QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2018
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 000-09992
KLA-Tencor Corporation
(Exact name of registrant as specified in its charter)
Delaware
04-2564110
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
One Technology Drive, Milpitas, California
95035
(Address of Principal Executive Offices)
(Zip Code)
(408) 875-3000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer ¨
Non-accelerated filer ¨
(Do not check if a smaller reporting company)
Smaller reporting company ¨
Emerging growth company ¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of January 18, 2019, there were 151,363,988 shares of the registrant’s Common Stock, $0.001 par value, outstanding.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
NOTE 1 – BASIS OF PRESENTATION
Basis of Presentation. For purposes of this report, “KLA,” “KLA-Tencor,” the “Company,” “we,” “our,” “us,” or similar references mean KLA-Tencor Corporation, and its majority-owned subsidiaries unless the context requires otherwise. The condensed consolidated financial statements have been prepared by us pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations.
In the opinion of management, the unaudited interim financial statements reflect all adjustments (consisting only of normal, recurring adjustments) necessary for a fair statement of the financial position, results of operations, comprehensive income, and cash flows for the periods indicated. These financial statements and notes, however, should be read in conjunction with Item 8, “Financial Statements and Supplementary Data” included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018, filed with the SEC on August 6, 2018.
The condensed consolidated financial statements include the accounts of KLA and its majority-owned subsidiaries. All significant intercompany balances and transactions have been eliminated.
The results of operations for the three and six months ended December 31, 2018 are not necessarily indicative of the results that may be expected for any other interim period or for the full fiscal year ending June 30, 2019.
Certain reclassifications have been made to the prior year’s Condensed Consolidated Financial Statements to conform to the current year presentation. The reclassifications did not have material effects on the prior year’s Condensed Consolidated Balance Sheets, Statements of Operations, Comprehensive Income and Cash Flows.
Proposed Merger with Orbotech, Ltd. On March 18, 2018, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Orbotech, Ltd. (“Orbotech”) pursuant to which we would acquire Orbotech for $38.86 in cash and 0.25 of a share of our common stock in exchange for each ordinary share of Orbotech, which at the time of announcement valued Orbotech at $3.2 billion in enterprise value. The merger contemplated by the Merger Agreement (the “Orbotech Merger”) is subject to receipt of required regulatory approvals and satisfaction of the other customary closing conditions. KLA continues to have advanced discussions with the State Administration for Market Regulation of the People’s Republic of China (SAMR) regarding clearance of the proposed merger with a goal of obtaining clearance as soon as practicable in 2019.
Management Estimates. The preparation of the condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions in applying our accounting policies that affect the reported amounts of assets and liabilities (and related disclosure of contingent assets and liabilities) at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Comparability. Effective on the first day of fiscal 2019, we adopted Accounting Standards Update 2014-09, Revenue from Contracts with Customers (“ASC 606”). Prior periods were not retrospectively restated, and accordingly, the consolidated balance sheet as of June 30, 2018, and the condensed consolidated statements of operations for the three and six months ended December 31, 2017 were prepared using accounting standards that were different than those in effect for the three and six months ended December 31, 2018.
Recent Accounting Pronouncements.
Recently Adopted
In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASC 606, which supersedes the guidance in ASC 605, Revenue Recognition (“ASC 605”). Under ASC 606, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, ASC 606 requires enhanced disclosures, including disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. We adopted the ASC 606 as of July 1, 2018 in our first quarter of our fiscal year ending June 30, 2019, using the modified retrospective transition approach. For additional detail, refer to Note 2 “Revenue.”
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. We adopted this update beginning in the first quarter of our fiscal year ending June 30, 2019 on a prospective basis and the adoption had no material impact on our condensed consolidated financial statements.
In August 2016, the FASB issued an accounting standard update intended to clarify how certain cash receipts and cash payment are presented and classified in the statement of cash flows. We adopted this update beginning in the first quarter of our fiscal year ending June 30, 2019 on a retrospective basis and the adoption had no material impact on our condensed consolidated financial statements.
In October 2016, the FASB issued an accounting standard update to recognize the income tax consequences of intra-entity transfers of assets other than inventory when they occur. This eliminates the exception to postpone recognition until the asset has been sold to an outside party. We adopted this update beginning in the first quarter of our fiscal year ending June 30, 2019 on a modified retrospective basis and the adoption had no material impact on our condensed consolidated financial statements.
In January 2017, the FASB issued an accounting standard on clarifying the definition of a business, with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. We adopted this update beginning in the first quarter of our fiscal year ending June 30, 2019 on a prospective basis and the adoption had no material impact on our condensed 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 our fair value. We early adopted this update in the first quarter of our fiscal year ending June 30, 2019 on a prospective basis and the adoption had no material impact on our condensed consolidated financial statements.
In March 2017, the FASB issued an accounting standard update that changes the statements of operation classification of net periodic benefit cost related to defined benefit pension and/or other post-retirement benefit plans. Under the update, employers will present the service cost component of net periodic benefit cost in the same statements of operations line item(s) as other employee compensation costs arising from services rendered during the period. Only the service cost component will be eligible for capitalization in assets. Employers will present the other components of the net periodic benefit costs separately from the line item(s) that includes the service cost and outside of any subtotal of operating income, if one is presented. We adopted this update beginning in the first quarter of our fiscal year ending June 30, 2019 on a retrospective basis and the adoption had no material impact on our condensed consolidated financial statements.
In May 2017, the FASB issued an accounting standard update regarding stock compensation that provides guidance about which changes to the terms and conditions of a share-based payment award require an entity to apply modification accounting in order to reduce diversity in practice and reduce complexity. We adopted this update beginning in the first quarter of our fiscal year ending June 30, 2019 on a prospective basis and the adoption had no material impact on our condensed consolidated financial statements.
In August 2017, the FASB issued an accounting standard update to hedge accounting to better align our risk management activities by refining financial and non-financial hedging strategy eligibilities. This update also amends the presentation and disclosure requirements to increase transparency to better understand an entity’s risk exposures and how hedging strategies are used to manage those exposures. We early adopted this update in the second quarter of our fiscal year ending June 30, 2019 under the modified retrospective approach. The cumulative effect adjustment for the elimination of the ineffectiveness was not material to our condensed consolidated financial statements. The presentation and disclosure have been amended on a prospective basis, as required by this update.
In February 2018, the FASB issued an accounting standard update that provides an option to reclassify disproportional tax effects and other income tax effects (“stranded tax effects”) caused by the Tax Cuts and Jobs Act (“the Act”) from accumulated other comprehensive income (“AOCI”) to retained earnings. We early adopted this update in the first quarter of our fiscal year ending June 30, 2019 and applied this update in the period of adoption. As a result of the adoption, we made a reclassification from AOCI to beginning retained earnings of approximately $10.7 million related to the stranded tax effects.
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 our classification. Under the new guidance, a lessee will be required to recognize assets and liabilities for all leases with lease terms of more than 12 months using a modified retrospective transition method. In July 2018, the FASB issued an amendment to the standard which provide us an option to apply the practical expedient allowed in the standard retrospectively with the cumulative effect recognized as of the date of adoption. The update is effective for us beginning in the first quarter of our fiscal year ending June 30, 2020. Early adoption is permitted. We are currently evaluating the impact of this accounting standard update on our condensed 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 us beginning in the first quarter of our fiscal year ending June 30, 2021, with early adoption permitted starting in the first quarter of fiscal year ending June 30, 2020. We are currently evaluating the impact of this accounting standard update on our condensed consolidated financial statements.
In August 2018, the FASB issued an accounting standard update which modifies the existing accounting standards for fair value measurement disclosure. This update eliminates the amount of and reasons for transfers between level 1 and level 2 of the fair value hierarchy, and the policy for timing of transfers between levels. This standard update is effective for us beginning in the first quarter of our fiscal year ending June 30, 2021, and early adoption is permitted. We are currently evaluating the impact of this accounting standard update on our condensed consolidated financial statements.
In August 2018, the FASB issued an accounting standard update to amend the disclosure requirements related to defined benefit pension and other post-retirement plans. Some of the changes include adding a disclosure requirement for significant gains and losses related to changes in the benefit obligation for the period, and removing the amounts in accumulated other comprehensive income expected to be recognized as components of net periodic benefit cost over the next fiscal year. This standard update is effective for us for the fiscal year ending June 30, 2021, and early adoption is permitted. We are currently evaluating the impact of this accounting standard update on our condensed consolidated financial statements.
In August 2018, the FASB issued an accounting standard update to align the requirements for capitalizing implementation costs incurred in a cloud computing arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The guidance clarifies which costs should be capitalized including the cost to acquire the license and the related implementation costs. This standard update is effective for us beginning in the first quarter of our fiscal year ending June 30, 2021, with an option to be adopted either prospectively or retrospectively. Early adoption is permitted. We are currently evaluating the impact of this accounting standard update on our condensed consolidated financial statements.
Significant Accounting Policies. We updated our accounting policies for Revenue Recognition, Business Combinations, Global Intangible Low-Taxed Income (“GILTI”), and Derivative Financial Instruments. There has been no other material changes to our significant accounting policies in Note 1 “Description of Business and Summary of Significant Accounting Policies,” of the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018.
Revenue Recognition. We primarily derive revenue from the sale of process control and yield management solutions for the semiconductor and related nanoelectronics industries, maintenance and support of all these products, installation and training services and the sale of spare parts. Our solutions provide a comprehensive portfolio of inspection, metrology and data analytics products, which are accompanied by a flexible portfolio of services to enable our customers to maintain the performance and productivity of the solutions purchased. Our solutions are generally not sold with a right of return, nor have we experienced significant returns from or refunds to our customers.
We account for a contract with a customer when there is approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectibility of consideration is probable.
Our revenues are measured based on consideration stipulated in the arrangement with each customer, net of any sales incentives and amounts collected on behalf of third parties, such as sales taxes. The revenues are recognized as separate performance obligations that are satisfied by transferring control of the product or service to the customer.
Our arrangements with our customers include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. A product or service is considered distinct if it is separately identifiable from other deliverables in the arrangement and if a customer can benefit from it on its own or with other resources that are readily available to the customer.
The transaction consideration, including any sales incentives, is allocated between separate performance obligations of an arrangement based on the stand-alone selling prices (“SSP”) for each distinct product or service. Management considers a variety of factors to determine the SSP, such as, historical standalone sales of products and services, discounting strategies and other observable data.
From time to time, our contracts are modified to account for additional, or to change existing, performance obligations. Our contract modifications are generally accounted for prospectively.
Product revenue
We recognize revenue from product sales at a point in time when we have satisfied our performance obligation by transferring control of the product to the customer. We use judgment to evaluate whether the control has transferred by considering several indicators, including:
•
whether we have a present right to payment;
•
the customer has legal title;
•
the customer has physical possession;
•
the customer has significant risk and rewards of ownership; and
•
the customer has accepted the product, or whether customer acceptance is considered a formality based on history of acceptance of similar products (for example, when the customer has previously accepted the same tool, with the same specifications, and when we can objectively demonstrate that the tool meets all of the required acceptance criteria, and when the installation of the system is deemed perfunctory).
Not all of the indicators need to be met for us to conclude that control has transferred to the customer. In circumstances in which revenue is recognized prior to the product acceptance, the portion of revenue associated with our performance obligations to install product is deferred and recognized upon acceptance.
We enter into volume purchase agreements with some of our customers. We adjust the transaction consideration for estimated credits earned by our customers for such incentives. These credits are estimated based upon the forecasted and actual product sales for any given period, and agreed-upon incentive rate. The estimate is updated at each reporting period.
We offer perpetual and term licenses for defects and data analysis software. The primary difference between perpetual and term licenses is the duration over which the customer can benefit from the use of the software, while the functionality and the features of the software are the same. The software is generally bundled with post-contract customer support (“PCS”), which includes unspecified software updates that are made available throughout the entire term of the arrangement. Revenue from software licenses is recognized at a point in time, when the software is made available to the customer. Revenue from PCS is deferred at contract inception and recognized ratably over the service period, or as services are performed.
Services and spare parts revenue
The majority of product sales include a standard 12-month warranty that is not separately paid for by the customers. The customers may also purchase extended warranty for periods beyond the initial year as part of the initial product sale. We have concluded that the standard 12-month warranty as well as any extended warranty periods included in the initial product sales are separate performance obligations. The estimated fair value of warranty services is deferred and recognized ratably as revenue over the warranty period, as the customer simultaneously receives and consumes the benefits of warranty services provided by us.
Additionally, we offer product maintenance and support services, which the customer may purchase separately from the standard and extended warranty offered as part of the initial product sale. Revenue from separately negotiated maintenance and support service contracts is also recognized over time based on the terms of the applicable service period. Revenue from services performed in the absence of a maintenance contract, including training revenue, is recognized when the related services are performed. We also sell spare parts, revenue from which is recognized when control over the spare parts is transferred to the customer.
Installation services include connecting and validating configuration of the product. In addition, several testing protocols are completed to confirm the equipment is performing to customer specifications. Revenue from product installation are deferred and recognized at a point in time, once installation is complete.
Significant Judgments
Our contracts with our customers often include promises to transfer multiple products and services. Each product and service is generally capable of being distinct and represents a separate performance obligation. Determining the SSP for each distinct performance obligation and allocation of consideration from an arrangement to the individual performance obligations and the appropriate timing of revenue recognition are significant judgments with respect to these arrangements. We typically estimate the SSP of products and services based on observable transactions when the products and services are sold on a standalone basis and those prices fall within a reasonable range. We typically have more than one SSP for individual products and services due to the stratification of these products by customers and circumstances. In these instances, we use information such as the size of the customer, geographic region, as well as customization of the products in determining the SSP. In instances where the SSP is not directly observable, we determine the SSP using information that includes market conditions, entity-specific factors, including discounting strategies, information about the customer or class of customer that is reasonably available and other observable inputs. While changes in the allocation of SSP between performance obligations will not affect the amount of total revenue recognized for a particular contract, any material changes could impact the timing of revenue recognition, which could have a material effect on our financial position and result of operations.
Although the products are generally not sold with a right of return, we may provide other credits or sales incentives, which are accounted for either as variable consideration or material right, depending on the specific terms and conditions of the arrangement. These credits and incentives are estimated at contract inception and updated at the end of each reporting period if and when additional information becomes available.
As outlined above, we use judgments to evaluate whether or not the customer has obtained control of the product and considers the several indicators in evaluating whether or not control has transferred to the customer. Not all of the indicators need to be met for us to conclude that control has transferred to the customer.
Contract Assets/Liabilities
The timing of revenue recognition, billings and cash collections may result in accounts receivable, contract assets, and contract liabilities (deferred revenue) on our condensed consolidated balance sheet. A receivable is recorded in the period we deliver products or provide services when we have an unconditional right to payment. Contract assets primarily relate to the value of products and services transferred to the customer for which the right to payment is not just dependent on the passage of time. Contract assets are transferred to receivable when rights to payment become unconditional.
A contract liability is recognized when we receive payment or have an unconditional right to payment in advance of the satisfaction of performance. The contract liabilities represent (1) deferred product revenue related to the value of products that have been shipped and billed to customers and for which the control has not been transferred to the customers, and (2) deferred service revenue, which is recorded when we receive consideration, or such consideration is unconditionally due, from a customer prior to transferring services to the customer under the terms of a contract. Deferred service revenue typically results from warranty services, and maintenance and other service contracts.
Contract assets and liabilities related to rights and obligations in a contract are recorded net in the condensed consolidated balance sheets. Upon the adoption of ASC 606, deferred costs of revenue is included in other current assets while under the legacy guidance deferred costs of revenue was included in deferred system profit.
Business Combinations. We allocate the fair value of the purchase price of our acquisitions to the tangible assets acquired, liabilities assumed, and intangible assets acquired, including in-process research and development (“IPR&D”), based on their estimated fair values. The excess of the fair value of the purchase price over the fair values of these net tangible and intangible assets acquired is recorded as goodwill. Management's estimates of fair value are based upon assumptions believed to be reasonable, but our estimates and assumptions are inherently uncertain and subject to refinement. As a result, during the measurement period, which will not exceed one year from the acquisition date, we record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the fair value of the purchase price of our acquisitions, whichever comes first, any subsequent adjustments are recorded to our condensed consolidated statements of operations.
The fair value of IPR&D is initially capitalized as an intangible asset with an indefinite life and assessed for impairment
thereafter. When an IPR&D project is completed, the IPR&D is reclassified as an amortizable purchased intangible asset and amortized over the asset’s estimated useful life. Acquisition-related expenses are recognized separately from the business combination and are expensed as incurred.
Derivative Financial Instruments. We use 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 our 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. We also use interest rate lock agreements to hedge the risk associated with the variability of cash flows due to changes in the benchmark interest rate of the intended debt financing. We believe these financial instruments do not subject us to speculative risk that would otherwise result from changes in currency exchange rates or interest rates. All of our 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 or debt financing expected to occur within twelve to eighteen months, the effective portion of the gains or losses is reported in accumulated other comprehensive income (loss) (“OCI”) and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Prior to adopting the new accounting guidance for hedge accounting, time value was excluded from the assessment of effectiveness for derivative instruments designated as cash flow hedges. Time value was amortized on a mark-to-market basis and recognized in earnings over the life of the derivative contract. For derivative contracts executed after adopting the new accounting guidance, the election to include time value for the assessment of effectiveness is made on all forward contracts designated as cash flow hedges. The change in fair value of the derivative are recorded in OCI until the hedged transaction is recognized in earnings. The assessment effectiveness of options contracts designated as cash flow hedges continue to exclude time value after adopting the new accounting guidance. The initial value of the component excluded from the assessment of effectiveness are recognized in earnings over the life of the derivative contracts. Any difference between change in the fair value of the excluded components and the amounts recognized in earnings are recorded in OCI. For derivative instruments that are not designated as a cash flow hedge, gains and losses are recognized in other expense (income), net. We use foreign currency forward contracts to hedge certain foreign currency denominated assets or liabilities. The gains and losses on these derivative instruments are largely offset by the changes in the fair value of the assets or liabilities being hedged.
Global Intangible Low-Taxed Income. The Tax Cuts and Jobs Act (the “Act”) includes provisions for Global Intangible Low-Taxed Income (“GILTI”) wherein taxes on foreign income are imposed in excess of a deemed return on tangible assets of foreign corporations. This income will effectively be taxed at a 10.5% tax rate in general. As a result, the Company’s deferred tax assets and liabilities were being evaluated to determine if the deferred tax assets and liabilities should be recognized for the basis differences expected to reverse as a result of GILTI provisions that are effective for the Company after the fiscal year ending June 30, 2018, or should the tax on GILTI provisions be recognized as period costs in each year incurred. The Company has elected to account for GILTI as a component of current period tax expense starting from the first quarter of the fiscal year ending June 30, 2019.
NOTE 2 – REVENUE
New Revenue Accounting Standard
Method and Impact of Adoption
At the beginning of the fiscal year 2019, we adopted ASC 606 using the modified retrospective transition approach for all contracts completed and not completed as of the date of adoption. Under the modified retrospective transition approach, periods prior to the adoption date were not adjusted and continue to be reported in accordance with ASC 605. A cumulative effect of applying ASC 606 was recorded to the beginning retained earnings to reflect the impact of all existing arrangements under ASC 606.
The cumulative effect of applying ASC 606 represents a net decrease of $21.0 million as of July 1, 2018, which primarily related to the following:
•
A decrease of approximately $97.0 million in retained earnings related to the deferral of estimated fair value of the warranty services provided with our products for which revenue will be recognized in future periods under ASC 606. Further, upon adoption of ASC 606, we will recognize the standard warranty for a majority of products as a separate performance obligation, while in prior periods, we accounted for the estimated warranty cost as a charge to costs of sales when revenue was recognized. This was partially offset by an increase in retained earnings of approximately $37.0 million related to reversal of standard warranty expense, which was charged to cost of revenues in prior periods.
•
An increase in retained earnings of approximately $26.0 million due to a change in the timing of transfer of control over products to the customers.
The following table summarizes the effects of adopting ASC 606 on our condensed consolidated balance sheet as of December 31, 2018:
December 31, 2018 (In thousands)
As reported under
ASC 606
Prior to
adoption of
ASC 606
Effect of changes
ASSETS
Accounts receivable, net
$
658,080
$
678,863
$
(20,783
)
Other current assets
127,350
71,214
56,136
Deferred income taxes
225,124
206,674
18,450
LIABILITIES
Deferred system revenue
$
196,242
$
—
$
196,242
Deferred service revenue
168,936
66,759
102,177
Deferred system profit
—
319,696
(319,696
)
Other current liabilities
714,873
733,220
(18,347
)
Deferred service revenue, non-current
90,466
83,338
7,128
STOCKHOLDERS’ EQUITY
Retained earnings
$
1,048,804
$
962,561
$
86,243
Accumulated other comprehensive income (loss)
(70,447
)
(70,502
)
55
The following table summarizes the effects of adopting ASC 606 on our condensed consolidated statements of operations for the three months ended December 31, 2018:
Three months ended December 31, 2018 (In thousands, except per share amounts)
The following table summarizes the effects of adopting ASC 606 on our condensed consolidated statements of operations for the six months ended December 31, 2018:
Six months ended December 31, 2018 (In thousands, except per share amounts)
As reported under
ASC 606
Prior to
adoption of
ASC 606
Effect of changes
Revenues:
Product
$
1,681,428
$
1,576,088
$
105,340
Service
531,730
460,643
71,087
Costs and expenses:
Costs of revenues
789,647
734,790
54,857
Other expense (income), net
(19,253
)
(19,213
)
(40
)
Provision for income taxes
78,487
64,335
14,152
Net income
$
765,044
$
657,586
$
107,458
Net income per share:
Basic
$
4.98
$
4.29
$
0.69
Diluted
$
4.96
$
4.27
$
0.69
Under ASC 606, revenue is recognized earlier than it would have been recognized under legacy guidance primarily due to our assessment of timing of transfer of control. Additionally, we render standard warranty coverage on our products for 12 months, providing labor and parts necessary to repair and maintain the products during the warranty period. Prior to adoption of ASC 606, we accounted for the estimated warranty cost as a charge to costs of sales when revenue was recognized. Upon adoption of ASC 606, the standard warranty for the majority of products is recognized as a separate performance obligation in service revenue.
Contract Balances
As of
As of
(In thousands, except for percentage)
December 31, 2018
July 1, 2018
$ Change
% Change
Accounts receivable, net
$
658,080
$
635,878
$
22,202
3.49
%
Contract assets
$
23,316
$
14,727
$
8,589
58.32
%
Contract liabilities
$
455,644
$
556,691
$
(101,047
)
(18.15
)%
Our payment terms and conditions vary by contract type, although terms generally include a requirement of payment of 70% to 90% of total contract consideration within 30 to 60 days of shipment, with the remainder payable within 30 days of acceptance.
The change in contract assets during the six months ended December 31, 2018 was mainly due to $23.2 million of revenue recognized in excess of the amounts billed to the customers, partially offset by $14.6 million of contract assets reclassified to net accounts receivable as our right to consideration for these contract assets became unconditional. Contract assets are included in Other current assets on our condensed consolidated balance sheet.
During the six months ended December 31, 2018, we recognized revenue of $371.4 million that was included in contract liabilities as of July 1, 2018. This was partially offset by the value of products and services billed to customers for which control of the products and service has not transferred to the customers. Contract liabilities are included in current and non-current liabilities on our condensed consolidated balance sheets.
Remaining Performance Obligations
As of December 31, 2018, we had $1.66 billion of remaining performance obligations, which represents our obligation to deliver products and services, and consists primarily of sales orders where written customer requests have been received. We expect to recognize approximately 5% to 15% of these performance obligations as revenue beyond the next twelve months, subject to risk of delays, pushouts, and cancellation by the customer, usually with limited or no penalties.
Refer to Note 17 “Segment Reporting and Geographic Information” for information related to revenue by geographic region as well as significant product and service offerings.
We account for shipping and handling costs as activities to fulfill the promise to transfer the goods, instead of a promised service to our customer.
•
We have elected to not adjust the promised amount of consideration for the effects of a significant financing component as we expect, at contract inception, that the period between when the entity transfers a promised good or service to a customer and when the customer pays for that good or service will generally be one year or less.
•
We have elected to expense costs to obtain a contract as incurred because the expected amortization period is one year or less.
•
We have elected to reflect the aggregate effect of all modifications that occurred before July 1, 2018 in determining the transaction price, identifying the satisfied and unsatisfied performance obligations, and allocating the transaction price to the performance obligations.
NOTE 3 – FAIR VALUE MEASUREMENTS
Our financial assets and liabilities are measured and recorded at fair value, except for our debt and certain equity investments in privately-held companies. Prior to July 1, 2018, the equity investments were generally accounted for under the cost method of accounting and were periodically assessed for other-than-temporary impairment when an event or circumstance indicated that an other-than-temporary decline in value may have occurred. Effective July 1, 2018, equity investments without a readily available fair value are accounted for using the measurement alternative. The measurement alternative is calculated as cost minus impairment, if any, plus or minus changes resulting from observable price changes.
Our 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. We have 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 our cash equivalents, accounts receivable, accounts payable and other current assets and liabilities approximate their carrying amounts due to the relatively short maturity of these items.
Fair Value Hierarchy. The authoritative guidance for fair value measurements establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:
Level 1
Valuations based on quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.
Level 2
Valuations based on quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities.
Level 3
Valuations based on inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
As of December 31, 2018, the types of instruments valued based on quoted market prices in active markets included money market funds, certain U.S. Treasury securities and U.S. Government agency securities. Such instruments are generally classified within Level 1 of the fair value hierarchy. The types of instruments valued based on other observable inputs included corporate debt securities, sovereign securities and certain U.S. Treasury 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 we execute our 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. Our foreign currency contracts’ valuation inputs are based on quoted prices and quoted pricing intervals from public data sources and do not involve management judgment. These contracts are typically classified within Level 2 of the fair value hierarchy.
The fair value of contingent consideration payable, which resulted from the acquisitions of privately-held companies, was classified as Level 3 and estimated using significant inputs that were not observable in the market.
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 our Condensed Consolidated Balance Sheet as follows:
As of December 31, 2018 (In thousands)
Total
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Little or no market activity
Inputs
(Level 3)
Assets
Cash equivalents:
Money market funds and other
$
877,527
$
877,527
$
—
$
—
U.S. Treasury securities
668,058
—
668,058
—
Marketable securities:
Corporate debt securities
500,594
—
500,594
—
Sovereign securities
10,919
—
10,919
—
U.S. Government agency securities
172,615
172,615
—
—
U.S. Treasury securities
211,588
211,588
—
—
Total cash equivalents and marketable securities(1)
2,441,301
1,261,730
1,179,571
—
Other current assets:
Derivative assets
1,732
—
1,732
—
Other non-current assets:
Executive Deferred Savings Plan
181,104
137,301
43,803
—
Total financial assets(1)
$
2,624,137
$
1,399,031
$
1,225,106
$
—
Liabilities
Other current liabilities:
Derivative liabilities
$
(14,318
)
$
—
$
(14,318
)
$
—
Contingent consideration payable
(2,529
)
—
—
(2,529
)
Total financial liabilities
$
(16,847
)
$
—
$
(14,318
)
$
(2,529
)
________________
(1) Excludes cash of $204.5 million held in operating accounts and time deposits of $48.3 million as of December 31, 2018.
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 our Condensed Consolidated Balance Sheet as follows:
As of June 30, 2018 (In thousands)
Total
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
Significant Other
Observable Inputs
(Level 2)
Assets
Cash equivalents:
Corporate debt securities
$
4,995
$
—
$
4,995
Money market funds and other
863,115
863,115
—
U.S. Government agency securities
7,675
—
7,675
U.S. Treasury securities
1,996
—
1,996
Marketable securities:
Corporate debt securities
735,408
—
735,408
Sovereign securities
17,142
—
17,142
U.S. Government agency securities
316,022
299,501
16,521
U.S. Treasury securities
405,654
364,574
41,080
Total cash equivalents and marketable securities(1)
2,352,007
1,527,190
824,817
Other current assets:
Derivative assets
5,385
—
5,385
Other non-current assets:
Executive Deferred Savings Plan
197,213
143,580
53,633
Total financial assets(1)
$
2,554,605
$
1,670,770
$
883,835
Liabilities
Other current liabilities:
Derivative liabilities
$
(6,828
)
$
—
$
(6,828
)
Total financial liabilities
$
(6,828
)
$
—
$
(6,828
)
________________
(1) Excludes cash of $473.8 million held in operating accounts and time deposits of $54.5 million as of June 30, 2018.
There were no transfers between Level 1 and Level 2 fair value measurements during the six months ended December 31, 2018. We did not have any assets or liabilities measured at fair value on a recurring basis within Level 3 fair value measurements as of June 30, 2018.
Deferred costs of revenue were previously included under deferred system profit prior to the adoption of ASC 606.
(2)
We have a non-qualified deferred compensation plan (known as “Executive Deferred Savings Plan” or “EDSP”) under which certain employees and non-employee directors may defer a portion of their compensation. The expense (benefit) associated with changes in the EDSP liability included in selling, general and administrative expense was $(19.8) million and $7.0 million during the three months ended December 31, 2018 and 2017, respectively and was $(12.3) million and $13.8 million during the six months ended December 31, 2018 and 2017, respectively. The amount of net gains (losses) associated with changes in the EDSP assets included in selling, general and administrative expense was $(19.4) million and $7.0 million during the three months ended December 31, 2018 and 2017, respectively and was $(12.0) million and $13.9 million the six months ended December 31, 2018 and 2017, respectively. For additional details, refer to Note 1, “Description of Business and Summary of Significant Accounting Policies,” of the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018.
Accumulated Other Comprehensive Income (Loss)
The components of accumulated other comprehensive income (loss) (“OCI”) as of the dates indicated below were as follows:
(In thousands)
Currency Translation Adjustments
Unrealized Gains (Losses) on Available-for-Sale Securities
Unrealized Gains (Losses) on Cash Flow Hedges
Unrealized Gains (Losses) on Defined Benefit Plans
Total
Balance as of December 31, 2018
$
(43,041
)
$
(6,736
)
$
(4,402
)
$
(16,268
)
$
(70,447
)
Balance as of June 30, 2018
$
(29,974
)
$
(11,032
)
$
1,932
$
(14,859
)
$
(53,933
)
The effects on net income (loss) of amounts reclassified from accumulated OCI to the Condensed Consolidated Statement of Operations for the indicated period were as follows (in thousands):
Location in the Condensed Consolidated
Three months ended December 31,
Six months ended December 31,
Accumulated OCI Components
Statements of Operations
2018
2017
2018
2017
Unrealized gains (losses) on cash flow hedges from foreign exchange and interest rate contracts(1)
Revenues
$
1,705
$
397
$
2,688
$
1,365
Costs of revenues
(158
)
377
(292
)
1,338
Interest expense
189
189
377
378
Net gains (losses) reclassified from accumulated OCI
$
1,736
$
963
$
2,773
$
3,081
Unrealized gains (losses) on available-for-sale securities
Other expense (income), net
$
(469
)
$
(69
)
$
(950
)
$
(63
)
__________________
(1)
Reflects the adoption of the new accounting guidance for hedge accounting in the second quarter of fiscal year 2019. For additional details, refer to Note 15, “Derivative Instruments and Hedging Activities.”
The amounts reclassified out of accumulated OCI related to our defined benefit pension plans, which were recognized as a component of net periodic cost for the three and six months ended December 31, 2018 were $0.2 million and $0.4 million, respectively. The amounts reclassified out of accumulated OCI related to our defined benefit pension plans, which were recognized as a component of net periodic cost for the three and six months ended December 31, 2017 were $0.4 million and $0.8 million, respectively. For additional details, refer to Note 11, “Employee Benefit Plans” of the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018.
The amortized cost and fair value of marketable securities as of the dates indicated below were as follows:
As of December 31, 2018 (In thousands)
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair
Value
Corporate debt securities
$
505,296
$
—
$
(4,702
)
$
500,594
Money market funds and other
877,527
—
—
877,527
Sovereign securities
11,008
—
(89
)
10,919
U.S. Government agency securities
174,058
2
(1,445
)
172,615
U.S. Treasury securities
881,704
36
(2,094
)
879,646
Subtotal
2,449,593
38
(8,330
)
2,441,301
Add: Time deposits(1)
48,265
—
—
48,265
Less: Cash equivalents
1,589,418
36
—
1,589,454
Marketable securities
$
908,440
$
2
$
(8,330
)
$
900,112
As of June 30, 2018 (In thousands)
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Fair Value
Corporate debt securities
$
747,763
$
148
$
(7,508
)
$
740,403
Money market funds and other
863,115
—
—
863,115
Sovereign securities
17,293
—
(151
)
17,142
U.S. Government agency securities
326,508
16
(2,827
)
323,697
U.S. Treasury securities
411,329
3
(3,682
)
407,650
Subtotal
2,366,008
167
(14,168
)
2,352,007
Add: Time deposits(1)
54,537
—
—
54,537
Less: Cash equivalents
930,608
—
—
930,608
Marketable securities
$
1,489,937
$
167
$
(14,168
)
$
1,475,936
________________
(1) Time deposits excluded from fair value measurements.
Our investment portfolio consists of both corporate and government securities that have a maximum maturity of three years. The longer the duration of these securities, the more susceptible they are to changes in market interest rates and bond yields. As yields increase, those securities with a lower yield-at-cost show a mark-to-market unrealized loss. Most of our unrealized losses are due to changes in market interest rates and bond yields. We believe that we have 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 our investments that were in an unrealized loss position as of the date indicated below:
As of December 31, 2018 (In thousands)
Fair Value
Gross
Unrealized
Losses(1)
Corporate debt securities
$
497,833
$
(4,702
)
U.S. Treasury securities
211,588
(2,094
)
U.S. Government agency securities
169,967
(1,445
)
Sovereign securities
10,919
(89
)
Total
$
890,307
$
(8,330
)
__________________
(1) As of December 31, 2018, the amount of total gross unrealized losses related to investments that had been in a continuous loss position for 12 months or more was $7.9 million.
The contractual maturities of securities classified as available-for-sale, regardless of their classification on our Condensed Consolidated Balance Sheet, as of the date indicated below were as follows:
As of December 31, 2018 (In thousands)
Amortized Cost
Fair Value
Due within one year
$
567,385
$
563,316
Due after one year through three years
341,055
336,796
$
908,440
$
900,112
Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Realized gains and losses on available-for-sale securities for the three and six months ended December 31, 2018 and 2017 were immaterial.
NOTE 6 - BUSINESS COMBINATIONS
In September 2018, we acquired certain assets and assumed certain liabilities of a privately-held company for a total purchase consideration of $4.1 million, which includes a promise to pay an additional consideration of up to $1.5 million contingent on the achievement of certain milestones. As of December 31, 2018, the estimated fair value of the additional consideration was $0.9 million, which is classified as a current liability on the condensed consolidated balance sheet.
In July 2018, we acquired the outstanding shares of a privately-held company for a total purchase consideration of $11.3 million, including the fair value of the promise to pay an additional consideration of up to $4.5 million contingent on the achievement of certain revenue milestones. As of December 31, 2018, the estimated fair value of the additional consideration was $1.6 million, which is classified as a current liability on the condensed consolidated balance sheet.
We have included the financial results of the acquisitions completed during the first quarter of the fiscal year 2019 in our condensed consolidated financial statements from the date of acquisition. These results were not individually or in aggregate material to our condensed consolidated financial statements.
For the fiscal year ended June 30, 2018, we acquired a product line from Keysight Technologies, Inc., a related party, for a total purchase consideration of $12.1 million, of which $5.2 million was allocated to goodwill based on the fair value at the acquisition date. Goodwill recognized was deductible for income tax purposes. For additional details, refer to Note 5 “Business Combinations,” of the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018.
NOTE 7 – GOODWILL AND PURCHASED INTANGIBLE ASSETS
Goodwill
We have four reporting units: Wafer Inspection, Patterning, Global Service and Support (“GSS”), and Others. The following table presents goodwill carrying value and the movements by reporting unit during the six months ended December 31, 2018:
(In thousands)
Wafer Inspection
Patterning
GSS
Others
Total
Balance as of June 30, 2018
$
281,005
$
53,255
$
8,039
$
12,399
$
354,698
Acquired goodwill
—
—
4,631
1,176
5,807
Foreign currency and other adjustments
(25
)
—
—
—
(25
)
Balance as of December 31, 2018
$
280,980
$
53,255
$
12,670
$
13,575
$
360,480
The change in goodwill during the six months ended December 31, 2018 resulted primarily from the acquisition of certain assets and liabilities of privately-held companies. For additional details, refer to Note 6 “Business Combinations”.
As of December 31, 2018, there have been no significant events or circumstances affecting the carrying value of goodwill subsequent to the qualitative assessment performed in the third quarter of the fiscal year ended June 30, 2018. For additional details, refer to Note 6 “Goodwill and Purchased Intangible Assets,” of the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018. The next annual assessment of goodwill by reporting unit is scheduled to be performed in the third quarter of the fiscal year ending June 30, 2019.
The components of purchased intangible assets as of the dates indicated below were as follows:
(In thousands)
As of December 31, 2018
As of June 30, 2018
Category
Range of
Useful Lives
Gross
Carrying
Amount
Accumulated
Amortization
and
Impairment
Net
Amount
Gross
Carrying
Amount
Accumulated
Amortization
and
Impairment
Net
Amount
Existing technology
4-7 years
$
166,029
$
146,001
$
20,028
$
160,859
$
144,202
$
16,657
Trade name/Trademark
5-7 years
21,073
20,143
930
20,993
20,060
933
Customer relationships
4-7 years
58,050
55,388
2,662
56,680
55,136
1,544
Other
<1-5 years
1,270
1,072
198
660
461
199
Total
$
246,422
$
222,604
$
23,818
$
239,192
$
219,859
$
19,333
Purchased intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable.
For the three months ended December 31, 2018 and 2017, amortization expense for purchased intangible assets was $1.3 million and $1.2 million, respectively. For the six months ended December 31, 2018 and 2017, amortization expense for purchased intangible assets was $2.7 million and $2.4 million, respectively. The change in purchased intangible assets gross carrying amount resulted primarily from the acquisition of certain assets and liabilities of privately-held companies. For additional details, refer to Note 6 “Business Combinations.”
Based on the purchased intangible assets gross carrying amount recorded as of December 31, 2018, and assuming no subsequent additions to, or impairment of, the underlying assets, the remaining estimated annual amortization expense is expected to be as follows:
The following table summarizes our debt as of December 31, 2018 and June 30, 2018:
As of December 31, 2018
As of June 30, 2018
Amount
(In thousands)
Effective
Interest Rate
Amount (In thousands)
Effective
Interest Rate
Fixed-rate 3.375% Senior Notes due on November 1, 2019
$
250,000
3.377
%
$
250,000
3.377
%
Fixed-rate 4.125% Senior Notes due on November 1, 2021
500,000
4.128
%
500,000
4.128
%
Fixed-rate 4.650% Senior Notes due on November 1, 2024(1)
1,250,000
4.682
%
1,250,000
4.682
%
Fixed-rate 5.650% Senior Notes due on November 1, 2034
250,000
5.670
%
250,000
5.670
%
Total
2,250,000
2,250,000
Unamortized discount
(2,343
)
(2,523
)
Unamortized debt issuance costs
(9,279
)
(10,075
)
Total
$
2,238,378
$
2,237,402
Reported as:
Current portion of long-term debt
$
249,996
$
—
Long-term debt
1,988,382
2,237,402
Total
$
2,238,378
$
2,237,402
__________________
(1)
The effective interest rate disclosed above for this series of Senior Notes excludes the impact of the treasury rate lock hedge discussed below. The effective interest rate including the impact of the treasury rate lock hedge was 4.626%.
As of December 31, 2018, future principal payments for the long-term debt are $250.0 million in fiscal year 2020; $500.0 million in fiscal year 2022; and $1.50 billion after fiscal year 2023.
Senior Notes:
In November 2014, we issued $2.50 billion aggregate principal amount of senior, unsecured long-term notes (collectively referred to as “Senior Notes”) as part of the leveraged recapitalization plan.
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. In October 2014, we entered into a series of forward contracts to lock the 10-year treasury rate (“benchmark rate”) on a portion of the Senior Notes with a notional amount of $1.00 billion in aggregate. For additional details, refer to Note 15, “Derivative Instruments and Hedging Activities” of this report, and Note 7 “Debt” of the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018.
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 indenture for the Senior Notes (the “Indenture”) includes covenants that limit our ability to grant liens on our facilities and enter into sale and leaseback transactions, subject to certain allowances under which certain sale and leaseback transactions are not restricted.
In certain circumstances involving a change of control followed by a downgrade of the rating of a series of Senior Notes by at least two of Moody’s, S&P and Fitch Inc., unless we have exercised our rights to redeem the Senior Notes of such series, we 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, we 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 December 31, 2018 and June 30, 2018 was approximately $2.30 billion and $2.33 billion, respectively. While the Senior Notes are recorded at cost, the fair value of the long-term debt was determined based on quoted prices in markets that are not active; accordingly, the long-term debt is categorized as Level 2 for purposes of the fair value measurement hierarchy.
As of December 31, 2018, we were in compliance with all of our covenants under the Indenture associated with the Senior Notes.
In November 2017, we entered into a Credit Agreement (the “Credit Agreement”) providing for a $750.0 million five-year unsecured Revolving Credit Facility (the “Revolving Credit Facility”), which replaced our prior Credit Facility. Subject to the terms of the Credit Agreement, the Revolving Credit Facility may be increased in an amount up to $250.0 million in the aggregate. In November 2018, we entered into an Incremental Facility, Extension and Amendment Agreement (the “Amendment”), which amends the Credit Agreement to (a) extend the Maturity Date (the “Maturity Date”) from November 30, 2022 to November 30, 2023, (b) increase the total commitment by $250.0 million and (c) effect certain other amendments to the Credit Agreement as set forth in the Amendment. After giving effect to the Amendment, the total commitments under the Credit Agreement are $1.00 billion.
We may borrow, repay and reborrow funds under the Revolving Credit Facility until the Maturity Date, at which time such Revolving Credit Facility will terminate, and all outstanding loans under such facility, together with all accrued and unpaid interest, must be repaid. We may prepay outstanding borrowings under the Revolving Credit Facility at any time without a prepayment penalty.
Borrowings under the Revolving Credit Facility will bear interest, at our option, at either: (i) the Alternative Base Rate (“ABR”) plus a spread, which ranges from 0 bps to 75 bps, or (ii) the London Interbank Offered Rate (“LIBOR”) plus a spread, which ranges from 100 bps to 175 bps. The spreads under ABR and LIBOR are subject to adjustment in conjunction with credit rating downgrades or upgrades. We are also obligated to pay an annual commitment fee on the daily undrawn balance of the Revolving Credit Facility, which ranges from 10 bps to 25 bps, subject to an adjustment in conjunction with changes to our credit rating. As of December 31, 2018, we pay an annual commitment fee of 12.5 bps on the daily undrawn balance of the Revolving Credit Facility.
The Revolving Credit Facility requires us 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, we are required to maintain the maximum leverage ratio as described in the Credit Agreement, on a quarterly basis of 3.00 to 1.00, covering the trailing four consecutive fiscal quarters for each fiscal quarter, which can be increased to 4.00 to 1.00 for a period of time in connection with a material acquisition or a series of material acquisitions.
We were in compliance with all covenants under the Credit Agreement as of December 31, 2018 and had no outstanding borrowings under the unfunded Revolving Credit Facility.
NOTE 9 – EQUITY AND LONG-TERM INCENTIVE COMPENSATION PLANS
Equity Incentive Program
As of December 31, 2018, we were able to issue equity incentive awards, such as restricted stock units (“RSUs”) and stock options, to our employees, consultants and members of our Board of Directors under our 2004 Equity Incentive Plan (the “2004 Plan”) with 13.4 million shares available for issuance.
For details of the 2004 Plan refer to Note 8 “Equity and Long-Term Incentive Compensation Plans,” of the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018.
Equity Incentive Plans - General Information
The following table summarizes the combined activity under our equity incentive plans for the indicated periods:
(In thousands)
Available
For Grant(1)
Balance as of June 30, 2018
3,680
Plan shares increased
12,000
Restricted stock units granted (2)
(675
)
Restricted stock units granted adjustment (3)
5
Restricted stock units canceled
20
Balance as of December 31, 2018
15,030
__________________
(1)
The number of RSUs reflects the application of the award multiplier (1.8x or 2.0x depending on the grant date of the applicable award).
Includes RSUs granted to senior management during the six months ended December 31, 2018 with performance-based vesting criteria (in addition to service-based vesting criteria for any of such RSUs that are deemed to have been earned). As of December 31, 2018, it had not yet been determined the extent to which (if at all) the performance-based vesting criteria had been satisfied. Therefore, this line item includes all such performance-based RSUs granted during the six months ended December 31, 2018, reported at the maximum possible number of shares that may ultimately be issuable if all applicable performance-based criteria are achieved at their maximum levels and all applicable service-based criteria are fully satisfied (0.4 million shares for the six months ended December 31, 2018 reflects the application of the multiplier described above).
(3)
Represents the portion of RSUs granted with performance-based vesting criteria and reported at the actual number of shares issued upon achievement of the performance vesting criteria during the six months ended December 31, 2018.
The fair value of stock-based awards is measured at the grant date and is recognized as an expense over the employee’s requisite service period. For RSUs granted without “dividend equivalent” rights, fair value is calculated using the closing price of our common stock on the grant date, adjusted to exclude the present value of dividends which are not accrued on those RSUs. The fair value for RSUs granted with “dividend equivalent” rights is determined using the closing price of our common stock on the grant date. The fair value for purchase rights under our Employee Stock Purchase Plan is determined using a Black-Scholes model.
The following table shows stock-based compensation expense for the indicated periods:
Three months ended December 31,
Six months ended December 31,
(In thousands)
2018
2017
2018
2017
Stock-based compensation expense by:
Costs of revenues
$
1,823
$
1,656
$
3,654
$
3,072
Research and development
2,483
2,275
5,002
4,446
Selling, general and administrative
11,389
9,808
23,177
20,252
Total stock-based compensation expense
$
15,695
$
13,739
$
31,833
$
27,770
The following table shows stock-based compensation capitalized as inventory as of the dates indicated below:
(In thousands)
As of December 31, 2018
As of June 30, 2018
Inventory
$
4,859
$
4,580
Restricted Stock Units
The following table shows the activity and weighted-average grant date fair value for RSUs during the six months ended December 31, 2018:
Shares(1)
(In thousands)
Weighted-Average
Grant Date
Fair Value
Outstanding restricted stock units as of June 30, 2018(2)
2,014
$
76.50
Granted(2)
338
$
117.21
Granted adjustments(3)
(2
)
$
50.88
Vested and released
(383
)
$
66.41
Withheld for taxes
(264
)
$
66.41
Forfeited
(10
)
$
81.55
Outstanding restricted stock units as of December 31, 2018(2)
1,693
$
88.48
__________________
(1)
Share numbers reflect actual shares subject to awarded RSUs. 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.
Includes RSUs granted to senior management with performance-based vesting criteria (in addition to service-based vesting criteria for any of such RSUs that are deemed to have been earned). As of December 31, 2018, it had not yet been determined the extent to which (if at all) the performance-based vesting criteria had been satisfied. Therefore, this line item includes all such performance-based RSUs, reported at the maximum possible number of shares (42 thousand shares for the fiscal year ended June 30, 2017, 0.2 million shares for the fiscal year ended June 30, 2018 and 0.2 million shares for the six months ended December 31, 2018) that may ultimately be issuable if all applicable performance-based criteria are achieved at their maximum and all applicable service-based criteria are fully satisfied.
(3)
Represents the portion of RSUs granted with performance-based vesting criteria and reported at the actual number of shares issued upon achievement of the performance vesting criteria during six months ended December 31, 2018.
The RSUs granted by us 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 us as of the applicable vesting date. The RSUs granted to the independent members of the Board of Directors' vest annually.
The following table shows the weighted-average grant date fair value per unit for the RSUs granted, vested, and tax benefits realized by us in connection with vested and released RSUs for the indicated periods:
Three months ended December 31,
Six months ended December 31,
(In thousands, except for weighted-average grant date fair value)
2018
2017
2018
2017
Weighted-average grant date fair value per unit
$
96.51
$
105.15
$
117.21
$
91.39
Grant date fair value of vested restricted stock units
$
6,862
$
5,322
$
42,934
$
41,856
Tax benefits realized by us in connection with vested and released restricted stock units
$
3,812
$
(1,930
)
$
10,730
$
16,482
As of December 31, 2018, the unrecognized stock-based compensation expense balance related to RSUs was $116.4 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 1.5 years. The intrinsic value of outstanding RSUs as of December 31, 2018 was $151.5 million.
Cash-Based Long-Term Incentive Compensation
We have adopted a cash-based long-term incentive (“Cash LTI Plan”) program for many of our employees as part of our employee compensation program. Executives and non-employee Board of Directors’ members are not participating in this program. During the six months ended December 31, 2018 and 2017, we approved Cash LTI awards of $5.6 million and $4.0 million, respectively under our Cash LTI Plan. During the three months ended December 31, 2018 and 2017, we recognized $12.0 million and $11.5 million, respectively, in compensation expense under the Cash LTI Plan. During the six months ended December 31, 2018 and 2017, we recognized $27.2 million and $26.3 million, respectively, in compensation expense under the Cash LTI Plan. As of December 31, 2018, the unrecognized compensation balance (excluding the impact of estimated forfeitures) related to the Cash LTI Plan was $104.9 million. For details, refer to Note 8 “Equity and Long-Term Incentive Compensation Plans,” of the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018.
Employee Stock Purchase Plan
Our Employee Stock Purchase Plan (“ESPP”) provides that eligible employees may contribute up to 15% of their eligible earnings toward the semi-annual purchase of our 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 our common stock at the commencement of the applicable six-month offering period or (ii) the fair market value of our common stock on the purchase date. We estimate the fair value of purchase rights under the ESPP using a Black-Scholes model.
The fair value of each purchase right under the ESPP was estimated on the date of grant using the Black-Scholes model and the straight-line attribution approach with the following weighted-average assumptions:
Three months ended December 31,
Six months ended December 31,
2018
2017
2018
2017
Stock purchase plan:
Expected stock price volatility
30.0
%
25.9
%
30.0
%
25.9
%
Risk-free interest rate
1.9
%
0.9
%
1.9
%
0.9
%
Dividend yield
2.9
%
2.6
%
2.9
%
2.6
%
Expected life (in years)
0.5
0.5
0.5
0.5
The following table shows the tax benefits realized by us in connection with the disqualifying dispositions of shares purchased under the ESPP and the weighted-average fair value per share for the indicated periods:
(In thousands, except for weighted-average fair value per share)
Three months ended December 31,
Six months ended December 31,
2018
2017
2018
2017
Total cash received from employees for the issuance of shares under the ESPP
$
20,556
$
20,579
$
20,556
$
20,579
Number of shares purchased by employees through the ESPP
270
264
270
264
Tax benefits realized by us in connection with the disqualifying dispositions of shares purchased under the ESPP
$
92
$
47
$
603
$
894
Weighted-average fair value per share based on Black-Scholes model
$
22.73
$
19.04
$
22.73
$
19.04
The ESPP shares are replenished annually on the first day of each fiscal year by virtue of an evergreen provision. The provision allows for share replenishment equal to the lesser of 2.0 million shares or the number of shares which we estimate will be required to be issued under the ESPP during the forthcoming fiscal year. As of December 31, 2018, a total of 2.4 million shares were reserved and available for issuance under the ESPP.
Quarterly cash dividends
On November 7, 2018, our Board of Directors declared a regular quarterly cash dividend of $0.75 per share on the outstanding shares of our common stock, which was paid on December 4, 2018 to the stockholders of record as of the close of business on November 17, 2018. The total amount of regular quarterly cash dividends and dividend equivalents paid by us during the three months ended December 31, 2018 and 2017 was $114.5 million and $92.6 million, respectively. The total amount of regular quarterly cash dividends and dividend equivalents paid by us during the six months ended December 31, 2018 and 2017 was $234.4 million and $186.7 million, respectively. The amount of accrued dividends payable for regular quarterly cash dividends on unvested RSUs with dividend equivalent rights as of December 31, 2018 and June 30, 2018 was $5.4 million and $6.7 million, respectively. These accrued cash dividends will be paid upon vesting of the underlying RSUs.
Special cash dividend
On November 19, 2014, our Board of Directors declared a special cash dividend of $16.50 per share on our outstanding common stock. The declaration and payment of the special cash dividend was part of our leveraged recapitalization transaction under which the special cash dividend was financed through a combination of existing cash and proceeds from the debt financing disclosed in Note 8 “Debt” that was completed during the three months ended December 31, 2014. The total amount of the special cash dividend accrued by us at the declaration date was substantially 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 RSUs and to be paid when such underlying unvested RSUs vest. During the three months ended December 31, 2018 and 2017, the total special cash dividends paid with respect to vested RSUs were immaterial. During the six months ended December 31, 2018 and 2017, the total special cash dividends paid with respect to vested RSUs were $2.9 million and $6.2 million, respectively. As of December 31, 2018, all of the special cash dividends accrued with respect to outstanding RSUs were vested and paid in full. For details of the special cash dividend, refer to Note 8 “Equity and Long-Term Incentive Compensation Plans,” of the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018.
Our Board of Directors has authorized a program which permits us to repurchase up to $1.00 billion of its common stock, or up to $2.00 billion if the Orbotech Merger closes. For additional details, refer to Note 1, “Basis of Presentation”. The intent of this program is to offset the dilution from our equity incentive plans, employee stock purchase plan, the issuance of shares in the merger involving Orbotech, as well as to return excess cash to our stockholders. Subject to market conditions, applicable legal requirements and other factors, the repurchases were made in the open market in compliance with applicable securities laws, including the Securities Exchange Act of 1934 and the rules promulgated thereunder, such as Rule 10b-18 and Rule 10b5-1. This stock repurchase program has no expiration date and may be suspended at any time. As of December 31, 2018, an aggregate of approximately $411.7 million was available for repurchase under our stock repurchase program.
Share repurchases for the indicated periods (based on the trade date of the applicable repurchase) were as follows: