UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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, 2006
For the Fiscal Year Ended June 30, 2007 |
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Transition Period from To
For the Transition Period from to |
Commission File No. 0-9992
KLA-TENCOR CORPORATION
(Exact Name of Registrant as Specified in its Charter)
Delaware | 04-2564110 | |
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification Number) | |
160 Rio Robles, San Jose, California | 95134 | |
(Address of Principal Executive Offices) | (Zip Code) |
Registrant’s Telephone Number, Including Area Code: (408) 875-3000
Securities Registered Pursuant to Section 12(b) of the Act:
Title of Each Class | Name of Each Exchange on Which Registered | |
Common Stock, $0.001 | The NASDAQ | |
Common Stock Purchase Rights |
Stock Market |
Securities Registered Pursuant to Section 12(g) of the Act:
None
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
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 Registrantregistrant 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. x¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨
Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant based upon the closing price of the registrant’s stock, as of December 31, 2005,2006, was $5,554,245,988.$6.8 billion. 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 199,725,957193,153,711 shares of common stock outstanding as of DecemberJuly 31, 2006.2007.
DOCUMENTS INCORPORATED BY REFERENCE
NonePortions of the Proxy Statement for the 2007 Annual Meeting of Stockholders to be held on November 15, 2007 (“Proxy Statement”), and to be filed pursuant to Regulation 14A within 120 days after the registrant’s fiscal year ended June 30, 2007, are incorporated by reference into Part III of this report.
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PART I | ||||||||
Item 1. | 1 | |||||||
Item 1A. | 13 | |||||||
Item | 21 | |||||||
Item 2. | 22 | |||||||
Item 3. | 23 | |||||||
Item 4. | ||||||||
PART II | ||||||||
Item 5. | ||||||||
Item 6. | 30 | |||||||
Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | |||||||
Item 7A. | Quantitative and Qualitative Disclosure | |||||||
Item 8. | ||||||||
Consolidated Balance Sheets | ||||||||
90 | ||||||||
Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | 92 | ||||||
Item 9A. | 92 | |||||||
Item 9B. | 95 | |||||||
PART III | ||||||||
Item 10. | Directors, | 96 | ||||||
Item 11. | 96 | |||||||
Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | 96 | ||||||
Item 13. | Certain Relationships and Related Transactions, and Director Independence | 96 | ||||||
Item 14. | Principal | 96 | ||||||
PART IV | ||||||||
Item 15. | 97 | |||||||
101 | ||||||||
102 | ||||||||
103 |
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical fact may be forward-looking statements. You can identify these and other forward-looking statements by the use of words such as “may,” “will,” “could,” “would,” “should,” “expects,” “plans,” “anticipates,” “relies,” “believes,” “estimates,” “predicts,” “intends,” “potential,” “continue,” or the negative of such terms, or other comparable terminology. Forward-looking statements also include the assumptions underlying or relating to any of the foregoing statements. Such forward-looking statements include, among others, those statements regarding the future impact of the restatement of our historical financial statements, shareholder litigation and related matters arising from the discovery that we had retroactively priced stock options (primarily from July 1, 1997 to June 30, 2002) and had not accounted for them correctly; forecasts of the future results of our operations; the percentage of spending that our customers allocate to process control; orders for our products and capital equipment generally; sales of semiconductors; the allocation of capital spending by our customers; growth of revenue in the semiconductor industry, the semiconductor capital equipment industry and business; technological trends in the semiconductor industry; the future impact of the restatement of our historical financial statements, shareholder litigation and related matters arising from the discovery that we had retroactively priced stock options (primarily from July 1, 1997 to June 30, 2002) and had not accounted for them correctly; our future product offerings and product features; the success and market acceptance of new products; timing of shipment of backlog; the future of our product shipments and our product and service revenues; our future gross margins; the future of our selling, general and administrative expenses; international sales and operations; maintenance of our competitive advantage; success of our product offerings; creation and funding of programs for research and development; attraction and retention of employees; results of our investment in leading edge technologies; the effects of hedging transactions; the effect of the sale of trade receivables and promissory notes from customers; our future income tax rate; dividends; the completion of any acquisitions of third parties, or the technology or assets thereof; benefits received from any acquisitions and development of acquired technologies; sufficiency of our existing cash balance, investments and cash generated from operations to meet our operating and working capital requirements; and the adoption of new accounting pronouncements.
Our actual results may differ significantly from those projected in the forward-looking statements in this report. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in Item 1A, “Risk Factors” as well as in Item 1, “Business” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Annual Report on Form 10-K. You should carefully review these risks and also review the risks described in other documents we file from time to time with the Securities and Exchange Commission, including the Quarterly Reports on Form 10-Q that we will file in the fiscal year 2007.ending June 30, 2008. You are cautioned not to place undue reliance on these forward-looking statements, and we expressly assume no obligationsobligation to update the forward-looking statements in this report that occur after the date hereof.
EXPLANATORY NOTE REGARDING RESTATEMENTS
This Annual Report on Form 10-K for our fiscal year ended June 30, 2006 includes restatements of the following previously filed financial statements and data (and related disclosures): (1) our consolidated financial statements as of and for our fiscal years ended June 30, 2005 and 2004; (2) our selected consolidated financial data as of and for our fiscal years ended June 30, 2005, 2004, 2003 and 2002, and (3) our unaudited quarterly financial data for the first three quarters in our fiscal year ended June 30, 2006 and for all quarters in our fiscal year ended June 30, 2005. See Note 2, “Restatement of Consolidated Financial Statements,” to Consolidated Financial Statements and Exhibit 99.1 for a detailed discussion of the effect of the restatements.
As a result of an investigation of our historical stock option practices by a Special Committee of our Board of Directors (see Item 3—Legal Proceedings), we discovered that certain of our stock options, primarily those granted from July 1, 1997 to June 30, 2002, had been retroactively priced for all employees who received these grants (less than 15% of these options were granted to executive officers). This means that the option exercise price was not the market price of the option shares on the actual grant date of the option, but instead was
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a lower market price on an earlier date. The actual grant date—when the essential actions necessary to grant the option were completed, including the final determination of the number of shares to be granted to each employee and the exercise price—is the correct measurement date to determine the market price of the option shares under the accounting rules in effect at the time. More than 95% of the total in-the-money value (market price on the actual grant date minus exercise price) of all of our retroactively priced options was attributable to those granted from July 1, 1997 to June 30, 2002.
We previously applied Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and its related Interpretations and provided the required pro forma disclosures under Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” through the fiscal year ended June 30, 2005. Under APB Opinion No. 25, a non-cash, stock-based compensation expense was recognized for any option for which the exercise price was below the market price on the actual grant date. Because each of our retroactively priced options had an exercise price below the market price on the actual grant date, there should have been a charge for each of these options under APB Opinion No. 25 equal to the number of option shares, multiplied by the difference between the exercise price and the market price on the actual grant date. That expense should have been amortized over the vesting period of the option. Starting in our fiscal year ended June 30, 2006, we adopted SFAS No. 123(R), “Share-Based Payment.” As a result, for fiscal year 2006, the additional stock-based compensation expense required to be recorded for each retroactively priced option was equal to the incremental fair value of these options on the actual grant date over the remaining vesting period of the option. We did not record these stock-based compensation expenses under APB Opinion No. 25 or SFAS No. 123(R) related to our retroactively priced options in our previously issued financial statements, and that is why we are restating them in this filing. To correct our past accounting for stock options, we recorded additional pre-tax, non-cash, stock-based compensation expense of (a) $348 million for the periods July 1, 1994 to June 30, 2005 under APB Opinion No. 25 and (b) $22 million for the year ended June 30, 2006 under SFAS No. 123(R). We expect to amortize an additional $6 million of such pre-tax charges under SFAS No. 123(R) in future periods to properly account for past retroactively priced option grants.
Management reviewed the findings of the Special Committee and conducted its own internal review of our past stock option grants and other aspects of our historical financial statements. Management agrees with the Special Committee that there was retroactive pricing of stock options granted to all option holders, primarily from July 1, 1997 to June 30, 2002. The restatements included in this Annual Report on Form 10-K include adjustments arising from the Special Committee investigation and management’s internal review.
Unless otherwise noted, all of the information in this Annual Report on Form 10-K is as of June 30, 2006. This Report does not reflect any subsequent events that occurred after June 30, 2006 other than the Special Committee investigation, resulting restatements and related matters. Our previously filed financial statements for the quarter ended September 30, 2005 are restated in our Quarterly Report on Form 10-Q for the quarter ended September 30, 2006, which we are filing concurrently with this Annual Report on Form 10-K. We will later restate our previously filed financial statements for the quarters ended December 31, 2005 and March 31, 2006 when included in our Quarterly Reports on Form 10-Q for the quarters ended December 31, 2006 and March 31, 2007, respectively. The Selected Quarterly Condensed Consolidated Financial Data and related Management’s Discussion and Analysis for the quarters ended September 30, 2005, December 31, 2005 and March 31, 2006 are included in Exhibit 99.1 of this Annual Report on Form 10-K. We have not amended and do not intend to amend any of our previously filed Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for the periods affected by the restatements. Such previous filings should not be relied upon.
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ITEM 1. | BUSINESS |
The Company
KLA-Tencor Corporation (“KLA-Tencor” or the “Company” and also referred to as “we” or “our”) is the world’s leading supplier of process control and yield management solutions for the semiconductor and related microelectronics industries. Our products are also used in a number of other industries, including wafer manufacturing and data storage.
Within our primary area of focus, our comprehensive portfolio of products, services, analysis, software and expertise is designed to helphelps integrated circuit (“IC”) manufacturers manage yield throughout the entire fabrication process—from research and development to final mass-production yield analysis.
We offer a broad spectrum ofvolume production. These products and solutions are designed to help customers accelerate their development cycles, bring their fabs to production more quickly and achieve higher and more stable yields.
KLA-Tencor’s products and services that are used by virtually every major wafer, IC and photomask manufacturer in the world. These customers turn to us for inline wafer defect monitoring; reticle and photomask defect inspection; critical dimension (“CD”) metrology; wafer overlay;overlay metrology; film and surface measurement; and overall yield and fab-wide data analysis. Our advanced products, coupled with our unique yield technology services, allow us to deliver the yield management solutions our customers need to accelerate their yield learning rates, reduce their yield excursion risks and adopt industry-leading yield management practices.
KLA-Tencor Corporation was formed in April 1997 through the merger of KLA Instruments Corporation and Tencor Instruments, two long-time leaders in the semiconductor equipment industry, each with over 20 years of experience. KLA Instruments Corporation was incorporated in Delaware in 1975; Tencor Instruments was incorporated in California in 1976. Effective April 30, 1997, a wholly owned subsidiary of KLA Instruments Corporation merged into Tencor Instruments, merged intoand Tencor Instruments became a wholly owned subsidiary of KLA Instruments Corporation. Immediately following this merger, KLA Instruments Corporation changed its name to KLA-Tencor Corporation.
Additional information about KLA-Tencor is available on our web site at www.kla-tencor.com. We make available free of charge on our web site our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those Reportsreports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file them with or furnish them to the Securities and Exchange Commission (“SEC”). Information contained on our web site is not part of this Annual Report on Form 10-K or our other filings with the SEC. Additionally, these filings may be obtained by visiting the Public Reference Room of the SEC at 100 F Street, NE, Washington, DC 20549 or by calling the SEC at 1-800-SEC-0330, by sending an electronic message to the SEC at publicinfo@sec.gov or by sending a fax to the SEC at 1-202-777-1027. In addition, the SEC maintains a website (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically.
Industry
General Background
The semiconductor or integrated circuit (“IC” or “chip”) industry is KLA-Tencor’s core focus. The semiconductor fabrication process begins with a bare silicon wafer—a round disk that is six, eight or twelve inches in diameter, about as thick as a credit card and gray in color. The process of manufacturing wafers is itself highly sophisticated, involving the creation of large ingots of silicon by pulling them out of a vat of molten silicon. The ingots are then sliced into wafers and polished to a mirror finish on the side where the circuits are to be made.finish.
The manufacturing cycle of an integrated circuit (“IC” or “chip”)IC is grouped into three phases: design, fabrication and testing. IC design involves the architectural layout of the circuit, as well as design verification and photomask or reticle generation.
The fabrication of a chip is accomplished by depositing a series of film layers that act as conductors, semiconductors or insulators. The deposition of these film layers is interspersed with numerous other process steps that create circuit patterns, remove portions of the film layers, and perform
other functions such as heat treatment, measurement and inspection. Most advanced chip designs require over 500hundreds of individual steps, many of which are performed multiple times. Most chips consist of two main structures: the lower structure, typically consisting of transistors or capacitors, which performperforms the “smart” functions of the chip; and the upper ‘interconnect’ structure, typically consisting of “interconnect” circuitry which connects the components in the lower structure.
When all of the layers on the wafer have been completed, each die on the wafer is then tested for functionality. The wafer is placed on a prober that is used to attach the input/output pins of the device to a tester. When chips are tested on the wafer, it is called sort test. A sort test determines which chips are good. The wafer is then cut up, and the good die are bonded to lead frames that contain pins used to attach the chip to the outside printed circuit board. Wires are bonded from the input/output pads of the IC to the pins of the lead-frame. Then the lead frame is encapsulated in packages typically made of plastic or ceramic materials. The packaged parts are put through a final test and then shipped to customers. This entire packaging and testing process is called the “back end.”
Current Trends
Companies that anticipate future market demands by developing and refining new technologies and manufacturing processes are better positioned to lead in the semiconductor market. During past industry cycles, semiconductor manufacturers generally contended with one key new technology or market trend, such as a specific design rule shrink. In today’s market, the leading semiconductor manufacturers are investing in bringing a multitude of new technologies into production at the same time, including copper interconnects, new substrate and transistorfilm materials and advanced lithography techniques and 300-mm (12-inch) wafers.techniques.
While many of these technologies have been adopted at the development and pilot production stages, significant challenges and risks associated with each technology have affected their adoption into full-volume production. For example, as design rules decrease, yields become more sensitive to the size and density of defects, while device performance characteristics (namely speed or capacity) become more sensitive to such parameters as linewidth and film thickness variation. Copper introduces new physical defects, which are harder to find within the interconnect structure, as well as electrical defects, which cannot be detected using conventional optical inspection systems. New process materials, such as low-khigh-k dielectrics, silicon-on-insulator (“SOI”) wafers and 193-nmimmersion lithography-capable photoresists require extensive characterization before they can be readied forused in the manufacturing process. Film uniformity is also more difficult to maintain on larger wafers. Moving several of these advanced technologies into production at once only adds to the risks that chipmakers face, since technical challenges in bringing any one of these into production could also slow the adoption of the other technologies.
The focus of our activities has been the development of new process control and yield management tools that enable chipmakers to accelerate the adoption of these new technologies into full-volume production, while minimizing their associated risks. With our portfolio of application-focused technologies and our dedicated yield technology expertise, we are in position to be a key supplier of comprehensive yield management solutions that enable our customers to achieve success for their next-generation products.face.
The continuing evolution of semiconductor devices to smaller linewidth geometries and more complex multi-level circuitry has significantly increased the cost and performance requirements of the capital equipment used to manufacture these devices. Construction of an advanced wafer fabrication facility today can cost over $3 billion, substantially more than previous generation facilities. As a result, chipmakers are demanding increased productivity and higher returns from their manufacturing equipment. Our
By developing new process control and yield management equipment enablestools that help chipmakers accelerate the adoption of these new technologies into volume production, we enable our customers to better leverage these increasingly expensive facilities, reduce their production costs and significantly improve their return on investment (“ROI”)—helping them. Once customers’ production lines are operating at high volume, our tools help ensure that yields are stable and process excursions are identified and quickly resolved. Historically, the move to become low-cost producers.each new generation’s smaller design rules has increased in-process variability and thus has often required increased inspection and metrology sampling.
With our broad portfolio of application-focused technologies and our dedicated yield technology expertise, we are in position to be a key supplier of comprehensive yield management solutions for customers’ next-generation products, including those required for the 45nm generation and beyond.
Our Process Control and Yield Acceleration Solutions
Accelerating the yield ramp and maximizing production yields of high-performance devices are key goals of modern semiconductor manufacturing. Ramping to high-volume production ahead of competitors can
dramatically increase the revenue an IC manufacturer realizes for a given product. KLA-Tencor systems not only
analyze defectivity and metrology issues at critical points in the wafer, photomask and IC manufacturing processes, but also provide information to our customers so that they can identify and address the underlying process problems. The ability to locate the source of defects and characterize process issues enables our
customers to improve control over their manufacturing processes, so they can increase their yield of high-performance parts—thus maximizing their profit.
Products
KLA-Tencor operates primarily in one segment for the design, manufacture and marketing of process control and yield management systems for the semiconductor and related microelectronics industry. We also currently offer products that serve the wafer manufacturing, data storage and other industries. We design, market, manufacture and sell our equipment—consisting of patterned and unpatterned wafer inspection, optical overlay metrology, electron-beam (e-beam) review, reticle and photomask inspection, spectroscopic, and film and surface measurement tools—as well as our advanced yield analysis and defect classification software to provide fab-wide yield management solutions. These solutions are optimized for the manufacturing process cells used in IC production, including lithography, deposition, etch, and chemical mechanical planarization (CMP). Our offerings can be broadly categorized into four groups: Defect Inspection; Metrology; Services; Softwareproduct related services; and Other.Software. For our customers manufacturing larger design-rule devices, we provide refurbished KLA-Tencor Certified tools along with warranty and support.
Defect Inspection
KLA-Tencor’s defect inspection tools are usedallow our customers to detect, count, classify and characterize yield failures caused by particles, pattern defects, surface anomalies and electrical failuresissues during all stages of the IC manufacturing process, from new product development through yield ramp to baseline yield improvement during volume production.process. Our portfolio includes theof tools that enableenables our customers to findramp their production lines faster by finding new defect types during development and ramp, and monitorto maintain high and stable yields by monitoring defect levelcount by type during production.
Defect inspection is especially critical as our customers move to production of 65nm design-rule devices, and begin development of the 45nm node. The number of yield-relevant defects increases as semiconductor process tolerances (“process windows”) become tighter, a result of smaller, more densely packed semiconductor circuit patterns. Also, new defect types and yield issues arise from the necessary introduction of innovative materials, device structures and lithography techniques. As a result, chip manufacturers need to inspect more wafers per lot, more process layers and more area on the wafer, at higher sensitivities. KLA-Tencor defectsupplies a wide portfolio of high performance inspection, reviewclassification and analysis tools find, identify and locate the source of all types of physical and electrical defects, on all layers.systems that enable our customers to solve their toughest yield issues.
High-Sensitivity Broadband Brightfield Inspection
AsBrightfield inspection systems provide benchmark sensitivity to small defects, and capture the greatest range of defect types, which becomes increasingly important as our customers move to 65nm production45nm and begin development of the 45nm node, they face a plethora of new defect types and noise sources as well as a dramatic rise in systematic defects, arising from the adoption of new materials, device structures and lithography techniques. The magnitude of these defect challenges calls for inspection solutions with improved sensitivity and greater range of defect type capture on all layers. In response to these needs, KLA-Tencor unveiled its new 2800™smaller production. Our 2800™ Series full-spectrum brightfield inspection platform in July 2005. The 2800 features a unique broadband light source spanning deep ultraviolet (DUV), UVsystem has been widely adopted at leading-edge memory, logic and visible wavelengths, and a proprietary optical design that maximizes sensitivity at all throughput settings. This new full-spectrum brightfield inspector has the ability to tune its wavelength to optimize defect capture on each layer. The 2800 Seriesfoundry fabs worldwide, because it delivers the high-sensitivitysensitivity and production-worthy performance that chipmakers need to produce market-leading 65nm devices. Key to the 2800 inspection system’s success is the industry’s only full-spectrum broadband light source, spanning deep ultraviolet to visible wavelengths. With the ability to tune its wavelength and employ various optical modes and algorithms, the 2800 inspection system provides sensitivity to an unequalled range of defect types throughout the chip manufacturing process. In June 2007 we introduced the newest additions to our 28xx product series, the 2810 and 2815. Targeting the 45nm node, these are the first inspection systems designed specifically for memory or logic applications. The 2810 and 2815 have twice the computing speed of the 2800 and new optical modes that enable increased defect capture.
High-Performance Darkfield Inspection
In July 2005, we unveiled theDarkfield inspection systems are used to cost effectively monitor process tools for defect yield excursions. Our widely-adopted Puma 9000™ Series (“Puma”), our latest-generation darkfield inspection platform. Puma represents a marked departure from traditional darkfield tools, which are based on acousto-optical device (“AOD”) scanners and photo-multiplier tube (“PMT”) detectors—technologies that are reaching their limits. Puma replaces the AOD/PMT technology withplatform leverages our patented Streak™
laser imaging technology. Scalable for multiple technology generations, Streak combinesto produce the highest sensitivities at production throughputs of any darkfield inspection system on the market. Combining advanced UV-laser illumination optics with a solid-state multi-pixel linear sensor to image the scattered light. The resultlight, Streak is an inspection system with higher sensitivity at production throughputs than can be achieved with traditional AOD/PMT-based inspection systems. Puma can be configured to accommodate applications ranging from process tool monitoring through critical etch line monitoring, allowing our customers to cost-optimize their inspection strategies and achieve tighter production control.
Electron-Beam Inspection
For advanced IC manufacturing, e-beam inspection is essential—not only during IC development, where the highest sensitivity is needed to root out defects, but also in production, where dedicated systems are required to monitor key process steps. Only e-beam technology can find the smallest physical defects and the subtle electrical defects that plague customers as they introduce new materials and device structures at the 65nm and 45nm nodes. In FebruarySeptember 2006, we introduced the latest additionPuma 9110 and 9130. The Puma 91xx platform builds on the advantages of the Puma 9000, with double its throughput, as well as greater sensitivity and ease of use. In June 2007, we added to our eS3x seriesthe 91xx family by introducing the Puma 9150, which features enhancements that further increase the range of e-beam inspection systems—the eS32™. A single system spanning development and production applications, the eS32 provides the best sensitivity at throughput for defect types that opticalthe system can capture.
High Resolution Electron Beam Review and Classification
Once a defect has been identified, a chipmaker must be able to review and classify the defect in order to identify and address the cause of the defect. As chipmakers moved to the 45nm node, however, inspection tools were identifying defects that fell below the resolution limit of the review tools commercially available at that time. To address this situation, we re-entered the defect review and classification market by introducing the eDR™-5200 in early July 2007. The eDR-5200 features a lens system that delivers a significant improvement in resolution, meeting production and process development requirements for advanced design-rule semiconductor devices. Unique connectivity technology between the eDR-5200 and our market-leading inspection systems cannot find.provides additional benefits to our customers with respect to defect re-detection, classification and speed. Because the eDR-5200 was introduced after the end of the fiscal year covered by this Annual Report on Form 10-K, sales of this product are not reflected in the financial statements included in this report.
Wafer and Film Surface Inspection
All chipmakers extensively utilize inspection tools to detect defects on blanket (unpatterned) films and bare wafer surfaces. In 2004, we unveiled theOur Surfscan SP2™ whichand Surfscan® SP2XP products are designed to detect those types of defects.
Unpatterned Wafer and Film Surface Inspection: For certain types of inspection, such as the qualification of new process tools, periodic checks of process tools already in production, or qualification of process tools after maintenance, chipmakers may prefer to use bare or blanket-film wafers instead of patterned wafers. The Surfscan SP2™ incorporates a new UV illumination technology to significantly enhance inspection sensitivity and speed on IC films, as well as both traditional silicon and engineered substrates. The Surfscan SP2 is capable of detecting defects as small as 30nm at higher throughputs than thosethat of the previous-generation Surfscan SP1™DLS DLS tool. inspection system.
Bare Wafer Surface Inspection:Inspection:The wafer substrate is the foundation of an integrated circuit. Having a defect-free wafer substrate is essential, since defects on the surface of the wafer can adversely affect subsequent semiconductor processes, and ultimately impact IC performance. AtIn January 2007 we introduced the Surfscan SP2XP, a system which has the speed and sensitivity of the Surfscan SP2, plus a new optical subsystem that allows the tool to distinguish between inherent defects in the silicon crystal—which can kill transistors and thus require scrapping the wafer—and other defect types that may be eliminated through cleaning or re-polishing the wafer. The Surfscan SP2XP provides wafer manufacturers with the ability to scrap fewer wafers, enhancing their profitability. This tool has been adopted by all major wafer manufacturers worldwide.
Electron-Beam Inspection
For advanced IC manufacturing, e-beam inspection is essential—not only during IC development, where the highest sensitivity is needed to discover defects, but also in production, where dedicated systems are required to monitor key process steps for defect excursions. Only e-beam technology can find the smallest physical defects and the subtle electrical defects that plague customers as they introduce new materials and device structures at the 65nm node and beyond, transistor performance in high-end devices depends critically on45nm nodes.
In February 2006, we introduced the physicallatest addition to our eS3x series of e-beam inspection systems—the eS32™. A single system spanning development and electrical properties ofproduction applications, the wafer surface below it. Epitaxial silicon layers and engineered substrates, such as silicon-on-insulator (SOI), have become important substrate materials—with associated challenges. The Surfscan SP2 is the industry standard advanced wafereS32 e-beam inspection system and is being adopted by virtually all wafer manufacturers worldwide to provide critical quality control.provides the best sensitivity at throughput for defect types that optical systems cannot find.
Unpatterned SurfaceMacro Defect Inspection: IC applications for the Surfscan SP1 and Surfscan SP2 inspectors include not only incoming wafer surface quality measurements, but also process tool qualification and monitoring. Instead of inspecting a patterned wafer, a bare or blanket-film wafer can be used to qualify new process tools, periodically check process tools already in production, or qualify process tools after maintenance.Wafer Dispositioning
Advanced fabs require accurate and rapid disposition decision making during manufacturing, as well as quick assessment of tool and process module output. Operators have historically performed this task by visually inspecting a small sample of wafers for macro defects under a manual or semi-automated light microscope. However, advanced 300mm manufacturing, with large wafer surfaces, smaller device features and factory automation, challenges the ability of the operator to reliablyassess wafers and repeatably assess the waferlots in a reliable and lot.repeatable manner. These conditions place large quantities of valuable wafers at risk.
In May 2006, we introduced the Viper 24352435XP™ is an automated 300mm wafer and tool dispositioning system, thatwhich captures a broad range of defect types at very high throughput—enabling inspection of 100% of wafer lots. Delivering quick go/no-go decisions, the system enables fab engineers to take corrective action early, when wafers can be reworked or process tool problems can be repaired before additional lots are put at risk. Viper 24352435XP can be integrated rapidly and seamlessly into a production environment in the lithography, CMP, etch, and films process modules.
Wafer Edge Inspection
As customers move to smaller design rules and new, more complex material stacks, the high stress wafer edge region has become a source of yield-limiting defects. Material at the edge of the wafer can flake off and fall onto the regions where the chips are being built, causing loss of yield. The recent introduction of immersion lithography adds to the potential for flakes to migrate and cause yield loss, since the flakes can be transported by the immersion fluid.
To help customers identify and fix these edge-related yield issues, KLA-Tencor introduced the VisEdge™ CV300, in October 2006. The tool’s unique optics design and advanced defect classification capabilities allow IC manufacturers to capture a wide range of wafer-edge defect types with high sensitivity.
Reticle Inspection
Error-free reticles are the first step in ensuring high yields in the manufacturing process, since defects in reticles can be replicated on wafers. Reticles are high-precision quartz plates that contain microscopic images of electronic circuits. Placed into steppers or scanners, these reticles are used to transfer circuit patterns onto wafers to fabricate ICs. The extension of optical lithography belowIt is extremely important that these features are printed correctly on the 130nm node has resultedreticles; very small variations in line width or placement, or defects within or adjacent to these structures, can cause devastating yield loss in the mask error enhancement factor (“MEEF”), where reticle defects once too small to print on the wafer become enhanced in the lithography process to create yield-killing wafer defects.printed die.
In 2003,2007, we introduced TeraScan™, a high-resolution inspection system for XRET photomasks, providing a comprehensive mask inspection solution for sub-90nm IC production. TeraScan, along with the revolutionary STARlightTeraScanHR™ reticle inspection system, offers high-sensitivitywhich provides unique defect-detection and productivity features that enable the production of defect-free reticles. The new system includes higher resolution optical imaging and several new inspection modes that enable the system to detect classical defects (intrusions, extrusions and point defects) as small as 80nm, and CD defects as small as 50nm. TeraScan has the ability to inspect nearly any type of photomask used in IC production, regardlessfind all types of reticle wavelengthdefects. The TeraScanHR system’s high sensitivity, improved productivity, and resolution enhancement technology, for sub-90nm design rules.flexible configurations make it a cost-effective solution that meets the needs of reticle manufacturers.
As IC manufacturing costs and complexities increase with each technology node, ensuring high-yield becomes paramount for today’s wafer fabs. The combination of 193nm lithography and 300mm wafer processing further exacerbatesfabs use the progressive defects problem because the photomasks must endure longer periods of exposure at higher energy—creating an ideal breeding ground for these contaminants. In addition to finding these elusive defects before they print, reticle inspection techniques must contend with a multitude of new XRET types and the increased packing density of device features associated with 65nm designs.
The industry’s highest resolution contamination mode inspection technology, STARlight-2™ was deliveredinspection system to qualify incoming reticles for use in 2005IC production, and also to re-check the reticle periodically as it is used in production. Based on the TeraScan platform. By leveraging platform advances in resolution, along with a detailed understanding of today’s XRET photomasks, STARlight-2 takes the industry-standard STARlight™ algorithms to the next level. Theplatform, STARlightlight-2-2 algorithms have been especially optimized for the mask re-qualification use case in a wafer fab. STARlight-2 provides early warning on progressive mask defects as well as excellent offers high sensitivity to traditional contamination, and ESD. This full-field contamination inspection can handle both single-die and multi-die masks and it covers high-density patterned areas as well as scribes and borders while improving productivity through effective defect categorization using ReviewSmart™ and Litho3™.
Transparent Film and Substrate Inspection
Understanding the optical surface properties of modern materials has become a critical part of manufacturing in industries ranging from microelectronics to biomedicine. With the increasing complexity of manufacturing processes and products comes the need for extremely precise analysis and control of surface properties such as film thickness uniformity, contamination and defectivity, often in real time and online. This trend is paving the way for nondestructive optical metrology techniques to move into volume production environments. Through our acquisition of Candela Instruments during fiscal year 2005, we added the Candela™ series of Optical Surface Analyzers (“OSA”) to our inspection portfolio. These systems automatically detect and classify surfaceprogressive defects on optoelectronic and semiconductor wafers, including transparent wafers such as sapphire and glass. By simultaneously measuring reflectivity and topographic variations(crystals which grow on the surface, these systems enable detection of particles, stains, scratches, pitsreticles over time), and bumps. Epi layers and film coatings can also be inspected for uniformity, particles, and surface defects.the damage from electrostatic discharge.
Process Window Qualification
Reticles used in the manufacture of today’s advanced ICs incorporate complex resolution enhancement techniques (RETs) that enable lithographers to extend existing lithographic processes to print features smaller than the wavelength of light
used—a process called sub-wavelength lithography. These enhancements include OPC and PSM technology, which togethertechniques reduce the size and fine-tune the shape of features on the wafer. During the photolithography patterning process, marginal RET designs can print as out-of-focus features-orfeatures—or not print at all, creating open circuits that translate to electrical failures within the device. However, since these errors represent design marginalities rather than physical defects on the reticle, they cannot be caught using traditional reticle inspection.
Our Process Window Qualification (“PWQ”) solution enables device manufacturers to identify reticle design marginalities by examining the wafer for poorly printed features using their KLA-Tencor 23xx or 2800our broadband brightfield wafer inspection systems. PWQ enables lithographers to compare die resulting from marginal lithography parameters with die printed under optimized conditions, to identify and prioritize
problematic regions as a function of process parameters. This method enables lithographers to understandsystems, so the consequences of operatingmanufacturers can then make more informed decisions about how closely they will operate near the boundaries of the process window—allowing more informed decisions about whetherwindow, and how to redesignaddress any design marginalities resulting from that decision.
Transparent Film and Opaque Substrate Inspection
Understanding the reticle or fine-tune inline defectoptical surface properties of modern materials has become a critical part of manufacturing. With the increasing complexity of manufacturing processes and CD monitoring effortsproducts comes the need for extremely precise analysis and control of surface properties such as film thickness uniformity, contamination and defectivity, often in real time and online. The Candela™ CS20 Optical Surface Analyzer automatically detects and classifies surface defects on optoelectronic and semiconductor wafers, including wafers made of transparent materials such as sapphire and glass. By simultaneously measuring reflectivity and topographic variations on the surface, these systems enable customers to minimize the impact of the design error on device yield.inspect epitaxial layers and film coatings for uniformity issues and defects.
Metrology
Metrology is a critical componentdiscipline in the production of detecting, understanding and correcting yield problems.high performance, reliable devices. Whether it is verifying that thea design will be manufacturable, fully characterizing a new process, or monitoring high-volume manufacturing, our comprehensive set of metrology, analysis and process window optimization products provide the full range of the critical measurements needed by fabs to manage their manufacturing process. With our unique combination of overlay, critical dimension, and film metrology measurements,gives IC manufacturers have the capabilitiesability to maintain tight control of their lithography, etch, deposition and CMP processes. This enables them to ramp processes faster and detect process excursions earlier, preventing further material from being processed.
Optical Overlay Metrology
Decreasing linewidths, larger die sizes and increasing chip density all affect the tolerances for layer-to-layer alignment, oroverlay and can result in overlay misregistration errors—. Mis-registration errors represent a crucial cause of
yield loss. Today’s lithography scanners or steppers require in-line monitoring to insure layer to layerensure layer-to-layer alignment is within spec.within-spec. These advanced lithography systems also require regular maintenance and performance tests to insureensure they are meeting the process requirements. MetrologyOverlay metrology systems are needed to verify scanner or stepper performance after periodic maintenance and to measureby measuring the pattern alignment between differentadjacent layers of the semiconductor devices in production to ensure overlay errors are kept within specification.
In fiscal year 2005, we introduced Archer AIM+™, our latest overlay metrology solution, whichchip, as it is designed to address chipmakers’ lithography overlay control needs beyond the 65nm node. Archer AIM+ incorporates a new optic system design and improved illumination system to reduce total measurement uncertainty (“TMU”), a key metric of overlay metrology performance and exceed the 45nm node overlay control requirements outlined in the 2005 edition of the International Technology Roadmap for Semiconductors.built.
In 2006, we introduced the K-T AnalyzerArcher 100™ lithography correctibles platform to accelerate and improve advanced lithography cell qualification and control. Seamlessly integrated with KLA-Tencor’s Archer overlay metrology platform for 65nm and below IC production, K-T Analyzer provides automated, on-tool analysis of overlay and CD metrology data in real time, giving engineers immediate feedbackOverlay Control System, based on the qualityindustry-proven Archer™ platform. Fully redesigned optics, tighter stage tolerances, and new imaging and illumination modes combine to deliver the high levels of their lithography process. This enables themperformance and productivity needed to correct errors quickly, reduce unnecessary wafer rework, and make efficient use of lithography equipment, thereby ensuring that optimal productivity and tight process control are maintained in the lithography cell. K-T Analyzer is now being used to enhance focus/dose analysis applications at several leading logic and memory manufacturers worldwide.address increasingly tighter overlay error budgets.
CD Metrology
TraditionalThe critical dimension (CD) is the smallest intended linewidth for a given device. While a useful measurement for previous-generation devices, traditional CD linewidth measurements no longer provide all the information that chipmakers need to accurately predict yield and transistor performance. Complete featureInstead, complete profile information, is needed, including CD, sidewall angle, height and depth. Contact hole profile measurements are also critical, since contact hole sizes that are significantly reduced or closedthe width at the top and bottom of the structure can resultfeature, the sidewall angle and the height or depth of the feature, are needed. For this reason, CD control in significant yield loss.the fab is increasingly changing from traditional CD-SEM (scanning electron microscope) measurements to optical CD.
In February 2006, we introduced the SpectraCD-XT™—our fourth-generation of inline optical CD metrology systems for advanced patterning process control at the 90nm and 65nm nodes.control. The SpectraCD-XT is a non-destructive, dedicated CD and
profile metrology system built on our high-throughput, production-proven Archer platform. The tool is the only high performance spectroscopic ellipsometry (SE)-based
system with sub-2-secondWith a move-acquire-measure (“MAM”) time. This performance allowstime under two seconds and a throughput of over 100 wafers per hour, the SpectraCD-XT leads the industry in productivity, allowing chipmakers to detect even the smallest profile excursions rapidly and increase sampling or reduce turn-around-time for critical CD or profile measurements. CD control in the fab is increasingly changing over to Optical CD from traditional CD-SEM metrology tools. We have ceased further development of the CD-SEM metrology tools. SpectraCD-XT further enables this transition with its throughput of greater than 100 wafers per hour, making it the lowest cost of ownership CD tool on the market.repeatably.
Film Measurement
Our film measurement productsmetrology systems measure a variety of optical and electrical properties of thin films.films deposited on a wafer. These productssystems are used to control a wide range of wafer fabrication steps, where both within-wafer and wafer-to-wafer process uniformity are of paramount importancecritical to semiconductor manufacturers—enabling them to achieveachieving high device performance characteristics at low cost.
In 2004, we introduced SpectraFx 200™, our most advanced, seventh-generation thin-film metrology system, builds upon our expertise in spectroscopic ellipsometry (SE) to enablemeasure the thickness and optical properties of complex, multi-layer film stacks. SpectraFx 200 introduces new technology to extend the measurement results from patterned targets to predict in-die process variation. This technique enables IC manufacturers to achieve cost-effective production control over their advanced film processes at the 65nm node and below. Based on our patented SE technology, SpectraFx 200 utilizes a unique Dielectric Pattern Metrology (“DPM”) capability to provide accurate and robust measurements of in-die process variation on product wafers non-destructively.
Contamination Monitoring
GateOne of the key parts of a transistor is called the gate, and the quality of the dielectric qualitythat comprises it is critical to the overall speed and reliability of an IC. Below the 90nm node, dielectricsIC device. In today’s devices, gate dielectric films have become so thin (less than 20 angstroms, or 2nm) that their electrical performance characteristics of the dielectric films become justare as critical as their physical characteristics in determining overall transistor performance. Our Quantox™ product line provides non-contact, inline electrical performance measurements of key parameters that determine the quality of advanced gate dielectric films, including contamination and oxide thickness, as well as electrical capacitance and leakage. Our latest Quantox XP™ system provides information on both the physical and electrical properties of advanced gate dielectric materials, as well asmaterials. Quantox data from the gate dielectric has shown high correlation to device electrical test data enablingon the finished device. This correlation enables chipmakers to predict transistor performance inline, rather than having to wait until an end-of-line electrical test—a process that normally can taketakes days or weeks to complete.
Implant Metrology
KLA-Tencor now offers implant and anneal micro-uniformity monitoring with the Therma-Probe® solution. Therma-Probe is the industry standard for implant dose metrology. With its advances in modulated optical reflectance, Therma-Probe provides dose measurements for in-line monitoring, including anneal and ultra-shallow junction (USJ) depth profiling. The system contributes to higher yield by monitoring for process excursions.
Substrate & Surface Metrology
At the 45nm node and below, small deviations in wafer shape such as bow, warp and edge roll-off can translate to intolerable errors in the IC’s critical dimensions and layer-to-layer alignment. With our acquisition of ADE Corporation, we are well positioned to provide the wafer shape metrology equipment required by both wafer and IC manufacturers, for the 45nm node and beyond.
WaferSight™ and NanoMapper™ are high-precision surface mapping systems for bare wafers, based on optical interferometry. The WaferSight system measures full-wafer dimensional parameters such as flatness, bow and thickness. These measurements are made on every advanced bare wafer shipped to fabs, to ensure it meets the stringent requirements of advanced lithography and chemical mechanical polishing (CMP). NanoMapper provides whole-wafer nanotopography measurements for polished wafer surfaces with sub-nanometer height sensitivity. NanoMapper also includes interactive 3D graphics and analysis software, allowing rapid visualization and quantification of nanotopography effects, for faster process development and precision process control during production.
In substrate and media manufacturing, we offer metrology and defect inspection solutions with our Candela™ and ADE series of optical and magnetic inspection systems. Our Candela 6100 and 6300 series patented X-beam optical surface analyzers are the industry leaders in defect sensitivity and characterization for substrate and media manufacturing. Those products are now complemented by certain products that we acquired from ADE, such as the MicroXam™ and OptiFLAT™ optical interferometers for disk flatness and waviness metrology, as well as the magnetic products that provide critical metrology for perpendicular magnetic recording process control, including the Diskmapper® M3.
Our stylus profilers measure the surface topography of films and etched surfaces, and are used in basic research and development as well as semiconductor production and quality control. The latest generation of our HRP® high resolution profilers,We also offer the HRP-340, combines the dishing and erosion measurement capabilities of our long-scan profilers with high-aspect-ratio etched feature measurement capability, which has historically been limited to atomic force microscopes (“AFM”). This allows customers to monitor their critical etch processes, such as shallow trench isolation (“STI”) and dual-damascene via/trench. The P-16P-16+™ advanced surface profiler is a benchtop contact stylus profiler, designed for automated step height, surface contour, waviness and roughness measurements, and provideswith detailed 2D and 3D topographic analysis of topography for a variety of surfaces and materials. In addition, we also provide stress measurement systems
Process Metrology Systems
KLA-Tencor now offers specialized, instrumented substrates that measure a wafer’s response to the process inside the process chamber, while the process is occurring. These metrology wafers measure the temperature variation of the process over time, to optimize, troubleshoot and capabilities,monitor complex processes, such as our new wafer bowplasma etch. Other measurement parameters are also available, including plasma monitoring. Both chipmakers and wafer stress option for our ASET-F5x™process equipment manufacturers use these wafers to visualize, diagnose and SpectraFx 100 thin-film metrologycontrol their processes and process tools which detects reliability-related problems such as film cracking, voiding and lifting.in a wide variety of applications.
Services
KLA-Tencor Service enables customers to maximize the performance and productivity of their assetsmetrology and inspection systems over the entire tool life cycle.cycle of a tool. We deliver yield management expertise spanning all technology nodes, and collaborate with customers to determine the best products and services to meet technology requirements and optimize cost of ownership. We help customers meet their production goals by maximizing tool uptime and performance with a
menu of support services, unique expertise from local service engineers, worldwide spares and consumables depots, and round-the-clock tech support experts in our Online Support Centers accessed through our iSupport™ secure network. KLA-Tencor’s Technology Engagement Services (TES) collaborates with customers to use effective recipes to improve baseline performance and avoid costly process errors, as well as extend the life of their installed base and more effectively determine when new tools and upgrades are necessary.would be beneficial.
Software and Other
Our productivity and analysis solutions translate raw inspection and metrology data into patternsconsolidated information that can reveal process problems and help semiconductor manufacturers develop long-term yield improvement strategies. Leveraging our core competencies, KLA-Tencor is also adding value to emerging markets and new high-growth areas. Outside the semiconductor industry, we manufacture, sell and service yield management solutions to the data storage market, with offerings for hard disk drive and component makers.
Yield Management & Analysis Solutions
Klarity Defect® is ouran automated inline defect analysis module and defect data management system designed to help fabs achieve faster yield learning cycles. By identifying excursions in real time, Klarity Defect enables fabs to embed expert decision-making processes within analysis recipes. These processes are automatically triggered when user-specified events occur. In addition to freeing fab engineers from repetitive analysis tasks, this capability dramatically improves fab operating efficiency by providing relevant information in less time and with less effort for faster identification of yield problems.
Our Klarity ACE™ yield analysis solution enables fast integration, correlation and analysis of yield- and process-related data to accurately determine the source of defects and process excursions. It can differentiate between random and systematic yield problems, providing users with the data they need in order to take appropriate corrective measures.
In fiscal year 2005, we introduced Klarity SSA™ (Spatial Signature Analysis), a new capability that provides automated classification and root cause analysis of spatial signatures, which are signatures—defect clusters and patterns that can be indicative of anindicate a potential out-of-spec process or process tool problem. Klarity SSA can be utilized for a variety of applications where enhanced excursion detection is needed, including process line and tool monitoring, as well as engineering analysis.
FabVision™ is a real-time, fab-wide data management system that continuously monitors, reports and manages product quality information. Alerts on process excursions, daily reports and selected data are generated and sent automatically worldwide to better manage operations at the fab, process or customer level. The integrated database enables quick analysis across keyand response to customers’ inquiries about product history and quality. With real-time production information, the FabVision system provides management, engineering and operations with the capability to proactively detect process modules.excursions that can lead to yield loss.
Our ProDATA™ lithography data analysis tool, along with our PROLITH™ lithography and etch optimization tool, helps manufacturers reduce their advanced lithography development time and cost, as well as optimize their design-for-manufacturing (“DFM”) efforts.
Our IMPACT XPiDO™ (inline Defect Organizer) automated defect classification (“ADC”) solution provides consistent and accurate classification of yield-limiting defects to help our customers accelerate their ramp to higher process yields. IMPACT XP incorporates our SmartGalleryiDO uses an intuitive decision-tree format to split classification into a series of logical steps. Leveraging local defect geometry for improved performance, iDO works with KLA-Tencor defect inspection, review and data analysis systems for excursion monitoring, excursion problem resolution, and baseline yield improvement.
Our Archer Analyzer™ tool,software provides critical post processing of overlay data into information which reducesindicates appropriate corrective action for the setup time associatedrelevant process tool. This function is increasing in importance with ADC implementation in fabs. This is a critical requirement, particularly for foundriessub-65nm design rules, immersion lithography and application specific integrated circuit (“ASIC”) manufacturers, who specialize in short runs of multiple products. Our Real Time Classification™ (“RTC”) and iADC™ technologies, which provide classification and binning of defect types in real time during inspection, are critical features on all of our latest-generation e-beam and optical inspection tools.double patterning lithography.
Computational Lithography
IC physical designs (layouts)As customers move to smaller design rules, they must print very small features and complex patterns. The resolution required to create these features is more than today’s lithography scanners can provide directly, because the features are modified with Reticle Enhancement Techniques (“RET”) andsmaller than the wavelength of the light used to create them. In order to increase the effective resolution of the process, our customers are using reticle enhancement techniques (RETs) such as Optical Proximity Correction (“OPC”) to improve the patterning of features from photomask to wafers during lithography. The physical(OPC) and Sub-Resolution Assist Features (SRAF).
Introduced in May 2007, our LithoWare™ lithography optimization tool analyzes design may include features that are not compatable with today’s sub-wavelength lithography. Also, the RET/OPC models used to apply the modifications may be constrained by the layout. Lastly,layout constraints, as well as the manufacturing process variability of focus and exposure during lithography may also cause
lithography. Systematic errors in feature sizing. Such systematc errorsthese areas can create either open circuits that translate to electrical failures, or geometric variations that result in speed and power performance issues within the device.
Our DesignScan™ computational lithography solution enables device manufacturers LithoWare is designed to comprehensively identify marginal features inreduce the post-OPC mask design data by performing a physics-based simulation of the lithography process (and its variability) followed by an inspection of the results by comparing backtime and cost required to the original layout of the design. The simulationdevelop RET and inspection is performed on our high speed image computing platform which allows for very fast full chip inspections. This enables lithography aware optimization of the final OPC design for the lithography process and its variabilities with the final result of improving yield, and reducing mask manufacturing re-spins for faster time to market.
Data Storage Industry
In the front-end of thin film head wafer manufacturing, we provide the same process control equipment with which we serve the semiconductor industry, with particular strength in photolithography control. In the back-end of head manufacturing, we are the leading provider of a range of test equipment, including fly-height and head resonance testers such as the D6, high-resolution surface profilers, and the MRW3 quasi-static tester. In substrate and media manufacturing, we are the leading provider of metrology and defect inspection solutions with our Candela™ 6120 system with optical surface analysis technology. Additionally, we are leveraging our expertise in magnetics to meet customers’ challenges in the emerging magnetic random access memory (“MRAM”) market.processes.
Customers
To support our growing, global customer base, we maintain a significant presence throughout the United States, Europe, Asia-Pacific and Japan, staffed with local sales and applications engineers, customer and field service engineers and yield management consultants. We count among our largest customers the leading semiconductor manufacturers from each of these regions. In the fiscal years ended June 30, 2007, 2006 2005, and 2004,2005, no customer accounted for more than 10% of our total revenues.
Our business depends upon the capital expenditures of semiconductor manufacturers, which in turn depend onis driven by the current and anticipated market demand for ICs and products utilizing ICs. We do not consider our business to be seasonal in nature, but it is cyclical with respect to the capital equipment procurement practices of semiconductor manufacturers, and it is impacted by the investment patterns of such manufacturers in different global markets. Downturns in the semiconductor industry or slowdowns in the worldwide economy could have a material adverse effect on our future business and financial results.
Sales, Service and Marketing
Our sales, service and marketing efforts are focused onaimed at building long-term relationships with our customers. We focus on providing a single and comprehensive resource for the full breadth of process control and yield management products and services. Customers benefit from the simplified planning and coordination, as well as the increased equipment compatibility, found whenthat are realized as a result of dealing with a single supplier. Our revenues are derived primarily from product sales, mostly through our direct sales force.
We believe that the size and location of our field sales, service and applications engineering, and marketing organizations represent a competitive advantage in our served markets. We have direct sales forces in the United States, Europe, Asia-Pacific and Japan. We maintain an export compliance program that is designed to fully meet the requirements of the United States Departments of Commerce and State.
As of June 30, 2006,2007, we employed over 2,300approximately 2,500 sales and related personnel, service engineers and applications engineers. In addition to sales and service offices in the United States, we conduct sales, marketing and services out of wholly-owned subsidiaries or branches of United States subsidiaries in other countries,
including China, France, Germany, India, Israel, Italy, Japan, Malaysia, Singapore, South Korea, Malaysia, Singapore, Taiwan, Thailand and the United Kingdom. International revenues accounted for approximately 80%76.3%, 76%79.9%, and 77%76.3% of our total revenues in the fiscal years ended June 30, 2007, 2006 2005, and 2004,2005, respectively. Additional information regarding our revenues from foreign operations for our last three fiscal years can be found in Note 14, “Segment Reporting and Geographic Information” to the Consolidated Financial Statements found under Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.Statements.
We believe that sales outside the United States will continue to be a significant percentage of our total revenues. Our future performance will depend, in part, on our ability to continue to compete successfully in Asia, one of the largest markets for the sale of yield management services in process monitoringour equipment. Our ability to compete in this area is dependent upon the continuation of favorable trading relationships between countries in the region (especially Taiwan, China, Japan and South Korea) and the United States, and our continuing ability to maintain satisfactory relationships with leading semiconductor companies in the region.
International sales and operations may be adversely affected by the imposition of governmental controls, restrictions on export technology, political instability, trade restrictions, changes in tariffs and the difficulties associated with staffing and managing international operations. In addition, international sales may be adversely affected by the economic conditions in each country. The revenues from our international business may also be affected by fluctuations in currency exchange rates. Although we attempt to manage the currency risk inherent in non-dollar sales through hedging activities, there can be no assurance that such efforts will be adequate. These factors could have a material adverse effect on our future business and financial results.
Backlog
Our backlog for system shipments and associated warranty totaled $999$1,060.8 million and $646$998.7 million atas of June 30, 20062007 and 2005,2006, respectively. We include in our backlog only those customer orders for which we have accepted purchase orders and assigned shipment dates within twelve months from the date of order. Orders for service and unreleased products are excluded from the backlog. We expect to fill the present backlog of orders during fiscal year 2007;2008; however, all orders are subject to cancellation or delay by the customer. Due to possible customer changes in delivery schedules or cancellation of orders, our backlog at any particular date is not necessarily indicative of actual sales for any succeeding period.
Research and Development
The market for yield management and process monitoring systems is characterized by rapid technological development and product innovation. These technical innovations are inherently complex and require long development cycles and appropriate professional staffing. We believe that continued and timely development of new products and enhancements to existing products are necessary to maintain our competitive position.
Accordingly, we devote a significant portion of our human and financial resources to research and development programs and seek to maintain close relationships with customers to remain responsive to their needs. As part of our customer relationships, we may enter into certain strategic development and engineering programs whereby our customers offset certain of our research and development costs. As of June 30, 2006,2007, we employed approximately 1,2001,300 research and development personnel.
Our key research and development activities during fiscal year 20062007 involved development of process control and yield management equipment especially reticle inspection and advanced wafer inspection for smaller feature sizes, copper-based devices and 300-mm wafers.sub-65nm processing. For information regarding our research and development expenses during the last three fiscal years, including costs offset by our strategic development and engineering programs, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Annual Report on Form 10-K.
In order to make continuing developments in the semiconductor industry, we are committed to significant engineering efforts toward both product improvement and new product development. New product introductions may contribute to fluctuations in operating results, since customers may defer ordering existing products. If new products have reliability or quality problems, those problems may result in reduced orders, higher manufacturing costs, delays in acceptance of and payment for new products, and additional service and warranty expenses. There can be no assurance that we will successfully develop and manufacture new products, or that new products introduced by us will be accepted in the marketplace. If we do not successfully introduce new products, our results of operations will be adversely affected.
Manufacturing, Raw Materials and Supplies
We perform system design, assembly and testing in-house and utilize an outsourcing strategy for the manufacture of components and major subassemblies. Our in-house manufacturing activities consist primarily of assembling and testing components and subassemblies that are acquired through third-party vendors and integrating those subassemblies into our finished products. Our principal manufacturing activities take place in San Jose and Milpitas, California, with additional significant operations in San Diego and Hayward, California, Migdal Ha’Emek, Israel and Northtech, Singapore. As of June 30, 2006,2007, we employed approximately 1,000 manufacturing personnel.
Many of the parts, components and subassemblies (collectively “parts”) that we use are standard commercial products, although certain parts are made to our specifications. We use numerous vendors to supply parts for the manufacture and support of our products. Although we make reasonable efforts to ensure that these parts are available from multiple suppliers, this is not always possible and certain parts included in our systems may be obtained only from a single supplier or a limited group of suppliers. We endeavor to minimize the risk of production interruption by selecting and qualifying alternative suppliers for key parts, by monitoring the financial condition of key suppliers, and by ensuring adequate inventories of key parts are available to maintain manufacturing schedules.
Although we seek to reduce our dependence on sole and limited source suppliers, in some cases the partial or complete loss of certain of these sources could disrupt scheduled deliveries to customers, damage customer relationships and have a material adverse effect on our results of operations.
Competition
The worldwide market for process control and yield management systems is highly competitive. In each of our product markets, we face competition from established and potential competitors, some of which may have greater financial, research, engineering, manufacturing and marketing resources than we have, such as Applied Materials, Inc. and Hitachi Electronics Engineering Co., Ltd. We may also face future competition from new market entrants from other overseas and domestic sources. We expect our competitors to continue to improve the design and performance of their current products and processes and to introduce new products and processes with
improved price and performance characteristics. We believe that to remain competitive, we will require significant financial resources to offer a broad range of products, to maintain customer service and support centers worldwide, and to invest in product and process research and development.
Significant competitive factors in the market for process control and yield management systems include system performance, ease of use, reliability, installed base and technical service and support. We believe that, while price and delivery are important competitive factors, the customers’ overriding requirement is for systems that easily and effectively incorporate automated and highly accurate inspection and metrology capabilities into their existing manufacturing processes to enhance productivity.
Management believes that we are well positioned in the market with respect to both our products and services. However, any loss of competitive position could negatively impact our prices, customer orders,
revenues, gross margins and market share, any of which would negatively impact our operating results and financial condition.
Acquisitions and Alliances
We continuously evaluate strategic acquisitions and alliances to expand our technologies, product offerings and distribution capabilities. Acquisitions involve numerous risks, including management issues and costs in connection with integration of the operations, technologies and products of the acquired companies, possible write-downs of impaired assets, and the potential loss of key employees of the acquired companies. The inability to manage these risks effectively could negatively impact our operating results and financial condition. Additional information regarding our business combinations during the fiscal year 2006ended June 30, 2007 can be found in Note 6 and Note 16 of5, “Business Combinations” to the Consolidated Financial Statements found under Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K. We acquired all of the shares of ADE Corporation, a supplier of semiconductor process control solutions on October 11, 2006 for a total cash amount of $482 million.Statements.
Patents and Other Proprietary Rights
We protect our proprietary technology through reliance on a variety of intellectual property laws, including patent, copyright and trade secret. We have filed and obtained a number of patents in the United States and abroad and intend to continue pursuing the legal protection of our technology through intellectual property laws. In addition, from time to time we acquire license rights under United States and foreign patents and other proprietary rights of third parties.
Although we consider patents and other intellectual property significant to our business, due to the rapid pace of innovation within the process control and yield management systems industry, we believe that our protection through patent and other intellectual property rights is less important than factors such as our technological expertise, continuing development of new systems, market penetration, installed base and the ability to provide comprehensive support and service to customers worldwide.
No assurance can be given that patents will be issued on any of our applications, that license assignments will be made as anticipated, or that our patents, licenses or other proprietary rights will be sufficiently broad to protect our technology. No assurance can be given that any patents issued to or licensed by us will not be challenged, invalidated or circumvented or that the rights granted thereunder will provide us with a competitive advantage. In addition, there can be no assurance that we will be able to protect our technology or that competitors will not be able to independently develop similar or functionally competitive technology.
Employees
As of June 30, 2006,2007, we employed approximately 5,9006,000 people. None of our employees are represented by a labor union. We have not experienced work stoppages and believe that our employee relations are good.
Competition is intense in the recruiting of personnel in the semiconductor and semiconductor equipment industry. We believe that our future success will depend, in part, on our continued ability to hire and retain qualified management, marketing and technical employees.
ITEM 1A. | RISK FACTORS |
Our operating results and stock price have varied widely in the past, and our future operating results will continue to be subject to quarterly variations based upon numerous factors, including those listed in this section and throughout this Annual Report on Form 10-K. Our stock price will continue to be subject to daily variations as well. In addition, our future operating results and stock price may not follow any past trends.
We believe the factors that could make our results fluctuate and difficult to predict include:
the cyclical nature of the semiconductor equipment industry;
global economic uncertainty;
competitive pressures;
our ability to develop and implement new technologies and introduce new products;
our ability to maintain supply of key components;
our ability to manage our manufacturing requirements;
our reliance on services provided by third parties;
our customers’ acceptance and adoption of our new products and technologies;
our ability to protect our intellectual property;
litigation regarding intellectual property and other business matters;
our ability to attract, retain and replace key employees;
our ability to manage risks associated with acquisitions and alliances;
the amount of resources we are required to devote to compliance with securities laws and listing requirements;
worldwide political instability;
earthquake and other uninsured risks;
future changes in accounting and tax standards or practices;
changing legal and regulatory environment;
our exposure to fluctuations in foreign currency exchange rates;
our ability to successfully modify new systems and guard against computer viruses; and
our ability to continue to successfully address and resolve all issues arising from the discovery that we had retroactively priced stock options (primarily from July 1, 1997 to June 30, 2002) and had not accounted for them correctly;
correctly.
Operating results also could be affected by sudden changes in customer requirements and other economic conditions affecting customer demand and the cost of operations in one or more of the global markets in which we do business. As a result of these or other factors, we could fail to achieve our expectations as to future revenue, gross profit and income from operations. Our failure to meet the performance expectations set and published by external sources could result in a sudden and significant drop in the price of our stock, particularly on a short-term basis, and could negatively affect the value of any investment in our stock.
The discovery that we had retroactively priced stock options (primarily from July 1, 1997 to June 30, 2002) and had not accounted for them correctly has had, and may continue to have, a material adverse effect on our financial results.
We cannot predict the outcome of the pending government inquiries or shareholder lawsuits, and we may face additional government actions, shareholder lawsuits and other legal proceedings related to our historical
stock option practices and the remedial actions we have taken. All of these events have required us, and will continue to require us, to expend significant management time and incur significant accounting, legal, and other expenses. This could divert attention and resources from the operation of our business and adversely affects our financial condition and results of operations.
The Special Committee investigation of our historical stock option practices and resulting restatements has been time consuming and expensive, and has had a material adverse effect on us.
The Special Committee investigation and restatement activities have required us to expend significant management time and incur significant accounting, legal, and other expenses. The resulting restatements have had a material adverse effect on our results of operations. We have recorded additional pre-tax, non-cash, stock-based compensation expense of (a) $348 million for the periods from July 1, 1994 to June 30, 2005 under APB Opinion No. 25 and (b) $22 million for the year ended June 30, 2006 under SFAS No. 123(R). We expect to amortize an additional $6 million of such expenses in future periods. In addition, we have established a Special Litigation Committee to oversee the litigation matters that arose out of the investigation and the restatements and we cannot predict what additional actions may be required by these Committees. The period of time necessary to resolve these follow-up matters is uncertain, and these matters could require significant additional attention and resources.
The ongoing government inquiries relating to our historical stock option practices are time consuming and expensive and could result in injunctions, fines and penalties that may have a material adverse effect on our financial condition and results of operations.
The inquiries by the United States Attorney’s Office for the Northern District of California (“USAO”) and the United States Securities and Exchange Commission (“SEC”) into our historical stock option practices are ongoing. We have fully cooperated with the USAO and the SEC and intend to continue to do so. The period of time necessary to resolve these inquiries is uncertain, and we cannot predict the outcome of these inquiries or whether we will face additional government inquiries, investigations or other actions related to our historical stock option practices. These inquiries will likely require us to continue to expend significant management time and incur significant legal and other expenses, and could result in civil and criminal actions seeking, among other things, injunctions against the Company and the payment of significant fines and penalties by the Company, which may have a material adverse effect on our financial condition, results of operations and cash flow.
We have not been in compliance with SEC reporting requirements and Nasdaq listing requirements and may continue to face compliance issues with both. If we are unable to remain in compliance with SEC reporting requirements and Nasdaq listing requirements, there may be a material adverse effect on the Company and our stockholders.
Due to the Special Committee investigation and resulting restatements, we could not file our periodic reports with the SEC on time and faced the possibility of delisting of our stock from the Nasdaq Global Select Market. With the filing of this Report and our Quarterly Report on Form 10-Q for the quarter ended September 30, 2006, we believe we have returned to full compliance with SEC reporting requirements and Nasdaq listing requirements and, therefore, that the Nasdaq delisting matter is now closed. However, if the SEC has comments on these Reports (or other reports that we previously filed) that require us to file amended reports, or if the Nasdaq Listing Qualifications Panel does not concur that we are in compliance with applicable listing requirements, we may be unable to maintain an effective listing of our stock on a national securities exchange. If this happens, the price of our stock and the ability of our stockholders to trade in our stock could be adversely affected. In addition, we would be subject to a number of restrictions regarding the registration of our stock under federal securities laws, and we would not be able to issue stock options or other equity awards to our employees or allow them to exercise their outstanding options, which could adversely affect our business and results of operations.
We have been named as a party to a number of shareholder derivativeRisks Associated with Our Industry and class action lawsuits relating to our historical stock option practices, and we may be named in additional lawsuits in the future. This litigation could become time consuming and expensive and could result in the payment of significant judgments and settlements, which could have a material adverse effect on our financial condition and results of operations.Market Conditions
In connection with our historical stock option practices and resulting restatements, a number of derivative actions were filed against certain of our current and former directors and officers purporting to assert claims on the Company’s behalf. In addition, a number of securities class action complaints were filed against us and certain of our current and former directors and officers seeking damages related to our historical stock option practices and the resulting investigation, inquiries and restatements. There may be additional lawsuits of this nature filed in the future. We cannot predict the outcome of these lawsuits, nor can we predict the amount of time and expense that will be required to resolve these lawsuits. If these lawsuits become time consuming and expensive, or if there are unfavorable outcomes in any of these cases, there could be a material adverse effect on our business, financial condition and results of operations.
Our insurance coverage will not cover our total liabilities and expenses in these lawsuits, in part because we have a significant deductible on certain aspects of the coverage. In addition, subject to certain limitations, we are obligated to indemnify our current and former directors, officers and employees in connection with the investigation of our historical stock option practices and the related government inquiries and litigation. We currently hold insurance policies for the benefit of our directors and officers, although our insurance coverage may not be sufficient in some or all of these matters. Furthermore, the insurers may seek to deny or limit coverage in some or all of these matters, in which case we may have to self-fund all or a substantial portion of our indemnification obligations.
We are subject to the risks of additional lawsuits in connection with our historical stock option practices, the resulting restatements, and the remedial measures we have taken.
In addition to the possibilities that there may be additional governmental actions and shareholder lawsuits against us, we may be sued or taken to arbitration by former officers and employees in connection with their stock options, employment terminations and other matters. These lawsuits may be time consuming and expensive, and cause further distraction from the operation of our business. The adverse resolution of any specific lawsuit could have a material adverse effect on our business, financial condition and results of operations.
Our efforts to correct past material weaknesses in our internal controls may not have been sufficient, and we may discover additional material weaknesses in our internal controls.
As a result of the Special Committee investigation and our management’s internal review of our historical stock option practices and related matters, we identified past material weaknesses in our internal controls and procedures (see Item 9A—Controls and Procedures). A material weakness is a control deficiency, or combination of them, that results in more than a remote likelihood that a material misstatement in our financial statements will not be prevented or detected. We believe that we have remedied the past material weaknesses in our internal controls and procedures, but there can be no assurance that our corrections were sufficient or fully effective, or that we will not discover additional material weaknesses in our internal controls and procedures in the future.
Failure to maintain effective internal controls may cause us to delay filing our periodic reports with the SEC, affect our Nasdaq listing, and adversely affect our stock price.
The Securities and Exchange Commission, as directed by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring public companies to include a report of management on internal control over financial reporting in their annual reports on Form 10-K that contain an assessment by management of the effectiveness of
the Company’s internal control over financial reporting. In addition, our independent registered public accounting firm must attest to and report on management’s assessment of the effectiveness of the internal control over financial reporting. Although we review our internal control over financial reporting in order to ensure compliance with the Section 404 requirements, if our independent registered public accounting firm is not satisfied with our internal control over financial reporting or the level at which these controls are documented, designed, operated or reviewed, or if the independent registered public accounting firm interprets the requirements, rules and/or regulations differently from our interpretation, then they may decline to attest to management’s assessment or may issue a report that is qualified. This could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our financial statements, which ultimately could negatively impact our stock price.
Federal securities laws, rules and regulations, as well as Nasdaq rules and regulations, require companies to maintain extensive corporate governance measures, impose comprehensive reporting and disclosure requirements, set strict independence and financial expertise standards for audit and other committee members and impose civil and criminal penalties for companies and their chief executive officers, chief financial officers and directors for securities law violations. These laws, rules and regulations have increased and will continue to increase the scope, complexity and cost of our corporate governance, reporting and disclosure practices, which could harm our results of operations and divert management’s attention from business operations.
It may be difficult or costly to obtain director and officer insurance coverage as a result of our stock options problems.
We expect that the issues arising from our previous retroactive pricing of stock options will make it more difficult to obtain director and officer insurance coverage in the future. If we are able to obtain this coverage, it could be significantly more costly than in the past, which would have an adverse effect on our financial results and cash flow. As a result of this and related factors, our directors and officers could face increased risks of personal liability in connection with the performance of their duties. As a result, we may have difficultly attracting and retaining qualified directors and officers, which could adversely affect our business.
The semiconductor equipment industry is highly cyclical. The purchasing decisions of our customers are highly dependent on the economies of both the local markets in which they are located and the semiconductor industry worldwide.If we fail to respond to industry cycles, our business could be seriously harmed.
The timing, length and severity of the up-and-down cycles in the semiconductor equipment industry are difficult to predict. This cyclical nature of the industry in which we operate affects our ability to accurately predict future revenue and, thus, future expense levels. When cyclical fluctuations result in lower than expected revenue levels, operating results may be adversely affected and cost reduction measures may be necessary in order for us to remain competitive and financially sound. During a down cycle, we must be in a position to adjust our cost and expense structure to prevailing market conditions and to continue to motivate and retain our key employees. In addition, during periods of rapid growth, we must be able to increase manufacturing capacity and personnel to meet customer demand. We can provide no assurance that these objectives can be met in a timely manner in response to industry cycles.
Our business is ultimately driven by the global demand for electronic devices by consumers and businesses. A majority of our annual revenue is derived from outside the United States, and we expect that international revenue will continue to represent a substantial percentage of our revenue. A protracted global economic slowdown may adversely affect our business and results of operations.
A majority of our annual revenue is derived from outside the United States, and we expect that international revenue will continue to represent a substantial percentage of our revenue. Our international revenue and operations are affected by economic conditions specific to each country and region. Because of our significant dependence on international revenue, a decline in the economies of any of the countries or regions in which we
do business could negatively affect our operating results. Managing global operations and sites located throughout the world presents challenges associated with, among other things, cultural diversity and organizational alignment. Moreover, each region in the global semiconductor equipment market exhibits unique characteristics that can cause capital equipment investment patterns to vary significantly from period to period. Periodic local or international economic downturns, trade balance issues, political instability, legal or regulatory changes or terrorism in regions where we have operations along with fluctuations in interest and currency exchange rates could negatively affect our business and results of operations. Although we attempt to manage near-term currency risks through the use of hedging instruments, there can be no assurance that such efforts will be adequate.
Our future performance depends, in part, upon our ability to continue to compete successfully worldwide.
Our industry includes large manufacturers with substantial resources to support customers worldwide. Some of our competitors are diversified companies with greater financial resources and more extensive research, engineering, manufacturing, marketing and customer service and support capabilities than we.we possess. We face competition from companies whose strategy is to provide a broad array of products and services, some of which compete with the products and services that we offer. These competitors may bundle their products in a manner that may discourage customers from purchasing our products, including pricing such competitive tools significantly below our product offerings. In addition, we face competition from smaller emerging semiconductor equipment companies whose strategy is to provide a portion of the products and services similar to whatthat we offer, using innovative technology to sell products into specialized markets. Loss of competitive position could negatively affect our prices, customer orders, revenue, gross margins, and market share, any of which would negatively affect our operating results and financial condition.
Risks Related to Our Business
If we do not develop and introduce new products and technologies in a timely manner in response to changing market conditions or customer requirements, our business could be seriously harmed.
Success in the semiconductor equipment industry depends, in part, on continual improvement of existing technologies and rapid innovation of new solutions. For example, in the current semiconductor industry, the size of semiconductor devices continues to
shrink and the industry is currently transitioning to the use of new materials and innovative fab processes. While we expect these trends will increase our customers’ reliance on our diagnostic products, we cannot ensurebe sure that they will directly improve our business. These and other evolving customer needs require us to respond with continued development programs and to cut back or discontinue older programs, which may no longer have industry-wide support. Technical innovations are inherently complex and require long development cycles and appropriate staffing of highly qualified employees. Our competitive advantage and future business success depend on our ability to accurately predict evolving industry standards, to develop and introduce new products whichthat successfully address changing customer needs, to win market acceptance of these new products and to manufacture these new products in a timely and cost-effective manner.
In this environment, we must continue to make significant investments in research and development in order to enhance the performance and functionality of our products, to keep pace with competitive products and to satisfy customer demands for improved performance, features and functionality. Substantial research and development costs typically are incurred before we confirm the technical feasibility and commercial viability of a new product, and not all development activities result in commercially viable products. There can be no assurance that revenue from future products or product enhancements will be sufficient to recover the development costs associated with such products or enhancements. In addition, we cannot ensurebe sure that these products or enhancements will receive market acceptance or that we will be able to sell these products at prices that are favorable to us. Our business will be seriously harmed if we are unable to sell our products at favorable prices or if the market in which we operate does not accept our products.
Our business would be harmed if we do not receive sufficient parts to meet our production requirements in a timely and cost-effective manner.
We use a wide range of materials in the production of our products, including custom electronic and mechanical components, and we use numerous suppliers to supply these materials. We generally do not have
guaranteed supply arrangements with our suppliers. Because of the variability and uniqueness of customers’ orders, we do not maintain an extensive inventory of materials for manufacturing. We seek to minimize the risk of production and service interruptions and/or shortages of key parts by selecting and qualifying alternative suppliers for key parts, monitoring the financial stability of key suppliers and maintaining appropriate inventories of key parts. Although we make reasonable efforts to ensure that parts are available from multiple suppliers, key parts may be available only from a single supplier or a limited group of suppliers. Our operating results and business may be adversely impacted if we are unable to obtain parts to meet our production requirements, or if we are only able to do so on unfavorable terms.
Disruption of our manufacturing facilities due to earthquake, flood, other natural catastrophic events or terrorism could result in cancellation of orders or loss of customers and could seriously harm our business.
Most of our manufacturing facilities are located in the United States, with small operations located in Israel and Singapore. Operations at our manufacturing facilities and our assembly subcontractors are subject to disruption for a variety of reasons, including work stoppages, acts of war, terrorism, fire, earthquake, energy shortages, flooding or other natural disasters. Such disruption could cause delays in shipments of products to our customers. We cannot ensure that alternate production capacity would be available if a major disruption were to occur or that, if it were available, it could be obtained on favorable terms.
We outsource a number of services to third-party service providers, which decreases our control over the performance of these functions; disruptionsfunctions. Disruptions or delays at our third-party service providers could adversely impact our operations.
We outsource a number of services, including our transportation and logistics management of spare parts, to domestic and overseas third-party service providers. While outsourcing arrangements may lower our cost of operations, they also reduce our direct control over the services rendered. It is uncertain what effect such
diminished control will have on the quality or quantity of products delivered or services rendered, or our ability to quickly respond to changing market conditions. Disruptions or delays at our third-party service providers due to events such as regional economic, business, environmental or political or informationalevents, information technology system failures or military actions could adversely impact our operations and our ability to ship products, manage our product inventory or record and report financial and management information on a timely and accurate basis.
Our success is dependent in part on our technology and other proprietary rights. If we are unable to maintain our lead or protect our proprietary technology, we may lose valuable assets and market share.
Our success is dependent in part on our technology and other proprietary rights. We own various United States and international patents and have additional pending patent applications relating to some of our products and technologies. The process of seeking patent protection is lengthy and expensive, and we cannot be certain that pending or future applications will actually result in issued patents or that issued patents will be of sufficient scope or strength to provide meaningful protection or commercial advantage to us. Other companies and individuals, including our larger competitors, may develop technologies and obtain patents relating to our technologybusiness that are similar or superior to our technology or may design around the patents we own, adversely affecting our business.
We also maintain trademarks on certain of our products and services and claim copyright protection for certain proprietary software and documentation. However, we can give no assurance that our trademarks and copyrights will be upheld or successfully deter infringement by third parties.
While patent, copyright and trademark protection for our intellectual property is important, we believe our future success in highly dynamic markets is most dependent upon the technical competence and creative skills of our personnel. We attempt to protect our trade secrets and other proprietary information through confidentiality
and other agreements with our customers, suppliers, employees and consultants and through other security measures. We also maintain exclusive and non-exclusive licenses with third parties for strategic technology used in certain products. However, these employees, consultants and third parties may breach these agreements, and we may not have adequate remedies for wrongdoing. In addition, the laws of certain territories in which we develop, manufacture or sell our products may not protect our intellectual property rights to the same extent as do the laws of the United States. In any event, the extent to which we can protect our trade secrets through the use of confidentiality agreements is limited, and our success will depend to a significant extent on our ability to innovate ahead of our competitors.
We might be involved in intellectual property disputes or other intellectual property infringement claims that may be costly to resolve, prevent us from selling or using the challenged technology and seriously harm our operating results and financial condition.
As is typical in the semiconductor equipment industry, from time to time we have received communications from other parties asserting the existence of patent rights, copyrights, trademark rights or other intellectual property rights which they believe cover certain of our products, processes, technologies or information. Litigation tends to be expensive and requires significant management time and attention and could have a negative effect on our results of operations or business if we lose or have to settle a case on significantly adverse terms. Our customary practice is to evaluate such infringement assertions and to consider whether to seek licenses where appropriate. However, we cannot ensure that licenses can be obtained or, if obtained, will be on acceptable terms or that costly litigation or other administrative proceedings will not occur. The inability to obtain necessary licenses or other rights on reasonable terms, or the instigation of litigation or other administrative proceedings, could seriously harm our operating results and financial condition.
We depend on key personnel to manage our business effectively, and if we are unable to attract, retain and motivate our key employees, our sales and product development could be harmed.
Our employees are vital to our success, and our key management, engineering and other employees are difficult to replace. We generally do not have employment contracts with our key employees. Further, we do not
maintain key person life insurance on any of our employees. The expansion of high technology companies worldwide has increased demand and competition for qualified personnel. If we are unable to retain key personnel, or if we are not able to attract, assimilate or retain additional highly qualified employees to meet our needs in the future, our business and operations could be harmed.
We have madeAcquisitions are an important element of our strategy but, because of the uncertainties involved, we may not find suitable acquisition candidates and we expectmay not be able to continue to make acquisitions that could cause diversion of company’s resourcessuccessfully integrate and our operating results could be harmed.manage acquired businesses.
In addition to our efforts to develop new technologies from internal sources, we also seekpart of our growth strategy is to pursue acquisitions and acquire new technologies from external sources. As part of this effort, we may make acquisitions of, or significant investments in, businesses with complementary products, services and/or technologies. Acquisitions involve numerous risks, including management issuesThere can be no assurance that we will find suitable acquisition candidates or that acquisitions we complete will be successful. In addition, we may use equity to finance future acquisitions, which would increase our number of shares outstanding and costsbe dilutive to current shareholders.
If we are unable to successfully integrate and manage acquired businesses or if acquired businesses perform poorly, then our business and financial results may suffer. It is possible that the businesses we have acquired, as well as businesses that we may acquire in connection with the integration of the operationsfuture, may perform worse than expected or prove to be more difficult to integrate and personnel, technologies and products of the acquired companies, the possible write-downs of impaired assets, and the potential loss ofmanage than expected. In addition, we may lose key employees of the acquired companies. The inabilityAs a result, risks associated with acquisition transactions may give rise to manage these risks effectivelya material adverse effect on our business and financial results for a number of reasons, including:
we may have to devote unanticipated financial and management resources to acquired businesses;
we may not be able to realize expected operating efficiencies or product integration benefits from our acquisitions;
we may have to write-off goodwill or other intangible assets; and
we may incur unforeseen obligations or liabilities in connection with acquisitions.
Compliance with federal securities laws, rules and regulations, as well as Nasdaq requirements, is becoming increasingly complex, and the significant attention and expense we must devote to those areas may have an adverse impact on our business.
Federal securities laws, rules and regulations, as well as Nasdaq rules and regulations, require companies to maintain extensive corporate governance measures, impose comprehensive reporting and disclosure requirements, set strict independence and financial expertise standards for audit and other committee members and impose civil and criminal penalties for companies and their chief executive officers, chief financial officers and directors for securities law violations. These laws, rules and regulations have increased and will continue to increase the scope, complexity and cost of our corporate governance, reporting and disclosure practices, which could seriously harm our business.results of operations and divert management’s attention from business operations.
We are predominantly uninsured for losses and interruptions caused by terrorist acts and acts of war. If international political instability continues or increases, our business and results of operation could be harmed.
The threat of terrorism targeted at the regions of the world in which we do business, including the United States, increases the uncertainty in our markets. Any act of terrorism which affects the economy or the semiconductor industry could adversely affect our business. Increased international political instability, disruption in air transportation and further enhanced security measures as a result of terrorist attacks, and the continuing instability in the Middle East, may hinder our ability to do business and may increase our costs of operations. Such continuing instability could cause us to incur increased costs in transportation, make such
transportation unreliable, increase our insurance costs, and cause international currency markets to fluctuate. This
same instability could have the same effects on our suppliers and their ability to timely deliver their products. If this international political instability continues or increases, our business and results of operations could be harmed. We are predominantly uninsured for losses and interruptions caused by terrorist acts and acts of war.
We self insure certain risks including earthquake risk. If one or more of the uninsured events occurs, we could suffer major financial loss.
We purchase insurance to help mitigate the economic impact of certain insurable risks; however, certain other risks are uninsurable or are insurable only at significant costscost and cannot be mitigated with insurance. An earthquake could significantly disrupt our manufacturing operations, most of which are conducted in California. It could also significantly delay our research and engineering effort on new products, most of which is also conducted in California. We take steps to minimize the damage that would be caused by an earthquake, but there is no certainty that our efforts will prove successful in the event of an earthquake. We self insure earthquake risks because we believe this is thea prudent financial decision based on our large cash reserves and the high cost and limited coverage available in the earthquake insurance market. Certain other risks are also self insured either based on a similar cost benefit analysis, or based on the unavailability of insurance. If one or more of the uninsured events occurs, we could suffer major financial loss.
A change in accounting standards or practices or a change in existing taxation rules or practices can have a significant effect on our reported results and may even affect reporting of transactions completed before the change is effective.
New accounting pronouncements and taxation rules and varying interpretations of accounting pronouncements and taxation practicerules have occurred and may occur in the future. Changes to existing rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business.
For example, the adoption of Statement of Financial Accounting Standards (“SFAS”) No. 123(R),Share-Based Paymentwhich required us to measure all employee stock-based compensation awards using a fair value method beginning in fiscal year 2006 and record such expense in our consolidated financial statements, has had a material impact on our consolidated financial statements, as reported under accounting principles generally accepted in the United States of America.
We are exposed to various risks related to the regulatory environments where we perform our operationoperations and conduct our business.
We are subject to various risks related to new, different, inconsistent or even conflicting laws, rules and regulations that may be enacted by legislative bodies and/or regulatory agencies in the countries in which we operate and with which we must comply, including environmental and safety regulations. Changes to existing laws, rules or regulations, including changes that result in inconsistent or conflicting laws, rules or regulations, in the countries in which we operate may adversely affect our reported financial results or the way we conduct our business.
We are exposed to foreign currency exchange rate fluctuations; although we hedge certain currency risks, we may still be adversely affected by changes in foreign currency exchange rates or declining economic conditions in these countries.
We have some exposure to fluctuations in foreign currency exchange rates, primarily the Japanese Yen. We have international subsidiaries that operate and sell our products globally. We routinely hedge these exposures in an effort to minimize the impact of currency rate fluctuations, but these hedges may be inadequate to protect us from currency rate fluctuations. To the extent that these hedges are inadequate, our reported financial results or the way we conduct our business could be adversely affected.
We are exposed to fluctuations in the market values of our portfolio investments and in interest rates; impairment of our investments could harm our earnings.
Our investment portfolio consists of both corporate and government securities that have a maximum effective maturity of 10 years. The longer the duration of these securities, the more susceptible they are to changes in
market interest rates and bond yields. As yields increase, those securities with a lower yield-at-cost show a mark-to-market unrealized loss. All unrealized losses are due to changes in interest rates and bond yields. We have the ability to realize the full value of all these investments upon maturity. Unrealized losses are due to changes in interest rates and bond yields.
We rely upon certain critical information systems for our daily business operation, ouroperation. Our inability to use or access these information systems at critical points in time could unfavorably impact the timeliness and efficiency of our business operation.
Our global operations are linked by information systems, including telecommunications, the internet, our corporate intranet, network communications, email and various computer hardware and software applications. Despite our implementation of network security measures, our tools and servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems and tools located at customer sites. Any such event could have an adverse effect on our business, operating results and financial condition.
Acquisitions are an important element of our strategy but, because of the uncertainties involved, we may not find suitable acquisition candidates and we may not be able to successfully integrate and manage acquired businesses.
Part of our growth strategy is to pursue acquisitions. There can be no assurance that we will find suitable acquisition candidates or that acquisitions we complete will be successful. In addition, we may use equity to finance future acquisitions, which would increase our number of shares outstanding and be dilutive to current shareholders.
If we are unable to successfully integrate and manage acquired businesses or if acquired businesses perform poorly, then our business and financial results may suffer. It is possible that the businesses we have acquired, such as ADE Corporation, which we acquired on October 11, 2006, as well as businesses that we may acquire in the future, may perform worse than expected or prove to be more difficult to integrate and manage than expected. If that happens, there may be a material adverse effect on our business and financial results for a number of reasons, including:
We may experience difficulties with our enterprise resource planning (“ERP”) system and other IT systems. System failure or malfunctioning may result in disruption of operations and the inability to process transactions, and this could adversely affect our financial results.
System failure or malfunctioning could disrupt our ability to timely and accurately process and report key components of theour results of our consolidated operations, our financial position and cash flows. Any disruptions or difficulties that may occur in connection with our ERP system or other systems could also adversely affect our ability to complete important business processes such as the evaluation of our internal controls and attestation activities pursuant to Section 404 of the Sarbanes-Oxley Act of 2002. If we encounter unforeseen problems with regard to our ERP system or other systems, our business could be adversely affected.
Risks Related to the Restatement of Our Prior Financial Results
Our efforts to correct past material weaknesses in our internal controls may not have been sufficient, and we may discover additional material weaknesses in our internal controls.
As previously disclosed, the Company has undergone an investigation of the Company’s historical stock option practices by the Special Committee of the Company’s Board of Directors (for more information regarding the Special Committee investigation and its findings, please refer to Item 3, “Legal Proceedings”). As a result of that Special Committee investigation and our management’s internal review of our historical stock option practices and related matters, we identified past material weaknesses in our internal controls and procedures (see Item 9A, “Controls and Procedures”). A “material weakness” is a control deficiency, or combination of them, that results in more than a remote likelihood that a material misstatement in our financial statements will not be prevented or detected. We believe that we have remedied the past material weaknesses in our internal controls and procedures, but there can be no assurance that our corrections were sufficient or fully effective, or that we will not discover additional material weaknesses in our internal controls and procedures in the future.
The Special Committee investigation of our historical stock option practices and the resulting restatements have been time consuming and expensive, and have had a material adverse effect on us.
The Special Committee investigation and the resulting restatement activities have required us to expend significant management time and incur significant accounting, legal and other expenses. In addition, we have established a Special Litigation Committee to oversee the litigation matters that have arisen out of the
investigation and the restatements, and we cannot predict what additional actions may be required by these Committees. The period of time that will be necessary to resolve these matters is uncertain, and these matters could require significant additional attention and resources.
The ongoing government inquiry relating to our historical stock option practices is time consuming and expensive and could result in injunctions, fines and penalties that may have a material adverse effect on our financial condition, results of operations and cash flow.
On July 25, 2007, we announced that the Company had reached a settlement with the SEC by consenting to the entry of a permanent injunction against future violations of the reporting, books and records, and internal controls provisions of the federal securities laws. The settlement resolves completely the SEC investigation into the Company’s historical stock option granting practices. KLA-Tencor was not charged by the SEC with fraud, nor was the Company required to pay any civil penalty, fine or money damages as part of the settlement. While the SEC has completed its investigation, the inquiry by the United States Attorney’s Office for the Northern District of California (“USAO”) into our historical stock option practices is ongoing. We have fully cooperated with the USAO and intend to continue to do so. The period of time necessary to resolve this inquiry is uncertain, and we cannot predict the outcome of this inquiry or whether we will face additional government inquiries, investigations or other actions related to our historical stock option practices. This inquiry may require us to continue to expend significant management time and incur significant legal and other expenses, and could result in criminal actions seeking, among other things, injunctions against the Company and the payment of significant fines and penalties by the Company, which may have a material adverse effect on our financial condition, results of operations and cash flow.
We have been named as a party to a number of shareholder derivative and class action lawsuits relating to our historical stock option practices, and we may be named in additional lawsuits in the future. This litigation could become time consuming and expensive and could result in the payment of significant judgments and settlements, which could have a material adverse effect on our financial condition and results of operations.
In connection with our historical stock option practices and resulting restatements, a number of derivative actions were filed against certain of our current and former directors and officers purporting to assert claims on the Company’s behalf. In addition, a number of securities class action complaints were filed against us and certain of our current and former directors and officers seeking damages related to our historical stock option practices and the resulting investigation, inquiries and restatements. There may be additional lawsuits of this nature filed in the future. We cannot predict the outcome of these lawsuits, nor can we predict the amount of time and expense that will be required to resolve these lawsuits. If these lawsuits become time consuming and expensive, or if there are unfavorable outcomes in any of these cases, there could be a material adverse effect on our business, financial condition and results of operations.
Our insurance coverage will not cover our total liabilities and expenses in these lawsuits, in part because we have a significant deductible on certain aspects of the coverage. In addition, subject to certain limitations, we are obligated to indemnify our current and former directors, officers and employees in connection with the investigation of our historical stock option practices and the related litigation and ongoing government inquiry. We currently hold insurance policies for the benefit of our directors and officers, although our insurance coverage may not be sufficient in some or all of these matters. Furthermore, the insurers may seek to deny or limit coverage in some or all of these matters, in which case we may have to self-fund all or a substantial portion of our indemnification obligations.
We are subject to the risks of additional government actions, shareholder lawsuits and other legal proceedings related to our historical stock option practices, the resulting restatements, and the remedial measures we have taken.
It is possible that there may be additional governmental actions, shareholder lawsuits and other legal proceedings brought against us in connection with our historical stock option practices. In addition, we may be
sued or taken to arbitration by former officers and employees in connection with their stock options, employment terminations and other matters. These proceedings may require us to expend significant management time and incur significant accounting, legal and other expenses, and may divert attention and resources from the operation of our business. These expenditures and diversions, as well as the adverse resolution of any specific lawsuit, could have a material adverse effect on our business, financial condition and results of operations.
Failure to maintain effective internal controls may cause us to delay filing our periodic reports with the SEC, affect our Nasdaq listing, and adversely affect our stock price.
The Securities and Exchange Commission, as directed by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring public companies to include a report of management on internal control over financial reporting in their annual reports on Form 10-K that contain an assessment by management of the effectiveness of the Company’s internal control over financial reporting. In addition, our independent registered public accounting firm must attest to and report on management’s assessment of the effectiveness of the internal control over financial reporting. The Company has in prior periods identified certain material weaknesses in its internal control over financial reporting. However, we believe the Company remediated those past material weaknesses, and we have not identified any material weaknesses in our internal control over financial reporting for the fiscal year ended June 30, 2007. Although we review our internal control over financial reporting in order to ensure compliance with the Section 404 requirements, if our independent registered public accounting firm is not satisfied with our internal control over financial reporting or the level at which these controls are documented, designed, operated or reviewed, or if our independent registered public accounting firm interprets the requirements, rules and/or regulations differently from our interpretation, then they may decline to attest to management’s assessment or may issue a report that is qualified. This could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our financial statements, which ultimately could negatively impact our stock price.
It may be difficult or costly to obtain director and officer insurance coverage as a result of the issues arising out of our historical stock option practices.
We expect that the issues arising from our previous retroactive pricing of stock options will make it more difficult to obtain director and officer insurance coverage in the future. If we are able to obtain this coverage, it could be significantly more costly than in the past, which would have an adverse effect on our financial results and cash flow. As a result of this and related factors, our directors and officers could face increased risks of personal liability in connection with the performance of their duties. As a result, we may have difficulty attracting and retaining qualified directors and officers, which could adversely affect our business.
ITEM 1B. | UNRESOLVED STAFF COMMENTS |
None.
ITEM 2. | PROPERTIES |
Information regarding our principal properties atas of June 30, 20062007 is set forth below:
Location | Type | Principal | Square Footage | Ownership | |||||
| Office and plant |
| Owned | ||||||
Fremont, CA(1) | Office and plant | Research, Engineering, Marketing, Manufacturing, Service and Sales Administration | 145,947 | Leased | |||||
Hayward, CA |
| Manufacturing | 14,150 | Leased | |||||
Livermore, | Office and plant | Training, Service and Engineering | 241,252 | Owned | |||||
Milpitas, CA | Office, plant and warehouse | Research, Engineering, Marketing, Manufacturing, Service and Sales Administration | 727,302 | Owned | |||||
San Diego, CA | Office, plant and warehouse | Research, Engineering, Marketing, Manufacturing and Service | 15,600 | Leased | |||||
San Jose, CA | Office and plant | Research, Engineering and Manufacturing | 17,060 | Leased | |||||
San Jose, | Office, plant and warehouse | Corporate Headquarters, Research, Engineering, Marketing, Manufacturing, Service and Sales Administration | 603,313 | Owned | |||||
| Office, plant and warehouse | Research, Engineering, Marketing, Manufacturing and Service | 50,400 | Leased | |||||
| Office | Research, Engineering, Marketing, Manufacturing and Service | 116,908 | Leased | |||||
Beaverton, OR | Office | Sales and Service | 13,075 | Leased | |||||
Austin, TX | Office | Sales, Service and Research | 32,118 | Leased | |||||
Richardson, TX | Office | Sales and Service | 16,818 | Leased | |||||
| Office | Sales and Service | 12,782 | Leased | |||||
| Office, plant and warehouse | Sales, Service, Engineering and | |||||||
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Dresden, Germany | Office and warehouse | Sales, Service and | 12,909 | Leased | |||||
Chennai, India | Office | Engineering | 149,121 | Owned | |||||
Midgal Ha’Emek, Israel | Office and plant | Manufacturing | 12,314 | Leased | |||||
Migdal Ha’Emek and Herzliya, Israel | Office and plant | Research, Engineering, Marketing, Manufacturing and Service and Sales Administration | 64,584 | Owned | |||||
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| Office | Sales and Service | 16,644 | Leased | |||||
| Office and |
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| Sales, Service and | 53,773 | Leased |
Location | Type | Principal | Square Footage | Ownership | ||||
| Office, plant and warehouse | Manfacturing, Sales, Service and Warehouse | 45,327 | Leased | ||||
Serangoon, Singapore(3) | Office and plant | Manufacturing | 185,809 | Owned | ||||
Kyung Ki, South Korea | Office | Sales and Service | Leased | |||||
Hsinchu, | Office | Sales and Service | Leased | |||||
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(1) | Portions of certain properties are sublet or are vacant and marketed to sublease. |
(2) | Certain properties in San Jose, California and Livermore, California |
(3) | The land on which the Serangoon, Singapore building resides is leased. |
We also leaseAs of June 30, 2007, we owned or leased a total of approximately 3.0 million square feet of space worldwide, including the locations listed above and office space for other, smaller sales and service offices in several locations throughout the world. Our operating leases expire at various times through June 30, 20152018 with renewal options at the fair market value for additional periods up to five years. Additional information regarding these leases is incorporated by reference from Note 1211, “Commitments and Contingencies” to the Consolidated Financial Statements found under Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.Statements. We believe our properties are adequately maintained and suitable for their intended use and that our production facilities have capacity adequate for our current needs.needs, even after giving effect to the sale of certain properties as noted above.
ITEM 3. | LEGAL PROCEEDINGS |
Special Committee Investigation of Historical Stock Option Practices
On May 22, 2006, the Wall Street Journal published an article about stock option backdating that questioned the stock option practices at several companies, including KLA-Tencor. On May 23, 2006, we received a subpoena from the United States Attorney’s Office for the Northern District of California (“USAO”) and a letter of inquiry from the United States Securities and Exchange Commission (“SEC”) regarding our stock option practices. Later on May 23, 2006, our Board of Directors appointed a Special Committee composed solely of independent directors to conduct a comprehensive investigation of our historical stock option practices. The Special Committee promptly engaged independent legal counsel and accounting experts to assist with the investigation. The investigation included an extensive review of our historical stock option practices, accounting policies, accounting records, supporting documentation, email communications and other documentation, as well as interviews of a number of current and former directors, officers and employees. On September 27, 2006, the Special Committee reported the bulk of its findings and recommendations to our Board of Directors.
Findings and Remedial ActionsRestatements of Prior Period Consolidated Financial Statements in Previous Filings
On September 28, 2006, we announced that we would have to restate our previously issued financial statements to correct our past accounting for stock options. As a result of the Special Committee investigation, we discovered that certain of our stock options, primarily those granted from July 1, 1997 to June 30, 2002, had been retroactively priced for all employees who received these grants. This means that the option exercise price was not the market price of the option shares on the actual grant date of the option, but instead was a lower market price on an earlier date. The actual grant date—when the essential actions necessary to grant the option were completed, including the final determination of the number of shares to be granted to each employee and the exercise price—is the correct measurement date to determine the market price of the option shares under the accounting rules in effect at the time. More than 95% of the total in-the-money value (market price on the actual grant date minus exercise price) of all of our retroactively priced options was attributable to those granted from July 1, 1997 to June 30, 2002.
We previously applied Accounting Principles Board (“APB”) Opinion No. 25, “AccountingIn our Annual Report on Form 10-K for Stock Issued to Employees,” and its related Interpretations and provided the required pro forma disclosures under Statement of
Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” through our fiscal year ended June 30, 2005. Under APB Opinion No. 25, a non-cash, stock-based compensation expense was required to be recognized2006 (filed on January 29, 2007) and our quarterly reports on Form 10-Q for any optionthe quarters ended September 30, 2006, December 31, 2006 and
March 31, 2007 (filed on January 29, 2007, February 9, 2007 and May 7, 2007, respectively), we restated (1) our consolidated financial statements as of and for which the exercise price was belowfiscal years ended June 30, 2005 and 2004; (2) our selected consolidated financial data as of and for our fiscal years ended June 30, 2005, 2004, 2003 and 2002; and (3) our unaudited quarterly financial data for the market price on the actual grant date. Because each of our retroactively priced options had an exercise price below the market price on the actual grant date, there should have been a non-cash charge for each of these options under APB Opinion No. 25 equal to the number of option shares, multiplied by the difference between the exercise price and the market price on the actual grant date. That expense should have been amortized over the vesting period of the option. Startingfirst three quarters in our fiscal year ended June 30, 2006 we adopted SFAS No. 123(R), “Share-Based Payment.” As a result, beginning in fiscal year 2006, the additional stock-based compensation expense required to be recordedand for each retroactively priced option is equal to the incremental fair value of the option on the actual grant date, amortized over the remaining vesting period of the option. We did not record these stock-based compensation expenses under APB Opinion No. 25 or SFAS No. 123(R) related to our retroactively priced optionsall quarters in our previously issued financial statements, and that is why we are restating them in this filing. To correct our past accounting for stock options, we recorded additional pre-tax, non-cash, stock-based compensation expense of (a) $348 million for the periods July 1, 1994 to June 30, 2005 under APB Opinion No. 25 and (b) $22 million for thefiscal year ended June 30, 2006 under SFAS No. 123(R). We expect2005. All financial information included in this Annual Report on Form 10-K reflects our restatement and does not contain any further restatement.
Findings Leading up to amortize an additional $6 million of such pre-tax charges under SFAS No. 123(R) in future periods to properly account for past retroactively priced stock options.Restatement and Certain Remedial Actions
By October 16, 2006, the Special Committee had substantially completed its investigation. The Special Committee concluded that (1) there was retroactive pricing of stock options granted to all employees who received options, primarily during the periods from July 1, 1997 to June 30, 2002 (less than 15% of these options were granted to executive officers), (2) the retroactively priced options were not accounted for correctly in our previously issued financial statements, (3) the retroactive pricing of options was intentional, not inadvertent or through administrative error, (4) the retroactive pricing of options involved the selection of fortuitously low exercise prices by certain former executive officers, and other former executives may have been aware of this conduct, (5) the retroactive pricing of options involved the falsification of Company records, resulting in erroneous statements being made in financial and other reports previously filed with the SEC, as well as in information previously provided to our independent registered public accounting firm, and (6) in most instances, the retroactive pricing of options violated the terms of our stock option plans. Because virtually all holders of retroactively priced options issued by the Company were not involved in or aware of the retroactive pricing, the Board of Directors decided that we should continue to honor the options that violated the terms of ourthe Company’s stock option plans, except in certain individual cases as described below.
The Special Committee concluded that, with a few immaterial exceptions, the retroactive pricing of stock options stopped after June 30, 2002. After that time, there were procedures in place designed to provide reasonable assurance that stock options were priced on the grant date. The Special Committee also concluded that none of our independent Directorsdirectors was involved in or aware of the retroactive pricing of stock options. Based on the Special Committee’s report, our Board of Directors concluded that no current members of management were involved in the retroactive pricing of stock options. During its investigation of our historical stock option practices, the Special Committee did not find evidence of any other financial reporting or accounting issues.
As a result of the Special Committee investigation, on October 16, 2006, we terminated our employment relationship and agreement with Kenneth L. Schroeder, and we announced our intent to cancel all outstanding stock options held by Mr. Schroeder that were retroactively priced or otherwise improperly granted. Those options were canceled in December 2006. Mr. Schroeder was the Company’s Chief Executive Officer and a member of its Board of Directors from mid-1999 until January 1, 2006, and was a member of the Company’s stock option committee from 1994 until December 31, 2005. From January 1, 2006 to October 16, 2006, Mr. Schroeder was employed as a Senior Advisor to the Company. On November 10, 2006, Mr. Schroeder’s counsel informed us that Mr. Schroeder contests our right to terminate his employment relationship and agreement and to cancel any of his options. We intend to vigorously defend any claims that may be made by Mr. Schroeder regarding these matters, which could involve a material amount.
Also on October 16, 2006, Stuart J. Nichols, Vice President and General Counsel, resigned. Mr. Nichols and we entered into a Separation Agreement and General Release under which Mr. Nichols’ outstanding retroactively priced stock options have been re-priced by increasing the exercise price to the market price of the option shares on the actual grant date. Under SFAS No. 123(R), no incremental charge will bewas recognized in the financial statements forduring the quarterfiscal year ended December 31, 2006.June 30, 2007.
On October 16, 2006, Kenneth Levy, Founder and Chairman of the Board of Directors of the Company, retired as a director and employee, and was named Chairman Emeritus by our Board of Directors. Mr. Levy and we entered into a Separation Agreement and General Release under which Mr. Levy’s outstanding retroactively
priced stock options have been re-priced by increasing the exercise price to the market price of the option shares on the actual grant date. Under SFAS No. 123(R), no incremental charge will bewas recognized in the financial statements for the quarterfiscal year ended December 31, 2006.June 30, 2007. Mr. Levy was the Company’s Chief Executive Officer from 1975 until mid-1999 (with the exception of mid-1997 to mid-1998), was a member of the Company’s Board of Directors from 1975 until his retirement, was Chairman of the Board of Directors from 1999 until his retirement, and was a member of the Company’s stock option committeeStock Option Committee from 1994 until use of that committee was suspended in the fall of 2006.
On December 21, 2006, Jon D. Tompkins resigned as a director of the Company, and we agreed to modify the outstanding options held by Mr. Tompkins (all of which were fully vested) to extend the post-termination exercisability period to December 31, 2007, which is the last day of the calendar year in which those options would have terminated in the absence of such extension. Mr. Tompkins, the Chief Executive Officer of Tencor Instruments before its merger into the Company in mid-1997, was the Company’s Chief Executive Officer from mid-1997 to mid-1998, was a member of the Company’s stock option committee from mid-1997 until mid-1999, and was a member of the Company’s Board of Directors from mid-1997 until his resignation.
Although the Board of Directors concluded that John H. Kispert, our President and Chief Operating Officer, was not involved in and was not aware of the improper stock option practices, based on the Special Committee’s recommendation, his outstanding retroactively priced options have been re-priced because he served as Chief Financial Officer during part of the period in question. This re-pricing involved increasing the exercise price to the market price of the option shares on the actual grant date. Under SFAS No. 123(R), no incremental charge will bewas recognized in the financial statements forduring the quarterfiscal year ended December 31, 2006.
After the Special Committee substantially completed its investigation, a number of follow-up activities continued, especially in connection with the preparation of this Annual Report on Form 10-K and our Quarterly Report on Form 10-Q for the quarter ended SeptemberJune 30, 2006. The Special Committee also continues to assist the Company in connection with the government inquiries described below. Additional follow-up activities may be required.2007.
Government Inquiries and SEC Settlement Relating to Historical Stock Option Practices
On May 23, 2006, we received a subpoena from the USAO requesting information relating to our past stock option grants and related accounting matters. Also on May 23, 2006, we received a letter from the SEC making an informal inquiry and request for information on the same subject matters. We learned on February 2, 2007 that the SEC had opened a formal investigation into these matters. We cooperated fully with the SEC investigation. On July 25, 2007, we announced that the Company had reached a settlement with the SEC by consenting to the entry of a permanent injunction against future violations of the reporting, books and records, and internal controls provisions of the federal securities laws. The settlement resolves completely the SEC investigation into the Company’s historical stock option granting practices. KLA-Tencor was not charged by the SEC with fraud; nor was the Company required to pay any civil penalty, fine, or money damages as part of the settlement.
We are cooperating fully with the USAO and SEC inquiriesUSAO’s continuing inquiry and intend to continue to do so. These inquiries likely willThis inquiry may require us to expend significant management time and incur significant legal and other expenses, and could result in civil and criminal actions seeking, among other things, injunctions against the Company and the payment of significant fines and penalties by the Company, which may adversely affect our results of operations and cash flow.
We have also responded to inquiries from the U.S. Department of Labor, which is conducting an examination of our 401(k) Savings Plan.Plan prompted by our stock option issues. We are cooperating fully with this examination and intend to continue to do so.
We cannot predict how long it will take to or how much more time and resources we will have to expend to resolve these government inquiries, nor can we predict the outcome of these inquiries. Also, there can be no assurance that other inquiries, investigations or actions will not be started by other United States federal or state regulatory agencies or by foreign governmental agencies.
Late SEC Filings and Nasdaq Delisting Proceedings
Due to the Special Committee investigation and the resulting restatements, we did not file on time this Annual Report on Form 10-K and our Quarterly Report on Form 10-Q for the quarter ended September 30, 2006. As a result, we received two Nasdaq Staff Determination letters, dated September 14, 2006 and November 14, 2006, respectively, stating that we were not in compliance with the filing requirements of Marketplace Rule 4310(c)(14) and, therefore, that our stock was subject to delisting from the Nasdaq Global Select Market. We appealed this determination and requested a hearing before a Nasdaq Listing Qualifications Panel. On October 26, 2006, we attended a hearing, at which we sought appropriate exceptions to the filing requirements from the Panel pending completion and filing of our delinquent reports. On January 3, 2007, the Panel granted our request for continued listing of our stock on the Nasdaq Global Select Market, subject to the condition that we file this Report and our Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 on or before January 31, 2007.
With the filing of this Report and our Quarterly Report on Form 10-Q for the quarter ended September 30, 2006, we believe we have returned to full compliance with SEC reporting requirements and Nasdaq listing requirements, and, therefore, that the Nasdaq delisting matter is now closed. However, we cannot predict whether the SEC will review these Reports and, if so, whether the SEC will have comments on these Reports (or other reports that we previously filed) that may require us to file amended reports with the SEC. In addition, we cannot predict whether the Nasdaq Listing Qualifications Panel will concur that we are in compliance with all relevant listing requirements. If either of those events occurs, we might be unable to remain in compliance with SEC reporting requirements and Nasdaq listing requirements, and, therefore, we might be unable to maintain an effective listing of our common stock on the Nasdaq Global Select Market or any other national securities exchange.
Shareholder Derivative Litigation Relating to Historical Stock Option Practices
Beginning on May 22, 2006, several persons and entities identifying themselves as shareholders of KLA-Tencor filed derivative actions purporting to assert claims on behalf of and in the name of the Company
against various of our current and former directors and officers relating to our accounting for stock options issued from 1994 to the present. The complaints in these actions allege that the individual defendants breached their fiduciary duties and other obligations to the Company and violated state and federal securities laws in connection with our historical stock option granting process, our accounting for past stock options, and historical sales of stock by the individual defendants. Three substantially similar actions are pending, one in the U.S. District Court for the Northern District of California (which consists of three separate lawsuits consolidated in one action); one in the California Superior Court for Santa Clara County; and one in the Delaware Chancery Court.
The plaintiffs in the derivative actions have asserted claims for violations of Sections 10(b) (including Rule 10b-5 thereunder), 14(a), and 20(a) of the Securities Exchange Act of 1934, unjust enrichment, breach of fiduciary duty and aiding and abetting such breach, negligence, misappropriation of information, abuse of control, gross mismanagement, waste of corporate assets, breach of contract, constructive fraud, rescission, and violations of California Corporations Code section 25402, as well as a claim for an accounting of all stock option grants made to the named defendants. KLA-Tencor is named as a nominal defendant in these actions. On behalf of KLA-Tencor, the plaintiffs seek unspecified monetary and other relief against the named defendants. The plaintiffs are James Ziolkowski, Mark Ziering, Alaska Electrical Pension Fund, Jeffrey Rabin, and Benjamin Langford. The individual named defendants are current directors and officers; Edward W. Barnholt, H. Raymond Bingham, Robert T. Bond, Jeffrey L. Hall, Stephen P. Kaufman, John H. Kispert, Lida Urbanek and Richard P. Wallace; and former directors and officers; Robert J. Boehlke, Leo Chamberlain, Gary E. Dickerson, Richard J. Elkus, Jr., Dennis J. Fortino, Kenneth Levy, Michael E. Marks, Stuart J. Nichols, Arthur P. Schnitzer, Kenneth L. Schroeder and Jon D. Tompkins. Current director David C. Wang and former director Dean O. Morton were originally named as defendants in one of the derivative actions filed in the U.S. District Court for the Northern District of California, but were dropped as named defendants as of December 22, 2006 upon the filing of a consolidated complaint in that action.
The derivative actions are at an early stage. Discovery has not commenced, and theThe defendants are not yet required to respond to the complaints.complaints in the actions pending in California, and the defendants have moved to dismiss or stay the action pending in Delaware. Our Board of Directors has appointed a Special Litigation Committee (“SLC”) composed solely of independent directors to conduct an independent investigation of the claims asserted in the derivative actions and to determine the Company’s position with respect to those claims. The SLC’s investigation is in progress. We cannot predict whether these actions are likely to result in any material recovery by or expense to KLA-Tencor.
Shareholder Class Action Litigation Relating to Historical Stock Option Practices
KLA-Tencor and various of our current and former directors and officers were named as defendants in a putative securities class action filed on June 29, 2006 in the U.S. District Court for the Northern District of California. Two similar actions were filed later in the same court, and all three cases have been consolidated into one action. The complaints allegeconsolidated complaint alleges claims under the Securities Exchange Act of 1934 as a result of our past stock option grants and related accounting and reporting, and seek unspecified monetary damages and other relief. The plaintiffs seek to represent a class consisting of purchasers of KLA-Tencor stock between February 13,June 30, 2001 and May 22, 2006 who allegedly suffered losses as a result of material misrepresentations in KLA-Tencor’s SEC filings during that period. The lead plaintiffs, who seek to represent the class, are the Police and Fire Retirement System of the City of Detroit, the Louisiana Municipal Police Employees’ Retirement System, and the City of Philadelphia Board of Pensions and Retirement. The defendants are KLA-Tencor, Edward W. Barnholt, H. Raymond Bingham, Robert J. Boehlke, Robert T. Bond, Gary E. Dickerson, Richard J. Elkus, Jr., Jeffrey L. Hall, Stephen P. Kaufman, John H. Kispert, Kenneth Levy, Michael E. Marks, Stuart J. Nichols, Kenneth L. Schroeder, Jon D. Tompkins, Lida Urbanek and Richard P. Wallace.
This litigation is at an early stage. Discovery has not commenced, and the court has not yet determined whether the plaintiffs may sue on behalf of any class of purchasers,purchasers. The Company and all other defendants filed motions to dismiss these cases in June 2007, which are now pending before the defendants are not yet required to respond to the complaints.Court. The Company intends to vigorously defend this litigation.
As part of a derivative lawsuit filed in the Delaware Chancery Court on July 21, 2006 (described above), a plaintiff claiming to be a KLA-Tencor shareholder also asserted a separate putative class action claim against KLA-Tencor and certain of our current and former directors and officers alleging that shareholders incurred damage due to purported dilution of KLA-Tencor common stock resulting from historical stock option granting practices. The Company intendshas moved to vigorously defenddismiss this litigation.claim.
We cannot predict the outcome of the shareholder class action cases (described above), and we cannot estimate the likelihood or potential dollar amount of any adverse results. However, an unfavorable outcome in this litigation could have a material adverse impact upon our financial position, results of operations or cash flows for the period in which the outcome occurs and in future periods.
Indemnification Obligations
Subject to certain limitations, we are obligated to indemnify our current and former directors, officers and employees in connection with the investigation of our historical stock option practices and the related litigation and ongoing government inquiries and litigation.inquiry. These obligations arise under the terms of our certificate of incorporation, our bylaws, applicable contracts, and Delaware and California law. The obligation to indemnify generally means that we are required to pay or reimburse the individuals’ reasonable legal expenses and possibly damages and other liabilities incurred in connection with these matters. We are currently paying or reimbursing legal expenses being incurred in connection with these matters by a number of our current and former directors, officers and employees. Although the maximum potential amount of future payments KLA-Tencor could be required to make under these agreements is theoretically unlimited, the Company believeswe believe the fair value of this liability, to the extent estimable, is adequately coveredappropriately considered within the reserves it hasreserve we have established for currently pending legal proceedings.
Other Legal Matters
We are named from time to time as a party to lawsuits in the normal course of our business. Litigation in general, and intellectual property and securities litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the results of legal proceedings are difficult to predict.
ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
None.
ITEM 5. | MARKET FOR THE REGISTRANT’S COMMON |
Our common stock is listed and traded on the NasdaqNASDAQ Global Select Market under the symbol “KLAC.”
Due to the Special Committee investigation of our historical stock option practices (see Item 3—Legal Proceedings) and the resulting restatements (see Note 2, “Restatements of Consolidated Financial Statements and Special Committee and Company Findings,” to Consolidated Financial Statements), we did not file our periodic reports with the SEC on time and therefore the Company’s stock was subject to delisting from the Nasdaq Global Select Market. With the filing of this Report and our Quarterly Report on Form 10-Q for the quarter ended September 30, 2006, we believe we have returned to full compliance with SEC reporting requirements and Nasdaq listing requirements and, therefore, that the Nasdaq delisting matter is now closed. (See Item 1A—Risk Factors)
The prices per share reflected in the following table represent the high and low closing prices for our common stock on the NasdaqNASDAQ Global Select Market for the periods indicated.
Fiscal year 2006 | Fiscal year 2005 | |||||||||||
High | Low | High | Low | |||||||||
First Quarter ended September 30, 2005 | $ | 51.70 | $ | 43.60 | $ | 47.16 | $ | 35.69 | ||||
Second Quarter ended December 31, 2005 | 54.09 | 45.52 | 48.99 | 40.23 | ||||||||
Third Quarter ended March 31, 2006 | 54.18 | 48.20 | 50.81 | 42.25 | ||||||||
Fourth Quarter ended June 30, 2006 | 50.39 | 39.07 | 46.87 | 38.86 |
Year ended June 30, 2007 | Year ended June 30, 2006 | |||||||||||
High | Low | High | Low | |||||||||
First Fiscal Quarter | $ | 46.29 | $ | 39.05 | $ | 51.70 | $ | 43.60 | ||||
Second Fiscal Quarter | $ | 52.43 | $ | 43.85 | $ | 54.09 | $ | 45.52 | ||||
Third Fiscal Quarter | $ | 54.42 | $ | 46.97 | $ | 54.18 | $ | 48.20 | ||||
Fourth Fiscal Quarter | $ | 56.92 | $ | 53.09 | $ | 50.39 | $ | 39.07 |
InDuring the firstthird quarter of the fiscal year 2007 ended SeptemberJune 30, 2006, the high and low closing prices of2005, our common stock on the Nasdaq Global Select Market were $46.29 and $39.05. In addition, in the second quarter of fiscal year 2007 ended December 31, 2006, the high and low closing prices of our common stock on the Nasdaq Global Select Market were $52.43 and $43.85.
As of December 31, 2006, there were 792 holders of record of our common stock.
During the fourth quarter of fiscal year 2006, the Company’s Board of Directors authorizedapproved the initiation of a quarterly cash dividend of $0.12 per share. The total amount of dividends paid during the fiscal year ended June 30, 20062007 was $95.3$95.1 million. During the first quarter of the fiscal year 2007, the Company’sending June 30, 2008, our Board of Directors authorized a quarterly cash dividend of $0.12$0.15 per share, which was declared on August 3, 20068, 2007 and will be paid on September 1, 20062007 to our stockholders of record on August 15, 2006. During the second quarter20, 2007.
As of fiscal yearJuly 31, 2007, the Company’s Board of Directors authorized a quarterly cash dividend of $0.12 per share, which was declared on November 6, 2006 and was paid on December 1, 2006 to our stockholdersthere were 758 holders of record on November 15, 2006. Additional information concerning dividends may be found in the following sections of this Form 10-K: “Selected Financial Data” in Part II, Item 6 and “Consolidated Statements of Cash Flows” and “Consolidated Statements of Stockholders’ Equity” in Part II, Item 8.our common stock.
Equity CompensationRepurchase Plans
Following is a summary of stock repurchases for each month during the fourth quarter of the fiscal year ended June 30, 2006:2007:(1)
Period | Total Number of (or Units) | Average Price Paid per Share (or Unit) | Maximum Number of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs(3) | ||||
First Quarter ended September 30, 2005 | 738,500 | $ | 48.05 | 7,611,500 | |||
Second Quarter ended December 31, 2005 | 997,000 | $ | 49.02 | 6,614,500 | |||
Third Quarter ended March 31, 2006 | 1,148,000 | $ | 51.19 | 5,466,500 | |||
Fourth Quarter ended June 30, 2006 | 1,640,000 | $ | 47.73 | 3,826,500 | |||
Total | 4,523,500 | $ | 48.95 | ||||
Period | Total Number of Shares Purchased | Average Price Paid per Share | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs(3) | ||||
April 1, 2007—April 30, 2007(2) | 350,000 | $ | 54.77 | 13,206,500 | |||
May 1, 2007—May 31, 2007(2) | 350,000 | $ | 54.76 | 12,856,500 | |||
June 1, 2007—June 30, 2007(2) | 120,000 | $ | 54.55 | 12,736,500 | |||
Purchases under ASR in June 2007(4) | 2,031,542 | $ | 53.52 | N/A | |||
Total | 2,851,542 | $ | 53.87 | ||||
(1) | In July 1997, the Board of Directors authorized KLA-Tencor to systematically repurchase up to 17.8 million shares of its common stock in the open market. This |
Following the conclusion of the fiscal year covered by this report, in August 2007, the Board of Directors authorized KLA-Tencor to repurchase up to an additional 10.0 million shares of its common stock under the repurchase program (in addition to the 37.8 million shares described in the preceding paragraph).
(2) | All shares were purchased pursuant to the |
(3) | The stock repurchase |
(4) | In addition to the above stock repurchases, the Board of Directors authorized a repurchase of up to $750.0 million of the Company’s common stock pursuant to an Accelerated Share Repurchase program (“ASR”) in February 2007. The ASR was completed during the fourth quarter of the fiscal year ended June 30, |
ITEM 6. | SELECTED FINANCIAL DATA |
The following tables include selected consolidated summary financial data for each of our last five fiscal years. As discussed in Note 2, “Restatements of Consolidated Financial Statements and Special Committee and Company Findings,” to Consolidated Financial Statements, our selected consolidated financial data as of and for our fiscal years ended June 30, 2005, 2004, 2003 and 2002 have been restated to correct our past accounting for stock options and certain other adjustments. This data should be read in conjunction with Item 8, “Financial Statements and Supplementary Data,” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Report.Annual Report on Form 10-K.
Years ended June 30, | 2006 | 2005 | 2004 | 2003 | 2002 | ||||||||||
(in millions, except per share data) | As previously reported | As previously reported | As previously reported | As previously reported | |||||||||||
Consolidated Statements of Operations: | |||||||||||||||
Revenues | $ | 2,071 | $ | 2,085 | $ | 1,497 | $ | 1,323 | $ | 1,637 | |||||
Income from operations | 310 | 583 | 297 | 139 | 245 | ||||||||||
Net income | 380 | 467 | 244 | 137 | 216 | ||||||||||
Dividends paid per share | 0.48 | 0.12 | — | — | — | ||||||||||
Earnings per share: | |||||||||||||||
Basic | 1.92 | 2.38 | 1.25 | 0.72 | 1.15 | ||||||||||
Diluted | 1.86 | 2.32 | 1.21 | 0.70 | 1.10 | ||||||||||
Consolidated Balance Sheets: | |||||||||||||||
Cash, cash equivalents and marketable securities | $ | 2,326 | $ | 2,195 | $ | 1,876 | $ | 1,488 | $ | 1,334 | |||||
Working capital | 2,541 | 2,271 | 1,280 | 1,155 | 932 | ||||||||||
Total assets | 4,576 | 3,986 | 3,539 | 2,867 | 2,718 | ||||||||||
Stockholders’ equity | 3,568 | 3,045 | 2,628 | 2,216 | 2,030 |
(in thousands, except per share data) | |||||||||||||||
Year ended June 30, | 2007 | 2006 | 2005 | 2004 | 2003 | ||||||||||
Consolidated Statements of Operations: | |||||||||||||||
Revenues | $ | 2,731,229 | $ | 2,070,627 | $ | 2,081,878 | $ | 1,497,218 | $ | 1,321,149 | |||||
Income from operations | $ | 589,868 | $ | 309,791 | $ | 545,120 | $ | 243,630 | $ | 72,090 | |||||
Net income | $ | 528,098 | $ | 380,452 | $ | 445,049 | $ | 212,476 | $ | 94,024 | |||||
Dividends paid per share | $ | 0.48 | $ | 0.48 | $ | 0.12 | $ | — | $ | — | |||||
Net Income per share: | |||||||||||||||
Basic | $ | 2.68 | $ | 1.92 | $ | 2.27 | $ | 1.09 | $ | 0.50 | |||||
Diluted | $ | 2.61 | $ | 1.86 | $ | 2.21 | $ | 1.05 | $ | 0.48 | |||||
As of June 30, | 2007 | 2006 | 2005 | 2004 | 2003 | ||||||||||
Consolidated Balance Sheets: | |||||||||||||||
Cash, cash equivalents and marketable securities | $ | 1,710,629 | $ | 2,325,796 | $ | 2,195,186 | $ | 1,876,356 | $ | 1,487,883 | |||||
Working capital | $ | 2,179,564 | $ | 2,594,512 | $ | 2,265,202 | $ | 1,279,821 | $ | 1,154,844 | |||||
Total assets | $ | 4,623,249 | $ | 4,575,911 | $ | 4,040,603 | $ | 3,598,880 | $ | 2,923,930 | |||||
Stockholders’ equity | $ | 3,550,042 | $ | 3,567,991 | $ | 3,096,670 | $ | 2,680,417 | $ | 2,263,562 |
Years ended June 30, Consolidated Statements of Operations: Revenues Income from operations Net income Dividends paid per share Earnings per share: Basic Diluted Consolidated Balance Sheets: Cash, cash equivalents and marketable securities Working capital Total assets Stockholders’ equity Year ended June 30, Consolidated Statements of Operations: Revenues Income from operations Net income Dividends paid per share Earnings per share: Basic Diluted Consolidated Balance Sheets: Cash, cash equivalents and marketable securities Working capital Total assets Stockholders’ equity 2006 2005 2004 2003 2002 (in millions, except per share data) Adjustments Adjustments Adjustments Adjustments N/A (3 ) — (2 ) 2 N/A (38 ) (53 ) (67 ) (78 ) N/A (22 ) (32 ) (43 ) (50 ) N/A — — — — N/A (0.11 ) (0.16 ) (0.22 ) (0.27 ) N/A (0.11 ) (0.16 ) (0.22 ) (0.25 ) N/A — — — — N/A (6 ) — — (6 ) N/A 55 60 57 44 N/A 52 52 48 31 2006 2005 2004 2003 2002 (in millions, except per share data) As restated As restated As restated As restated $ 2,071 $ 2,082 $ 1,497 $ 1,321 $ 1,639 310 545 244 72 167 380 445 212 94 166 0.48 0.12 — — — 1.92 2.27 1.09 0.50 0.88 1.86 2.21 1.05 0.48 0.85 $ 2,326 $ 2,195 $ 1,876 $ 1,488 $ 1,334 2,541 2,265 1,280 1,155 926 4,576 4,041 3,599 2,924 2,762 3,568 3,097 2,680 2,264 2,061
Effective in the fiscal year ended June 30, 2006, we implemented Statement of Financial Accounting Standards (“SFAS”)SFAS No. 123(R) “Share-Based Payment.”Share-Based Payment. It requires us to measure all employee stock-based compensation awards using a fair value method and record such expense in our consolidated financial statements. In addition, to correct our past accounting for retroactively priced stock options, granted primarily from July 1, 1997 to June 30, 2002, we recorded an aggregate of $348 million of additional pre-tax, non-cash, stock-based compensation expense ($230 million net of tax), for the periods July 1, 1994 to June 30, 2005 under APB No. 25. Also, we recorded an aggregate of $22 million of additional pre-tax, non-cash, stock-based compensation expense ($10 million net of tax) for the year ended June 30, 2006 under SFAS No. 123(R). The net income in fiscal year 2006 includes approximately $106 million of non-cash, stock-based compensation expense, compared to $25 million in fiscal year 2005, $31 million in fiscal year 2004, $47 million in fiscal year 2003 and $52 million in fiscal year 2002.
In addition, we have made other adjustments totaling $1 million net of tax for the periods July 1, 1994 to June 30, 2005 to record unadjusted differences identified in prior years that were not material to our previously filed financial statements as well as adjustments to correct the classification of certain amounts presented as cash and cash equivalents and marketable securities related to investments in Variable Rate Demand Notes.
Diluted shares in fiscal years 2002 to 2005 increased as a result of the restatement adjustments to correct our past accounting for stock options that were retroactively priced. We use the treasury stock method to calculate the weighted-average shares used in the diluted earnings per share calculation. As part of the restatement, we revised our treasury stock calculations in accordance with SFAS No. 128, “Earnings Per Share.” These calculations assume that (i) all retroactively priced options are exercised, (ii) we repurchase shares with the proceeds of these hypothetical exercises along with the tax benefit resulting from the hypothetical exercises, and (iii) any unamortized deferred stock-based compensation is also used to repurchase shares.
Consolidated working capital as of June 30, 2005, 2004, 2003 and 2002 has been adjusted primarily as a result of the restatements to correct our past accounting for stock options. These adjustments primarily affect deferred tax assets and tax liabilities.
ITEM 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and the related notes included in Item 8, “Financial Statements and Supplementary Data,” in this Annual Report on Form 10-K. This discussion contains forward-looking statements, which involve risk and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of certain factors, including but not limited to those discussed in “Item 1A. RiskItem 1A, “Risk Factors” and elsewhere in this Annual Report on Form 10-K. (See “Special Note Regarding Forward-Looking Statements.”)
Restatements of Prior Period Consolidated Financial Statements and Special Committee and Company Findingsin Previous Filings
Special Committee Investigation of Historical Stock Option Practices
On May 22, 2006, the Wall Street Journal published an article about stock option backdating that questioned the stock option practices at several companies, including KLA-Tencor. On May 23, 2006, we received a subpoena from the United States Attorney’s OfficeIn our Annual Report on Form 10-K for the Northern District of California (“USAO”) and a letter of inquiry from the United States Securities and Exchange Commission (“SEC”) regarding our stock option practices. Later on May 23, 2006, our Board of Directors appointed a Special Committee composed solely of independent directors to conduct a comprehensive investigation of our historical stock option practices. The Special Committee promptly engaged independent legal counsel and accounting experts to assist with the investigation. The investigation included an extensive review of our historical stock option practices, accounting policies, accounting records, supporting documentation, email communications and other documentation, as well as interviews of a number of current and former directors, officers and employees. On September 27, 2006, the Special Committee reported the bulk of its findings and recommendations to our Board of Directors.
Findings and Remedial Actions
On September 28, 2006, we announced that we would have to restate our previously issued financial statements to correct our past accounting for stock options. As a result of the Special Committee investigation, we discovered that certain of our stock options, primarily those granted from July 1, 1997 to June 30, 2002, had been retroactively priced for all employees who received these grants. This means that the option exercise price was not the market price of the option shares on the actual grant date of the option, but instead was a lower market price on an earlier date. The actual grant date—when the essential actions necessary to grant the option were completed, including the final determination of the number of shares to be granted to each employee and the exercise price—is the correct measurement date to determine the market price of the option shares under the accounting rules in effect at the time. More than 95% of the total in-the-money value (market price on the actual grant date minus exercise price) of all of our retroactively priced options was attributable to those granted from July 1, 1997 to June 30, 2002.
We previously applied Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and its related Interpretations and provided the required pro forma disclosures under Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” through our fiscal year ended June 30, 2005. Under APB Opinion No. 25, a non-cash, stock-based compensation expense was required to be recognized2006 (filed on January 29, 2007) and our quarterly reports on Form 10-Q for any optionthe quarters ended September 30, 2006, December 31, 2006 and March 31, 2007 (filed on January 29, 2007, February 9, 2007 and May 7, 2007, respectively), we restated (1) our consolidated financial statements as of and for which the exercise price was belowfiscal years ended June 30, 2005 and 2004; (2) our selected consolidated financial data as of and for our fiscal years ended June 30, 2005, 2004, 2003 and 2002; and (3) our unaudited quarterly financial data for the market price on the actual grant date. Because each of our retroactively priced options had an exercise price below the market price on the actual grant date, there should have been a non-cash charge for each of these options under APB Opinion No. 25 equal to the number of option shares, multiplied by the difference between the exercise price and the market price on the actual grant date. That expense should have been amortized over the vesting period of the option. Startingfirst three quarters in our fiscal year ended June 30, 2006 we adopted SFAS No. 123(R), “Share-Based Payment.” As a result, beginningand for all quarters in our fiscal year 2006, the additional stock-based compensation expense requiredended June 30, 2005. In those filings, to be recorded for each retroactively priced option is equal to the incremental fair value of the option on the actual grant date,
amortized over the remaining vesting period of the option. We did not record these stock-based compensation expenses under APB Opinion No. 25 or SFAS No. 123(R) related to our retroactively priced options in our previously issued financial statements, and that is why we are restating them in this filing. To correct our past accounting for stock options, we recorded total additional pre-tax, non-cash, stock-based compensation expense of (a) $348$375.7 million for the periods from July 1, 1994 to June 30, 2005 under APB Opinion No. 25 and (b) $22 million for the year ended June 30, 2006 under SFAS No. 123(R). We expect to amortize an additional $6 million of such pre-tax charges under SFAS No. 123(R)2007. All financial information included in future periods to properly account for past retroactively priced stock options.
By October 16, 2006, the Special Committee had substantially completed its investigation. The Special Committee concluded that (1) there was retroactive pricing of stock options granted to all employees who received options, primarily during the periods from July 1, 1997 to June 30, 2002 (less than 15% of these options were granted to executive officers), (2) the retroactively priced options were not accounted for correctly in our previously issued financial statements, (3) the retroactive pricing of options was intentional, not inadvertent or through administrative error, (4) the retroactive pricing of options involved the selection of fortuitously low exercise prices by certain former executive officers, and other former executives may have been aware of this conduct, (5) the retroactive pricing of options involved the falsification of Company records, resulting in erroneous statements being made in financial and other reports previously filed with the SEC, as well as in information previously provided to our independent registered public accounting firm, and (6) in most instances, the retroactive pricing of options violated the terms of our stock option plans. Because virtually all holders of retroactively priced options issued by the Company were not involved in or aware of the retroactive pricing, the Board of Directors decided that we should continue to honor the options that violated the terms of our stock option plans, except in certain individual cases as described below.
The Special Committee concluded that, with a few immaterial exceptions, the retroactive pricing of stock options stopped after June 30, 2002. After that time, there were procedures in place designed to provide reasonable assurance that stock options were priced on the grant date. The Special Committee also concluded that none of our independent Directors was involved in or aware of the retroactive pricing of stock options. Based on the Special Committee’s report, our Board of Directors concluded that no current members of management were involved in the retroactive pricing of stock options. During its investigation of our historical stock option practices, the Special Committee did not find evidence of any other financial reporting or accounting issues.
As a result of the Special Committee investigation, on October 16, 2006, we terminated our employment relationship and agreement with Kenneth L. Schroeder, and we announced our intent to cancel all outstanding stock options held by Mr. Schroeder that were retroactively priced or otherwise improperly granted. Those options were canceled in December 2006. Mr. Schroeder was the Company’s Chief Executive Officer and a member of its Board of Directors from mid-1999 until January 1, 2006, and was a member of the Company’s stock option committee from 1994 until December 31, 2005. From January 1, 2006 to October 16, 2006, Mr. Schroeder was employed as a Senior Advisor to the Company. On November 10, 2006, Mr. Schroeder’s counsel informed us that Mr. Schroeder contests our right to terminate his employment relationship and agreement and to cancel any of his options. We intend to vigorously defend any claims that may be made by Mr. Schroeder regarding these matters, which could involve a material amount.
Also on October 16, 2006, Stuart J. Nichols, Vice President and General Counsel, resigned. Mr. Nichols and we entered into a Separation Agreement and General Release under which Mr. Nichols’ outstanding retroactively priced stock options have been re-priced by increasing the exercise price to the market price of the option shares on the actual grant date. Under SFAS No. 123(R), no incremental charge will be recognized in the financial statements for the quarter ended December 31, 2006.
On October 16, 2006, Kenneth Levy, Founder and Chairman of the Board of Directors of the Company, retired as a director and employee, and was named Chairman Emeritus by our Board of Directors. Mr. Levy and we entered into a Separation Agreement and General Release under which Mr. Levy’s outstanding retroactively
priced stock options have been re-priced by increasing the exercise price to the market price of the option shares on the actual grant date. Under SFAS No. 123(R), no incremental charge will be recognized in the financial statements for the quarter ended December 31, 2006. Mr. Levy was the Company’s Chief Executive Officer from 1975 until mid-1999 (with the exception of mid-1997 to mid-1998), was a member of the Company’s Board of Directors from 1975 until his retirement, was Chairman of the Board of Directors from 1999 until his retirement, and was a member of the Company’s stock option committee from 1994 until use of that committee was suspended in the fall of 2006.
On December 21, 2006, Jon D. Tompkins resigned as a director of the Company, and we agreed to modify the outstanding options held by Mr. Tompkins (all of which were fully vested) to extend the post-termination exercisability period to December 31, 2007, which is the last day of the calendar year in which those options would have terminated in the absence of such extension. Mr. Tompkins, the Chief Executive Officer of Tencor Instruments before its merger into the Company in mid-1997, was the Company’s Chief Executive Officer from mid-1997 to mid-1998, was a member of the Company’s stock option committee from mid-1997 until mid-1999, and was a member of the Company’s Board of Directors from mid-1997 until his resignation.
Although the Board of Directors concluded that John H. Kispert, our President and Chief Operating Officer, was not involved in and was not aware of the improper stock option practices, based on the Special Committee’s recommendation, his outstanding retroactively priced options have been re-priced because he served as Chief Financial Officer during part of the period in question. This re-pricing involved increasing the exercise price to the market price of the option shares on the actual grant date. Under SFAS No. 123(R), no incremental charge will be recognized in the financial statements for the quarter ended December 31, 2006.
Restatement and Impact on Financial Statements
In addition to restating the consolidated financial statements in response to the Special Committee’s findings, we are recording additional non-cash adjustments that were previously considered to be immaterial relating primarily to the accounting for the employee stock purchase plan, corrections for the recognition of deferred tax assets, the release of tax reserves, the timing of revenue recognition, gains and losses on hedging contracts and the calculation of minority interest. We have also corrected the classification of certain amounts presented as cash and cash equivalents and marketable securities relating to investments in Variable Rate Demand Notes. For the fiscal years ended June 30, 2004 and prior, we previously recorded no stock-based compensation expense; therefore, the additional stock-based compensation expense noted below represents the total stock-based compensation expense for these periods. For the year ended June 30, 2005, we recorded $2.9 million of stock-based compensation with a related tax benefit of $1.1 million in our previously reported financial statements. For fiscal 2005, total stock-based compensation was $37.0 million with a related tax benefit of $12.1 million. The income statement impact of the restatement is as follows (in thousands):
Years ended June 30, | Total effect at | 2005 | 2004 | Cumulative effect at July 1, 2003 | 2003 | 2002 | ||||||||||||||||||
Net income, as previously reported | $ | 466,695 | $ | 243,701 | $ | 137,191 | $ | 216,166 | ||||||||||||||||
Additional compensation expense resulting from improper measurement dates for stock option grants | $ | (347,817 | ) | (34,086 | ) | (53,208 | ) | $ | (260,523 | ) | (70,032 | ) | (76,582 | ) | ||||||||||
Tax related effects | 117,776 | 12,149 | 22,320 | 83,307 | 22,866 | 25,009 | ||||||||||||||||||
Additional compensation expense resulting from improper measurement dates for stock option grants, net of tax | (230,041 | ) | (21,937 | ) | (30,888 | ) | (177,216 | ) | (47,166 | ) | (51,573 | ) | ||||||||||||
Other adjustments, net of tax | (991 | ) | 291 | (337 | ) | (945 | ) | 3,970 | 1,091 | |||||||||||||||
Total decrease to net income | $ | (231,032 | ) | (21,646 | ) | (31,225 | ) | $ | (178,161 | ) | (43,196 | ) | (50,482 | ) | ||||||||||
Net income, as restated | $ | 445,049 | $ | 212,476 | $ | 93,995 | $ | 165,684 | ||||||||||||||||
Years ended June 30, Additional compensation expense resulting from improper measurement dates for stock option grants Tax related effects Additional compensation expense resulting from improper measurement dates for stock option grants, net of tax 2001 2000 1999 1998 1997 1996 1995 $ (59,261 ) $ (23,296 ) $ (17,630 ) $ (5,219 ) $ (2,852 ) $ (2,747 ) $ (2,904 ) 17,262 7,198 6,054 1,861 1,036 983 1,038 $ (41,999 ) $ (16,098 ) $ (11,576 ) $ (3,358 ) $ (1,816 ) $ (1,764 ) $ (1,866 )
We adopted SFAS No. 123(R) effective July 1, 2005. The grant date fair values of stock options granted prior to fiscal year 2006 were changed as a result of the findings that certain stock option grants were retroactively priced. This change resulted in additional stock-based compensation expense of $22 million and a related tax benefit of $12 million being recognized in fiscal year 2006 under SFAS No. 123(R).
Government Inquiries Relating to Historical Stock Option Practices
We are cooperating fully with the USAO and SEC inquiries and intend to continue to do so. These inquiries likely will require us to expend significant management time and incur significant legal and other expenses, and could result in civil and criminal actions seeking, among other things, injunctions against the Company and the payment of significant fines and penalties by the Company, which may adversely affect our results of operations and cash flow. We cannot predict how long it will take or how much more time and resources we will have to expend to resolve these government inquiries, nor can we predict the outcome of these inquiries.
Late SEC Filings and Nasdaq Delisting Proceedings
Due to the Special Committee investigation and the resulting restatements, we did not file on time this Annual Report on Form 10-K reflects that restatement and our Quarterly Report on Form 10-Q for the quarter ended September 30, 2006. As a result, we received two Nasdaq Staff Determination letters, dated September 14, 2006 and November 14, 2006, respectively, stating that we weredoes not in compliance with the filing requirements of Marketplace Rule 4310(c)(14) and, therefore, that our stock was subject to delisting from the Nasdaq Global Select Market. We appealed this determination, attended a hearing, and obtained approval of our request for continued listing of our stock on the Nasdaq Global Select Market, subject to the condition that we file this Report and our Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 on or before January 31, 2007.
With the filing of this Report and our Quarterly Report on Form 10-Q for the quarter ended September 30, 2006, we believe we have returned to full compliance with SEC reporting requirements and Nasdaq listing requirements, and, therefore, that the Nasdaq delisting matter is now closed. However, SEC comments on these Reports (or other reports that we previously filed) or other factors could render us unable to maintain an effective listing of our common stock on the Nasdaq Global Select Market orcontain any other national securities exchange.
Shareholder Litigation Relating to Historical Stock Option Practices
Several derivative actions have been filed purporting to assert claims on behalf of and in the name of the Company against various of our current and former directors and officers relating to our accounting for stock options issued from 1994 to the present. The complaints in these actions allege that the individual defendants breached their fiduciary duties and other obligations to the Company and violated state and federal securities laws in connection with our historical stock option granting process, our accounting for past stock options, and historical sales of stock by the individual defendants. On behalf of KLA-Tencor, the plaintiffs seek unspecified monetary and other relief against the named defendants. The derivative actions are at an early stage. Our Board of Directors has appointed a Special Litigation Committee (“SLC”) composed solely of independent directors to
conduct an independent investigation of the claims asserted in the derivative actions and to determine the Company’s position with respect to those claims. The SLC’s investigation is in progress. We cannot predict whether these actions are likely to result in any material recovery by or expense to KLA-Tencor.
KLA-Tencor and various of our current and former directors and officers were named as defendants in several putative securities class action lawsuits that have been consolidated into one action. The complaints allege claims under the Securities Exchange Act of 1934 as a result of our past stock option grants and related accounting and reporting, and seek unspecified monetary damages and other relief. The plaintiffs seek to represent a class consisting of purchasers of KLA-Tencor stock between February 13, 2001 and May 22, 2006 who allegedly suffered losses as a result of material misrepresentations in KLA-Tencor’s SEC filings during that period. This litigation is at an early stage. One of the derivative actions noted above also includes a putative class
action claim on behalf of KLA-Tencor shareholders against the Company and certain of our current and former directors and officers alleging that shareholders incurred damage due to purported dilution of KLA-Tencor common stock resulting from historical stock option granting practices. The Company intends to vigorously defend these litigations.
We cannot predict the outcome of the shareholder class action cases described above and we cannot estimate the likelihood or potential dollar amount of any adverse results. However, an unfavorable outcome in this litigation could have a material adverse impact upon the financial position, results of operations or cash flows for the period in which the outcome occurs and in future periods.further restatement.
CRITICAL ACCOUNTING ESTIMATES AND POLICIES
The preparation of our Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions in applying our accounting policies that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We based these estimates and assumptions on historical experience, and evaluate them on an on-going basis to ensure that they remain reasonable under current conditions. Actual results could differ from those estimates. We discuss the development and selection of the critical accounting estimates with the Audit Committee of our Board of Directors on a quarterly basis, and the Audit Committee has reviewed the Company’s related disclosure in this Annual Report on Form 10-K. The items in our financial statements requiring significant estimates and judgments are as follows:
AllowanceRevenue Recognition.We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller’s price is fixed or determinable, and collectibility is reasonably assured. We derive revenue from three sources—system sales, spare part sales and service contracts. We typically recognize revenue for Doubtful Accounts.A majoritysystem sales upon acceptance by the customer that the system has been installed and is operating according to predetermined specifications. We also recognize revenue prior to written acceptance from the customer, as follows:
When system sales to independent distributors have no installation requirement, contain no acceptance agreement, and 100% payment is due upon shipment, revenue is recognized upon shipment;
When the installation of the system is deemed perfunctory, revenue is recognized upon shipment. The portion of revenue associated with installation is deferred based on estimated fair value, and that revenue is recognized upon completion of the installation;
When the customer fab has already accepted the same tool, with the same specifications, and it can be objectively demonstrated that the tool meets all of the required acceptance criteria upon shipment, revenue is recognized upon shipment. The portion of revenue associated with installation is deferred based on estimated fair value, and that revenue is recognized upon completion of the installation;
When the customer withholds signature on our acceptance document due to issues unrelated to product performance, revenue is recognized when the system is performing as intended and meets all published and contractually agreed specifications;
When the system is damaged during transit, revenue is recognized upon receipt of cash payment from the customer.
Total revenue recognized without a written acceptance from the customer was approximately 13.5%, 4.4% and 6.6% of total revenues for the fiscal years ended June 30, 2007, 2006 and 2005 respectively. The increase in revenue recognized without a written acceptance is primarily driven by increased shipments of tools that have already met the required acceptance criteria at those customer fabs, and an increase in sales of systems with perfunctory installation. Shipping charges billed to customers are included in system revenue, and the related shipping costs are included in costs of revenues.
Trade-in rights are occasionally granted to customers to trade in tools in connection with subsequent purchases. We estimate the value of the trade-in right and reduce the revenue of the initial sale. This amount is recognized at the earlier of the exercise of the trade-in right or the expiration of the trade-in right.
Spare parts revenue is recognized when the product has been shipped, risk of loss has passed to the customer, and collection of the resulting receivable is probable.
Service and maintenance revenue is recognized ratably over the term of the maintenance contract. Consulting and training revenue is recognized when the related services are performed.
The deferred system profit balance equals the amount of deferred system revenue that was invoiced and due on shipment less applicable product and warranty costs.
We also defer the fair value of non-standard warranty bundled with equipment sales as unearned revenue. Non-standard warranty includes services incremental to the standard 40-hour per week coverage for twelve months. Non-standard warranty is recognized ratably as revenue when the applicable warranty term period commences.
Software is incidental to our products as determined in accordance with AICPA Statement of Position (“SOP”) No. 97-2,Software Revenue Recognition and Emerging Issues Task Force (“EITF”) Issue No. 03-05,Applicability of SOP 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software. We periodically review the software element of our trade receivables are derived from sales to large multinational semiconductor manufacturers throughout the world. In order to monitor potential credit losses, we perform ongoing credit evaluations of our customers’ financial condition. An allowance for doubtful accounts is maintained for potential credit losses based upon our assessment of the expected collectibility of all accounts receivable. The allowance for doubtful accounts is reviewed on a quarterly basis to assess the adequacy of the allowance. We take into consideration (1) any circumstances of which we are aware of a customer’s inability to meet its financial obligations;systems in accordance with SOP No. 97-2 and (2) our judgments as to prevailing economic conditions in the industry and their impact on our customers. If circumstances change, and the financial condition of our customers are adversely affected and unable to meet their financial obligations to us, we may need to take additional allowances, which would result in a reduction of our net income.EITF Issue No. 03-05.
Inventories.Inventories are stated at the lower of cost (on a first-in, first-out basis) or market. Demonstration units are stated at their manufacturing cost, and reserves are recorded to state the demonstration units at their net realizable value. We review the adequacy of itsour inventory reserves on a quarterly basis.
We review and set standard costs semi-annually at current manufacturing costs in order to approximate actual costs. Our manufacturing overhead standards for product costs are calculated assuming full absorption of forecasted spending over projected volumes, adjusted for excess capacity. Abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage) are recognized as current period charges.
We write down inventory based on forecasted demand and technological obsolescence. These factors
are impacted by market and economic conditions, technology changes, new product introductions and changes in strategic direction and require estimates that may include uncertain elements. Actual demand may differ from forecasted demand, and such differences may have a material effect on recorded inventory values.
Warranty.We provide standard warranty coverage on our systems for 40 hours per week for twelve months, providing labor and parts necessary to repair the systems during the warranty period. We account for the estimated warranty cost as a charge to costs of revenues when revenue is recognized. The estimated warranty cost is based on historical product performance and field expenses. Utilizing actual service records, we calculate the average service hours and parts expense per system and apply the labor and overhead rates to determine the estimated warranty charge. We update these estimated charges on a quarterly basis. The actual product performance and/or field expense profiles may differ, and in those cases we adjust our warranty reserves accordingly. The difference between the estimated and actual warranty costs tends to be larger for new product introductions as there is limited or no historical product performance to estimate warranty expense; more mature products with longer product performance histories tend to be more stable in our warranty charge estimates. Non-standard warranty generally includes services incremental to the standard 40-hour per week coverage for twelve months. Non-standard warranty is deferred as unearned revenue and is recognized ratably as revenue when the applicable warranty term period commences. See Note 1211, “Commitments and Contingencies” to the Consolidated Financial Statements “Commitments and Contingencies” for a detailed description.
Revenue Recognition.Allowance for Doubtful Accounts.A majority of our trade receivables are derived from sales to large multinational semiconductor manufacturers throughout the world. In order to monitor potential credit losses, we perform ongoing credit evaluations of our customers’ financial condition. An allowance for doubtful accounts is maintained for probable credit losses based upon our assessment of the expected collectibility of all accounts receivable. The allowance for doubtful accounts is reviewed on a quarterly basis to assess the adequacy of the allowance. We recognize revenue when persuasive evidencetake into consideration (1) any circumstances of an arrangement exists,which we are aware of a customer’s inability to meet its financial obligations; and (2) our judgments as to prevailing economic conditions in the sale price is fixed or determinable, delivery has occurred or services have been rendered,industry and collectibility is reasonably assured. System revenue includes hardwaretheir impact on our customers. If circumstances change, and software that is incidental to the product. We generally recognize system revenue upon confirmation by the customer that the system has been installed and is operating according to pre-determined specifications. In certain cases,financial condition of our policy does not require written acceptance from the customer and we recognize system revenue upon shipment. Total revenue recognized without a written acceptance from the customer was approximately 4.4%, 6.6%, and 4.9% of total revenue for the fiscal years ended June 30, 2006, 2005 and 2004, respectively. The fluctuation of revenue exceptions is primarily driven by the shipment patterns of tools that have already met the required acceptance criteria. (See Note 1 to Consolidated Financial Statements under “Revenue Recognition” for detailed description of exceptions.) Shipping charges billed to customers are includedadversely affected and they are unable to meet their financial obligations to us, we may need to take additional allowances, which would result in system revenue and the related shipping costs are included in costs of revenues.
Revenue from software license fees is typically recognized upon shipment if collection of the resulting receivable is probable, the fee is fixed or determinable, and vendor-specific objective evidence exists to allocate a portion of the total fee to any undelivered elements of the arrangement. Such undelivered elements in these arrangements typically consist of services and/or unspecified software upgrades. If vendor-specific objective evidence does not exist for the undelivered elements of the arrangement, all revenue is deferred until such evidence does exist, or until all elements are delivered, whichever is earlier. In instances where an arrangement to deliver software requires significant modification or customization, license fees are recognized under the percentage of completion method of contract accounting. We periodically review the software elementreduction of our systems in accordance with AICPA Statement of Position (“SOP”) No. 97-2, “Software Revenue Recognition” and Emerging Issues Task Force (“EITF”) Issue No. 03-05, “Applicability of SOP 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software.”
Trade-in rights are occasionally granted to customers to trade in tools in connection with subsequent purchases. We estimate the value of the trade-in right and reduce the revenue of the initial sale.
Spare parts revenue is recognized when the product has been shipped, risk of loss has passed to the customer and collection of the resulting receivable is probable.
Service and maintenance revenue is recognized ratably over the term of the maintenance contract. If maintenance is included in an arrangement, which includes a software license agreement, amounts related to
maintenance are allocated based on vendor specific objective evidence. Consulting and training revenue is recognized when the related services are performed.
The deferred system profit balance at June 30, 2006 was $226 million. This amount equals the amount of deferred system revenue that was invoiced and due on shipment less applicable product and warranty costs. The deferred profit balance increased from $212 million at June 30, 2005 primarily because shipments were higher than customer acceptance for which revenue was recognized during fiscal year 2006.
We also defer the fair value of non-standard warranty bundled with equipment sales as unearned revenue. Non-standard warranty includes services incremental to the standard 40-hour per week coverage for twelve months. Non-standard warranty is recognized ratably as revenue when the applicable warranty term period commences. The unearned revenue balance was flat at $81 million at June 30, 2006 and 2005.net income.
Stock-Based Compensation.Prior to July 1, 2005, we applied APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and its related Interpretations and provided the required pro forma disclosures under SFAS No. 123, “Accounting for Stock-Based Compensation.” In accordance with APB Opinion No. 25, a non-cash, stock-based compensation expense was recognized for any options for which the exercise price was below the market price on the actual grant date. The charge for the options with an exercise price below the market price on the actual grant date was equal to the number of options multiplied by the difference between the exercise price and the market price of the option shares on the actual grant date. That expense was amortized over the vesting period of the option. Beginning July 1, 2005, we have accounted for stock-based compensation using the fair value of stock options usingbased on a Black-Scholes valuationoption-pricing model, consistent with the provisions of SFAS No. 123(R), as clarified by Securities and Exchange Commission Staff Accounting Bulletin (“SAB”) No. 107. We elected to adopt the modified prospective application method as provided by SFAS No. 123(R). Accordingly, during the fiscal yearyears ended June 30, 2006 and 2007, we recorded stock-based compensation costexpense totaling the amount that would have been recognized had the fair value method been applied under SFAS No. 123 been applied since the effective date of SFAS No. 123 for the pre-fiscalgrants made prior to the fiscal year ended June 30, 2006, grants and under SFAS No. 123(R) for the grants made during the fiscal yearyears ended June 30, 2006 grants. and 2007.
SFAS No. 123(R) requires the use of option pricing models that were not developed for use in valuing employee stock options. The Black-Scholes option-pricing model was developed for use in estimating the fair value of short-lived exchange traded options that have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions, including the option’s expected life and the expected price volatility of the underlying stock. The expected stock price volatility assumption was determined using the implied volatility of the Company’s common stock. We determined that implied volatility is more reflective of market conditions and a better indicator of expected volatility than a blended volatility. Prior to the adoption of SFAS No. 123(R), we used a combination of historical and implied volatility in deriving the expected volatility assumption.
In November 2005, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) No. 123(R)-3 “TransitionTransition Election Related to Accounting for Tax Effects of Share-Based Payment Awards”Awards (“FSP 123R-3”). We have elected not to adopt the alternative transition method provided in the FSP 123R-3 for calculating the tax effects of stock-based compensation pursuant to SFAS No. 123(R). We followed paragraph 81 of SFAS No. 123(R) to calculate the initial pool of excess tax benefits and to determine the subsequent impact on the Additional Paid-In-CapitalPaid-in-Capital (“APIC”) pool and Consolidated Statements of Cash Flows of the tax effects of
employee stock-based compensation awards that arewere outstanding upon adoption of SFAS No. 123(R). We have elected to ignore the indirect tax effects of share-based compensation deductions when calculating the windfall benefits and are recognizing the full effect of these deductions in the income statement in the period in which the taxable event occurs. See Note 76, “Stock-Based Compensation” to the Consolidated Financial Statements “Stock-Based Compensation” for a detailed description.
Contingencies and Litigation. The Company isWe are subject to the possibility of losses from various contingencies. Considerable judgment is necessary to estimate the probability and amount of any loss from such contingencies. An accrual is made when it is probable that a liability has been incurred or an asset has been impaired and the amount of loss can be reasonably estimated. The Company accruesWe accrue a liability and chargescharge operations for the estimated costs expected to be incurred over the next twelve months of adjudication or settlement of asserted and unasserted claims existing as of the balance sheet date. See Item 3, “Legal Proceedings” and Note 1211, “Commitments and Contingencies” to the Consolidated Financial Statements “Commitments and Contingencies” for a detailed description.
Goodwill and Intangible Assets.As required by SFAS No. 142,Goodwill and Other Intangible Assets,goodwill is not amortized but is subject to impairment tests annually, or earlier if indicators of potential impairment exist, using a fair-value-based approach. Purchased technology, patents, trademarks and other intangible assets are presented at cost, net of accumulated amortization. Intangible assets are amortized on a straight line basis which approximates their estimated useful lives and assessed for impairment under SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets. Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in each business combination. We completed the annual evaluation of the goodwill by reporting unit during the quarter ended December 31, 2006, and concluded that there was no impairment. There have been no significant events or circumstances affecting the valuation of goodwill subsequent to the impairment test performed in the second quarter of the fiscal year ended June 30, 2007.
Income Taxes.We account for income taxes in accordance with SFAS No. 109, “AccountingAccounting for Income Taxes”, which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. SFAS No. 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that a portion of the deferred tax asset will not be realized. We have determined that our future taxable income will be sufficient to recover all of our deferred tax assets. However, should there be a change in our ability to recover our deferred tax assets, we could be required to record a valuation allowance against our deferred tax assets. This would result in an increase to our tax provision in the period in which we determined that the recovery was not probable.
On a quarterly basis, we provide for income taxes based upon an estimated annual effective income tax rate. The effective tax rate is highly dependent upon the geographic composition of worldwide earnings, tax regulations governing each region, availability of tax credits and the effectiveness of our tax planning strategies. We carefully monitor the changes in many factors and adjust our effective income tax rate on a timely basis. If actual results differ from these estimates, this could have a material effect on our financial condition and results of operations.
In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our best estimate of whether, and the extent to which, additional tax payments are probable. If we ultimately determine that payment of these amounts is unnecessary, we reverse the liability and recognize a tax benefit during the period in which we determine that the liability is no longer necessary. We record an additional charge in our provision for taxes in the period in which we determine that the recorded tax liability is less than we expect the ultimate assessment to be. See Note 11 to Consolidated Financial Statements “Income Taxes” for a detailed description.
Effects of Recent Accounting Pronouncements.
In September 2006,February 2007, the SEC staffFASB issued Staff Accounting Bulletin (“SAB”)SFAS No. 108, “Considering the Effects159,The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SABFASB Statement No. 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements. SAB No. 108 requires registrants to quantify the impact of correcting all misstatements using both the “rollover” method,115, which focuses primarily on the impact of a misstatement on the income statement and is the method we currently use, and the “iron curtain” method, which focuses primarily on the effect of correcting the period-end balance sheet. The use of both of these methods is referred to as the “dual approach” and should be combined with the evaluation of qualitative elements surrounding the errors in accordance with SAB No. 99, “Materiality.” The provisions of SAB No. 108 are effective for the Company forin fiscal years beginning July 1, 2006.2008. This statement permits an entity to choose to measure many financial instruments and certain other items at fair value at specified election dates. Subsequent unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings. The adoptionCompany is currently evaluating the potential impact of SAB No. 108 is not expected to have a material impactthis statement on the Company’sits consolidated financial position, results of operations orand cash flows.
In September 2006, the FASB issued SFAS No. 157, “FairFair Value Measurements.”Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of SFAS No. 157 are effective for the Company for fiscal years beginning July 1, 2008. We are evaluating the impact of the provisions of this statement on the Company’sour consolidated financial position, results of operations and cash flows.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” SFAS No. 158 requires employers to fully recognize the obligations associated with single-employer defined benefit pension, retiree healthcare and other postretirement plans in their financial statements. The provisions of SFAS No. 158 are effective for the Company as of the end of the fiscal year ending June 30, 2007. We are evaluating the impact of the provisions of this statement on the Company’s consolidated financial position, results of operations and cash flows.
In June 2006, the FASB published FASB Interpretation No. (“FIN”) 48, “AccountingAccounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “AccountingAccounting for Income Taxes.” This InterpretationTaxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This InterpretationFIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This InterpretationFIN 48 is effective for theour Company in fiscal years beginning July 1, 2007. Any differences between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption will be accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. In addition, the adoption of FIN 48 will result in the reclassification of certain unrecognized tax benefits from current to non-current liabilities in our statement of financial position. We are currently evaluating the potential impact of the provisionsimplementation of this InterpretationFIN 48 on the Company’sour consolidated financial position, results of operations and cash flows.
In February 2006, the FASB issued SFAS No. 155, “AccountingAccounting for Certain Hybrid Financial Instruments,” an amendment ofSFAS No. 133, “AccountingAccounting for Derivative Instruments and Hedging Activities” and SFAS No. 140, “AccountingAccounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” This Statement permitsLiabilities. These Statements permit fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. This Statement isThese Statements are effective for the Company for all financial instruments acquired or issued after July 1, 2007. The adoption of SFAS No. 155 is not expected to have a material effect on the Company’s consolidated financial position, results of operations or cash flows.
In June 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” a replacement of APB Opinion No. 20, “Accounting Changes,” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS No. 154 changes the requirements for the accounting for and reporting of a change in accounting principle. Previously, most voluntary changes in accounting principles required recognition via a cumulative effect adjustment within net income of the period of the change. SFAS No. 154 requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 is effective for the Company for accounting changes made in fiscal years beginning July 1, 2006; however, the Statement does not change the transition provisions of any existing accounting pronouncements. The adoption of SFAS No. 154 is not expected to have a material effect on the Company’s consolidated financial position, results of operations or cash flows.
In March 2005, the FASB published FIN 47, “Accounting for Conditional Asset Retirement Obligations,” which clarifies that the term, conditional asset retirement obligation, as used in SFAS No. 143, “Accounting for Asset Retirement Obligations,” refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. The uncertainty about the timing and (or) method of settlement of a conditional asset retirement obligation should be factored into the measurement of the liability when sufficient information exists. The Interpretation also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. The adoption of this Interpretation did not have a material effect on our consolidated financial position, results of operations or cash flows.
In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets,” an amendment of APB Opinion No. 29. SFAS No. 153 addresses the measurement of exchanges of nonmonetary assets and redefines the scope of transactions that should be measured based on the fair value of the assets exchanged. SFAS No. 153 is effective for the Company for nonmonetary asset exchanges beginning in the first quarter of fiscal 2006. The adoption of SFAS No. 153 did not have a material effect on our consolidated financial position, results of operations or cash flows.
In November 2004, the FASB issued SFAS No. 151, “Inventory Costs,” an amendment of Accounting Research Bulletin (“ARB”) No. 43, Chapter 4. SFAS No. 151 clarifies that abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage) are required to be recognized as current period charges. The provisions of SFAS No.151 are effective for the Company for fiscal years beginning July 1, 2005. The adoption of SFAS No. 151 did not have a material impact on our consolidated financial position, results of operations or cash flows.
EXECUTIVE SUMMARY
KLA-Tencor Corporation is the world’s leading supplier of process control and yield management solutions for the semiconductor and related microelectronics industries. Our comprehensive portfolio of products, services, software analysis, services and expertise is designed to helphelps integrated circuit manufacturers manage yield throughout the entire wafer fabrication process—from research and development to final mass production yield analysis.volume production.
Revenues, income from operations, net income, cash flow from operations, and diluted earnings per share are some of the key indicators we use to monitor our financial condition and operating performance. The following table sets forth some of the key quarterly unaudited financial information which we use to manage our business. See Exhibit 99.1 for further detail of the impact of the restatements on these quarterly results.
(In millions, except per share data) | First Quarter | Second Quarter Ended December 31, 2005 | Third Quarter Ended March 31, 2006 | Fourth 2006 | ||||||||
As restated | As restated | As restated | ||||||||||
Revenues | $ | 484 | $ | 488 | $ | 520 | $ | 579 | ||||
Total costs and operating expenses | 409 | 413 | 435 | 504 | ||||||||
Income from operations | 75 | 75 | 85 | 75 | ||||||||
Net income | 75 | 76 | 97 | 132 | ||||||||
Net income per share: | ||||||||||||
Basic | $ | 0.38 | $ | 0.39 | $ | 0.48 | $ | 0.66 | ||||
Diluted | $ | 0.37 | $ | 0.38 | $ | 0.47 | $ | 0.65 |
(In millions, except per share data) | First Quarter | Second Quarter Ended December 31, 2004 | Third Quarter Ended March 31, 2005 | Fourth 2005 | ||||||||||||||||||||
As restated | As restated | As restated | As restated | |||||||||||||||||||||
(in thousands, except per share data) | First quarter ended | Second quarter ended | Third quarter ended March 31, 2007 | Fourth quarter ended June 30, 2007 | ||||||||||||||||||||
Revenues | $ | 519 | $ | 533 | $ | 540 | $ | 490 | $ | 629,363 | $ | 649,270 | $ | 716,208 | $ | 736,388 | ||||||||
Total costs and operating expenses | 372 | 385 | 396 | 384 | 475,373 | 570,911 | 533,553 | 561,524 | ||||||||||||||||
Income from operations | 147 | 148 | 144 | 106 | 153,990 | 78,359 | 182,655 | 174,864 | ||||||||||||||||
Net income | 110 | 122 | 117 | 96 | 135,922 | 90,049 | 154,785 | 147,342 | ||||||||||||||||
Net income per share: | ||||||||||||||||||||||||
Basic | $ | 0.56 | $ | 0.62 | $ | 0.59 | $ | 0.49 | $ | 0.68 | $ | 0.45 | $ | 0.78 | $ | 0.77 | ||||||||
Diluted | $ | 0.55 | $ | 0.61 | $ | 0.58 | $ | 0.48 | $ | 0.67 | $ | 0.44 | $ | 0.76 | $ | 0.75 | ||||||||
(in thousands, except per share data) | First quarter ended | Second quarter ended December 31, 2005 | Third quarter ended March 31, 2006 | Fourth quarter ended June 30, 2006 | ||||||||||||||||||||
Revenues | $ | 484,261 | $ | 487,682 | $ | 519,648 | $ | 579,036 | ||||||||||||||||
Total costs and operating expenses | 409,271 | 412,688 | 434,721 | 504,156 | ||||||||||||||||||||
Income from operations | 74,990 | 74,994 | 84,927 | 74,880 | ||||||||||||||||||||
Net income | 75,487 | 76,605 | 96,684 | 131,676 | ||||||||||||||||||||
Net income per share: | ||||||||||||||||||||||||
Basic | $ | 0.38 | $ | 0.39 | $ | 0.48 | $ | 0.66 | ||||||||||||||||
Diluted | $ | 0.37 | $ | 0.38 | $ | 0.47 | $ | 0.65 |
Industry Trends
Industry analystsAs a supplier to the global semiconductor and semiconductor-related industries, we are subject to business cycles, the timing, length and volatility of which can be difficult to predict. The industries we serve have predictedhistorically been cyclical due to sudden changes in demand and manufacturing capacity. We expect that semiconductor revenues and semiconductor equipment revenues will each grow in the ranges of -5% to +10% in calendar year 2007. Over the longer term, we expectour customers’ capital spending on process control to continue to represent a higher percentage of our customers’ capital spending.increase over the long term. We believe that this percentage increase in process control spending will be driven by the demand for more precise diagnostics capabilities to address multiple new defects as a result of further shrinking of device feature sizes, the transition to new materials, new devices and circuit architecture, new lithography challenges and fab process innovation. We anticipate that these factors will drive increased demand for our products and services.services over the coming years. The key drivers for growth in the semiconductor equipment industry in calendar year 2007 are the transition to 300 millimeter fabs,65nm design nodes, the increased demand for consumer electronics, and the strength of the NAND flash memory market.
Revenues and Gross Margin
Fiscal Year Ended June 30, | Year ended June 30, | |||||||||||||||||||||||||||||||||||||
(in millions) | 2006 | 2005 | 2004 | |||||||||||||||||||||||||||||||||||
As restated | As restated | |||||||||||||||||||||||||||||||||||||
(in thousands) | 2007 | 2006 | 2005 | FY07 vs. FY06 | FY06 vs. FY05 | |||||||||||||||||||||||||||||||||
Revenues: | ||||||||||||||||||||||||||||||||||||||
Product | $ | 1,713 | $ | 1,768 | $ | 1,200 | $ | 2,308,942 | $ | 1,713,237 | $ | 1,767,676 | $ | 595,705 | 35 | % | $ | (54,439 | ) | -3 | % | |||||||||||||||||
Service | 358 | 314 | 297 | 422,287 | 357,390 | 314,202 | 64,897 | 18 | % | 43,188 | 14 | % | ||||||||||||||||||||||||||
Total revenues | $ | 2,071 | $ | 2,082 | $ | 1,497 | $ | 2,731,229 | $ | 2,070,627 | $ | 2,081,878 | $ | 660,602 | $ | (11,251 | ) | |||||||||||||||||||||
Costs of revenues | $ | 942 | $ | 871 | $ | 684 | $ | 1,190,323 | $ | 942,091 | $ | 871,000 | $ | 248,232 | 26 | % | $ | 71,091 | 8 | % | ||||||||||||||||||
Stock-based compensation expense included in costs of revenues | $ | 30 | $ | 9 | $ | 11 | $ | 29,183 | $ | 29,620 | $ | 9,167 | $ | (437 | ) | -1 | % | $ | 20,453 | 223 | % | |||||||||||||||||
Gross margin percentage | 55 | % | 58 | % | 54 | % | 56 | % | 55 | % | 58 | % | 1 | % | -3 | % | ||||||||||||||||||||||
Stock-based compensation expense included in costs of revenues as a percentage of revenue | 1 | % | 0 | % | 1 | % | ||||||||||||||||||||||||||||||||
Stock-based compensation expense included in costs of revenues as a percentage of total revenues | 1 | % | 1 | % | 0 | % | 0 | % | 1 | % |
Product revenues
ForProduct revenues increased in the fiscal year ended June 30, 2006
Product revenue in fiscal year 2006 decreased $55 million, or 3%, to $1.7 billion, from $1.8 billion in fiscal year 2005. Product revenue in fiscal year 2005 increased $568 million, or 47% to $1.8 billion, from $1.2 billion in fiscal year 2004. Product revenue increased in fiscal year 20052007 primarily as a result of fulfilling a higher level of orders received in prior periods. Ourdue to our customers’ increased capital spending in the area of process control and yield management is duemanagement. The higher level of customer spending in the fiscal year ended June 30, 2007 was driven by our customers’ demand for more precise diagnostics capabilities to the increasing complexityaddress multiple new defects as a result of processing in their fabs as more complex chips are produced, new materials such as copper are introduced andfurther shrinking of device feature sizes, are reduced.the transition to new materials, new devices and circuit architecture, new lithography challenges and fab process innovation.
Per ourProduct revenue recognition policy, we do not require written acceptance fromwas relatively flat in the customer under certain situations. Revenue recognized under conditions where our policy does not requirefiscal year ended June 30, 2006 as compared to the need for a written acceptance by the customer was approximately 4.4%, 6.6% and 4.9% of total revenue for fiscal years 2006, 2005 and 2004, respectively.year ended June 30, 2005.
Service revenues
Service revenue in fiscal year 2006 increased $44 million, or 14% to $358 million, from $314 million in fiscal year 2005. Service revenue in fiscal year 2005 increased $17 million, or 6% to $314 million, from $297 million in fiscal year 2004. Service revenue isrevenues are generated from maintenance service contracts, as well as time and material billable service calls made to our customers after the expiration of the warranty period. Service revenuerevenues continued to increase through the three year period disclosed in the table above as our installed base of equipment at our customers’ sites continued to grow. The amount of service revenuerevenues generated is generally a function of the number of post-warranty systems installed at our customers’ sites and the utilization of those systems.
Revenues by region
Revenues by region for the periods indicated were as follows (in millions)thousands):
Fiscal year ended June 30, | ||||||||||||||||||||||||||||||||||||
2006 | 2005 | 2004 | Year ended June 30, | |||||||||||||||||||||||||||||||||
As restated | As restated | 2007 | 2006 | 2005 | ||||||||||||||||||||||||||||||||
United States | $ | 417 | 20 | % | $ | 494 | 24 | % | $ | 343 | 23 | % | $ | 647,813 | 24 | % | $ | 416,468 | 20 | % | $ | 494,250 | 24 | % | ||||||||||||
Europe & Israel | 288 | 14 | 266 | 13 | 186 | 12 | 271,814 | 10 | % | 287,562 | 14 | % | 266,048 | 13 | % | |||||||||||||||||||||
Japan | 541 | 26 | 450 | 21 | 395 | 26 | 600,861 | 22 | % | 541,411 | 26 | % | 450,240 | 21 | % | |||||||||||||||||||||
Taiwan | 363 | 18 | 430 | 21 | 263 | 18 | 559,083 | 20 | % | 363,014 | 18 | % | 429,672 | 21 | % | |||||||||||||||||||||
Korea | 277 | 13 | 148 | 7 | 144 | 10 | 288,756 | 11 | % | 277,316 | 13 | % | 148,287 | 7 | % | |||||||||||||||||||||
Asia Pacific | 185 | 9 | 294 | 14 | 166 | 11 | 362,902 | 13 | % | 184,856 | 9 | % | 293,381 | 14 | % | |||||||||||||||||||||
Total | $ | 2,071 | 100 | % | $ | 2,082 | 100 | % | $ | 1,497 | 100 | % | $ | 2,731,229 | 100 | % | $ | 2,070,627 | 100 | % | $ | 2,081,878 | 100 | % | ||||||||||||
International revenues were 80%, 76% and 77% of revenue during the fiscal years ended June 30, 2006, 2005 and 2004, respectively. A significant portion of our revenuerevenues continues to be generated in Asia, where a substantial portion of the world’s semiconductor manufacturing capacity is located.located, and we expect that will continue to be the case.
Gross margin
Our gross margin fluctuates with revenue levels and product mix, and is affected by variations in costs related to manufacturing and servicing our products. GrossThe increase in gross margin decreased by 3 points to 55% during the fiscal year 2006ended June 30, 2007 was primarily due to increased revenues and savings realized from 58%our cost reduction initiative during the fiscal year. In addition, the following charges were recorded in the fiscal year ended June 30, 2007:
$33.9 million for additional amortization of intangibles and fair value adjustment for inventory related to the acquisitions completed as of June 30, 2007, of which $13.8 million was recorded in the fourth quarter of the fiscal year ended June 30, 2007;
$4.9 million for severance and benefits related to an employee workforce reduction, of which $2.3 million was recorded in the fourth quarter of the fiscal year ended June 30, 2007; and
An aggregate of $4.7 million for reimbursement of taxes to employees, including management, related to IRC Section 409A and cash payment to employees to compensate them for lost benefits resulting from the suspension of the Company’s Employee Stock Purchase Plan (“ESPP”), which $4.7 million amount was recorded primarily in the second and third quarters of the fiscal year ended June 30, 2007.
The decrease in gross margin during the fiscal year ended June 30, 2006 compared to the fiscal year ended June 30, 2005 was primarily due to our cessation of development work related to CDSEM and stock-based compensation expense recorded during the fiscal year ended June 30, 2006, which contributed 1% and 1%, respectively, to the decrease in gross margin. During the fourth quarter of the fiscal year ended June 30, 2006, we ceased development work on the next generation equipment for CDSEM and incurred charges of $27$26.5 million related toresulting from write-offs of related inventory as well as forand other liabilities incurred related to the decision to ceasecessation of future development of CDSEM. Although we have ceased future development of CDSEM, we will continue to service previously sold equipment. Gross margin improved by 4 points to 58% in fiscal year 2005 relative to 54% in fiscal year 2004 due to lower cost of building, installing and maintaining our products, combined with an increase in revenues.
Engineering, Research and Development (“R&D”)
Fiscal year ended June 30, | ||||||||||||||||||||||||||||||||||||||
(in millions) | 2006 | 2005 | 2004 | |||||||||||||||||||||||||||||||||||
(dollar amounts in thousands) | Year ended June 30, | |||||||||||||||||||||||||||||||||||||
As restated | As restated | 2007 | 2006 | 2005 | FY07 vs. FY06 | FY06 vs. FY05 | ||||||||||||||||||||||||||||||||
R&D expenses | $ | 394 | $ | 352 | $ | 299 | $ | 437,513 | $ | 393,823 | $ | 351,984 | $ | 43,690 | 11 | % | $ | 41,839 | 12 | % | ||||||||||||||||||
Stock-based compensation expense included in R&D expenses | $ | 50 | $ | 12 | $ | 18 | $ | 42,431 | $ | 49,509 | $ | 12,255 | $ | (7,078 | ) | -14 | % | $ | 37,254 | 304 | % | |||||||||||||||||
R&D expenses as a percentage of total revenues | 19 | % | 17 | % | 20 | % | 16 | % | 19 | % | 17 | % | -3 | % | 2 | % | ||||||||||||||||||||||
Stock-based compensation expense included in R&D expenses as a percentage of total revenues | 2 | % | 1 | % | 1 | % | ||||||||||||||||||||||||||||||||
Stock-based compensation expense included in R&D expense as a percentage of total revenues | 2 | % | 2 | % | 1 | % | 0 | % | 1 | % |
The increase in R&D expenses increased $42 million or 12% to $394 million during the fiscal year 2006 from $352 million duringended June 30, 2007 primarily reflects additional expenses related to the following charges recorded in the fiscal year 2005. R&D expenses increased $53ended June 30, 2007:
$17.9 million or 18% to $352for in-process research and development (“IPR&D”) charges and amortization of intangibles associated with the acquisitions that we completed as of June 30, 2007, of which $12.3 million duringwas recorded in fourth quarter of the fiscal year 2005 from $299ended June 30, 2007;
$10.0 million duringfor impairment of certain patents recorded in the fourth quarter of the fiscal year 2004. ended June 30, 2007;
An aggregate of $5.8 million for reimbursement of taxes to employees, including management, related to IRC Section 409A and cash payments to employees to compensate them for lost benefits resulting from the suspension of the Company’s ESPP, which $5.8 million amount was recorded primarily in the second and third quarters of the fiscal year ended June 30, 2007; and
$4.3 million for severance and benefits related to an employee workforce reduction, of which $2.2 million was recorded in the fourth quarter of the fiscal year ended June 30, 2007.
The increase in R&D expenses in the fiscal year ended June 30, 2006 iscompared to the fiscal year ended June 30, 2005 was primarily attributable to increased stock-based compensation expenses. In addition, the increase in R&D expenses compared to fiscal year 2004 is due to the business acquired during 2005. Note, however, that R&D expenses, as a percentageimplementation of total revenues, decreased fromSFAS No. 123(R).
During the fiscal year 2004ended June 30, 2007, we recorded $16.6 million for in-process research and development charges. The fair value of the purchased IPR&D was determined using the income approach, which discounts expected future cash flows from projects to their net present value. Future cash flows were estimated, taking into account the expected life cycles of the products and the underlying technology, relevant market sizes and industry trends. We determined a discount rate for each project based on the relative risks inherent in the project’s development horizon, the estimated costs of development, and the level of technological change in the project and the industry, among other factors. IPR&D was expensed upon acquisition because technological feasibility had not been achieved and no future alternative uses existed. The development of these technologies remains a risk due to the remaining efforts to achieve technological feasibility, rapidly changing customer markets, uncertain standards for new products, and significant competitive threats. The nature of the efforts to develop these technologies into commercially viable products consists primarily of planning, designing, experimenting, and testing activities necessary to determine that the technologies can meet market expectations, including functionality and technical requirements.
During the fiscal year 2005 as a resultended June 30, 2007, we determined that we would not pursue future development of higher total revenuescertain patents initially licensed during fiscal year 2005.2006 for approximately $14.0 million. Since we did not have any alternative use of these patents and we believe the fair value to be $0, the carrying value of $10.7 million was written off. The write off was recorded as $10.0 million to R&D expense and $0.7 million to cost of revenues in the fiscal year ended June 30, 2007.
R&D expenses include the benefit of $11$12.7 million, $8$11.4 million and $11$7.9 million of external funding received during the fiscal years ended June 30, 2007, 2006 2005 and 2004,2005, respectively, for certain strategic development programs conducted with several of our customers andprimarily from government grants. We expect our R&D expenses to increase in absolute dollars over the next several years as we accelerate our investments in critical programs focusing on new technologies and enhancements to existing products.
Our future operating results will depend significantly on our ability to produce products and provide services that have a competitive advantage in our marketplace. To do this, we believe that we must continue to make substantial investments in our research and development. We remain committed to product development in new and emerging technologies as we address the yield challenges our customers face at future technology nodes.
Selling, General and Administrative (“SG&A”)
Fiscal year ended June 30, | ||||||||||||||||||||||||||||||||||||||
(in millions) | 2006 | 2005 | 2004 | |||||||||||||||||||||||||||||||||||
(dollar amounts in thousands) | Year ended June 30, | |||||||||||||||||||||||||||||||||||||
As restated | As restated | 2007 | 2006 | 2005 | FY07 vs. FY06 | FY06 vs. FY05 | ||||||||||||||||||||||||||||||||
SG&A expenses | $ | 425 | $ | 314 | $ | 271 | $ | 513,525 | $ | 424,922 | $ | 313,774 | $ | 88,603 | 21 | % | $ | 111,148 | 35 | % | ||||||||||||||||||
Stock-based compensation expense included in SG&A expenses | $ | 86 | $ | 16 | $ | 24 | $ | 37,164 | $ | 85,613 | $ | 15,580 | $ | (48,449 | ) | -57 | % | $ | 70,033 | 450 | % | |||||||||||||||||
SG&A expenses as a percentage of total revenues | 21 | % | 15 | % | 18 | % | 19 | % | 21 | % | 15 | % | -2 | % | 6 | % | ||||||||||||||||||||||
Stock-based compensation expense included in SG&A expenses as a percentage of total revenues | 4 | % | 1 | % | 2 | % | 1 | % | 4 | % | 1 | % | -3 | % | 3 | % |
The increase in SG&A expenses increased $111 million or 35% to $425 million during fiscal year 2006 from $314 million during the fiscal year 2005.ended June 30, 2007 primarily reflects additional charges recorded in SG&A as follows:
$56.8 million for impairment charges related to the write-down of buildings which was recorded in the second quarter of the fiscal year ended June 30, 2007;
$11.3 million for severance and related benefits related to an employee workforce reduction, of which $6.1 million was recorded in the fourth quarter of the fiscal year ended June 30, 2007;
$12.3 million for additional amortization of intangibles related to the acquisitions that we completed as of June 30, 2007, of which $1.7 million is recorded in the fourth quarter of the fiscal year ended June 30, 2007;
$15.8 million for legal and other expenses related to the stock options investigation, shareholder litigation and related matters which was primarily recorded in the first three quarters of the fiscal year ended June 30, 2007; and
$8.0 million for reimbursement of taxes to employees, including management, related to IRC Section 409A and cash payments to employees to compensate them for lost benefits from the suspension of the Company’s ESPP, which $8.0 million amount was recorded primarily in the second and third quarters of fiscal year ended June 30, 2007.
The cumulative increase in SG&A expenses increased $43 million or 16% to $314 million duringin the fiscal year 2005 from $271 million duringended June 30, 2007 as compared to the fiscal year 2004.ended June 30, 2006 was offset in part by a decrease in stock-based compensation expense primarily due to a reversal of $20.3 million in stock-based compensation expense related to our former Chief Executive Officer. In addition, certain options granted in prior years were fully vested in the fiscal year ended June 30, 2007 resulting in lower levels of stock-based compensation expense
In November 2006, as part of our long-term business plan, we decided to sell certain real estate properties owned by the Company in San Jose, California and Livermore, California. Based on the valuation of these assets, we recorded an asset impairment charge of approximately $56.8 million, which has been included in SG&A during the fiscal year ended June 30, 2007. See Note 15, “Asset Impairment and Severance Charges” to the Consolidated Financial Statements for more information.
The increase in SG&A expenses fromin the fiscal year 2005 to fiscal yearended June 30, 2006 iswas primarily due to higher levels of stock-based compensation expense; increased compensation expense due to implementation of $70 millionSFAS No. 123(R) in the fiscal year ended June 30, 2006 and increased legal costs of $21$21.1 million attributable to accrued expenses related to the stock option investigation. The increase in SG&A expenses from fiscal year 2004 to fiscal year 2005 is primarily due to higher compensation costs associated with an increase in customer application support, increased staffing and consolidating the results of operations of the entities acquired during fiscal year 2005.
During November 2005, we announced that effective January 1, 2006, Kenneth L. Schroeder would cease to be our Chief Executive Officer and would thereafter be employed as a Senior Advisor. The Company and Mr. Schroeder also revised his prior agreement with the Company and defined the salary, bonus payout and equity award vesting during the period of his employment as a Senior Advisor. Effective January 1, 2006, we determined that all service conditions associated with certain prior equity awards under the terms of the revised agreement with Mr. Schroeder had been satisfied; accordingly, we recorded at that time an additional non-cash, stock-based compensation charge of approximately $9.8 million relating to these equity awards. The above-mentioned charge is included as a component of Selling, General and AdministrativeSG&A expense during the fiscal year ended June 30, 2006. On October 16, 2006, following the Special Committee investigation of our historical stock option practices, we terminated all aspects of Mr. Schroeder’s employment relationship and agreement with the Company. As a result, vesting of Mr. Schroeder’s then outstanding stock options and restricted stock awards immediately ceased, and the 890,9140.9 million unvested option shares and 100,0000.1 million unvested restricted stock award shares held by Mr. Schroeder at the time of termination were canceled. Accordingly, in the second quarter of the fiscal year ended June 30, 2007 we will reversereversed approximately $20$20.3 million of the non-cash, stock-based compensation charge recorded in prior periods. In December 2006, we canceled 596,7400.6 million vested option shares held by Mr. Schroeder as of the time of termination, representing those shares that had been retroactively priced or otherwise improperly granted.
In November 2006, as part of the long-term business plan, we decided to sell certain real estate properties owned by the Company in San Jose, California and Livermore, California. We will record an asset impairment charge of approximately $56 million in the quarter ended December 31, 2006. In addition, we reduced our work-force by approximately 150 people and will accrue approximately $10 million in severance charges in the quarter ended December 31, 2006 to be paid over the next twelve months.
Interest Income and Other, Net
Fiscal year ended June 30, | Year ended June 30, | |||||||||||||||||||||||
(in millions) | 2006 | 2005 | 2004 | |||||||||||||||||||||
As restated | As restated | |||||||||||||||||||||||
(dollar amounts in thousands) | 2007 | 2006 | 2005 | |||||||||||||||||||||
Interest income and other, net | $ | 68 | $ | 38 | $ | 27 | $ | 87,367 | $ | 68,067 | $ | 37,956 | ||||||||||||
Percentage of total revenues | 3 | % | 2 | % | 2 | % | 3 | % | 3 | % | 2 | % |
Interest income and other, net is comprised primarily of interest income earned on theour investment and cash portfolio, realized gains or losses on sales of marketable securities, as well as income recognized upon settlement of certain foreign currency contracts. The increaseincreases in interest income and other, net, in each of the fiscal years ended June 30, 2007 and 2006, as compared to the prior fiscal years isyear were primarily due to the increase in cash levels andhigher short-term interest rates. In addition, in the fiscal year ended June 30, 2007, we had an equity interest in a development stage company which we consolidated as of March 31, 2004. During the fiscal year ended June 30, 2007, we acquired the remaining minority interest in this entity and subsequently sold certain assets of this entity and recorded a gain of $3.9 million.
Provision for Income Taxes
Our effective income tax rate was 0.4%22.2%, 0.4% and 24.3% and 21.4% in the fiscal years ended June 30, 2007, 2006 2005 and 2004,2005, respectively. In general, our effective income tax rate differs from the statutory rate of 35% largely asis a function of benefits realized from our Extraterritorial Income (“ETI”) exclusion, foreign earnings taxed at different rates, research and development tax credits and tax exempt interest.
In the yearfiscal years ended June 30, 2007 and June 30, 2006, the Company reduced its total income tax reserves by $15.3 million and $79.7 million of which $44.8 million relates to the fourth quarter of fiscal year 2006.respectively. This was primarily due to expiring statutestatutes of limitations, several tax settlements reached with various tax authorities and reassessments of tax exposures based on the status of current audits in various jurisdictions. Included inIn the tax settlements, wasfiscal year ended June 30, 2006, we entered into a settlement with the Internal Revenue Service related to an examination for the fiscal years ended June 30, 2003 and 2004. In the fiscal year ended June 30, 2007, we entered into a settlement with the California Franchise Tax Board related to an examination for the fiscal years ended June 30, 1997, 1998 and 1999.
Our benefits for income taxestax related to equity awards were $34.5 million, $58.2 million $12.1 million and $22.3$12.1 million for the fiscal years ended June 30, 2007, 2006 June 30,and 2005, and June 30, 2004, respectively.
Our future effective income tax rate depends on various factors, such as tax legislation, the geographic composition of our pre-tax income, non tax-deductible expenses incurred in connection with acquisitions, amounts of tax-exempt interest income and research and development credits as a percentage of aggregate pre-tax income, and the effectiveness of our tax planning strategies.
The statute of limitations has expired for franchise taxes in California, the state in which the Company’s headquarters are located, through the fiscal year ended June 30, 2002, and the Internal Revenue Service completed an audit of the Company’s corporate tax returns for the fiscal yearyears ended June 30, 2003 and 2004 corporate tax returns.during the fiscal year ended June 30, 2006. Liabilities for anticipated worldwide tax audit issues have been established based on our estimate of whether, and the extent to which, additional tax payments are probable. The Company believes that adequate reserves have been provided to cover any potential additional tax assessments.
Equity Incentive Program
The Company’sOur equity incentive program is a broad-based, long-term retention program that is intended to attract and retain key employees, and align stockholder and employee interests. The equity incentive program consists of two plans: one under which non-employee directors may be granted options to purchase shares of our stock, and another in which non-employee directors, officers, key employees, consultants and all other employees may be
granted options to purchase shares of our stock, restricted stock units and other types of equity awards. For the past several years exceptuntil June 30, 2006, stock options (except for the retroactively priced stock options stock options havewhich were granted primarily prior to fiscal year 2002) were generally been granted at the market price of our common stock on the date of grant, generally havewith a vesting period of five
years and are exercisable for aan 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 time-based or performance-based vesting. Substantially all of our employees that meet established performance goals and qualify as key employees participate in our main equity incentive plan. Since July 1, 2006, we have granted only restricted stock units under our equity incentive program, except for options granted to non-employee directors as part of their regular compensation package for service through June 30, 2007.
On October 18, 2004, the Company’sour stockholders approved the 2004 Equity Incentive Plan (the “2004 Plan”) which provides for the grant of options to purchase shares of the Company’sour common stock, stock appreciation rights, restricted stock, performance shares, performance units and deferred stock units to our employees, consultants and members of our Board of Directors. Since the adoption of the 2004 Plan, no further grants are permitted under the 1982 Stock Option Plan or 2000 Non-Statutory Stock Option Plan. The 2004 Plan permits the issuance of 12,500,000up to 12.5 million shares of common stock, of which 6.33.3 million shares arewere available for grant as of June 30, 2006. At that2007. Any 2004 Plan awards of restricted stock, 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 awardsshall be counted against the total number of shares issuable under the 2004 Plan as 1.8 shares for 30.4 million shares areevery one share subject thereto. Total options and restricted stock units outstanding under all plans.plans as of June 30, 2007 were 19.6 million and 3.4 million, respectively.
Stock-Based Compensation Expense
Effective July 1, 2005, we adopted the provisions of SFAS No. 123(R), “Share-Based Payment.”Share-Based Payment. SFAS No. 123(R) establishes accounting for stock-based awards exchanged for employee services. Accordingly, stock-based compensation cost is measured at grant date, based on the fair value of the award which is computed using a Black-Scholes option valuation model, and is recognized as expense over the employee’s requisite service period.
During fiscal years 2006, 2005, and 2004, we recorded The following table shows stock-based compensation expense by type of $165 million, $37 million,award for the fiscal years ended June 30, 2007, 2006 and $53 million, respectively, of which, $22 million, $34 million, and $53 million was attributable2005:
Year ended June 30, | |||||||||
(in thousands ) | 2007 | 2006 | 2005 | ||||||
Stock-based compensation expense by type of award: | |||||||||
Employee stock options | $ | 82,440 | $ | 140,447 | $ | 34,902 | |||
Employee stock purchase plan | 11,964 | 16,188 | — | ||||||
Restricted stock units | 14,374 | 8,107 | 2,139 | ||||||
Total stock-based compensation | $ | 108,778 | $ | 164,742 | $ | 37,041 | |||
The decrease in stock-based compensation expense in the fiscal year ended June 30, 2007 as compared to the restatements.fiscal year ended June 30, 2006 was primarily due to a reversal of $20.3 million in stock-based compensation expense related to the cancellation of options and restricted stock units previously held by our former Chief Executive Officer. In addition, certain options granted in prior years were fully vested in the fiscal year ended June 30, 2007 resulting in lower levels of stock-based compensation expense. These decreases were offset by $9.3 million of cash compensation related to bonuses payable to the holders of amended options to compensate them for the increase in their option exercise price.
CompensationThe increase in stock-based compensation expense recognized for all stock options forin the fiscal yearsyear ended June 30, 2006 as compared to the fiscal year ended June 30, 2005 and 2004 was $141 million, $35 million, and $53 million, respectively. is primarily due to the implementation of SFAS No. 123(R).
As of June 30, 2006,2007, the unrecognized stock-based compensation after estimated forfeituresbalance related to stock options was $223$106.0 million and is expected towill be recognized over an estimated weighted-averageweighted average amortization period of 3.32.6 years.
Compensation expense recognized in connection with the employee stock purchase plan for fiscal year 2006 was $16 million, the majority of which is included in selling, general and administration expense. As the plan was non-compensatory under APB Opinion No. 25, no compensation expense was recorded in connection with the plan in fiscal years 2005 and 2004.
Compensation expense recognized for restricted stock units for fiscal years 2006 and 2005 was $8 million and $2 million, respectively. No compensation expense was recognized in fiscal year 2004. As of June 30, 2006,2007, the unrecognized stock-based compensation after estimated forfeituresbalance related to restricted stock units was $26 million. That cost is expected to$71.2 million and will be recognized over an estimated weighted-averageweighted average amortization period of 3.73.2 years.
Liquidity and Capital Resources
As of June 30, | ||||||||||||
(in millions) | 2006 | 2005 | 2004 | |||||||||
Cash and cash equivalents | $ | 1,129 | $ | 663 | $ | 354 | ||||||
Short-term marketable securities | 1,197 | 1,532 | 779 | |||||||||
Long-term marketable securities | — | — | 743 | |||||||||
Total cash, cash equivalents and marketable securities | $ | 2,326 | $ | 2,195 | $ | 1,876 | ||||||
Percentage of total assets | 51 | % | 54 | % | 52 | % |
(dollar amounts in thousands) Cash and cash equivalents Short-term marketable securities Total cash, cash equivalents and marketable securities Percentage of total assets (in thousands) Cash provided by operating activities Cash (used in) provided by investing activities Cash used in financing activities Effect of exchange rate changes on cash and cash equivalents Net increase (decrease) in cash and cash equivalents As of June 30, 2007 2006 2005 $ 722,511 $ 1,129,191 $ 663,163 988,118 1,196,605 1,532,023 $ 1,710,629 $ 2,325,796 $ 2,195,186 37 % 51 % 54 % Year ended June 30, 2007 2006 2005 $ 610,686 $ 315,169 $ 506,735 (399,268 ) 225,070 (124,598 ) (633,227 ) (84,959 ) (81,069 ) 15,129 10,748 8,213 $ (406,680 ) $ 466,028 $ 309,281
We have historically financed our operations through cash generated from operations. Cash provided by operating activities was $315 million, $507 million, and $350 million in fiscal years 2006, 2005 and 2004, respectively. Cash provided by operating activities inthe fiscal year 2006ended June 30, 2007 consisted primarily of net income of $380$528.1 million increased by non-cash depreciation and amortization of $69$109.3 million, stock-based compensation of $165 million, tax benefit from equity awards of $32$99.6 million and an increase in accounts payablenon-cash impairment charges of $27$67.6 million, partially offset by an increase in accounts receivable of $115$107.3 million, a decrease in accounts payable of $45.6 million, a decrease in deferred system profit of $24.4 million and increase in other assets of $19.4 million.
Cash provided by operating activities in the fiscal year ended June 30, 2006 consisted primarily of net income of $380.5 million increased by non-cash depreciation and amortization of $69.4 million, stock-based compensation of $164.7 million, tax benefit from equity awards of $31.9 million and an increase in accounts payable of $27.1 million, partially offset by an increase in accounts receivable of $114.9 million, an increase in inventories of $88$87.7 million, and an increase in net deferred income tax assets of $134$134.4 million.
Cash provided by operating activities in the fiscal year ended June 30, 2005 consisted primarily of net income of $445$445.0 million increased by non-cash depreciation and amortization of $70$70.2 million, stock-based compensation of $37$37.0 million, decrease in accounts receivable of $37$36.6 million and decrease in other assets and liabilities of $43$42.8 million partially offset by a decrease in deferred system profit of $71$70.8 million and an increase in net deferred income tax assets of $53$53.5 million.
Cash provided by operating activities during fiscal year 2004 consisted primarily of net income of $212 million, increased by non-cash depreciation and amortization of $82 million, stock-based compensation of $53 million, tax benefit from equity awards of $40 million, an increase in deferred system profit of $107 million and an increase in accounts payable of $30 million partially offset by an increase in other assets and liabilities of $87 million, an increase in net deferred income tax assets of $29 million, an increase in accounts receivable of $149 million and an increase in inventories of $76 million.
Cash provided by investing activities was $225 million in fiscal year 2006. Cash used in investing activities was $125 million and $441 million in fiscal years 2005 and 2004, respectively. Investing activities typically consist of purchases and sales or maturities of marketable securities, purchases of capital assets to support long-term growth and acquisitions of technology or other companies to allow access to new markets or emerging technologies.
Cash used in financing activities was $85 million and $81 million in fiscal years 2006 and 2005, compared with $113 million of cash generated from financing activities in During the fiscal year 2004. ended June 30, 2007, we paid $521.7 million for acquisitions completed during the fiscal year including the acquisition of certain assets of a development stage company. Also, purchases of capital assets in the fiscal year ended June 30, 2007 includes purchases of $29.9 million related to our Singapore facility.
Financing activities include dividend payments to our common stockholders and sales and repurchases of our common stock. Issuance of common stock provided $213$263.2 million, $134$212.7 million and $169$133.6 million in the fiscal years ended June 30, 2007, 2006 2005 and 2004,2005, respectively. We used $221$808.5 million, $204$221.4 million and $56$203.7 million in the fiscal years ended June 30, 2007, 2006 2005 and 2004,2005, respectively, to repurchase shares of our common stock under the stock repurchase program initiated in 1997.stock. The stock repurchase program was suspended in May 2006. We anticipate resuming2006 and resumed in February 2007. The increase from fiscal year 2006 to 2007 was primarily due to the Accelerated Share Repurchase (“ASR”) program described below. This increase in our share repurchases underis the programprimary reason for the decrease in calendar 2007. cash, cash equivalents and marketable securities as of June 30, 2007 versus June 30, 2006.
During the third quarter of the fiscal year ended June 30, 2005, our Board of Directors also approved the initiation of a quarterly cash dividend and declared a dividend of 12 cents$0.12 per share of our outstanding common stock. The total amount of dividends paid during the fiscal years ended June 30, 2007, 2006 and 2005 was $95$95.1 million, $95.4 million and $24$23.6 million, respectively. Further, thea dividend of 12 cents$0.15 per share of our outstanding common stock for the first quarter of the fiscal 2007year ending June 30, 2008 was declared onin August, 3, 20062007 and waswill be paid on September 1, 20062007 to our stockholders on record as of August 15, 2006.20, 2007.
In February 2007, we entered into an ASR program with a third-party investment bank and prepaid $750.0 million to repurchase its common stock. The total amountpurchase price per share of dividends paidthe common stock repurchased through the ASR was determined and adjusted based on a discount to the volume-weighted average price of our common stock during a period following the firstexecution of the ASR agreement, subject to a maximum price per share. During the fiscal year ended June 30, 2007 we repurchased 14.0 million shares of our common stock under the ASR, of which 2.0 million shares were delivered to us in the fourth quarter of the fiscal 2007year ended June 30, 2007.
The shares repurchased under the ASR decreased our basic and diluted weighted average shares outstanding. This decrease was approximately $24 million. In addition,partially offset by additional shares issued upon the dividendexercise of 12 cents per share foremployee stock options and in connection with stock purchases under our Employee Stock Purchase Plan.
Following the second quarter of fiscal 2007 was declared on November 6, 2006 and was paid on December 1, 2006 to our stockholders on record as of November 15, 2006. The total amount of dividends paid in the second quarter of fiscal 2007 was $24 million.
On October 11, 2006, we acquired allconclusion of the fiscal year covered by this report, in August 2007, the Board of Directors authorized KLA-Tencor to repurchase up to an additional 10.0 million shares of ADE Corporation (“ADE”), a supplier of semiconductor process control solutions. Perits common stock under the Amended Merger Agreement between the Company and ADE, we paid $482 million (which included goodwill and intangibles of $262 million and $137 million, respectively) in cash to the shareholders of ADE. The acquisition will be accounted for as a purchase.repurchase program.
The following is a schedule summarizing our significant obligations to make future payments under contractual obligations as of June 30, 2006 (in millions):2007:
Total | Payments Due by Fiscal Year | |||||||||||||||||||||||||||||||||||||||||
2007 | 2008 | 2009 | 2010 | 2011 | Thereafter | |||||||||||||||||||||||||||||||||||||
(in thousands) | Total | 2008 | 2009 | 2010 | 2011 | 2012 | Thereafter | |||||||||||||||||||||||||||||||||||
Purchase commitments | $ | 145,548 | $ | 143,574 | $ | 1,974 | $ | — | $ | — | $ | — | $ | — | ||||||||||||||||||||||||||||
Operating leases | $ | 19.7 | $ | 6.5 | $ | 4.6 | $ | 3.4 | $ | 1.9 | $ | 1.3 | $ | 2.0 | 38,218 | 10,364 | 7,956 | 5,400 | 3,913 | 2,308 | 8,277 | |||||||||||||||||||||
Cash purchase of ADE | $ | 482.0 | $ | 482.0 | ||||||||||||||||||||||||||||||||||||||
Pension obligations | 10,387 | 864 | 924 | 976 | 1,001 | 902 | 5,720 | |||||||||||||||||||||||||||||||||||
Other obligations |
| 20,640 |
| 20,640 | — | — | — | — | — | |||||||||||||||||||||||||||||||||
Total contractual cash obligations | $ | 501.7 | $ | 488.5 | $ | 4.6 | $ | 3.4 | $ | 1.9 | $ | 1.3 | $ | 2.0 | $ | 214,793 | $ | 175,442 | $ | 10,854 | $ | 6,376 | $ | 4,914 | $ | 3,210 | $ | 13,997 | ||||||||||||||
We have agreements with financial institutions to sell certain of our trade receivables and promissory notes from customers without recourse. During the years ended June 30, 2006 and 2005, approximately $278 million and $306 million of receivables were sold under these arrangements, respectively.
In addition, from time to time we will discount, without recourse, Letters of Credit (“LCs”) received from customers in payment for goods.
The following table shows total receivables sold under factoring agreements and proceeds from sales of goods. DuringLCs and related discounting fees paid during the years ended June 30, 20062007 and 2005, several LCs were sold with proceeds totaling $69 million and $30 million, respectively. Discounting fees were $0.8 million and $0.2 million for the years ended June 30, 2006 and 2005, respectively.2006:
Year ended June 30, | |||||||||
(in thousands) | 2007 | 2006 | 2005 | ||||||
Receivables sold under factoring agreements | $ | 278,560 | $ | 277,960 | $ | 306,175 | |||
Proceeds from sales of LCs | $ | 61,850 | $ | 69,286 | $ | 29,602 | |||
Discounting fees paid on sales of LCs(1) | $ | 804 | $ | 788 | $ | 195 |
(1) | Discounting fees were equivalent to interest expense and were recorded in interest and other income net. |
We maintain $25guarantee arrangements of $27.9 million of short-term credit facilities in various locations to fund overdraft, Custom’scustoms guarantee for VAT and letter of creditLC needs of ourits subsidiaries in Europe and Asia. A total of $20Approximately $18.4 million was outstanding under these facilitiesarrangements as of June 30, 2006.2007.
We maintain certain purchase commitments with our suppliers to ensure a smooth and continuous supply chain for key components. Our liability inunder these purchase commitments is generally restricted to a forecasted
time-horizon as mutually agreed upon between the parties. This forecast time-horizon can vary among different suppliers. We estimate our purchase commitment as of June 30, 20062007 to be approximately $210$145.5 million most of which we expect to spend in fiscal year 2007.are primarily due within the next 12 months. Actual expenditures will vary based upon the volume of the transactions and length of contractual service provided. In addition, the amounts paid under these arrangements may change in the event that the arrangements are renegotiated or canceled. Certain agreements provide for potential cancellation penalties.
We provide standard warranty coverage on our systems for 40 hours per week for twelve months, providing labor and parts necessary to repair the systems during the warranty period. We account for the estimated warranty cost as a charge to costs of revenues when revenue is recognized. The estimated warranty cost is based on historical product performance and field expenses. The actual product performance and/or field expense profiles may differ, and in those cases we adjust our warranty reserves accordingly. The difference between the estimated and actual warranty costs tends to be larger for new product introductions as there is limited or no historical product performance to estimate warranty expense; more mature products with longer product performance histories tend to be more stable in our warranty charge estimates. Non-standard warranty coverage generally includes services incremental to the standard 40-hour per week coverage for twelve months. See Note 1211 “Commitments and Contingencies” to the Consolidated Financial Statements “Commitments and Contingencies” for a detailed description.
Because virtually all holders of retroactively priced options issued by the Company were not involved in or aware of the retroactive pricing, the Company has taken certain actions to deal with the adverse tax consequences that may be incurred by the holders of retroactively priced options. The adverse tax consequences are that retroactively priced stock options vesting after December 31, 2004 (“409A Affected Options”) subject the option holder to a penalty tax under IRC Section 409A (and, as applicable, similar penalty taxes under California and other state tax laws). One such action by the Company involved offering to amend the 409A Affected Options to increase the exercise price to the market price on the actual grant date or, if lower, the market price at the time of the amendment. The amended options are not subject to taxation under IRC Section 409A. Under IRS regulations, these option amendments had to be completed by December 31, 2006 for anyone who was an executive officer when he or she received 409A Affected Options; the amendments for non-officers do not need to be completed until December 31, 2007.
During the fiscal year ended June 30, 2007, we accrued approximately $20.2 million payable to non-executive holders of the amended options to compensate them for the resulting increase in their option exercise prices. The $20.2 million is payable in January 2008. Of the $20.2 million, $9.3 million was recorded as stock-based compensation expense, and the remaining $10.9 million was recorded in common stock and capital in excess of par value in the balance sheet. The amount of these bonuses will effectively repaid to the Company if and when the options are exercised and the increased exercise price is paid. However, there is no assurance that the options will be exercised and the employees will retain the bonuses under all circumstances. During the fiscal year ended June 30, 2007, we also recorded approximately $13.9 million to compensate certain option holders whose employment had terminated, or who had already exercised 409A Affected Options, for the additional taxes they incurred under IRC Section 409A (and, as applicable, similar state tax laws).
Three of the Company’s option holders were subject to the December 31, 2006 deadline described above. Accordingly, in December 2006, the Company offered to amend the 409A Affected Options held by Mr. Wallace, the Company’s Chief Executive Officer, and two former executive officers to increase the exercise price so that these options will not subject the option holder to a penalty tax under IRC Section 409A. All three individuals accepted the Company’s offer. In addition, the Company agreed to pay each of the three individuals a cash bonus in January 2008 equal to the aggregate increase in the exercise prices for his amended options. For Mr. Wallace, the amount of this bonus is $0.4 million. To account for these actions, the Company has recorded a charge of $0.3 million, net of amount reclassified from capital in excess of par, during the fiscal year ended June 30, 2007. We are involved in several litigation cases as described in Note 12, “Litigation and Other Legal Matters” to the Consolidated Financial Statements. We cannot predict the outcome of these cases, and we cannot estimate the likelihood or potential dollar amount of any adverse results.
Working capital increaseddecreased to $2.5 billion$2,179.6 million as of June 30, 2006,2007, compared to $2.3 billion at$2,594.5 million as of June 30, 2005. At2006. This decrease is primarily due to cash payments for the ASR program and acquisitions in the fiscal year ended June 30, 2006,2007. As of June 30, 2007, our principal sources of liquidity consisted of $2.3 billion$1,710.6 million of cash, cash equivalents, and marketable securities. Our liquidity is affected by many factors, some of which are based on the normal ongoing operations of the business, and others of which relate to the uncertainties of global economies and the semiconductor and the semiconductor equipment industries. Although cash requirements will fluctuate based on the timing and extent of these factors, we believe that cash generated from operations, together with the liquidity
provided by existing cash balances, will be sufficient to satisfy our liquidity requirements for at least the next twelve months.
Off-Balance Sheet Arrangements
Under our foreign-currency risk management strategy, we utilize derivative instruments to protect our interests from unanticipated fluctuations in earnings and cash flows caused by volatility in currency exchange rates. This financial exposure is monitored and managed as an integral part of our overall risk management program which focuses on the unpredictability of financial markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on our operating results. We continue our policy of hedging our current and anticipatedforecasted foreign currency exposures with hedging instruments having tenors of up to twelve18 months. At June 30, 2006, we had cash flowThe outstanding hedge contracts, maturing throughout fiscal year 2007 to sell $167.5 million and purchase $15.2 million, in foreign currency, primarily in Japanese Yen. At June 30, 2006, we had other foreign currency hedge contracts maturing throughout fiscal year 2007 to sell $260.2 million and purchase $128.4 million, in foreign currency, primarily in Japanese Yen.with maximum maturity of 13 months, were as follows:
As of June 30, | ||||||||
(in thousands) | 2007 | 2006 | ||||||
Cash flow hedge contracts | ||||||||
Purchase | $ | 4,651 | $ | 15,173 | ||||
Sell | (242,942 | ) | (167,525 | ) | ||||
Other foreign currency hedge contracts | ||||||||
Purchase | 126,992 | 128,406 | ||||||
Sell | (265,378 | ) | (260,165 | ) | ||||
Net | $ | (376,677 | ) | $ | (284,111 | ) | ||
ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK |
We are exposed to financial market risks, including changes in interest rates, foreign currency exchange rates and marketable equity security prices. To mitigate these risks, we utilize derivative financial instruments, such as foreign currency hedges. We do not use derivative financial instruments for speculative or trading purposes. All of the potential changes noted below are based on sensitivity analyses performed on our financial position atas of June 30, 2006.2007. Actual results may differ materially.
As of June 30, 2006,2007, we had an investment portfolio of fixed income securities of $1.2 billion,$988.1 million, excluding those classified as cash and cash equivalents (detail of these securities is included in Note 4 of3, “Marketable Securities” to the Notes to Consolidated Financial Statements found under Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K). These securities, as with all fixed income instruments, are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10% from levels as of June 30, 2006,2007, the fair value of the portfolio would decline by $7$5.1 million.
As of June 30, 2006,2007, we had net forward contracts to sell $284$376.7 million in foreign currency in order to hedge certain currency exposures (detail of these contracts and Hedging Activitieshedging activities is included in Note 13, “Derivative Instruments and Hedging Activities” to the Consolidated Financial Statements under “Derivative Instruments”)Statements). If we had entered into these contracts on June 30, 2006,2007, the U.S. dollar equivalent would be $288have been $365.0 million. A 10% adverse move in all currency exchange rates affecting the contracts would decrease the fair value of the contracts by $39$50.3 million. However, if this occurred, the fair value of the underlying exposures hedged by the contracts would increase by a similar amount. Accordingly, we believe that, as a result of the hedging of certain of our foreign currency exposure, changes in most relevant foreign currency exchange rates should have no material impact on income or cash flows.
ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
Consolidated Balance Sheets as of June 30, | ||
51 | ||
90 |
As of June 30, | |||||||
(in thousands, except per share data) | 2006 | 2005 | |||||
As restated(1) | |||||||
ASSETS | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 1,129,191 | $ | 663,163 | |||
Marketable securities | 1,196,605 | 1,532,023 | |||||
Accounts receivable, net | 439,899 | 333,218 | |||||
Inventories | 449,156 | 359,840 | |||||
Deferred income taxes | 253,811 | 263,212 | |||||
Other current assets | 74,581 | 50,435 | |||||
Total current assets | 3,543,243 | 3,201,891 | |||||
Land, property and equipment, net | 395,412 | 385,921 | |||||
Other assets | 637,256 | 452,791 | |||||
Total assets | $ | 4,575,911 | $ | 4,040,603 | |||
LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||
Current liabilities: | |||||||
Accounts payable | $ | 95,192 | $ | 67,717 | |||
Deferred system profit | 226,142 | 212,137 | |||||
Unearned revenue | 80,543 | 80,772 | |||||
Other current liabilities | 600,604 | 576,063 | |||||
Total current liabilities | 1,002,481 | 936,689 | |||||
Commitments and contingencies (Note 12) | |||||||
Minority interest in subsidiary | 5,439 | 7,244 | |||||
Stockholders’ equity: | |||||||
Preferred stock, $0.001 par value, 1,000 shares authorized, none outstanding | — | — | |||||
Common stock, $0.001 par value, 500,000 shares authorized, 199,144 and 196,624 shares issued and outstanding | 199 | 196 | |||||
Capital in excess of par value | 1,421,174 | 1,281,318 | |||||
Deferred stock-based compensation | — | (53,723 | ) | ||||
Retained earnings | 2,137,710 | 1,852,606 | |||||
Accumulated other comprehensive income | 8,908 | 16,273 | |||||
Total stockholders’ equity | 3,567,991 | 3,096,670 | |||||
Total liabilities and stockholders’ equity | $ | 4,575,911 | $ | 4,040,603 | |||
As of June 30, | ||||||
(in thousands, except per share data) | 2007 | 2006 | ||||
ASSETS | ||||||
Current assets: | ||||||
Cash and cash equivalents | $ | 722,511 | $ | 1,129,191 | ||
Marketable securities | 988,118 | 1,196,605 | ||||
Accounts receivable, net | 581,500 | 439,899 | ||||
Inventories, net | 535,370 | 449,156 | ||||
Deferred income taxes | 339,133 |
| 307,561 | |||
Other current assets | 86,139 | 74,581 | ||||
Total current assets | 3,252,771 | 3,596,993 | ||||
Land, property and equipment, net | 382,240 | 395,412 | ||||
Goodwill | 311,856 | 49,292 | ||||
Purchased intangibles, net | 175,432 | 21,049 | ||||
Other assets | 500,950 |
| 513,165 | |||
Total assets | $ | 4,623,249 | $ | 4,575,911 | ||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||
Current liabilities: | ||||||
Accounts payable | $ | 92,165 | $ | 95,192 | ||
Deferred system profit | 201,747 | 226,142 | ||||
Unearned revenue | 99,254 | 80,543 | ||||
Other current liabilities | 680,041 | 600,604 | ||||
Total current liabilities | 1,073,207 | 1,002,481 | ||||
Commitments and contingencies (Note 11 and 12) | ||||||
Minority interest in subsidiary | — | 5,439 | ||||
Stockholders’ equity: | ||||||
Preferred stock, $0.001 par value, 1,000 shares authorized, none outstanding | — | — | ||||
Common stock, $0.001 par value, 500,000 shares authorized, 230,599 and 223,266 shares issued, 191,364 and 199,144 shares outstanding, as of June 30, 2007 and June 30, 2006, respectively | 191 | 199 | ||||
Capital in excess of par value | 967,695 | 1,421,174 | ||||
Retained earnings | 2,570,751 | 2,137,710 | ||||
Accumulated other comprehensive income | 11,405 | 8,908 | ||||
Total stockholders’ equity | 3,550,042 | 3,567,991 | ||||
Total liabilities and stockholders’ equity | $ | 4,623,249 | $ | 4,575,911 | ||
See accompanying notes to consolidated financial statements.
Consolidated Statements of Operations
Year ended June 30, | |||||||||
(in thousands, except per share data) | 2006 | 2005 | 2004 | ||||||
As restated(1) | As restated(1) | ||||||||
Revenues: | |||||||||
Product | $ | 1,713,237 | $ | 1,767,676 | $ | 1,200,160 | |||
Service | 357,390 | 314,202 | 297,058 | ||||||
Total revenues | 2,070,627 | 2,081,878 | 1,497,218 | ||||||
Costs and operating expenses: | |||||||||
Costs of revenues* | 942,091 | 871,000 | 684,483 | ||||||
Engineering, research and development* | 393,823 | 351,984 | 298,507 | ||||||
Selling, general and administrative* | 424,922 | 313,774 | 270,598 | ||||||
Total costs and operating expenses | 1,760,836 | 1,536,758 | 1,253,588 | ||||||
Income from operations | 309,791 | 545,120 | 243,630 | ||||||
Interest income and other, net | 68,067 | 37,956 | 26,758 | ||||||
Income before income taxes and minority interest | 377,858 | 583,076 | 270,388 | ||||||
Provision for income taxes | 1,507 | 141,405 | 57,912 | ||||||
Income before minority interest | 376,351 | 441,671 | 212,476 | ||||||
Minority interest | 4,101 | 3,378 | — | ||||||
Net income | $ | 380,452 | $ | 445,049 | $ | 212,476 | |||
Net income per share: | |||||||||
Basic | $ | 1.92 | $ | 2.27 | $ | 1.09 | |||
Diluted | $ | 1.86 | $ | 2.21 | $ | 1.05 | |||
Weighted-average number of shares: | |||||||||
Basic | 198,625 | 196,346 | 194,976 | ||||||
Diluted | 204,097 | 201,126 | 202,302 | ||||||
* includes the following amounts related to equity awards | |||||||||
Costs of revenues | $ | 29,620 | $ | 9,167 | $ | 11,450 | |||
Engineering, research and development | 49,509 | 12,255 | 17,866 | ||||||
Selling, general and administrative | 85,613 | 15,580 | 23,892 |
Year ended June 30, | |||||||||
(in thousands, except per share data) | 2007 | 2006 | 2005 | ||||||
Revenues: | |||||||||
Product | $ | 2,308,942 | $ | 1,713,237 | $ | 1,767,676 | |||
Service | 422,287 | 357,390 | 314,202 | ||||||
Total revenues | 2,731,229 | 2,070,627 | 2,081,878 | ||||||
Costs and operating expenses: | |||||||||
Costs of revenues* | 1,190,323 | 942,091 | 871,000 | ||||||
Engineering, research and development* | 437,513 | 393,823 | 351,984 | ||||||
Selling, general and administrative* | 513,525 | 424,922 | 313,774 | ||||||
Total costs and operating expenses | 2,141,361 | 1,760,836 | 1,536,758 | ||||||
Income from operations | 589,868 | 309,791 | 545,120 | ||||||
Interest income and other, net | 87,367 | 68,067 | 37,956 | ||||||
Income before income taxes and minority interest | 677,235 | 377,858 | 583,076 | ||||||
Provision for income taxes | 150,509 | 1,507 | 141,405 | ||||||
Income before minority interest | 526,726 | 376,351 | 441,671 | ||||||
Minority interest | 1,372 | 4,101 | 3,378 | ||||||
�� | |||||||||
Net income | $ | 528,098 | $ | 380,452 | $ | 445,049 | |||
Net income per share: | |||||||||
Basic | $ | 2.68 | $ | 1.92 | $ | 2.27 | |||
Diluted | $ | 2.61 | $ | 1.86 | $ | 2.21 | |||
Weighted-average number of shares: | |||||||||
Basic | 197,126 | 198,625 | 196,346 | ||||||
Diluted | 202,204 | 204,097 | 201,126 | ||||||
* includes the following amounts related to equity awards | |||||||||
Costs of revenues | $ | 29,183 | $ | 29,620 | $ | 9,167 | |||
Engineering, research and development | 42,431 | 49,509 | 12,255 | ||||||
Selling, general and administrative | 37,164 | 85,613 | 15,580 |
See accompanying notes to consolidated financial statements.
Consolidated Statements of Stockholders’ Equity
Common Stock and Capital in Excess of Par Value | Retained Earnings | Deferred Stock-Based Compensation | Accumulated Comprehensive | Total Stockholders’ | |||||||||||||||||||
(in thousands) | Shares | Amount | |||||||||||||||||||||
Balances at June 30, 2003, as reported | 191,733 | $ | 814,968 | $ | 1,396,886 | $ | — | $ | 3,687 | $ | 2,215,541 | ||||||||||||
Cumulative effect of restatements | — | 356,439 | (178,161 | ) | (129,685 | ) | — | 48,593 | |||||||||||||||
Balances at June 30, 2003, as restated(1) | 191,733 | 1,171,407 | 1,218,725 | (129,685 | ) | 3,687 | 2,264,134 | ||||||||||||||||
Components of comprehensive income: | |||||||||||||||||||||||
Net income | — | — | 212,476 | — | — | 212,476 | |||||||||||||||||
Change in unrealized gain on investments | — | — | — | — | (9,724 | ) | (9,724 | ) | |||||||||||||||
Currency translation adjustments | — | — | — | — | 10,009 | 10,009 | |||||||||||||||||
Deferred gains on cash flow hedging instruments | — | — | — | — | (1,813 | ) | (1,813 | ) | |||||||||||||||
Total comprehensive income | 210,948 | ||||||||||||||||||||||
Net issuance under employee stock plans | 6,278 | 168,812 | — | — | — | 168,812 | |||||||||||||||||
Repurchase and retirement of common stock | (1,175 | ) | (55,806 | ) | — | — | — | (55,806 | ) | ||||||||||||||
Stock-based compensation | — | (7,085 | ) | — | 59,381 | — | 52,296 | ||||||||||||||||
Tax benefits of stock option transactions | — | 40,005 | — | — | — | 40,005 | |||||||||||||||||
Balances at June 30, 2004, as restated(1) | 196,836 | 1,317,333 | 1,431,201 | (70,304 | ) | 2,159 | 2,680,389 | ||||||||||||||||
Components of comprehensive income: | |||||||||||||||||||||||
Net income | — | — | 445,049 | — | — | 445,049 | |||||||||||||||||
Change in unrealized gain on investments | — | — | — | — | 5,315 | 5,315 | |||||||||||||||||
Currency translation adjustments | — | — | — | — | 3,929 | 3,929 | |||||||||||||||||
Deferred gains on cash flow hedging instruments | — | — | — | — | 4,870 | 4,870 | |||||||||||||||||
Total comprehensive income | 459,163 | ||||||||||||||||||||||
Net issuance under employee stock plans | 4,734 | 133,602 | — | — | — | 133,602 | |||||||||||||||||
Repurchase and retirement of common stock | (4,946 | ) | (203,658 | ) | — | — | — | (203,658 | ) | ||||||||||||||
Cash dividends paid ($0.12 per share) | — | — | (23,644 | ) | — | — | (23,644 | ) | |||||||||||||||
Stock-based compensation | — | 18,525 | — | 16,581 | — | 35,106 | |||||||||||||||||
Tax benefits of stock option transactions | — | 15,134 | — | — | — | 15,134 | |||||||||||||||||
Other | — | 578 | — | — | — | 578 | |||||||||||||||||
Balances at June 30, 2005, as restated(1) | 196,624 | 1,281,514 | 1,852,606 | (53,723 | ) | 16,273 | 3,096,670 | ||||||||||||||||
Elimination of deferred stock-based compensation upon adoption of SFAS No. 123(R) | — | (53,723 | ) | — | 53,723 | — | — | ||||||||||||||||
Components of comprehensive income: | |||||||||||||||||||||||
Net income | — | — | 380,452 | — | 380,452 | ||||||||||||||||||
Change in unrealized gain on investments | — | — | — | — | (5,271 | ) | (5,271 | ) | |||||||||||||||
Currency translation adjustments | — | — | — | — | 1,297 | 1,297 | |||||||||||||||||
Deferred gains on cash flow hedging instruments | — | — | — | — | (3,391 | ) | (3,391 | ) | |||||||||||||||
Total comprehensive income | 373,087 | ||||||||||||||||||||||
Net issuance under employee stock plans | 7,044 | 212,653 | — | — | — | 212,653 | |||||||||||||||||
Repurchase and retirement of common stock | (4,524 | ) | (221,417 | ) | — | — | — | (221,417 | ) | ||||||||||||||
Cash dividends paid ($0.48 per share) | — | — | (95,348 | ) | — | — | (95,348 | ) | |||||||||||||||
Stock-based compensation | — | 170,474 | — | — | — | 170,474 | |||||||||||||||||
Tax benefits of stock option transactions | — | 31,872 | — | — | — | 31,872 | |||||||||||||||||
Balances at June 30, 2006 | 199,144 | $ | 1,421,373 | $ | 2,137,710 | $ | — | $ | 8,908 | $ | 3,567,991 | ||||||||||||
Common Stock and Par Value | Retained Earnings | Deferred Compensation | Accumulated Income | Total Equity | |||||||||||||||||||
(in thousands) | Shares | Amount | |||||||||||||||||||||
Balances at June 30, 2004 | 196,836 | $ | 1,317,333 | $ | 1,431,201 | $ | (70,304 | ) | $ | 2,159 | $ | 2,680,389 | |||||||||||
Components of comprehensive income: | |||||||||||||||||||||||
Net income | — | — | 445,049 | — | — | 445,049 | |||||||||||||||||
Change in unrealized gain on investments | — | — | — | — | 5,315 | 5,315 | |||||||||||||||||
Currency translation adjustments | — | — | — | — | 3,929 | 3,929 | |||||||||||||||||
Deferred gains on cash flow hedging instruments | — | — | — | — | 4,870 | 4,870 | |||||||||||||||||
Total comprehensive income | 459,163 | ||||||||||||||||||||||
Net issuance under employee stock plans | 4,734 | 133,602 | — | — | — | 133,602 | |||||||||||||||||
Repurchase of common stock | (4,946 | ) | (203,658 | ) | — | — | — | (203,658 | ) | ||||||||||||||
Cash dividends paid ($0.12 per share) | — | — | (23,644 | ) | — | — | (23,644 | ) | |||||||||||||||
Stock-based compensation | — | 18,525 | — | 16,581 | — | 35,106 | |||||||||||||||||
Tax benefits of stock option transactions | — | 15,134 | — | — | — | 15,134 | |||||||||||||||||
Other | — | 578 | — | — | — | 578 | |||||||||||||||||
Balances at June 30, 2005 | 196,624 | 1,281,514 | 1,852,606 | (53,723 | ) | 16,273 | 3,096,670 | ||||||||||||||||
Elimination of deferred stock-based compensation upon adoption of SFAS No. 123(R) | — | (53,723 | ) | — | 53,723 | — | — | ||||||||||||||||
Components of comprehensive income: | |||||||||||||||||||||||
Net income | — | — | 380,452 | — | — | 380,452 | |||||||||||||||||
Change in unrealized gain on investments | — | — | — | — | (5,271 | ) | (5,271 | ) | |||||||||||||||
Currency translation adjustments | — | — | — | — | 1,297 | 1,297 | |||||||||||||||||
Deferred gains on cash flow hedging instruments | — | — | — | — | (3,391 | ) | (3,391 | ) | |||||||||||||||
Total comprehensive income | 373,087 | ||||||||||||||||||||||
Net issuance under employee stock plans | 7,044 | 212,653 | — | — | — | 212,653 | |||||||||||||||||
Repurchase of common stock | (4,524 | ) | (221,417 | ) | — | — | — | (221,417 | ) | ||||||||||||||
Cash dividends paid ($0.48 per share) | — | — | (95,348 | ) | — | — | (95,348 | ) | |||||||||||||||
Stock-based compensation | — | 170,474 | — | — | — | 170,474 | |||||||||||||||||
Tax benefits of stock option transactions | — | 31,872 | — | — | — | 31,872 | |||||||||||||||||
Balances at June 30, 2006 | 199,144 | 1,421,373 | 2,137,710 | — | 8,908 | 3,567,991 | |||||||||||||||||
Components of comprehensive income: | |||||||||||||||||||||||
Net income | — | — | 528,098 | — | — | 528,098 | |||||||||||||||||
Change in unrealized gain on investments | — | — | — | — | 2,152 | 2,152 | |||||||||||||||||
Currency translation adjustments | — | — | — | — | (1,604 | ) | (1,604 | ) | |||||||||||||||
Deferred losses on cash flow hedging instruments | — | — | — | — | 5,395 | 5,395 | |||||||||||||||||
Total comprehensive income | 534,041 | ||||||||||||||||||||||
Defined benefit obligation upon adoption of SFAS 158, net of tax | — | — | — | — | (3,446 | ) | (3,446 | ) | |||||||||||||||
Net issuance under employee stock plans | 7,323 | 263,245 | — | — | — | 263,245 | |||||||||||||||||
Repurchase of common stock | (15,103 | ) | (808,461 | ) | — | — | — | (808,461 | ) | ||||||||||||||
Cash dividends paid ($0.48 per share) | — | — | (95,057 | ) | — | — | (95,057 | ) | |||||||||||||||
Stock-based compensation | — | 86,261 | — | — | — | 86,261 | |||||||||||||||||
Tax benefits of stock option transactions | — | 3,868 | — | — | — | 3,868 | |||||||||||||||||
Stock options assumed from acquisitions and other | — | 1,600 | — | — | — | 1,600 | |||||||||||||||||
Balances at June 30, 2007 | 191,364 | $ | 967,886 | $ | 2,570,751 | $ | — | $ | 11,405 | $ | 3,550,042 | ||||||||||||
See accompanying notes to consolidated financial statements.
Consolidated Statements of Cash Flows
Year Ended June 30, | ||||||||||||
(in thousands) | 2006 | 2005 | 2004 | |||||||||
As restated(1) | As restated(1) | |||||||||||
Cash flows from operating activities: | ||||||||||||
Net income | $ | 380,452 | $ | 445,049 | $ | 212,476 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
Depreciation and amortization | 69,436 | 70,153 | 82,226 | |||||||||
Non-cash, stock-based compensation | 164,742 | 37,002 | 53,208 | |||||||||
Minority interest | (4,101 | ) | (3,378 | ) | ||||||||
Net loss (gain) on sale of marketable securities and other investments | 8,173 | 3,204 | (8,889 | ) | ||||||||
Deferred income taxes | (134,384 | ) | (53,497 | ) | (29,055 | ) | ||||||
Tax benefit from employee stock options | 31,872 | 15,134 | 40,005 | |||||||||
Excess tax benefit from stock-based compensation cost | (14,417 | ) | — | — | ||||||||
Changes in assets and liabilities, net of assets acquired and liabilities assumed in business combinations: | ||||||||||||
Accounts receivable, net | (114,928 | ) | 36,645 | (149,240 | ) | |||||||
Inventories | (87,676 | ) | (18,295 | ) | (76,135 | ) | ||||||
Other assets | (36,340 | ) | (33,254 | ) | (26,291 | ) | ||||||
Accounts payable | 27,053 | 2,751 | 30,104 | |||||||||
Deferred system profit | 14,005 | (70,813 | ) | 107,478 | ||||||||
Other current liabilities | 11,282 | 76,034 | 113,790 | |||||||||
Net cash provided by operating activities | 315,169 | 506,735 | 349,677 | |||||||||
Cash flows from investing activities: | ||||||||||||
Acquisitions of businesses, net of cash received | (7,664 | ) | (44,628 | ) | — | |||||||
Purchase of property, plant and equipment | (73,810 | ) | (59,675 | ) | (55,528 | ) | ||||||
Purchase of available-for-sale securities | (4,625,243 | ) | (3,537,460 | ) | (2,968,900 | ) | ||||||
Proceeds from sale of available-for-sale securities | 4,735,225 | 3,183,368 | 2,381,876 | |||||||||
Proceeds from maturity of available-for-sale securities | 196,562 | 333,797 | 202,035 | |||||||||
Net cash provided by (used in) investing activities | 225,070 | (124,598 | ) | (440,517 | ) | |||||||
Cash flows from financing activities: | ||||||||||||
Issuance of common stock | 212,653 | 133,602 | 168,812 | |||||||||
Payment of dividends to stockholders | (95,348 | ) | (23,644 | ) | — | |||||||
Excess tax benefit from stock-based compensation cost | 14,417 | — | — | |||||||||
Stock repurchases | (221,417 | ) | (203,658 | ) | (55,806 | ) | ||||||
Proceeds from sale of minority interest in subsidiary | 4,736 | 12,631 | — | |||||||||
Net cash (used in) provided by financing activities | (84,959 | ) | (81,069 | ) | 113,006 | |||||||
Effect of exchange rate changes on cash and cash equivalents | 10,748 | 8,213 | 6,968 | |||||||||
Net increase in cash and cash equivalents | 466,028 | 309,281 | 29,134 | |||||||||
Cash and cash equivalents at beginning of period | 663,163 | 353,882 | 324,748 | |||||||||
Cash and cash equivalents at end of period | $ | 1,129,191 | $ | 663,163 | $ | 353,882 | ||||||
Supplemental cash flow disclosures: | ||||||||||||
Income taxes paid, net | $ | 131,436 | $ | 185,315 | $ | 11,899 | ||||||
Interest paid | $ | 1,614 | $ | 1,114 | $ | 647 |
Year Ended June 30, | ||||||||||||
(in thousands) | 2007 | 2006 | 2005 | |||||||||
Cash flows from operating activities: | ||||||||||||
Net income | $ | 528,098 | $ | 380,452 | $ | 445,049 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
Depreciation and amortization | 109,290 | 69,436 | 70,153 | |||||||||
Impairment charges | 67,550 | — | — | |||||||||
Non-cash, stock-based compensation | 99,635 | 164,742 | 37,002 | |||||||||
Minority interest | (1,372 | ) | (4,101 | ) | (3,378 | ) | ||||||
Net loss (gain) on sale of marketable securities and other investments | (2,298 | ) | 8,173 | 3,204 | ||||||||
Deferred income taxes | (13,944 | ) | (134,384 | ) | (53,497 | ) | ||||||
Tax benefit from employee stock options | 3,868 | 31,872 | 15,134 | |||||||||
Excess tax benefit from stock-based compensation cost | (7,046 | ) | (14,417 | ) | — | |||||||
Changes in assets and liabilities, net of assets acquired and liabilities assumed in business combinations: | ||||||||||||
Accounts receivable, net | (107,345 | ) | (114,928 | ) | 36,645 | |||||||
Inventories | 9,015 | (87,676 | ) | (18,295 | ) | |||||||
Other assets | (19,439 | ) | (36,340 | ) | (33,254 | ) | ||||||
Accounts payable | (45,562 | ) | 27,053 | 2,751 | ||||||||
Deferred system profit | (24,395 | ) | 14,005 | (70,813 | ) | |||||||
Other current liabilities | 14,631 | 11,282 | 76,034 | |||||||||
Net cash provided by operating activities | 610,686 | 315,169 | 506,735 | |||||||||
Cash flows from investing activities: | ||||||||||||
Acquisitions of businesses, net of cash received | (521,693 | ) | (7,664 | ) | (44,628 | ) | ||||||
Purchase of property, plant and equipment | (83,782 | ) | (73,810 | ) | (59,675 | ) | ||||||
Purchase of available-for-sale securities | (3,299,976 | ) | (4,625,243 | ) | (3,537,460 | ) | ||||||
Proceeds from sale of available-for-sale securities | 3,298,635 | 4,735,225 | 3,183,368 | |||||||||
Proceeds from maturity of available-for-sale securities | 207,548 | 196,562 | 333,797 | |||||||||
Net cash provided by (used in) investing activities | (399,268 | ) | 225,070 | (124,598 | ) | |||||||
Cash flows from financing activities: | ||||||||||||
Issuance of common stock | 263,245 | 212,653 | 133,602 | |||||||||
Payment of dividends to stockholders | (95,057 | ) | (95,348 | ) | (23,644 | ) | ||||||
Excess tax benefit from stock-based compensation cost | 7,046 | 14,417 | — | |||||||||
Stock repurchases | (808,461 | ) | (221,417 | ) | (203,658 | ) | ||||||
Proceeds from sale of minority interest in subsidiary | — | 4,736 | 12,631 | |||||||||
Net cash used in financing activities | (633,227 | ) | (84,959 | ) | (81,069 | ) | ||||||
Effect of exchange rate changes on cash and cash equivalents | 15,129 | 10,748 | 8,213 | |||||||||
Net increase (decrease) in cash and cash equivalents | (406,680 | ) | 466,028 | 309,281 | ||||||||
Cash and cash equivalents at beginning of period | 1,129,191 | 663,163 | 353,882 | |||||||||
Cash and cash equivalents at end of period | $ | 722,511 | $ | 1,129,191 | $ | 663,163 | ||||||
Supplemental cash flow disclosures: | ||||||||||||
Income taxes paid, net | $ | 209,513 | $ | 131,436 | $ | 185,315 | ||||||
Interest paid | $ | 2,172 | $ | 1,614 | $ | 1,114 |
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Operations and Principles of Consolidation.KLA-Tencor Corporation (“KLA-Tencor” or the “Company”) is a global provider of process control and yield management solutions for the semiconductor manufacturing and related microelectronics industries. Headquartered in San Jose, California, KLA-Tencor has subsidiaries both in the United States and in key markets throughout the world.
The Consolidated Financial Statements include the accounts of KLA-Tencor and its majority-owned subsidiaries, and the ownership interests of minority investors are recorded as minority interests. All significant intercompany balances and transactions have been eliminated.
Management Estimates.The preparation of the Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Fair Value of Financial Instruments.KLA-Tencor has evaluated the estimated fair value of financial instruments using available market information and valuation methodologies as provided by the custodian. The use of different market assumptions and/or estimation methodologies could have a significant effect on the estimated fair value amounts. The fair value of KLA-Tencor’s cash, cash equivalents, accounts receivable, accounts payable and other current liabilities approximate their carrying amounts due to the relatively short maturity of these items.
Cash Equivalents and Marketable Securities. All highly liquid debt instruments with original or remaining maturities of less than three months at the date of purchase are considered to be cash equivalents. Marketable securities are generally classified as available-for-sale for use in current operations if required and are reported at fair value, with unrealized gains and losses, net of tax, presented as a separate component of accumulated other comprehensive income. The fair value of marketable securities is based on quoted market prices. All realized gains and losses and unrealized losses and declines in fair value that are other than temporary are recorded in earnings in the period of occurrence. The specific identification method is used to determine the realized gains and losses on investments.
Non-Marketable Equity Securities and Other Investments.KLA-Tencor acquires certain equity investments for the promotion of business and strategic objectives, and to the extent these investments continue to have strategic value, KLA-Tencor typically does not attempt to reduce or eliminate the inherent market risks. Non-marketable equity securities and other investments are recorded at historical cost. If KLA-Tencor has the ability to exercise significant influence over the investee, but does not have control, KLA-Tencor’s proportionate share of income or losses from investments is accounted for under the equity method and any gain or loss is recorded in interest income and other, net. Non-marketable equity securities equity-method investments, and other investments are included in “Other assets” on the balance sheet. Non-marketable equity securities are subject to a periodic impairment review; however, there are no open-market valuations, and the impairment analysis requires significant judgment. This analysis includes assessment of the investee’s financial condition, the business outlook for its products and technology, its projected results and cash flow, the likelihood of obtaining subsequent rounds of financing and the impact of any relevant contractual equity preferences held by KLA-Tencor or others. If
Variable Interest Entities.FASB Interpretation No. (“FIN”) 46(R),Consolidation of Variable Interest Entities, an investee obtains additional funding atinterpretation of ARB No. 51, requires that if the Company is the primary beneficiary of a valuation lower than KLA-Tencor’s carrying amount, itvariable interest entity, the assets, liabilities, and results of operations of the variable interest entity should be included in the Company’s consolidated financial statements. KLA-Tencor has concluded that none of the Company’s equity investments are material to the Company’s financial position and do not require consolidation as they are either not variable interest entities or, in the event they are variable interest entities, that KLA-Tencor is presumed thatnot considered to be the investment is other than temporarily impaired, unless specific facts and circumstances indicate otherwise, for example if KLA-Tencor holds contractual rights that include a preference over the rights of other investors.primary beneficiary.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Inventories. Inventories are stated at the lower of cost (on a first-in, first-out basis) or market. Demonstration units are stated at their manufacturing cost and reserves are recorded to state the demonstration
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
units at their net realizable value. KLA-Tencor reviews the adequacy of its inventory reserves on a quarterly basis. The Company reviews and sets standard costs semi-annually at current manufacturing costs in order to approximate actual costs. The Company’s manufacturing overhead standards for product costs are calculated assuming full absorption of forecasted spending over projected volumes, adjusted for excess capacity. Abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage) are recognized as current period charges. The Company writes down product inventory based on forecasted demand and technological obsolescence.obsolescence and parts inventory based on past usage. These factors are impacted by market and economic conditions, technology changes, new product introductions and changes in strategic direction and require estimates that may include uncertain elements. Actual demand may differ from forecasted demand and such differences may have a material effect on recorded inventory values.
Allowance for Doubtful Accounts.A majority of the trade receivables are derived from sales to large multinational semiconductor manufacturers throughout the world. In order to monitor potential credit losses, the Company performs ongoing credit evaluations of our customers’ financial condition. An allowance for doubtful accounts is maintained for probable credit losses based upon the Company’s assessment of the expected collectibility of all accounts receivable. The allowance for doubtful accounts is reviewed on a quarterly basis to assess the adequacy of the allowance.
Property and Equipment.Property and equipment are recorded at cost, net of accumulated depreciation. Depreciation of property and equipment is based on the straight-line method over the estimated useful lives of the assets, which are generally thirty to thirty-five years for buildings, ten to fifteen years for leasehold improvements, five to seven years for furniture and fixtures, and threetwo to five years for machinery and equipment. Leasehold improvements are amortized by the straight-line method over the shorter of the life of the related asset or the term of the underlying lease. Construction in process does not depreciate until the assets are placed in service. Depreciation expense for the fiscal years ended June 30, 2007, 2006 and 2005 and 2004 was $52$58.3 million, $48$52.4 million and $46$48.0 million, respectively.
Goodwill and Intangible Assets.As required by Statement of Financial Accounting Standards (“SFAS”)SFAS No. 142,Goodwill and Other Intangible Assets, goodwill is not amortized but is subject to impairment tests annually, or earlier if indicators of potential impairment exist, using a fair-value-based approach. Purchased technology, patents, trademarks and other intangible assets are presented at cost, net of accumulated amortization. Intangible assets are amortized overon a straight line basis which approximates their estimated useful lives and assessed for impairment under SFAS No. 144.144, Accounting for the Impairment or Disposal of Long-Lived Assets. Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in each business combination. The Company completed its annual evaluation of the goodwill by reporting unit during the quarter ended December 31, 2005,2006, and concluded that there was no impairment. There have been no significant events or circumstances affecting the valuation of goodwill subsequent to the impairment test performed in the second quarter of the fiscal year 2006.ended June 30, 2007.
Impairment of Long-Lived Assets. KLA-Tencor evaluates the carrying value of its long-lived assets whenever events or changes in circumstances indicate that the carrying value of the asset may be impaired in accordance with the provisions of SFAS No. 144, “AccountingAccounting for the Impairment or Disposal of Long-Lived Assets.”Assets. An impairment loss is recognized when estimated future cash flows expected to result from the use of the asset including disposition, is less than the carrying value of the asset. Such an impairment charge would be measured as the excess of the asset over its fair value.
Software Development Costs.KLA-Tencor capitalizes certain internal and external costs incurred to acquire and create internal use software in accordance with AICPA Statement of Position (“SOP”) No. 98-1, “Accounting
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.”Use. Capitalized software is included in property and equipment when development is complete and is depreciated over three to five years when placed in service.
Concentration of Credit Risk.Financial instruments that potentially subject KLA-Tencor to significant concentrations of credit risk consist primarily of cash equivalents, short-term and non-current marketable securities, trade accounts receivable and derivative financial instruments used in hedging activities. KLA-Tencor invests in a variety of financial instruments, such as, but not limited to, certificates of deposit, corporate and municipal bonds, United States Treasury and agency securities, equity securities and, by policy, limits the amount of credit exposure with any one financial institution or commercial issuer. KLA-Tencor has not experienced any material credit losses on its investments.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
A majority of KLA-Tencor’s trade receivables are derived from sales to large multinational semiconductor manufacturers located throughout the world, and inwith a majority located in Asia. Concentration of credit risk with respect to trade receivables is considered to be limited due to itsthe Company’s customer base and the diversity of its geographic sales areas. KLA-Tencor performs ongoing credit evaluations of its customers’ financial condition and generally requires no collateral to secure accounts receivable. KLA-Tencor maintains an allowance for potential credit losses based upon expected collectibility of all accounts receivable. In addition, KLA-Tencor may utilize letters of credit or non-recourse factoring to mitigate credit risk when considered appropriate.
KLA-Tencor is exposed to credit loss in the event of nonperformance by counterparties on the foreign exchange contracts used in hedging activities and in certain factoring transactions. These counterparties are large international financial institutions and to date no such counterparty has failed to meet its financial obligations under such contracts.
Foreign Currency.The functional currencies of KLA-Tencor’s significant foreign subsidiaries are generally the local currencies. Accordingly, all assets and liabilities of the foreign operations are translated to U.S. dollars at current period end exchange rates, and revenues and expenses are translated to U.S. dollars using average exchange rates in effect during the period. The gains and losses from foreign currency translation of these subsidiaries’ financial statements are recorded directly into a separate component of stockholders’ equity under the caption “Accumulated other comprehensive income.”
KLA-Tencor’s subsidiaries in Israel and Singapore use the U.S. dollar as their functional currency. Accordingly, assets and liabilities of these subsidiaries are translated using exchange rates in effect at the end of the period, except for non-monetary assets, such as inventories and property, plant and equipment that are translated using historical exchange rates. Revenues and costs are translated using average exchange rates for the period, except for costs related to those balance sheet items that are translated using historical exchange rates. The resulting translation gains and losses are included in the Consolidated Statements of Operations as incurred.
Derivative Financial Instruments. KLA-Tencor uses financial instruments, such as forward exchange contracts and currency options, to hedge a portion of, but not all, existing and forecasted foreign currency denominated transactions expected to occur within twelve months. The purpose of KLA-Tencor’s foreign currency program is to manage the effect of exchange rate fluctuations on certain foreign currency denominated revenues, costs and eventual cash flows. The effect of exchange rate changes on forward exchange contracts is expected to offset the effect of exchange rate changes on the underlying hedged items. KLA-Tencor believes these financial instruments do not subject itthe Company to speculative risk that would otherwise result from changes in currency exchange rates. KLA-Tencor does not use derivative financial instruments for speculative or trading purposes.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
All of KLA-Tencor’s derivative financial instruments are recorded at fair value based upon quoted market prices for comparable instruments. For derivative instruments designated and qualifying as cash flow hedges of forecasted foreign currency denominated transactions, the effective portion of the gain or loss on these hedges is reported as a component of accumulated other comprehensive income in stockholders’ equity, and is reclassified into earnings when the hedged transaction affects earnings. If the transaction being hedged fails to occur, or if a portion of any derivative is ineffective, the gain or loss on the associated financial instrument is recorded immediately in earnings. For derivative instruments used to hedge existing foreign currency denominated assets or liabilities, the gain or loss on these hedges is recorded immediately in earnings to offset the changes in the fair value of the assets or liabilities being hedged.
Warranty.KLA-Tencor provides standard warranty coverage on its systems for 40 hours per week for twelve months, providing labor and parts necessary to repair the systems during the warranty period. KLA-Tencor accounts for the estimated warranty cost as a charge to costs of revenues when revenue is recognized. The estimated warranty
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
cost is based on historical product performance and field expenses. Utilizing actual service records, KLA-Tencor calculates the average service hours and parts expense per system and applies the actual labor and overhead rates to determine the estimated warranty charge. KLA-Tencor updates these estimated charges every quarter.on a quarterly basis. The actual product performance and/or field expense profiles may differ, and in those cases KLA-Tencor adjusts warranty accruals accordingly (see Note 1211, “Commitments and Contingencies”).
Revenue Recognition.KLA-Tencor recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller’s price is fixed or determinable, and collectibility is reasonably assured. KLA-Tencor derives revenue from fourthree sources—system sales, spare part sales and service contracts and software license fees.contracts. KLA-Tencor recognizes revenue for system sales upon acceptance by the customer that the system has been installed and is operating according to predetermined specifications. This positive affirmation is generally evidenced by an acceptance document signed by the customer. In certain limited cases, KLA-Tencor may recognizealso recognizes revenue without a writtenprior to acceptance from the customer, as follows:
When system sales to independent distributors have no installation requirement, contain no acceptance agreement, and 100% payment is due upon shipment, revenue is recognized on shipment;
When the installation of the system is deemed perfunctory, revenue is recognized upon shipment. The portion of revenue associated with installation is deferred;
When the customer fab has already accepted the same tool, with the same specifications, and it can be objectively demonstrated that it meets all of the required acceptance criteria upon shipment, a portion of revenue can be recognized at the time of shipment. Revenue recognized upon shipment is exclusive of the amount allocable to the installation element. Revenue attributable to the installation element represents the fair value of installation;
When the system is performing in production or R&D and meets all published and contractually agreed specifications, but the customer withholds signature on our acceptance document due to warranty or other issues unrelated to product performance;performance, revenue is recognized when the system is performing as intended and meets all published and contractually agreed specifications;
When the system is damaged during transit, revenue is recognized upon receipt of cash payment from the customer.
Total revenue recognized without a written acceptance from the customer was approximately 4.4%13.5%, 6.6%4.4% and 4.9%6.6% of total revenuerevenues for the fiscal years ended June 30, 2007, 2006 and 2005, respectively. The increase in revenue recognized without a written acceptance is primarily driven by increased shipments of tools that have already met the required acceptance criteria at those customer fabs, and 2004, respectively.an increase in the revenue derived from systems with perfunctory installation. Shipping charges billed to customers are included in system revenue, and the related shipping costs are included in costs of revenues.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
KLA-Tencor also allows for multiple element revenue arrangements in cases where certain elements of a sales contract are not delivered and accepted at the same time. In such cases, KLA-Tencor defers the relative fair value of the undelivered element until that element is delivered to and accepted by the customer. To be considered a separate element, the product or service in question must represent a separate unit of accounting and fulfill the following criteria: (a) the delivered item(s) has value to the customer on a standalone basis; (b) there is objective and reliable evidence of the fair value of the undelivered item(s); and (c) if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the Company. If the arrangement does not meet all the above criteria, the entire amount of the sales contract is deferred until all elements are accepted by the customer.
Spare parts revenue is recognized when the product has been shipped, risk of loss has passed to the customer and collection of the resulting receivable is probable.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Service and maintenance contract revenue is recognized ratably over the term of the maintenance contract. If maintenance is included in an arrangement, which includes a software license agreement, amounts related to maintenance are allocated based on vendor specific objective evidence. Non-standard warranty includes services incremental to the standard 40-hour per week coverage for twelve months. Non-standard warranty is deferred as unearned revenue and is recognized ratably as revenue when the applicable warranty term period commences. Consulting and training revenue is recognized when the related services are performed, and collectibility is reasonably assured.
Revenue from software license fees is typically recognized upon shipment if collection of the resulting receivable is probable, the fee is fixed or determinable, and vendor-specific objective evidence exists to allocate a portion of the total fee to any undelivered elements of the arrangement. Such undelivered elements in these arrangements typically consist of services and/or unspecified software upgrades. If vendor-specific objective evidence does not exist for the undelivered elements of the arrangement, all revenue is deferred until such evidence does exist, or until all elements are delivered, whichever is earlier. In instances where an arrangement to deliver software requires significant modification or customization, license fees are recognized under the percentage of completion method of contract accounting. The Company periodically reviews the software element of its systems in accordance with SOP No. 97-2, “Software Revenue Recognition” and Emerging Issues Task Force (“EITF”) No. 03-05, “Applicability of SOP 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software.”
Trade-in rights are occasionally granted to customers to trade in tools in connection with subsequent purchases. The Company estimates the value of the trade-in right and reduces the revenue of the initial sale.
The deferred system profit balance as of June 30, 2007 and 2006 and 2005 was $226$201.7 million and $212$226.1 million, respectively, and equals the amount of system revenue that was invoiced and due on shipment but deferred, less applicable product and warranty costs. KLA-Tencor also defers the fair value of extended service contracts and of non-standard warranty bundled with equipment sales as unearned revenue. The unearned revenue balance was $81$99.3 and $80.5 million as of June 30, 2007 and 2006, respectively.
Software is incidental to the Company’s products as determined in accordance with SOP No. 97-2,Software Revenue Recognitionand 2005.Emerging Issues Task Force (“EITF”) Issue No. 03-05,Applicability of SOP 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software. The Company periodically reviews the software element of products in accordance with SOP 97-2 and EITF Issue No. 03-05.
Research and Development Costs. Research and development costs are expensed as incurred.
Strategic Development Agreements. Gross engineering, research and development expenses were partially offset by $11$12.7 million, $8$11.4 million and $11$7.9 million in external funding received under certain strategic development programs conducted with several of KLA-Tencor’s customers andprimarily from government grants in the fiscal years ended June 30, 2007, 2006 2005 and 2004,2005, respectively.
Shipping and Handling Costs. Shipping and handling costs are included as a component of cost of sales.
Accounting for Stock-Based Compensation Plans.Prior to July 1, 2005, the Company previously applied Accounting Principles Board (“APB”) Opinion No. 25, “AccountingAccounting for Stock Issued to Employees” and its related Interpretations and provided the required pro forma disclosures of Statement of Financial Accounting Standards (“SFAS”)SFAS No. 123, “AccountingAccounting for Stock-Based Compensation.”Compensation. In accordance with APB Opinion No. 25, a non-cash, stock-based compensation expense was recognized for any options for which the exercise price iswas below the market price on the actual grant date. The charge for such options is equal to the number of option shares multiplied by the difference between the exercise price and the market price on the actual grant date. That expense should have been amortized over the vesting period of the option. Beginning July 1, 2005, the Company has accounted for stock-based compensation using the provisions of SFAS No. 123(R), “Share-Based Payment.” SFAS No. 123(R) establishes accounting for stock-based awards exchanged for employee services. Accordingly, stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
ascharge for the options with an exercise price below the market price on the actual grant date was equal to the number of options multiplied by the difference between the exercise price and the market price of the option shares on the actual grant date. That expense was amortized over the employee’s requisite service period.vesting period of the option.
Pro forma information regarding net income and net income per share is required by SFAS No. 123 and has been determined as if the Company had accounted for its employee stock purchase plan and employee stock option plans under the fair value method of SFAS No. 123.
(in thousands, except per share data) | Year ended June 30, 2005 | |||
Net income | $ | 445,049 | ||
Add: | ||||
Stock-based compensation expense included in reported net income, net of tax | 23,768 | |||
Deduct: | ||||
Total stock-based compensation expense determined under fair value based method for all awards, net of tax | (108,926 | ) | ||
Net income—pro forma | $ | 359,891 | ||
Earnings per share: | ||||
As reported (pro-forma) | ||||
Basic | $ | 2.27 | ||
Diluted | $ | 2.21 | ||
Pro forma | ||||
Basic | $ | 1.83 | ||
Diluted | $ | 1.79 |
Beginning July 1, 2005, the Company has accounted for stock-based compensation using the fair value of stock options based on Black-Scholes option-pricing model, consistent with the provisions of SFAS No. 123(R) and Securities and Exchange Commission Staff Accounting Bulletin (“SAB”) No. 107. The Company elected to adopt the modified prospective application method as provided by SFAS No. 123(R). Accordingly, during the fiscal year ended June 30, 2006, the Company recorded stock-based compensation costexpense totaling the amount that would have been recognized had the fair value method been applied under SFAS No. 123 been applied since the effective date of SFAS No. 123 for the pre-fiscalgrants made before the fiscal year ended June 30, 2006, year grants and under SFAS No. 123(R) for the grants made during the fiscal yearyears ended June 30, 2006 grants.and 2007.
SFAS No. 123(R) requires the use of option pricing models that were not developed for use in valuing employee stock options. The Black-Scholes option-pricing model was developed for use in estimating the fair value of short-lived exchange traded options that have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions, including the option’s expected life and the expected price volatility of the underlying stock. The expected stock price volatility assumption was determined using the implied volatility of the Company’s common stock. The Company determined that implied volatility is more reflective of market conditions and a better indicator of expected volatility than a blended volatility. Prior to the adoption of SFAS No. 123(R), the Company used a combination of historical and implied volatility in deriving the expected volatility assumption.
In November 2005, the FASB issued FASB Staff Position No. 123(R)-3,Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards (“FSP 123R-3”). The Company has elected not to adopt the alternative transition method provided in FSP 123R-3 for calculating the tax effects of stock-based
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
compensation pursuant to SFAS No. 123(R). The Company followed paragraph 81 of SFAS No. 123(R) to calculate the initial pool of excess tax benefits and to determine the subsequent impact on the Additional Paid-in-Capital (“APIC”) pool and Consolidated Statements of Cash Flows of the tax effects of employee stock-based compensation awards that are outstanding upon adoption of SFAS No. 123(R). The Company has elected to ignore the indirect tax effects of share-based compensation deductions when calculating the windfall benefits and recognizes the full effect of these deductions in the income statement in the period in which the taxable event occurs.
Advertising Expenses. Advertising costs are expensed as incurred. Advertising expenses for the fiscal years ended June 30, 2007, 2006 and 2005 and 2004 were $4.9 million, $5.0 million $4.6 million and $3.9$4.6 million, respectively.
Income Taxes. KLA-Tencor accounts for income taxes in accordance with SFAS No. 109, “AccountingAccounting for Income Taxes”, which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. SFAS No. 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that a portion of the deferred tax asset will not be realized. KLA-Tencor has determined that the Company’s future taxable income will be sufficient to recover all of ourits deferred tax assets. However, should there be a change in ourits ability to recover the Company’s deferred tax assets, KLA-Tencor could be required to record a valuation allowance against the Company’s deferred tax assets. This would result in an increase to the Company’s tax provision in the period in which the Company determined that the recovery was not probable.
In addition, the calculation of the Company’s tax liabilities involves dealing with uncertainties in the application of complex tax regulations. KLA-Tencor recognizedrecognizes liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on the Company’sour best estimate of whether, and the extent to which, additional tax payments are probable. If the Company ultimately determines that payment of these amounts is unnecessary, the Company will reverse the liability and recognize a tax benefit during the period in which the Company determines that the liability is no longer necessary. KLA-Tencor will record an additional charge in the Company’s provision for taxes in the period in which the Company determines that the recorded tax liability is less than the Company expects the ultimate assessment to be.
Earnings Per Share. Basic earnings per share (“EPS”) is calculated by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is calculated by using the weighted-average number of common shares outstanding during the period and gives effectincreased to allinclude the number of additional shares of common stock that would have been outstanding if the dilutive potential shares of common sharesstock had been issued. The dilutive effect of outstanding during the period. The reconciling difference between the computation of basicoptions and restricted stock units is reflected in diluted earnings per share presented is the inclusionby application of the dilutive effecttreasury stock method, which includes consideration of stock optionsstock-based compensation required by SFAS No. 123(R) and restricted stock units.
Variable Interest Entities.FASB InterpretationSFAS No. (“FIN”) 46(R) requires that if an entity is the primary beneficiary of a variable interest entity, the assets, liabilities, and results of operations of the variable interest entity should be included in the consolidated financial statements of the entity. KLA-Tencor adopted FIN 46(R) effective March 31, 2004. KLA-Tencor had a minority equity interest in a development stage company for which KLA-Tencor was considered to be the primary beneficiary within the provisions of FIN 46(R)128,Earnings Per Share. KLA-Tencor consolidated this entity as of March 31, 2004. During the quarter ended December 31, 2004, KLA-Tencor acquired the remaining equity outstanding in this entity. Subsequently, KLA-Tencor transferred the assets of this entity to a limited liability corporation in which a third party acquired a minority interest (see Note 6 “Business Combinations”). The impact of the consolidation did not have a material impact on KLA-Tencor’s financial position or results of operations. KLA-Tencor has concluded that none of the Company’s remaining equity investments are material to the Company’s financial position and do not require consolidation as they are either not variable interest entities or, in the event they are variable interest entities, that KLA-Tencor is not considered to be the primary beneficiary.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Contingencies and Litigation.The Company is subject to the possibility of losses from various contingencies. Considerable judgment is necessary to estimate the probability and amount of any loss from such contingencies. An accrual is made when it is probable that a liability has been incurred or an asset has been impaired and the amount of loss can be reasonably estimated. The Company accrues a liability and charges operations for the estimated costs expected to be incurred over the next twelve months of adjudication or settlement of asserted and unasserted claims existing as of the balance sheet date. See Item 3, “Legal Proceedings” and Note 12 to Consolidated Financial Statements11, “Commitments and Contingencies” for a detailed description.
Reclassifications. The Company has reclassified certain prior period balances to conform to the correct presentation. These reclassifications did not impact any prior amounts presented in our consolidated balance sheets, consolidated statementsof reported total assets, total liabilities, stockholders’ equity, results of operations consolidated statements of stockholders’ equity or consolidated statements of cash flows.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Recent Accounting Pronouncements. In September 2006,February 2007, the SEC staffFASB issued Staff Accounting Bulletin (“SAB”)SFAS No. 108, “Considering the Effects159,The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SABFASB Statement No. 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements. SAB No. 108 requires registrants to quantify the impact of correcting all misstatements using both the “rollover” method,115, which focuses primarily on the impact of a misstatement on the income statement and is the method currently used by the Company, and the “iron curtain” method, which focuses primarily on the effect of correcting the period-end balance sheet. The use of both of these methods is referred to as the “dual approach” and should be combined with the evaluation of qualitative elements surrounding the errors in accordance with SAB No. 99, “Materiality.” The provisions of
SAB No. 108 are effective for the Company forin fiscal years beginning July 1, 2006.2008. This statement permits an entity to choose to measure many financial instruments and certain other items at fair value at specified election dates. Subsequent unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings. The adoptionCompany is currently evaluating the potential impact of SAB No. 108 is not expected to have a material impactthis statement on the Company’sits consolidated financial position, results of operations orand cash flows.
In September 2006, the FASB issued SFAS No. 157, “FairFair Value Measurements.”Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of SFAS No. 157 are effective for the Company for fiscal years beginning July 1, 2008. The Company is evaluating the impact of the provisions of this statement on its consolidated financial position, results of operations and cash flows.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” SFAS No. 158 requires employers to fully recognize the obligations associated with single-employer defined benefit pension, retiree healthcare and other post-retirement plans in their financial statements. The provisions of SFAS No. 158 are effective for the Company as of the end of the fiscal year ending June 30, 2007. The Company is evaluating the impact of the provisions of this statement on its consolidated financial position, results of operations and cash flows.
In June 2006, the FASB published FIN 48 “Accounting,Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109”109 which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109,Accounting for Income Taxes. This InterpretationTaxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This InterpretationFIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This InterpretationFIN 48 is effective for the Company in fiscal years beginning July 1, 2007. Any differences between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption will be accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. In addition, the adoption of FIN 48 will result in the reclassification of certain unrecognized tax benefits from current to non-current liabilities in the Company’s statement of financial position. The Company is currently evaluating the potential impact of the provisionsimplementation of this InterpretationFIN 48 on its consolidated financial position, results of operations and cash flows.
In February 2006, the FASB issued SFAS No. 155, “AccountingAccounting for Certain Hybrid Financial Instruments,” an amendment of SFAS No. 133, “AccountingAccounting for Derivative Instruments and Hedging Activities” and SFAS No. 140, “AccountingAccounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.”Liabilities. This Statement permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. This Statement is effective for the Company for all financial
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
instruments acquired or issued after July 1, 2007. The adoption of SFAS No. 155 is not expected to have a material effect on the Company’s consolidated financial position, results of operations or cash flows.
In June 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” a replacement of APB Opinion No. 20, “Accounting Changes,” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS No. 154 changes the requirements for the accounting for and reporting of a change in accounting principle. Previously, most voluntary changes in accounting principles required recognition via a cumulative effect adjustment within net income of the period of the change. SFAS No. 154 requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 is effective for the Company for accounting changes made in fiscal years beginning July 1, 2006; however, the Statement does not change the transition provisions of any existing accounting pronouncements. The adoption of SFAS No. 154 is not expected to have a material effect on the Company’s consolidated financial position, results of operations or cash flows.
In March 2005, the FASB published FIN 47, “Accounting for Conditional Asset Retirement Obligations,” which clarifies that the term, conditional asset retirement obligation, as used in SFAS No. 143, “Accounting for Asset Retirement Obligations,” refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. The uncertainty about the timing and (or) method of settlement of a conditional asset retirement obligation should be factored into the measurement of the liability when sufficient information exists. The Interpretation also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. The adoption of this Interpretation did not have a material effect on the Company’s consolidated financial position, results of operations or cash flows.
In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets,” an amendment of APB Opinion No. 29. SFAS No. 153 addresses the measurement of exchanges of nonmonetary assets and redefines the scope of transactions that should be measured based on the fair value of the assets exchanged. SFAS No. 153 was effective for the Company for nonmonetary asset exchanges beginning in the first quarter of fiscal 2006. The adoption of SFAS No. 153 did not have a material effect on the Company’s consolidated financial position, results of operations or cash flows.
In November 2004, the FASB issued SFAS No. 151, “Inventory Costs,” an amendment of Accounting Research Bulletin (“ARB”) No. 43, Chapter 4. SFAS No. 151 clarifies that abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage) are required to be recognized as current period charges. The provisions of SFAS No.151 are effective for the Company for fiscal years beginning July 1, 2005. The adoption of SFAS No. 151 did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
NOTE 2—RESTATEMENTS OF CONSOLIDATED FINANCIAL STATEMENTS AND SPECIAL COMMITTEE AND COMPANY FINDINGS
Special Committee InvestigationRestatements of Historical Stock Option Practices
On May 22, 2006, the Wall Street Journal published an article about stock option backdating that questioned the stock option practices at several companies, including KLA-Tencor. On May 23, 2006, the Company received a subpoena from the United States Attorney’s Office for the Northern District of California (“USAO”) and a letter of inquiry from the United States Securities and Exchange Commission (“SEC”) regarding the Company’s stock option practices. Later on May 23, 2006, the Board of Directors appointed a Special Committee composed solely of independent directors to conduct a comprehensive investigation of the Company’s historical stock option practices. The Special Committee promptly engaged independent legal counsel and accounting experts to assist with the investigation. The investigation included an extensive review of the Company’s
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
historical stock option practices, accounting policies, accounting records, supporting documentation, email communications and other documentation, as well as interviews of a number of current and former directors, officers and employees. On September 27, 2006, the Special Committee reported the bulk of its findings and recommendations to the Board of Directors.
Findings and Remedial Actions
Prior Period Consolidated Financial Statements in Previous Filings.On September 28, 2006, the Company announced that it would have to restate its previously issued financial statements to correct itsfor past accounting for stock options. As a result of an investigation of the Company’s historical stock option practices by a Special Committee investigation,appointed by the CompanyCompany’s Board of Directors, it was discovered that certain of its stock options, primarily those granted from July 1, 1997 to June 30, 2002, had been retroactively priced for all employees who received these grants. This means that the option exercise price was not the market price of the option shares on the actual grant date of the option, but instead was a lower market price on an earlier date. The actual grant date—when the essential actions necessary to grant the option were completed, including the final determination of the number of shares to be granted to each employee and the exercise price—is the correct measurement date to determine the market price of the option shares under the accounting rules in effect at the time. More than 95% of the total in-the-money value (market price on the actual grant date minus exercise price) of all ofIn the Company’s retroactively priced options was attributable to those granted from July 1, 1997 toAnnual Report on Form 10-K for the fiscal year ended June 30, 2002.
The Company previously applied Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,”2006 (filed on January 29, 2007) and its related Interpretationsquarterly reports on Form 10-Q for the quarters ended September 30, 2006, December 31, 2006 and providedMarch 31, 2007 (filed on January 29, 2007, February 9, 2007 and May 7, 2007, respectively), the required pro forma disclosures under StatementCompany restated (1) its consolidated financial statements as of Financial Accounting Standards (“SFAS”) No. 123, “Accountingand for Stock-Based Compensation,” throughthe fiscal years ended June 30, 2005 and 2004; (2) its selected consolidated financial data as of and for the fiscal years ended June 30, 2005, 2004, 2003 and 2002; and (3) its unaudited quarterly financial data for the first three quarters in the fiscal year ended June 30, 2006 and for all quarters in the fiscal year ended June 30, 2005. Under APB Opinion No. 25, a non-cash, stock-based compensation expense was required to be recognized for any option for which the exercise price was below the market price on the actual grant date. Because each of the Company’s retroactively priced options had an exercise price below the market price on the actual grant date, there should have been a non-cash charge for each of these options under APB Opinion No. 25 equal to the number of option shares, multiplied by the difference between the exercise price and the market price on the actual grant date. That expense should have been amortized over the vesting period of the option. Starting in its fiscal year ended June 30, 2006, the Company adopted SFAS No. 123(R), “Share-Based Payment.” As a result, beginning in fiscal year 2006, the additional stock-based compensation expense required to be recorded for each retroactively priced option is equal to the incremental fair value of the option on the actual grant date, amortized over the remaining vesting period of the option. The Company did not record these stock-based compensation expenses under APB Opinion No. 25 or SFAS No. 123(R) related to its retroactively priced options in the Company’s previously issuedAll financial statements, and that is why the Company is restating theminformation included in this filing. To correctAnnual Report on Form 10-K reflects the Company’s past accounting for stock options, it recorded additional pre-tax, non-cash, stock-based compensation expense of (a) $348 million for the periods July 1, 1994 to June 30, 2005 under APB Opinion No. 25restatement and (b) $22 million for the year ended June 30, 2006 under SFAS No. 123(R). The Company expects to amortize an additional $6 million of such pre-tax charges under SFAS No. 123(R) in future periods to properly account for past retroactively priced stock options.
By October 16, 2006, the Special Committee had substantially completed its investigation. The Special Committee concluded that (1) there was retroactive pricing of stock options granted to all employees who received options, primarily during the periods from July 1, 1997 to June 30, 2002 (less than 15% of these options were granted to executive officers), (2) the retroactively priced options weredoes not accounted for correctly in the Company’s previously issued financial statements, (3) the retroactive pricing of options was intentional, not inadvertent or through administrative error, (4) the retroactive pricing of options involved the selection of fortuitously low exercise prices by certain former executive officers, and other former executives may have been aware of this conduct, (5) the retroactive pricing of options involved the falsification of Company records, resulting in erroneous statements being made in financial and other reports previously filed with the SEC, as wellcontain any further restatement.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
NOTE 2—FINANCIAL STATEMENT COMPONENTS
Consolidated Balance Sheets
As of June 30, | ||||||||
(in thousands) | 2007 | 2006 | ||||||
Accounts receivable, net: | ||||||||
Accounts receivable, gross | $ | 593,229 | $ | 452,007 | ||||
Allowance for doubtful accounts | (11,729 | ) | (12,108 | ) | ||||
$ | 581,500 | $ | 439,899 | |||||
Inventories, net: | ||||||||
Customer service parts | $ | 175,763 | $ | 169,747 | ||||
Raw materials | 155,846 | 100,532 | ||||||
Work-in-process | 105,254 | 91,413 | ||||||
Finished goods and demonstration equipment | 98,507 | 87,464 | ||||||
$ | 535,370 | $ | 449,156 | |||||
Land, property and equipment, net: | ||||||||
Land | $ | 84,456 | $ | 86,408 | ||||
Buildings and improvements | 151,466 | 162,337 | ||||||
Machinery and equipment | 419,840 | 388,113 | ||||||
Office furniture and fixtures | 37,919 | 42,769 | ||||||
Leasehold improvements | 141,236 | 142,587 | ||||||
Construction in process | 17,191 | 12,809 | ||||||
852,108 | 835,023 | |||||||
Less: accumulated depreciation | (469,868 | ) | (439,611 | ) | ||||
$ | 382,240 | $ | 395,412 | |||||
Other assets: | ||||||||
Long-term investments | $ | 179,725 | $ | 164,552 | ||||
Deferred tax assets—long-term | 309,487 |
| 338,278 |
| ||||
Other | 11,738 | 10,335 | ||||||
$ | 500,950 | $ | 513,165 | |||||
Other current liabilities: | ||||||||
Warranty and retrofit | $ | 66,669 | $ | 50,604 | ||||
Compensation and benefits | 332,053 | 281,815 | ||||||
Income taxes payable | 85,993 | 126,750 | ||||||
Other accrued expenses | 195,326 | 141,435 | ||||||
$ | 680,041 | $ | 600,604 | |||||
Accumulated other comprehensive income: | ||||||||
Currency translation adjustments | $ | 11,067 | $ | 12,671 | ||||
Gains (losses) on cash flow hedging instruments, net of taxes (benefits) of $3,269 in 2007 and $(49) in 2006 | 5,266 | (80 | ) | |||||
Unrealized gains (losses) on investments, net of taxes (benefits) of $(1,045) in 2007 and $(2,175) in 2006 | (1,482 | ) | (3,683 | ) | ||||
Adjustment to initially apply FASB Statement No. 158, net of taxes (benefits) of $(2,218) in 2007 | (3,446 | ) | — | |||||
$ | 11,405 | $ | 8,908 | |||||
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
As of fiscal year ended June 30, 2007, the net book value of property and equipment includes assets held for sale of $12.8 million.
Consolidated Statements of Operations
Year ended June 30, | ||||||||||||
(in thousands) | 2007 | 2006 | 2005 | |||||||||
Interest income and other, net: | ||||||||||||
Interest income | $ | 76,201 | $ | 66,417 | $ | 38,783 | ||||||
Interest expense | (2,781 | ) | (2,175 | ) | (1,750 | ) | ||||||
Foreign exchange gains | 14,156 | 13,958 | 4,762 | |||||||||
Realized losses on sale of investments | (1,602 | ) | (8,173 | ) | (3,204 | ) | ||||||
Other | 1,393 | (1,960 | ) | (635 | ) | |||||||
$ | 87,367 | $ | 68,067 | $ | 37,956 | |||||||
NOTE 3—MARKETABLE SECURITIES
The amortized costs and estimated fair value of securities available-for-sale as of June 30, 2007 and 2006 are as follows:
As of June 30, 2007 (in thousands) | Gross Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Gross Fair Value | |||||||||
U.S. Treasuries | $ | — | $ | — | $ | — | $ | — | |||||
U.S. Government agency securities | 3,043 | — | — | 3,043 | |||||||||
Municipal bonds | 1,000,443 | 95 | (2,661 | ) | 997,877 | ||||||||
Corporate debt securities | 3,500 | — | — | 3,500 | |||||||||
Corporate equity securities | 244 | 39 | — | 283 | |||||||||
Money market, bank deposits and other | 538,275 | — | — | 538,275 | |||||||||
Subtotal | 1,545,505 | 134 | (2,661 | ) | 1,542,978 | ||||||||
Less: Cash equivalents | 554,860 | — | — | 554,860 | |||||||||
Marketable securities | $ | 990,645 | $ | 134 | $ | (2,661 | ) | $ | 988,118 | ||||
As of June 30, 2006 (in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||
U.S. Treasuries | $ | 25,816 | $ | 129 | $ | (37 | ) | $ | 25,908 | ||||
U.S. Government agency securities | 354,234 | — | (667 | ) | 353,567 | ||||||||
Municipal bonds | 1,006,592 | 17 | (5,536 | ) | 1,001,073 | ||||||||
Corporate debt securities | — | — | — | — | |||||||||
Corporate equity securities | 142 | 220 | — | 362 | |||||||||
Money market, bank deposits and other | 804,017 | — | — | 804,017 | |||||||||
Subtotal | 2,190,801 | 366 | (6,240 | ) | 2,184,927 | ||||||||
Less: Cash equivalents | 988,338 | — | (16 | ) | 988,322 | ||||||||
Marketable securities | $ | 1,202,463 | $ | 366 | $ | (6,224 | ) | $ | 1,196,605 | ||||
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
KLA-Tencor’s investment portfolio consists of both corporate and government securities that have a maximum maturity of 10 years. The longer the duration of these securities, the more susceptible they are to changes in information previously providedmarket interest rates and bond yields. As yields increase, those securities with a lower yield-at-cost show a mark-to-market unrealized loss. All unrealized losses are due to changes in interest rates and bond yields. The Company has the Company’s independent registered public accounting firm,ability to realize the full value of all these investments upon maturity. The following table summarizes the fair value and (6)gross unrealized losses of its investments, aggregated by investment instrument and length of time that the individual securities have been in most instances, the retroactive pricinga continuous unrealized loss position as of options violated the termsJune 30, 2007:
(in thousands) | Fair Value | Gross Unrealized Losses(1) | |||||
Municipal bonds | $ | 611,201 | $ | (2,661 | ) | ||
Total | $ | 611,201 | $ | (2,661 | ) | ||
(1) | Of the total gross unrealized losses, approximately $1,000 of gross unrealized losses relates primarily to municipal bonds with a fair value of $0.3 million that have been in a loss position for 12 months or more. |
The contractual maturities of securities classified as available-for-sale as of June 30, 2007, other than corporate equity securities, regardless of the Company’s stock option plans. Because virtually all holders of retroactively priced options issued byconsolidated balance sheet classification, are as follows:
(in thousands) | Amortized Cost | Estimated Fair Value | ||||
Due within one year | $ | 936,556 | $ | 936,442 | ||
Due after one year through three years | 488,232 | 486,538 | ||||
Due after three years | 120,473 | 119,715 | ||||
$ | 1,545,261 | $ | 1,542,695 | |||
Actual maturities may differ from contractual maturities because borrowers may have the Companyright to call or prepay obligations with or without call or prepayment penalties. Net realized losses for the fiscal years ended June 30, 2007, 2006 and 2005 were not involved in or awareapproximately $1.6 million, $8.2 million and $3.2 million, respectively.
NOTE 4—GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill
The following table presents goodwill balances and the movements during the fiscal years ended June 30, 2007 and 2006:
(in thousands) | Amount | |||
As of June 30, 2005 | $ | 47,445 | ||
Acquisitions | 2,231 | |||
Adjustments | (384 | ) | ||
As of June 30, 2006 | $ | 49,292 | ||
Acquisitions | 264,956 | |||
Adjustments | (2,392 | ) | ||
As of June 30, 2007 | $ | 311,856 | ||
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Goodwill represents the excess of the retroactive pricing,purchase price over the Board of Directors decided that the Company should continue to honor the options that violated the termsfair value of the Company’s stock option plans, exceptnet tangible and identifiable intangible assets acquired in certain individual cases as described below.
each business combination. The Special Committee concluded that,carrying value of goodwill was allocated to KLA-Tencor’s reporting units pursuant to SFAS No. 142. In accordance with a few immaterial exceptions, the retroactive pricing of stock options stopped after June 30, 2002. After that time, there were procedures in place designed to provide reasonable assurance that stock options were priced on the grant date. The Special Committee also concluded that noneSFAS No. 142, KLA-Tencor completed its annual evaluation of the Company’s independent Directors was involved in or aware of the retroactive pricing of stock options. Based on the Special Committee’s report, the Board of Directors concluded that no current members of management were involved in the retroactive pricing of stock options. During its investigation of the Company’s historical stock option practices, the Special Committee did not find evidence of any other financialgoodwill by reporting or accounting issues.
As a result of the Special Committee investigation, on October 16, 2006, the Company terminated its employment relationship and agreement with Kenneth L. Schroeder, and the Company announced its intent to cancel all outstanding stock options held by Mr. Schroeder that were retroactively priced or otherwise improperly granted. Those options were canceled in December 2006. Mr. Schroeder was the Company’s Chief Executive Officer and a member of its Board of Directors from mid-1999 until January 1, 2006, and was a member of the Company’s stock option committee from 1994 until December 31, 2005. From January 1 to October 16, 2006, Mr. Schroeder was employed as a Senior Advisor to the Company. On November 10, 2006, Mr. Schroeder’s counsel informed the Company that Mr. Schroeder contests the Company’s right to terminate his employment relationship and agreement and to cancel any of his options. The Company intends to vigorously defend any claims that may be made by Mr. Schroeder regarding these matters, which could involve a material amount.
Also on October 16, 2006, Stuart J. Nichols, Vice President and General Counsel, resigned. Mr. Nichols and the Company entered into a Separation Agreement and General Release under which Mr. Nichols’ outstanding retroactively priced stock options have been re-priced by increasing the exercise price to the market price of the option shares on the actual grant date. Under SFAS No. 123(R), no incremental charge will be recognized in the financial statements forunit during the quarter ended December 31, 2006.
On October 16, 2006, Kenneth Levy, Founder and Chairmanconcluded that there was no impairment. There have been no significant events or circumstances affecting the valuation of goodwill subsequent to the impairment test performed in the second quarter of the Boardfiscal year ended June 30, 2007. Refer to Note 5, “Business Combinations” for a detailed description of Directorsacquisitions completed in the fiscal year ended June 30, 2007.
Adjustments to goodwill during the fiscal year ended June 30, 2007 resulted from the purchase of the remaining minority interest in a development stage company which was consolidated as of March 31, 2004. See Note 5, “Business Combinations” for a detailed description.
Other Intangible Assets
The components of other intangible assets as of June 30, 2007 and June 30, 2006 were as follows:
(in thousands) | As of June 30, 2007 | As of June 30, 2006 | ||||||||||||||||||
Category | Range of | Gross Carrying Amount | Accumulated Amortization | Net Amount | Gross Carrying Amount | Accumulated Amortization | Net Amount | |||||||||||||
Existing technology | 4-7 years | $ | 96,534 | $ | 14,152 | $ | 82,382 | $ | 13,078 | $ | 5,018 | $ | 8,060 | |||||||
Patents | 6-13 years | 38,997 | 8,114 | 30,883 | 18,161 | 5,622 | 12,539 | |||||||||||||
Trade name / Trademark | 4-10 years | 20,835 | 2,086 | 18,749 | 1,225 | 775 | 450 | |||||||||||||
Customer relationships | 6-7 years | 45,445 | 3,689 | 41,756 | — | — | — | |||||||||||||
Other | 0-1 year | 10,120 | 8,458 | 1,662 | 200 | 200 | — | |||||||||||||
Total | $ | 211,931 | $ | 36,499 | $ | 175,432 | $ | 32,664 | $ | 11,615 | $ | 21,049 | ||||||||
During the fiscal year ended June 30, 2007, it was determined that the Company retired as a director and employee, and was named Chairman Emeritus bywould not pursue future development of certain patents initially licensed during the Boardfiscal year ended June 30, 2006 for approximately $14.0 million. Since the Company did not have any alternative use of Directors. Mr. Levythese patents and the Company entered into a Separation Agreementbelieves the fair value to be $0, the carrying value of $10.7 million was written off. This write off was recorded as $10.0 million to R&D expense and General Release under which Mr. Levy’s outstanding retroactively priced stock options$0.7 million to cost of revenues in the fiscal year ended June 30, 2007.
For the fiscal years ended June 30, 2007, 2006 and 2005, amortization expense for other intangible assets was $29.4 million, $4.5 million and $3.3 million, respectively. Based on intangible assets recorded as of June 30, 2007, and assuming no subsequent additions to, or impairment of the underlying assets, the remaining estimated annual amortization expense is expected to be as follows (in thousands):
Year ending June 30: | Amount | ||
2008 | $ | 33,508 | |
2009 | 31,997 | ||
2010 | 31,901 | ||
2011 | 30,894 | ||
2012 | 27,813 | ||
Thereafter | 19,319 | ||
Total | $ | 175,432 | |
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
NOTE 5—BUSINESS COMBINATIONS
All of the Company’s qualifying business combinations have been re-priced by increasingaccounted for using the exercise pricepurchase method of accounting. Consideration includes the cash paid and the value of options assumed, less any cash acquired, and excludes contingent employee compensation payable in cash. Prior to the market priceadoption of the option shares on the actual grant date. Under SFAS No. 123(R), no incremental charge will be recognizedthe Company accounted for the intrinsic value of stock options assumed related to future services as deferred stock-based compensation within stockholders’ equity.
During the fiscal year ended June 30, 2007, the Company completed the acquisition of the following businesses for net cash consideration of approximately $509.7 million (net cash consideration for ADE Corporation was $390.2 million) primarily to expand the Company’s product portfolio:
Entity | Date Acquired | Business | ||
ADE Corporation | October 2006 | Inspection and metrology product portfolio | ||
OnWafer Technologies, Inc. | January 2007 | Expanded offering of metrology solutions | ||
SensArray Corporation | January 2007 | Expanded offering of metrology solutions | ||
Japan ADE, Ltd | April 2007 | Distributor of ADE products in Japan | ||
Therma-Wave, Inc. | May 2007 | Expanded offering of metrology solutions |
The following table summarizes the aggregate estimated fair values of the net assets acquired at the applicable date of acquisition for the above companies:
(in thousands) | Preliminary Purchase Price Allocation | |||
Cash | $ | 128,696 | ||
Current assets | 173,368 | |||
Intangibles: | ||||
Existing technology | 85,660 | |||
Patents | 30,200 | |||
Trade name / Trademarks | 19,610 | |||
Customer relationships | 45,445 | |||
In Process R&D | 5,500 | |||
Other intangible assets | 9,946 | |||
Noncurrent assets | 41,511 | |||
Goodwill | 264,956 | |||
Liabilities assumed(1) | (165,350 | ) | ||
$ | 639,542 | |||
Cash consideration | $ | 638,390 | ||
Value of options assumed | 1,152 | |||
Total consideration | $ | 639,542 | ||
(1) | $17.1 million of accrued restructuring created as a result of the Company’s acquisitions during the fiscal year ended June 30, 2007 has been included in liabilities assumed. The Company formulated the restructuring plans on the completion date of the acquisitions. At June 30, 2007, the balance of accrued restructuring is $17.0 million. |
In addition to the acquisition transactions listed above, in the financial statementsfiscal year ended June 30, 2007, the Company acquired a development stage company for $15.0 million of which $3.0 million is payable upon achievement of certain milestones over the quarter ended December 31, 2006. Mr. Levy was the Company’s Chief Executive Officer from 1975 until mid-1999 (with the exception of mid-1997 to mid-1998), was a member of the Company’s Board of Directors from 1975 until his retirement, was Chairman of the Board of Directors from 1999 until his retirement, and was a member of the Company’s stock option committee from 1994 until use of that committee was suspended in the fall of 2006.
On December 21, 2006, Jon D. Tompkins resignedfollowing two years. The acquisition has been accounted for as a directorpurchase of the Company,assets primarily consisting of in-process research and the Company agreed to modify the outstanding options held by Mr. Tompkins (all of which were fully vested) to extend the post-termination exercisability period to December 31, 2007, which is the last day of the calendar year in which those options would have terminated in the absence of such extension. Mr. Tompkins, the Chief Executive Officer of Tencor Instruments before its merger into the Company in mid-1997, was the Company’s Chief Executivedevelopment (“IPR&D”) and certain patents.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Officer from mid-1997 to mid-1998, was a memberThe fair value of the Company’s stock option committeepurchased IPR&D and identified intangibles was determined using the income approach, which discounts expected future cash flows from mid-1997 until mid-1999,projects to their net present value. Each project was analyzed to determine the technological innovations included; the utilization of core technology; the complexity, cost and was a membertime to complete development; any alternative future use or current technological feasibility; and the stage of completion. Future cash flows were estimated, taking into account the expected life cycles of the Company’s Board of Directors from mid-1997 until his resignation.
Althoughproducts and the Board of Directors concluded that John H. Kispert, the Company’s Presidentunderlying technology, relevant market sizes and Chief Operating Officer, was not involved in and was not aware of the improper stock option practices,industry trends. The Company determined a discount rate for each project based on the Special Committee’s recommendation, his outstanding retroactively priced options have been re-priced because he served as Chief Financial Officer during partrelative risks inherent in the project’s development horizon, the estimated costs of development, and the level of technological change in the project and the industry, among other factors. Goodwill represents the excess of purchase price over the fair value of the periodnet tangible and identifiable intangible assets acquired in question. This re-pricing involved increasingeach business combination.
The Company expensed IPR&D of $16.6 million upon the exercise price to the market pricecompletion of the option shares on the actual grant date. Under SFAS No. 123(R), no incremental charge will be recognizedacquisitions in the financial statements for the quarter ended December 31, 2006.
Restatement and Impact on Financial Statements
In addition to restating the consolidated financial statements in response to the Special Committee’s findings, the Company is recording additional non-cash adjustments that were previously considered to be immaterial relating primarily to the accounting for employee stock purchase plans, corrections for the recognition of deferred tax assets, the release of tax reserves, the timing of revenue recognition, gains and losses on hedging contracts and the calculation of minority interest. The Company has also corrected the classification of certain amounts presented as cash and cash equivalents and marketable securities relating to investments in Variable Rate Demand Notes. For the fiscal yearsyear ended June 30, 20042007 in connection with acquired intellectual property for which technological feasibility has not been established and no future alternative uses exist.
The Company currently has not identified any material pre-merger contingencies where a liability is probable and the amount of the liability can be reasonably estimated. If information becomes available prior to the Company previously recorded no stock-based compensation expense; therefore,end of the additional stock-based compensation expense noted below representspurchase price allocation period, which would indicate that it is probable that such events had occurred and the total stock-based compensation expense for these periods. Foramounts can be reasonably estimated, such items will be included in the purchase price allocation.
Pro forma earnings information has not been presented because the effect of the acquisitions in the fiscal year ended June 30, 2007 was not material either on an individual or an aggregate basis.
In connection with the acquisitions completed during the fiscal year ended June 30, 2005, KLA-Tencor became subject to a $9.1 million contingent cash payment based on the continued employment of certain employees over two years. The contingency is accounted for as compensation expense over the contingent employment period. During the fiscal year ended June 30, 2006, $5.4 million of this amount was paid, and the remaining $3.7 million was paid during the fiscal year ended June 30, 2007.
The Company had an equity interest in a development stage company which was consolidated as of March 31, 2006. During the fiscal year ended June 30, 2007, the Company purchased the remaining minority interest and assumed 100% ownership in this entity. Subsequently, the Company sold certain assets of this entity to an unrelated third party and recorded $2.9 milliona gain of stock-based compensation with a related tax benefit of $1.1$3.9 million in its previously reported financial statements. Forother income in the fiscal 2005, total stock-based compensation was $37.0 million with a related tax benefit of $12.1 million. The income statement impact of the restatement is as follows (in thousands):year ended June 30, 2007.
Years ended June 30, | Total effect at | 2005 | 2004 | Cumulative effect at July 1, 2003 | 2003 | 2002 | ||||||||||||||||
Net income, as previously reported | $ | 466,695 | $ | 243,701 | ||||||||||||||||||
Additional compensation expense resulting from improper measurement dates for stock option grants | $ | (347,817 | ) | (34,086 | ) | (53,208 | ) | $ | (260,523 | ) | (70,032 | ) | (76,582 | ) | ||||||||
Tax related effects | 117,776 | 12,149 | 22,320 | 83,307 | 22,866 | 25,009 | ||||||||||||||||
Additional compensation expense resulting from improper measurement dates for stock option grants, net of tax | (230,041 | ) | (21,937 | ) | (30,888 | ) | (177,216 | ) | (47,166 | ) | (51,573 | ) | ||||||||||
Other adjustments, net of tax | (991 | ) | 291 | (337 | ) | (945 | ) | |||||||||||||||
Total decrease to net income | $ | (231,032 | ) | (21,646 | ) | (31,225 | ) | $ | (178,161 | ) | ||||||||||||
Net income, as restated | $ | 445,049 | $ | 212,476 | ||||||||||||||||||
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Years ended June 30, | 2001 | 2000 | 1999 | 1998 | 1997 | 1996 | 1995 | |||||||||||||||||||||
Additional compensation expense resulting from improper measurement dates for stock option grants | $ | (59,261 | ) | $ | (23,296 | ) | $ | (17,630 | ) | $ | (5,219 | ) | $ | (2,852 | ) | $ | (2,747 | ) | $ | (2,904 | ) | |||||||
Tax related effects | 17,262 | 7,198 | 6,054 | 1,861 | 1,036 | 983 | 1,038 | |||||||||||||||||||||
Additional compensation expense resulting from improper measurement dates for stock option grants, net of tax | $ | (41,999 | ) | $ | (16,098 | ) | $ | (11,576 | ) | $ | (3,358 | ) | $ | (1,816 | ) | $ | (1,764 | ) | $ | (1,866 | ) | |||||||
The CompanyNOTE 6—STOCK-BASED COMPENSATION
Effective July 1, 2005, KLA-Tencor adopted the provisions of SFAS No. 123(R) effective July 1, 2005. The,Share-Based Payment. SFAS No. 123(R) establishes accounting for stock-based awards exchanged for employee services. Accordingly, stock-based compensation cost is measured at grant date, based on the fair valuesvalue of the award, and is recognized as expense over the employee’s requisite service period. The Company previously applied APB Opinion No. 25,Accounting for Stock Issued to Employees and its related Interpretations and provided the required pro forma disclosures of SFAS No. 123Accounting for Stock-Based Compensation.
The following table shows pre-tax stock-based compensation expense by type of award for the fiscal years ended June 30, 2007, 2006 and 2005:
(in thousands) | Year ended June 30, | ||||||||
2007 | 2006 | 2005 | |||||||
Stock-based compensation expense by type of award: | |||||||||
Employee stock options | $ | 82,440 | $ | 140,447 | $ | 34,902 | |||
Employee stock purchase plan | 11,964 | 16,188 | — | ||||||
Restricted stock units | 14,374 | 8,107 | 2,139 | ||||||
Total stock-based compensation(1) | $ | 108,778 | $ | 164,742 | $ | 37,041 | |||
(1) | Stock-based compensation expense for the fiscal year ended June 30, 2007 includes a $20.3 million reversal of stock-based compensation charges related to the cancellation of stock options and restricted stock units held by the Company’s former Chief Executive Officer and $9.3 million of cash compensation related to bonuses payable to the holders of the amended options to compensate them for the increase in their option exercise prices. As of June 30, 2007, the unrecognized stock-based compensation balance was $177.2 million. |
Stock Options
The following table shows the number of options granted, grant-date fair value, and stock-based compensation expense related to stock options for the fiscal years ended June 30, 2007, 2006 and 2005:
(in thousands) | Year ended June 30, | ||||||||
2007 | 2006 | 2005 | |||||||
Number of options granted | 269 | 4,856 | 9,625 | ||||||
Grant-date fair value after estimated forfeitures | $ | 2,395 | $ | 68,810 | $ | 214,926 | |||
Stock-based compensation expense(1) | $ | 82,440 | $ | 140,447 | $ | 34,902 |
(1) | Stock-based compensation expense related to options for the fiscal year ended June 30, 2007 is net of a $16.2 million reversal of stock-based compensation charges related to the cancellation of stock options held by the Company’s former Chief Executive Officer. |
As of June 30, 2007, the unrecognized stock-based compensation balance related to stock options was $106.0 million and will be recognized over an estimated weighted average amortization period of 2.6 years.
The following table shows stock-based compensation capitalized as inventory and deferred system profit as of June 30, 2007 and 2006:
(in thousands) | As of June 30, | |||||
2007 | 2006 | |||||
Inventory | $ | 6,229 | $ | 6,041 | ||
Deferred system profit | $ | 1,386 | $ | 1,580 |
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Valuation Assumptions
In connection with the adoption of SFAS No. 123(R), the Company reassessed its valuation technique and related assumptions. The Company estimates the fair value of stock options using a Black-Scholes valuation model, consistent with the provisions of SFAS No. 123(R), SEC SAB No. 107 and the Company’s prior period pro forma disclosures of net earnings, including stock-based compensation (determined under a fair value method as prescribed by SFAS No. 123). The fair value of each option grant is 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, | |||||||||
2007 | 2006 | 2005 | |||||||
Stock option plan: | |||||||||
Expected stock price volatility | 34 | % | 30 | % | 58 | % | |||
Risk free interest rate | 4.9 | % | 4.1 | % | 3.6 | % | |||
Dividend yield | 1.1 | % | 1.0 | % | 0.1 | % | |||
Expected life of options (in years) | 4.4 | 4.6 | 5.6 | ||||||
Stock purchase plan: | |||||||||
Expected stock price volatility | 35 | % | 34 | % | 34 | % | |||
Risk free interest rate | 5.0 | % | 3.9 | % | 3.4 | % | |||
Dividend yield | 1.0 | % | 1.0 | % | — | ||||
Expected life of options (in years) | 1.3 | 1.3 | 1.2 |
SFAS No. 123(R) requires the use of option pricing models that were not developed for use in valuing employee stock options. The Black-Scholes option-pricing model was developed for use in estimating the fair value of short-lived exchange traded options that have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions, including the option’s expected life and the price volatility of the underlying stock. The expected stock price volatility assumption was determined using the implied volatility of the Company’s common stock. The Company’s computation of expected volatility is based on market-based implied volatility from traded options on the Company’s stock. Prior to the adoption of SFAS No. 123(R), the Company used a combination of historical and implied volatility in deriving its expected volatility assumption. The Company determined that implied volatility is more reflective of market conditions and a better indicator of expected volatility than a blended volatility.
Equity Incentive Program
The Company’s equity incentive program is a broad-based, long-term retention program that is intended to attract and retain key employees, and align stockholder and employee interests. The equity incentive program consists of two plans: one under which non-employee directors may be granted options to purchase shares of the Company’s stock, and another in which non-employee directors, officers, key employees, consultants and all other employees may be granted options to purchase shares of the Company’s stock, restricted stock units and other types of equity awards. For the past several years until June 30, 2006, stock options (except for the retroactively priced options which were granted primarily prior to fiscal year ended June 30, 2002) were generally granted at the market price of the Company’s common stock on the date of grant, 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 time-based or performance-based vesting. Substantially all of the Company’s employees that meet established performance goals and qualify as key employees participate in its main equity incentive plan. Since July 1, 2006, the Company has granted only restricted stock units under its equity incentive program, except for options granted to non-employee directors as part of their regular compensation package for service through June 30, 2007.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
On October 18, 2004, our stockholders approved the 2004 Equity Incentive Plan (the “2004 Plan”) which provides for the grant of options to purchase shares of our common stock, stock appreciation rights, restricted stock, performance shares, performance units and deferred stock units to our employees, consultants and members of our Board of Directors. Since the adoption of the 2004 Plan, no further grants are permitted under the 1982 Stock Option Plan or 2000 Non-Statutory Stock Option Plan. The 2004 Plan permits the issuance of up to 12.5 million shares of common stock, of which 3.3 million shares were available for grant as of June 30, 2007. Any 2004 Plan awards of restricted stock, 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 shall be counted against the total number of shares issuable under the plan as 1.8 shares for every one share subject thereto. Total options outstanding under all plans as of June 30, 2007 was 19.6 million.
The following table summarizes the combined activity under the equity incentive plans for the indicated periods:
(In thousands except for Weighted Average Exercise Price) | Available For Grant | Options Outstanding | Weighted- Average Exercise Price | ||||||
Balances at June 30, 2004 | 17,351 | 29,696 | $ | 35.11 | |||||
Additional shares reserved | 18,370 | — | — | ||||||
Plan shares expired | (15,814 | ) | — | — | |||||
Options granted(1) | (9,625 | ) | 9,625 | $ | 40.31 | ||||
Restricted stock units granted(2) | (733 | ) | — | — | |||||
Options canceled/expired/forfeited | 2,267 | (2,267 | ) | $ | 41.84 | ||||
Options exercised | — | (3,675 | ) | $ | 26.56 | ||||
Balances at June 30, 2005 | 11,816 | 33,379 | $ | 37.08 | |||||
Additional shares reserved | 34 | — | — | ||||||
Plan shares expired | (1,281 | ) | — | — | |||||
Options granted | (4,856 | ) | 4,856 | $ | 48.37 | ||||
Restricted stock units granted(2) | (1,280 | ) | — | — | |||||
Restricted stock units canceled(2) | 24 | — | — | ||||||
Options canceled/expired/forfeited | 1,861 | (1,861 | ) | $ | 44.05 | ||||
Options exercised | — | (6,012 | ) | $ | 29.34 | ||||
Balances at June 30, 2006 | 6,318 | 30,362 | $ | 40.00 | |||||
Additional shares registered for acquisitions | 206 | — | — | ||||||
Plan shares expired | (3,230 | ) | — | — | |||||
Options granted | (269 | ) | 269 | $ | 45.54 | ||||
Restricted stock units granted(2) | (5,124 | ) | — | — | |||||
Restricted stock units canceled(2) | 994 | — | — | ||||||
Options canceled/expired/forfeited | 4,628 | (4,628 | ) | $ | 41.79 | ||||
Options exercised | — | (6,624 | ) | $ | 35.98 | ||||
Options assumed from acquisitions | (206 | ) | 206 | $ | 31.96 | ||||
Balances at June 30, 2007 | 3,317 | 19,585 | $ | 42.28 | |||||
(1) | Employees received stock options totaling 2.0 million shares of common stock as an advance on their fiscal year 2006 stock option grants in the first quarter of the fiscal year ended June 30, 2005. The grant was equivalent to 50% of the employee’s fiscal year 2005 stock option grant. These advanced grant options vest on a six (6) year schedule with 20% of the option shares vesting upon completion of two (2) years of service and the remaining 80% of the option shares vesting in a series of forty-eight (48) successive equal monthly installments upon completion of each additional month of continuous service over the remainder of the vesting term. |
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(2) | Any 2004 Plan awards of restricted stock, 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 shall be counted against the total number of shares issuable under the 2004 Plan as 1.8 shares for every one share subject thereto. |
The weighted average grant date fair value of options, as determined under SFAS No. 123(R), granted during the fiscal yearyears ended June 30, 2007, 2006 and 2005 were changed$11.01, $14.17 and $22.33 per share, respectively. As of June 30, 2007, 13.1 million options were exercisable with a weighted average exercise price of $41.16 and weighted-average remaining contractual term of 5 years. The aggregate intrinsic value for the options exercisable as of June 30, 2007 was $180.9 million.
The total intrinsic value of options exercised during the fiscal years ended June 30, 2007, 2006 and 2005 was $111.4 million, $130.2 million, and $69.9 million, respectively. The total cash received from employees as a result of the findings that certainemployee stock option grantsexercises during the fiscal years ended June 30, 2007, 2006 and 2005 was approximately $238.4 million, $176.4 million, and $97.6 million, respectively. In connection with these exercises, the tax benefits realized by the Company for the fiscal years ended June 30, 2007, 2006 and 2005 were retroactively priced. This change resulted in additional$39.5 million, $46.6 million and $25.2 million, respectively.
The Company settles employee stock option exercises with newly issued common shares.
Restricted Stock Units
The following table shows the number of restricted stock units granted, grant-date fair value, and stock-based compensation expense for the fiscal years ended June 30, 2007, 2006 and 2005:
(in thousands) | Year ended June 30, | ||||||||
2007 | 2006 | 2005 | |||||||
Number of shares granted | 2,846 | 711 | 407 | ||||||
Grant-date fair value | $ | 92,467 | $ | 23,208 | $ | 16,423 | |||
Stock-based compensation expense(1) | $ | 14,374 | $ | 8,107 | $ | 2,139 |
(1) | Stock-based compensation expense related to restricted stock units for the year ended June 30, 2007 is net of a $4.1 million reversal of stock-based compensation charges related to the cancellation of restricted stock units held by the Company’s former Chief Executive Officer. |
Beginning in the fiscal year ended June 30, 2007, the restricted stock units generally vest in two equal installments on the second and fourth anniversaries of $22the date of grant. Prior to the fiscal year ended June 30, 2007, the restricted stock units generally vested in two equal installments over four or five years from the anniversary date of the grant. The value of the restricted stock units was based on the closing market price of the Company’s common stock on the date of award. The restricted stock units were 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 units, the share reserve under the 2004 Plan will be reduced by 1.8 shares, as provided under the terms of the 2004 Plan.
As of June 30, 2007, the unrecognized stock-based compensation balance related to restricted stock units was $71.2 million and will be recognized over an estimated weighted average amortization period of 3.2 years. Additionally, the number of restricted stock awards outstanding as of June 30, 2007 was 3.4 million.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
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 related tax benefitformula based on the fair market value of $12 million being recognizedthe common stock at the time of enrollment into the offering period versus the fair market value on the date of purchase. Offering periods are generally two years in length. On September 28, 2006, the ESPP was suspended due to the ongoing stock option investigation, and accordingly there were no shares purchased under the ESPP during the six months ended December 31, 2006. After filing the Company’s Annual Report on January 29, 2007 of the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2006 and its Quarterly Report on Form 10-Q for the quarter ended September 30, 2006, approximately 0.3 million shares were purchased under SFAS No. 123(R).the ESPP on February 1, 2007.
The cumulative effect ofcompensation cost in connection with the restatements up throughESPP in the fiscal years ended June 30, 2003 increased additional paid-in capital by $3562007 and 2006 was $12.0 million from $815and $16.2 million, to $1.2 billion, increased deferred stock-based compensation from zero to $130 million, decreased retained earnings by $178 million from $1.4 billion to $1.2 billion, and increased total stockholders’ equity by $49 million from $2.2 billion to $2.3 billion.
Diluted shares in fiscal years 2004 and 2005 also increased as a result of the restatement adjustments to correct the past accounting for stock options that were retroactively priced. The Company uses the treasury stock method to calculate the weighted-average shares used in the diluted EPS calculation. As part of the restatement, the Company revised its treasury stock calculationsrespectively, in accordance with SFAS No. 128, “Earnings Per Share.” These calculations assume that (i) all retroactively priced options are exercised, (ii)123(R). The total cash received from employees for the issuance of shares under the ESPP was approximately $24.9 million and $36.3 million during the fiscal years ended June 30, 2007 and 2006, respectively. As the ESPP was non-compensatory under APB Opinion No. 25, no compensation expense was recorded in connection with the plan in the fiscal year ended June 30, 2005. In the fiscal years ended June 30, 2007, 2006 and 2005, employees purchased 0.7 million, 1.0 million, and 1.1 million shares issued at a weighted-average fair value of $35.68, $36.21 and $34.43, respectively. In connection with the disqualifying dispositions of shares purchased under the ESPP, the Company repurchases shares with the proceeds of these hypothetical exercises along withrealized the tax benefits of $1.3 million, $1.5 million, and $1.5 million for the fiscal years ended June 30, 2007, 2006 and 2005, respectively.
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 issue under the ESPP during the forthcoming fiscal year. As of June 30, 2007, a total of 1.1 million shares were reserved and available for issuance under the ESPP.
On October 12, 2006, the Compensation Committee of the Board of Directors of the Company approved an alternative financial benefit resulting fromconsisting of a cash payment to all employees below the hypothetical exercises,vice president level who had been active participants in the ESPP before it was temporarily suspended on September 28, 2006. The alternative financial benefit is intended to compensate such employees for the estimated financial benefit they would have realized had the ESPP continued in operation after September 28, 2006 and (iii) any unamortized deferreduntil December 31, 2006. On January 24, 2007, the Compensation Committee extended this alternative financial benefit into calendar year 2007 to cover the period until the ESPP suspension ended. The Company recorded approximately $4.6 million for the alternative financial benefit during the fiscal year ended June 30, 2007 as a component of stock-based compensation is also used to repurchase shares.expense.
In addition,Former Chief Executive Officer Agreement and Termination
During November 2005, the Company evaluated the impact of the restatements onannounced that effective January 1, 2006, Kenneth L. Schroeder would cease to be its global tax provision.Chief Executive Officer and would thereafter be employed as a Senior Advisor. The Company and its subsidiaries file tax returns in multiple tax jurisdictions around the world. In certain jurisdictions, including, but not limited to, the United States and the United Kingdom,Mr. Schroeder also revised his prior agreement with the Company is able to claimand defined the salary, bonus payout and equity award vesting during the period of his employment as a tax deduction relative to stock options. In those jurisdictions, where a tax deduction is claimed,Senior Advisor. Effective January 1, 2006, the Company hasdetermined that all service conditions associated with certain prior equity awards under the terms of the revised agreement with Mr. Schroeder had been satisfied; and accordingly, the Company recorded deferred tax assets, totaling $51.6at that time an additional non-cash, stock-based compensation charge of approximately $9.8 million atrelating to these equity awards. The above mentioned charge is included as a component of Selling, General and Administrative (“SG&A”) expense during the fiscal year ended June 30, 2005, to reflect future tax deductions to 2006. On October 16, 2006, following
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
the extentSpecial Committee investigation of the Company’s historical stock option practices, the Company believes such assets to be recoverable. The Company also believes that it should not have taken a United States tax deduction in prior years for stock option related amounts pertaining to certain executives under Internal Revenue Code (IRC) Section 162(m). Section 162(m) limitsterminated all aspects of Mr. Schroeder’s employment relationship and agreement with the deductibility of compensation above certain thresholds. The Company has determined that excess deductions were taken on prior tax returns due to the finding that retroactive pricing of certain stock options occurred.Company. As a result, vesting of Mr. Schroeder’s then outstanding stock options and restricted stock awards immediately ceased, and the Company’s tax liabilities have increased0.9 million unvested option shares and 0.1 million unvested restricted stock award shares held by approximately $8 million.Mr. Schroeder at the time of termination were canceled. Accordingly, during the fiscal year ended June 30, 2007 the Company reversed $20.3 million of the non-cash, stock-based compensation charges that had been recorded in prior periods related to unvested option shares and restricted stock award shares. In December 2006, the Company also canceled 0.6 million vested option shares held by Mr. Schroeder as of the time of termination, representing those shares that had been retroactively priced or otherwise improperly granted.
IRC Section 409A Affected Options
Because virtually all holders of retroactively priced options issued by the Company were not involved in or aware of the retroactive pricing, the Company has taken and intends to take certain actions to deal with the adverse tax consequences that may be incurred by the holders of retroactively priced options. The adverse tax consequences are that retroactively priced stock options vesting after December 31, 2004 (“409A Affected Options”) subject the option holder to a penalty tax under IRC Section 409A (and, as applicable, similar penalty taxes under California and other state tax laws). One such action by the Company is to offerinvolved offering to amend the 409A Affected Options to increase the exercise price to the market price on the actual grant date or, if lower, the market price at the time of the amendment. The amended options would not be subject to taxation under IRC
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Section 409A. Under IRS regulations, these option amendments had to be completed by December 31, 2006 for anyone who was an executive officer when he or she received 409A Affected Options; the amendments for non-officers cannotcould not be offered until after thisthe Company’s Annual Report ison Form 10-K for the fiscal year ended June 30, 2006 and Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 were filed and do not need to be completed until December 31, 2007. Another action is
During the fiscal year ended June 30, 2007, the Company accrued approximately $20.2 million payable to approve bonuses payable tonon-executive holders of the amended options to compensate them for the resulting increase in their option exercise price. The $20.2 million is payable in January 2008. Of the $20.2 million, $9.3 million was recorded as stock-based compensation expense, and the remaining $10.9 million was recorded in common stock and capital in excess of par value in the balance sheet. The amount of these bonuses would be effectively repaid to the Company if and when the options are exercised and the increased exercise price is paid (butpaid. However, there is no assurance that the options will be exercised). Finally,exercised and the employees will retain the bonuses under all circumstances. During the fiscal year ended June 30, 2007, the Company intendshas also recorded approximately $13.9 million to compensate certain option holders whose employment terminated or who havehad already exercised 409A Affected Options for the additional taxes they incur under IRC Section 409A (and, as applicable, similar state tax laws).
Three of the Company’s option holders were subject to the December 31, 2006 deadline described above. Accordingly, in December 2006, the Company offered to amend the 409A Affected Options held by Mr. Wallace, the Company’s Chief Executive Officer, and two former executive officers to increase the exercise price so that these options will not subject the option holder to a penalty tax under IRC Section 409A. All three individuals accepted the Company’s offer. In addition, the Company agreed to pay each of the three individuals a cash bonus in January 2008 equal to the aggregate increase in the exercise prices for his amended options. For Mr. Wallace, the amount of this bonus is $0.4 million. TheTo account for these actions, the Company plans to take similar actions with respect tohas recorded a charge of $0.3 million, net of amount reclassified from capital in excess of par, during the outstanding 409A Affected Options granted to non-officers as soon as possible after the filing of this Report. The Company estimates that the total cash payments needed to deal with the adverse tax consequences of retroactively priced options granted to non-officers will be approximately $30 million.fiscal year ended June 30, 2007.
With respect to thecertain individuals whose options were canceled or re-priced by the Company following the Special Committee investigation, no bonuses of the type described above will be paid.
The following tables reflect the impact of the additional non-cash charges for stock-based compensation expense and related tax effects as well as additional non-cash adjustments that were previously considered to be immaterial and the correct classification as marketable securities of Variable Rate Demand Notes on:
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Consolidated StatementsOther actions related to executive stock options
On October 16, 2006, Kenneth Levy, Founder and Chairman of Operations
(in thousands, except per share data) | Year ended June 30, 2005 | Year ended June 30, 2004 | ||||||||||||||||||
As previously reported | Adjustments | As restated | As previously reported | Adjustments | As restated | |||||||||||||||
Revenues: | ||||||||||||||||||||
Product | $ | 1,770,300 | $ | (2,624 | ) | $ | 1,767,676 | $ | 1,200,160 | $ | — | $ | 1,200,160 | |||||||
Service | 314,853 | (651 | ) | 314,202 | 296,558 | 500 | 297,058 | |||||||||||||
Total revenues | 2,085,153 | (3,275 | ) | 2,081,878 | 1,496,718 | 500 | 1,497,218 | |||||||||||||
Costs and operating expenses: | ||||||||||||||||||||
Costs of revenues* | 862,353 | 8,647 | 871,000 | 670,013 | 14,470 | 684,483 | ||||||||||||||
Engineering, research and development* | 340,277 | 11,707 | 351,984 | 280,641 | 17,866 | 298,507 | ||||||||||||||
Selling, general and administrative* | 299,961 | 13,813 | 313,774 | 248,706 | 21,892 | 270,598 | ||||||||||||||
Total costs and operating expenses | 1,502,591 | 34,167 | 1,536,758 | 1,199,360 | 54,228 | 1,253,588 | ||||||||||||||
Income from operations | 582,562 | (37,442 | ) | 545,120 | 297,358 | (53,728 | ) | 243,630 | ||||||||||||
Interest income and other, net | 37,755 | 201 | 37,956 | 27,358 | (600 | ) | 26,758 | |||||||||||||
Income before income taxes and minority interest | 620,317 | (37,241 | ) | 583,076 | 324,716 | (54,328 | ) | 270,388 | ||||||||||||
Provision for income taxes | 157,000 | (15,595 | ) | 141,405 | 81,015 | (23,103 | ) | 57,912 | ||||||||||||
Income before minority interest | 463,317 | (21,646 | ) | 441,671 | 243,701 | (31,225 | ) | 212,476 | ||||||||||||
Minority interest | 3,378 | — | 3,378 | — | — | — | ||||||||||||||
Net income | $ | 466,695 | $ | (21,646 | ) | $ | 445,049 | $ | 243,701 | $ | (31,225 | ) | $ | 212,476 | ||||||
Net income per share: | ||||||||||||||||||||
Basic | $ | 2.38 | $ | (0.11 | ) | $ | 2.27 | $ | 1.25 | $ | (0.16 | ) | $ | 1.09 | ||||||
Diluted | $ | 2.32 | $ | (0.11 | ) | $ | 2.21 | $ | 1.21 | $ | (0.16 | ) | $ | 1.05 | ||||||
Weighted-average number of shares: | ||||||||||||||||||||
Basic | 196,346 | — | 196,346 | 194,976 | — | 194,976 | ||||||||||||||
Diluted | 201,014 | 112 | 201,126 | 201,799 | 503 | 202,302 | ||||||||||||||
* includes the following amounts related to equity awards | ||||||||||||||||||||
Costs of revenues | $ | — | $ | 9,167 | $ | 9,167 | $ | — | $ | 11,450 | $ | 11,450 | ||||||||
Engineering, research and development | 548 | 11,707 | 12,255 | — | 17,866 | 17,866 | ||||||||||||||
Selling, general and administrative | 2,368 | 13,212 | 15,580 | — | 23,892 | 23,892 |
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Consolidated Balance Sheets
(in thousands, except per share data) | June 30, 2005 | |||||||||||
As previously reported(1) | Adjustments | As restated | ||||||||||
ASSETS | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | $ | 663,163 | $ | — | $ | 663,163 | ||||||
Marketable securities | 1,532,023 | — | 1,532,023 | |||||||||
Accounts receivable, net | 333,218 | — | 333,218 | |||||||||
Inventories | 358,339 | 1,501 | 359,840 | |||||||||
Deferred income taxes | 265,467 | (2,255 | ) | 263,212 | ||||||||
Other current assets | 50,435 | — | 50,435 | |||||||||
Total current assets | 3,202,645 | (754 | ) | 3,201,891 | ||||||||
Land, property and equipment, net | 385,222 | 699 | 385,921 | |||||||||
Other assets | 398,505 | 54,286 | 452,791 | |||||||||
Total assets | $ | 3,986,372 | $ | 54,231 | $ | 4,040,603 | ||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||||
Current liabilities: | ||||||||||||
Accounts payable | $ | 67,717 | $ | — | $ | 67,717 | ||||||
Deferred system profit | 209,899 | 2,238 | 212,137 | |||||||||
Unearned revenue | 80,122 | 650 | 80,772 | |||||||||
Other current liabilities | 574,124 | 1,939 | 576,063 | |||||||||
Total current liabilities | 931,862 | 4,827 | 936,689 | |||||||||
Commitments and contingencies (Note 12) | ||||||||||||
Minority interest in subsidiary | 9,253 | (2,009 | ) | 7,244 | ||||||||
Stockholders’ equity: | ||||||||||||
Preferred stock, $0.001 par value, 1,000 shares authorized, none outstanding | — | — | — | |||||||||
Common stock, $0.001 par value, 500,000 shares authorized, 196,624 shares issued and outstanding | 196 | — | 196 | |||||||||
Capital in excess of par value | 957,541 | 323,777 | 1,281,318 | |||||||||
Deferred stock-based compensation | (14,415 | ) | (39,308 | ) | (53,723 | ) | ||||||
Retained earnings | 2,083,638 | (231,032 | ) | 1,852,606 | ||||||||
Accumulated other comprehensive income | 18,297 | (2,024 | ) | 16,273 | ||||||||
Total stockholders’ equity | 3,045,257 | 51,413 | 3,096,670 | |||||||||
Total liabilities and stockholders’ equity | $ | 3,986,372 | $ | 54,231 | $ | 4,040,603 | ||||||
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Consolidated Statements of Cash Flows
(in thousands) | Year Ended June 30, 2005 | Year Ended June 30, 2004 | ||||||||||||||||||||||
As previously reported(1) | Adjustments | As restated | As previously reported(1) | Adjustments | As restated | |||||||||||||||||||
Cash flows from operating activities: | ||||||||||||||||||||||||
Net income | $ | 466,695 | $ | (21,646 | ) | $ | 445,049 | $ | 243,701 | $ | (31,225 | ) | $ | 212,476 | ||||||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||||||||||||||
Depreciation and amortization | 70,853 | (700 | ) | 70,153 | 82,926 | (700 | ) | 82,226 | ||||||||||||||||
Non-cash, stock-based compensation | 2,916 | 34,086 | 37,002 | 53,208 | 53,208 | |||||||||||||||||||
Minority interest | (3,378 | ) | (3,378 | ) | — | |||||||||||||||||||
Net loss (gain) on sale of marketable securities and other investments | 3,204 | 3,204 | (8,889 | ) | (8,889 | ) | ||||||||||||||||||
Deferred income taxes | (42,604 | ) | (10,893 | ) | (53,497 | ) | (24,578 | ) | (4,477 | ) | (29,055 | ) | ||||||||||||
Tax benefit from employee stock options | 24,525 | (9,391 | ) | 15,134 | 56,830 | (16,825 | ) | 40,005 | ||||||||||||||||
Changes in assets and liabilities, net of assets acquired and liabilities assumed in business combinations: | ||||||||||||||||||||||||
Accounts receivable, net | 36,645 | 36,645 | (149,240 | ) | (149,240 | ) | ||||||||||||||||||
Inventories | (18,778 | ) | 483 | (18,295 | ) | (78,616 | ) | 2,481 | (76,135 | ) | ||||||||||||||
Other assets | (33,254 | ) | (33,254 | ) | (26,291 | ) | (26,291 | ) | ||||||||||||||||
Accounts payable | 2,751 | 2,751 | 30,104 | 30,104 | ||||||||||||||||||||
Deferred system profit | (74,914 | ) | 4,101 | (70,813 | ) | 107,327 | 151 | 107,478 | ||||||||||||||||
Other current liabilities | 72,074 | 3,960 | 76,034 | 116,403 | (2,613 | ) | 113,790 | |||||||||||||||||
Net cash provided by operating activities | 506,735 | — | 506,735 | 349,677 | — | 349,677 | ||||||||||||||||||
Cash flows from investing activities: | ||||||||||||||||||||||||
Acquisitions of businesses, net of cash received | (44,628 | ) | (44,628 | ) | — | |||||||||||||||||||
Purchase of property, plant and equipment | (59,675 | ) | (59,675 | ) | (55,528 | ) | (55,528 | ) | ||||||||||||||||
Purchase of available-for-sale securities | (3,537,460 | ) | (3,537,460 | ) | (2,968,900 | ) | (2,968,900 | ) | ||||||||||||||||
Proceeds from sale of available-for-sale securities | 3,183,368 | 3,183,368 | 2,381,876 | 2,381,876 | ||||||||||||||||||||
Proceeds from maturity of available-for-sale securities | 333,797 | 333,797 | 202,035 | 202,035 | ||||||||||||||||||||
Net cash used in investing activities | (124,598 | ) | — | (124,598 | ) | (440,517 | ) | — | (440,517 | ) | ||||||||||||||
Cash flows from financing activities: | ||||||||||||||||||||||||
Issuance of common stock | 133,602 | 133,602 | 168,812 | 168,812 | ||||||||||||||||||||
Payment of dividends to stockholders | (23,644 | ) | (23,644 | ) | ||||||||||||||||||||
Stock repurchases | (203,658 | ) | (203,658 | ) | (55,806 | ) | (55,806 | ) | ||||||||||||||||
Proceeds from sale of minority interest in subsidiary | 12,631 | 12,631 | — | |||||||||||||||||||||
Net cash (used in) provided by financing activities | (81,069 | ) | — | (81,069 | ) | 113,006 | — | 113,006 | ||||||||||||||||
Effect of exchange rate changes on cash and cash equivalents | 8,213 | 8,213 | 6,968 | 6,968 | ||||||||||||||||||||
Net increase in cash and cash equivalents | 309,281 | — | 309,281 | 29,134 | — | 29,134 | ||||||||||||||||||
Cash and cash equivalents at beginning of period | 353,882 | 353,882 | 324,748 | 324,748 | ||||||||||||||||||||
Cash and cash equivalents at end of period | $ | 663,163 | $ | — | $ | 663,163 | $ | 353,882 | $ | — | $ | 353,882 | ||||||||||||
Supplemental cash flow disclosures: | ||||||||||||||||||||||||
Income taxes paid, net | $ | 185,315 | $ | 185,315 | $ | 11,899 | $ | 11,899 | ||||||||||||||||
Interest paid | $ | 1,114 | $ | 1,114 | $ | 647 | $ | 647 |
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Pro forma information
Pro forma information regarding net income and net income per share is required by SFAS No. 123 and has been determined as if the Company, had accounted for its employee stock purchase planretired as a director and employee, and was named Chairman Emeritus by our Board of Directors. Mr. Levy entered into a Separation Agreement and General Release with the Company under which Mr. Levy’s outstanding retroactively priced stock option plans underoptions have been re-priced by increasing the fair value method of SFAS No. 123. The impactexercise price to the market price of the restatementsoption shares on the pro forma information is as follows:
(in thousands) | Year ended June 30, 2005 | Year ended June 30, 2004 | ||||||||||||||||||||||
As previously reported | Adjustments | As restated | As previously reported | Adjustments | As restated | |||||||||||||||||||
Net income | $ | 466,695 | $ | (21,646 | ) | $ | 445,049 | $ | 243,701 | $ | (31,225 | ) | $ | 212,476 | ||||||||||
Add: | ||||||||||||||||||||||||
Stock-based compensation expense included in reported net income, net of tax | 1,831 | 21,937 | 23,768 | — | 30,888 | 30,888 | ||||||||||||||||||
Deduct: | ||||||||||||||||||||||||
Total stock-based compensation expense determined under fair value based method for all awards, net of tax | (93,281 | ) | (15,645 | ) | (108,926 | ) | (82,446 | ) | (30,009 | ) | (112,455 | ) | ||||||||||||
Net income—pro forma | $ | 375,245 | $ | (15,354 | ) | $ | 359,891 | $ | 161,252 | $ | (30,346 | ) | $ | 130,909 | ||||||||||
Earnings per share: | ||||||||||||||||||||||||
As reported | ||||||||||||||||||||||||
Basic | $ | 2.38 | $ | (0.11 | ) | $ | 2.27 | $ | 1.25 | $ | (0.16 | ) | $ | 1.09 | ||||||||||
Diluted | $ | 2.32 | $ | (0.11 | ) | $ | 2.21 | $ | 1.21 | $ | (0.16 | ) | $ | 1.05 | ||||||||||
Pro forma | ||||||||||||||||||||||||
Basic | $ | 1.91 | $ | (0.08 | ) | $ | 1.83 | $ | 0.83 | $ | (0.16 | ) | $ | 0.67 | ||||||||||
Diluted | $ | 1.87 | $ | (0.08 | ) | $ | 1.79 | $ | 0.80 | $ | (0.15 | ) | $ | 0.65 |
Correction of classification of cash and cash equivalents and marketable securities
In the third quarter of fiscal 2006, the Company corrected the classification of its variable-rate demand notes with reset dates of 90 days or less, moving them from cash equivalents to short-term investments on the Consolidated Balance Sheets. In the third quarter of fiscal 2005, the Company corrected the classification of its auction rate securities, moving them from cash equivalents to short-term investments on the Consolidated Balance Sheets. All Balance Sheets in these consolidated financial statements present Variable Rate Demand Notes as marketable securities.
As a result, the impact on the Consolidated Balance Sheet at June 30, 2005 was as follows:
(in thousands) | As originally reported | As restated | ||||
Cash and cash equivalents | $ | 874,509 | $ | 663,163 | ||
Marketable securities | $ | 1,320,677 | $ | 1,532,023 |
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Also, as a result of these changes, purchases and sales of Variable Rate Demand Notes are now presented as investing activities, rather than as changes in cash and cash equivalents. The impact of this change on the Consolidated Statement of Cash Flows was as follows:
Year ended June 30, (in thousands) | 2005 | 2004 | ||||||||||||||
As originally reported | As restated | As originally reported | As restated | |||||||||||||
Cash used for purchase of available-for-sale securities | $ | (2,579,371 | ) | $ | (3,537,460 | ) | $ | (2,078,409 | ) | $ | (2,968,900 | ) | ||||
Proceeds from sale of available-for-sale securities | $ | 2,205,354 | $ | 3,183,368 | $ | 1,649,558 | $ | 2,381,876 | ||||||||
Proceeds from maturities of available-for-sale securities | $ | 320,252 | $ | 333,797 | $ | 163,823 | $ | 202,035 | ||||||||
Net cash used in investing activities | $ | (158,068 | ) | $ | (124,598 | ) | $ | (320,556 | ) | $ | (440,517 | ) |
NOTE 3—FINANCIAL STATEMENT COMPONENTS
Consolidated Balance Sheets
June 30, (in thousands) | 2006 | 2005 | ||||||
As restated | ||||||||
Accounts receivable, net | ||||||||
Accounts receivable, gross | $ | 452,007 | �� | $ | 345,443 | |||
Allowance for doubtful accounts | (12,108 | ) | (12,225 | ) | ||||
$ | 439,899 | $ | 333,218 | |||||
Inventories | ||||||||
Customer service parts | $ | 169,747 | $ | 124,631 | ||||
Raw materials | 100,532 | 88,798 | ||||||
Work-in-process | 91,413 | 64,389 | ||||||
Finished goods and demonstration equipment | 87,464 | 82,022 | ||||||
$ | 449,156 | $ | 359,840 | |||||
Land, property and equipment, net | ||||||||
Land | $ | 86,408 | $ | 84,548 | ||||
Buildings and improvements | 162,337 | 154,405 | ||||||
Machinery and equipment | 388,113 | 348,845 | ||||||
Office furniture and fixtures | 42,769 | 41,480 | ||||||
Leasehold improvements | 142,587 | 138,787 | ||||||
Construction in process | 12,809 | 6,276 | ||||||
835,023 | 774,341 | |||||||
Less: accumulated depreciation | (439,611 | ) | (388,420 | ) | ||||
$ | 395,412 | $ | 385,921 | |||||
Other assets | ||||||||
Goodwill & other intangibles, net | $ | 70,341 | $ | 58,670 | ||||
Long-term investments | 164,552 | 137,143 | ||||||
Deferred tax assets—long-term | 392,028 | 246,899 | ||||||
Other | 10,335 | 10,079 | ||||||
$ | 637,256 | $ | 452,791 | |||||
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 30, (in thousands) | 2006 | 2005 | |||||
As restated | |||||||
Other current liabilities | |||||||
Warranty and retrofit | $ | 50,604 | $ | 52,845 | |||
Compensation and benefits | 281,815 | 251,060 | |||||
Income taxes payable | 126,750 | 159,928 | |||||
Other accrued expenses | 141,435 | 112,230 | |||||
$ | 600,604 | $ | 576,063 | ||||
Accumulated other comprehensive income | |||||||
Currency translation adjustments | $ | 12,671 | $ | 11,374 | |||
Gains (losses) on cash flow hedging instruments, net of taxes (benefits) of $(49) in 2006 and $2,023 in 2005 | (80 | ) | 3,311 | ||||
Unrealized gains (losses) on investments, net of taxes (benefits) of $(2,175) in 2006 and $954 in 2005 | (3,683 | ) | 1,588 | ||||
$ | 8,908 | $ | 16,273 | ||||
Consolidated Statements of Operations
Year ended June 30, (in thousands) | 2006 | 2005 | 2004 | |||||||||
As restated | As restated | |||||||||||
Interest income and other, net | ||||||||||||
Interest income | $ | 66,417 | $ | 38,783 | $ | 20,359 | ||||||
Interest expense | (2,175 | ) | (1,750 | ) | (519 | ) | ||||||
Foreign exchange gains | 13,958 | 4,762 | 3,527 | |||||||||
Realized (losses) gains on sale of investments | (8,173 | ) | (3,204 | ) | 8,889 | |||||||
Other | (1,960 | ) | (635 | ) | (5,498 | ) | ||||||
$ | 68,067 | $ | 37,956 | $ | 26,758 | |||||||
NOTE 4—MARKETABLE SECURITIES
The amortized costs and estimated fair value of securities available-for-sale as of June 30, 2006 and 2005 are as follows:
June 30, 2006 (in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||
U.S. Treasuries | $ | 25,816 | $ | 129 | $ | (37 | ) | $ | 25,908 | ||||
U.S. Government agency securities | 354,234 | — | (667 | ) | 353,567 | ||||||||
Municipal bonds | 1,006,592 | 17 | (5,536 | ) | 1,001,073 | ||||||||
Corporate equity securities | 142 | 220 | — | 362 | |||||||||
Money market, bank deposits and other | 804,017 | — | — | 804,017 | |||||||||
Subtotal | 2,190,801 | 366 | (6,240 | ) | 2,184,927 | ||||||||
Less: Cash equivalents | 988,338 | — | (16 | ) | 988,322 | ||||||||
Marketable securities | $ | 1,202,463 | $ | 366 | $ | (6,224 | ) | $ | 1,196,605 | ||||
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 30, 2005 (in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||
U.S. Treasuries | $ | 42,898 | $ | 19 | $ | (335 | ) | $ | 42,582 | ||||
U.S. Government agency securities | 34,798 | — | — | 34,798 | |||||||||
Municipal bonds | 1,457,114 | 1,295 | (2,561 | ) | 1,455,848 | ||||||||
Corporate equity securities | 7,772 | 4,115 | — | 11,887 | |||||||||
Money market bank deposits and other | 520,122 | — | — | 520,122 | |||||||||
Subtotal | 2,062,704 | 5,429 | (2,896 | ) | 2,065,237 | ||||||||
Less: Cash equivalents | 533,223 | — | (9 | ) | 533,214 | ||||||||
Marketable securities | $ | 1,529,481 | $ | 5,429 | $ | (2,887 | ) | $ | 1,532,023 | ||||
KLA-Tencor’s investment portfolio consists of both corporate and government securities that have a maximum maturity of 10 years. The longer the duration of these securities, the more susceptible they are to changes in market interest rates and bond yields. As yields increase, those securities with a lower yield-at-cost show a mark-to-market unrealized loss. All unrealized losses are due to changes in interest rates and bond yields. The Company has the ability to realize the full value of all these investments upon maturity. The following table summarizes the fair value and gross unrealized losses of its investments, aggregated by investment instrument and length of time that the individual securities have been in a continuous unrealized loss position at June 30, 2006 (in thousands):
Total in a loss position(1) | |||||||
FMV | Gross Unrealized Losses | ||||||
U.S. Government and agency securities | $ | 115,527 | $ | (704 | ) | ||
Municipal bonds | 694,377 | (5,536 | ) | ||||
Total | $ | 809,904 | $ | (6,240 | ) | ||
The contractual maturities of securities classified as available-for-sale as of June 30, 2006, regardless of the consolidated balance sheet classification, are as follows (in thousands):
Amortized Cost | Estimated Fair Value | |||||
Due within one year | $ | 1,446,541 | $ | 1,446,128 | ||
Due after one year through three years | 502,082 | 499,592 | ||||
Due after three years | 242,037 | 238,845 | ||||
$ | 2,190,660 | $ | 2,184,565 | |||
Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Net realized losses for the years ended June 30, 2006 and 2005 were approximately $8.2 and $3.2 million, respectively. Net realized gains for the year ended June 30, 2004 were approximately $8.9 million.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
NOTE 5—GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill
The carrying value of goodwill was $49.3 million and $47.4 million as of June 30, 2006 and 2005, respectively, and was allocated to KLA-Tencor’s reporting units pursuant to SFAS No. 142. In accordance with SFAS No. 142, KLA-Tencor completed its annual evaluation of the goodwill by reporting unit during the quarter ended December 31, 2005, and concluded that there was no impairment. There have been no significant events or circumstances affecting the valuation of goodwill subsequent to the impairment test performed in the second quarter of fiscal year 2006.
Other Intangible Assets
The components of other intangible assets as of June 30, 2006 were as follows (in thousands):
Gross Carrying Amount | Accumulated Amortization | Net Amount | |||||||
Existing technology | $ | 13,078 | $ | 5,018 | $ | 8,060 | |||
Patents | 18,161 | 5,622 | 12,539 | ||||||
Trademark | 1,225 | 775 | 450 | ||||||
Other | 200 | 200 | — | ||||||
Total | $ | 32,664 | $ | 11,615 | $ | 21,049 | |||
The components of other intangible assets as of June 30, 2005 were as follows (in thousands):
Gross Carrying Amount | Accumulated Amortization | Net Amount | |||||||
Existing technology | $ | 12,537 | $ | 2,807 | $ | 9,730 | |||
Patents | 4,761 | 3,889 | 872 | ||||||
Trademark | 1,225 | 602 | 623 | ||||||
Other | 200 | 200 | — | ||||||
Total | $ | 18,723 | $ | 7,498 | $ | 11,225 | |||
During the quarter ended September 30, 2005, the Company entered into an agreement to license certain patents for approximately $14 million which will be amortized over a period of 10 years. For the fiscal years ended June 30, 2006, 2005 and 2004, amortization expense for other intangible assets was $4.5 million, $3.3 million and $1.5 million, respectively. Based on intangible assets recorded at June 30, 2006, and assuming no subsequent additions to, or impairment of the underlying assets, the remaining estimated annual amortization expense is expected to be as follows (in thousands):
Fiscal year ending June 30: | Amount | ||
2007 | $ | 3,374 | |
2008 | 3,030 | ||
2009 | 2,906 | ||
2010 | 2,906 | ||
2011 | 2,906 | ||
Thereafter | 5,927 | ||
Total | $ | 21,049 | |
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
NOTE 6—BUSINESS COMBINATIONS
All of the Company’s qualifying business combinations have been accounted for using the purchase method of accounting. Consideration includes the cash paid and the value of options assumed, less any cash acquired, and excludes contingent employee compensation payable in cash. Prior to the adoption ofactual grant date. Under SFAS No. 123(R), the Company accounted for the intrinsic value of stock options assumed related to future services as deferred stock-based compensation within stockholders’ equity.
During the fiscal year 2005, the Company completed the acquisition of the following three businesses for net cash consideration of approximately $43.5 million primarily to expand the Company’s product portfolio.
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The following table summarizes the estimated fair values of the net assets acquired at the date of the acquisitions (in thousands):
Amount | ||||
Cash | $ | 4,653 | ||
Purchased in-process research & development | 700 | |||
Existing technology | 10,685 | |||
Trademarks | 600 | |||
Other intangible assets | 200 | |||
Other tangible assets and liabilities | (1,615 | ) | ||
Deferred stock-based compensation | 908 | |||
Deferred tax assets | 4,827 | |||
Goodwill | 28,713 | |||
Net assets acquired | $ | 49,671 | ||
Cash consideration | $ | 48,181 | ||
Value of stock options assumed | 1,490 | |||
Total consideration | $ | 49,671 | ||
In connection with the acquisitions completed during the fiscal year 2005, KLA-Tencor is subject to a $9.1 million contingent cash payment based on the continued employment of certain employees over two years. The contingency is accounted for as compensation expense over the contingent employment period. At June 30, 2006, $3.7 million of this payment remains outstanding.
The deferred stock-based compensationno incremental charge was recognized in connection with these business combinations is being amortized over the period earned. Amortization of deferred stock-based compensation was $126,000 duringfinancial statements for the fiscal year ended June 30, 2006.
During fiscal year 2005, KLA-Tencor acquired2007. Mr. Levy was the remaining equity outstandingCompany’s Chief Executive Officer from 1975 until mid-1999 (with the exception of Blue29, its variable interest entity consolidated after adoption of FIN 46(R). Subsequently, KLA-Tencor transferred the assets of Blue29mid-1997 to mid-1998), was a limited liability corporation in which a third party acquired a minority interest for total proceeds of $12.6 million.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Pro forma earnings information has not been presented because the effectmember of the acquisitions in 2005Company’s Board of Directors from 1975 until his retirement, was not material either on an individual or an aggregate basis.
The fair valueChairman of the purchased IPR&DBoard of Directors from 1999 until his retirement, and identified intangibles was determined using the income approach, which discounts expected future cash flows from projects to their net present value. Each project was analyzed to determine the technological innovations included; the utilization of core technology; the complexity, cost and time to complete development; any alternative future use or current technological feasibility; and the stage of completion. Future cash flows were estimated, taking into account the expected life cyclesa member of the productsCompany’s Stock Option Committee from 1994 until use of that committee was suspended in the fall of 2006.
Also on October 16, 2006, Stuart J. Nichols, Vice President and General Counsel, resigned. Mr. Nichols entered into a Separation Agreement and General Release with the underlying technology, relevantCompany under which Mr. Nichols’ outstanding retroactively priced stock options have been re-priced by increasing the exercise price to the market sizes and industry trends. The Company determined a discount rate for each project basedprice of the option shares on the relative risks inherent in the project’s development horizon, the estimated costs of development, and the level of technological change in the project and the industry, among other factors. The Company began amortizing the acquired identified intangibles over their useful life of six months to seven years.
NOTE 7—STOCK-BASED COMPENSATION
Effective July 1, 2005, KLA-Tencor adopted the provisions ofactual grant date. Under SFAS No. 123(R), “Share-Based Payment.” SFAS No. 123(R) establishes accountingno incremental charge was recognized in the financial statements for stock-based awards exchanged for employee services. Accordingly, stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized as expense over the employee’s requisite service period. The Company previously applied APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and its related Interpretations and provided the required pro forma disclosures of SFAS No. 123, “Accounting for Stock-Based Compensation.” The Company determined that, during the periods from July 1, 1994 to June 30, 2005, certain stock options were retroactively priced and recorded $348 million of compensation expense under APB No. 25. See Note 2 for additional information.
Adoption of SFAS No. 123(R)
The Company elected to adopt the modified prospective application method as provided by SFAS No. 123(R). Accordingly, during the fiscal year ended June 30, 2007.
On December 21, 2006, Jon D. Tompkins resigned as a director of the Company, recorded stock-based compensation cost totalingand we agreed to modify the amount thatoutstanding options held by Mr. Tompkins (all of which were fully vested) to extend the post-termination exercisability period to December 31, 2007, which is the last day of the calendar year in which those options would have been recognized had the fair value method been applied since the effective date of SFAS No. 123 valued under SFAS No. 123 for the pre-fiscal year 2006 grants and under SFAS No. 123(R) for the fiscal year 2006 grants.
In November 2005, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) No. FAS 123(R)-3, “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards” (“FSP 123R-3”). The Company has elected not to adopt the alternative transition method providedterminated in the FSP 123R-3 for calculatingabsence of such extension. Mr. Tompkins, the tax effectsChief Executive Officer of stock-based compensation pursuant to SFAS No. 123(R). TheTencor Instruments before its merger into the Company followed paragraph 81 of SFAS No. 123(R) to calculate the initial pool of excess tax benefits and to determine the subsequent impact on the APIC pool and Consolidated Statements of Cash Flows of the tax effects of employee stock-based compensation awards that are outstanding upon adoption of SFAS No. 123(R).
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The effect of adopting SFAS No. 123(R) in the year ended June 30, 2006 (including the effect of the restatements)mid-1997, was as follows:
(in thousands except per share data) | Year ended June 30, 2006 | |||
Additional pre-tax stock-based compensation | $ | 131,869 | ||
Additional stock-based compensation, net of tax | 85,263 | |||
Cash flows from operations | (14,417 | ) | ||
Cash flows from financing activities | 14,417 | |||
Effect on earnings per share: | ||||
Basic | $ | 0.43 | ||
Diluted | $ | 0.42 |
In the Company’s pro forma disclosures priorChief Executive Officer from mid-1997 to the adoption of SFAS No. 123(R), the Company accounted for forfeitures upon occurrence. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised if necessary in subsequent periods if actual forfeitures differ from those estimates. The unrecognized stock-based compensation, including the impact of the restatements,mid-1998, was $248.8 million as of June 30, 2006.
Approximately $6.0 million and $1.6 million of stock-based compensation was capitalized as inventory and deferred system profit, respectively, at June 30, 2006. Approximately $1.5 million and $0.4 million of stock-based compensation was capitalized as inventory and deferred system profit, respectively, at June 30, 2005.
Effective July 1, 2006, $53.7 million of deferred stock-based compensation separately recorded as a reduction to stockholders’ equity was reclassified as a reduction of common stock and Capital in Excess of Par Value in connection with the adoption of SFAS No. 123(R).
Valuation Assumptions
In connection with the adoption of SFAS No. 123(R), the Company reassessed its valuation technique and related assumptions. The Company estimates the fair value of stock options using a Black-Scholes valuation model, consistent with the provisions of SFAS No. 123(R), SEC SAB No. 107 and the Company’s prior period pro forma disclosures of net earnings, including stock-based compensation (determined under a fair value method as prescribed by SFAS No. 123). The fair value of each option grant is estimated on the date of grant using the Black-Scholes option valuation model with the following weighted-average assumptions:
2006 | 2005 | 2004 | |||||||
Stock option plan: | |||||||||
Expected stock price volatility | 30 | % | 58 | % | 60 | % | |||
Risk free interest rate | 4.1 | % | 3.6 | % | 3.4 | % | |||
Dividend yield | 1.0 | % | 0.1 | % | — | ||||
Expected life of options (in years) | 4.6 | 5.6 | 5.5 | ||||||
Stock purchase plan: | |||||||||
Expected stock price volatility | 34 | % | 34 | % | 47 | % | |||
Risk free interest rate | 3.9 | % | 3.4 | % | 1.6 | % | |||
Dividend yield | 1.0 | % | — | — | |||||
Expected life of options (in years) | 1.3 | 1.2 | 1.2 |
SFAS No. 123(R) requires the use of option-pricing models that were not developed for use in valuing employee stock options. The Black-Scholes option-pricing model was developed for use in estimating the fair
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
value of short-lived exchange traded options that have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions, including the option’s expected life and the price volatility of the underlying stock. The expected stock price volatility assumption was determined using the implied volatility of the Company’s common stock. The Company determined that implied volatility is more reflective of market conditions and a better indicator of expected volatility than a blended volatility. Prior to the adoption of SFAS No. 123(R), the Company used a combination of historical and implied volatility in deriving its expected volatility assumption.
Equity Incentive Program.The Company’s equity incentive program is a broad-based, long-term retention program that is intended to attract and retain key employees, and align stockholder and employee interests. The equity incentive program consists of two plans: one under which non-employee directors may be granted options to purchase sharesmember of the Company’s stock option committee from mid-1997 until mid-1999, and another in which non-employee directors, officers, key employees, consultants and all other employees may be granted options to purchase shareswas a member of the Company’s Board of Directors from mid-1997 until his resignation.
Although the Board of Directors concluded that John H. Kispert, our President and Chief Operating Officer, was not involved in and was not aware of the improper stock restricted stock units and other types of equity awards. Foroption practices, based on the past several years, stock options (except for theSpecial Committee’s recommendation, his outstanding retroactively priced option grants)options have generally been granted atre-priced because he served as Chief Financial Officer during part of the period in question. This re-pricing involved increasing the exercise price to the market price of the Company’s common stockoption shares on the date ofactual grant generally have a vesting period of five years and are exercisabledate. Under SFAS No. 123(R), no incremental charge was recognized in the financial statements for a 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 time-based or performance-based vesting. Substantially all of the Company’s employees that meet established performance goals and qualify as key employees participate in its main equity incentive plan.
On October 18, 2004, the Company’s stockholders approved the 2004 Equity Incentive Plan (the “2004 Plan”) which provides for the grant of options to purchase shares of the Company’s common stock, stock appreciation rights, restricted stock, performance shares, performance units and deferred stock units to the Company’s employees, consultants and members of the Company’s Board of Directors. Since the adoption of the 2004 Plan, no further grants are permitted under the 1982 Stock Option Plan or 2000 Non-Statutory Stock Option Plan. The 2004 Plan permits the issuance of 12,500,000 shares of common stock, of which 6.3 million shares are available for grant as of June 30, 2006. At that date, awards for 30.4 million shares are outstanding under all plans.
During the fiscal year ended June 30, 2005, the following actions were taken with regard to the 2004 Plan. The Company initially reserved 11,000,000 shares for grant in the 2004 Plan. In addition, 1,465,853 shares were added to the reserve from 1982 Stock Option Plan and 2000 Non-Statutory Plan due to forfeitures or expirations. All other stock option plans other than the 2004 Plan were terminated and as a result, 15,814,111 shares which were previously unissued under these plans, were no longer available for grant.
As part of the ADE acquisition in October 2006, the Company has assumed 251,314 ADE options which will convert to 175,697 options of KLA-Tencor.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The following table summarizes the Company’s equity compensation plans as of June 30, 2006:
Number of securities to be issued upon exercise of outstanding options, warrants and rights(1) | Weighted-average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column 1)(2) | |||||
Equity compensation plans approved by stockholders | 24,431,083 | $ | 40.26 | 8,122,294 | |||
Equity compensation plans not approved by stockholders | 5,931,209 | $ | 38.96 | — | |||
Total | 30,362,292 | $ | 40.00 | 8,122,294 | |||
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The following table summarizes the combined activity under the equity incentive plans for the indicated periods:
Available For Grant | Awards Outstanding | Weighted- Average Exercise Price | |||||||
Balances at June 30, 2003 | 16,919,718 | 29,733,958 | $ | 29.94 | |||||
Additional shares reserved | 5,751,033 | — | — | ||||||
Options granted | (6,298,343 | ) | 6,298,343 | $ | 52.09 | ||||
Options canceled/expired | 978,478 | (978,478 | ) | $ | 38.66 | ||||
Options exercised | — | (5,357,878 | ) | $ | 25.74 | ||||
Balances at June 30, 2004 | 17,350,886 | 29,695,945 | $ | 35.11 | |||||
Additional shares reserved | 18,369,456 | — | — | ||||||
Plan shares expired | (15,814,111 | ) | — | — | |||||
Options granted(1) | (9,625,481 | ) | 9,625,481 | $ | 40.31 | ||||
Restricted stock units granted(2) | (732,528 | ) | — | — | |||||
Options canceled/expired/forfeited | 2,267,362 | (2,267,362 | ) | $ | 41.84 | ||||
Options exercised | — | (3,675,077 | ) | $ | 26.56 | ||||
Balances at June 30, 2005 | 11,815,584 | 33,378,987 | $ | 37.08 | |||||
Additional shares reserved | 34,147 | — | — | ||||||
Plan shares expired | (1,280,552 | ) | — | — | |||||
Options granted | (4,856,055 | ) | 4,856,055 | $ | 48.37 | ||||
Restricted stock units granted(2) | (1,279,620 | ) | — | — | |||||
Options canceled/expired/forfeited | 1,860,864 | (1,860,864 | ) | $ | 44.05 | ||||
Restricted stock units canceled(2) | 24,062 | — | — | ||||||
Options exercised | — | (6,011,886 | ) | $ | 29.34 | ||||
Balances at June 30, 2006 | 6,318,430 | 30,362,292 | $ | 40.00 | |||||
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The options outstanding and exercisable at June 30, 2006 were in the following exercise price ranges:
Options Outstanding | Options Exercisable | |||||||||||||||||||
Range of Exercise Prices | Number of Shares Outstanding | Weighted- Average Remaining Contractual Term | Weighted- Average Exercise Price | Aggregate Intrinsic Value | Number Vested and Exercisable | Weighted- Average Remaining Contractual Term | Weighted- Average Exercise Price | Aggregate Intrinsic Value | ||||||||||||
(in years) | (in thousands) | (in years) | (in thousands) | |||||||||||||||||
$ 5.95-$9.53 | 34,729 | 0.79 | $ | 9.18 | $ | 1,125 | 34,729 | 0.79 | $ | 9.18 | $ | 1,125 | ||||||||
$ 9.54-$19.88 | 1,466,927 | 2.12 | $ | 11.88 | $ | 43,558 | 1,466,927 | 2.12 | $ | 11.88 | $ | 43,558 | ||||||||
$19.89-$29.96 | 4,135,017 | 4.90 | $ | 28.71 | $ | 53,157 | 3,622,575 | 4.89 | $ | 28.62 | $ | 46,909 | ||||||||
$29.97-$39.35 | 10,289,835 | 6.77 | $ | 37.04 | $ | 46,631 | 5,142,845 | 5.66 | $ | 35.48 | $ | 31,320 | ||||||||
$39.36-$49.99 | 9,824,253 | 6.49 | $ | 45.65 | $ | 775 | 3,798,926 | 5.56 | $ | 44.83 | $ | 332 | ||||||||
$50.00-$68.00 | 4,611,531 | 6.90 | $ | 53.88 | — | 2,401,559 | 6.93 | $ | 54.23 | — | ||||||||||
$ 5.95-$68.00 | 30,362,292 | 6.21 | $ | 40.00 | $ | 145,246 | 16,467,561 | 5.33 | $ | 36.71 | $ | 123,244 | ||||||||
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value, based on the Company’s closing stock price of $41.57 as of June 30, 2006, which would have been received by the option holders had all option holders exercised their options as of that date. The total number of options with intrinsic value exercisable as of June 30, 2006 was 10.6 million shares.
The weighted-average grant date fair value of options, as determined under SFAS No. 123(R), granted in fiscal years 2006, 2005 and 2004 were $14.17, $22.33 and $29.09, respectively. Options exercisable were 16,467,561, 17,331,534 and 16,438,597 as of June 30, 2006, 2005 and 2004, respectively.
The total intrinsic value of options exercised during the 2006 and 2005 was $130.2 million and $69.9 million, respectively. In connection with these exercises, the tax benefits realized by the Company for 2006 and 2005 was $47 million and $25 million, respectively.
The Company settles employee stock option exercises with newly issued common shares.
Stock-based compensation cost as calculated on a fair value basis for options for fiscal years 2006, 2005, and 2004 was $140.4 million, $34.9 million, and $53.2 million, respectively. As of June 30, 2006, there was $223.0 million of total unrecognized stock-based compensation after estimated forfeitures related to stock options granted under the Equity Incentive Program. That cost is expected to be recognized over an estimated weighted-average amortization period of 3.3 years.
Restricted Stock Units
During the fiscal year ended June 30, 2006, the Company’s Board of Directors approved the grant of 710,900 shares of restricted stock units to selected employees. These restricted stock units generally vest in two equal installments on the fourth and fifth anniversaries of the date of grant. The value of the restricted stock units was based on the closing market price of the Company’s common stock on the date of grant. The total grant date fair value of the restricted stock units awarded during the fiscal year ended June 30, 2006 was $23.2 million after estimated forfeitures. Stock-based compensation cost for restricted stock units for fiscal years 2006 and 2005 was $8.1 million and $2.1 million, respectively. No stock-based compensation cost was recognized in fiscal year 2004.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
As of June 30, 2006, there was $25.8 million of total unrecognized stock-based compensation after estimated forfeitures related to restricted stock units granted under the Equity Incentive Program. That cost is expected to be recognized over an estimated weighted-average amortization period of 3.7 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 employee’s purchase price is derived from a formula based on the fair market value of the common stock at the time of enrollment into the offering period versus the fair market value on the date of purchase. Offering periods are generally two years in length. The compensation cost in connection with the plan in fiscal year 2006 was $16.2 million, in accordance with SFAS No. 123(R). The total cash received from employees for the issuance of shares under the employee stock purchase plan was approximately $36.3 million during fiscal year 2006. As the plan is non-compensatory under APB Opinion No. 25, no compensation expense was recorded in connection with the plan in fiscal years 2005 and 2004. The ESPP is considered compensatory under SFAS No. 123(R). In fiscal years 2006, 2005 and 2004, employees purchased 1,021,872; 1,059,415; and 958,698 of shares issued at a weighted-average fair value of $36.21, $34.43 and $31.99, respectively.
The plan 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 2,000,000 shares or the number of shares which KLA-Tencor estimates will be required to issue under the plan during the forthcoming fiscal year. At June 30, 2006, a total of 1,803,864 shares were reserved and available for issuance under this plan.
See Note 16 “Subsequent Events” for discussion of suspension of the plan as announced during the first quarter of fiscal 2007.
Former Chief Executive Officer Agreement and Termination. During November 2005, the Company announced that effective January 1, 2006, Kenneth L. Schroeder would cease to be its Chief Executive Officer and would thereafter be employed as a Senior Advisor. The Company and Mr. Schroeder also revised his prior agreement with the Company and defined the salary, bonus payout and equity award vesting during the period of his employment as a Senior Advisor. Effective January 1, 2006, the Company determined that all service conditions associated with certain prior equity awards under the terms of the revised agreement with Mr. Schroeder had been satisfied; accordingly, the Company recorded at that time an additional non-cash, stock-based compensation charge of approximately $9.8 million relating to these equity awards. The above mentioned charge is included as a component of Selling, General and Administrative expense during fiscal 2006. On October 16, 2006, following the Special Committee investigation of the Company’s historical stock option practices, the Company terminated all aspects of Mr. Schroeder’s employment relationship and agreement with the Company. As a result, vesting of Mr. Schroeder’s then outstanding stock options and restricted stock awards immediately ceased, and the 890,914 unvested option shares and 100,000 unvested restricted stock award shares held by Mr. Schroeder at the time of termination were canceled. Accordingly, in the second quarter of fiscal 2007 the Company will reverse approximately $20 million of the non-cash, stock-based compensation charge recorded in prior periods. In December 2006, the Company canceled 596,740 vested option shares held by Mr. Schroeder as of the time of termination, representing those shares that had been retroactively priced or otherwise improperly granted.
Stockholders’ Rights Plan. In March 1989, KLA-Tencor implemented a plan to protect stockholders’ rights in the event of a proposed takeover of KLA-Tencor. Each stockholder under the plan is entitled to one right per common stock owned. The plan was amended in April 1996. The plan provides that if any person or group acquires 15% or more of KLA-Tencor’s common stock, each right not owned by such person or group will entitle its holder to purchase, at the then-current exercise price, KLA-Tencor’s common stock at a value of twice
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
that exercise price. Under the amended plan, the rights were redeemable at KLA-Tencor’s option for $0.01 per right. All rights expired in April 2006.
NOTE 8—7—STOCK REPURCHASE PROGRAM
In July 1997, the Board of Directors authorized KLA-Tencor to systematically repurchase shares of its common stock in the open market. This plan was put into place to reduce the dilution from KLA-Tencor’s employee benefit and incentive plans such as the stock option and employee stock purchase plans, and to return excess cash to the Company’s shareholders. Since the inception of the repurchase program in 1997 through June 30, 20062007 the Board of Directors had authorized KLA-Tencor to repurchase a total of 27.837.8 million shares, including 1010.0 million shares authorized in February 2005.
2005, and an additional 10.0 million shares authorized in February 2007. The Company’s systematic buyback program was suspended in May 2006.2006, and resumed in February 2007. We account for repurchased common stock under the cost method and include such treasury stock as a component of our common shareholders’ equity.
In addition, the Board of Directors authorized a repurchase of up to $750.0 million of the Company’s common stock pursuant to an Accelerated Share Repurchase program (“ASR”) in February 2007. The Company intendsentered into the ASR with a third-party investment bank and prepaid $750.0 million to recommence purchasesrepurchase its common stock. The purchase price per share of the common stock repurchased through the ASR was determined and
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
adjusted based on a discount to the volume-weighted average price of the Company’s common stock during a period following the execution of the ASR agreement, subject to a maximum price per share. During the fiscal year ended June 30, 2007 the Company received approximately 14.0 million shares under the ASR.
The payment of $750.0 million was included in the cash flows from financing activities in the Company’s Consolidated Statement of Cash Flows. The shares received were multiplied by the closing stock price on the date of receipt to determine the cost of repurchase. The Company’s outstanding shares decreases as shares are physically received under the Company’s repurchase program, including the ASR. Diluted net income per share increased by $0.05 for the fiscal year ended June 30, 2007, due to the reduction of the weighted average number of common shares outstanding during the period as soon as possible after it has returned to full compliance with applicable SEC reporting requirements.a result of the ASR.
Share repurchases for the fiscal years ended June 30, 20062007 and 20052006 were as follows (in thousands):follows:
Fiscal year ended June 30, | 2006 | 2005 | ||||||||||
(in thousands) | Year ended June 30, | |||||||||||
2007 | 2006 | |||||||||||
Number of shares of common stock repurchased | 4,524 | 4,946 | 15,103 | 4,524 | ||||||||
Total cost of repurchase | $ | 221,417 | $ | 203,658 | $ | 808,461 | $ | 221,417 |
As discussed in Note 17, “Subsequent Events,” during August 2007, the Company’s Board of Directors approved the repurchase of an additional 10.0 million shares of the Company’s common stock under the Company’s repurchase program.
NOTE 9—8—EARNINGS PER SHARE
Basic earnings per share (“EPS”) is calculated by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is calculated by using the weighted-average number of common shares outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the dilutive potential shares of common stock had been issued. The dilutive effect of outstanding options and restricted stock units is reflected in diluted earnings per share by application of the treasury stock method, which includes consideration of stock-based compensation required by SFAS No. 123(R),Share-Based Payment and SFAS No. 128, “EarningsEarnings Per Share.”
Share. The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts):share:
Fiscal year ended June 30, | 2006 | 2005 | 2004 | |||||||||||||||
(in thousands, except per share data) | Year ended June 30, | |||||||||||||||||
As restated | As restated | 2007 | 2006 | 2005 | ||||||||||||||
Numerator: | ||||||||||||||||||
Net income | $ | 380,452 | $ | 445,049 | $ | 212,476 | $ | 528,098 | $ | 380,452 | $ | 445,049 | ||||||
Denominator: | ||||||||||||||||||
Weighted-average shares outstanding, excluding unvested restricted stock | 198,625 | 196,346 | 194,976 | |||||||||||||||
Weighted average shares outstanding, excluding unvested restricted stock units | 197,126 | 198,625 | 196,346 | |||||||||||||||
Effect of dilutive options and restricted stock | 5,472 | 4,780 | 7,326 | 5,078 | 5,472 | 4,780 | ||||||||||||
Denominator for diluted earnings per share | 204,097 | 201,126 | 202,302 | 202,204 | 204,097 | 201,126 | ||||||||||||
Basic earnings per share | $ | 1.92 | $ | 2.27 | $ | 1.09 | $ | 2.68 | $ | 1.92 | $ | 2.27 | ||||||
Diluted earnings per share | $ | 1.86 | $ | 2.21 | $ | 1.05 | $ | 2.61 | $ | 1.86 | $ | 2.21 | ||||||
Potentially dilutive securities(1) | 10,224 | 17,044 | 9,924 |
(1) | These securities are excluded from the computation of diluted earnings per share for the above periods because their effect would have been anti-dilutive. |
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Potentially dilutive securities that were excluded from the computation of diluted earnings per share for the above periods because their effect would have been anti-dilutive were as follows (in thousands except price data):
Fiscal year ended June 30, | 2006 | 2005 | ||||
Number of shares | 17,044 | 9,924 | ||||
Price range | $ | 48.73-$68.00 | $ | 43.61-$68.00 |
During the third quarter of the fiscal year ended March 31,June 30, 2005, the Company’s Board of Directors authorized a quarterly cash dividend of $0.12 per share with the first dividend payable on June 1, 2005 to shareholders of record as of May 2, 2005.share. The total amount of dividends paid during the fiscal years ended June 30, 2007, 2006 and 2005 was $95.1 million, $95.3 million, and $23.6 million, respectively.
As discussed in Note 17, “Subsequent Events,” on August 8, 2007, the Company declared a quarterly cash dividend of $0.15 per share to be paid on September 1, 2007 to stockholders of record on August 20, 2007.
NOTE 10—9—EMPLOYEE BENEFIT PLANS
KLA-Tencor has a profit sharing program for eligible employees, which distributes on a quarterly basis, a percentage of pre-tax profits. In addition, KLA-Tencor has an employee savings plan that qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code. Starting fiscal year 2000, KLA-Tencor has matchedmatches up to a maximum of $1,000$3,000 or 50% of the first $2,000$6,000 of an eligible employee’s contribution, with $500 of the amount funded from the profit sharing program.contribution. The total charge to operations under the profit sharing and 401(k) programs aggregated $17$19.0 million, $16$17.0 million and $9$16.0 million in the fiscal years ended June 30, 2007, 2006 2005 and 2004,2005, respectively. KLA-Tencor has no defined benefit plans in the United States. In addition to the profit sharing plan and the United States employee saving plan, several of KLA-Tencor’s foreign subsidiaries have retirement plans for their full-time employees, several of which are defined benefit plans. Consistent with the requirements of local law, the Company deposits funds for certain of these plans with insurance companies, third-party trustees, or into government-managed accounts, and/or accrues for the unfunded portion of the obligation. The assumptions used in calculating the obligation for the foreign plans depend on the local economic environment.
KLA- Tencor adopted SFAS No. 158,Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans an amendment of FASB Statements No. 87, 88, 106, and 132(R),effective June 30, 2007. Upon adoption, SFAS 158 requires an employer to recognize the funded status of each of its defined pension and postretirement benefit plans as a net asset or liability in its statement of financial position with an offsetting amount in accumulated other comprehensive income. Additionally, SFAS 158 requires an employer to measure the funded status of each of its plans as of the date of its year-end statement of financial position. The benefit obligations and related assets under thesethe Company’s plans have been measured as of June 30, 2006.
KLA-TENCOR CORPORATION2007.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Summary data relating to the KLA-Tencor’s foreign defined benefit pension plans, including key weighted-average assumptions used is provided in the following tables:
Year ended June 30, | ||||||||
(in thousands) | 2006 | 2005 | ||||||
Change in projected benefit obligation | ||||||||
Projected benefit obligation at beginning of fiscal year | $ | 20,731 | $ | 15,390 | ||||
Service cost, including plan participant contributions | 2,088 | 2,541 | ||||||
Interest cost | 500 | 387 | ||||||
Actuarial (gain) loss | (2,376 | ) | 2,586 | |||||
Benefit payments | (516 | ) | (291 | ) | ||||
Foreign currency exchange rate changes | (602 | ) | 118 | |||||
Projected benefit obligation at the end of the fiscal year | $ | 19,825 | $ | 20,731 | ||||
Year ended June 30, | ||||||||
(in thousands) | 2006 | 2005 | ||||||
Change in fair value of plan assets | ||||||||
Fair value of plan assets at beginning of fiscal year | $ | 4,285 | $ | 3,382 | ||||
Actual return on plan assets | 2 | (1 | ) | |||||
Employer contributions | 901 | 840 | ||||||
Benefit and expense payments | (78 | ) | (83 | ) | ||||
Foreign currency exchange rate changes | (15 | ) | 147 | |||||
Fair value of plan assets at end of fiscal year | $ | 5,095 | $ | 4,285 | ||||
As of June 30, | ||||||||
(in thousands) | 2006 | 2005 | ||||||
Funded status | ||||||||
Ending funded status | $ | (14,730 | ) | $ | (16,446 | ) | ||
Unrecognized transition obligation | 374 | 546 | ||||||
Unrecognized net actuarial loss | 2,611 | 5,180 | ||||||
Net amount recognized | $ | (11,745 | ) | $ | (10,720 | ) | ||
The accumulated benefit obligation for all defined benefit plans was $14.0 million and $13.6 million at June 30, 2006 and 2005, respectively.
As of June 30, | ||||||
(in thousands) | 2006 | 2005 | ||||
Plans with accumulated benefit obligations in excess of plan assets | ||||||
Accumulated benefit obligation | $ | 14,007 | $ | 13,563 | ||
Projected benefit obligation | 19,825 | 20,731 | ||||
Plan assets at fair value | 5,095 | 4,285 |
Year ended June 30, | ||||||
2006 | 2005 | 2004 | ||||
Weighted-average assumptions | ||||||
Discount rate | 2.5%-5.0% | 1.5%-5.5% | 1.5% -5.3% | |||
Expected return on assets | 3.5%-4.5% | 3.5%-4.3% | 3.5% -5.3% | |||
Rate of compensation increases | 2.0%-4.0% | 2.0%-4.0% | 2.0% -3.3% |
Year ended June 30, | ||||||||
(in thousands) | 2007 | 2006 | ||||||
Change in projected benefit obligation | ||||||||
Projected benefit obligation at beginning of fiscal year | $ | 19,825 | $ | 20,731 | ||||
Service cost, including plan participant contributions | 1,768 | 2,088 | ||||||
Interest cost | 559 | 500 | ||||||
Actuarial (gain) loss | 2,777 | (2,376 | ) | |||||
Benefit payments | (1,519 | ) | (516 | ) | ||||
Acquisitions | 1,297 | — | ||||||
Foreign currency exchange rate changes | (707 | ) | (602 | ) | ||||
Projected benefit obligation at the end of the fiscal year | $ | 24,000 | $ | 19,825 | ||||
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Year ended June 30, | ||||||||
(in thousands) | 2007 | 2006 | ||||||
Change in fair value of plan assets | ||||||||
Fair value of plan assets at beginning of fiscal year | $ | 5,095 | $ | 4,285 | ||||
Actual return on plan assets | 47 | 2 | ||||||
Employer contributions | 1,020 | 901 | ||||||
Benefit and expense payments | (231 | ) | (78 | ) | ||||
Acquisitions | 348 | — | ||||||
Foreign currency exchange rate changes | 71 | (15 | ) | |||||
Fair value of plan assets at end of fiscal year | $ | 6,350 | $ | 5,095 | ||||
As of June 30, | ||||||||
(in thousands) | 2007 | 2006 | ||||||
Funded status | ||||||||
Ending funded status | $ | (17,650 | ) | $ | (14,730 | ) | ||
Unrecognized transition obligation | — | 374 | ||||||
Unrecognized net actuarial loss | — | 2,611 | ||||||
Net amount recognized | $ | (17,650 | ) | $ | (11,745 | ) | ||
As of June 30, | ||||||
(in thousands) | 2007 | 2006 | ||||
Plans with accumulated benefit obligations in excess of plan assets | ||||||
Accumulated benefit obligation | $ | 16,128 | $ | 14,007 | ||
Projected benefit obligation | $ | 24,000 | $ | 19,825 | ||
Plan assets at fair value | $ | 6,350 | $ | 5,095 |
Year ended June 30, | ||||||
2007 | 2006 | 2005 | ||||
Weighted average assumptions | ||||||
Discount rate | 2.0%-5.0% | 2.5%-5.0% | 1.5%-5.5% | |||
Expected return on assets | 3.0%-4.5% | 3.5%-4.5% | 3.5%-4.3% | |||
Rate of compensation increases | 3.0%-4.0% | 2.0%-4.0% | 2.0%-4.0% |
The expected rate of return on assets assumptions were developed by considering the historical returns and expectations of future returns relevant to the country in which each plan is in effect and the investments applicable to the corresponding plan. The discount rate for each plan was derived by reference to appropriate benchmark yields on high quality corporate bonds, allowing for the approximate duration of both plan obligations and the relevant benchmark index.
The incremental effect of applying the recognition provision of SFAS No. 158 on individual line items in the Consolidated Balance Sheet as of June 30, 2007 is as follows:
(in thousands) | Prior to SFAS No. 158 | Adjustments | After Application of SFAS No. 158 | |||||||||
Deferred income taxes | $ | 336,915 | $ | 2,218 | $ | 339,133 | ||||||
Other current liabilities | $ | (674,377 | ) | $ | (5,664 | ) | $ | (680,041 | ) | |||
Accumulated other comprehensive income | $ | (14,851 | ) | $ | 3,446 | $ | (11,405 | ) |
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Amounts recognized in accumulated other comprehensive income consist of:
Year ended June 30, | ||||||
(in thousands) | 2007 | 2006 | ||||
Unrecognized transition obligation | $ | 339 | $ | — | ||
Unrealized net actuarial loss | 5,325 | — | ||||
Amount recognized | $ | 5,664 | $ | — | ||
Amounts in accumulated other comprehensive income expected to be recognized as components of net periodic benefit cost over the fiscal year ended June 30, 2008 is as follows:
(in thousands) | Year ended June 30, 2008 | ||
Unrecognized transition obligation | $ | 255 | |
Unrealized net actuarial loss | 34 | ||
Amount expected to be recognized | $ | 289 | |
The components of KLA-Tencor’s net periodic cost relating to its foreign subsidiaries defined pension plans are as follows:
Year ended June 30, | Year ended June 30, | |||||||||||||||||||||||
(in thousands) | 2006 | 2005 | 2004 | 2007 | 2006 | 2005 | ||||||||||||||||||
Components of net periodic pension cost | ||||||||||||||||||||||||
Service cost, net of plan participant contributions | $ | 2,088 | $ | 2,541 | $ | 2,174 | $ | 1,767 | $ | 2,088 | $ | 2,541 | ||||||||||||
Interest cost | 500 | 387 | 338 | 559 | 500 | 387 | ||||||||||||||||||
Return on plan assets | (171 | ) | (148 | ) | (75 | ) | (209 | ) | (171 | ) | (148 | ) | ||||||||||||
Amortization of net transitional obligation | 154 | 255 | 248 | 32 | 154 | 255 | ||||||||||||||||||
Amortization of net gain | 184 | 70 | 37 | 131 | 184 | 70 | ||||||||||||||||||
Net periodic pension cost | $ | 2,755 | $ | 3,105 | $ | 2,722 | $ | 2,280 | $ | 2,755 | $ | 3,105 | ||||||||||||
The foreign plans’ investments are managed by third-party trustees consistent with regulations or market practice of the country where the assets are invested. KLA-Tencor is not actively involved in the investment strategy nor does it have control over the target allocation of these investments. These investments made up 100% of total foreign plan assets in the fiscal years ended June 30, 2007, 2006 2005 and 2004.2005.
Expected funding for the foreign plans during the fiscal year 2007ending June 30, 2008 is $0.9$1.0 million.
The total benefits to be paid from the foreign pension plans are not expected to exceed $1.2$1.1 million in any year through 2014.2015.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Executive Savings Plan
KLA-Tencor has a non-qualified deferred compensation plan whereby certain executives may defer a portion of their salary and bonus. Participants are credited with returns based on their allocation of their account balances among mutual funds. KLA-Tencor controls the investment of these funds and the participants remain general creditors of KLA-Tencor. Distributions from the plan commence the quarter following a participant’s retirement or termination of employment. AtAs of June 30, 2006,2007, KLA-Tencor had a deferred compensation liability under the plan of $142.5$154.5 million included as a component of other current liabilities on the consolidated balance sheet.Consolidated Balance Sheet.
NOTE 11—10—INCOME TAXES
The components of income before income taxes are as follows (in thousands):follows:
Year ended June 30, | 2006 | 2005 | 2004 | ||||||
As restated | As restated | ||||||||
Domestic income before income taxes | $ | 329,066 | $ | 510,328 | $ | 208,910 | |||
Foreign income before income taxes | 48,792 | 72,748 | 61,478 | ||||||
Total net income before taxes | $ | 377,858 | $ | 583,076 | $ | 270,388 | |||
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands) | Year ended June 30, | ||||||||
2007 | 2006 | 2005 | |||||||
Domestic income before income taxes | $ | 538,257 | $ | 329,066 | $ | 510,328 | |||
Foreign income before income taxes | 138,978 | 48,792 | 72,748 | ||||||
Total net income before taxes | $ | 677,235 | $ | 377,858 | $ | 583,076 | |||
The provision for income taxes is comprised of the following (in thousands):following:
Year ended June 30, | 2006 | 2005 | 2004 | |||||||||||||||||||||
(in thousands) | Year ended June 30, | |||||||||||||||||||||||
As restated | As restated | 2007 | 2006 | 2005 | ||||||||||||||||||||
Current: | ||||||||||||||||||||||||
Federal | $ | 106,676 | $ | 170,507 | $ | 56,185 | $ | 133,287 | $ | 106,676 | $ | 170,507 | ||||||||||||
State | 8,998 | 8,017 | 10,028 | 3,204 | 8,998 | 8,017 | ||||||||||||||||||
Foreign | 20,217 | 16,378 | 20,754 | 27,189 | 20,217 | 16,378 | ||||||||||||||||||
135,891 | 194,902 | 86,967 | $ | 163,680 | $ | 135,891 | $ | 194,902 | ||||||||||||||||
Deferred: | ||||||||||||||||||||||||
Federal | (125,632 | ) | (51,526 | ) | (17,099 | ) | (21,741 | ) | (125,632 | ) | (51,526 | ) | ||||||||||||
State | (3,535 | ) | (3,029 | ) | (11,304 | ) | 5,534 | (3,535 | ) | (3,029 | ) | |||||||||||||
Foreign | (5,217 | ) | 1,058 | (652 | ) | 3,036 | (5,217 | ) | 1,058 | |||||||||||||||
(134,384 | ) | (53,497 | ) | (29,055 | ) | (13,171 | ) | (134,384 | ) | (53,497 | ) | |||||||||||||
Provision for income taxes | $ | 1,507 | $ | 141,405 | $ | 57,912 | $ | 150,509 | $ | 1,507 | $ | 141,405 | ||||||||||||
Actual current tax liabilities are lower than reflected above for the fiscal years ended June 30, 2007, 2006 and 2005 and 2004 by $32$1.3 million, $13$31.9 million and $41$12.6 million, respectively, due primarily to the stock option deduction benefits recorded as credits to capital in excess of par value.
The significant components of deferred income tax assets (liabilities) are as follows (in thousands):
Year ended June 30, | 2006 | 2005 | ||||||
As restated | ||||||||
Deferred tax assets: | ||||||||
Tax credits and net operating losses | $ | 27,037 | $ | 43,817 | ||||
Employee benefits accrual | 66,880 | 62,390 | ||||||
Stock-based compensation | 87,466 | 51,611 | ||||||
Capitalized R&D expenses | 204,913 | 106,972 | ||||||
Depreciation and amortization | 3,188 | 4,724 | ||||||
Inventory reserve | 57,481 | 59,994 | ||||||
Non-deductible reserves | 63,167 | 52,884 | ||||||
Unrealized loss on investments | 2,240 | — | ||||||
Deferred system profit | 79,936 | 92,460 | ||||||
Unearned revenue | 24,651 | 21,075 | ||||||
Other | 35,969 | 20,406 | ||||||
Total deferred tax assets | 652,928 | 516,333 | ||||||
Deferred tax liabilities: | ||||||||
Unremitted earnings of foreign subsidiaries not permanently reinvested | (10,726 | ) | (11,247 | ) | ||||
Unrealized gain on investments | — | (2,968 | ) | |||||
Other | (826 | ) | (331 | ) | ||||
Total deferred tax liabilities | (11,552 | ) | (14,546 | ) | ||||
Total net deferred tax assets | $ | 641,376 | $ | 501,787 | ||||
At June 30, 2006, approximately $9.3 million of federal net operating loss (“NOL”) carryforwards were available to offset future taxable income. The utilization of NOLs due to the change of ownership is subject to an
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The significant components of deferred income tax assets (liabilities) are as follows:
(in thousands) | As of June 30, | |||||||
2007 | 2006 | |||||||
Deferred tax assets: | ||||||||
Tax credits and net operating losses | $ | 52,493 | $ | 27,037 | ||||
Employee benefits accrual | 77,315 | 66,880 | ||||||
Stock-based Compensation | 88,073 | 87,466 | ||||||
Capitalized R&D expenses | 182,279 | 204,913 | ||||||
Depreciation and amortization | — | 3,188 | ||||||
Inventory reserves | 60,693 | 57,481 | ||||||
Non-deductible reserves | 56,040 | 63,167 | ||||||
Unrealized loss on investments | — | 2,240 | ||||||
Deferred profit | 80,018 | 79,936 | ||||||
Unearned revenue | 31,021 | 24,651 | ||||||
Other | 46,937 | 36,906 | ||||||
Total deferred tax assets | $ | 674,869 | $ | 653,865 | ||||
Deferred tax liabilities: | ||||||||
Unremitted earnings of foreign subsidiaries not permanently reinvested | $ | (11,663 | ) | $ | (11,663 | ) | ||
Depreciation and amortization | (14,104 | ) | — | |||||
Unrealized gain on investments | (2,371 | ) | — | |||||
Other | (935 | ) | (826 | ) | ||||
Total deferred tax liabilities | (29,073 | ) | (12,489 | ) | ||||
Total net deferred tax assets | $ | 645,796 | $ | 641,376 | ||||
As of June 30, 2007, the Company had U.S. federal and state net operating loss (“NOL”) carry-forwards of approximately $85.2 million and $46.1 million, respectively. The Company also had U.S. federal and state tax credit carry-forwards of approximately $0.6 million and $29.7 million, respectively. The U.S. net operating loss and tax credit carry-forwards will expire at various dates beginning in 2017 through 2027. The utilization of NOLs created by acquired companies is subject to annual limitationlimitations under Section 382 of the Internal Revenue Code. However, it is not expected that such annual limitation will not impair the realization of these NOLs. If not utilized, the federal NOLs will begin to expire in 2021.
KLA-Tencor has2017 and state taxNOLs will begin to expire in 2010. Certain state credits carryforwardin the amount of $2.1 million will expire at June 30, 2006 totaling $36 million. There is no expiration limit on the tax credits.various dates beginning in 2008 through 2021. The remaining state credits of $27.6 million will be carried over indefinitely.
The reconciliation of the United States federal statutory income tax rate to KLA-Tencor’s effective income tax rate is as follows:
Year ended June 30, | 2006 | 2005 | 2004 | 2007 | 2006 | 2005 | ||||||||||||
As restated | As restated | |||||||||||||||||
Federal statutory rate | 35.0 | % | 35.0 | % | 35.0 | % | 35.0 | % | 35.0 | % | 35.0 | % | ||||||
State income taxes, net of federal benefit | 0.6 | 0.6 | (0.2 | ) | 1.1 | 0.6 | 0.6 | |||||||||||
Effect of foreign operations taxed at various rates | (2.0 | ) | (1.8 | ) | (1.4 | ) | (3.7 | ) | (2.0 | ) | (1.8 | ) | ||||||
Export sales benefit | (5.7 | ) | (5.1 | ) | (4.6 | ) | (3.2 | ) | (5.7 | ) | (5.1 | ) | ||||||
Research and development tax credit | (2.4 | ) | (3.0 | ) | (2.5 | ) | (1.8 | ) | (2.4 | ) | (3.0 | ) | ||||||
Tax exempt interest | (4.5 | ) | (1.8 | ) | (2.2 | ) | (2.5 | ) | (4.5 | ) | (1.8 | ) | ||||||
Net change in tax reserves | (18.3 | ) | 1.7 | (0.8 | ) | (1.2 | ) | (18.3 | ) | 1.7 | ||||||||
Domestic manufacturing benefit | (1.6 | ) | — | — | (0.8 | ) | (1.6 | ) | — | |||||||||
Other | (0.7 | ) | (1.3 | ) | (1.9 | ) | (0.7 | ) | (0.7 | ) | (1.3 | ) | ||||||
Provision for Income Taxes | 0.4 | % | 24.3 | % | 21.4 | % | 22.2 | % | 0.4 | % | 24.3 | % | ||||||
In the year ended June 30, 2006, the Company reduced its total income tax reserves by $79.7 million. This was primarily due to expiring statute of limitations, several tax settlements reached with various tax authorities and reassessments of tax exposures based on the status of current audits in various jurisdictions. Included in the tax settlements was a settlement with the Internal Revenue Service related to an examination for the years ended June 30, 2003 and 2004.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Undistributed earnings of KLA-Tencor’s foreign subsidiaries amounted to approximately $298$406.6 million atas of June 30, 2006. Among it,2007, of which approximately $269$375.7 million are considered to be indefinitely reinvested;reinvested and accordingly, no provision for U.S. federal and state income taxes has been provided thereon. Upon repatriation of those earnings, in the form of dividends or otherwise, the CompanyKLA-Tencor would be subject to both U.S. income taxes (subject to an adjustment for foreign tax credit) and withholding taxes payable to the various foreign countries. Determination of the amount of unrecognized deferred U.S. income tax liability is not practicable due to the complexities associated with its hypothetical calculation. The Company’sKLA-Tencor’s consolidated financial statements fully provide for any related liability on amounts that maybe repatriated.
In the fiscal years ended June 30, 2007 and 2006, KLA-Tencor reduced its total income tax reserves by $15.3 million and $79.7 million, respectively. This was primarily due to expiring statutes of limitations, several tax settlements reached with various tax authorities and reassessments of tax exposures based on the status of current audits in various jurisdictions. In the fiscal year ended June 30, 2006, KLA-Tencor entered into a settlement with the Internal Revenue Service related to an examination for the fiscal years ended June 30, 2003 and 2004. In the fiscal year ended June 30, 2007, KLA-Tencor entered into a settlement with California Franchise Tax Board related to an examination for the fiscal years ended June 30, 1997, 1998 and 1999.
KLA-Tencor benefits from several tax holidays in Israel and Singapore where it manufactures certain of its products. These tax holidays are on approved investments and are scheduled to expire at varying times within the next fourthree to eightnine years. The Company is in compliance with all the terms and conditions of the tax holidays. The net impact of these tax holidays was to decrease the Company’s tax expense by approximately $13.6 million, $5.0 million and $7.6 million in the fiscal years ended June 30, 2007, 2006 and 2005, respectively.
NOTE 12—11—COMMITMENTS AND CONTINGENCIES
Factoring. KLA-Tencor has agreements with financial institutions to sell certain of its trade receivables and promissory notes from customers without recourse. During the fiscal year ended June 30, 2006 and 2005, approximately $278 million and $306 million of receivables were sold under these arrangements, respectively.KLA-TencorKLA-Tencor does not believe it is at risk for any material losses as a result of these agreements.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
In addition, from time to time KLA-Tencor will discount without recourse Letters of Credit (“LCs”) received from customers in payment for paymentgoods.
The following table shows total receivables sold under factoring agreements and proceeds from sales of goods. DuringLCs and related discounting fees paid for the fiscal years 2006ended June 30, 2007 and 2005, several LCs were sold with proceeds totaling $69 million and $30 million, respectively. Discounting fees of $0.8 million and $0.2 million for fiscal years 2006 and 2005, respectively, were equivalent to interest expense and were recorded in interest and other income net.2006:
Year ended June 30, | ||||||
(in thousands) | 2007 | 2006 | ||||
Receivables sold under factoring agreements | $ | 278,560 | $ | 277,960 | ||
Proceeds from sales of LCs | $ | 61,850 | $ | 69,286 | ||
Discounting fees paid on sales of LCs(1) | $ | 804 | $ | 788 |
(1) | Discounting fees were equivalent to interest expense and were recorded in interest and other income net. |
Facilities. KLA-Tencor leases certain of its facilities under operating leases, which qualify for operating lease accounting treatment under SFAS No. 13, “AccountingAccounting for Leases” and, as such, these facilities are not included on its Condensed Consolidated Balance Sheets. Rent expense was approximately $8.4$9.7 million, $12.0$8.4 million and $12.0 million for the fiscal years ended June 30, 2007, 2006 and 2005, and 2004, respectively.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The following is a schedule of operating lease payments (in thousands):
Fiscal year ending June 30, | Amount | |||||
2007 | $ | 6,540 | ||||
Year ending June 30, | Amount | |||||
2008 | 4,630 | $ | 10,364 | |||
2009 | 3,378 | 7,956 | ||||
2010 | 1,906 | 5,400 | ||||
2011 | 1,250 | 3,913 | ||||
Thereafter | 2,010 | |||||
2012 | 2,308 | |||||
2013 and thereafter | 8,277 | |||||
Total minimum lease payments | $ | 19,714 | $ | 38,218 | ||
Purchase Commitments.KLA-Tencor maintains certain open inventory purchase commitments with its suppliers to ensure a smooth and continuous supply chain for key components. KLA-Tencor’s liability inunder these purchase commitments is generally restricted to a forecasted time-horizon as mutually agreed upon between the parties. This forecastedforecast time-horizon can vary among different suppliers. The Company’s open inventory purchase commitments were approximately $210$145.5 million as of June 30, 2006.2007 and are primarily due within the next 12 months. Actual expenditures will vary based upon the volume of the transactions and length of contractual service provided. In addition, the amounts paid under these arrangements may be less in the event that the arrangements are renegotiated or canceled. Certain agreements provide for potential cancellation penalties.
Guarantees.KLA-Tencor provides standard warranty coverage on its systems for twelve months, providing labor and parts necessary to repair the systems during the warranty period. KLA-Tencor accounts for the estimated warranty cost as a charge to costscost of revenues when revenue is recognized. The estimated warranty cost is based on historical product performance and field expenses. Utilizing actual service records, KLA-Tencor calculates the average service hours and parts expense per system and applies the actual labor and overhead rates to determine the estimated warranty charge. KLA-Tencor updates these estimated charges every quarter.periodically. The actual product performance and/or field expense profiles may differ, and in those cases KLA-Tencor adjusts warranty accruals accordingly.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The following table provides the changes in the product warranty accrual for the fiscal years ended June 30, 20062007 and 20052006 (in thousands):
Year ended June 30, | ||||||||||||||||
2006 | 2005 | 2007 | 2006 | |||||||||||||
Beginning balance | $ | 46,647 | $ | 38,865 | $ | 45,642 | $ | 46,647 | ||||||||
Accruals for warranties issued during the period | 49,662 | 54,871 | 61,786 | 49,662 | ||||||||||||
Changes in liability related to pre-existing warranties | (9,217 | ) | (12,246 | ) | (7,589 | ) | (9,217 | ) | ||||||||
Settlements made during the period | (41,450 | ) | (34,843 | ) | (47,001 | ) | (41,450 | ) | ||||||||
Ending balance | $ | 45,642 | $ | 46,647 | $ | 52,838 | $ | 45,642 | ||||||||
Subject to certain limitations, KLA-Tencor indemnifies its current and former officers and directors for certain events or occurrences. Although the maximum potential amount of future payments KLA-Tencor could be required to make under these agreements is theoretically unlimited, the Company believes the fair value of this liability, to the extent estimable, is appropriately considered within the reserve it has established for currently pending legal proceedings.
KLA-Tencor is a party to a variety of agreements pursuant to which it may be obligated to indemnify the other party with respect to certain matters. Typically, these obligations arise in connection with contracts and
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
license agreements or the sale of assets, under which the Company customarily agrees to hold the other party harmless against losses arising from a breach of warranties, representations and covenants related to such matters as title to assets sold, validity of certain intellectual property rights, non-infringement of third-party rights, and certain income tax-related matters. In each of these circumstances, payment by the Company is typically subject to the other party making a claim to and cooperating with the Company pursuant to the procedures specified in the particular contract. This usually allows the Company to challenge the other party’s claims or, in case of breach of intellectual property representations or covenants, to control the defense or settlement of any third-party claims brought against the other party. Further, the Company’s obligations under these agreements may be limited in terms of amounts, activity (typically at the Company’s option to replace or correct the products or terminate the agreement with a refund to the other party), and duration. In some instances, the Company may have recourse against third parties and/or insurance covering certain payments made by the Company.
It is not possible to predict the maximum potential amount of future payments under these or similar agreements due to the conditional nature of the Company’s obligations and the unique facts and circumstances involved in each particular agreement. Historically, payments made by the Company under these agreements didhave not havehad a material effect on its business, financial condition, results of operations or cash flows.
The Company maintains $25guarantee arrangements of $27.9 million of short-term credit facilities in various locations to fund overdraft, Custom’scustoms guarantee for VAT and letter of credit needs of its subsidiaries in Europe and Asia. A total of $20Approximately $18.4 million was outstanding under these facilitiesarrangements as of June 30, 2006.2007.
NOTE 12—LITIGATION AND OTHER LEGAL MATTERS
Restatements of Prior Period Consolidated Financial Statements in Previous Filings.On September 28, 2006, the Company announced that it would have to restate previously issued financial statements to correct for past accounting for stock options. As a result of the Special Committee investigation, it was discovered that certain stock options, primarily those granted from July 1, 1997 to June 30, 2002, had been retroactively priced for all employees who received these grants. In the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2006 (filed on January 29, 2007) and the quarterly reports on Form 10-Q for the quarters ended September 30, 2006, December 31, 2006 and March 31, 2007 (filed on January 29, 2007, February 9, 2007 and May 7, 2007, respectively), the Company restated (1) consolidated financial statements as of and for the fiscal years ended June 30, 2005 and 2004; (2) selected consolidated financial data as of and for the fiscal years ended June 30, 2005, 2004, 2003 and 2002; and (3) unaudited quarterly financial data for the first three quarters in the fiscal year ended June 30, 2006 and for all quarters in the fiscal year ended June 30, 2005. All financial information included in this Annual Report on Form 10-K reflects the restatement and does not contain any further restatement.
Government Inquiries and SEC Settlement Relating to Historical Stock Option Practices.On May 23, 2006, the Company received a subpoena from the USAOUnited States Attorney’s Office requesting information relating to itsour past stock option grants and related accounting matters. Also on May 23, 2006, the Company received a letter from the SEC making an informal inquiry and request for information on the same subject matters. The Company learned on February 2, 2007 that the SEC had opened a formal investigation into these matters. The Company cooperated fully with the SEC investigation. On July 25, 2007, the Company announced that it had reached a settlement with the SEC by consenting to the entry of a permanent injunction against future violations of the reporting, books and records, and internal controls provisions of the federal securities laws. The settlement resolves completely the SEC investigation into the Company’s historical stock option granting practices. KLA-Tencor was not charged by the SEC with fraud; nor was the Company required to pay any civil penalty, fine, or money damages as part of the settlement.
The Company is cooperating fully with the USAO and SEC inquiriesUSAO’s continuing inquiry and intends to continue to do so. These inquiries likely willThis inquiry may require the Companyit to expend significant management time and incur significant legal and other
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
expenses, and could result in civil and criminal actions seeking, among other things, injunctions against the Company and the payment of significant fines and penalties by the Company, which may adversely affect its results of operations and cash flow.
The Company has also responded to inquiries from the U.S. Department of Labor, which is conducting an examination of itsour 401(k) Savings Plan.Plan prompted by our stock option issues. The Company is cooperating fully with this examination and intendsintend to continue to do so.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The Company cannot predict how long it will take to or how much more time and resources it will have to expend to resolve these government inquiries, nor can it predict the outcome of these inquiries. Also, there can be no assurance that other inquiries, investigations or actions will not be started by other United States federal or state regulatory agencies or by foreign governmental agencies.
Late SEC Filings and Nasdaq Delisting Proceedings.Due to the Special Committee investigation and the resulting restatements, the Company did not file on time this Annual Report on Form 10-K and its Quarterly Report on Form 10-Q for the quarter ended September 30, 2006. As a result, the Company received two Nasdaq Staff Determination letters, dated September 14, 2006 and November 14, 2006, respectively, stating that it was not in compliance with the filing requirements of Marketplace Rule 4310(c)(14) and, therefore, that the Company’s stock was subject to delisting from the Nasdaq Global Select Market. The Company appealed this determination and requested a hearing before a Nasdaq Listing Qualifications Panel. On October 26, 2006, the Company attended a hearing, at which it sought appropriate exceptions to the filing requirements from the Panel pending completion and filing of the Company’s delinquent reports. On January 3, 2007, the Panel granted the Company’s request for continued listing of its stock on the Nasdaq Global Select Market, subject to the condition that the Company file this Report and its Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 on or before January 31, 2007.
Shareholder Derivative Litigation Relating to Historical Stock Option Practices.Beginning on May 22, 2006, several persons and entities identifying themselves as shareholders of KLA-Tencor filed derivative actions purporting to assert claims on behalf of and in the name of the Company against various of the Company’s current and former directors and officers relating to its accounting for stock options issued from 1994 to the present. The complaints in these actions allege that the individual defendants breached their fiduciary duties and other obligations to the Company and violated state and federal securities laws in connection with the Company’s historical stock option granting process, its accounting for past stock options, and historical sales of stock by the individual defendants. Three substantially similar actions are pending, one in the U.S. District Court for the Northern District of California (which consists of three separate lawsuits consolidated intoin one action); one in the California Superior Court for Santa Clara County; and one in the Delaware Chancery Court.
The plaintiffs in the derivative actions have asserted claims for violations of Sections 10(b) (including Rule 10b-5 thereunder), 14(a), and 20(a) of the Securities Exchange Act of 1934, unjust enrichment, breach of fiduciary duty and aiding and abetting such breach, negligence, misappropriation of information, abuse of control, gross mismanagement, waste of corporate assets, breach of contract, constructive fraud, rescission, and violations of California Corporations Code section 25402, as well as a claim for an accounting of all stock option grants made to the named defendants. KLA-Tencor is named as a nominal defendant in these actions. On behalf of KLA-Tencor, the plaintiffs seek unspecified monetary and other relief against the named defendants. The plaintiffs are James Ziolkowski, Mark Ziering, Alaska Electrical Pension Fund, Jeffrey Rabin, and Benjamin Langford. The individual named defendants are current directors and officers;officers Edward W. Barnholt, H. Raymond Bingham, Robert T. Bond, Jeffrey L. Hall, Stephen P. Kaufman, John H. Kispert, Lida Urbanek and Richard P. Wallace; and former directors and officers;officers Robert J. Boehlke, Leo Chamberlain, Gary E. Dickerson, Richard J. Elkus, Jr., Dennis J. Fortino, Kenneth Levy, Michael E. Marks, Stuart J. Nichols, Arthur P. Schnitzer, Kenneth L. Schroeder and Jon D. Tompkins. Current director David C. Wang and former director Dean O. Morton were originally named as defendants in one of the derivative actions filed in the U.S. District Court for the Northern District of California, but were dropped as named defendants as of December 22, 2006 upon the filing of a consolidated complaint in that action.
The derivative actions are at an early stage. Discovery has not commenced, and theThe defendants are not yet required to respond to the complaints.complaints in the actions pending in California, and the defendants have moved to dismiss or stay the action pending in Delaware. The Company’s Board of Directors has appointed a Special Litigation Committee (“SLC”) composed solely of independent directors to conduct an independent investigation of the
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
claims asserted in the derivative actions and to determine the Company’s position with respect to those claims. The SLC’s investigation is in progress. The Company cannot predict whether these actions are likely to result in any material recovery by or expense to KLA-Tencor.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Shareholder Class Action Litigation Relating to Historical Stock Option Practices.KLA-Tencor and various of its current and former directors and officers were named as defendants in a putative securities class action filed on June 29, 2006 in the U.S. District Court for the Northern District of California. Two similar actions were filed later in the same court, and all three cases have been consolidated into one action. The complaints allegeconsolidated complaint alleges claims under the Securities Exchange Act of 1934 as a result of the Company’s past stock option grants and related accounting and reporting, and seek unspecified monetary damages and other relief. The plaintiffs seek to represent a class consisting of purchasers of KLA-Tencor stock between February 13,June 30, 2001 and May 22, 2006 who allegedly suffered losses as a result of material misrepresentations in KLA-Tencor’s SEC filings during that period. The lead plaintiffs, who seek to represent the class, are the Police and Fire Retirement System of the City of Detroit, the Louisiana Municipal Police Employees’ Retirement System, and the City of Philadelphia Board of Pensions and Retirement. The defendants are KLA-Tencor, Edward W. Barnholt, H. Raymond Bingham, Robert J. Boehlke, Robert T. Bond, Gary E. Dickerson, Richard J. Elkus, Jr., Jeffrey L. Hall, Stephen P. Kaufman, John H. Kispert, Kenneth Levy, Michael E. Marks, Stuart J. Nichols, Kenneth L. Schroeder, Jon D. Tompkins, Lida Urbanek and Richard P. Wallace.
This litigation is at an early stage. Discovery has not commenced, and the court has not yet determined whether the plaintiffs may sue on behalf of any class of purchasers,purchasers. The Company and all other defendants filed motions to dismiss these cases in June 2007, which are now pending before the defendants are not yet required to respond to the complaints.Court. The Company intends to vigorously defend this litigation.
As part of a derivative lawsuit filed in the Delaware Chancery Court on July 21, 2006 (described above), a plaintiff claiming to be a KLA-Tencor shareholder also asserted a separate putative class action claim against the Company and certain of its current and former directors and officers alleging that shareholders incurred damage due to purported dilution of KLA-Tencor common stock resulting from historical stock option granting practices. The Company has moved to dismiss this claim.
The Company cannot predict the outcome of the shareholder class action cases (described above), and it cannot estimate the likelihood or potential dollar amount of any adverse results. However, an unfavorable outcome in this litigation could have a material adverse impact upon the financial position, results of operations or cash flows for the period in which the outcome occurs and in future periods.
Indemnification Obligations.Subject to certain limitations, the Company is obligated to indemnify its current and former directors, officers and employees in connection with the investigation of the Company’s historical stock option practices and the related litigation and ongoing government inquiries and litigation.inquiry. These obligations arise under the terms of the Company’s certificate of incorporation, its bylaws, applicable contracts, and Delaware and California law. The obligation to indemnify generally means that the Company is required to pay or reimburse the individuals’ reasonable legal expenses and possibly damages and other liabilities incurred in connection with these matters. The Company is currently paying or reimbursing legal expenses being incurred in connection with these matters by a number of its current and former directors, officers and employees. Although the maximum potential amount of future payments KLA-Tencor could be required to make under these agreements is theoretically unlimited, the Company believes the fair value of this liability, to the extent estimable, is adequately coveredappropriately considered within the reservesreserve it has established for currently pending legal proceedings.
Other Legal Matters.The Company is named from time to time as a party to lawsuits in the normal course of its business. Litigation, in general, and intellectual property and securities litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the results of legal proceedings are difficult to predict.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
NOTE 13—DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Under its foreign-currency risk management strategy, KLA-Tencor utilizes derivative instruments to protect its interests from unanticipated fluctuations in earnings and cash flows caused by volatility in currency exchange rates. This financial exposure is monitored and managed by KLA-Tencor as an integral part of its overall risk management program which focuses on the unpredictability of financial markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on its operating results. KLA-Tencor continues its policy of hedging its current and anticipated foreign currency exposures with hedging instruments having tenors of up to twelveeighteen months.
KLA-Tencor accounts for derivatives in accordance with SFAS No. 133, “AccountingAccounting for Derivative Instruments and Hedging Activities.”Activities. SFAS No. 133 requires that all derivatives be recorded on the balance sheet at fair value. Changes in the fair value of derivatives which do not qualify or are not effective as hedges must be recognized currently in earnings. All derivatives were reflected at fair value on the balance sheet date.
Cash Flow Hedges
KLA-Tencor’s international sales are primarily denominated in U.S. dollars. For foreign currency denominated sales,sales/expenses, however, the volatility of the foreign currency markets represents risk to KLA-Tencor’s margins. KLA-Tencor defines its exposure as the risk of changes in the functional-currency-equivalent cash flows attributable to changes in the related foreign currency exchange rates. Upon forecasting the exposure, KLA-Tencor hedges with forward sales contracts whose critical terms are designed to match those of the underlying exposure.and currency options. These hedges are evaluated for effectiveness at inception and at least quarterly using the dollar-offset method.regression analysis. Ineffectiveness is measured by comparing the change in value of the forward contracts to the change in value of the underlying transaction, with the effective portion of the hedge accumulated in Other Comprehensive Income (“OCI”). The mark-to-mark of excluded component (forward points) or any measured ineffectiveness is included immediately in “Interest income and other, net” in the Consolidated Statements of Operations. Deferred hedge gains and losses and OCI associated with hedges of foreign currency salessales/expenses are reclassified to revenuerevenue/expenses upon recognition in income of the underlying hedged exposure. All amounts reported in OCI atas of June 30, 20062007 are anticipated to be reclassified to revenuerevenue/expenses within twelve months. At June 30, 2006, KLA-Tencor had
The outstanding cash flow hedge contracts, maturing throughout fiscal year 2007 to sell $167.5 million and purchase $15.2 million, in foreign currency, primarily in Japanese Yen. with maximum maturity of 13 months, were as follows:
As of June 30, | ||||||||
(in thousands) | 2007 | 2006 | ||||||
Purchase | $ | 4,651 | $ | 15,173 | ||||
Sell | (242,942 | ) | (167,525 | ) | ||||
Net | $ | (238,291 | ) | $ | (152,352 | ) | ||
The following table summarizes hedging activity in the OCI account during the fiscal years ended June 30, 20062007 and 20052006 (in thousands):
Year ended June 30, | ||||||||||||||||
2006 | 2005 | 2007 | 2006 | |||||||||||||
Beginning Balance | $ | 5,335 | $ | (1,559 | ) | $ | (129 | ) | $ | 5,335 | ||||||
Effective portion of cash flow hedging instruments | 7,528 | 4,428 | 13,608 | 7,528 | ||||||||||||
Reclassified to revenue upon revenue recognition | (12,992 | ) | 2,466 | (4,944 | ) | (12,992 | ) | |||||||||
Ending Balance | $ | (129 | ) | $ | 5,335 | $ | 8,535 | $ | (129 | ) | ||||||
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Other Foreign Currency Hedges
KLA-Tencor hedges its monetary non-functional assets and liabilities, and those of its subsidiaries. SFAS No. 52, “ForeignForeign Currency Translation”, requires that such monetary assets and liabilities be remeasured periodically for changes in the rate of exchange against the entities’ functional currency. Changes in value of these assets and liabilities are recorded in “Interest income and other, net” in the Consolidated Statements of Operations. The volatility of the non-functional currencies together with the requirement to remeasure
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
non-functional assets and liabilities may result in some volatility to KLA-Tencor’s Consolidated Statements of Operations if left unhedged. In order to mitigate these effects, KLA-Tencor enters into remeasurement hedges which are forward contracts used to offset the foreign currency positions represented by non-functional monetary assets and liabilities. Remeasurement hedges are not SFAS No. 133 designated hedges, thus changes in value of the remeasurement hedges are recorded currently in earnings. Changes in the values of underlying monetary non-functional assets and liabilities are also recorded currently in earnings and should offset the change in value of the hedges. At June 30, 2006, KLA-Tencor hadThe outstanding other foreign currency hedge contracts, maturing throughout fiscal year 2007 to sell $260.2 million and purchase $128.4 million, in foreign currency, primarily in Japanese Yen.with maximum maturity of 13 months, were as follows:
As of June 30, | ||||||||
(in thousands) | 2007 | 2006 | ||||||
Purchase | 126,992 | 128,406 | ||||||
Sell | (265,378 | ) | (260,165 | ) | ||||
Net | $ | (138,386 | ) | $ | (131,759 | ) | ||
NOTE 14—SEGMENT REPORTING AND GEOGRAPHIC INFORMATION
KLA-Tencor reports one reportable segment in accordance with the provisions of SFAS No. 131, “DisclosuresDisclosures about Segments of an Enterprise and Related Information.”Information. Operating segments are defined as components of an enterprise about which separate financial information is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. KLA-Tencor’s chief operating decision makers are the Chief Executive Officer and the Chief Operating Officer.
KLA-Tencor is engaged primarily in designing, manufacturing, and marketing yield management and process monitoring systems for the semiconductor industry. All operating units have been aggregated due to their inter-dependencies, commonality of long-term economic characteristics, products and services, the production processes, class of customer and distribution processes. The Company’s service products are an extension of the system product portfolio and provide customers with spare parts and fab management services (including system preventive maintenance and optimization services) to improve yield, increase production uptime and throughput, and lower the cost of ownership. Since KLA-Tencor operates in one segment, all financial segment information required by SFAS No. 131 can be found in the Consolidated Financial Statements.condensed consolidated financial statements.
KLA-Tencor’s significant operations outside the United States include manufacturing facilities in Israel and Singapore, and sales, marketing and service offices in Western Europe, Japan, and the Asia Pacific region. For geographical revenue reporting, revenues are attributed to the geographic location in which the customer is located. Long-lived assets consist primarily of net property and equipment and are attributed to the geographic locationregion in which they are located.
The following is a summary of revenues by geographic region for fiscal years 2006, 2005 and 2004 (in thousands).
Year ended June 30, | |||||||||
2006 | 2005 | 2004 | |||||||
As restated | As restated | ||||||||
Revenue: | |||||||||
United States | $ | 416,468 | $ | 494,250 | $ | 342,678 | |||
Europe & Israel | 287,562 | 266,048 | 186,424 | ||||||
Japan | 541,411 | 450,240 | 395,240 | ||||||
Taiwan | 363,014 | 429,672 | 263,386 | ||||||
Korea | 277,316 | 148,287 | 143,547 | ||||||
Asia Pacific | 184,856 | 293,381 | 165,943 | ||||||
Total | $ | 2,070,627 | $ | 2,081,878 | $ | 1,497,218 | |||
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Long-lived assets by geographic region as of June 30, 2006 and 2005 were as follows (in thousands):
As of June 30, | ||||||
2006 | 2005 | |||||
As restated | ||||||
Long-lived assets: | ||||||
United States | $ | 366,714 | $ | 373,125 | ||
Europe & Israel | 9,503 | 9,074 | ||||
Japan | 3,665 | 4,350 | ||||
Taiwan | 1,919 | 2,356 | ||||
Korea | 6,216 | 4,849 | ||||
Asia Pacific | 17,730 | 2,246 | ||||
Total | $ | 405,747 | $ | 396,000 | ||
The following is a summary of major product revenues for fiscal years 2006, 2005 and 2004 (as a percentage of total revenue).
Year ended June 30, | |||||||||
2006 | 2005 | 2004 | |||||||
Defect Inspection | 62 | % | 65 | % | 61 | % | |||
Metrology | 15 | 17 | 15 | ||||||
Service | 16 | 14 | 20 | ||||||
Software and other | 7 | 4 | 4 | ||||||
100 | % | 100 | % | 100 | % | ||||
For the fiscal years ended June 30, 2006, 2005 and 2004, no customer accounted for more than 10% of total revenues and one customer accounted for 13%, 12%, and 10% of net accounts receivable, respectively.
NOTE 15—SUBSEQUENT EVENTS
On August 3, 2006, the Board of Directors of the Company declared a quarterly cash dividend of 12 cents per share, and, as a result, a total of $24 million was paid on September 1, 2006 to stockholders of record on August 15, 2006.
On September 19, 2006, the Compensation Committee of the Board of Directors of the Company approved awards of restricted stock units covering a total of 2,530,689 shares of the Company’s common stock to employees of the Company, including the executive officers. The restricted stock units were awarded under the Company’s 2004 Equity Incentive 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 units, the share reserve under the Plan will be reduced by 1.8 shares, as provided under the terms of such Plan.
On September 27, 2006, the Company determined that its historical financial statements for one or more prior fiscal years would have to be restated to correct its past accounting for stock options. The Company temporarily suspended employee participation in several equity incentive programs because the Form S-8 registration statements covering the shares of common stock issuable under those programs incorporate one or more financial statements that would have to be restated. As part of such suspension, participants in the
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Company’s 401(k) Plan became subject toThe following is a blackout period during which theysummary of revenues by geographic region for the fiscal years ended June 30, 2007, 2006 and 2005:
Year ended June 30, | |||||||||
(in thousands) | 2007 | 2006 | 2005 | ||||||
Revenue: | |||||||||
United States | $ | 647,813 | $ | 416,468 | $ | 494,250 | |||
Europe & Israel | 271,814 | 287,562 | 266,048 | ||||||
Japan | 600,861 | 541,411 | 450,240 | ||||||
Taiwan | 559,083 | 363,014 | 429,672 | ||||||
Korea | 288,756 | 277,316 | 148,287 | ||||||
Asia Pacific | 362,902 | 184,856 | 293,381 | ||||||
Total | $ | 2,731,229 | $ | 2,070,627 | $ | 2,081,878 | |||
Long-lived assets by geographic region as of June 30, 2007 and 2006 were precluded from acquiring sharesas follows:
As of June 30, | ||||||
(in thousands) | 2007 | 2006 | ||||
Long-lived assets: | ||||||
United States | $ | 321,146 | $ | 366,714 | ||
Europe & Israel | 11,466 | 9,503 | ||||
Japan | 6,821 | 3,665 | ||||
Taiwan | 1,720 | 1,919 | ||||
Korea | 6,524 | 6,216 | ||||
Asia Pacific | 46,301 | 17,730 | ||||
Total | $ | 393,978 | $ | 405,747 | ||
The following is a summary of major product revenues for the Company’s common stock under that plan.fiscal years ended June 30, 2007, 2006 and 2005 (as a percentage of total revenue).
On October 11,
Year ended June 30, | |||||||||
2007 | 2006 | 2005 | |||||||
Defect Inspection | 61 | % | 62 | % | 65 | % | |||
Metrology | 19 | % | 15 | % | 17 | % | |||
Service | 15 | % | 16 | % | 14 | % | |||
Software and other | 5 | % | 7 | % | 4 | % | |||
100 | % | 100 | % | 100 | % | ||||
For the fiscal years ended June 30, 2007, 2006 the Company acquired all of the shares of ADE Corporation (“ADE”), a supplier of semiconductor process control solutions. Per the Amended Merger Agreement between the Company and ADE, the Company paid $482 million (which included goodwill and intangibles of $262 million and $137 million, respectively) in cash to the shareholders of ADE. The acquisition will be2005, no customer accounted for as a purchase.
On October 12, 2006,more than 10% of total revenues. For the Compensation Committeefiscal year ended June 30, 2007, no customer accounted for more than 10% of net accounts receivable. For the Board of Directors of the Company approved an alternative financial benefit for all employees below the vice president level who had been active participants in the ESPP before it was temporarily suspended on September 28, 2006. The alternative financial benefit is intended to compensate such employees for the estimated financial benefit they would have realized had the ESPP continued in operation after September 28,fiscal years ended June 30, 2006 and until December 31, 2006. On January 24,2005, one customer accounted for 13.0% and 12.2% of net accounts receivable, respectively.
NOTE 15—ASSET IMPAIRMENT AND SEVERANCE CHARGES
During the fiscal year ended June 30, 2007, the Compensation Committee extended this alternative financial benefit into 2007 to cover the period until the ESPP suspension ends.
On October 16, 2006, the Company terminated all aspects of its employment relationship and agreement with Kenneth L. Schroeder, former Chief Executive Officer of the Company. Also on October 16, 2006, Stuart J. Nichols, General Counsel of the Company, resigned, and Kenneth Levy, Chairman of the Board of Directors of the Company, retired as a director and employee. In December 2006, all outstanding retroactively priced vested options held by Mr. Schroeder were canceled. Accordingly, in the second quarter of fiscal 2007 the Company will reverse approximately $20 million of the non-cash, stock-based compensation recorded in prior periods. Also, on October 16, 2006 all outstanding retroactively priced options held by Mr. Levy and Mr. Nichols were re-priced. The exercise price of each re-priced option was increased to the market price on the actual grant date. Under SFAS No. 123(R), no incremental charge will be recognized in the financial statements for the quarter ended December 31, 2006. Further, although the Board of Directors concluded that John H. Kispert, the Company’s President and Chief Operating Officer, was not involved in and was not aware of the improper stock option practices, based on the Special Committee’s recommendation, his outstanding retroactively priced options were re-priced in December 2006, because he served as Chief Financial Officer during part of the period in question. Under SFAS No. 123(R), no incremental charge will be recognized in the financial statements for the quarter ended December 31, 2006.
On November 6, 2006, the Board of Directors of the Company declared a quarterly cash dividend of 12 cents per share, and, as a result, a total of $24 million was paid on December 1, 2006 to stockholders of record on November 15, 2006.
In November 2006, as part of the Company’s long-term business plan, the Company decided to sell certain real estate properties owned by the Company in San Jose, California and Livermore, California. The Company will record an asset impairment charge of approximately $56 million in the quarter ended December 31, 2006. In addition, the Company reduced its work-force by approximately 150 people and will accrue approximately $10 million in severance charges in the quarter ended December 31, 2006 to be paid over the next twelve months.
On December 21, 2006, Jon D. Tompkins resigned as a director of the Company, and the Company agreed to modify the outstanding options held by Mr. Tompkins (all of which were fully vested) to extend the post-termination exercisability period to December 31, 2007, which is the last day of the calendar year in which those options would have terminated in the absence of such extension.
Because virtually all holders of retroactively priced options issued by the Company were not involved in or aware of the retroactive pricing, the Company has taken and intends to take certain actions to deal with the
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
adverse tax consequences that may be incurred byCalifornia. Based on the holdersvaluation of retroactively priced options. The adverse tax consequences are that retroactively priced stock options vesting after December 31, 2004 (“409A Affected Options”) subject the option holder to a penalty tax under IRC Section 409A (and,these assets using relevant market indicators such as applicable, similar penalty taxes under California and other state tax laws). One such action byrange of estimated selling prices, the Company is to offer to amendrecorded an asset impairment charge of approximately $56.8 million, which has been included in SG&A during the 409A Affected Options to increase the exercise price to the market price on the actual grant date or, if lower, the market price at the time of the amendment. The amended options would not be subject to taxation under IRC Section 409A. Under IRS regulations, these option amendments had to be completed by December 31, 2006 for anyone who was an executive officer when he or she received 409A Affected Options; the amendments for non-officers cannot be offered until after this Report is filed and do not need to be completed until December 31,fiscal year ended June 30, 2007. Another action is to approve bonuses payable to holders of the amended options to compensate them for the resulting increase in their option exercise price. The amount of these bonuses would be effectively repaid to the Company if and when the options are exercised and the increased exercise price is paid (but there is no assurance that the options will be exercised). Finally, the Company intends to compensate certain option holders who have already exercised 409A Affected Options for the additional taxes they incur under IRC Section 409A (and, as applicable, similar state tax laws).
Three of the Company’s option holders were subject to the December 31, 2006 deadline described above. Accordingly, in December 2006, the Company offered to amend the 409A Affected Options held by Mr. Wallace, the Company’s Chief Executive Officer, and two former executive officers to increase the exercise price so that these options will not subject the option holder to a penalty tax under IRC Section 409A. All three individuals accepted the Company’s offer. In addition, the Company agreed to pay eachreduced its workforce by approximately 430 people (primarily in San Jose, California and Milpitas, California) and recorded approximately $20.5 million in severance charges during the fiscal year ended June 30, 2007. Approximately $4.9 million of the three individuals a cash bonuscharges has been recorded as cost of revenues, $4.3 million in January 2008 equal toengineering, research and development expenses, and $11.3 million has been recorded as SG&A expenses. These severance charges will be paid over the aggregate increasenext twelve months.
The following table provides the changes in the exercise pricesseverance accrual for his amended options. For Mr. Wallace, the amount of this bonus is $0.4 million. To account for these actions, the Company will record a net charge of $0.3 million in the quarterfiscal year ended December 31, 2006. June 30, 2007:
(in thousands) | Amounts | |||
Balance as of June 30, 2006 | $ | — | ||
Severance charges | 20,545 | |||
Cash payments | (16,299 | ) | ||
Balance as of June 30, 2007 | $ | 4,246 | ||
NOTE 16—RELATED PARTY TRANSACTIONS
The Company planspurchased from, or sold to, take similar actions with respect to the outstanding 409A Affected Options granted to non-officers as soon as possible after the filing of this Report. The Company estimates that the total cash payments needed to deal with the adverse tax consequences of retroactively priced options granted to non-officers will be approximately $30 million.
With respect to the individuals whose options were canceledJDS Uniphase Corporation, Freescale Semiconductor, Inc., National Semiconductor Corp., STMicroelectronics, NV and Oracle Corporation, where one or re-priced by the Company following the Special Committee investigation, no bonusesmore members of the type described above will be paid.Company’s board of directors also serves as an executive officer or board member. For the fiscal years ended June 30, 2007, 2006 and 2005, the Company’s total revenues from transactions with these parties were approximately $40 million, $30 million and $10 million, respectively. Management believes that such transactions are at arms length and on similar terms as would have been obtained from unaffiliated third parties.
NOTE 17—SUBSEQUENT EVENTS
On January 7,August 8, 2007, the Company signeddeclared a definitive merger agreement to acquire Therma-Wave, Inc. through aquarterly cash tender offerdividend of $1.65$0.15 per share or a totalto be paid on September 1, 2007 to stockholders of approximately $74 million. Therma-Wave develops, manufactures, markets and services process control metrology systems used inrecord on August 20, 2007.
In August 2007, the manufactureBoard of semiconductors. The transaction is subjectDirectors authorized KLA-Tencor to customary closing conditions, including regulatory approvals andrepurchase up to an additional 10.0 million shares of its common stock under the acquisition by the Company of a majority of the voting power of Therma-Wave in the tender offer.repurchase program.
KLA-TENCOR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
NOTE 16—18—QUARTERLY CONSOLIDATED RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the Company’s quarterly consolidated results of operations (unaudited) for the fiscal years ended June 30, 20062007 and 2005. Note that this information includes the effects of the restatements as discussed in Note 2 to Consolidated Financial Statements.2006.
(In thousands, except per share data) | First Quarter Ended September 30, 2005 | Second Quarter Ended December 31, 2005 | Third Quarter Ended March 31, 2006 | Fourth Quarter June 30, 2006 | ||||||||
As restated | As restated | As restated | ||||||||||
Revenue | $ | 484,261 | $ | 487,682 | $ | 519,648 | $ | 579,036 | ||||
Total costs and operating expenses | 409,271 | 412,688 | 434,721 | 504,156 | ||||||||
Income from operations | 74,990 | 74,994 | 84,927 | 74,880 | ||||||||
Net income | 75,487 | 76,605 | 96,684 | 131,676 | ||||||||
Net income per share: | ||||||||||||
Basic | $ | 0.38 | $ | 0.39 | $ | 0.48 | $ | 0.66 | ||||
Diluted | $ | 0.37 | $ | 0.38 | $ | 0.47 | $ | 0.65 |
(In thousands, except per share data) | First Quarter Ended September 30, 2004 | Second Quarter Ended December 31, 2004 | Third Quarter Ended March 31, 2005 | Fourth Quarter Ended June 30, 2005 | ||||||||||||||||||||
As restated | As restated | As restated | As restated | |||||||||||||||||||||
(in thousands, except per share data) | First quarter ended September 30, 2006 | Second quarter Ended December 31, 2006 | Third quarter ended March 31, 2007 | Fourth quarter ended June 30, 2007 | ||||||||||||||||||||
Revenue | $ | 518,773 | $ | 532,853 | $ | 539,841 | $ | 490,411 | $ | 629,363 | $ | 649,270 | $ | 716,208 | $ | 736,388 | ||||||||
Total costs and operating expenses | 372,213 | 384,520 | 396,206 | 383,819 | 475,373 | 570,911 | 533,553 | 561,524 | ||||||||||||||||
Gross margin | 359,244 | 351,498 | 409,457 | 420,707 | ||||||||||||||||||||
Income from operations | 146,560 | 148,333 | 143,635 | 106,592 | 153,990 | 78,359 | 182,655 | 174,864 | ||||||||||||||||
Net income | 110,272 | 122,022 | 116,887 | 95,868 | 135,922 | 90,049 | 154,785 | 147,342 | ||||||||||||||||
Net income per share: | ||||||||||||||||||||||||
Basic | $ | 0.56 | $ | 0.62 | $ | 0.59 | $ | 0.49 | $ | 0.68 | $ | 0.45 | $ | 0.78 | $ | 0.77 | ||||||||
Diluted | $ | 0.55 | $ | 0.61 | $ | 0.58 | $ | 0.48 | $ | 0.67 | $ | 0.44 | $ | 0.76 | $ | 0.75 | ||||||||
(in thousands, except per share data) | First quarter ended September 30, 2005 | Second quarter ended December 31, 2005 | Third quarter ended March 31, 2006 | Fourth quarter ended June 30, 2006 | ||||||||||||||||||||
Revenue | $ | 484,261 | $ | 487,682 | $ | 519,648 | $ | 579,036 | ||||||||||||||||
Total costs and operating expenses | 409,271 | 412,688 | 434,721 | 504,156 | ||||||||||||||||||||
Gross margin | 269,124 | 271,467 | 293,073 | 294,872 | ||||||||||||||||||||
Income from operations | 74,990 | 74,994 | 84,927 | 74,880 | ||||||||||||||||||||
Net income | 75,487 | 76,605 | 96,684 | 131,676 | ||||||||||||||||||||
Net income per share: | ||||||||||||||||||||||||
Basic | $ | 0.38 | $ | 0.39 | $ | 0.48 | $ | 0.66 | ||||||||||||||||
Diluted | $ | 0.37 | $ | 0.38 | $ | 0.47 | $ | 0.65 |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To theThe Board of Directors and Stockholders of KLA-Tencor Corporation:
We have completed integrated audits of KLA-Tencor Corporation’s 20062007 and 20052006 consolidated financial statements and of its internal control over financial reporting as of June 30, 2006 and an audit of its 2004 consolidated financial statements2007, in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements and financial statement schedule
In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of KLA-Tencor Corporation and its subsidiaries at June 30, 20062007 and 2005,June 30, 2006, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 20062007 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 2 to the consolidated financial statements, the Company has restated its fiscal 2005 and fiscal 2004 consolidated financial statements.
As discussed in Note 76 to the consolidated financial statements, effective July 1, 2005 the Company changed its method of accounting for stock-based compensation.
As discussed in Note 9 to the consolidated financial statements, effective June 30, 2007 the Company changed its method of accounting for certain defined benefit pension plans.
Internal control over financial reporting
Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of June 30, 20062007 based on criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2006,2007, based on criteria established inInternal Control—Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As described in Management’s Report on Internal Control Over Financial Reporting, management has excluded ADE Corporation, OnWafer Technologies, Inc., SensArray Corporation, Japan ADE, Ltd., and Therma-Wave, Inc., from its assessment of internal control over financial reporting as of June 30, 2007 because these entities were acquired by the Company in purchase business combinations during the year ended June 30, 2007. We have also excluded such entities from our audit of internal control over financial reporting. The entities are wholly-owned subsidiaries whose combined total assets and combined total revenues represent 14.3% and 4.6%, respectively, of the consolidated financial statement amounts as of and for the year ended June 30, 2007.
/s/ PricewaterhouseCoopers LLP
San Jose, California
January 28,August 17, 2007
ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None.
ITEM 9A. | CONTROLS AND PROCEDURES |
Special Committee Investigation of Historical Stock Option Practices
On May 22, 2006, the Wall Street Journal published an article about stock option backdating that questioned the stock option practices at several companies, including KLA-Tencor. On May 23, 2006, the Company received a subpoena from the United States Attorney’s Office for the Northern District of California (“USAO”) and a letter of inquiry from the United States Securities and Exchange Commission (“SEC”) regarding the Company’s stock option practices. Later on May 23, 2006, the Board of Directors appointed a Special Committee composed solely of independent directors to conduct a comprehensive investigation of the Company’s historical stock option practices. The Special Committee promptly engaged independent legal counsel and accounting experts to assist with the investigation. The investigation included an extensive review of the Company’s historical stock option practices, accounting policies, accounting records, supporting documentation, email communications and other documentation, as well as interviews of a number of current and former directors, officers and employees. On September 27, 2006, the Special Committee reported the bulk of its findings and recommendations to the Board of Directors.
Findings and Remedial Actions
On September 28, 2006, the Company announced that it would have to restate its previously issued financial statements to correct its past accounting for stock options. As a result of the Special Committee investigation, the Company discovered that certain of its stock options, primarily those granted from July 1, 1997 to June 30, 2002, had been retroactively priced for all employees who received these grants. This means that the option exercise price was not the market price of the option shares on the actual grant date of the option, but instead was a lower market price on an earlier date. The actual grant date—when the essential actions necessary to grant the option were completed, including the final determination of the number of shares to be granted to each employee and the exercise price—is the correct measurement date to determine the market price of the option shares under the accounting rules in effect at the time. More than 95% of the total in-the-money value (market price on the actual grant date minus exercise price) of all of the Company’s retroactively priced options was attributable to those granted from July 1, 1997 to June 30, 2002.
The Company previously applied Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and its related Interpretations and provided the required pro forma disclosures under Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” through its fiscal year ended June 30, 2005. Under APB Opinion No. 25, a non-cash, stock-based compensation expense was required to be recognized for any option for which the exercise price was below the market price on the actual grant date. Because each of the Company’s retroactively priced options had an exercise price below the market price on the actual grant date, there should have been a non-cash charge for each of these options under APB Opinion No. 25 equal to the number of option shares, multiplied by the difference between the exercise price and the market price on the actual grant date. That expense should have been amortized over the vesting period of the option. Starting in its fiscal year ended June 30, 2006, the Company adopted SFAS No. 123(R), “Share-Based Payment.” As a result, beginning in fiscal year 2006, the additional stock-based compensation expense required to be recorded for each retroactively priced option is equal to the incremental fair value of the option on the actual grant date, amortized over the remaining vesting period of the option. The Company did not record these stock-based compensation expenses under APB Opinion No. 25 or SFAS No. 123(R) related to its retroactively priced options in the Company’s previously issued financial statements, and that is why it is restating them in this filing. To correct the Company’s past accounting for stock options, it recorded additional pre-tax, non-cash, stock-based compensation expense of (a) $348 million for the periods from July 1, 1994 to
June 30, 2005 under APB Opinion No. 25 and (b) $22 million for the year ended June 30, 2006 under SFAS No. 123(R). The Company expects to amortize an additional $6 million of such pre-tax charges under SFAS No. 123(R) in future periods to properly account for past retroactively priced stock options.
By October 16, 2006, the Special Committee had substantially completed its investigation. The Special Committee concluded that (1) there was retroactive pricing of stock options granted to all employees who received options, primarily during the periods from July 1, 1997 to June 30, 2002 (less than 15% of these options were granted to executive officers), (2) the retroactively priced options were not accounted for correctly in the Company’s previously issued financial statements, (3) the retroactive pricing of options was intentional, not inadvertent or through administrative error, (4) the retroactive pricing of options involved the selection of fortuitously low exercise prices by certain former executive officers, and other former executives may have been aware of this conduct, (5) the retroactive pricing of options involved the falsification of Company records, resulting in erroneous statements being made in financial and other reports previously filed with the SEC, as well as in information previously provided to the Company’s independent registered public accounting firm, and (6) in most instances, the retroactive pricing of options violated the terms of the Company’s stock option plans. Because virtually all holders of retroactively priced options issued by the Company were not involved in or aware of the retroactive pricing, the Board of Directors decided that the Company should continue to honor the options that violated the terms of the Company’s stock option plans, except in certain individual cases as described below.
The Special Committee concluded that, with a few immaterial exceptions, the retroactive pricing of stock options stopped after June 30, 2002. After that time, there were procedures in place designed to provide reasonable assurance that stock options were priced on the grant date. The Special Committee also concluded that none of the Company’s independent Directors was involved in or aware of the retroactive pricing of stock options. Based on the Special Committee’s report, the Board of Directors concluded that no current members of management were involved in the retroactive pricing of stock options. During its investigation of the Company’s historical stock option practices, the Special Committee did not find evidence of any other financial reporting or accounting issues.
As a result of the Special Committee investigation, on October 16, 2006, the Company terminated its employment relationship and agreement with Kenneth L. Schroeder, and the Company announced its intent to cancel all outstanding stock options held by Mr. Schroeder that were retroactively priced or otherwise improperly granted. Those options were canceled in December 2006. Mr. Schroeder was the Company’s Chief Executive Officer and a member of its Board of Directors from mid-1999 until January 1, 2006, and was a member of the Company’s stock option committee from 1994 until December 31, 2005. From January 1, 2006 to October 16, 2006, Mr. Schroeder was employed as a Senior Advisor to the Company. On November 10, 2006, Mr. Schroeder’s counsel informed the Company that Mr. Schroeder contests the Company’s right to terminate his employment relationship and agreement and to cancel any of his options. The Company intends to vigorously defend any claims that may be made by Mr. Schroeder regarding these matters, which could involve a material amount.
Also on October 16, 2006, Stuart J. Nichols, Vice President and General Counsel, resigned. Mr. Nichols and the Company entered into a Separation Agreement and General Release under which Mr. Nichols’ outstanding retroactively priced stock options have been re-priced by increasing the exercise price to the market price of the option shares on the actual grant date. Under SFAS No. 123(R), no incremental charge will be recognized in the financial statements for the quarter ended December 31, 2006.
On October 16, 2006, Kenneth Levy, Founder and Chairman of the Board of Directors of the Company, retired as a director and employee, and was named Chairman Emeritus by the Company’s Board of Directors. Mr. Levy and the Company entered into a Separation Agreement and General Release under which Mr. Levy’s outstanding retroactively priced stock options have been re-priced by increasing the exercise price to the market price of the option shares on the actual grant date. Under SFAS No. 123(R), no incremental charge will be recognized in the financial statements for the quarter ended December 31, 2006. Mr. Levy was the Company’s
Chief Executive Officer from 1975 until mid-1999 (with the exception of mid-1997 to mid-1998), was a member of the Company’s Board of Directors from 1975 until his retirement, was Chairman of the Board of Directors from 1999 until his retirement, and was a member of the Company’s stock option committee from 1994 until use of that committee was suspended in the fall of 2006.
On December 21, 2006, Jon D. Tompkins resigned as a director of the Company, and the Company agreed to modify the outstanding options held by Mr. Tompkins (all of which were fully vested) to extend the post-termination exercisability period to December 31, 2007, which is the last day of the calendar year in which those options would have terminated in the absence of such extension. Mr. Tompkins, the Chief Executive Officer of Tencor Instruments before its merger into the Company in mid-1997, was the Company’s Chief Executive Officer from mid-1997 to mid-1998, was a member of the Company’s stock option committee from mid-1997 until mid-1999, and was a member of the Company’s Board of Directors from mid-1997 until his resignation.
Although the Board of Directors concluded that John H. Kispert, the Company’s President and Chief Operating Officer, was not involved in and was not aware of the improper stock option practices, based on the Special Committee’s recommendation, his outstanding retroactively priced options have been re-priced because he served as Chief Financial Officer during part of the period in question. This re-pricing involved increasing the exercise price to the market price of the option shares on the actual grant date. Under SFAS No. 123(R), no incremental charge will be recognized in the financial statements for the quarter ended December 31, 2006.
Restatement and Impact on Financial Statements
This Annual Report on Form 10-K includes restatements of the following previously filed financial statements and data (and related disclosures): (1) the Company’s consolidated financial statements as of and for the fiscal years ended June 30, 2005 and 2004; (2) the Company’s selected consolidated financial data as of and for the fiscal years ended June 30, 2005, 2004, 2003 and 2002, and (3) the Company’s unaudited quarterly financial data for the first three quarters in our fiscal year ended June 30, 2006 and for all quarters in our fiscal year ended June 30, 2005. As a result of the restatements, the related disclosures included in the Notes to Consolidated Financial Statements have been revised if indicated as restated.
The total effect of the restatements up through June 30, 2005 resulted in pre-tax, non-cash, stock-based compensation charges in the amount of $348 million under APB Opinion No. 25. Effective July 1, 2005, the Company adopted SFAS No. 123(R). The grant date fair values of stock options granted prior to the fiscal year ended June 30, 2006 were changed as a result of the findings that certain stock option grants were retroactively priced. This change resulted in additional stock-based compensation expense of $22 million and a related tax benefit of $12 million being recognized in fiscal year 2006 under SFAS No. 123(R).
In addition, the Company evaluated the impact of the restatements on its global tax provision. The Company and its subsidiaries file tax returns in multiple tax jurisdictions around the world. In certain jurisdictions, including, but not limited to, the United States and the United Kingdom, the Company is able to claim a tax deduction relative to stock options. In those jurisdictions, where a tax deduction is claimed, the Company has recorded deferred tax assets, totaling $51.6 million at June 30, 2005, to reflect future tax deductions to the extent the Company believes such assets to be recoverable. The Company also believes that it should not have taken a United States tax deduction in prior years for stock option related amounts pertaining to certain executives under Internal Revenue Code (IRC) Section 162(m). Section 162(m) limits the deductibility of compensation above certain thresholds. The Company has determined that excess deductions were taken on prior tax returns due to the finding that retroactive pricing of certain stock options occurred. As a result, the Company’s tax liabilities have increased by approximately $8 million.
Because virtually all holders of retroactively priced options issued by the Company were not involved in or aware of the retroactive pricing, the Company has taken and intends to take certain actions to deal with the adverse tax consequences that may be incurred by the holders of retroactively priced options. The adverse tax consequences are that retroactively priced stock options vesting after December 31, 2004 (“409A Affected
Options”) subject the option holder to a penalty tax under IRC Section 409A (and, as applicable, similar penalty taxes under California and other state tax laws). One such action by the Company is to offer to amend the 409A Affected Options to increase the exercise price to the market price on the actual grant date or, if lower, the market price at the time of the amendment. The amended options would not be subject to taxation under IRC Section 409A. Under IRS regulations, these option amendments had to be completed by December 31, 2006 for anyone who was an executive officer when he or she received 409A Affected Options; the amendments for non-officers cannot be offered until after this Report is filed and do not need to be completed until December 31, 2007. Another action is to approve bonuses payable to holders of the amended options to compensate them for the resulting increase in their option exercise price. The amount of these bonuses would be effectively repaid to the Company if and when the options are exercised and the increased exercise price is paid (but there is no assurance that the options will be exercised). Finally, the Company intends to compensate certain option holders who have already exercised 409A Affected Options for the additional taxes they incur under IRC Section 409A (and, as applicable, similar state tax laws).
Three of the Company’s option holders were subject to the December 31, 2006 deadline described above. Accordingly, in December 2006, the Company offered to amend the 409A Affected Options held by Richard P. Wallace, the Company’s Chief Executive Officer, and two former executive officers to increase the exercise price so that these options will not subject the option holder to a penalty tax under IRC Section 409A. All three individuals accepted the Company’s offer. In addition, the Company agreed to pay each of the three individuals a cash bonus in January 2008 equal to the aggregate increase in the exercise prices for his amended options. For Mr. Wallace, the amount of this bonus is $0.4 million. The Company plans to take similar actions with respect to the outstanding 409A Affected Options granted to non-officers as soon as possible after the filing of this Report. The Company estimates that the total cash payments needed to deal with the adverse tax consequences of retroactively priced options granted to non-officers will be approximately $30 million.
With respect to the individuals whose options were canceled or re-priced by the Company following the Special Committee investigation, no bonuses of the type described above will be paid.
Remediation of Past Material Weaknesses in Internal Control Overover Financial Reporting
A material weakness is a control deficiency, or a combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements would not be prevented or detected.
As a result of the investigation of the Company’s historical stock option practices by the Special Committee of the Company’s Board of Directors (for more information regarding the Special Committee investigation and its findings, please refer to Item 3, “Legal Proceedings”), the Company identified certain material weaknesses in its internal control over financial reporting in periods ending prior to the fiscal year ended June 30, 2006.2007. Before June 30, 2002, the Company did not have sufficient safeguards in place to monitor its control practices regarding stock option pricing and related financial reporting and to foster an effective flow of information between those responsible for stock option pricing and those responsible for financial reporting. Inadequate training, communication and coordination in and among the Company’s human resources, stock administration, legal and finance functions prevented the Company from assuring that stock options were priced and accounted for correctly, primarily from July 1, 1997 to June 30, 2002.
In addition, the stock option pricing process during that time period was overly dependent on certain former executive officers of the Company, and was administered by a stock option committee that was not always properly constituted and sometimes acted outside the scope of the authority delegated to it by the Company’s Board of Directors. The individual who served as the Company’s Chief Executive Officer during part of that time period and continuing until midway through the last fiscal year, was involved in the past retroactive pricing of stock options. To that extent, the material weaknesses in the Company’s internal control over financial reporting continued until midway through the Company’s fiscal year ended June 30, 2006. However, no issues regarding stock option pricing and accounting arose during the last fiscal year.
Since mid-2002, the Company has made a number of important changes in its controls related to granting, pricing and accounting for stock options. In addition, the Company’s Board of Directors elected a new management team and approved new procedures for approving stock options and other equity awards. These changes includinginclude the following:
In response to certain of the reporting requirements of the Sarbanes-Oxley Act of 2002, which requires executive officers to report stock option grants within two business days, the Company implemented new procedures for stock option grants that were designed to provide reasonable assurance that stock options were priced on the actual grant date. Since that time, with a few immaterial exceptions, there have been no instances of retroactive pricing of stock options.
Also in response to the requirements of the Sarbanes-Oxley Act of 2002, the Company established a confidential hotline for use by employees to report actual or suspected wrongdoing and to answer questions about business conduct. Reports may be made anonymously, and all reports are investigated. Information about this hotline is available on the Company’s internal and external websites, and employees are reminded of its existence at least annually.
Effective July 1, 2005, the Company adopted SFAS No. 123(R) and added controls in its stock administration, human resources and finance functions to ensure that stock-based compensation expenses are recorded correctly. In addition, the Company hired individuals knowledgeable about the requirements of SFAS No. 123(R).
In January 2006, a new management team elected by the Board of Directors took office. The new management team is led by Richard P. Wallace, the Chief Executive Officer. After joining the Company in 1988, Mr. Wallace had spent most of his career in business unit roles, with no responsibility for corporate functions and no participation in the stock option granting process until mid-2005. During January 2006, well before the stock option issues were discovered, Mr. Wallace launched a number of key initiatives designed to foster open and direct communications and to establish a “tone at the top” based on integrity and excellence. Mr. Wallace regularly communicates with all employees to reinforce these values, and the Company believes that these values have been embraced by the management team and general employee population.
As a result of the Special Committee investigation, in the fall of 2006, the Board of Directors suspended use of the stock option committee and delegated sole authority for granting stock options and restricted stock awards to the full Compensation Committee, subject to ratification by the Board of Directors, with the grant date being the date of the Compensation Committee approval and with the pricing based on the market price on the grant date. The Board of Directors may in the future evaluate the possibility of again using a stock option committee, and, if so, the Company will implement additional controls designed to assure that the stock option committee is properly constituted and acts within the scope of its delegated authority.
In February 2007, the Compensation Committee approved, and the Board of Directors ratified, a new policy regarding equity award grant procedures. The new policy incorporates the following elements (many of which were existing practices):
Annual reviews by the Compensation Committee of equity award dilution targets and overall equity plan design.
Quarterly approvals of equity awards by the Compensation Committee, at regularly scheduled meetings, including annual focal awards, employee new-hire and promotion awards, and ongoing special program awards; quarterly meetings are usually scheduled in August, November, February and May.
In non-routine circumstances such as the hiring of a senior executive, approvals of equity awards by the Compensation Committee at special meetings or, when a special meeting is not feasible, by unanimous written consent; otherwise, no equity awards will be approved by unanimous written consent. Clarification and enhancement of the administrative process for issuing equity awards to assure that (a) the grant date of each award is the date of Compensation Committee approval, (b) the exercise or valuation price of each award is the closing market price on the date of grant, (c) notifications of the awards are promptly sent to the recipients, and (d) the awards are promptly entered into the Company’s equity award database and financial records.
Annual reconciliations and reports regarding equity awards to allow the Compensation Committee to verify compliance with this policy;
The Company believes that these changes remediated the past material weaknesses identified above and reduced to remote the likelihood that any retroactive pricing of stock options or any material error in accounting for stock options would not have been detected as of June 30, 2006.2007. As a result, the Company believes that the likelihood that a material error in its financial statements that could have originated during the last fiscal year and would not have been detected as of June 30, 20062007 was remote.
Evaluation of Disclosure Controls and Procedures
Attached as exhibits to this Annual Report are certifications of the Company’s Chief Executive Officer (CEO) and Chief Financial Officer (CFO), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (Exchange Act). This Controls and Procedures section includes the information concerning the controls evaluation referred to in the certifications, and it should be read in conjunction with the certifications for a more complete understanding of the topics presented.
The Company conducted an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures (as defined in the Rules 13a-15(e) and 15d-15(e) under the Exchange Act) (Disclosure Controls) as of the end of the period covered by this Report required by Exchange Act Rules 13a-15(b) or 15d-15b. The controls evaluation was conducted under the supervision and with the participation of the Company’s management, including the CEO and CFO. Based on this evaluation, the Company’s CEO and our CFO have concluded that as of the end of the period covered by this report the Company’s disclosure controls and procedures were effective at a reasonable assurance level.
Definition of Disclosure Controls
Disclosure Controls are controls and procedures designed to reasonably assure that information required to be disclosed in the Company’s reports filed under the Exchange Act, such as this Report, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure Controls are also designed to reasonably assure that such information is accumulated and communicated to the Company’s management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. The Company’s Disclosure Controls include components of its internal control over financial reporting, which consists of control processes designed to provide reasonable assurance regarding the reliability of its financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles in the U.S. To the extent that components of the Company’s internal control over financial reporting are included within its Disclosure Controls, they are included in the scope of the Company’s annual controls evaluation.
Management’s Report on Internal Control over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Under the supervision and with the participation of the Company’s management, including the CEO and CFO, the Company conducted an evaluation of the effectiveness of its internal control over financial reporting based on criteria established in the framework inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, the Company’s management concluded that the Company’s internal control over financial reporting was effective as of June 30, 2006.2007. The Company has excluded ADE Corporation, OnWafer Technologies, Inc., SensArray Corporation, Japan ADE, Ltd., and Therma-Wave, Inc., from the assessment of internal control over financial reporting as of June 30, 2007 because these entities were acquired by the Company in purchase business combinations during the fiscal year ended June 30, 2007. These entities are wholly-owned subsidiaries whose combined total assets and combined total revenues represent 14.3% and 4.6%, respectively, of the consolidated financial statement amounts of the Company as of and for the fiscal year ended June 30, 2007. The assessment by the Company’s management of the effectiveness of the Company’s internal control over financial reporting as of June 30, 20062007 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears in Item 8, “Financial Statements and Supplementary Data” in this Annual Report on page 101 of this Report.Form 10-K.
Limitations on the Effectiveness of Controls
The Company’s management, including the CEO and CFO, does not expect that the Company’s Disclosure Controls or internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based
in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Changes in Internal Control over Financial Reporting
There were no changes in the Company’s internal control over financial reporting that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B. | OTHER INFORMATION |
None.
ITEM 10. | DIRECTORS, |
INFORMATION ABOUT THE DIRECTORS AND THE NOMINEES
The following table sets forth certainFor the information with respect to the Company’s Boardrequired by this Item, see “Information About Executive Officers”, “Section 16(a) Beneficial Ownership Reporting Compliance”, “Our Corporate Governance Practices—Standards of Directors asBusiness Conduct”, “Proposal One: Election of December 31, 2006:
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INFORMATION ABOUT EXECUTIVE OFFICERS
Set forth below are the names, agesDirectors” and positions of the executive officers of KLA-Tencor as of December 31, 2006.
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ABOUT THE BOARD OF DIRECTORS AND ITS COMMITTEES
The Board of Directors
The Board of Directors of the Company held a total of seven meetings during the fiscal year ended June 30, 2006.
All Directors during the last fiscal year other than Kenneth Levy (who retired on October 16, 2006), Jon D. Tompkins (who resigned on December 21, 2006) and Mr. Wallace met the definition of independence within the meaning of the Nasdaq National Market director independence standards. None of the Company’s Directors fall outside of the SEC’s 10% ownership safe harbor.
The Board of Directors has three standing committees: the Audit Committee; the Compensation Committee; and the Nominating and Governance Committee. The Board of Directors has determined that each of the members of each of the Committees has no material relationship with the Company (including any relationship that, in the opinion of the Board, would interfere with the exercise of independent judgment as a Director) and is independent within the meaning of the Nasdaq National Market director independence standards, including in the case of the Audit Committee, the heightened “independence” standard required for audit committee members.
Each Committee meets regularly and has a written charter approved by the Board of Directors, all of which were attached as appendices to the Proxy Statement related to our 2003 Annual Meeting, which was filed with the Securities and Exchange Commission on September 23, 2003 and are available via our website athttp://ir.kla-tencor.com. At each regularly scheduled Board of Directors meeting, a member of each Committee reports on any significant matters addressed by the Committee. In 2002, after reviewing the Sarbanes-Oxley Act of 2002 and the proposed rules of the SEC and the Nasdaq Stock Market, the Board of Directors revised all of its Committee charters to implement voluntarily the proposed standards and to expand the responsibilities of each Committee as well as establish independence and self-assessment requirements. The Board of Directors and each Committee regularly reviews the Committee charters.
During the fiscal year ended June 30, 2006, all incumbent Directors attended at least 80% of the total number of meetings of“About the Board of Directors and each Director attended at least 80% of the aggregate of the total number of meetings held by all Committees of the Board on which each such Director served (during the periods that each such Director served).
Although we do not have a formal policy mandating attendance by members of the Board of Directors at our annual meetings of stockholders, we do have a formal policy encouraging their attendance at annual meetings of KLA-Tencor stockholders. All of the Directors attended the 2005 Annual Meeting of stockholders.
For more information regarding the responsibilities of our Board Committees, please refer to our charters which can be found on our corporate governance website located athttp://ir.kla-tencor.com.
Audit Committee
The Audit Committee is one of three standing committees of the Board of Directors (the other two committees are the Compensation Committee; and the Nominating and Governance Committee). The Audit Committee consists of Mr. Bingham, Mr. Bond, and Mr. Kaufman, with Mr. Wang having observer status. Richard J. Elkus, Jr. was also on the Audit Committee until he retired effective November 4, 2005. The Board of Directors has determined that Mr. Bingham is an “audit committee financial expert” within the meaning of the rules and regulations promulgated by the SEC. During fiscal year 2006, Mr. Bingham was the Chairman of the Audit Committee. The Audit Committee is responsible for appointing, compensating and overseeing the work of the Company’s independent auditors, approving the services performed by the Company’s independent auditors and for reviewing and evaluating the Company’s accounting principles and its system of internal accounting controls. The Audit Committee held six meetings during the last fiscal year.
The Board of Directors has determined that each of the members of the Audit Committee: (1) meets the definition of independence within the meaning of Nasdaq’s director independence standards, (2) meets the definition of audit committee member independence within the meaning of Rule 10A-3 under the Securities Exchange Act of 1934 and (3) has no material relationship with the Company (including any relationship that,Its Committees-Audit Committee” in the opinion of the Board, would interfere with the exercise of independent judgment as a Director).Proxy Statement, which is incorporated herein by reference.
Compensation Committee
The Compensation Committee consists of Mr. Barnholt, Mr. Bond, and Ms. Urbanek. During fiscal year 2006, Mr. Bond was the Chairman of the Compensation Committee. The Compensation Committee reviews and approves the Company’s executive compensation policy and administers the Company’s employee equity award plans. The Compensation Committee also reviews and approves (subject to ratification by the Board of Directors) the cash and equity compensation for our Chief Executive Officer and other executive officers, as well as for members of the Board of Directors. The Compensation Committee held six meetings during the last fiscal year.
Nominating and Governance Committee
The Nominating and Governance Committee consists of Mr. Barnholt, Mr. Bingham and Mr. Kaufman. Mr. Barnholt served as the Chairman of the Nominating and Governance Committee during fiscal year 2006. The Nominating and Governance Committee is primarily responsible for identifying and evaluating the qualifications of all candidates for election to the Board of Directors, as well as reviewing corporate governance policies and procedures. The Nominating and Governance Committee held four meetings during the last fiscal year.
It is the Nominating and Governance Committee’s policy to consider candidates for the Board of Directors recommended by stockholders who have owned at least 1% of the Company’s outstanding shares for at least one year and who have evidenced intent to continue as substantial stockholders for the long term. Stockholders wishing to submit recommendations must notify the Company’s Assistant Secretary in writing of their intent to do so and provide the Company with certain information set forth in Section 11 of our bylaws and all other information regarding nominees that is required to be provided pursuant to Regulation 14A of the Securities Exchange Act of 1934, or as otherwise requested by the Nominating and Governance Committee. In addition, stockholders may nominate candidates for the Board of Directors pursuant to the provisions of Section 11 of our bylaws and in conformance with the requirements of Regulation 14A of the Securities Exchange Act of 1934.
In considering candidates for Director nomination, including evaluating any recommendations from stockholders as set forth above, the Nominating and Governance Committee considers only candidates who have demonstrated executive experience, have experience in an applicable industry, or significant high level experience in accounting, legal or a technical field applicable to the Company. In addition, in evaluating Director candidates, the Nominating and Governance Committee considers all factors it considers appropriate, which may include strength of character, mature judgment, career specialization, relevant technical skills, diversity of experience and the extent to which the candidate would fill a present need on the Board of Directors.
The Nominating and Governance Committee regularly assesses the appropriate size and composition of the Board of Directors, and whether any vacancies on the Board are expected. In the event that vacancies are anticipated, or otherwise arise, the Nominating and Governance Committee considers potential candidates that may come to its attention through current members of the Board of Directors, professional search firms, stockholders who have owned at least 1% of the Company’s outstanding shares for at least one year and who have evidenced intent to continue as a substantial stockholder for the long term, or other persons. In evaluating properly submitted stockholder recommendations, the Nominating and Governance Committee uses the evaluation standards discussed above and seeks to achieve a balance of knowledge, experience and capability on the Board of Directors.
Code of Ethics
KLA-Tencor expects its Directors, executives and employees to conduct themselves with the highest degree of integrity, ethics and honesty. KLA-Tencor’s credibility and reputation depend upon the good judgment, ethical standards and personal integrity of each Director, executive and employee. In order to provide assurances to KLA-Tencor and its stockholders, KLA-Tencor has implemented standards of business conduct which provide clear guidelines regarding business conduct standards, including those applicable to conflicts of interest, as well as an explanation of the Company’s reporting and investigatory procedures. These standards of business conduct apply to all directors, executives and employees of the Company, including our principal executive officer, principal financial officer, principal accounting officer and controller. Our standards of business conduct can be viewed on our website athttp://ir.kla-tencor.com.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires the Company’s executive officers, Board members, and persons who own more than ten percent of a registered class of the Company’s equity securities to file reports of ownership and changes in ownership with the SEC, and such persons are also required by SEC regulations to furnish the Company with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms received by it, the Company believes that, with the exceptions noted below, during fiscal 2006 all executive officers, Board members and greater than ten percent stockholders of the Company complied with all applicable filing requirements. Due to an administrative error on the part of the Company, the following individuals failed to timely file a Form 4 for one option grant each: Richard Elkus and Robert Bond. Richard Elkus reported his August 9, 2005 option exercises on September 6, 2006 and Robert Bond reported his September 13, 2005 option exercises on September 21, 2005.
ITEM 11. | EXECUTIVE COMPENSATION |
EXECUTIVE COMPENSATION AND OTHER MATTERS
ExecutiveFor the information required by this Item, see “Executive Compensation
The following table sets forth and Other Matters”, and “Director Compensation” in the compensation earned for services rendered in all capacities to the Company and its subsidiaries for the fiscal year ended June 30, 2006 and each of the preceding two fiscal yearsProxy Statement, which is incorporated herein by each person who served as Chief Executive Officer during the fiscal year ended June 30, 2006 and each of the four other most highly compensated executive officers whose salary plus bonus for that fiscal year exceeded $100,000. The listed individuals will be referred to as the named executive officers. No executive officer terminated employment with the Company during fiscal year 2006.reference.
Annual Compensation | Long-Term Compensation | |||||||||||||||||||||
Name and Principal Position | Year | Salary(1) | Bonus(1)(2) | Other Annual Compensation ($) | Restricted Stock Award(s)(3) | Securities Underlying Options/ SARs (#) | All Other Compensation | |||||||||||||||
Richard P. Wallace Chief Executive Officer | 2006 | $ | 555,293 | $ | 1,185,830 | N/A | $ | 5,138,500 | (5) | 175,000 | $ | 1,000 | ||||||||||
2005 | $ | 392,181 | $ | 791,653 | N/A | $ | 1,672,395 | (5) | 86,250 | $ | 1,000 | |||||||||||
2004 | $ | 336,501 | $ | 443,730 | N/A | N/A | 76,250 | $ | 1,000 | |||||||||||||
John H. Kispert President & Chief Operating Officer | 2006 | $ | 499,838 | $ | 908,519 | N/A | $ | 2,626,500 | (6) | 100,000 | $ | 1,000 | ||||||||||
2005 | $ | 447,066 | $ | 900,251 | N/A | $ | 1,966,186 | (6) | 86,250 | $ | 1,000 | |||||||||||
2004 | $ | 396,393 | $ | 658,700 | N/A | N/A | 76,250 | $ | 1,000 | |||||||||||||
Jeffrey L. Hall Senior Vice President & Chief Financial Officer | 2006 | $ | 272,677 | $ | 339,262 | N/A | $ | 787,950 | (8) | 45,000 | $ | 1,000 | ||||||||||
2005 | $ | 240,614 | $ | 359,923 | N/A | $ | 419,500 | (8) | 21,950 | $ | 1,000 | |||||||||||
2004 | $ | 194,799 | $ | 184,738 | (7) | N/A | N/A | 14,300 | $ | 1,000 | ||||||||||||
Avi Cohen Group Vice President | 2006 | $ | 325,408 | $ | 440,199 | N/A | N/A | (10) | 75,000 | $ | 1,000 | |||||||||||
2005 | $ | 303,288 | $ | 505,920 | $ | 34,279 | (9) | $ | 1,355,986 | (10) | 81,000 | $ | 1,000 | |||||||||
2004 | $ | 253,346 | $ | 295,975 | $ | 83,405 | (9) | N/A | 40,250 | $ | 1,000 | |||||||||||
Lance Glasser Chief Technical Officer | 2006 | $ | 325,393 | $ | 459,292 | $ | 2,896 | (11) | N/A | (12) | 75,000 | $ | 1,000 | |||||||||
2005 | $ | 300,606 | $ | 473,744 | $ | 1,480 | (11) | $ | 1,355,986 | (12) | 78,750 | $ | 1,000 | |||||||||
2004 | $ | 241,760 | $ | 267,046 | $ | 740 | (11) | N/A | 25,750 | $ | 1,000 | |||||||||||
Former Officers | ||||||||||||||||||||||
Kenneth L. Schroeder (13) Former Chief Executive Officer | 2006 | $ | 750,090 | $ | 1,500,181 | N/A | N/A | 325,800 | $ | 1,000 | ||||||||||||
2005 | $ | 746,460 | $ | 2,018,130 | N/A | $ | 4,068,000 | 348,300 | $ | 1,000 | ||||||||||||
2004 | $ | 581,195 | $ | 1,183,023 | N/A | N/A | 158,950 | $ | 0 |
Mr. Wallace: 37% Annual Performance Bonus and 63% OCPB
Mr. Kispert: 37% Annual Performance Bonus and 63% OCPB
Mr. Hall: 37% Annual Performance Bonus and 63% OCPB
Mr. Cohen: 37% Annual Performance Bonus and 63% OCPB
Mr. Glasser: 39% Annual Performance Bonus and 61% OCPB
Mr. Schroeder: 50% Annual Performance Bonus and 50% OCPB
2006: 25,000 RSUs that had a fair market value per share of $47.95 when awarded on September 26, 2005;
75,000 RSUs that had a fair market value per share of $52.53 when awarded on February 17, 2006.
2005: 41,111 RSUs that had a fair market value per share of $40.68 when awarded on October 18, 2004.
2006: 50,000 RSUs that had a fair market value per share of $52.53 when awarded on February 17, 2006.
2005: 48,333 RSUs that had a fair market value per share of $40.68 when awarded on October 18, 2004.
2006: 15,000 RSUs that had a fair market value per share of $52.53 when awarded on February 17, 2006.
2005: 10,000 RSUs that had a fair market value per share of $41.95 when awarded on May 16, 2005.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
Stock Option Grants and Exercises
The following tables set forth the number of securities underlying stock options granted to the named executive officers under the Company’s stock option plans and the options exercised by such named executive officers during the fiscal year ended June 30, 2006. No stock appreciation rights were granted to any of the named executive officers during the 2006 fiscal year.
Number of Options(1) | Percent of Year(2) | Exercise or ($/share) | Expiration Date | Potential Realizable Value At Assumed Annual Rates of Stock Price Appreciation for Option Term ($)(3) | ||||||||||||
5% | 10% | |||||||||||||||
Richard P. Wallace | 125,000 | $ | 47.95 | 9/26/2012 | $ | 2,440,058 | $ | 5,686,373 | ||||||||
Chief Executive Officer | 50,000 | $ | 52.53 | 2/17/2013 | $ | 1,069,249 | $ | 2,491,805 | ||||||||
Total | 175,000 | 3.60 | % | $ | 3,509,307 | $ | 8,178,179 | |||||||||
John H. Kispert | 75,000 | $ | 47.95 | 9/26/2012 | $ | 1,464,035 | $ | 3,411,824 | ||||||||
President & Chief Operating Officer | 25,000 | $ | 52.53 | 2/17/2013 | $ | 534,625 | $ | 1,245,903 | ||||||||
Total | 100,000 | 2.06 | % | $ | 1,998,660 | $ | 4,657,727 | |||||||||
Jeffrey L. Hall | 30,000 | $ | 47.95 | 9/26/2012 | $ | 585,614 | $ | 1,364,730 | ||||||||
Senior Vice President & Chief Financial Officer | 15,000 | $ | 52.53 | 2/17/2013 | $ | 320,775 | $ | 747,542 | ||||||||
Total | 45,000 | 0.93 | % | $ | 906, 389 | $ | 2,112,271 | |||||||||
Avi Cohen | 75,000 | $ | 47.95 | 9/26/2012 | $ | 1,464,035 | $ | 3,411,824 | ||||||||
Group Vice President | ||||||||||||||||
Total | 75,000 | 1.54 | % | $ | 1,464,035 | $ | 3,411,824 | |||||||||
Lance Glasser Chief Technical Officer | 75,000 | $ | 47.95 | 9/26/2012 | $ | 1,464,035 | $ | 3,411,824 | ||||||||
Total | 75,000 | 1.54 | % | $ | 1,464,035 | $ | 3,411,824 | |||||||||
Kenneth L. Schroeder | 75,000 | $ | 47.95 | 9/26/2015 | $ | 2,261,662 | $ | 5,731,496 | ||||||||
Former Chief Executive | 175,000 | $ | 47.95 | 9/26/2015 | $ | 5,277,212 | $ | 13,373,491 | ||||||||
Officer(4) | 75,800 | $ | 47.95 | 9/26/2015 | $ | 2,285,787 | $ | 5,792,632 | ||||||||
Total | 325,800 | 6.71 | % | $ | 9,824,661 | $ | 24,897,620 |
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
The following table sets forth information with respect to exercise of options during fiscal year 2006 by the named executive officers and the unexercised options held by them at the end of such year. No stock appreciation rights were held or exercised by the named executive officers during fiscal year 2006.
Number of Acquired on Exercise | Value Realized(1) | Number of Securities Underlying Unexercised Options at 6/30/2006 | Value of Unexercised at 6/30/2006(2) | ||||||||||||||
Vested | Unvested | Exercisable | Unexercisable | ||||||||||||||
Richard P. Wallace | (3) | (3) | 152,710 | 275,918 | $ | 768,254 | $ | 238,413 | |||||||||
Chief Executive Officer | |||||||||||||||||
John H. Kispert(5) | 67,500 | $ | 1,386,048 | 103,782 | 201,918 | $ | 309,359 | $ | 252,783 | ||||||||
President & Chief Operating Officer | |||||||||||||||||
Jeffrey L. Hall | 7,000 | $ | 147,507 | 66,459 | 69,552 | $ | 185,479 | $ | 75,887 | ||||||||
Senior Vice President & Chief Financial Officer | |||||||||||||||||
Avi Cohen | 54,813 | $ | 2,119,863 | 145,498 | 151,002 | $ | 957,924 | $ | 165,804 | ||||||||
Group Vice President | |||||||||||||||||
Lance Glasser | 22,000 | $ | 880,919 | 128,482 | 142,018 | $ | 956,569 | $ | 150,406 | ||||||||
Chief Technical Officer | |||||||||||||||||
Kenneth L. Schroeder(4) | 206,032 | $ | 7,292,153 | 630,652 | 939,448 | $ | 6,120,407 | $ | 2,804,498 | ||||||||
Former Chief Executive Officer |
DIRECTOR COMPENSATION
Employee Directors
Members of the Board of Directors who are employees do not receive any additional compensation for their services as Directors.
Outside Directors
Members of the Board who are not employees of the Company (“Outside Directors”) receive equity and cash compensation as determined by the Compensation Committee, subject to ratification by the Board of Directors. Equity compensation to Outside Directors is provided under the Company’s 1998 Outside Director Plan and 2004 Equity Incentive Plan, both of which were approved by stockholders.
Outside Director Stock Options
Each Outside Director receives a non-statutory stock option to purchase 5,000 shares of Common Stock as of the date on which such Director first becomes an Outside Director (the “First Option”). If a new Outside Director does not join the Board at the beginning of the Company’s fiscal year, the First Option will be prorated to reflect the quarter in which such new Outside Director joins the Board. In addition, each Outside Director will automatically be granted a series of non-statutory stock options each year to purchase up to an additional 5,000 shares of common stock in the aggregate (collectively the “Subsequent Grant”). The Subsequent Grant will be provided to each Outside Director in 1,250 share option grants each quarter, approximately two business days following the Company’s earnings release for the prior fiscal quarter, with the first such quarterly grant to be made at least 6 months after the date of grant of the First Option. The Chairman of the Audit Committee receives an additional non-statutory stock option grant to purchase another 2,500 shares of common stock on the date of each subsequent annual meeting on which such Director remains the Chairman of the Audit Committee. The term of each option granted under the 1998 Director Plan may not exceed 10 years. The 1998 Director Plan provides that the exercise price shall be equal to the fair market value of the common stock on the date of grant of the option. Options granted under the 1998 Director Plan are fully vested and immediately exercisable upon grant.
Outside Director Restricted Stock Unit Awards
On an annual basis, each Outside Director is awarded restricted stock units with a value of $50,000 at the time of the award. The restricted stock units vest upon completion of one year of Board service measured from the date of grant, but the shares of common stock subject to the vested units are not delivered until 3 years after the date of grant or sooner upon a director’s resignation from the Board.
Cash Compensation
Each Outside Director receives an annual fee of $40,000 and $2,500 for each meeting they attend plus reasonable expenses in attending such meeting. Committee members receive $1,500 per committee meeting they attend. The Committee Chair positions receive an additional annual retainer of $10,000.
ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
EQUITY COMPENSATION PLAN
EquityFor the information required by this Item, see “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information
The following table provides information as of June 30, 2006 with respect to shares of the Company’s common stock that may be issued under the Company’s existing equity compensation plans. The table does not include information with respect to shares of the Company’s common stock subject to outstanding options granted under equity compensation plans or option agreements that were assumed by the Company in connection with the Company’s acquisitions of the companies that originally granted those options. However, Footnote (8) to the table sets forth the total number of shares of common stock issuable upon the exercise of those assumed options as of June 30, 2006, and the weighted-average exercise price of those options. Except for the adjustments described in Footnote (8) with respect to the outstanding assumed options, no additional options may be granted under those assumed plans.
Number of Securities to be Issued Upon Exercise of Outstanding Options(1) | Weighted-Average Exercise Price of Outstanding Options | Number of Column A)(2) | |||||
A | B | C | |||||
Equity Compensation Plans Approved by Stockholders | 24,431,083 | $ | 40.26 | 8,122,294 | |||
Equity Compensation Plans Not Approved by Stockholders | 5,931,209 | $ | 38.96 | ||||
Total | 30,362,292 | $ | 40.00 | 8,122,294 |
Compensation Committee Interlocks and Insider Participation
The Compensation Committee currently consists of Mr. Bond (Chair), Mr. Barnholt and Ms. Urbanek. None of these individuals were officers or employees of the Company at any time during the 2006 fiscal year or at any other time. During the 2006 fiscal year, there was no instance where an executive officer of the Company served as a member of the board of directors or compensation committee of any entity and an executive officer of that entity served on the Company’s Board of Directors or Compensation Committee.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Principal Stockholders
As of June 30, 2006, based on our review of filings made with the Securities and Exchange Commission, we are aware of the following entities being the beneficial owner of more than 5% of the Company’s common stock:
Name and Address | Number of Shares Beneficially Owned | Percent of Shares Beneficially Owned(1) | |||
Capital Guardian Trust Co.(2) 333 South Hope Street Los Angeles, CA 90071 | 29,588,909 | 14.86 | % | ||
Capital Research & Management Co.(2) 333 South Hope Street Los Angeles, CA 90071 | 18,458,818 | 9.27 | % | ||
Fidelity Management Research(2)(3) 1 Federal Street Boston, MA 02109 | 17,611,015 | 8.84 | % | ||
Alliance Bernstein LP(2) 1345 Avenue of the Americas 38th Fl. New York, NY 10105-0096 | 12,700,633 | 6.38 | % |
Management
The following table sets forth the beneficial ownership of the Company’s common stock as of December 31, 2006 by all Directors, each of the named executive officers set forthInformation” in the Summary Compensation Table, andProxy Statement, which is incorporated herein by all Directors and current executive officers as a group. Shares that become issuable under outstanding restricted stock units upon satisfaction of the applicable vesting requirements are not included in the table but are indicated in footnote 17 to such table:reference.
Name and Address | Number of Shares Beneficially Owned | Percent of Shares Beneficially Owned(1) | |||
Richard P. Wallace (2) | 231,919 | * | |||
Edward W. Barnholt (3) | 72,832 | * | |||
H. Raymond Bingham (4) | 61,000 | * | |||
Robert T. Bond (5) | 58,000 | * | |||
Stephen P. Kaufman (6) | 37,000 | * | |||
Lida Urbanek (7) | 1,385,581 | * | |||
David C. Wang | — | * | |||
John H. Kispert (8) | 167,941 | * | |||
Jeffrey L. Hall (9) | 62,828 | * | |||
Avi Cohen (10)(13) | — | * | |||
Lance Glasser (11)(13) | 46,798 | * | |||
Kenneth L. Schroeder (12)(13) | — | * | |||
All Directors and executive officers as a group (12 persons) (14) | 2,118,899 | 1.06 | % |
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ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE |
Change of Control Agreements
Kenneth L. Schroeder
On December 21, 2005,For the Company entered into an amendedinformation required by this Item, see “Certain Relationships and restated employment agreement with Mr. Schroeder (the “Schroeder Agreement”) which replacedRelated Transactions” and superseded Mr. Schroeder’s prior employment agreement. The Schroeder Agreement addressed Mr. Schroeder’s terms of employment with the Company as President and Chief Executive Officer as well as employment terms if he were to become a part-time employee. In pertinent part, the Schroeder Agreement specified (a) the terms of compensation and benefits for Mr. Schroeder if his status with the Company were to change from full-time to part-time employment (under which part-time status he would continue to receive his base salary, bonuses and equity vesting similar to when he was a full-time employee for a specified period), (b) circumstances in the event of a change-of-control of the
Company under which the vesting of his equity awards would accelerate in full, (c) circumstances in which he would forfeit certain equity awards and forego future cash payments (e.g., a termination for “cause”), and (d) his obligations to abide by a non-competition provision.
On October 16, 2006, following the Special Committee investigation of the Company’s historical stock option practices, the Company terminated all aspects of Mr. Schroeder’s employment relationship and all employment or service arrangements between Mr. Schroeder and the Company. In connection with Mr. Schroeder’s termination, the Company canceled all outstanding vested stock options held by Mr. Schroeder that were retroactively priced or otherwise improperly granted. In addition, all of the unvested stock options and equity awards held by Mr. Schroeder on his termination date immediately ceased vesting and were canceled. On November 10, 2006, Mr. Schroeder’s counsel informed the Company that Mr. Schroeder contests the Company’s right to terminate his employment relationship and agreement and to cancel any of his options. The Company intends to vigorously defend any claims that may be made by Mr. Schroeder regarding these matters, which could involve a material amount.
Kenneth Levy
In connection with the merger between KLA Instruments Corporation and Tencor Instruments (effective April 30, 1997), the Company entered into identical employment arrangements, subsequently amended, (the “Retention and Non-Competition Agreement”) with Messrs. Levy and Schroeder. (Mr. Schroeder’s Retention and Non-Competition Agreement was replaced and superseded in its entirety by the Schroeder Agreement described above, which was subsequently terminated). Mr. Levy’s Retention and Non-Competition Agreement, as amended, addressed Mr. Levy’s terms of employment with the Company as well as employment terms if he were to become a part-time employee. In pertinent part, Mr. Levy’s Agreement specified (a) the terms of compensation and benefits for Levy if his status with the Company were to change from full-time to part-time employment (under which part-time status he would continue to receive his base salary, bonuses and equity vesting similar to when he was a full-time employee for a specified period), (b) circumstances in which he would forfeit certain equity awards and foregoing future cash payments (e.g., a termination for “cause”), and (c) his obligations to abide by a non-competition provision.
On October 16, 2006, the Company and Mr. Levy entered into a Separation Agreement and General Release (the “Separation Agreement”). Pursuant to the terms of the Separation Agreement, (a) Mr. Levy’s prior Retention and Non-Competition Agreement was terminated by mutual agreement and Mr. Levy retired as a director and employee of the Company and was named Chairman Emeritus, (b) all outstanding retroactively priced stock options held by Mr. Levy have been re-priced, with the exercise prices of such stock options being increased to the market prices on the corrected measurement dates, and (c) Mr. Levy will be entitled to receive the following benefits: (i) a lump sum payment equal to $37,500, (ii) continued secretarial services until he reaches age 70, and (iii) maintenance of an executive office off the Company’s premises until he reaches age 70.
Other Executive Officers
In fiscal year 2002,“About the Board of Directors approved individual “change-in-control” agreements for Messrs. Schroeder and Kispert (Mr. Schroeder’s change-in-control agreement was replaced and superseded in its entirety by the Schroeder Agreement described above, which was subsequently terminated.) The change-in-control provisions of Mr. Kispert’s agreement take effect if his employment is terminated involuntarily or constructively within two years after a change in control of the Company. If the provisions become effective, Mr. Kispert, would become eligible to receive: (i) an amount equal to two times his annual compensation, (ii) an amount equal to two times his bonus amount, (iii) continuation of health benefits for two years, and (iv) full acceleration of vesting for all options held. For the purpose of this agreement, a change in control occurs upon merger of the Company with or into another corporation, or a change in more than half of the total voting power of the Company, or upon the sale of substantially all of the assets of the Company. Mr. Kispert’s agreement was replaced and superseded in its entirety by the Executive Severance Plan adopted on February 17, 2006, as described below.
Executive Severance Plan
On February 17, 2006, the Board of Directors of KLA-Tencor Corporation (the “Company”) adopted the KLA-Tencor Corporation Executive Severance Plan (“Plan”). The Plan specifies the compensation and benefits that Plan participants will receiveIts Committees” in the event of termination of employment with the Company. In exchange for receiving severance benefits under the Plan, participants will be required to agree to non-compete and non-solicitation restrictions for the period of time duringProxy Statement, which they are receiving Plan benefits. The severance period for individual participants, and whether or not participants will be eligible for pre-change of control severance benefits will be determinedis incorporated herein by the Compensation Committee.reference.
Plan participants are the Company’s Chief Executive Officer (“CEO”), Chief Operating Officer (“COO”), and Chief Financial Officer (“CFO”). If the CEO or COO are terminated other than for cause or voluntarily for good reason prior to a change in control they will receive (i) two years’ base salary, (ii) a pro rated annual incentive payment, (iii) pro rated vesting on any equity awards through the end of the month of their termination of employment, (iv) any stock options or stock appreciation rights granted after February 16, 2006 will have a post-termination exercise period of one year, or, if less, the original term of the award.
If the CEO is terminated other than for cause or voluntarily for good reason within two years following a change in control, he will receive (i) three years’ base salary, (ii) three years’ annual incentive payment paid at his target bonus amount, (iii) 100% vesting acceleration on any equity awards, and (iv) any stock options or stock appreciation rights granted after February 16, 2006 will have a post-termination exercise period of one year, or, if less, the original term of the award.
If the COO or the CFO are terminated other than for cause or voluntarily for good reason within two years following a change in control, they will receive (i) two years’ base salary (ii) two years’ annual incentive payment paid at their target bonus amounts, (iii) 100% vesting acceleration on any equity awards, and (iv) any stock options or stock appreciation rights granted after February 16, 2006 will have a post-termination exercise period of one year, or, if less, the original term of the award.
ITEM 14. | PRINCIPAL |
Fees
The aggregate fees billedFor the information required by this Item, see “Proposal Three: Ratification of Appointment of PricewaterhouseCoopers LLP KLA-Tencor’s independent registered public accounting firm,as the Company’s Independent Registered Public Accounting Firm for the Fiscal Year Ending June 30, 2008” in fiscal years 2006 and 2005 were as follows:
Services Rendered/Fees | 2006 | 2005 | ||||
Audit Fees(1) | $ | 3,170,000 | $ | 3,215,000 | ||
Audit-Related Fees(2) | $ | 207,000 | $ | 32,000 | ||
Total Audit and Audit-Related Fees | $ | 3,388,000 | $ | 3,247,000 | ||
Tax Compliance | $ | 174,000 | $ | 371,000 | ||
Tax Planning and Consulting | $ | 372,000 | $ | 462,000 | ||
Total Tax Fees(3) | $ | 545,000 | $ | 833,000 | ||
All Other Fees(4) | $ | 0 | $ | 91,000 |
Pre-approval Policies and Procedures
The Audit Committee has adopted a policy regarding non-audit services providedthe Proxy Statement, which is incorporated herein by PricewaterhouseCoopers LLP, our independent registered public accounting firm. First, the policy ensures the independence of our auditors by expressly naming all services that the auditors may not perform and reinforcing the principle of independence regardless of the type of service. Second, certain non-audit services such as tax-related services and acquisition advisory services are permitted but limited in proportion to the audit fees paid. Third, the Chair of the Audit Committee pre-approves non-audit services not specifically permitted under this policy and the Audit Committee reviews the annual plan and any subsequent engagements. Thus, all of the services described above under audit-related fees, tax fees and all other fees were approved by the Audit Committee pursuant to its pre-approval policies and procedures.
On a quarterly basis, management provides written updates to the Audit Committee providing an update of audit and non-audit services, the amount of audit and non-audit service fees incurred to date, and the estimated cost to complete such services.
There were no instances during the current fiscal year where services were performed by the independent registered public accounting firm where the pre-approval requirements were waived.reference.
ITEM 15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULE |
(a) The following documents are filed as part of this Annual Report on Form 10-K:
1. Financial Statements:
The following financial statements and schedules of the Registrant are contained in Item 8, “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K:
Consolidated Balance Sheets as of June 30, | ||
90 |
2. Financial Statement Schedule:
The following financial statement schedule of the Registrant is filed as part of this Annual Report on Form 10-K and should be read in conjunction with the financial statements:
2. Financial Statement Schedule: | ||
The following financial statement schedule of the Registrant is filed as part of this Annual Report on Form 10-K and should be read in conjunction with the financial statements: | ||
All other schedules are omitted because they are either not applicable or the required information is shown in the Consolidated Financial Statements or notes thereto.
3. Exhibits
Incorporated by Reference | ||||||||||
Exhibit | Exhibit Description | Form | File No. | Exhibit Number | Filing Date | |||||
2.1 | Agreement and Plan of Merger relating to the acquisition of ADE Corporation | 8-K | No. 000-09992 | 2.1 | February 23, 2006 | |||||
2.2 | Amended and Restated Agreement and Plan of Merger relating to the acquisition of ADE Corporation | 8-K | No. 000-09992 | 2.1 | May 26, 2006 | |||||
3.1 | Amended and Restated Certificate of Incorporation | 10-Q | No. 000-09992 | 3.1 | May 14, 1997 | |||||
3.2 | Certificate of Amendment of Amendment and Restated Certificate of Incorporation | 10-Q | No. 000-09992 | 3.1 | February 14, 2001 | |||||
3.3 | Bylaws, as amended November 17, 1998 | S-8 | No. 333-68415 | 3.2 | December 4, 1998 | |||||
4.1 | Amended and Restated Rights Agreement dated as of August 25, 1996 between the Company and First National Bank of Boston, as Rights Agent. The Agreement includes the Form of Right Certificate as Exhibit A and the Summary of Terms of Rights as Exhibit B | 8-A/A, Amendment No. 2 | No. 000-09992 | 1 | September 24, 1996 |
Incorporated by Reference | ||||||||||
Exhibit | Exhibit Description | Form | File No. | Exhibit Number | Filing Date | |||||
2.1 | Amended and Restated Agreement and Plan of Merger relating to the acquisition of ADE Corporation | 8-K | No. 000-09992 | 2.1 | May 26, 2006 | |||||
3.1 | Amended and Restated Certificate of Incorporation | 10-Q | No. 000-09992 | 3.1 | May 14, 1997 | |||||
3.2 | Certificate of Amendment of Amended and Restated Certificate of Incorporation | 10-Q | No. 000-09992 | 3.1 | February 14, 2001 | |||||
3.3 | Bylaws, as amended November 17, 1998 | S-8 | No. 333-68415 | 3.2 | December 4, 1998 | |||||
4.1 | Amended and Restated Rights Agreement dated as of April 25, 1996 between the Company and The First National Bank of Boston, as Rights Agent. This agreement includes the Form of Right Certificate as Exhibit A and the Summary of Terms of Rights as Exhibit B | 8-A/A, Amendment No. 2 | No. 000-09992 | 1 | September 24, 1996 |
Exhibit Exhibit Description 10.1 10.2 10.3 10.4 10.5 10.6 10.7 10.8 10.9 10.10 10.11 10.12 10.13 10.14 10.15 10.16 10.17 10.18 10.19 10.20 10.21 10.22 Exhibit Exhibit Description 10.1 10.2 10.3 10.4 10.5 10.6 10.7 10.8 10.9 10.10 10.11 10.12 10.13 10.14 10.15 10.16 10.17 10.18 10.19 10.20 Incorporated by Reference
Number Form File No. Exhibit
Number Filing Date 1998 Outside Director Option Plan* S-8 No. 333-68423 10.1 December 4, 1998 1997 Employee Stock Purchase Plan* S-8 No. 333-45271 10.2 January 30, 1998 Tencor Instruments Amended and Restated 1993 Equity Incentive Plan S-8 No. 333-22939 10.75 March 7, 1997 Restated 1982 Stock Option Plan, as amended November 18, 1996* S-8 No. 333-22941 10.74 March 7, 1997 Excess Profit Stock Plan* S-8 No. 333-60883 10.15 August 7, 1997 Form of KLA-Tencor Corporation Corporate Officers Retention Plan* S-4 No. 333-23075 10.2 March 11, 1997 Form of Indemnification Agreement for directors and executive officers* 10-K No. 000-09992 10.3 September 29, 1997 Livermore Land Purchase and Sale Agreement 10-K No. 000-09992 10.16 September 28, 2000 Severance Agreement and General Release 10-K No. 000-09992 10.9 August 30, 2004 2004 Equity Incentive Plan* Proxy No. 000-09992 Appendix A September 9, 2004 Form of Option Agreement under 1998 Outside Director Option Plan* 8-K No. 000-09992 10.1 October 18, 2004 Blue29 Corporation 2003 Stock Incentive Plan* S-8 No. 333-120218 10.1 November 4, 2004 Option Grant Notification* 8-K No. 000-09992 10.1 September 29, 2005 Amended and restated agreement by and between KLA-Tencor Corporation and Kenneth L. Schroeder* 10-Q No. 000-09992 10.14 February 2, 2006 KLA-Tencor Corporation Performance Bonus Plan* 10-Q No. 000-09992 10.15 February 2, 2006 KLA-Tencor Corporation Executive Severance Plan* 10-Q No. 000-09992 10.17 February 22, 2006 Notice of Grant of Restricted Stock Units* 10-Q No. 000-09992 10.18 May 4, 2006 Form of Restricted Stock Unit Award Notification 8-K No. 000-09992 10.19 September 20, 2006 Form of Restricted Stock Unit Agreement 8-K No. 000-09992 10.20 September 20, 2006 Separation Agreement and General Release by and between KLA-Tencor Corporation and Kenneth Levy 8-K No. 000-09992 99.1 October 30, 2006 Amendment No. 1 to Separation Agreement and General Release by and between KLA-Tencor Corporation and Kenneth Levy 8-K No. 000-09992 99.2 October 30, 2006 Form of Stock Option Amendment and Special Bonus Agreement 8-K No. 000-09992 99.1 January 5, 2007 Incorporated by Reference
Number Form File No. Exhibit
Number Filing Date 1998 Outside Director Option Plan* S-8 No. 333-68423 10.1 December 4, 1998 1997 Employee Stock Purchase Plan* S-8 No. 333-45271 10.2 January 30, 1998 Tencor Instruments Amended and Restated 1993 Equity Incentive Plan S-8 No. 333-22939 10.75 March 7, 1997 Restated 1982 Stock Option Plan, as amended November 18, 1996* S-8 No. 333-22941 10.74 March 7, 1997 Excess Profit Stock Plan* S-8 No. 333-60883 10.15 August 7, 1997 Form of KLA-Tencor Corporation Corporate Officers Retention Plan* S-4 No. 333-23075 10.2 March 11, 1997 Form of Indemnification Agreement for directors and executive officers* 10-K No. 000-09992 10.3 September 29, 1997 Livermore Land Purchase and Sale Agreement 10-K No. 000-09992 10.16 September 28, 2000 Severance Agreement and General Release 10-K No. 000-09992 10.9 August 30, 2004 2004 Equity Incentive Plan* Proxy No. 000-09992 Appendix A September 9, 2004 Form of Option Agreement under 1998 Outside Director Option Plan* 8-K No. 000-09992 10.1 October 18, 2004 Blue29 Corporation 2003 Stock Incentive Plan* S-8 No. 333-120218 10.1 November 4, 2004 Option Grant Notification* 8-K No. 000-09992 10.1 September 29, 2005 Amended and restated agreement by and between KLA-Tencor Corporation and Kenneth L. Schroeder* 10-Q No. 000-09992 10.14 February 2, 2006 KLA-Tencor Corporation Performance Bonus Plan* 10-Q No. 000-09992 10.15 February 2, 2006 KLA-Tencor Corporation Executive Severance Plan* 10-Q No. 000-09992 10.17 February 22, 2006 Notice of Grant of Restricted Stock Units* 10-Q No. 000-09992 10.18 May 4, 2006 Form of Restricted Stock Unit Award Notification 8-K No. 000-09992 10.19 September 20, 2006 Form of Restricted Stock Unit Agreement 8-K No. 000-09992 10.2 September 20, 2006 Separation Agreement and General Release by and between KLA-Tencor Corporation and Kenneth Levy 8-K No. 000-09992 99.1 October 30, 2006
Exhibit Exhibit Description 10.21 10.22 10.23 10.24 10.25 10.26 10.27 10.28 10.29 10.30 10.31 10.32 10.33 10.34 10.35 10.36 10.37 21.1 Incorporated by Reference
Number Form File No. Exhibit
Number Filing Date Amendment No. 1 to Separation Agreement and General Release by and between KLA-Tencor Corporation and Kenneth Levy 8-K No. 000-09992 99.2 October 30, 2006 Form of Stock Option Amendment and Special Bonus Agreement 8-K No. 000-09992 99.1 January 5, 2007 KLA-Tencor Corporation Outstanding Corporate Performance Plan for Fiscal 2007 *+ 10-K No. 000-09992 10.23 January 29, 2007 Agreement by and between KLA-Tencor Corporation and Lawrence Gross (as amended and restated) 10-K No. 000-09992 10.24 January 29, 2007 Agreement by and between KLA-Tencor Corporation and Jorge Titinger (as amended and restated) 10-K No. 000-09992 10.25 January 29, 2007 Agreement by and between KLA-Tencor Corporation and Ben Tsai (as amended and restated) 10-K No. 000-09992 10.26 January 29, 2007 Letter Agreement between KLA-Tencor Corporation, Merrill Lynch International and Merrill Lynch, Pierce, Fenner & Smith Incorporated+ 10-Q No. 000-09992 10.27 May 7, 2007 Letter Agreement by and between KLA-Tencor Corporation and Brian M. Martin 10-Q No. 000-09992 10.28 May 7, 2007 Therma-Wave, Inc.’s 2000 Equity Incentive Plan* (1) (1) (1) (1) Amendment No. 1 to Therma-Wave, Inc.’s 2000 Equity Incentive Plan* (2) (2) (2) (2) Amendment No. 2 to Therma-Wave, Inc.’s 2000 Equity Incentive Plan* (3) (3) (3) (3) Amendment No. 3 to Therma-Wave, Inc.’s 2000 Equity Incentive Plan* (4) (4) (4) (4) Amendment No. 4 to Therma-Wave, Inc.’s 2000 Equity Incentive Plan* (5) (5) (5) (5) ADE Corporation’s 1995 Stock Option Plan* (6) (6) (6) (6) ADE Corporation 1997 Employee Stock Option Plan* (7) (7) (7) (7) Amendment to ADE Corporation’s 1997 Employee Stock Option Plan dated April 7, 1999* (8) (8) (8) (8) ADE Corporation’s 2000 Employee Stock Option Plan (as amended)* (9) (9) (9) (9) List of Subsidiaries
Incorporated by Reference | ||||||||||
Exhibit | Exhibit Description | Form | File No. | Exhibit Number | Filing Date | |||||
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23.1 | Consent of Independent Registered Public Accounting Firm | |||||||||
31.1 | Certification of Chief Executive Officer under Rule 13a-14(a) of the Securities Exchange Act of 1934 | |||||||||
31.2 | Certification of Chief Financial Officer under Rule 13a-14(a) of the Securities Exchange Act of 1934 | |||||||||
32 | Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 | |||||||||
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* | Denotes a management contract, plan or arrangement |
+ | Confidential treatment has been requested as to a portion of this exhibit. |
(1) | Incorporated by reference to Exhibit 10.22 to Therma-Wave, Inc.’s Annual Report on Form 10-K for the fiscal year ended March 31, 2000 (Commission File No. 000-26911). |
(2) | Incorporated by reference to Exhibit 99.2 to Therma-Wave, Inc.’s Registration Statement on Form S-8, filed February 22, 2002 (Commission File No. 333-83282). |
(3) | Incorporated by reference to Exhibit 99.1 to Therma-Wave, Inc.’s Current Report on Form 8-K, filed August 27, 2004 (Commission File No. 000-26911). |
(4) | Incorporated by reference to Exhibit 99.2 to Therma-Wave, Inc.’s Current Report on Form 8-K, filed August 27, 2004 (Commission File No. 000-26911). |
(5) | Incorporated by reference to Exhibit 10.21 to Therma-Wave, Inc.’s Annual Report on Form 10-K for the fiscal year ended April 3, 2005 (Commission File No. 000-26911). |
(6) | Incorporated by reference to Exhibit 10.2 to ADE Corporation’s Annual Report on Form 10-K for the fiscal year ended April 30, 2006 (Commission File No. 000-26714). |
(7) | Incorporated by reference to Exhibit 10.3 to ADE Corporation’s Annual Report on Form 10-K for the fiscal year ended April 30, 1999 (Commission File No. 000-26714). |
(8) | Incorporated by reference to Exhibit 4.3 to ADE Corporation’s Registration Statement on Form S-8, filed February 18, 1998 (Commission File No. 333-46505). |
(9) | Incorporated by reference to Exhibit 10.4 to ADE Corporation’s Registration Statement on Form S-1 (Commission File No. 33-96408). |
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
KLA-Tencor Corporation | ||||||||||
By: | /s/ RICHARD P. WALLACE | |||||||||
(Date) | Richard P. Wallace | |||||||||
Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature | Title | Date | ||
/ Richard P. Wallace | Chief Executive Officer and Director (principal executive officer) | |||
/ Jeffrey L. Hall | Senior Vice President and Chief Financial Officer (principal financial officer and principal accounting officer) | |||
/ Edward W. Barnholt | Chairman of the Board and Director | |||
/ H. Raymond Bingham | Director | |||
/ Robert T. Bond | Director | |||
/s/ R Robert M. Calderoni | Director | August 17, 2007 | ||
/s/ JOHN T. DICKSON John T. Dickson | Director | August 17, 2007 | ||
/s/ STEPHEN P. KAUFMAN Stephen P. Kaufman | Director | |||
/s/ K Kevin J. Kennedy | Director | August 17, 2007 | ||
/s/ LIDA URBANEK Lida Urbanek | Director | |||
/ David C. Wang | Director |
Valuation and Qualifying Accounts
(in thousands) | Balance at Beginning of Period | Charged to Expense | Deductions | Balance At End of Period | Balance at of Period | Charged to Expense | Deductions | Balance At End of Period | ||||||||||||||||||
Year Ended June 30, 2004: | ||||||||||||||||||||||||||
Fiscal Year Ended June 30, 2005: | ||||||||||||||||||||||||||
Allowance for Doubtful Accounts | $ | 12,617 | $ | 57 | $ | (276 | ) | $ | 12,398 | $ | 12,398 | $ | 228 | $ | (401 | ) | $ | 12,225 | ||||||||
Year Ended June 30, 2005: | ||||||||||||||||||||||||||
Fiscal Year Ended June 30, 2006: | ||||||||||||||||||||||||||
Allowance for Doubtful Accounts | $ | 12,398 | $ | 228 | $ | (401 | ) | $ | 12,225 | $ | 12,225 | $ | 16 | $ | (133 | ) | $ | 12,108 | ||||||||
Year Ended June 30, 2006: | ||||||||||||||||||||||||||
Fiscal Year Ended June 30, 2007: | ||||||||||||||||||||||||||
Allowance for Doubtful Accounts | $ | 12,225 | $ | 16 | $ | (133 | ) | $ | 12,108 | $ | 12,108 | $ | 63 | $ | (442 | ) | $ | 11,729 |
EXHIBIT INDEX
Incorporated by Reference | ||||||||||
Exhibit | Exhibit Description | Form | File No. | Exhibit Number | Filing Date | |||||
2.1 | Agreement and Plan of Merger relating to the acquisition of ADE Corporation | 8-K | No. 000-09992 | 2.1 | February 23, 2006 | |||||
2.2 | Amended and Restated Agreement and Plan of Merger relating to the acquisition of ADE Corporation | 8-K | No. 000-09992 | 2.1 | May 26, 2006 | |||||
3.1 | Amended and Restated Certificate of Incorporation | 10-Q | No. 000-09992 | 3.1 | May 14, 1997 | |||||
3.2 | Certificate of Amendment of Amendment and Restated Certificate of Incorporation | 10-Q | No. 000-09992 | 3.1 | February 14, 2001 | |||||
3.3 | Bylaws, as amended November 17, 1998 | S-8 | No. 333-68415 | 3.2 | December 4, 1998 | |||||
4.1 | Amended and Restated Rights Agreement dated as of August 25, 1996 between the Company and First National Bank of Boston, as Rights Agent. The Agreement includes the Form of Right Certificate as Exhibit A and the Summary of Terms of Rights as Exhibit B | 8-A/A, Amendment No. 2 | No. 000-09992 | 1 | September 24, 1996 | |||||
10.1 | 1998 Outside Director Option Plan* | S-8 | No. 333-68423 | 10.1 | December 4, 1998 | |||||
10.2 | 1997 Employee Stock Purchase Plan* | S-8 | No. 333-45271 | 10.2 | January 30, 1998 | |||||
10.3 | Tencor Instruments Amended and Restated 1993 Equity Incentive Plan | S-8 | No. 333-22939 | 10.75 | March 7, 1997 | |||||
10.4 | Restated 1982 Stock Option Plan, as amended November 18, 1996* | S-8 | No. 333-22941 | 10.74 | March 7, 1997 | |||||
10.5 | Excess Profit Stock Plan* | S-8 | No. 333-60883 | 10.15 | August 7, 1997 | |||||
10.6 | Form of KLA-Tencor Corporation Corporate Officers Retention Plan* | S-4 | No. 333-23075 | 10.2 | March 11, 1997 | |||||
10.7 | Form of Indemnification Agreement for directors and executive officers* | 10-K | No. 000-09992 | 10.3 | September 29, 1997 |
Exhibit Number | Exhibit Description | Incorporated by Reference | ||||||||
Form | File No. | Exhibit Number | Filing Date | |||||||
2.1 | Amended and Restated Agreement and Plan of Merger relating to the acquisition of ADE Corporation | 8-K | No. 000-09992 | 2.1 | May 26, 2006 | |||||
3.1 | Amended and Restated Certificate of Incorporation | 10-Q | No. 000-09992 | 3.1 | May 14, 1997 | |||||
3.2 | Certificate of Amendment of Amended and Restated Certificate of Incorporation | 10-Q | No. 000-09992 | 3.1 | February 14, 2001 | |||||
3.3 | Bylaws, as amended November 17, 1998 | S-8 | No. 333-68415 | 3.2 | December 4, 1998 | |||||
4.1 | Amended and Restated Rights Agreement dated as of April 25, 1996 between the Company and The First National Bank of Boston, as Rights Agent. This agreement includes the Form of Right Certificate as Exhibit A and the Summary of Terms of Rights as Exhibit B | 8-A/A, Amendment No. 2 | No. 000-09992 | 1 | September 24, 1996 | |||||
10.1 | 1998 Outside Director Option Plan* | S-8 | No. 333-68423 | 10.1 | December 4, 1998 | |||||
10.2 | 1997 Employee Stock Purchase Plan* | S-8 | No. 333-45271 | 10.2 | January 30, 1998 | |||||
10.3 | Tencor Instruments Amended and Restated 1993 Equity Incentive Plan | S-8 | No. 333-22939 | 10.75 | March 7, 1997 | |||||
10.4 | Restated 1982 Stock Option Plan, as amended November 18, 1996* | S-8 | No. 333-22941 | 10.74 | March 7, 1997 | |||||
10.5 | Excess Profit Stock Plan* | S-8 | No. 333-60883 | 10.15 | August 7, 1997 | |||||
10.6 | Form of KLA-Tencor Corporation Corporate Officers Retention Plan* | S-4 | No. 333-23075 | 10.2 | March 11, 1997 | |||||
10.7 | Form of Indemnification Agreement for directors and executive officers* | 10-K | No. 000-09992 | 10.3 | September 29, 1997 | |||||
10.8 | Livermore Land Purchase and Sale Agreement | 10-K | No. 000-09992 | 10.16 | September 28, 2000 | |||||
10.9 | Severance Agreement and General Release | 10-K | No. 000-09992 | 10.9 | August 30, 2004 |
Exhibit Exhibit Description 10.8 10.9 10.10 10.11 10.12 10.13 10.14 10.15 10.16 10.17 10.18 10.19 10.20 10.21 10.22 10.23 Exhibit Description Incorporated by Reference Form File No. Filing Date Incorporated by Reference
Number Form File No. Exhibit
Number Filing Date Livermore Land Purchase and Sale Agreement 10-K No. 000-09992 10.16 September 28, 2000 Severance Agreement and General Release 10-K No. 000-09992 10.9 August 30, 2004 2004 Equity Incentive Plan* Proxy No. 000-09992 Appendix A September 9, 2004 Form of Option Agreement under 1998 Outside Director Option Plan* 8-K No. 000-09992 10.1 October 18, 2004 Blue29 Corporation 2003 Stock Incentive Plan* S-8 No. 333-120218 10.1 November 4, 2004 Option Grant Notification* 8-K No. 000-09992 10.1 September 29, 2005 Amended and restated agreement by and between KLA-Tencor Corporation and Kenneth L. Schroeder* 10-Q No. 000-09992 10.14 February 2, 2006 KLA-Tencor Corporation Performance Bonus Plan* 10-Q No. 000-09992 10.15 February 2, 2006 KLA-Tencor Corporation Executive Severance Plan* 10-Q No. 000-09992 10.17 February 22, 2006 Notice of Grant of Restricted Stock Units* 10-Q No. 000-09992 10.18 May 4, 2006 Form of Restricted Stock Unit Award Notification 8-K No. 000-09992 10.19 September 20, 2006 Form of Restricted Stock Unit Agreement 8-K No. 000-09992 10.20 September 20, 2006 Separation Agreement and General Release by and between KLA-Tencor Corporation and Kenneth Levy 8-K No. 000-09992 99.1 October 30, 2006 Amendment No. 1 to Separation Agreement and General Release by and between KLA-Tencor Corporation and Kenneth Levy 8-K No. 000-09992 99.2 October 30.2006 Form of Stock Option Amendment and Special Bonus Agreement* 8-K No. 000-09992 99.1 January 5, 2007 KLA-Tencor Corporation Outstanding Corporate Performance Plan for Fiscal 2007*+ Exhibit
Number Exhibit
Number 10.10 2004 Equity Incentive Plan* Proxy No. 000-09992 Appendix A September 9, 2004 10.11 Form of Option Agreement under 1998 Outside Director Option Plan* 8-K No. 000-09992 10.1 October 18, 2004 10.12 Blue29 Corporation 2003 Stock Incentive Plan* S-8 No. 333-120218 10.1 November 4, 2004 10.13 Option Grant Notification* 8-K No. 000-09992 10.1 September 29, 2005 10.14 Amended and restated agreement by and between KLA-Tencor Corporation and Kenneth L. Schroeder* 10-Q No. 000-09992 10.14 February 2, 2006 10.15 KLA-Tencor Corporation Performance Bonus Plan* 10-Q No. 000-09992 10.15 February 2, 2006 10.16 KLA-Tencor Corporation Executive Severance Plan* 10-Q No. 000-09992 10.17 February 22, 2006 10.17 Notice of Grant of Restricted Stock Units* 10-Q No. 000-09992 10.18 May 4, 2006 10.18 Form of Restricted Stock Unit Award Notification 8-K No. 000-09992 10.19 September 20, 2006 10.19 Form of Restricted Stock Unit Agreement 8-K No. 000-09992 10.2 September 20, 2006 10.20 Separation Agreement and General Release by and between KLA-Tencor Corporation and Kenneth Levy 8-K No. 000-09992 99.1 October 30, 2006 10.21 Amendment No. 1 to Separation Agreement and General Release by and between KLA-Tencor Corporation and Kenneth Levy 8-K No. 000-09992 99.2 October 30, 2006 10.22 Form of Stock Option Amendment and Special Bonus Agreement 8-K No. 000-09992 99.1 January 5, 2007 10.23 KLA-Tencor Corporation Outstanding Corporate Performance Plan for Fiscal 2007 *+ 10-K No. 000-09992 10.23 January 29, 2007 10.24 Agreement by and between KLA-Tencor Corporation and Lawrence Gross (as amended and restated) 10-K No. 000-09992 10.24 January 29, 2007 10.25 Agreement by and between KLA-Tencor Corporation and Jorge Titinger (as amended and restated) 10-K No. 000-09992 10.25 January 29, 2007
Exhibit Description Incorporated by Reference Form File No. Filing DateExhibit
Number Exhibit
Number 10.26 Agreement by and between KLA-Tencor Corporation and Ben Tsai (as amended and restated) 10-K No. 000-09992 10.26 January 29, 2007 10.27 Letter Agreement between KLA-Tencor Corporation, Merrill Lynch International and Merrill Lynch, Pierce, Fenner & Smith Incorporated+ 10-Q No. 000-09992 10.27 May 7, 2007 10.28 Letter Agreement by and between KLA-Tencor Corporation and Brian M. Martin 10-Q No. 000-09992 10.28 May 7, 2007 10.29 Therma-Wave, Inc.’s 2000 Equity Incentive Plan* (1) (1) (1) (1) 10.30 Amendment No. 1 to Therma-Wave, Inc.’s 2000 Equity Incentive Plan* (2) (2) (2) (2) 10.31 Amendment No. 2 to Therma-Wave, Inc.’s 2000 Equity Incentive Plan* (3) (3) (3) (3) 10.32 Amendment No. 3 to Therma-Wave, Inc.’s 2000 Equity Incentive Plan* (4) (4) (4) (4) 10.33 Amendment No. 4 to Therma-Wave, Inc.’s 2000 Equity Incentive Plan* (5) (5) (5) (5) 10.34 ADE Corporation’s 1995 Stock Option Plan* (6) (6) (6) (6) 10.35 ADE Corporation 1997 Employee Stock Option Plan* (7) (7) (7) (7) 10.36 Amendment to ADE Corporation’s 1997 Employee Stock Option Plan dated April 7, 1999* (8) (8) (8) (8) 10.37 ADE Corporation’s 2000 Employee Stock Option Plan (as amended)* (9) (9) (9) (9) 21.1 List of Subsidiaries 23.1 Consent of Independent Registered Public Accounting Firm
Exhibit | Exhibit Description |
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31.1 | Certification of Chief Executive Officer under Rule 13a-14(a) of the Securities Exchange Act of 1934 | |||||||||
31.2 | Certification of Chief Financial Officer under Rule 13a-14(a) of the Securities Exchange Act of 1934 | |||||||||
32 | Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 | |||||||||
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* | Denotes a management contract, plan or arrangement |
+ | Confidential treatment has been requested as to a portion of this exhibit. |
(1) | Incorporated by reference to Exhibit 10.22 to Therma-Wave, Inc.’s Annual Report on Form 10-K for the fiscal year ended March 31, 2000 (Commission File No. 000-26911). |
(2) | Incorporated by reference to Exhibit 99.2 to Therma-Wave, Inc.’s Registration Statement on Form S-8, filed February 22, 2002 (Commission File No. 333-83282). |
(3) | Incorporated by reference to Exhibit 99.1 to Therma-Wave, Inc.’s Current Report on Form 8-K, filed August 27, 2004 (Commission File No. 000-26911). |
(4) | Incorporated by reference to Exhibit 99.2 to Therma-Wave, Inc.’s Current Report on Form 8-K, filed August 27, 2004 (Commission File No. 000-26911). |
(5) | Incorporated by reference to Exhibit 10.21 to Therma-Wave, Inc.’s Annual Report on Form 10-K for the fiscal year ended April 3, 2005 (Commission File No. 000-26911). |
(6) | Incorporated by reference to Exhibit 10.2 to ADE Corporation’s Annual Report on Form 10-K for the fiscal year ended April 30, 2006 (Commission File No. 000-26714). |
(7) | Incorporated by reference to Exhibit 10.3 to ADE Corporation’s Annual Report on Form 10-K for the fiscal year ended April 30, 1999 (Commission File No. 000-26714). |
(8) | Incorporated by reference to Exhibit 4.3 to ADE Corporation’s Registration Statement on Form S-8, filed February 18, 1998 (Commission File No. 333-46505). |
(9) | Incorporated by reference to Exhibit 10.4 to ADE Corporation’s Registration Statement on Form S-1 (Commission File No. 33-96408). |
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