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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1997
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 NO. 0-9992

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KLA-TENCOR CORPORATION

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 04-2564110

(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER

INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
160 RIO ROBLES SAN JOSE, CALIFORNIA 95134

(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 875-4200
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:

TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED

- ------------------------------------------------------------------------------------------------------
NONE NONE
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SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $0.001 PAR VALUE

COMMON STOCK PURCHASE RIGHTS

(TITLE OF CLASS)

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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 if disclosure of delinquent filers pursuant to Item

405 of Regulation S-K is not contained herein, and will not be contained, to the

best of registrant's knowledge, in definitive proxy or information statements

incorporated by reference in Part III of this Form 10-K or any amendment to this

Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of

the registrant based upon the closing price of the registrant's stock, as of

August 31, 1997, was $5,095,010,757. Shares of common stock held by each

officer and director and by each person or group who owns 5% or more of the

outstanding common stock have been excluded in that such persons or groups may

be deemed to be affiliates. This determination of affiliate status is not

necessarily a conclusive determination for other purposes.
The registrant had 84,318,173 shares of Common Stock outstanding as of

August 31, 1997.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Stockholders for the fiscal year ended

June 30, 1997 ("1997 Annual Report to Stockholders" ) are incorporated by

reference into Parts I, II and IV of this Report. Portions of the Proxy

Statement for the Annual Meeting of Stockholders ("Proxy Statement" ) to be held

on November 18, 1997, and to be filed pursuant to Regulation 14A within 120 days

after registrant's fiscal year ended June 30, 1997, are incorporated by

reference into Part III of this Report.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
THE COMPANY
Merger. Effective April 30, 1997, Tencor Instruments ("Tencor") merged

into a wholly-owned subsidiary of KLA Instruments Corporation ("KLA"). Following

the Merger, KLA changed its name to KLA-Tencor Corporation (the "Company"). In

the Merger, shares and options for Tencor common stock were exchanged on a

one-for-one basis for the common stock of KLA. The transaction was accounted for

as a pooling of interests for financial reporting purposes and structured to

qualify as a tax-free reorganization. The stockholders of each of KLA and Tencor

approved the transaction and the transaction was effective April 30, 1997.
The Merger brought together two companies with largely complementary

product lines which provide customers with yield management solutions and

process monitoring products throughout the semiconductor manufacturing process.

As the complexity of the sub-micron semiconductor manufacturing process

increases, the need for more, and more effective, process monitors also

increases. Quickly attaining and then maintaining high yields is one of the most

important determinants of profitability in the semiconductor industry. The

importance of high yields from the manufacturing process has grown dramatically

as wafer sizes increase and process geometries decrease. Total yield management

solutions have taken on a significance which has not been experienced in the

past. The Company, as a result of the Merger, is in a unique position to be the

single source for total yield management solutions with a portfolio of

applications-focused technologies and dedicated yield consulting expertise.
General. The Company was incorporated in Delaware in July 1975. Its

headquarters are located at 160 Rio Robles, San Jose, California, 95134,

telephone (408) 875-4200.
The Company is the leader in the design, manufacture, marketing and

service of yield management and process monitoring systems for the semiconductor

industry. The Company uses its technical expertise and understanding of customer

needs to supply unique yield management solutions and one of the broadest lines

of wafer inspection, thin film measurement, metrology and reticle inspection

systems available in the semiconductor industry. The Company's systems are used

to analyze product and process quality at critical steps in the manufacturing

process for integrated circuits and to provide feedback to our customers in

order that fabrication problems can be identified, addressed and contained. This

understanding of defect sources and how to contain them enables semiconductor

manufacturers to increase yields.
Semiconductor fabrication facilities are increasingly expensive to build

and equip. Yield management and process monitoring systems, which typically

represent a small percentage of the total investment required to build and equip

a fabrication facility, enable integrated circuit manufacturers to leverage

these expensive facilities and improve their returns on investment.
The Company's principal market is the semiconductor industry, marketing

and selling products worldwide to virtually all of the major semiconductor

manufacturers. The Company's revenues are derived primarily from product sales,

principally through its direct sales force, and to a lesser extent, through

distributors. The Company's technological strength has enabled it to develop and

introduce major new product families in each of its business units during the

last year.
YIELD MANAGEMENT SOLUTIONS
Maximizing yields, or the number of good die per wafer, is a key goal of

modern semiconductor manufacturing. Higher yields increase the revenue a

manufacturer can obtain for each semiconductor wafer processed. As geometry

linewidths decrease, yields become more sensitive to the size and density of

defects. Semiconductor manufacturers use yield management and process monitoring

systems to improve yields by identifying defects, by analyzing them to determine

process problems, and, after corrective action has been taken, by monitoring

subsequent results to ensure that the problem has been contained. Monitoring and

analysis often takes place at various points in the fabrication process as

wafers move through a production cycle consisting of hundreds of separate

process steps.
The following are some of the methods used to manage yield, all of which

require the capture and analysis of data gathered through many measurements:


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- Engineering analysis is performed off the manufacturing line to

identify and analyze defect sources. Engineering analysis

equipment operates with very high sensitivity to enable

comprehensive analysis of wafers. Because they operate off-line,

engineering analysis systems do not require high speeds of

operation.
- In-line monitoring is used to review the status of circuits

during production steps. Information generated is used to

determine whether the fabrication process steps are within

required tolerances and to make any necessary process

adjustments in real-time before wafer lots move to subsequent

process stations. Because the information is needed quickly to

be of greatest value, in-line monitoring requires both high

throughput and high sensitivity.
- Pass/fail tests are used at several steps in the manufacturing

process to evaluate products. For example, a pass/fail test is

used to determine whether reticles used in photolithography are

defect-free; electrical pass/fail testing is performed at the

end of the manufacturing process to determine whether products

meet performance specifications.
The most significant opportunities for yield improvement generally occur

when production is started at new factories and when new products are first

built. Equipment that helps a manufacturer quickly increase new product yields

enables the manufacturer to offer these new products in volume at a time when

they are likely to generate the greatest profits.
WAFER INSPECTION SYSTEMS
The Company created the market for automated inspection of semiconductor

wafers over 12 years ago. The wafer inspection group product offerings include

unpatterned wafer inspection and patterned wafer inspection tools which are used

to find, count and characterize particles and pattern defects on wafers both in

engineering applications and in-line at various stages during the semiconductor

and wafer manufacturing processes. Semiconductor manufacturers use wafer

inspection systems to monitor their manufacturing processes and to refine those

processes to increase the yield of acceptable integrated circuits. Accordingly,

semiconductor manufacturers base their purchase of wafer inspection systems on a

variety of criteria, including sensitivity, throughput, total cost of ownership,

ease of use, degree of automation, system repeatability and correlation and its

ability to be integrated into overall yield management systems. The Company

offers two primary product families in the wafer inspection area.
In 1992, the Company introduced the 2130 inspection required for

microprocessors and other logic devices as well as both the logic and repeating

array portions of memory devices. The 2130 was subsequently upgraded with each

new model having greater sensitivity and greater maximum speed compared to its

predecessor. The 2135 was introduced in 1996 with twice the throughput and

higher sensitivity compared to its predecessor. In 1997, the Company introduced

the 2138, a new patterned wafer inspection system specifically designed to

address chemical mechanical planarization (CMP) and other demanding inspection

applications. The 2138 is based on the 2135 inspection platform and combines an

ultra- broadband illumination source and significantly improved bright field

optics with Segmented Auto Thresholding. This combination significantly

increases defect sensitivity and capture, while reducing or eliminating false

defect counts in semiconductor processes. The 2138 extends the Company's full

line of intelligent in-line monitoring solutions.
The Company's Surfscan(R) family of laser-scanning products are widely

used for wafer qualification, process monitoring and equipment monitoring. They

provide the high sensitivity, fast throughput and low cost of ownership required

in a production environment and are used in virtually all semiconductor

manufacturing processes. Surfscans are key components of the defect reduction

strategies of many leading semiconductor manufacturers. The systems use a

standardized file format that allow defect location data to be easily

transferred to off-line review stations for defect classification. The latest

patterned Surfscan, the Surfscan AIT, is the cost/performance leader for in-line

monitoring of deposited films and CMP layers.
The Surfscan AIT and the 2138 are part of the Company's Intelligent Line

Monitoring solution, which includes the full line of patterned wafer inspection

systems, as well as the IMPACT/Online, ADC, CRS/Offline ADC and Quest defect

data analysis systems. This integrated yield management approach provides

semiconductor device manufacturers with a comprehensive tool set which enables

the acceleration of time-to-yield enhancements and yield goals.

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The SP1 is the Company's first system to address the unique unpatterned

inspection requirements of 300mm wafers. It performs rapid, highly sensitive

inspection of unpatterned 300mm wafers, providing capabilities critical to wafer

and equipment manufacturers who are developing products for emerging 0.25 micron

process technologies and below. It combines a stationary illumination beam,

uniform axi-symmetric collection optics and an optional bright field channel

with a rotating wafer scheme and allows detection of surface defects and

contaminants at speeds of 100 wafers per hour on 300mm wafers, and 150 wafers

per hour on 200mm wafers. The Surfscan 6420 detects submicron defects on metal

films and rough surfaces but still provides sensitivity down to 0.1 micron on

polished silicon. It is effective for detecting defects on non-uniform films, a

critical requirement for CMP applications.

As feature sizes of semiconductor circuits continue to decrease for

leading edge semiconductor products, the Company believes that conventional

optical technologies ultimately will begin to reach physical limits imposed by

the wavelength of light and fail to provide the necessary inspection resolution.

Working closely with those customers with the most advanced inspection

requirements, the Company has developed the SemSPEC, the industry's only fully

automatic electron beam inspection system. This system, comprised of the

industry's fastest scanning electron-optical column and a high speed image

computer, are used for wafer and x-ray mask inspection. The development of these

systems was funded in part by customer-sponsored research and development

programs. The Company expects the market for these inspection systems to emerge
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