Lam Research Corporation
LAM RESEARCH CORP (Form: 10-Q, Received: 01/30/2017 16:18:36)

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
   ___________________________________________________________
FORM 10-Q
  ___________________________________________________________
  (Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 25, 2016
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 0-12933  
___________________________________________________________
LAM RESEARCH CORPORATION
(Exact name of registrant as specified in its charter)
___________________________________________________________
Delaware
 
94-2634797
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
4650 Cushing Parkway
Fremont, California
 
94538
(Address of principal executive offices)
 
(Zip Code)
(510) 572-0200
(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 Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   x     No   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer
 
x
  
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
¨   (Do not check if a smaller reporting company)
  
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨     No   x
As of January 26, 2017 , the Registrant had 162,843,881  shares of common stock outstanding.
 




LAM RESEARCH CORPORATION
TABLE OF CONTENTS
 
 
 
Page No.
 
 
 
 
 
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.



Table of Contents


PART I. FINANCIAL INFORMATION

ITEM 1.
Financial Statements

LAM RESEARCH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
 
 
Three Months Ended
 
Six Months Ended
December 25,
2016
 
December 27,
2015
 
December 25,
2016
 
December 27,
2015
Revenue
$
1,882,299

 
$
1,425,534

 
$
3,514,718

 
$
3,025,577

Cost of goods sold
1,035,502

 
799,024

 
1,951,724

 
1,676,704

Gross margin
846,797

 
626,510

 
1,562,994

 
1,348,873

Research and development
246,804

 
220,754

 
482,044

 
454,963

Selling, general and administrative
160,165

 
166,922

 
325,175

 
319,648

Total operating expenses
406,969

 
387,676

 
807,219

 
774,611

Operating income
439,828

 
238,834

 
755,775

 
574,262

Other expense, net
(55,023
)
 
(29,935
)
 
(78,177
)
 
(57,056
)
Income before income taxes
384,805

 
208,899

 
677,598

 
517,206

Income tax (expense) benefit
(52,014
)
 
14,081

 
(80,972
)
 
(5,547
)
Net income
$
332,791

 
$
222,980

 
$
596,626

 
$
511,659

Net income per share:
 
 
 
 
 
 
 
Basic
$
2.05

 
$
1.41

 
$
3.69

 
$
3.23

Diluted
$
1.81

 
$
1.28

 
$
3.28

 
$
2.94

Number of shares used in per share calculations:
 
 
 
 
 
 
 
Basic
162,659

 
158,424

 
161,633

 
158,388

Diluted
183,543

 
174,242

 
181,780

 
174,308

Cash dividend declared per common share
$
0.45

 
$
0.30

 
$
0.75

 
$
0.60


3



Table of Contents


LAM RESEARCH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(unaudited)

 
 
Three Months Ended
 
Six Months Ended
December 25,
2016
 
December 27,
2015
 
December 25,
2016
 
December 27,
2015
Net income
$
332,791

 
$
222,980

 
$
596,626

 
$
511,659

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustment
(14,428
)
 
(1,022
)
 
(9,927
)
 
(8,844
)
Cash flow hedges:
 
 
 
 
 
 
 
Net unrealized gains during the period
15,225

 
3,703

 
12,804

 
3,159

Net (gains) losses reclassified into earnings
(502
)
 
(3,220
)
 
11,448

 
(2,879
)
 
14,723

 
483

 
24,252

 
280

Available-for-sale investments:
 
 
 
 
 
 
 
Net unrealized losses during the period
(13,585
)
 
(5,133
)
 
(16,308
)
 
(2,385
)
Net losses (gains) reclassified into earnings
91

 
(244
)
 
994

 
(224
)
 
(13,494
)
 
(5,377
)
 
(15,314
)
 
(2,609
)
Defined benefit plans, net change in unrealized component
122

 
93

 
245

 
188

Other comprehensive loss, net of tax
(13,077
)
 
(5,823
)
 
(744
)
 
(10,985
)
Comprehensive income
$
319,714

 
$
217,157

 
$
595,882

 
$
500,674


See Notes to Condensed Consolidated Financial Statements


4

Table of Contents


LAM RESEARCH CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
 
 
December 25,
2016
 
June 26,
2016
 
(unaudited)
 
(1)
 
ASSETS
 
 
 
 
Cash and cash equivalents
$
2,503,960

 
$
5,039,322

 
Investments
3,329,425

 
1,788,612

 
Accounts receivable, less allowance for doubtful accounts of $5,038 as of December 25, 2016 and $5,155 as of June 26, 2016
1,426,307

 
1,262,145

 
Inventories
1,018,891

 
971,911

 
Prepaid expenses and other current assets
225,291

 
151,160

(2)
Total current assets
8,503,874

 
9,213,150

 
Property and equipment, net
672,553

 
639,608

 
Restricted cash and investments
255,175

 
250,421

 
Goodwill
1,385,684

 
1,386,276

 
Intangible assets, net
487,897

 
564,921

 
Other assets
215,876

 
209,939

(2)
Total assets
$
11,521,059

 
$
12,264,315

 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
Trade accounts payable
$
445,113

 
$
348,199

 
Accrued expenses and other current liabilities
847,167

 
772,910

 
Deferred profit
407,843

 
349,199

 
Current portion of convertible notes and capital leases
957,895

 
947,733

(2)
Total current liabilities
2,658,018

 
2,418,041

 
Senior notes, convertible notes, and capital leases, less current portion
1,768,713

 
3,378,129

(2)
Income taxes payable
238,968

 
231,514

 
Other long-term liabilities
262,351

 
134,562

 
Total liabilities
4,928,050

 
6,162,246

 
Commitments and contingencies

 

 
Temporary equity, convertible notes
197,313

 
207,552

 
Stockholders’ equity:
 
 
 
 
Preferred stock, at par value of $0.001 per share; authorized - 5,000 shares, none outstanding

 

 
Common stock, at par value of $0.001 per share; authorized, 400,000 shares; issued and outstanding, 162,357 shares at December 25, 2016 and 160,201 shares at June 26, 2016
162

 
160

 
Additional paid-in capital
5,668,325

 
5,572,898

 
Treasury stock, at cost; 101,502 shares at December 25, 2016 and 101,071 shares at June 26, 2016
(4,497,714
)
 
(4,429,317
)
 
Accumulated other comprehensive loss
(70,077
)
 
(69,333
)
 
Retained earnings
5,295,000

 
4,820,109

 
Total stockholders’ equity
6,395,696

 
5,894,517

 
Total liabilities and stockholders’ equity
$
11,521,059

 
$
12,264,315

 
(1) Derived from audited financial statements
(2) Adjusted for effects of retrospective implementation of ASU 2015-3, see Note 2 and Note 11 for additional information.

See Notes to Condensed Consolidated Financial Statements


5

Table of Contents


LAM RESEARCH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

 
Six Months Ended
December 25,
2016
 
December 27,
2015
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
596,626

 
$
511,659

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
151,627

 
142,388

Deferred income taxes
42,248

 
2,613

Equity-based compensation expense
70,850

 
68,344

Loss on extinguishment of debt
36,325

 

Amortization of note discounts and issuance costs
13,032

 
33,480

Other, net
15,515

 
20,563

Changes in operating assets and liabilities
(48,901
)
 
(35,505
)
Net cash provided by operating activities
877,322

 
743,542

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Capital expenditures and intangible assets
(78,492
)
 
(77,597
)
Purchases of available-for-sale securities
(2,370,910
)
 
(808,292
)
Sales and maturities of available-for-sale securities
811,732

 
819,291

(Issuance) repayment of notes receivable, net
(500
)
 
8,082

Transfers of restricted cash and investments
(4,754
)
 

Other, net
(7,541
)
 
(6,246
)
Net cash used for investing activities
(1,650,465
)
 
(64,762
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Principal payments on long-term debt and capital lease obligations and payments for debt issuance costs
(1,616,641
)
 
(28,470
)
Treasury stock purchases
(69,522
)
 
(111,183
)
Dividends paid
(96,449
)
 
(95,555
)
Reissuance of treasury stock related to employee stock purchase plan
19,320

 
19,245

Proceeds from issuance of common stock
4,580

 
1,550

Other, net
(54
)
 
5,431

Net cash used for financing activities
(1,758,766
)
 
(208,982
)
Effect of exchange rate changes on cash and cash equivalents
(3,453
)
 
(3,464
)
Net (decrease) increase in cash and cash equivalents
(2,535,362
)
 
466,334

Cash and cash equivalents at beginning of period
5,039,322

 
1,501,539

Cash and cash equivalents at end of period
$
2,503,960

 
$
1,967,873

Schedule of noncash transactions:


 


Accrued payables for stock repurchases
8,382

 

Accrued payables for capital expenditures
24,216

 
8,842

Dividends payable
73,338

 
47,539

Transfers of inventory to property and equipment, net
23,828

 
14,732


See Notes to Condensed Consolidated Financial Statements


6

Table of Contents


LAM RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 25, 2016
(Unaudited)
NOTE 1 — BASIS OF PRESENTATION
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. The accompanying unaudited Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements of Lam Research Corporation (“Lam Research” or the “Company”) for the fiscal year ended June 26, 2016 , which are included in the Company’s Annual Report on Form 10-K as of and for the year ended June 26, 2016 (the “2016 Form 10-K”). The Company’s reports on Form 10-K, Form 10-Q and Form 8-K are available online at the Securities and Exchange Commission website on the Internet. The address of that site is www.sec.gov . The Company also posts its reports on Form 10-K, Form 10-Q and Form 8-K on its corporate website at http://investor.lamresearch.com . The content on any website referred to in this Form 10-Q is not a part of or incorporated by reference in this Form 10-Q unless expressly noted.
The condensed consolidated financial statements include the accounts of Lam Research and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. The Company’s reporting period is a 52/53-week fiscal year. The Company’s current fiscal year will end June 25, 2017 and includes 52  weeks. The quarters ended December 25, 2016 (the “December 2016 quarter”) and December 27, 2015 (the “December 2015 quarter”) included 13 weeks.
NOTE 2 — RECENT ACCOUNTING PRONOUNCEMENTS
In May 2014, the FASB released Accounting Standards Update (“ASU”) 2014-9, “Revenue from Contracts with Customers,” to supersede nearly all existing revenue recognition guidance under GAAP. The core principle of the standard is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. The new standard defines a five step process to achieve this core principle and, in doing so, it is possible more judgment and estimates may be required within the revenue recognition process than required under existing GAAP, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation.
In April 2016, the FASB released ASU 2016-10, “Revenue from Contracts with Customers.” The amendment clarifies guidance in ASU 2014-09, “Revenue from Contracts with Customers” to improve guidance on criteria in assessing whether promises to transfer goods and services are separately identifiable and improve the understanding of the licensing implementation guidance.
In May 2016, the FASB released ASU 2016-12, “Revenue from Contracts with Customers,” which also clarifies guidance in ASU 2014-09 on assessing collectability, non-cash consideration, presentation of sales tax and completed contracts and contract modification in transition.
In December 2016, the FASB released ASU 2016-20,“Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers,” which provides for correction or improvement to the guidance previously issued in ASU 2014-09.
The Company is required to adopt these standards starting in the first quarter of fiscal year 2019 using either of two methods: (i) retrospective to each prior reporting period presented with the option to elect certain practical expedients as defined within the standard; or (ii) retrospective with the cumulative effect of initially applying the standard recognized at the date of initial application and providing certain additional disclosures as defined per the standard. The Company has not yet selected a transition method, and is in the process of determining the impact that the new standard will have to its Condensed Consolidated Financial Statements. The Company does not plan to early adopt this standard.
In April 2015, the FASB released ASU 2015-3, “Interest – Imputation of Interest.” The amendment requires that debt issuance costs related to recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The Company adopted this standard in the September 2016 quarter, with retrospective application to the June 26, 2016 Condensed Consolidated Balance Sheet. The adoption did not have a material impact to the Condensed Consolidated Financial Statements.

7





In September 2015, the FASB released ASU 2015-16, “Business Combinations - Simplifying the Accounting for Measurement-Period Adjustments,” which eliminates the requirement to restate prior period financial statements for measurement period adjustments. Instead, the cumulative impact of measurement period adjustments, including the impact to prior periods, is required to be recognized in the reporting period in which the adjustment is identified. The Company adopted this standard in the September 2016 quarter, with no impact to the Condensed Consolidated Financial Statements.
In November 2015, the FASB issued ASU 2015-17, “Balance Sheet Classification of Deferred Taxes.” This ASU amends existing guidance to require that deferred income tax assets and liabilities be classified as non-current in a classified balance sheet, and eliminates the prior guidance which required an entity to separate deferred tax assets and liabilities into a current amount and a non-current amount in a classified balance sheet. The amendments in this ASU are effective for the Company beginning in its first quarter of fiscal year 2018. Earlier application is permitted as of the beginning of an interim or annual period. Additionally, the new guidance may be applied either prospectively to all deferred tax assets and liabilities or retrospectively to all periods presented. The Company plans to adopt the guidance prospectively in its first quarter of fiscal year 2018 with an anticipated reclassification from current assets and liabilities to non-current assets and liabilities on its Condensed Consolidated Balance Sheet.
In January 2016, the FASB released ASU 2016-1, “Financial Instruments - Overall - Recognition and Measurement of Financial Assets and Financial Liabilities.” The amendment changes the accounting for and financial statement presentation of equity investments, other than those accounted for under the equity method of accounting or those that result in consolidation of the investee. The amendment provides clarity on the measurement methodology to be used for the required disclosure of fair value of financial instruments measured at amortized cost on the balance sheet and clarifies that an entity should evaluate the need for a valuation allowance on deferred tax assets related to available-for-sale securities in combination with the entity's other deferred tax assets, among other changes. The Company is required to adopt this standard starting in the first quarter of fiscal year 2019 and does not anticipate that implementation will have a material impact to its Condensed Consolidated Financial Statements.
In January 2016, the FASB released ASU 2016-2, “Leases.” The amendment requires an entity to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. The amendment offers specific accounting guidance for a lessee, a lessor and sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. The Company is required to adopt this standard starting in the first quarter of fiscal year 2020. Early adoption is permitted. The Company is currently in the process of evaluating the impact of adoption on its Condensed Consolidated Financial Statements.
In March 2016, the FASB released ASU 2016-9, “Compensation - Stock Compensation.” Key changes in the amendment include:
entities will be required to recognize all excess tax benefits or deficiencies as an income tax benefit or expense in the income statement, eliminating APIC pools;
entities will no longer be required to delay recognition of excess tax benefits until they are realized;
entities will be required to classify the excess tax benefits as an operating activity in the statement of cash flows;
entities will be allowed to elect an accounting policy to either estimate the number of forfeitures, or account for forfeitures as they occur; and
entities can withhold up to the maximum individual statutory tax rate without classifying the awards as a liability, the cash paid to satisfy the statutory income tax withholding obligations shall be classified as a financing activity in the statement of cash flows.
The Company is required to adopt this standard starting in the first quarter of fiscal year 2018. The Company is currently in the process of evaluating the impact of adoption on its Condensed Consolidated Financial Statements.
In June 2016, the FASB released ASU 2016-13, “Financial Instruments - Credit Losses.” The amendment revises the impairment model to utilize an expected loss methodology in place of the currently used incurred loss methodology, which will result in more timely recognition of losses on financial instruments, including, but not limited to, available for sale debt securities and accounts receivable. The Company is required to adopt this standard starting in the first quarter of fiscal year 2021. Early adoption is permitted. The Company is currently in the process of evaluating the impact of adoption on its Condensed Consolidated Financial Statements.

8





In August 2016, the FASB released ASU 2016-15, “Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments.” The amendment provides and clarifies guidance on the classification of certain cash receipts and cash payments in the statement of cash flows to eliminate diversity in practice. The Company is required to adopt the standard update in the first quarter of fiscal year 2020, with a retrospective transition method required. Early adoption is permitted. The Company is currently in the process of evaluating the impact of adoption on its Condensed Consolidated Financial Statements.
In October 2016, the FASB released ASU 2016-16, “Income Tax - Intra-Entity Transfers of Assets Other Than Inventory.” This standard update improves the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. Early adoption is permitted. The Company is required to adopt the standard in the first quarter of fiscal year 2019. The Company is currently in the process of evaluating the impact of adoption on its Condensed Consolidated Financial Statements.
In November 2016, the FASB released ASU 2016-18, “Statement of Cash Flows - Restricted Cash.” This standard update requires that restricted cash and restricted cash equivalents be included in cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown in the statement of cash flows. The Company is required to adopt this standard in the first quarter of fiscal year 2019, with a retrospective transition method required. Early adoption is permitted. The Company is currently in the process of evaluating the impact of adoption on its Condensed Consolidated Financial Statements.
NOTE 3 — EQUITY-BASED COMPENSATION PLANS
The Company has stock plans that provide for grants of equity-based awards to eligible participants, including stock options, restricted stock units (“RSUs”), and market-based performance RSUs (“Market-based PRSUs”) of Lam Research common stock (“Common Stock”). An option is a right to purchase Common Stock at a set price. An RSU award is an agreement to issue a set number of shares of Common Stock at the time of vesting. The Company’s Market-based PRSUs contain both a market condition and a service condition. The Company’s options, RSU and Market-based PRSU awards typically vest over a period of three years . The Company also has an employee stock purchase plan that allows employees to purchase its Common Stock at a discount through payroll deductions.
The Company recognized the following equity-based compensation expense and related income tax benefit in the Condensed Consolidated Statements of Operations:
 
Three Months Ended
 
Six Months Ended
 
December 25,
2016
 
December 27,
2015
 
December 25,
2016
 
December 27,
2015
 
(in thousands)
Equity-based compensation expense
$
32,255

 
$
32,570

 
$
70,850

 
$
68,344

Income tax benefit recognized related to equity-based compensation expense
$
8,815

 
$
12,651

 
$
19,721

 
$
18,748

The estimated fair value of the Company’s stock-based awards, less expected forfeitures, is amortized over the awards’ vesting term on a straight-line basis.
Options and RSUs
The Lam Research Corporation 2015 Stock Incentive Plan, as amended (the “2015 Plan”), provides for the grant of non-qualified equity-based awards to eligible employees and non-employee directors of the Company and its subsidiaries. As of December 25, 2016, outstanding option and RSU awards were granted under the 2015 Plan, the Lam Research Corporation 2007 Stock Incentive Plan, as amended, or the 2011 Stock Incentive Plan, as amended (collectively the “Stock Plans”). A summary of stock plan transactions is as follows:

9





 
Options Outstanding
 
RSUs Outstanding
 
Number of
Shares
 
Weighted-
Average
Exercise Price
 
Number of
Shares
 
Weighted-
Average
Fair Market
Value
at Grant
June 26, 2016
907,411

 
$
47.41

 
4,335,104

 
$
69.30

Granted

 
$

 
91,818

 
$
94.16

Exercised
(143,829
)
 
$
33.91

 
N/A

 
N/A

Canceled
(13,770
)
 
$
70.26

 
(112,396
)
 
$
67.82

Vested restricted stock
N/A

 
N/A

 
(470,807
)
 
$
59.29

December 25, 2016
749,812

 
$
49.58

 
3,843,719

 
$
71.15


As of December 25, 2016 , there was $3.4 million of total unrecognized compensation cost related to unvested options granted and outstanding; that cost is expected to be recognized over a weighted-average remaining vesting period of 2.0 years . As of December 25, 2016 , there was $161.5 million of total unrecognized compensation expense related to unvested RSUs granted; that expense is expected to be recognized over a weighted-average remaining period of 1.9 years .
ESPP
The 1999 Employee Stock Purchase Plan, as amended and restated (the “1999 ESPP”), allows employees to designate a portion of their base compensation to be withheld through payroll deductions and used to purchase Common Stock at a purchase price per share equal to the lower of 85% of the fair market value of Common Stock on the first or last day of the applicable purchase period. Each offering period generally lasts up to 14 months and includes up to three interim purchase dates.
Purchase rights under the 1999 ESPP were valued using the Black-Scholes option valuation model and the following weighted-average assumptions for the six months ended December 25, 2016 and December 27, 2015 :
 
Six Months Ended
December 25,
2016
 
December 27,
2015
Expected term (years)
0.77

 
0.67

Expected stock price volatility
33.02
%
 
31.86
%
Risk-free interest rate
0.43
%
 
0.19
%
Dividend Yield
1.14
%
 
0.94
%

As of December 25, 2016 , there was $14.6 million of unrecognized compensation expense related to the 1999 ESPP, which is expected to be recognized over a remaining period of approximately 0.8 years .

10





NOTE 4 — OTHER EXPENSE, NET
The significant components of other expense, net, are as follows:
 
Three Months Ended
 
Six Months Ended
 
December 25,
2016
 
December 27,
2015
 
December 25,
2016
 
December 27,
2015
 
(in thousands)
Interest income
$
10,945

 
$
6,729

 
$
23,708

 
$
12,489

Interest expense
(26,641
)
 
(38,577
)
 
(68,070
)
 
(63,238
)
Gains (losses) on deferred compensation plan related assets, net
1,666

 
1,983

 
7,838

 
(3,181
)
Loss on extinguishment of debt
(36,325
)
 

 
(36,325
)
 

Foreign exchange gains (losses), net
1,011

 
512

 
2,230

 
(186
)
Other, net
(5,679
)
 
(582
)
 
(7,558
)
 
(2,940
)
 
$
(55,023
)
 
$
(29,935
)
 
$
(78,177
)
 
$
(57,056
)
Interest income in the three and six months ended December 25, 2016 increased, as compared to the three and six months ended December 27, 2015 , due to higher cash balances and higher yield. Interest expense in the three months ended December 25, 2016 decreased, as compared to the three months ended December 27, 2015 , primarily due to the maturity of the Convertible Notes due 2016 and the termination of the October 2015 bridge financing arrangement. Interest expense in the six months ended December 25, 2016 increased, as compared to the six months ended December 27, 2015 , primarily due to interest expense associated with the $2.4 billion Senior Note issuance in the three months ended June 26, 2016 . Loss on extinguishment of debt realized in the three months ended December 25, 2016 is a result of the mandatory redemption of the Senior notes due 2023 and 2026, as well as the termination of the Term Loan Agreement (refer to Note 11 and Note 15 for additional details regarding our debt redemptions and termination).
NOTE 5 — INCOME TAX EXPENSE
The Company recorded an income tax expense of $52.0 million and $81.0 million for the three and six months ended December 25, 2016 , which yielded an effective tax rate of approximately 13.5% and 11.9% , respectively.
The difference between the U.S. federal statutory tax rate of 35% and the Company’s effective tax rate for the three months and six months ended December 25, 2016 is primarily due to income in lower tax jurisdictions.

11





NOTE 6 — NET INCOME PER SHARE
Basic net income per share is computed by dividing net income by the weighted-average number of shares of Common Stock outstanding during the period. Diluted net income per share is computed using the treasury stock method, for dilutive stock options, RSUs, convertible notes, and warrants. Dilutive shares outstanding include the effect of the convertible notes. Refer to Note 11 for additional information regarding the Company's convertible notes. The following table reconciles the numerators and denominators of the basic and diluted computations for net income per share. 
 
Three Months Ended
 
Six Months Ended
 
December 25,
2016
 
December 27,
2015
 
December 25,
2016
 
December 27,
2015
 
(in thousands, except per share data)
Numerator:
 
 
 
 
 
 
 
Net income
$
332,791

 
$
222,980

 
$
596,626

 
$
511,659

Denominator:
 
 

 
 
 
 
Basic average shares outstanding
162,659

 
158,424

 
161,633

 
158,388

Effect of potential dilutive securities:
 
 

 
 
 
 
Employee stock plans
2,243

 
2,034

 
2,193

 
2,289

Convertible notes
16,640

 
13,363

 
15,930

 
13,242

Warrants
2,001

 
421

 
2,024

 
389

Diluted average shares outstanding
183,543

 
174,242

 
181,780

 
174,308

Net income per share - basic
$
2.05

 
$
1.41

 
$
3.69

 
$
3.23

Net income per share - diluted
$
1.81

 
$
1.28

 
$
3.28

 
$
2.94


For purposes of computing diluted net income per share, weighted-average common shares do not include potentially dilutive securities that are anti-dilutive under the treasury stock method. The following potentially dilutive securities were excluded:
 
Three Months Ended
 
Six Months Ended
 
December 25,
2016
 
December 27,
2015
 
December 25,
2016
 
December 27,
2015
 
(in thousands)
Number of options and RSUs excluded

 
79

 
3

 
85

Diluted shares outstanding do not include any effect resulting from the note hedges associated with the Company’s 2018 Notes as their impact would have been anti-dilutive.
NOTE 7 — FINANCIAL INSTRUMENTS
The Company maintains an investment portfolio of various holdings, types, and maturities. The Company’s mutual funds, which are related to the Company’s obligations under the deferred compensation plan, are classified as trading securities. Investments classified as trading securities are recorded at fair value based upon quoted market prices. Differences between the cost and fair value of trading securities are recognized as other income (expense) in the Condensed Consolidated Statements of Operations. All of the Company’s other investments are classified as available-for-sale and consequently are recorded in the Condensed Consolidated Balance Sheets at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income (loss), net of tax.
Fair Value
The Company defines fair value as 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. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact, and it considers assumptions that market participants would use when pricing the asset or liability.
A fair value hierarchy has been established that prioritizes the inputs to valuation techniques used to measure fair value. The level of an asset or liability in the hierarchy is based on the lowest level of input that is significant to the fair value measurement. Assets and liabilities carried at fair value are classified and disclosed in one of the following three categories:

12





Level 1: Valuations based on quoted prices in active markets for identical assets or liabilities with sufficient volume and frequency of transactions.
Level 2: Valuations based on observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or model-derived valuations techniques for which all significant inputs are observable in the market or can be corroborated by observable market data, for substantially the full term of the assets or liabilities.
Level 3: Valuations based on unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities and based on non-binding, broker-provided price quotes and may not have been corroborated by observable market data.
The Company’s primary financial instruments include its cash, cash equivalents, investments, restricted cash and investments, long-term investments, accounts receivable, accounts payable, long-term debt and capital leases, and foreign currency related derivative instruments. The estimated fair value of cash, accounts receivable and accounts payable approximates their carrying value due to the short period of time to their maturities. The estimated fair values of capital lease obligations approximate their carrying value as the substantial majority of these obligations have interest rates that adjust to market rates on a periodic basis. Refer to Note 11 for additional information regarding the fair value of the Company’s Senior Notes and Convertible Notes.

The following table sets forth the Company’s cash, cash equivalents, investments, restricted cash and investments, and other assets measured at fair value on a recurring basis as of December 25, 2016 and June 26, 2016 :  
 
December 25, 2016
 
 
 
 
 
 
 
 
(Reported Within)
Cost
 
Unrealized
Gain
 
Unrealized
(Loss)
 
Fair Value
 
Cash and
Cash
Equivalents
 
Investments
 
Restricted
Cash &
Investments
 
Other
Assets
(in thousands)
Cash
$
615,922

 
$

 
$

 
$
615,922

 
$
610,775

 
$

 
$
5,147

 
$

Level 1:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Time Deposit
728,810

 

 

 
728,810

 
478,782

 

 
250,028

 

Money Market Funds
1,233,602

 

 

 
1,233,602

 
1,233,602

 

 

 

U.S. Treasury and Agencies
811,564

 
39

 
(4,720
)
 
806,883

 
88,982

 
717,901

 

 

Mutual Funds
40,889

 
1,613

 

 
42,502

 

 

 

 
42,502

Level 1 Total
2,814,865

 
1,652

 
(4,720
)
 
2,811,797

 
1,801,366

 
717,901

 
250,028

 
42,502

Level 2:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Municipal Notes and Bonds
134,838

 
48

 
(115
)
 
134,771

 

 
134,771

 

 

Government-Sponsored Enterprises
31,357

 

 
(42
)
 
31,315

 

 
31,315

 

 

Foreign Government Bonds
30,605

 

 
(177
)
 
30,428

 
1,154

 
29,274

 

 

Corporate Notes and Bonds
2,361,859

 
542

 
(7,563
)
 
2,354,838

 
80,167

 
2,274,671

 

 

Mortgage Backed Securities — Residential
98,869

 
42

 
(975
)
 
97,936

 
10,498

 
87,438

 

 

Mortgage Backed Securities — Commercial
54,266

 
4

 
(215
)
 
54,055

 

 
54,055

 

 

Level 2 Total
2,711,794

 
636

 
(9,087
)
 
2,703,343

 
91,819

 
2,611,524

 

 

Total
$
6,142,581

 
$
2,288

 
$
(13,807
)
 
$
6,131,062

 
$
2,503,960

 
$
3,329,425

 
$
255,175

 
$
42,502

 

13





 
June 26, 2016
 
 
 
 
 
 
 
 
(Reported Within)
Cost
 
Unrealized
Gain
 
Unrealized
(Loss)
 
Fair Value
 
Cash and
Cash
Equivalents
 
Investments
 
Restricted
Cash &
Investments
 
Other
Assets
(in thousands)
Cash
$
418,216

 
$

 
$

 
$
418,216

 
$
412,573

 
$

 
$
5,643

 
$

Level 1:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Time Deposit
904,243

 

 

 
904,243

 
659,465

 

 
244,778

 

Money Market Funds
3,904,288

 

 

 
3,904,288

 
3,904,288

 

 

 

U.S. Treasury and Agencies
446,530

 
2,041

 
(2
)
 
448,569

 
62,996

 
385,573

 

 

Mutual Funds
39,318

 
1,400

 
(397
)
 
40,321

 

 

 

 
40,321

Level 1 Total
5,294,379

 
3,441

 
(399
)
 
5,297,421

 
4,626,749

 
385,573

 
244,778

 
40,321

Level 2:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Municipal Notes and Bonds
265,386

 
355

 
(16
)
 
265,725

 

 
265,725

 

 

U.S. Treasury and Agencies
8,068

 
151

 

 
8,219

 

 
8,219

 

 

Government-Sponsored Enterprises
31,885

 
91

 
(13
)
 
31,963

 

 
31,963

 

 

Foreign Government Bonds
41,440

 
76

 
(4
)
 
41,512

 

 
41,512

 

 

Corporate Notes and Bonds
979,566

 
4,341

 
(566
)
 
983,341

 

 
983,341

 

 

Mortgage Backed Securities — Residential
17,395

 
37

 
(152
)
 
17,280

 

 
17,280

 

 

Mortgage Backed Securities — Commercial
55,129

 
30

 
(160
)
 
54,999

 

 
54,999

 

 

Level 2 Total
1,398,869

 
5,081

 
(911
)
 
1,403,039

 

 
1,403,039

 

 

Total
$
7,111,464

 
$
8,522

 
$
(1,310
)
 
$
7,118,676

 
$
5,039,322

 
$
1,788,612

 
$
250,421

 
$
40,321

The Company accounts for its investment portfolio at fair value. Realized gains (losses) for investment sales are specifically identified. Management assesses the fair value of investments in debt securities that are not actively traded through consideration of interest rates and their impact on the present value of the cash flows to be received from the investments. The Company also considers whether changes in the credit ratings of the issuer could impact the assessment of fair value. The Company did not recognize any losses on investments due to other-than-temporary impairments during the three and six months ended December 25, 2016 or December 27, 2015 . Additionally, gross realized gains and gross realized (losses) from sales of investments were approximately $0.1 million and $(0.4) million , respectively, in the three months ended December 25, 2016 and $0.6 million and $(1.4) million , respectively, in the three months ended December 27, 2015 . Gross realized gains and gross realized (losses) from sales of investments were approximately $2.7 million and $(0.6) million , respectively, in the six months ended December 25, 2016 and $0.8 million and $(2.0) million , respectively, in the six months ended December 27, 2015 .


14





The following is an analysis of the Company’s cash, cash equivalents, investments, and restricted cash and investments in unrealized loss positions:
 
December 25, 2016
Unrealized Losses
Less Than 12 Months
 
Unrealized Losses
12 Months or Greater
 
Total
Fair Value
 
Gross
Unrealized
Loss
 
Fair Value
 
Gross
Unrealized
Loss
 
Fair Value
 
Gross
Unrealized
Loss
(in thousands)
 
Municipal Notes and Bonds
$
99,754

 
$
(111
)
 
$
1,996

 
$
(4
)
 
$
101,750

 
$
(115
)
 
U.S. Treasury & Agencies
684,419

 
(4,720
)
 

 

 
684,419

 
(4,720
)
 
Government-Sponsored Enterprises
30,627

 
(26
)
 
564

 
(16
)
 
31,191

 
(42
)
 
Foreign Government Bonds
26,189

 
(177
)
 

 

 
26,189

 
(177
)
 
Corporate Notes and Bonds
1,617,323

 
(7,476
)
 
34,456

 
(87
)
 
1,651,779

 
(7,563
)
Mortgage Backed Securities — Residential
75,601

 
(818
)
 
10,038

 
(157
)
 
85,639

 
(975
)
Mortgage Backed Securities — Commercial
44,494

 
(181
)
 
7,138

 
(34
)
 
51,632

 
(215
)
 
$
2,578,407

 
$
(13,509
)
 
$
54,192

 
$
(298
)
 
$
2,632,599

 
$
(13,807
)
The amortized cost and fair value of cash equivalents, investments and restricted investments with contractual maturities are as follows as of December 25, 2016 :
 
Cost
 
Estimated
Fair
Value
(in thousands)
Due in one year or less
$
3,036,400

 
$
3,035,906

Due after one year through five years
2,333,026

 
2,320,918

Due in more than five years
116,344

 
115,814

 
$
5,485,770

 
$
5,472,638

The Company has the ability, if necessary, to liquidate its investments in order to meet the Company’s liquidity needs in the next 12 months. Accordingly, those investments with contractual maturities greater than one year from the date of purchase nonetheless are classified as short-term on the accompanying Condensed Consolidated Balance Sheets.
Derivative Instruments and Hedging
The Company carries derivative financial instruments (“Derivatives”) on its Condensed Consolidated Balance Sheets at their fair values. The Company enters into foreign currency forward derivative contracts and foreign currency options with financial institutions with the primary objective of reducing volatility of earnings and cash flows related to foreign currency exchange rate fluctuations. The counterparties to these derivative contracts are large global financial institutions that the Company believes are creditworthy, and therefore, it does not consider the risk of counterparty nonperformance to be material.

15





Cash Flow Hedges
The Company’s financial position is routinely subjected to market risk associated with foreign currency exchange rate fluctuations on non-U.S. dollar transactions or cash flows, primarily from Japanese yen-denominated revenues, and euro denominated and Korean won-denominated expenses. The Company’s policy is to mitigate the foreign exchange risk arising from the fluctuations in the value of these non-U.S. dollar denominated transactions or cash flows through a foreign currency cash flow hedging program, using forward contracts and foreign currency options that generally expire within 12 months and no later than 24 months . These hedge contracts are designated as cash flow hedges and are carried on the Company’s balance sheet at fair value with the effective portion of the contracts’ gains or losses included in accumulated other comprehensive income (loss) and subsequently recognized in revenue/expense in the same period the hedged items are recognized.
In addition, during the year ended June 26, 2016, the Company entered into and settled forward-starting interest rate swap agreements to hedge against the variability of cash flows due to changes in certain benchmark interest rates on fixed rate debt. These instruments are designated as cash flow hedges at inception and are settled in conjunction with the issuance of debt. The effective portion of the contracts’ gain or loss is included in accumulated other comprehensive (loss) and is amortized into income as the hedged item impacts earnings.
At inception and at each quarter end, hedges are tested prospectively and retrospectively for effectiveness using regression analysis. Changes in the fair value of the forward contracts due to changes in time value are excluded from the assessment of effectiveness and are recognized in revenue or expense in the current period. The change in time value related to these contracts was not material for all reported periods. Changes in the fair value of foreign exchange options due to changes in time value are included in the assessment of effectiveness. To qualify for hedge accounting, the hedge relationship must meet criteria relating both to the derivative instrument and the hedged item. These criteria include identification of the hedging instrument, the hedged item, the nature of the risk being hedged and how the hedging instrument’s effectiveness in offsetting the exposure to changes in the hedged item’s fair value or cash flows will be measured. There were no material gains or losses during the three or six months ended December 25, 2016 and December 27, 2015 associated with ineffectiveness or forecasted transactions that failed to occur.
To receive hedge accounting treatment, all hedging relationships are formally documented at the inception of the hedge and the hedges must be tested to demonstrate an expectation of providing highly effective offsetting changes to future cash flows on hedged transactions. When derivative instruments are designated and qualify as effective cash flow hedges, the Company recognizes effective changes in the fair value of the hedging instrument within accumulated other comprehensive income (loss) until the hedged exposure is realized. Consequently, with the exception of excluded time value associated with the forward contracts and hedge ineffectiveness recognized, the Company’s results of operations are not subject to fluctuation as a result of changes in the fair value of the derivative instruments. If hedges are not highly effective or if the Company does not believe that the underlying hedged forecasted transactions will occur, the Company may not be able to account for its derivative instruments as cash flow hedges. If this were to occur, future changes in the fair values of the Company’s derivative instruments would be recognized in earnings. Additionally, related amounts previously recorded in other comprehensive income would be reclassified to income immediately. As of December 25, 2016 , the Company had gains of $10.5 million accumulated in other comprehensive income, net of tax, related to foreign exchange cash flow hedges which it expects to reclassify from other comprehensive income into earnings over the next 12 months . Additionally, the Company had a net loss of $1.9 million accumulated in other comprehensive income, net of tax, related to interest rate contracts which it expects to reclassify from other comprehensive income into earnings over the next 8.2 years . As a result of the October 5, 2016 termination of the Agreement and Plan of Merger and Reorganization with KLA-Tencor Corporation ("KLA-Tencor") (see Note 15 for additional information), a gain of approximately $1.1 million accumulated in other comprehensive income, net of tax, related to interest rate contracts associated with the 2026 Notes (as defined in Note 11) were reclassified into earnings in the three months ended December 25, 2016.
Fair Value Hedges
During the fiscal year ended June 26, 2016 , the Company entered into a series of interest rate contracts with a total notional value of $400 million whereby the Company receives fixed rates and pays variable rates based on certain benchmark interest rates, resulting in a net increase or decrease to interest expense, a component of Other expense, net in our Condensed Consolidated Statement of Operations. These interest rate contracts are designated as fair value hedges and hedge against changes in the fair value of our debt portfolio. The Company concluded that these interest rate contracts meet the criteria necessary to qualify for the short-cut method of hedge accounting, and as such an assumption is made that the change in the fair value of the hedged debt, due to changes in the benchmark rate, exactly offsets the change in the fair value of the interest rate swap. Therefore, the derivative is considered to be effective at achieving offsetting changes in the fair value of the hedged liability, and no ineffectiveness is recognized.

16





Balance Sheet Hedges
The Company also enters into foreign currency forward contracts to hedge fluctuations associated with foreign currency denominated monetary assets and liabilities, primarily third party accounts receivables, accounts payables and intercompany receivables and payables. These forward contracts are not designated for hedge accounting treatment. Therefore, the change in fair value of these derivatives is recorded as a component of other income (expense) and offsets the change in fair value of the foreign currency denominated assets and liabilities, which are also recorded in other income (expense).
As of December 25, 2016 , the Company had the following outstanding foreign currency contracts that were entered into under its cash flow and balance sheet hedge program:
 
Notional Value
Derivatives Designated as
Hedging Instruments:
 
Derivatives Not Designated
as Hedging Instruments:
(in thousands)
Foreign Currency Forward Contracts
 
 
 
 
 
 
 
 
Buy Contracts
 
Sell Contracts
 
Buy Contracts
 
Sell Contracts
Japanese yen
$

 
$
235,891

 
$

 
$
45,498

Swiss franc

 

 
8,740

 

Euro
39,463

 

 
20,608

 

Korean won
48,517

 

 
8,310

 

Chinese renminbi

 

 
8,203

 
 
Singapore dollar

 

 
20,732

 

Taiwan dollar

 

 
15,639

 

 
$
87,980

 
$
235,891

 
$
82,232

 
$
45,498


The fair value of derivative instruments in the Company’s Condensed Consolidated Balance Sheets as of December 25, 2016 and June 26, 2016 were as follows:
 
December 25, 2016
 
June 26, 2016
Fair Value of Derivative Instruments (Level 2)
 
Fair Value of Derivative Instruments (Level 2)
Asset Derivatives
 
Liability Derivatives
 
Asset Derivatives
 
Liability Derivatives
Balance Sheet
Location
 
Fair Value
 
Balance Sheet
Location
 
Fair Value
 
Balance Sheet
Location
 
Fair Value
 
Balance Sheet
Location
 
Fair Value
(in thousands)
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
Foreign exchange forward contracts
Prepaid expense
and other assets
 
$
13,432

 
Accrued liabilities
 
$
847

 
Prepaid expense
and other assets
 
$
249

 
Accrued liabilities
 
$
16,585

Interest rate contracts, short-term
Accrued expenses and other current liabilities
 

 
Prepaid expense
and other assets
 
2,024

 
Accrued expenses and other current liabilities
 
50

 
Prepaid expense
and other assets
 
159

Interest rate contracts, long-term
Other assets
 

 
Other long-term liabilities
 
17,152

 
Other assets
 
8,661

 
Other long-term liabilities
 

 
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
Foreign exchange forward contracts
Prepaid expense
and other assets
 
34

 
Accrued
liabilities
 
117

 
Prepaid expense
and other assets
 
107

 
Accrued
liabilities
 
1,529

Total Derivatives
 
 
$
13,466

 
 
 
$
20,140

 
 
 
$
9,067

 
 
 
$
18,273

Under the master netting agreements with the respective counterparties to the Company’s derivative contracts, subject to applicable requirements, the Company is allowed to net settle transactions of the same currency with a single net amount payable by one party to the other. However, the Company has elected to present the derivative assets and derivative liabilities on a gross basis on its balance sheet. As of December 25, 2016 , the potential effect of rights of off-set associated with the above

17





foreign exchange and interest rate contracts would be an offset to assets and liabilities by $3.5 million , resulting in a net derivative asset of $10.0 million and net derivative liability of $16.7 million . As of June 26, 2016 , the potential effect of rights of set-off associated with the above foreign exchange contracts would be an offset to both assets and liabilities by $6.4 million , resulting in a net derivative asset of $2.7 million and a net derivative liability of $11.9 million . The Company is not required to pledge, nor is the Company entitled to receive, cash collateral for these derivative transactions.
The effect of derivative instruments designated as cash flow hedges on the Company’s Condensed Consolidated Statements of Operations, including accumulated other comprehensive income (“AOCI”) was as follows:
 
 
Three Months Ended December 25, 2016
 
Six Months Ended December 25, 2016
 
 
Effective Portion
Ineffective 
Portion
and Amount
Excluded from
Effectiveness
 
Effective Portion
Ineffective 
Portion
and Amount
Excluded from
Effectiveness
 
Location of 
Gain (Loss)
Recognized 
in or 
Reclassified
into Income
Gain (Loss)
Recognized
in AOCI
 
Gain (Loss)
Reclassified
from AOCI
into Income
 
Gain (Loss)
Recognized
in Income
 
Gain (Loss)
Recognized
in AOCI
Gain (Loss)
Reclassified
from AOCI
into Income
Gain (Loss)
Recognized
in Income
Derivatives Designated
as Hedging Instruments
 
(in thousands)
Foreign Exchange Contracts
Revenue
$
18,138

 
$
(420
)
 
$
708

 
$
15,225

 
$
(14,025
)
 
$
1,413

Foreign Exchange Contracts
Cost of goods sold
(786
)
 
(180
)
 
(28
)
 
(551
)
 
(7
)
 
(95
)
Foreign Exchange Contracts
Selling, general, and
administrative
(348
)
 
(146
)
 
(15
)
 
(372
)
 
(155
)
 
(36
)
Foreign Exchange Contracts
Other expense, net

 

 
3

 

 

 
3

Interest Rate Contracts
Other expense, net

 
1,778

 

 

 
1,787

 

 
 
$
17,004

 
$
1,032

 
$
668

 
$
14,302

 
$
(12,400
)
 
$
1,285

 
 
Three Months Ended December 27, 2015
 
Six Months Ended December 27, 2015
 
 
Effective Portion
Ineffective 
Portion
and Amount
Excluded from
Effectiveness
 
Effective Portion
Ineffective 
Portion
and Amount
Excluded from
Effectiveness
 
Location of 
Gain (Loss)
Recognized 
in or 
Reclassified
into Income
Gain (Loss)
Recognized
in AOCI
Gain (Loss)
Reclassified
from AOCI
into Income
Gain (Loss)
Recognized
in Income
 
Gain (Loss)
Recognized
in AOCI
Gain (Loss)
Reclassified
from AOCI
into Income
Gain (Loss)
Recognized
in Income
Derivatives Designated
as Hedging Instruments
 
 
Foreign Exchange Contracts
Revenue
$
4,256

 
$
(4,808
)
 
$
215

 
$
4,187

 
$
(6,186
)
 
247

Foreign Exchange Contracts
Cost of goods sold
(223
)
 
1,052

 
(14
)
 
(638
)
 
2,557

 
(36
)
Foreign Exchange Contracts
Selling, general, and
administrative
147

 
111

 
(12
)
 
(26
)
 
369

 
(19
)
Interest Rate Contracts
Other expense, net

 
(95
)
 

 

 
(189
)
 



$
4,180

 
$
(3,740
)
 
$
189

 
$
3,523

 
$
(3,449
)
 
192


18





The effect of derivative instruments not designated as cash flow hedges on the Company’s Condensed Consolidated Statements of Operations was as follows:
 
 
Three Months Ended
 
Six Months Ended
 
December 25,
2016
 
December 27,
2015
 
December 25, 2016
 
December 27, 2015
Derivatives Not Designated as Hedging Instruments:
Location 
of Gain
Recognized 
in Income
 
Gain 
Recognized
in Income
 
Gain
Recognized
in Income
 
Gain
Recognized
in Income
 
Gain 
Recognized
in Income
 
 
 
(in thousands)
Foreign Exchange Contracts
Other 
income
 
$
4,343

 
$
1,561

 
$
3,960

 
$
7,568

Concentrations of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents, investments, restricted cash and investments, trade accounts receivable, and derivative financial instruments used in hedging activities. Cash is placed on deposit at large global financial institutions. Such deposits may be in excess of insured limits. Management believes that the financial institutions that hold the Company’s cash are creditworthy and, accordingly, minimal credit risk exists with respect to these balances.
The Company’s overall portfolio of available-for-sale securities must maintain an average minimum rating of “AA-” or “Aa3” as rated by Standard and Poor’s, Moody’s Investor Services, or Fitch Ratings. To ensure diversification and minimize concentration, the Company’s policy limits the amount of credit exposure with any one financial institution or commercial issuer.

The Company is exposed to credit losses in the event of nonperformance by counterparties on foreign currency forward hedge contracts that are used to mitigate the effect of exchange rate fluctuations, and on contracts related to structured share repurchase arrangements. These counterparties are large global financial institutions and, to date, no such counterparty has failed to meet its financial obligations to the Company.
Credit risk evaluations, including trade references, bank references and Dun & Bradstreet ratings, are performed on all new customers and the Company monitors its customers’ financial condition and payment performance. In general, the Company does not require collateral on sales.
NOTE 8 — INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out method) or market. System shipments to Japanese customers, for which title does not transfer until customer acceptance, are classified as finished goods inventory and carried at cost until title transfers. Inventories consist of the following:
 
December 25,
2016
 
June 26,
2016
(in thousands)
Raw materials
$
565,485

 
$
536,844

Work-in-process
198,497

 
151,406

Finished goods
254,909

 
283,661

 
$
1,018,891

 
$
971,911

NOTE 9 — GOODWILL AND INTANGIBLE ASSETS
Goodwill
The balance of goodwill is approximately $1.4 billion as of December 25, 2016 and June 26, 2016 . As of December 25, 2016 , $61.1 million of the goodwill balance is tax deductible and the remaining balance is not tax deductible due to purchase accounting and applicable foreign law.

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Intangible Assets
The following table provides the Company’s intangible assets as of December 25, 2016 :
 
Gross
 
Accumulated
Amortization
 
Net
(in thousands)
Customer relationships
$
615,167

 
$
(333,561
)
 
$
281,606

Existing technology
643,200

 
(444,018
)
 
199,182

Patents
36,553

 
(29,970
)
 
6,583

Other intangible assets
36,114

 
(35,588
)
 
526

Total intangible assets
$
1,331,034

 
$
(843,137
)
 
$
487,897


The following table provides the Company’s intangible assets as of June 26, 2016 :
 
Gross
 
Accumulated
Amortization
 
Net
(in thousands)
Customer relationships
$
615,272

 
$
(300,711
)
 
$
314,561

Existing technology
643,433

 
(401,036
)
 
242,397

Patents
36,053

 
(28,701
)
 
7,352

Other intangible assets
36,114

 
(35,503
)
 
611

Total intangible assets
$
1,330,872

 
$
(765,951
)
 
$
564,921

The Company recognized $38.6 million and $39.3 million in intangible asset amortization expense during the three months ended December 25, 2016 and December 27, 2015 , respectively. The Company recognized $77.3 million and $78.3 million in intangible asset amortization expense during the six months ended December 25, 2016 and December 27, 2015 , respectively.
The estimated future amortization expense of intangible assets, excluding those with indefinite lives, as of December 25, 2016 was as follows:
Fiscal Year
Amount
 
(in thousands)
2017 (remaining 6 months)
$
77,275

2018
153,446

2019
115,152

2020
50,332

2021
47,687

Thereafter
44,005

 
$
487,897

NOTE 10 — ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities consist of the following:
 
December 25,
2016
 
June 26,
2016
(in thousands)
Accrued compensation
$
417,952

 
$
331,528

Warranty reserves
119,334

 
100,321

Income and other taxes payable
56,021

 
86,723

Dividend payable
73,338

 
48,052

Other
180,522

 
206,286

 
$
847,167

 
$
772,910

 
 
 
 

20





NOTE 11 — LONG-TERM DEBT AND OTHER BORROWINGS
As of December 25, 2016 and June 26, 2016 , the Company's outstanding debt consisted of the following:
 
December 25, 2016
 
June 26, 2016
 
Amount
(in thousands)
 
Effective Interest Rate
 
Amount
(in thousands)
 
Effective Interest Rate
Fixed-rate 1.25% Convertible Notes Due May 15, 2018 ("2018 Notes")
$
449,849

(1)  
5.27
%
 
$
449,954

(3)  
5.27
%
Fixed-rate 2.75% Senior Notes Due March 15, 2020 ("2020 Notes")
500,000

 
2.88
%
 
500,000

 
2.88
%
Fixed-rate 2.80% Senior Notes Due June 15, 2021 ("2021 Notes")
800,000

 
2.95
%
 
800,000

 
2.95
%
Fixed-rate 3.45% Senior Notes Due June 15, 2023 ("2023 Notes")

 

 
600,000

 
3.60
%
Fixed-rate 3.80% Senior Notes Due March 15, 2025 ("2025 Notes")
500,000

 
3.87
%
 
500,000

 
3.87
%
Fixed-rate 3.90% Senior Notes Due June 15, 2026 ("2026 Notes")

 

 
1,000,000

 
4.01
%
Fixed-rate 2.625% Convertible Notes Due May 15, 2041 ("2041 Notes")
699,808

(1)  
4.28
%
 
699,895

(3)  
4.28
%
Total debt outstanding, at par
2,949,657

 
 
 
4,549,849

 
 
Unamortized discount
(206,996
)
 
 
 
(232,727
)
 
 
Fair value adjustment - interest rate contracts
(19,177
)
 
 
 
8,552

 
 
Unamortized bond issuance costs
(3,885
)
 
 
 
(7,213
)
(4)  
 
Total debt outstanding, at carrying value
$
2,719,599

 
 
 
$
4,318,461

 
 
Reported as:
 
 
 
 
 
 
 
Current portion of long-term debt
$
951,052

(2)  
 
 
$
940,537

(2)  
 
Long-term debt
1,768,547

 
 
 
3,377,924

 
 
Total debt outstanding, at carrying value
$
2,719,599

 
 
 
$
4,318,461

 
 
____________________________
(1) As of December 25, 2016 , these notes were convertible at the option of the bondholder, as a result of the condition described in (2) below. Upon closure of the conversion period, Notes not converted will be reclassified back into noncurrent liabilities and the temporary equity will be reclassified into permanent equity.
(2) As of the report date the market value of the Company's Common Stock was greater than 130% of the convertible notes conversion price for 20 or more of the 30 consecutive trading days preceding the quarter-end. As a result, the convertible notes were classified in current liabilities and a portion of the equity component, representing the unamortized discount, was classified in temporary equity on the Company's Consolidated Balance Sheets.
(3) As of June 26, 2016 , these notes were convertible at the option of the bond holder, as a result of the condition described in (2) above.
(4) The Company adopted ASU 2015-3, regarding the simplification of the presentation of bond issuance costs, which requires that bond issuance costs related to a recognized liability be presented on the balance sheet as a direct reduction from the carrying amount of that debt liability, consistent with debt discounts. The Company applied the accounting standard update on a retrospective basis by reclassifying the presentation of bond issuance costs totaling $1.76 million which was originally included in prepaid assets and other current assets against current portion of convertible notes and capital leases, and $5.45 million which was originally included in other assets against senior notes, convertible notes, and capital leases, less current portion on the Condensed Consolidated Balance Sheets for June 26, 2016 . There is no impact to the Company's Condensed Consolidated Statements of Operation, Stockholders' Equity, or Cash Flows for the fiscal year ended June 26, 2016 .
Convertible Senior Notes
In May 2011, the Company issued and sold $450 million in aggregate principal amount of 1.25% Convertible Senior Notes due May  2018 (the “2018 Notes”) at par. The Company pays cash interest at an annual rate of 1.25% , on the 2018 Notes, on a semi-annual basis on May 15 and November 15 of each year.
In June 2012, with the acquisition of Novellus Systems, Inc. (“Novellus”), the Company assumed $700 million in aggregate principal amount of 2.625% Convertible Senior Notes due May 2041 (the “2041 Notes,” and collectively with the 2018 Notes, the “Convertible Notes”). The Company pays cash interest at an annual rate of 2.625% , on a semi-annual basis on May 15 and November 15 of each year on the 2041 Notes. The 2041 Notes also have a contingent interest payment provision that may require the Company to pay additional interest, up to 0.60%  per year, based on certain thresholds, beginning with the semi-annual interest payment on May 15, 2021, and upon the occurrence of certain events, as outlined in the indenture governing the 2041 Notes.

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The Company separately accounts for the liability and equity components of the Convertible Notes. The initial debt components of the Convertible Notes were valued based on the present value of the future cash flows using the Company’s borrowing rate at the date of the issuance or assumption for similar debt instruments without the conversion feature, which equals the effective interest rate on the liability component disclosed in the table below, respectively. The equity component was initially valued equal to the principle value of the notes, less the present value of the future cash flows using the Company’s borrowing rate at the date of the issuance or assumption for similar debt instruments without a conversion feature, which equated to the initial debt discount.
Under certain circumstances, the Convertible Notes may be converted into shares of the Company’s Common Stock. The number of shares each debenture is convertible into is based on conversion rates, disclosed in the table below. Conversions in the three and six months ended December 25, 2016 were not material. During the quarter-ended December 25, 2016 , the company received notice of conversion for an additional $65.6 million principal value of Convertible Notes, that will settle in the March 26, 2017 quarter.
Selected additional information regarding the Convertible Notes outstanding as of December 25, 2016 and June 26, 2016 , the Convertible Notes consisted of the following:
 
December 25, 2016
 
June 26, 2016
2018 Notes
 
2041 Notes
 
2018 Notes
 
2041 Notes
(in thousands, except years, percentages, conversion rate, and conversion price)
Carrying amount of permanent equity component, net of tax
$
81,135

 
$
154,241

 
$
72,992

 
$
152,397

Carrying amount of temporary equity component, net of tax
$
23,685

 
$
173,628

 
$
31,894

 
$
175,658

Remaining amortization period (years)
1.4

 
24.4

 
1.9

 
24.9

Fair Value of Notes (Level 2)
$
801,919

 
$
2,219,497

 
 
 
 
Conversion rate (shares of common stock per $1,000 principal amount of notes)
16.4605

 
29.5403

 
 
 
 
Conversion price (per share of common stock)
$
60.75

 
$
33.85

 
 
 
 
If-converted value in excess of par value
$
350,306

 
$
1,534,067

 
 
 
 
Estimated share dilution using average quarterly stock price $100.52 per share
2,930


13,711

 
 
 
 
Convertible Note Hedges and Warrants
Concurrent with the issuance of the 2018 Notes and $450 million of notes that matured in May of 2016 (the "2016 Notes"), the Company purchased a convertible note hedge and sold warrants. The warrants settlement is contractually defined as net share settlement. The exercise price is adjusted for certain corporate events, including dividends on the Company’s Common Stock. During the three and six months ended December 25, 2016 , warrants associated with the 2016 Notes were exercised resulting in the issuance of approximately 0.9 million and 2.0 million shares, respectively, of the Company's Common Stock. As of December 25, 2016 , the warrants associated with the 2018 Notes had not been exercised and remained outstanding.
In conjunction with the convertible note hedge, counterparties agreed to sell to the Company shares of Common Stock equal to the number of shares issuable upon conversion of the 2018 Notes in full. The convertible note hedge transactions will be settled in net shares and will terminate upon the earlier of the maturity date or the first day none of the respective notes remain outstanding due to conversion or otherwise. Settlement of the convertible note hedge in net shares, based on the number of shares issued upon conversion of the 2018 Notes, on the expiration date would result in the Company receiving net shares equivalent to the number of shares issuable by the Company upon conversion of the 2018 Notes. The exercise price is adjusted for certain corporate events, including dividends on the Company’s Common Stock.

22





The following table presents the details of the warrants and convertible note hedge arrangements as of December 25, 2016 :
 
 
2018 Notes
 
(shares in thousands)