KLA Corporation Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

Derivative Instruments and Hedging Activities

Derivative Instruments and Hedging Activities

3 Months Ended

Sep. 30, 2019

Derivative Instruments and Hedging Activities Disclosure [Abstract]

DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

NOTE 16 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

The authoritative guidance requires companies to recognize all derivative instruments and hedging activities, including foreign currency exchange contracts and interest rate lock agreements, (collectively “derivatives”) as either assets or liabilities at fair value on the Condensed Consolidated Balance Sheets. In accordance with the accounting guidance, we designate foreign currency exchange contracts and interest rate lock agreements as cash flow hedges of certain forecasted foreign currency denominated sales, purchase and spending transactions, and the benchmark interest rate of the corresponding debt financing, respectively.

Our foreign subsidiaries operate and sell our products in various global markets. As a result, we are exposed to risks relating to changes in foreign currency exchange rates. We utilize foreign currency forward exchange contracts and option contracts to hedge against future movements in foreign exchange rates that affect certain existing and forecasted foreign currency denominated sales and purchase transactions, such as the Japanese yen, the euro, the pound sterling and the Israeli new shekel. We routinely hedge our exposures to certain foreign currencies with various financial institutions in an effort to minimize the impact of certain currency exchange rate fluctuations. These currency forward exchange contracts and options, designated as cash flow hedges, generally have maturities of less than 18 months. Cash flow hedges are evaluated for effectiveness monthly, based on changes in total fair value of the derivatives. If a financial counterparty to any of our hedging arrangements experiences financial difficulties or is otherwise unable to honor the terms of the foreign currency hedge, we may experience material losses.

In October 2014, we entered into a series of forward contracts (“Rate Lock Agreements”) to lock the benchmark rate on a portion of the Senior Notes. The Rate Lock Agreements had a notional amount of $1.00 billion in aggregate which matured in the second quarter of the fiscal year ended June 30, 2015. The Rate Lock Agreements were terminated on the date of the pricing of the $1.25 billion of 4.650% Senior Notes due in 2024 and we recorded the fair value of $7.5 million as a gain within accumulated other comprehensive income (loss) (“OCI”) as of December 31, 2014. We recognized $0.2 million for each of the three months ended September 30, 2019 and 2018, for the amortization of the gain recognized in accumulated other comprehensive income (loss), which amount reduced the interest expense. As of September 30, 2019, the unamortized portion of the fair value of the forward contracts for the Rate Lock Agreements was $3.8 million. For more details, refer to Note 16, “Derivative Instruments and Hedging Activities” of the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2019.

During the fiscal year ended June 30, 2018, we entered into a series of forward contracts (the “2018 Rate Lock Agreements”) to lock the benchmark interest rate prior to expected debt issuances. The objective of the 2018 Rate Lock Agreements was to hedge the risk associated with the variability in interest rates due to the changes in the benchmark rate leading up to the closing of the intended financing on the notional amount being hedged. The 2018 Rate Lock Agreement had a notional amount of $500.0 million in aggregate, which matured and terminated in the third quarter of fiscal year ending June 30, 2019 and we recorded the fair value of $13.6 million as a loss within OCI. We recognized $0.3 million amortization of the loss recognized in accumulated OCI, which increased the interest expense for the three months ended September 30, 2019. As of September 30, 2019, the unamortized portion of the fair value of the 2018 Rate Lock Agreements was $13.0 million.

For derivatives that are designated and qualify as cash flow hedges, the effective portion of the gains or losses is reported in 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 derivatives 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 item is recognized in earnings. The assessment of 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 contract. Any difference between change in the fair value of the excluded components and the amounts recognized in earnings are recorded in OCI.

For derivatives that are not designated as cash flow hedges, 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.

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

The gains (losses) on derivatives in cash flow hedging relationships recognized in OCI for the indicated periods were as follows:



	Three Months Ended
	September 30,
(In thousands)	2019			2018
Derivatives Designated as Hedging Instruments:
Foreign exchange contracts:
Amounts included in the assessment of effectiveness	$	(740	)	$	13,794
Amounts excluded from the assessment of effectiveness	$	(2	)	$	—

The locations and amounts of designated and non-designated derivative’s gains and losses reported in the Condensed Consolidated Statements of Operations for the indicated periods were as follows:



	Three Months Ended September 30,												Three Months Ended September 30,
	2019												2018
(In thousands)	Revenue			Cost of Revenues and Operating Expenses			Interest Expense			Other Expense (Income), Net			Revenue		Cost of Revenues			Interest Expense		Other Expense (Income), Net
Total amounts presented in the Condensed Consolidated Statement of Operations in which the effects of cash flow hedges are recorded	$	1,413,414		$	1,003,166		$	40,350		$	(1,618	)	$	1,093,260	$	381,387		$	26,362	$	(10,025	)
Gains (losses) on Derivatives Designated as Hedging Instruments:
Rate lock agreements:
Amount of gains (losses) reclassified from accumulated OCI to earnings	$	—		$	—		$	(99	)	$	—		$	—	$	—		$	—	$	—
Foreign exchange contracts:
Amount of gains (losses) reclassified from accumulated OCI to earnings	$	475		$	(1,801	)	$	—		$	—		$	983	$	(134	)	$	188	$	—
Amount excluded from the assessment of effectiveness recognized in earnings based on an amortization approach	$	(102	)	$	—		$	—		$	—		$	—	$	—		$	—	$	—
Amount excluded from the assessment of effectiveness	$	—		$	—		$	—		$	—		$	—	$	—		$	—	$	229
Gains (losses) on Derivatives Not Designated as Hedging Instruments:
Amount of gains (losses) recognized in earnings	$	—		$	—		$	—		$	2,325		$	—	$	—		$	—	$	3,763

The U.S. dollar equivalent of all outstanding notional amounts of foreign currency hedge contracts, with maximum remaining maturities of approximately ten months as of the dates indicated below were as follows:



(In thousands)	As of September 30, 2019		As of June 30, 2019
Cash flow hedge contracts - foreign currency
Purchase	$	26,488	$	31,108
Sell	$	117,761	$	113,226
Other foreign currency hedge contracts
Purchase	$	228,271	$	257,614
Sell	$	280,226	$	273,061

The locations and fair value of our derivatives reported in our Condensed Consolidated Balance Sheets as of the dates indicated below were as follows:



	Asset Derivatives					Liability Derivatives
	Balance Sheet Location	As of September 30, 2019		As of June 30, 2019		Balance Sheet Location	As of September 30, 2019		As of June 30, 2019
(In thousands)		Fair Value					Fair Value
Derivatives designated as hedging instruments
Foreign exchange contracts	Other current assets	608		397		Other current liabilities	824		2,097
Total derivatives designated as hedging instruments		608		397			824		2,097
Derivatives not designated as hedging instruments
Foreign exchange contracts	Other current assets	3,000		2,160		Other current liabilities	1,845		1,237
Total derivatives not designated as hedging instruments		3,000		2,160			1,845		1,237
Total derivatives		$	3,608	$	2,557		$	2,669	$	3,334

The changes in OCI, before taxes, related to derivatives for the indicated periods were as follows:



	Three Months Ended September 30,
(In thousands)	2019			2018
Beginning balance	$	(10,791	)	$	2,346
Amount reclassified to earnings	1,527			(1,037		)
Net change in unrealized gains or losses	(742		)	13,794
Ending balance	$	(10,006	)	$	15,103

Offsetting of Derivative Assets and Liabilities

We present derivatives at gross fair values in the Condensed Consolidated Balance Sheets. We have entered into arrangements with each of our counterparties, which reduce credit risk by permitting net settlement of transactions with the same counterparty under certain conditions. The information related to the offsetting arrangements for the periods indicated was as follows (in thousands):



As of September 30, 2019									Gross Amounts of Derivatives Not Offset in the Condensed Consolidated Balance Sheets
Description	Gross Amounts of Derivatives			Gross Amounts of Derivatives Offset in the Condensed Consolidated Balance Sheets		Net Amount of Derivatives Presented in the Condensed Consolidated Balance Sheets			Financial Instruments			Cash Collateral Received		Net Amount
Derivatives - Assets	$	3,608		$	—	$	3,608		$	(2,027	)	$	—	$	1,581
Derivatives - Liabilities	$	(2,669	)	$	—	$	(2,669	)	$	2,027		$	—	$	(642	)



As of June 30, 2019									Gross Amounts of Derivatives Not Offset in the Condensed Consolidated Balance Sheets
Description	Gross Amounts of Derivatives			Gross Amounts of Derivatives Offset in the Condensed Consolidated Balance Sheets		Net Amount of Derivatives Presented in the Condensed Consolidated Balance Sheets			Financial Instruments			Cash Collateral Received		Net Amount
Derivatives - Assets	$	2,557		$	—	$	2,557		$	(1,397	)	$	—	$	1,160
Derivatives - Liabilities	$	(3,334	)	$	—	$	(3,334	)	$	1,397		$	—	$	(1,937	)