively. While the Senior Notes are recorded at cost, the fair value of the long-term debt was determined based on quoted prices in markets that are not active; accordingly, the long-term debt is categorized as Level 2 for purposes of the fair value measurement hierarchy.

Credit Facility (Term Loans and Unfunded Revolving Credit Facility):

In November 2014, the Company entered into $750.0 million of five-year senior unsecured prepayable term loans and a $500.0 million unfunded revolving credit facility (collectively, the “Credit Facility”) under the Credit Agreement (the “Credit Agreement”). The interest under the Credit Facility will be payable on the borrowed amounts at the London Interbank Offered Rate (“LIBOR”) plus a spread, which is currently 125 bps, and this spread is subject to adjustment in conjunction with the Company’s credit rating downgrades or upgrades. The spread ranges from 100 bps to 175 bps based on the Company’s then effective credit rating. The Company is also obligated to pay an annual commitment fee of 15 bps on the daily undrawn balance of the revolving credit facility, which is also subject to an adjustment in conjunction with the Company’s credit rating downgrades or upgrades by Moody’s and S&P. The annual commitment fee ranges from 10 bps to 25 bps on the daily undrawn balance of the revolving credit facility, depending upon the then effective credit rating. Principal payments with respect to the term loans will be made on the last day of each calendar quarter, and any unpaid principal balance of the term loans, including accrued interest, shall be payable on November 14, 2019 (the “Maturity Date”). The Company may prepay the term loans and unfunded revolving credit facility at any time without a prepayment penalty. During the year ended June 30, 2017, the Company made term loan principal payments of $130.0 million. The remaining term loan balance of $446.3 million as of June 30, 2017 is due in the fiscal quarter ending December 31, 2019.

The Credit Facility requires the Company to maintain an interest expense coverage ratio as described in the Credit Agreement, on a quarterly basis, covering the trailing four consecutive fiscal quarters of no less than 3.50 to 1.00. In addition, the Company is required to maintain the maximum leverage ratio as described in the Credit Agreement on a quarterly basis of 3.00 to 1.00, covering the trailing four consecutive fiscal quarters for each fiscal quarter.

The Company was in compliance with the financial covenants under the Credit Agreement as of June 30, 2017 and had no outstanding borrowings under the unfunded revolving credit facility.

Debt Redemption:

In December 2014, the Company redeemed the $750.0 million aggregate principal amount of the 2018 Senior Notes. The redemption resulted in a pre-tax net loss on extinguishment of debt of $131.7 million for the three months ended December 31, 2014 after an offset of a $1.2 million gain upon the termination of the non-designated forward contract entered by the Company in November 2014. The objective of entering into the non-designated forward contract was to lock the treasury rate used to determine the redemption amount of the 2018 Senior Notes. The notional amount of the non-designated forward contract was $750.0 million. Refer to Note 16, “Derivative Instruments and Hedging Activities.”

NOTE 8 — EQUITY AND LONG-TERM INCENTIVE COMPENSATION PLANS

Equity Incentive Program

As of June 30, 2017, the Company had two plans under which the Company was able to issue equity incentive awards, such as restricted stock units and stock options, to its employees, consultants and members of its Board of Directors: the 2004 Equity Incentive Plan (the “2004 Plan”) and the 1998 Director Plan (the “Outside Director Plan”).

2004 Plan:

The 2004 Plan provides for the grant of options to purchase shares of the Company’s common stock, stock appreciation rights, restricted stock units, performance shares, performance units and deferred stock units to the Company’s employees, consultants and members of its Board of Directors. As of June 30, 2017, 3.1 million shares were available for issuance under the 2004 Plan.

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 follows, based on the grant date of the applicable award: (a) for any such awards granted before November 6, 2013, the awards counted against the 2004 Plan share reserve as 1.8 shares for every one share subject thereto; and (b) for any such awards granted on or after November 6, 2013, the awards count against the 2004 Plan share reserve as 2.0 shares for every one share subject thereto.

In addition, the plan administrator has the ability to grant “dividend equivalent” rights in connection with awards of restricted stock units, performance shares, performance units and deferred stock units before they are fully vested. The plan administrator, at its discretion, may grant a right to receive dividends on the aforementioned awards which may be settled in cash or Company stock at the discretion of the plan administrator subject to meeting the vesting requirement of the underlying awards.

Outside Director Plan

The Outside Director Plan only permits the issuance of stock options to the non-employee members of the Board of Directors. As of June 30, 2017, 1.7 million shares were available for grant under the Outside Director Plan.

Equity Incentive Plans - General Information

The following table summarizes the combined activity under the Company’s equity incentive plans for the indicated periods:

(In thousands)Available For Grant
Balances as of June 30, 20148,804
Restricted stock units granted(1)(3)(1,191)
Restricted stock units canceled(1)196
Options canceled/expired/forfeited11
Plan shares expired(2)(10)
Balances as of June 30, 2015(4)7,810
Restricted stock units granted(1)(3)(1,541)
Restricted stock units canceled(1)509
Balances as of June 30, 20166,778
Restricted stock units granted(1)(3)(2,169)
Restricted stock units canceled(1)101
Balances as of June 30, 20174,710
(1)The number of restricted stock units reflects the application of the award multiplier as described above (1.8x or 2.0x depending on the grant date of the applicable award).
(2)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 and 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, expired or forfeited under any other Company equity incentive plan do not result in additional shares being available to the Company for future grant.
(3)Includes restricted stock units granted to senior management with performance-based vesting criteria (in addition to service-based vesting criteria for any of such restricted stock units that are deemed to have been earned). As of June 30, 2017, it had not yet been determined the extent to which (if at all) the performance-based vesting criteria had been satisfied. Therefore, this line item includes all performance-based restricted stock units granted during the fiscal year, reported at the maximum possible number of shares that may ultimately be issuable if all applicable performance-based criteria are achieved at their maximum levels and all applicable service-based criteria are fully satisfied (84 thousand shares, 0.7 million shares and 0.6 million shares for the fiscal years ended June 30, 2017, 2016 and 2015, respectively, after application of the 1.8x or 2.0x multiplier described above).
(4)During the fiscal year ended June 30, 2015, the Company adjusted the number of shares subject to outstanding options under the 2004 Plan by an aggregate of 4,245 shares pursuant to a proportionate and equitable adjustment for the effect of the special cash dividend, as required by the 2004 Plan. The total number of outstanding options under the 2004 Plan as well as the associated exercise prices were adjusted to ensure the aggregate intrinsic value remained the same after considering the effect of the special cash dividend. As the adjustment was required by the 2004 Plan, under the authoritative guidance, the adjustment to the outstanding awards did not result in any incremental compensation expense. Additionally, the adjustment did not have an impact on the shares available for future issuance under the 2004 Plan.

The fair value of stock-based awards is measured at the grant date and is recognized as an expense over the employee’s requisite service period. For restricted stock units granted without “dividend equivalent” rights, fair value is calculated using the closing price of the Company’s common stock on the grant date, adjusted to exclude the present value of dividends which are not accrued on those restricted stock units. The fair value for restricted stock units granted with “dividend equivalent” rights is determined using the closing price of the Company’s common stock on the grant date. As of June 30, 2017, the Company accrued $13.8 million of dividends payable, which included both a special cash dividend and quarterly cash dividends for the unvested restricted stock units outstanding as of the dividend record date. The fair value for purchase rights under the Company’s Employee Stock Purchase Plan is determined using a Black-Scholes valuation model.

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

Year ended June 30,
(In thousands)201720162015
Stock-based compensation expense by:
Costs of revenues$5,338$4,689$7,242
Research and development8,0898,61812,259
Selling, general and administrative37,51631,74335,801
Total stock-based compensation expense$50,943$45,050$55,302

As a result of the early adoption of the accounting standard update on accounting for share-based payment awards in the first quarter of its fiscal year ended June 30, 2017, the Company recorded excess tax benefits in the provision for income taxes of $6.6 million. See Note 1, “Description of Business and Summary of Significant Accounting Policies” for additional details.

The following table shows stock-based compensation capitalized as inventory as of the dates indicated below:

(In thousands)As of June 30,
20172016
Inventory$2,820$2,685

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 fiscal year ended June 30, 2017 and restricted stock units outstanding as of June 30, 2017 and 2016:

Restricted Stock UnitsShares (In thousands) (1)Weighted-Average Grant Date Fair Value
Outstanding restricted stock units as of June 30, 2016(2)1,849$56.41
Granted(2)1,085$78.83
Vested and released(383)$52.73
Withheld for taxes(259)$52.73
Forfeited(51)$59.77
Outstanding restricted stock units as of June 30, 2017(2)2,241$68.24
(1)Share numbers reflect actual shares subject to awarded restricted stock units. As described above, under the terms of the 2004 Plan, the number of shares subject to each award reflected in this number is multiplied by either 1.8x or 2.0x (depending on the grant date of the award) to calculate the impact of the award on the share reserve under the 2004 Plan.
(2)Includes restricted stock units granted to senior management with performance-based vesting criteria (in addition to service-based vesting criteria for any of such restricted stock units that are deemed to have been earned). As of June 30, 2017, it had not yet been determined the extent to which (if at all) the performance-based vesting criteria had been satisfied. Therefore, this line item includes all performance-based restricted stock units, reported at the maximum possible number of shares (i.e., 42 thousand shares the fiscal years ended June 30, 2017 and 0.3 million shares for each of the fiscal years ended June 30, 2016 and 2015) that may ultimately be issuable if all applicable performance-based criteria are achieved at their maximum and all applicable service-based criteria are fully satisfied.

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

The following table shows the weighted-average grant date fair value per unit for the restricted stock units granted and the restricted stock units vested and tax benefits realized by the Company in connection with vested and released restricted stock units for the indicated periods:

(In thousands, except for weighted-average grant date fair value)Year ended June 30,
201720162015
Weighted-average grant date fair value per unit$78.83$51.12$74.48
Grant date fair value of vested restricted stock units$33,820$51,992$38,859
Tax benefits realized by the Company in connection with vested and released restricted stock units$15,829$27,412$26,250

As of June 30, 2017, the unrecognized stock-based compensation expense balance related to restricted stock units was $99.4 million, excluding the impact of estimated forfeitures, and will be recognized over a weighted-average remaining contractual term and an estimated weighted-average amortization period of 1.4 years. The intrinsic value of outstanding restricted stock units as of June 30, 2017 was $205.1 million.

Cash-Based Long-Term Incentive Compensation

The Company has adopted a cash-based long-term incentive (“Cash LTI”) program for many of its employees as part of the Company’s employee compensation program. During the fiscal years ended June 30, 2017 and 2016, the Company approved Cash LTI awards of $96.7 million and $49.3 million, respectively, 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 three or four equal installments, with one-third or one-fourth of the aggregate amount of the Cash LTI award vesting on each anniversary of the grant date over a three or four-year period. In order to receive payments under a Cash LTI award, participants must remain employed by the Company as of the applicable award vesting date. Executives and non-employee Board members are not participating in this program. During the fiscal years ended June 30, 2017, 2016 and 2015, the Company recognized $48.8 million, $44.6 million and $39.6 million, respectively, in compensation expense under the Cash LTI Plan. As of June 30, 2017, the unrecognized compensation balance (excluding the impact of estimated forfeitures) related to the Cash LTI Plan was $127.7 million.

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).

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:

Year ended June 30,
201720162015
Stock purchase plan:
Expected stock price volatility23.4%25.4%24.5%
Risk-free interest rate0.5%0.2%0.1%
Dividend yield2.8%3.3%2.8%
Expected life (in years)0.500.500.50

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

(In thousands, except for weighted-average fair value per share)Year ended June 30,
201720162015
Total cash received from employees for the issuance of shares under the ESPP$45,358$38,295$41,116
Number of shares purchased by employees through the ESPP705735759
Tax benefits realized by the Company in connection with the disqualifying dispositions of shares purchased under the ESPP$1,999$2,194$1,741
Weighted-average fair value per share based on Black-Scholes model$15.16$12.48$14.55

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 June 30, 2017, a total of 684 thousand shares were reserved and available for issuance under the ESPP.

Quarterly cash dividends

On May 4, 2017, the Company’s Board of Directors declared a regular quarterly cash dividend of $0.54 per share on the outstanding shares of the Company’s common stock, which was paid on June 1, 2017 to the stockholders of record as of the close of business on May 15, 2017. The total amount of regular quarterly cash dividends paid by the Company during the fiscal years ended June 30, 2017 and 2016 was $335.4 million and $324.5 million, respectively. The amount of accrued dividends payable for regular quarterly cash dividends on unvested restricted stock units with dividend equivalent rights was $4.8 million and $2.7 million as of June 30, 2017 and 2016, respectively. These amounts will be paid upon vesting of the underlying restricted stock units. Refer to Note 19, “Subsequent Events” for additional information regarding the declaration of the quarterly cash divided announced subsequent to June 30, 2017.

Special cash dividend

On November 19, 2014, the Company’s Board of Directors declared a special cash dividend of $16.50 per share, which was paid on December 9, 2014 to the stockholders of record as of the close of business on December 1, 2014. Additionally, in connection with the special cash dividend, the Company’s Board of Directors and the Compensation Committee of the Board of Directors approved a proportionate and equitable adjustment to outstanding equity awards (restricted stock units and stock options), as required under the 2004 Plan, subject to the vesting requirements of the underlying awards. As the adjustment was required by the 2004 Plan, the adjustment to the outstanding awards did not result in any incremental compensation expense due to modification of such awards, under the authoritative guidance. Under the authoritative guidance, the dividend when declared is recognized as a reduction of retained earnings, to the extent available, with any shortfall recognized as a reduction of additional paid-in-capital. The special cash dividend reduced the retained earnings by $2.11 billion as of the special cash dividend declaration date, reducing the retained earnings amount to zero and the excess amount of the special cash dividend of $646.5 million was charged against additional paid-in capital. The declaration and payment of the special cash dividend were part of the Company’s leveraged recapitalization transaction under which the special cash dividend was financed through a combination of existing cash and proceeds from the debt financing disclosed in Note 7, “Debt” that was completed during the three months ended December 31, 2014. The total amount of the special cash dividend accrued by the Company during the three months ended December 31, 2014 was approximately $2.76 billion, substantially all of which was paid out during the three months ended December 31, 2014, except for the aggregate special cash dividend of $43.0 million that was accrued for the unvested restricted stock units. As of June 30, 2017 and 2016, the Company had a total of $9.0 million and $16.9 million, respectively, of accrued dividends payable for the special cash dividend with respect to outstanding unvested restricted stock units, which will be paid when such underlying unvested restricted stock units vest. The Company paid a special cash dividend with respect to vested restricted stock units during the fiscal years ended June 30, 2017 and 2016 of $8.6 million and $21.8 million respectively. Other than the special cash dividend declared during the three months ended December 31, 2014, the Company historically has not declared any special cash dividend.

NOTE 9 — STOCK REPURCHASE PROGRAM

The Company’s Board of Directors has authorized a program for the Company to repurchase shares of the Company’s common stock. 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 were made in the open market in compliance with applicable securities laws, including the Securities Exchange Act of 1934 and the rules promulgated thereunder such as Rule 10b-18. As of June 30, 2017, an aggregate of approximately 5.7 million shares were available for repurchase under the Company’s repurchase program.

Share repurchases for the indicated periods (based on the trade date of the applicable repurchase) were as follows:

(In thousands)Year ended June 30,
201720162015
Number of shares of common stock repurchased2433,4459,255
Total cost of repurchases$25,002$175,743$608,856

NOTE 10 — NET INCOME PER SHARE

Basic net income per share is calculated by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted net income per share is calculated by using the weighted-average number of common shares outstanding during the period, increased to include the number of additional shares of common stock that would have been outstanding if the shares of common stock underlying the Company’s outstanding dilutive restricted stock units and stock options had been issued. The dilutive effect of outstanding restricted stock units and options is reflected in diluted net income per share by application of the treasury stock method.

The following table sets forth the computation of basic and diluted net income per share:

(In thousands, except per share amounts)Year ended June 30,
201720162015
Numerator:
Net income$926,076$704,422$366,158
Denominator:
Weighted-average shares-basic, excluding unvested restricted stock units156,468155,869162,282
Effect of dilutive restricted stock units and options (1)1,0139101,419
Weighted-average shares-diluted157,481156,779163,701
Basic net income per share$5.92$4.52$2.26
Diluted net income per share$5.88$4.49$2.24
Anti-dilutive securities excluded from the computation of diluted net income per share46936

(1) The Company has not had any outstanding stock options since August 2016.

NOTE 11 — EMPLOYEE BENEFIT PLANS

KLA-Tencor has a profit sharing program for eligible employees, which distributes, on a quarterly basis, a percentage of the Company’s pre-tax profits. In addition, the Company has an employee savings plan that qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code. Since April 1, 2011, the employer match amount was 50% of the first $8,000 of an eligible employee’s contribution (i.e., a maximum of $4,000) during each fiscal year.

The total expenses under the profit sharing and 401(k) programs aggregated $15.3 million, $15.3 million and $14.2 million in the fiscal years ended June 30, 2017, 2016 and 2015, respectively. The Company has no defined benefit plans in the United States. In addition to the profit sharing plan and the United States 401(k), several of the Company’s foreign subsidiaries have retirement plans for their full-time employees, several of which are defined benefit plans. Consistent with the requirements of local law, the Company deposits funds for certain of these plans with insurance companies, with third-party

trustees or into government-managed accounts and/or accrues for the unfunded portion of the obligation. The assumptions used in calculating the obligation for the foreign plans depend on the local economic environment.

The Company applies authoritative guidance that requires an employer to recognize the funded status of each of its defined pension and post-retirement benefit plans as a net asset or liability on its balance sheets. Additionally, the authoritative guidance requires an employer to measure the funded status of each of its plans as of the date of its year-end statement of financial position. The benefit obligations and related assets under the Company’s plans have been measured as of June 30, 2017 and 2016.

Summary data relating to the Company’s foreign defined benefit pension plans, including key weighted-average assumptions used, is provided in the following tables:

Year ended June 30,
(In thousands)20172016
Change in projected benefit obligation:
Projected benefit obligation as of the beginning of the fiscal year$89,923$75,928
Service cost4,0153,349
Interest cost1,1171,322
Contributions by plan participants76163
Actuarial loss2,9919,029
Benefit payments(1,363)(2,517)
Foreign currency exchange rate changes and others, net5062,649
Projected benefit obligation as of the end of the fiscal year$97,265$89,923
Year ended June 30,
(In thousands)20172016
Change in fair value of plan assets:
Fair value of plan assets as of the beginning of the fiscal year$18,894$17,038
Actual return on plan assets241588
Employer contributions3,3304,330
Benefit and expense payments(1,363)(2,517)
Foreign currency exchange rate changes and others, net678(545)
Fair value of plan assets as of the end of the fiscal year$21,780$18,894
As of June 30,
(In thousands)20172016
Underfunded status$75,485$71,029
As of June 30,
(In thousands)20172016
Plans with accumulated benefit obligations in excess of plan assets:
Accumulated benefit obligation$56,967$53,198
Projected benefit obligation$97,265$89,923
Plan assets at fair value$21,780$18,894
Year ended June 30,
201720162015
Weighted-average assumptions:
Discount rate0.8%-1.9%0.5%-2.0%1.3%-2.0%
Expected rate of return on assets1.5%-2.9%1.8%-2.5%1.8%-2.5%
Rate of compensation increases3.0%-5.8%3.0%-5.8%3.0%-5.5%

The assumptions for expected rate of return on assets were developed by considering the historical returns and expectations of future returns relevant to the country in which each plan is in effect and the investments applicable to the corresponding plan. The discount rate for each plan was derived by reference to appropriate benchmark yields on high quality corporate bonds, allowing for the approximate duration of both plan obligations and the relevant benchmark index.

The following table presents losses recognized in accumulated other comprehensive income (loss) before tax related to the Company’s foreign defined benefit pension plans:

Year ended June 30,
(In thousands)20172016
Unrecognized transition obligation$190$108
Unrecognized prior service cost51113
Unrealized net loss33,47731,739
Amount of losses recognized$33,718$31,960

Losses in accumulated other comprehensive income (loss) related to the Company’s foreign defined benefit pension plans expected to be recognized as components of net periodic benefit cost over the fiscal year ending June 30, 2018 are as follows:

(In thousands)Year ending June 30, 2018
Unrecognized transition obligation$—
Unrecognized prior service cost26
Unrealized net loss1,436
Amount of losses expected to be recognized$1,462

The components of the Company’s net periodic cost relating to its foreign subsidiaries’ defined pension plans are as follows:

Year ended June 30,
(In thousands)201720162015
Components of net periodic pension cost:
Service cost$4,015$3,349$3,905
Interest cost1,1171,3221,562
Return on plan assets(393)(406)(450)
Amortization of transitional obligation251249259
Amortization of prior service cost464646
Amortization of net loss1,6171,1321,014
Adjustment——(177)
Net periodic pension cost$6,653$5,692$6,159

Fair Value of Plan Assets

Fair value is the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The three levels of inputs used to measure fair value of plan assets are described in Note 2, “Fair Value Measurements.”

The foreign plans’ investments are managed by third-party trustees consistent with the regulations or market practice of the country where the assets are invested. The Company is not actively involved in the investment strategy, nor does it have control over the target allocation of these investments. These investments made up 100% of total foreign plan assets in the fiscal years ended June 30, 2017 and 2016.

The expected aggregate employer contribution for the foreign plans during the fiscal year ending June 30, 2018 is $2.1 million.

The total benefits to be paid from the foreign pension plans are not expected to exceed $3.0 million in any year through the fiscal year ending June 30, 2027.

Foreign plan assets measured at fair value on a recurring basis consisted of the following investment categories as of June 30, 2017 and 2016, respectively:

As of June 30, 2017 (In thousands)TotalQuoted Prices in Active Markets for Identical Assets (Level 1)Significant Other Observable Inputs (Level 2)
Cash and cash equivalents$13,784$13,784$—
Bonds, equity securities and other investments7,996—7,996
Total assets measured at fair value$21,780$13,784$7,996
As of June 30, 2016 (In thousands)TotalQuoted Prices in Active Markets for Identical Assets (Level 1)Significant Other Observable Inputs (Level 2)
Cash and cash equivalents$11,950$11,950$—
Bonds, equity securities and other investments6,944—6,944
Total assets measured at fair value$18,894$11,950$6,944

Concentration of Risk

The Company manages a variety of risks, including market, credit and liquidity risks, across its plan assets through its investment managers. The Company defines a concentration of risk as an undiversified exposure to one of the above-mentioned risks that increases the exposure of the loss of plan assets unnecessarily. The Company monitors exposure to such risks in the foreign plans by monitoring the magnitude of the risk in each plan and diversifying the Company’s exposure to such risks across a variety of instruments, markets and counterparties. As of June 30, 2017, the Company did not have concentrations of plan asset investment risk in any single entity, manager, counterparty, sector, industry or country.

NOTE 12 — INCOME TAXES

The components of income before income taxes are as follows:

Year ended June 30,
(In thousands)201720162015
Domestic income before income taxes$615,906$417,803$157,251
Foreign income before income taxes557,340440,389276,880
Total income before income taxes$1,173,246$858,192$434,131

The provision for income taxes is comprised of the following:

(In thousands)Year ended June 30,
201720162015
Current:
Federal$200,831$94,088$63,123
State4,6606,1233,655
Foreign38,20837,68025,438
243,699137,89192,216
Deferred:
Federal44415,645(22,390)
State2,8523,583409
Foreign175(3,349)(2,262)
3,47115,879(24,243)
Provision for income taxes$247,170$153,770$67,973

The significant components of deferred income tax assets and liabilities are as follows:

(In thousands)As of June 30,
20172016
Deferred tax assets:
Tax credits and net operating losses$134,052$116,277
Employee benefits accrual106,637109,524
Stock-based compensation15,25213,607
Inventory reserves95,20094,783
Non-deductible reserves43,14034,484
Depreciation and amortization3,41515,857
Unearned revenue15,75714,375
Other26,53826,877
Gross deferred tax assets439,991425,784
Valuation allowance(120,708)(104,968)
Net deferred tax assets$319,283$320,816
Deferred tax liabilities:
Unremitted earnings of foreign subsidiaries not indefinitely reinvested$(13,213)$(11,571)
Deferred profit(13,657)(10,346)
Unrealized gain on investments(2,707)(604)
Total deferred tax liabilities(29,577)(22,521)
Total net deferred tax assets$289,706$298,295

As of June 30, 2017, the Company had U.S. federal, state and foreign net operating loss (“NOL”) carry-forwards of approximately $29.4 million, $49.4 million and $41.9 million, respectively. The U.S. federal NOL carry-forwards will expire at various dates beginning in 2023 through 2029. The utilization of NOLs created by acquired companies is subject to annual limitations under Section 382 of the Internal Revenue Code. However, it is not expected that such annual limitation will significantly impair the realization of these NOLs. The state NOLs will begin to expire in 2018. State credits of $167.6 million will be carried over indefinitely. The foreign NOL carry-forwards will begin to expire in 2018.

The net deferred tax asset valuation allowance was $120.7 million and $105.0 million as of June 30, 2017 and June 30, 2016, respectively. The change was primarily due to an increase in the valuation allowance related to state credit carry-forwards generated in the fiscal year ended June 30, 2017. The valuation allowance is based on the Company’s assessment that it is more likely than not that certain deferred tax assets will not be realized in the foreseeable future. Of the valuation allowance as of June 30, 2017, $103.8 million relates to state credit carry-forwards. The remainder of the valuation allowance relates primarily to state and foreign NOL carry-forwards.

As of June 30, 2017, U.S. income taxes were not provided for on a cumulative total of approximately $2.60 billion of undistributed earnings for certain non-U.S. subsidiaries. If these undistributed earnings were repatriated to the United States, they would generate foreign tax credits to reduce the federal tax liability associated with the foreign dividend. Assuming full utilization of the foreign tax credits, the potential deferred tax liability associated with undistributed earnings would be approximately $866.0 million.

KLA-Tencor benefits from tax holidays in Israel and Singapore where it manufactures certain of its products. These tax holidays are on approved investments and are scheduled to expire at varying times in the next one to four years. The Company was in compliance with all the terms and conditions of the tax holidays as of June 30, 2017. The net impact of these tax holidays was to decrease the Company’s tax expense by approximately $32.6 million, $19.5 million and $20.4 million in the fiscal years ended June 30, 2017, 2016 and 2015, respectively. The benefits of the tax holidays on diluted net income per share were $0.21, $0.12 and $0.13 for the fiscal years ended June 30, 2017, 2016 and 2015, respectively.

One of the Company’s Singapore holidays is scheduled to expire in August 2018. The Company is unsure if the holiday will be extended. The Company’s tax rate on income earned under this holiday would increase from 5% to 17% if the holiday is not extended.

The reconciliation of the United States federal statutory income tax rate to KLA-Tencor’s effective income tax rate is as follows:

Year ended June 30,
201720162015
Federal statutory rate35.0%35.0%35.0%
State income taxes, net of federal benefit0.4%0.9%0.7%
Effect of foreign operations taxed at various rates(12.2)%(13.0)%(15.3)%
Research and development tax credit(1.1)%(1.9)%(3.7)%
Net change in tax reserves1.3%(2.2)%1.5%
Domestic manufacturing benefit(1.5)%(1.5)%(2.1)%
Effect of stock-based compensation(0.2)%0.3%0.8%
Other(0.6)%0.3%(1.2)%
Effective income tax rate21.1%17.9%15.7%

A reconciliation of gross unrecognized tax benefits is as follows:

Year ended June 30,
(In thousands)201720162015
Unrecognized tax benefits at the beginning of the year$50,365$69,018$59,575
Increases for tax positions taken in prior years6,7884,2451,245
Decreases for tax positions taken in prior years(246)(1,209)(7)
Increases for tax positions taken in current year14,69613,63611,634
Decreases for settlements with taxing authorities—(8,762)—
Decreases for lapsing of statutes of limitations(3,164)(26,563)(3,429)
Unrecognized tax benefits at the end of the year$68,439$50,365$69,018

The amount of unrecognized tax benefits that would impact the effective tax rate was $68.4 million, $50.4 million and $69.0 million as of June 30, 2017, 2016 and 2015 respectively. The amount of interest and penalties recognized during the years ended June 30, 2017, 2016, and 2015 was expense of $2.2 million, income of $4.3 million as a result of a release of unrecognized tax benefits, and expense of $1.2 million, respectively. KLA-Tencor’s policy is to include interest and penalties related to unrecognized tax benefits within other expense (income), net. The amount of interest and penalties accrued as of June 30, 2017 and 2016 was approximately $5.9 million and $3.7 million, respectively.

The Company is subject to federal income tax examinations for all years beginning from the fiscal year ended June 30, 2014. The Company is subject to state income tax examinations for all years beginning from the fiscal year ended June 30, 2013. The Company is also subject to examinations in other major foreign jurisdictions, including Singapore, for all years beginning from the fiscal year ended June 30, 2013. The Company is under income tax examination in Israel for the fiscal years ended June 30, 2013 through June 30, 2015. The Company believes that adequate amounts have been reserved for any adjustments that may ultimately result from any future examinations of these years.

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 $15.3 million of its existing unrecognized tax benefits within the next 12 months as a result of the lapse of statutes of limitations and the resolution of examinations with various tax authorities.

NOTE 13 — COMMITMENTS AND CONTINGENCIES

Employee Retention Commitments. In connection with the retention program adopted at the time the Company entered into the Merger Agreement with Lam Research, the Company has an estimated $20.8 million of employee-related retention commitments as of June 30, 2017 which are expected to be paid during the quarter ending December 31, 2017.

Factoring. KLA-Tencor has agreements (referred to as “factoring agreements”) with financial institutions to sell certain of its trade receivables and promissory notes from customers without recourse. The Company does not believe it is at risk for any material losses as a result of these agreements. In addition, the Company periodically sells certain letters of credit (“LCs”), without recourse, received from customers in payment for goods and services.

The following table shows total receivables sold under factoring agreements and proceeds from sales of LCs for the indicated periods:

Year ended June 30,
(In thousands)201720162015
Receivables sold under factoring agreements$152,509$205,790$137,285
Proceeds from sales of LCs$48,780$21,904$6,920

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

Facilities. KLA-Tencor leases certain of its facilities under arrangements that are accounted for as operating leases. Rent expense was $9.6 million, $8.7 million and $9.1 million for the fiscal years ended June 30, 2017, 2016 and 2015, respectively.

The following is a schedule of expected operating lease payments:

Fiscal year ending June 30,Amount (In thousands)
2018$9,073
20195,768
20204,341
20212,486
20221,358
2023 and thereafter2,489
Total minimum lease payments$25,515

Purchase Commitments. KLA-Tencor maintains commitments to purchase inventory from its suppliers as well as goods and services in the ordinary course of business. The Company’s liability under these purchase commitments is generally restricted to a forecasted time-horizon as mutually agreed upon between the parties. This forecasted time-horizon can vary among different suppliers. The Company’s estimate of its significant purchase commitments is approximately $432.8 million as of June 30, 2017 which are primarily due within the next 12 months. Actual expenditures will vary based upon the volume of the transactions and length of contractual service provided. In addition, the amounts paid under these arrangements may be less in the event that the arrangements are renegotiated or canceled. Certain agreements provide for potential cancellation penalties.

Cash Long-Term Incentive Plan. As of June 30, 2017, the Company had committed $163.1 million for future payment obligations under its Cash LTI Plan. The calculation of compensation expense related to the Cash LTI Plan includes estimated forfeiture rate assumptions. Cash LTI awards issued to employees under the Cash LTI Plan vest in to three or four equal installments, with one-third or one-fourth of the aggregate amount of the Cash LTI award vesting on each yearly anniversary of the grant date over a three or four-year period. In order to receive payments under a Cash LTI award, participants must remain employed by the Company as of the applicable award vesting date.

Warranties, Guarantees and Contingencies. KLA-Tencor provides standard warranty coverage on its systems for 40 hours per week for 12 months, providing labor and parts necessary to repair and maintain 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 regular 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:

Year ended June 30,
(In thousands)20172016
Beginning balance$34,773$36,413
Accruals for warranties issued during the period50,61639,175
Changes in liability related to pre-existing warranties(5,133)(9,146)
Settlements made during the period(34,798)(31,669)
Ending balance$45,458$34,773

The Company maintains guarantee arrangements available through various financial institutions for up to $25.3 million, of which $22.1 million had been issued as of June 30, 2017, primarily to fund guarantees to customs authorities for value-added tax (“VAT”) and other operating requirements of the Company’s subsidiaries in Europe and Asia.

KLA-Tencor is a party to a variety of agreements pursuant to which it may be obligated to indemnify the other party with respect to certain matters. Typically, these obligations arise in connection with contracts and license agreements or the sale of assets, under which the Company customarily agrees to hold the other party harmless against losses arising from, or provides customers with other remedies to protect against, bodily injury or damage to personal property caused by the Company’s products, non-compliance with the Company’s product performance specifications, infringement by the Company’s products of third-party intellectual property rights and a breach of warranties, representations and covenants related to matters such as title to assets sold, validity of certain intellectual property rights, non-infringement of third-party rights, and certain income tax-related matters. In each of these circumstances, payment by the Company is typically subject to the other party making a claim to and cooperating with the Company pursuant to the procedures specified in the particular contract.

This usually allows the Company to challenge the other party’s claims or, in case of breach of intellectual property representations or covenants, to control the defense or settlement of any third-party claims brought against the other party. Further, the Company’s obligations under these agreements may be limited in terms of amounts, activity (typically at the Company’s option to replace or correct the products or terminate the agreement with a refund to the other party), and duration. In some instances, the Company may have recourse against third parties and/or insurance covering certain payments made by the Company.

Subject to certain limitations, the Company is obligated to indemnify its current and former directors, officers and employees with respect to certain litigation matters and investigations that arise in connection with their service to the Company. These obligations arise under the terms of the Company’s certificate of incorporation, its bylaws, applicable contracts, and Delaware and California law. The obligation to indemnify generally means that the Company is required to pay or reimburse the individuals’ reasonable legal expenses and possibly damages and other liabilities incurred in connection with these matters.

In addition, the Company may in limited circumstances enter into agreements that contain customer-specific commitments on pricing, tool reliability, spare parts stocking levels, response time and other commitments. Furthermore, the Company may give these customers limited audit or inspection rights to enable them to confirm that the Company is complying with these commitments. If a customer elects to exercise its audit or inspection rights, the Company may be required to expend significant resources to support the audit or inspection, as well as to defend or settle any dispute with a customer that could potentially arise out of such audit or inspection. To date, the Company has made no significant accruals in its consolidated financial statements for this contingency. While the Company has not in the past incurred significant expenses for resolving disputes regarding these types of commitments, the Company cannot make any assurance that it will not incur any such liabilities in the future.

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

NOTE 14 — LITIGATION AND OTHER LEGAL MATTERS

Litigation Related to Terminated Merger with Lam Research.

In connection with the previously announced Merger transaction with Lam Research, four purported KLA-Tencor stockholders filed putative class actions on behalf of all KLA-Tencor stockholders. In January 2017, all four actions were dismissed with prejudice.

Other Legal Matters.

The Company is named from time to time as a party to lawsuits and other types of legal proceedings and claims in the normal course of its business. Actions filed against the Company include commercial, intellectual property, customer, and labor and employment related claims, including complaints of alleged wrongful termination and potential class action lawsuits regarding alleged violations of federal and state wage and hour and other laws. In general, legal proceedings and claims, regardless of their merit, and associated internal investigations (especially those relating to intellectual property or confidential information disputes) are often expensive to prosecute, defend or conduct and may divert management’s attention and other company resources. Moreover, the results of legal proceedings are difficult to predict, and the costs incurred in litigation can be substantial, regardless of outcome. The Company believes the amounts provided in its 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 consolidated financial statements or will not have a material adverse effect on its results of operations, financial condition or cash flows.

NOTE 15 — RESTRUCTURING CHARGES

The Company has in recent years undertaken a number of cost reduction activities, including workforce reductions, in an effort to lower its ongoing expense run rate. The program in the United States is accounted for in accordance with the authoritative guidance related to compensation for non-retirement post-employment benefits, whereas the programs in the Company’s international locations are accounted for in accordance with the authoritative guidance for contingencies.

During the fourth quarter of fiscal year ended 2015, the Company implemented a plan to reduce its global employee workforce to streamline the organization and business processes in response to changing customer requirements in the industry. The goals of this reduction were to enable continued innovation, direct the Company’s resources toward its best opportunities and lower its ongoing expense run rate. The Company substantially completed its global workforce reduction during the fiscal year ended June 30, 2016. Restructuring charges for the year ended June 30, 2016 were $8.9 million, of which $3.6 million was recorded to costs of revenues, $1.6 million to research and development expense and $3.7 million to selling, general and administrative expense lines of the consolidated statements of operations. Restructuring charges for the year ended June 30, 2015 were $31.6 million, of which $8.0 million was recorded to costs of revenues, $11.1 million to research and development expense and $12.5 million to selling, general and administrative expense lines of the consolidated statements of operations.

The following table shows the activity which is primarily related to accrued severance and benefits for the fiscal years ended June 30, 2017, 2016 and 2015:

Year ended June 30,
(In thousands)201720162015
Beginning balance$587$24,887$2,329
Restructuring costs—8,92631,569
Adjustments(147)(142)1,177
Cash payments(440)(33,084)(10,188)
Ending balance$—$587$24,887

NOTE 16 — 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 recognized in other expense (income), net in the consolidated statements 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, the New Taiwan dollar and the Israeli new shekel. The Company routinely hedges its exposures to certain foreign currencies with various financial institutions in an effort to minimize the impact of certain currency exchange rate fluctuations. These currency forward exchange contracts and options, designated as cash flow hedges, generally have maturities of less than 18 months. Cash flow hedges are evaluated for effectiveness monthly, based on changes in total fair value of the derivatives. If a financial counterparty to any of the Company’s hedging arrangements experiences financial difficulties or is otherwise unable to honor the terms of the foreign currency hedge, the Company may experience material losses.

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

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

In October 2014, in anticipation of the issuance of the Senior Notes, the Company entered into a series of forward contracts (“Rate Lock Agreements”) to lock the benchmark rate on a portion of the Senior Notes. The objective of the Rate Lock Agreements was to hedge the risk associated with the variability in interest rates due to the changes in the benchmark rate leading up to the closing of the intended financing, on the notional amount being hedged. The Rate Lock Agreements had a notional amount of $1.00 billion in aggregate which matured in the second quarter of the fiscal year ended June 30, 2015. The Company designated each of the Rate Lock Agreements as a qualifying hedging instrument and accounted for as a cash flow hedge, under which the effective portion of the gain or loss on the close out of the Rate Lock Agreements was initially recognized in accumulated other comprehensive income (loss) as a reduction of total stockholders’ equity and subsequently amortized into earnings as a component of interest expense over the term of the underlying debt. The ineffective portion, if any, was recognized in earnings immediately. The Rate Lock Agreements were terminated on the date of pricing of the $1.25 billion of 4.650% Senior Notes due in 2024 and the Company recorded the fair value of $7.5 million as a gain within accumulated other comprehensive income (loss) as of December 31, 2014. For the fiscal years ended June 30, 2017, 2016 and 2015, the Company recognized $0.8 million, $0.8 million and $0.5 million, respectively, for the amortization of the gain recognized in accumulated other comprehensive income (loss), which amount reduced the interest expense. As of June 30, 2017, the unamortized portion of the fair value of the forward contracts for the rate lock agreements was $5.5 million. The cash proceeds of $7.5 million from the settlement of the Rate Lock Agreements were included in the cash flows from operating activities in the consolidated statements of cash flows for the fiscal year ended June 30, 2015 because the designated hedged item was classified as interest expense in the cash flows from operating activities in the consolidated statements of cash flows.

In addition, in November 2014, the Company entered into a non-designated forward contract to lock the treasury rate used to determine the redemption amount of the 2018 Senior Notes. The objective of the forward contract was to hedge the risk associated with the variability of the redemption amount due to changes in interest rates through the redemption of the existing 2018 Senior Notes. The forward contract had a notional amount of $750.0 million. The forward contract was terminated in December 2014 and the resulting fair value of $1.2 million was included in the loss on extinguishment of debt and other, net line in the consolidated statements of operations, partially offsetting the loss on redemption of the debt during the three months ended December 31, 2014. The cash proceeds from the forward contract were included in the cash flows from financing activities in the consolidated statements of cash flows for the fiscal year ended June 30, 2015, partially offsetting the cash outflows for the redemption of the 2018 Senior Notes.

Derivatives in Cash Flow Hedging Relationships: Foreign Exchange and Interest Rate Contracts

The locations and amounts of designated and non-designated derivative instruments’ gains and losses reported in the consolidated financial statements for the indicated periods were as follows:

(In thousands)Location in Financial StatementsYear ended June 30,
20172016
Derivatives Designated as Hedging Instruments
Gains (losses) in accumulated OCI on derivatives (effective portion)Accumulated OCI$10,138$(9,622)
Gains (losses) reclassified from accumulated OCI into income (effective portion):Revenues$2,846$(2,926)
Costs of revenues(378)(1,551)
Interest expense754755
Net gains (losses) reclassified from accumulated OCI into income (effective portion)$3,222$(3,722)
Net losses recognized in income on derivatives (ineffective portion and amount excluded from effectiveness testing)Other expense (income), net$(929)$(989)
Derivatives Not Designated as Hedging Instruments
Gains (losses) recognized in incomeOther expense (income), net$7,318$(21,430)

The U.S. dollar equivalent of all outstanding notional amounts of hedge contracts, with maximum remaining maturities of approximately ten months and seven months as of June 30, 2017 and 2016, respectively, were as follows:

(In thousands)As of June 30, 2017As of June 30, 2016
Cash flow hedge contracts
Purchase$19,305$7,591
Sell$128,672$91,793
Other foreign currency hedge contracts
Purchase$165,563$122,275
Sell$118,504$115,087

The locations and fair value amounts of the Company’s derivative instruments reported in its Consolidated Balance Sheets as of the dates indicated below were as follows:

Asset DerivativesLiability Derivatives
Balance Sheet LocationAs of June 30, 2017As of June 30, 2016Balance Sheet LocationAs of June 30, 2017As of June 30, 2016
(In thousands)Fair ValueFair Value
Derivatives designated as hedging instruments
Foreign exchange contractsOther current assets$2,198$342Other current liabilities$72$4,736
Total derivatives designated as hedging instruments2,198342724,736
Derivatives not designated as hedging instruments
Foreign exchange contractsOther current assets3,733753Other current liabilities1,2036,911
Total derivatives not designated as hedging instruments3,7337531,2036,911
Total derivatives$5,931$1,095$1,275$11,647

The following table provides the balances and changes in accumulated OCI, before taxes, related to derivative instruments for the indicated periods:

Year ended June 30,
(In thousands)20172016
Beginning balance$1,210$7,110
Amount reclassified to income(3,222)3,722
Net change in unrealized gains or losses10,138(9,622)
Ending balance$8,126$1,210

Offsetting of Derivative Assets and Liabilities

KLA-Tencor presents derivatives at gross fair values in the Consolidated Balance Sheets. The Company has entered into arrangements with each of its counterparties, which reduce credit risk by permitting net settlement of transactions with the same counterparty under certain conditions. As of June 30, 2017 and 2016, information related to the offsetting arrangements was as follows (in thousands):

As of June 30, 2017Gross Amounts of Derivatives Not Offset in the Consolidated Balance Sheets
DescriptionGross Amounts of DerivativesGross Amounts of Derivatives Offset in the Consolidated Balance SheetsNet Amount of Derivatives Presented in the Consolidated Balance SheetsFinancial InstrumentsCash Collateral ReceivedNet Amount
Derivatives - Assets$5,931$—$5,931$(1,275)$—$4,656
Derivatives - Liabilities$(1,275)$—$(1,275)$1,275$—$—
As of June 30, 2016Gross Amounts of Derivatives Not Offset in the Consolidated Balance Sheets
DescriptionGross Amounts of DerivativesGross Amounts of Derivatives Offset in the Consolidated Balance SheetsNet Amount of Derivatives Presented in the Consolidated Balance SheetsFinancial InstrumentsCash Collateral ReceivedNet Amount
Derivatives - Assets$1,095$—$1,095$(843)$—$252
Derivatives - Liabilities$(11,647)$—$(11,647)$843$—$(10,804)

NOTE 17 — 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 its 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 reportable segment, all financial segment information required by the authoritative guidance can be found in the consolidated financial statements.

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

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):

(Dollar amounts in thousands)Year ended June 30,
201720162015
Revenues:
Taiwan$1,104,30732%$894,55730%$691,48225%
Korea688,09420%367,90512%405,32014%
North America523,02414%521,33518%815,91429%
China412,09812%430,07414%162,6696%
Japan351,20210%444,21615%426,96315%
Europe & Israel263,7898%167,9366%194,6707%
Rest of Asia137,5004%158,4705%117,0314%
Total$3,480,014100%$2,984,493100%$2,814,049100%

The following is a summary of revenues by major products for the indicated periods (as a percentage of total revenues):

(Dollar amounts in thousands)Year ended June 30,
201720162015
Revenues:
Wafer Inspection$1,601,19046%$1,293,92243%$1,224,85844%
Patterning917,17826%772,04526%736,95926%
Global Service and Support (1)897,79426%852,15129%790,97128%
Other63,8522%66,3752%61,2612%
Total$3,480,014100%$2,984,493100%$2,814,049100%

(1) The Global Service and Support revenues includes service revenues as presented in the consolidated statements of operations as well as certain product revenues, primarily revenues from the Company’s K-T Pro business.

In the fiscal year ended June 30, 2017, two customers accounted for approximately 23% and 16% of total revenues. In the fiscal year ended June 30, 2016, two customers accounted for approximately 18% and 10% of total revenues. In the fiscal year ended June 30, 2015, three customers accounted for approximately 15%, 12% and 11% of total revenues.

Long-lived assets by geographic region as of the dates indicated below were as follows:

As of June 30,
(In thousands)20172016
Long-lived assets:
United States$191,096$182,597
Singapore39,11841,658
Israel30,18230,844
Europe13,30013,347
Rest of Asia10,2799,568
Total$283,975$278,014

NOTE 18 — RELATED PARTY TRANSACTIONS

During the fiscal years ended June 30, 2017, 2016 and 2015, 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 were, during the periods presented, an executive officer or a board member or a board member of a subsidiary, including Broadcom Limited, Cisco Systems, Inc., Citrix Systems, Inc., Juniper Networks, Inc., Keysight Technologies, Inc., MetLife, and NetApp, Inc. The following table provides the transactions with these parties for the indicated periods (for the portion of such period that they were considered related):

Year ended June 30,
(In thousands)201720162015
Total revenues$16$8$1,856
Total purchases$1,048$983$1,098

The Company’s receivable and payable balances from these parties were immaterial at June 30, 2017 and 2016. Management believes that such transactions are at arm’s length and on similar terms as would have been obtained from unaffiliated third parties.

NOTE 19 — SUBSEQUENT EVENTS

On August 3, 2017, the Company announced that its Board of Directors had declared a quarterly cash dividend of $0.59 per share to be paid on September 1, 2017 to stockholders of record as of the close of business on August 15, 2017.

NOTE 20 — QUARTERLY CONSOLIDATED RESULTS OF OPERATIONS (UNAUDITED)

The following is a summary of the Company’s quarterly consolidated results of operations (unaudited) for the fiscal years ended June 30, 2017 and 2016.

(In thousands, except per share data)First quarter ended September 30, 2016Second quarter ended December 31, 2016Third quarter ended March 31, 2017Fourth quarter ended June 30, 2017
Total revenues$750,673$876,885$913,809$938,647
Gross margin$472,837$558,378$570,535$590,717
Net income$178,101$238,251$253,562$256,162
Net income per share:
Basic(1)$1.14$1.52$1.62$1.64
Diluted(1)$1.13$1.52$1.61$1.62
(In thousands, except per share data)First quarter ended September 30, 2015Second quarter ended December 31, 2015Third quarter ended March 31, 2016Fourth quarter ended June 30, 2016
Total revenues$642,644$710,245$712,433$919,171
Gross margin$372,400$429,265$437,834$581,603
Net income$104,897$152,207$175,777$271,541
Net income per share:
Basic(1)$0.67$0.98$1.13$1.74
Diluted(1)$0.66$0.98$1.12$1.73
(1)Basic and diluted net income 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 net income per share information may not equal annual basic and diluted net income per share.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of KLA-Tencor Corporation:

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of KLA-Tencor Corporation and its subsidiaries at June 30, 2017 and June 30, 2016, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2017 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2017 based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP

San Jose, California

August 4, 2017

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