Annual report pursuant to Section 13 and 15(d)

Note 8. Stock-Based Compensation

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Note 8. Stock-Based Compensation
 12 Months Ended
Jun. 30, 2011
Share-based Compensation [Abstract]  
Stock-based Compensation
STOCK-BASED COMPENSATION
Equity Incentive Program
Under the Company’s current equity incentive program, the Company issues equity awards from its 2004 Equity Incentive Plan (the “2004 Plan”), which provides for the grant of options to purchase shares of its common stock, stock appreciation rights, restricted stock units, performance shares, performance units and deferred stock units to its employees, consultants and members of its Board of Directors. The 2004 Plan permits the issuance of up to 32.0 million shares of common stock. Any 2004 Plan awards of restricted stock units, performance shares, performance units or deferred stock units with a per share or unit purchase price lower than 100% of fair market value on the grant date are counted against the total number of shares issuable under the 2004 Plan as 1.8 shares for every one share subject thereto.
The following table summarizes the combined activity under the equity incentive plans for the indicated periods:
(In thousands)
Available
For Grant
Balances as of June 30, 2008(1)
9,245

Restricted stock units granted(2)
(3,996
)
Restricted stock units canceled (2)
1,117

Restricted stock units withheld for taxes(2)(3)
695

Options canceled/expired/forfeited
2,414

Plan shares expired(4)
(1,773
)
Balances as of June 30, 2009(1)
7,702

Shares added to 2004 Plan
11,000

Restricted stock units granted(2)
(5,213
)
Restricted stock units canceled(2)
1,140

Restricted stock units withheld for taxes(2)(3)
244

Options canceled/expired/forfeited
1,161

Plan shares expired(4)
(872
)
Balances as of June 30, 2010(1)
15,162

Restricted stock units granted(2)(5)
(4,062
)
Restricted stock units canceled(2)
367

Options canceled/expired/forfeited
1,141

Plan shares expired(4)
(1,054
)
Balances as of June 30, 2011(1)
11,554


__________________  
(1)
Includes shares available for issuance under the 2004 Plan, as well as under the Company’s 1998 Outside Director Option Plan (the “Outside Director Plan”), which only permits the issuance of stock options to the Company’s non-employee members of the Board of Directors. As of June 30, 2011, 1.6 million shares were available for grant under the Outside Director Plan.
(2)
The number of restricted stock units provided in this row reflects the application of the 1.8x multiple described above.
(3)
Effective November 4, 2009, any shares withheld by the Company after such date in satisfaction of applicable withholding taxes upon the issuance, vesting or settlement of equity awards under the 2004 Plan will no longer be available for future issuance under the 2004 Plan.

(4)
Represents the portion of shares listed as “Options canceled/expired/forfeited” above that were issued under the Company’s equity incentive plans other than the 2004 Plan or the Outside Director Plan. Because the Company is only currently authorized to issue equity awards under the 2004 Plan and the Outside Director Plan, any equity awards that are canceled, expire or are forfeited under any other Company equity incentive plan do not result in additional shares being available to the Company for future grant.
(5)
Includes 0.3 million restricted stock units granted to senior management during the fiscal year ended June 30, 2011 with performance-based vesting criteria (in addition to service-based vesting criteria for any of such restricted stock units that are deemed to have been earned). As of June 30, 2011, it had not yet been determined the extent to which (if at all) the performance-based vesting criteria of such restricted stock units had been satisfied. Therefore, this line item includes all such performance-based restricted stock units, reported at the maximum possible number of shares that may ultimately be issuable under such restricted stock units if all applicable performance-based and service-based criteria are fully satisfied.
 Except for options granted to non-employee Board members as part of their regular compensation package for service through the end of the first quarter of fiscal year 2008, the Company has granted only restricted stock units under its equity incentive program since September 2006. For the preceding several years until June 30, 2006, stock options were granted at the market price of the Company’s common stock on the date of grant (except for the previously disclosed retroactively priced options which were granted primarily prior to the fiscal year ended June 30, 2002), generally with a vesting period of five years and an exercise period not to exceed seven years (ten years for options granted prior to July 1, 2005) from the date of issuance. Restricted stock units may be granted with varying criteria such as service-based and/or performance-based vesting.
The fair value of stock-based awards is measured at the grant date and is recognized as expense over the employee’s requisite service period. The fair value is determined using a Black-Scholes valuation model for purchase rights under the Company’s Employee Stock Purchase Plan and using the closing price of the Company’s common stock on the grant date for restricted stock units.
The following table shows pre-tax stock-based compensation expense for the indicated periods: 
 
Year ended June 30,
(In thousands)
2011
 
2010
 
2009
Stock-based compensation expense by:
 
 
 
 
 
Costs of revenues
$
13,935

 
$
14,275

 
$
19,932

Engineering, research and development
24,539

 
27,289

 
33,127

Selling, general and administrative
42,956

 
44,418

 
52,476

Total stock-based compensation expense
$
81,430

 
$
85,982

 
$
105,535


The following table shows stock-based compensation capitalized as inventory as of June 30, 2011 and 2010:
(In thousands)
As of June 30,
2011
 
2010
Inventory
$
6,701

 
$
6,687


Stock Options
The following table summarizes the activity and weighted-average exercise price for stock options under all plans for the fiscal year ended June 30, 2011: 
Stock Options
Shares
(In thousands)
 
Weighted-Average
Exercise Price
Outstanding stock options as of June 30, 2010
11,358

 
$
43.72

Granted
—

 
$
—

Exercised
(2,542
)
 
$
37.17

Cancelled/expired/forfeited
(1,141
)
 
$
46.73

Outstanding stock options as of June 30, 2011
7,675

 
$
45.38

Vested and exercisable as of June 30, 2011
7,672

 
$
45.38


The Company has not issued any stock options since November 1, 2007. The weighted-average remaining contractual terms for total options outstanding under all plans and for total options vested and exercisable under all plans as of June 30, 2011 were each 2.1 years. The aggregate intrinsic values for total options outstanding under all plans and for total options vested and exercisable under all plans as of June 30, 2011 were each $7.4 million. 
The authoritative guidance on stock-based compensation permits companies to select the option-pricing model used to estimate the fair value of their stock-based compensation awards. The Black-Scholes option-pricing model requires the input of assumptions, including the option’s expected life and the expected price volatility of the underlying stock. The expected stock price volatility assumption was based on the market-based implied volatility from traded options of the Company’s common stock.
The following table shows the total intrinsic value of options exercised, total cash received from employees as a result of employee stock option exercises, and tax benefits realized by the Company in connection with these stock option exercises for the indicated periods: 
(In thousands)
Year ended June 30,
2011
 
2010
 
2009
Total intrinsic value of options exercised
$
19,408

 
$
1,217

 
$
10,647

Total cash received from employees as a result of employee stock option exercises
$
94,488

 
$
15,154

 
$
9,804

Tax benefits realized in connection with these exercises
$
6,653

 
$
447

 
$
4,482


As of June 30, 2011, the unrecognized stock-based compensation balance related to stock options was $0.1 million and will be recognized over an estimated weighted-average amortization period of 0.8 years.
The Company settles employee stock option exercises with newly issued common shares except in certain tax jurisdictions where settling such exercises with treasury shares provides the Company or one of its subsidiaries with a tax benefit.
Restricted Stock Units
The following table shows the applicable number of restricted stock units and weighted-average grant-date fair value after estimated forfeitures for restricted stock units granted, vested and released, withheld for taxes, and forfeited during the fiscal year ended June 30, 2011 and restricted stock units outstanding as of June 30, 2011 and 2010:
 
Restricted Stock Units
Shares
(in thousands) (1)
 
Weighted-Average
Grant-Date
Fair Value
Outstanding restricted stock units as of June 30, 2010
6,470

 
$
22.52

Granted(2)
2,256

 
$
20.35

Vested and released
(1,337
)
 
$
24.12

Withheld for taxes
(645
)
 
$
24.60

Forfeited
(204
)
 
$
21.13

Outstanding restricted stock units as of June 30, 2011(2)
6,540

 
$
21.28

 __________________ 
(1)
Share numbers reflect actual shares subject to awarded restricted stock units. Under the terms of the 2004 Plan, each of the share numbers presented in this column is multiplied by 1.8 to calculate the impact on the share reserve under the 2004 Plan.
(2)
Includes 0.3 million restricted stock units granted to senior management during the fiscal year ended June 30, 2011 with performance-based vesting criteria (in addition to service-based vesting criteria for any of such restricted stock units that are deemed to have been earned). As of June 30, 2011, it had not yet been determined the extent to which (if at all) the performance-based vesting criteria of such restricted stock units had been satisfied. Therefore, this line item includes all such performance-based restricted stock units, reported at the maximum possible number of shares that may ultimately be issuable under such restricted stock units if all applicable performance-based and service-based criteria are fully satisfied.
The restricted stock units granted by the Company since the beginning of the fiscal year ended June 30, 2007 generally vest in two equal installments on the second and fourth anniversaries of the date of grant. Prior to the fiscal year ended June 30, 2007, the restricted stock units granted by the Company generally vested in two equal installments over four or five years from the date of the grant. The value of the restricted stock units is based on the closing market price of the Company’s common stock on the date of award. The restricted stock units have been awarded under the Company’s 2004 Plan, and each unit will entitle the recipient to one share of common stock when the applicable vesting requirements for that unit are satisfied. However, for each share actually issued under the awarded restricted stock units, the share reserve under the 2004 Plan will be reduced by 1.8 shares, as provided under the terms of the 2004 Plan.
The following table shows the grant-date fair value after estimated forfeitures, weighted-average grant date fair value per unit, and tax benefits realized by the Company in connection with vested and released restricted stock units for the indicated periods: 
(In thousands, except for weighted-average grant date fair value)
Year ended June 30,
2011
 
2010
 
2009
Grant-date fair value after estimated forfeitures
$
45,915

 
$
64,230

 
$
32,480

Weighted-average grant date fair value per unit
$
20.35

 
$
22.18

 
$
14.63

Tax benefits realized in connection with vested and released restricted stock units
$
23,302

 
$
14,181

 
$
13,270


As of June 30, 2011, the unrecognized stock-based compensation expense balance related to restricted stock units was $99.3 million and will be recognized over an estimated weighted-average amortization period of 2.2 years.
Employee Stock Purchase Plan
KLA-Tencor’s Employee Stock Purchase Plan (“ESPP”) provides that eligible employees may contribute up to 10% of their eligible earnings toward the semi-annual purchase of KLA-Tencor’s common stock. The ESPP is qualified under Section 423 of the Internal Revenue Code. The employee’s purchase price is derived from a formula based on the closing price of the common stock on the first day of the offering period versus the closing price on the date of purchase (or, if not a trading day, on the immediately preceding trading day).
 During the quarter ended December 31, 2008, the Company’s Board of Directors, as part of the Company’s ongoing efforts to reduce operating expenses, approved amendments to the ESPP so as to, among other things, reduce each offering period under the ESPP (and therefore the length of the look-back period) from 24 months to 6 months. This change became effective January 1, 2009, such that the offering period that began on January 1, 2009 had a duration of six months, and the purchase price with respect to such offering period was 85% of the lesser of (i) the fair market value of the Company’s common stock at the commencement of the six-month offering period or (ii) the fair market value of the Company’s common stock on the purchase date.
During the quarter ended March 31, 2009, the Company’s Board of Directors approved further amendments to the ESPP that (a) eliminated the look-back feature (i.e., the reference to the fair market value of the Company’s common stock at the commencement of the applicable six-month offering period) and (b) reduced the purchase price discount from 15% to 5%. These changes were effective July 1, 2009, such that the purchase price with respect to the six-month offering period that began on July 1, 2009 was 95% of the fair market value of the Company’s common stock on the purchase date, December 31, 2009.
During the quarter ended December 31, 2009, in response to improvements in the business conditions within the industries that the Company serves, the Company’s Board of Directors approved amendments to the ESPP that (a) reinstated the six-month look-back feature and (b) increased the purchase price discount from 5% to 15%. These changes became effective January 1, 2010, such that the purchase price with respect to each offering period beginning on or after such date will, until further amended, be 85% of the lesser of (i) the fair market value of the Company’s common stock at the commencement of the applicable six-month offering period or (ii) the fair market value of the Company’s common stock on the purchase date.
The Company estimates the fair value of purchase rights under the ESPP using a Black-Scholes valuation model. The fair value of each purchase right under the ESPP was estimated on the date of grant using the Black-Scholes option valuation model and the straight-line attribution approach with the following weighted-average assumptions: 
 
Year ended June 30,
 
2011
 
2010
 
2009
Stock purchase plan:
 
 
 
 
 
Expected stock price volatility
38.0
%
 
35.0
%
 
41.0
%
Risk free interest rate
0.2
%
 
0.2
%
 
1.8
%
Dividend yield
3.1
%
 
1.6
%
 
1.4
%
Expected life of options (in years)
0.50

 
0.50

 
1.30


The following table shows total cash received from employees for the issuance of shares under the ESPP, the number of shares purchased by employees through the ESPP, the tax benefits realized by the Company in connection with the disqualifying dispositions of shares purchased under the ESPP, and the weighted-average fair value per share:
(In thousands, except for weighted-average fair value per share)
Year ended June 30,
2011
 
2010
 
2009
Total cash received from employees for the issuance of shares under the ESPP
$
30,085

 
$
20,714

 
$
30,306

Number of shares purchased by employees through the ESPP
1,123

 
758

 
1,615

Tax benefits realized in connection with the disqualifying dispositions of shares purchased under the ESPP
$
2,194

 
$
994

 
$
1,612

Weighted-average fair value per share based on Black-Scholes model
$
7.41

 
$
8.51

 
$
11.06


The ESPP shares are replenished annually on the first day of each fiscal year by virtue of an evergreen provision. The provision allows for share replenishment equal to the lesser of 2.0 million shares or the number of shares which KLA-Tencor estimates will be required to be issued under the ESPP during the forthcoming fiscal year. During each of the fiscal years ended June 30, 2011, 2010 and 2009, 2.0 million additional shares were reserved under the ESPP. As of June 30, 2011, a total of 3.5 million shares were reserved and available for issuance under the ESPP, and no additional shares have been added to the ESPP with respect to the fiscal year ending June 30, 2012.
Executive Severance and Consulting Agreement
During August 2008, the Company announced that, effective January 1, 2009, John H. Kispert, the Company’s former President and Chief Operating Officer, would cease to be an employee of the Company. In accordance with the terms of a Severance and Consulting Agreement entered into between the Company and Mr. Kispert dated August 28, 2008, Mr. Kispert received, in addition to certain cash payments and benefits, the following benefits related to his outstanding equity awards: (i) accelerated, pro-rated vesting of the unvested portion (as of the date that his employment with the Company terminated) of all of his outstanding restricted stock units, such that a percentage of the unvested portion of each such restricted stock unit grant, representing the portion of the entire service vesting period under such grant that had been served by Mr. Kispert as of the date that he ceased to be an employee of the Company, was accelerated; (ii) the acceleration of the delivery of all restricted stock units for which vesting was accelerated in accordance with the provisions of the Severance and Consulting Agreement; and (iii) the extension of the post-termination exercise period of each of Mr. Kispert’s stock options so that each such option remained exercisable for twelve months following the date Mr. Kispert ceased to be an employee of the Company, but in no event beyond the original term of the award. In connection with the stock-related benefits agreed to under such agreement, the Company recorded an additional non-cash, stock-based compensation charge of approximately $4.7 million during the fiscal year ended June 30, 2009, which was included as a component of selling, general and administrative expense.