Management's Discussion and Analysis of Financial Condition and Results of
Operations
MERGER
On April 30, 1997, Tencor merged into a wholly-owned subsidiary of KLA using the
pooling-of-interests method of accounting. Each outstanding share of Tencor was
exchanged for one share of KLA and KLA changed its name to KLA-Tencor
Corporation (the Company). All financial data of the Company included herein
reflects the combination of the historical financial information of both KLA and
Tencor.
RESULTS OF OPERATIONS
As the Company began fiscal year 1997, semiconductor manufacturers were
reassessing their spending plans because of the sharp drop in prices for memory
devices. This change in market conditions caught them by surprise and resulted
in the postponement of many new memory fabrication facilities. Even though
prices for logic and microprocessors were not as affected, these manufacturers
postponed many expansion projects while they assessed the market. By the
December quarter, it became more clear that the memory price drop was not an
overall demand problem but a memory oversupply issue. New order levels reflected
these conditions and were quite low in the September quarter but began to
recover by December. Thus, many logic and microprocessor customers cautiously
began to resume their planned expansions. During the March and June quarters
these expansion plans accelerated and new orders for the Company reached record
levels by June. The market for logic, microprocessor, and foundry fabs continues
to be healthy while memory fab construction remains limited primarily to pilot
plants for next generation memories. The Company responded quickly to these
market changes and reduced spending and reduced shipment levels. Shipments
bottomed in December and grew gradually as the new order rate recovered.
The Company's operating results benefited from the demand for process control
equipment from previously constructed fabs which have not yet been outfitted
with a full complement of process monitoring equipment. Thus the Company's
results of operations were not affected as severely as many other semiconductor
equipment companies and this demand from older facilities has helped the Company
to recover faster.
REVENUES AND GROSS MARGINS
Aggregate revenues reflected the trends described above. Particular strength
came from several new product divisions which are either inventing new markets
or gaining share with new technologies in established markets. New markets were
addressed by the SEMSpec division, which markets a $7 million defect inspection
tool using a scanning electron beam, and by the Yield Management Group's new
Automatic Defect Classification product. Both these divisions experienced
significant new revenues during the year. Additionally, share of market
increases resulted in higher revenues for the CD SEM Metrology division (model
8100).
Gross margins decreased to 54.3% in 1997 from 57.1% in 1996. The decrease during
the period was due primarily to increased warranty and installation costs
related to new product introductions and to an increase in infrastructure costs
for the Company's Customer Service Group. Gross margin increased slightly to
57.1% in 1996 from 57.0% in 1995 on higher system product margins offset by
lower service margins. The Company anticipates that gross margin will increase
modestly in 1998.
RESEARCH AND DEVELOPMENT
Research and development (R&D) expenses were $134 million, $116 million and $74
million, or 13.0%, 10.6% and 10.6% of revenues in 1997, 1996 and 1995,
respectively. The Company has identified a large number of process monitoring
and yield management opportunities and has initiated new development programs in
these new market segments. As a result, the Company's spending on development
programs in 1997 rose as a percent of revenues and the Company expects R&D
spending to increase in absolute dollars in 1998.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative (SG&A) expenses were $219 million, $213
million and $141 million, or 21.3%, 19.4% and 20.2% of revenues, in 1997, 1996
and 1995, respectively.
The increase in absolute dollars in 1997 compared to 1996 can be attributed in
part to increases in expenses resulting from the significant efforts involved
with enhancements to the Company's information systems infrastructure. In 1996,
compared to 1995, SG&A expenses increased in relation
to the increased revenues. The Company anticipates that SG&A expenses will
increase in absolute dollars in 1998.
MERGER AND RESTRUCTURING COSTS
The Company recorded charges totaling $60.6 million for merger, restructuring
and other non-recurring events which occurred during the year ended June 30,
1997. During the quarter ended June 30, 1997, the Company recorded a pre-tax
charge of $52.1 million for merger, restructuring and other costs. This charge
included direct merger costs of $19.4 million for professional fees and other
transaction costs associated with the merger, $4.2 million for severance related
costs, $13.5 million for non-cash write-offs of certain property, equipment and
other assets, $2.6 million for the elimination and/or relocation of duplicate
sales and service facilities worldwide and $6.3 million of merger related
consulting services and other costs providing no expected future benefit to the
Company. Approximately $22 million of the original charge remained in accrued
liabilities as of June 30, 1997 and is expected to be utilized within the next
twelve months. In addition, the Company incurred a pre-tax charge of $6.1
million as a result of the write-off of a bad debt for shipments made to a
Thailand company in fiscal 1997.
During the quarter ended September 30, 1996, the Company recorded a charge for
Tencor restructuring costs of $8.5 million. This charge consisted of $2.0
million of employee severance and related costs and $6.5 million of lease exit
costs associated with the abandonment of certain of Tencor's leased facilities.
OTHER INCOME, NET
Other income, net consisted primarily of interest income on investments less
interest expense on bank borrowings. Also included were foreign currency gains
and losses, and certain royalties.
PROVISION FOR INCOME TAXES
The provision for income taxes on the Company's pretax income was 39.4%, 37.4%
and 37.2% in 1997, 1996 and 1995, respectively. The Company's effective tax rate
in- creased from 1996 to 1997 primarily as a result of certain merger related
costs that were not tax deductible.
OTHER ACQUISITION COSTS
In 1995, the Company acquired Metrologix Inc., a manufacturer of advanced
electron beam measurement equipment. A significant portion of the acquisition
cost was allocated to acquired in- process technology which was written-off at
the time of the acquisition, because substantial research and development
investment was necessary to complete the new product development then underway.
This resulted in a pre-tax charge of $25 million.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its growth primarily through cash flow from operations.
Cash flow from operations was $236 million in 1997 due to net income
(which includes non-cash charges for depreciation), and to declines in accounts
receivable and inventory balances year over year. The decrease in accounts
receivable during fiscal 1997 is due primarily to improved collections and as a
result of a factoring agreement to sell certain trade receivables.
Capital expenditures for each of the fiscal years 1997 and 1996 were
approximately $60 million, consisting primarily of computers, manufacturing
equipment and cleanrooms. The Company expects capital expenditures in 1998 to be
at levels approximating those of 1997.
At June 30, 1997, the Company's principal sources of liquidity consisted of $349
million in cash, cash equivalents and short-term investments, and $338 million
in marketable securities classified as long-term. The Company believes that the
existing
cash balances and short-term investments, along with cash generated from
operations, will be sufficient to meet the Company's working capital
requirements through 1998.
OTHER FACTORS AFFECTING COMPANY RESULTS
The Company will continue to invest during fiscal 1998 in expanding its sales
and service operations worldwide. The achievement of continued sales and
earnings growth will depend, in part, on the success of the merger between KLA
and Tencor. There can be no assurance that products, technologies, distribution
channels and key personnel will be effectively assimilated into the Company's
business, or that such integration may will not adversely affect the Company's
business, financial condition or results of operations.
As a participant in the semiconductor industry, the Company operates in a
technologically advanced, highly competitive environment. In addition, the
Company depends in large part on the capital expenditures of semiconductor
manufacturers worldwide, which in turn depend on the current and anticipated
market demand for integrated circuits and products utilizing integrated
circuits. The semiconductor industry has historically been highly cyclical and
has experienced periodic downturns, which have had an adverse effect on the
level of capital expenditures. While the Company cannot predict what effect
these various factors will have on operating results, the effect of these and
other factors could significantly affect the Company's future operating results
and stock market value.
The Company, from time to time, has experienced, and expects to continue to
experience, significant fluctuations in its results of operations, particularly
on a quarterly basis. The Company's expense levels are based, in part, on
expectations of future revenues. If revenue levels in a particular period do not
meet expectations, operating results will be adversely affected. A variety of
factors have an influence on the Company's operating results in a particular
period. These factors primarily include economic conditions in the semiconductor
industry, the timing of the receipt of orders from major customers, customer
cancellations or delays of shipments, the Company's ability to design, introduce
and manufacture new products on a cost effective and timely basis, specific
feature requests by customers, production delays or manufacturing
inefficiencies.
EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, The Financial Accounting Standards Board issued Statement No.
128, "Earnings per Share," which is required to be adopted in the Company's
fiscal quarter ending December 31, 1997. See Note 2 of Notes to Consolidated
Financial Statements for the effect of Statement No. 128.
MARKET RISK DISCLOSURE
At the end of fiscal 1997, the Company had an investment portfolio of fixed
income securities, excluding those classified as cash and cash equivalents, of
$408 million (see Note 6 of Notes to Consolidated Financial Statements). These
securities, like 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, 1997, the fair value of the portfolio would decline by approximately $5.5
million. However, the Company has the ability to hold its fixed income
investments until maturity, and therefore the Company would not expect to
recognize such an adverse impact in income or cash flows.
Other than statements of historical fact, statements made in this Annual Report
include forward looking statements, such as statements with respect to the
Company's future financial performance, operating results, plans and objectives.
Actual results may differ materially from those currently anticipated depending
on a variety of risk factors some of which are set forth in "Other Factors
Affecting Company Results" above.
KLA-Tencor CONSOLIDATED BALANCE SHEETS
June 30,
1996 1997
----------- -----------
In thousands, except per share data
ASSETS
Current assets:
Cash and cash equivalents $ 201,704 $ 279,225
Short-term investments 108,291 69,606
Accounts receivable, net 310,077 269,291
Inventories 197,803 174,634
Deferred income taxes 41,081 54,799
Other current assets 10,753 12,452
Total current assets 869,709 860,007
Land, property and equipment, net 104,837 117,595
Marketable securities 158,480 338,418
Other assets 24,893 27,287
Total assets $ 1,157,919 $ 1,343,307
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable $ 35,825 $ 25,113
Accounts payable 44,818 41,155
Other current liabilities 197,669 258,483
Total current liabilities 278,312 324,751
Deferred income taxes and other 8,608 3,943
Commitments and contingencies (Note 4)
Stockholders' equity:
Common stock, $0.001 par value, 250,000 authorized,
81,746 and 83,759 shares issued and outstanding 82 84
Capital in excess of par value 426,348 458,224
Retained earnings 437,310 542,706
Net unrealized gain on investments 9,203 17,591
Cumulative translation adjustment (1,944) (3,992)
Total stockholders' equity 870,999 1,014,613
Total liabilities and stockholders' equity $ 1,157,919 $ 1,343,307
See accompanying notes to consolidated financial statements.
KLA-Tencor CONSOLIDATED STATEMENTS OF INCOME
Year ended June 30, 1995 1996 1997
---------- ---------- ----------
In thousands, except per share data
Revenues $ 695,950 $1,094,492 $1,031,824
Costs and operating expenses:
Cost of goods sold 299,571 469,681 471,910
Engineering, research and development 73,945 115,920 134,105
Selling, general and administrative 140,585 212,625 219,425
Merger/restructuring and other charges 25,240 -- 60,552
Total costs and operating expenses 539,341 798,226 885,992
Income from operations 156,609 296,266 145,832
Interest income and other, net 10,417 17,834 28,147
Income before income taxes 167,026 314,100 173,979
Provision for income taxes 62,215 117,466 68,583
Net income $ 104,811 $ 196,634 $ 105,396
Net income per share $ 1.34 $ 2.34 $ 1.24
Weighted average common shares
and equivalents 78,427 84,195 85,203
See accompanying notes to consolidated financial statements.
KLA-Tencor CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock and Net Cumulative
Capital in Excess of Par Value Retained Unrealized Translation
Shares Amount Earnings Gain Adjustment Totals
------ ------ -------- ---- ---------- ------
In thousands
Balances at June 30, 1994 69,178 $ 170,645 $ 135,865 $ -- $ 823 $ 307,333
Net issuance under employee stock plans 2,846 14,490 -- -- -- 14,490
Equity offering, net of offering costs 7,796 195,019 -- -- -- 195,019
Release of escrowed shares 572 3,396 -- -- -- 3,396
Tax benefits of stock option transactions -- 23,260 -- -- -- 23,260
Cumulative translation adjustment -- -- -- -- 2,672 2,672
Unrealized gain on investments, net -- -- -- 1,241 -- 1,241
Net income -- -- 104,811 -- -- 104,811
Balances at June 30, 1995 80,392 406,810 240,676 1,241 3,495 652,222
Net issuance under employee stock plans 1,604 15,298 -- -- -- 15,298
Repurchase of common stock (250) (5,456) -- -- -- (5,456)
Tax benefits of stock option transactions -- 9,778 -- -- -- 9,778
Cumulative translation adjustment -- -- -- -- (5,439) (5,439)
Unrealized gain on investments, net -- -- -- 7,962 -- 7,962
Net income -- -- 196,634 -- -- 196,634
Balances at June 30, 1996 81,746 426,430 437,310 9,203 (1,944) 870,999
Net issuance under employee stock plans 2,013 22,235 -- -- -- 22,235
Tax benefits of stock option transactions -- 9,643 -- -- -- 9,643
Cumulative translation adjustment -- -- -- -- (2,048) (2,048)
Unrealized gain on investments, net -- -- -- 8,388 -- 8,388
Net income -- -- 105,396 -- -- 105,396
Balances at June 30, 1997 83,759 $ 458,308 $ 542,706 $ 17,591 $ (3,992) $ 1,014,613
See accompanying notes to consolidated financial statements.
KLA-TENCOR CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended June 30,
1995 1996 1997
--------- --------- ---------
In thousands
Cash flows from operating activities:
Net income $ 104,811 $ 196,634 $ 105,396
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation and amortization 15,014 24,967 52,340
Write-off of acquired in-process technology 16,154 -- --
Deferred income taxes (14,140) (19,611) (19,226)
Changes in assets and liabilities:
Accounts receivable, net (110,691) (96,586) 34,859
Inventories (37,311) (86,538) 21,307
Other assets (18,696) 3,815 (11,817)
Accounts payable 10,318 15,921 (3,580)
Accrued compensation 6,055 9,669 11,669
Other accrued expenses 31,878 47,669 30,084
Income taxes payable 14,196 15,329 15,300
Net cash provided by operating activities 17,588 111,269 236,332
Cash flows from investing activities:
Purchase of property and equipment (29,970) (64,589) (56,793)
Purchases of available for sale securities (429,519) (509,262) (997,283)
Proceeds from available for sale securities 211,326 484,060 870,391
Long-term equity investment (14,182) -- --
Net cash used in investing activities (262,345) (89,791) (183,685)
Cash flows from financing activities:
Issuance of common stock, net 41,146 25,076 31,878
Proceeds from equity offerings, net 195,019 -- --
Stock repurchases -- (5,456) --
Payments under debt obligations (1,921) (39,277) (42,490)
Borrowings under debt obligations 2,978 45,177 35,738
Net cash provided by financing activities 237,222 25,520 25,126
Effect of exchange rate changes on cash and cash equivalents (1,163) 2,586 (252)
Net increase in cash and cash equivalents (8,698) 49,584 77,521
Cash and cash equivalents at beginning of period 160,818 152,120 201,704
Cash and cash equivalents at end of period $ 152,120 $ 201,704 $ 279,225
Supplemental cash flow disclosures:
Income taxes paid $ 53,592 $ 108,196 $ 68,430
Interest paid $ 2,594 $ 2,103 $ 1,551
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BUSINESS COMBINATION AND BASIS OF PRESENTATION
Effective April 30, 1997 following the approval by stockholders, Tencor
Instruments (Tencor) merged into a wholly-owned subsidiary of KLA Instruments
(KLA) using the pooling-of-interests method of accounting. Each outstanding
share of Tencor common stock was exchanged for one share of KLA common stock
and the Company changed its name to KLA-Tencor Corporation (the Company). A
total of 31.9 million shares of common stock were issued. All financial data
of the Company included herein reflects the combination of the historical
financial information of both KLA and Tencor. The Consolidated Financial
Statements and other financial information presented as of June 30, 1996 and
1997 and for the three years then ended, reflects the combination of KLA's and
Tencor's operations for those periods.
The following table shows revenues and net income of
the separate companies through the periods preceding
the business combination:
Year ended June 30,
1995 1996 1997
---------- ---------- ----------
In thousands
Revenues:
KLA $ 442,416 $ 694,867 $ 473,586
Tencor 253,534 399,625 282,055
KLA-Tencor -- -- 276,183
Combined $ 695,950 $1,094,492 $1,031,824
Net income:
KLA $ 58,618 $ 120,884 $ 69,012
Tencor 46,193 75,750 35,782
KLA-Tencor -- -- 602
Combined $ 104,811 $ 196,634 $ 105,396
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the financial statements of the
Company and its wholly-owned subsidiaries. All significant intercompany
transactions and accounts have been eliminated. The Company has several foreign
subsidiaries. The functional currencies of the Company's significant foreign
subsidiaries are the local currencies. Accordingly, all assets and liabilities
of the foreign operations are translated to U.S. dollars at current exchange
rates, and revenues and expenses are translated to U.S. dollars using weighted
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 "cumulative translation adjustment." Foreign currency transaction gains
and losses have not been significant.
Management Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Cash Equivalents and Investments
Cash equivalents consist of highly liquid investments that are valued at
amortized cost, which approximates market value, and have original maturity
dates of three months or less from the date of acquisition. Investments in debt
and equity securities are classified as "available-for-sale" and have
maturities greater than three months from the date of acquisition. The Company
has classified all securities as available-for-sale, as the sale of such
securities may be required prior to maturity to implement management strategies.
Investments classified as available-for-sale are reported at fair value with
unrealized gains or losses excluded from earnings and reported as a separate
component of stockholders' equity, net of applicable taxes, until realized.
Revenue Recognition
The Company recognizes revenue when the product has been shipped and collection
of the resulting receivable is probable. A provision for the estimated costs of
fulfilling warranty and installation obligations is recorded at the time the
related revenue is recognized. Service and maintenance contract revenues are
deferred and recognized ratably over the period of the related contract.
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 costs and reserves
are recorded to state the demonstration units at their net realizable value.
Property and Equipment
Property and equipment are recorded at cost. Depreciation of property and
equipment is based on the straight-line method over the estimated useful lives
of the assets, which are 30 years for buildings, ten years for building
improvements, five to seven years for furniture and fixtures, and three to five
years for machinery and equipment. The life of the lease or the useful life,
whichever is shorter, is used for the amortization of leasehold improvements.
Concentration of Credit Risk
Financial instruments which potentially subject the Company to credit risk
consist principally of investments, accounts receivable and financial
instruments used in hedging activities.
Investments are maintained with high quality institutions, the composition and
maturities of which are regularly monitored by management. Generally, these
securities are highly liquid and may be redeemed upon demand and, therefore,
bear minimal risk. The Company, by policy, limits the amount of credit exposure
to any one financial institution or commercial issuer. The Company has not
experienced any material losses on its investments.
A majority of the Company's trade receivables are derived from sales to large
multinational semiconductor manufacturers. Concentration of credit risk with
respect to trade receivables is considered to be limited due to its customer
base and the diversity of its geographic sales areas. The Company performs
ongoing credit evaluations of its customers' financial condition. The Company
maintains a provision for potential credit losses based upon expected
collectibility of all accounts receivable. The write-off of uncollectible
amounts other than the receivable from a Thailand company (see Note 5) has been
insignificant.
The Company is exposed to credit loss in the event of nonperformance by
counterparties on the foreign exchange contracts used in hedging activities. The
Company does not anticipate nonperformance by these counterparties.
Foreign Currency
The Company does not use derivative financial instruments for speculative or
trading purposes. The Company enters into foreign currency forward exchange
contracts to hedge against future movements in foreign exchange rates that
affect certain foreign currency denominated sales and purchase transactions. The
Company attempts to match the forward contracts with the underlying items being
hedged in terms of currency, amount and maturity. Because the impact of
movements in currency exchange rates on forward contracts offsets the related
impact on the exposures hedged, these financial instruments do not subject the
Company to speculative risk that would otherwise result from changes in currency
exchange rates. Realized gains and losses on forward exchange contracts are
included in other income, net, which offset foreign exchange gains or losses
from revaluation of foreign currency-denominated receivable and payable
balances. The cash flows related to gains and losses on these contracts are
classified in the same category as the hedged transactions in the Consolidated
Statements of Cash Flows.
At June 30, 1997, the Company had forward exchange contracts maturing throughout
fiscal 1998 and early fiscal 1999 to sell and purchase approximately $225.3
million and $9.6 million, respectively, in foreign currency, primarily Japanese
yen. At June 30, 1996, the Company had forward contracts maturing throughout
fiscal 1997 to sell and purchase approximately $161.6 million and $5.3 million,
respectively, in foreign currency, primarily Japanese yen. Of these forward
exchange contracts, approximately $83.0 million and $1.0 million of contracts
hedge foreign currency assets and liabilities, respectively, carried on the
balance sheet as of June 30, 1997, and consequently the financial statements
reflect the fair market value of the contracts and their underlying
transactions. Approximately $142.3 million and $8.6 million of the contracts
hedge firm commitments for future sales and purchases, respectively, denominated
in foreign currency. The fair market value of these contracts on June 30, 1997,
based upon prevailing market rates on that date, was approximately $142.5
million and $8.3 million, respectively. As of June 30, 1997, and based on
prevailing market rates on that date, the unrealized loss on each set of
contracts was approximately $0.3 million.
Fair Value of Disclosures of Financial Instruments
The Company has evaluated the estimated fair value of financial instruments
using available market information and valuation methodologies. The amounts
reported as cash and cash equivalents, investments and bank borrowings
reasonably estimate their fair value.
Net Income Per Share
Net income per share is computed using the weighted average number of common and
common equivalent shares (weighted average shares) outstanding during the
period, which includes net shares issuable upon the exercise of stock options,
when dilutive.
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings per Share." The Statement
redefines earnings per share under generally accepted accounting principles, and
is effective for the Company's quarter ending December 31, 1997. Under the new
standard, primary earnings per share is replaced by basic earnings per share and
fully diluted earnings per share is replaced by diluted earnings per share. If
the Company had adopted this Statement for the year ended June 30, 1997, the
Company's earnings per share for the years ended June 30, 1997, 1996 and 1995
would have been as follows:
1995 1996 1997
-------- -------- --------
Earnings per share:
Basic $ 1.40 $ 2.42 $ 1.29
Diluted $ 1.34 $ 2.34 $ 1.24
Reclassifications
Certain amounts in fiscal years prior to 1997 have been reclassified to conform
to the 1997 financial statement presentation.
Stock-Based Compensation Plans
The Company accounts for its stock option plans and employee stock purchase plan
in accordance with provisions of the Accounting Principles Board's Opinion No.
25 (APB 25), "Accounting for Stock Issued to Employees." The Company's policy is
to grant options at the fair market value on the date of grant. Accordingly no
compensation expense has been recorded. In 1995, the Financial Accounting
Standards Board released SFAS 123, "Accounting for Stock-Based Compensation."
SFAS 123 provides an alternative to APB 25 requiring additional disclosure
effective for fiscal years beginning after December 15, 1995. The Company
continues to account for its employee stock plans in accordance with APB 25 and
provides the additional disclosure required by SFAS 123. Accordingly, SFAS 123
did not have any impact on the Company's financial position or results of
operations. See Note 8 of Notes to Consolidated Financial Statements.
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued Statement No. 130,
"Reporting Comprehensive Income." This Statement establishes standards for
reporting and display of comprehensive income and its components (revenues,
expenses, gains, and losses) in a full set of general-purpose financial
statements. Such items may include foreign currency translation adjustments,
unrealized gains/losses from investing and hedging activities, and other
transactions. This Statement requires that all items that are required to be
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. This Statement is required to be adopted in the
Company's fiscal year ending June 30, 1999.
In June 1997, the Financial Accounting Standards Board issued Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information." This
Statement establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports issued to stockholders. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. This Statement is required to be adopted
in the Company's fiscal year ending June 30, 1999.
NOTE 3 - BALANCE SHEET COMPONENTS
June 30,
1996 1997
------ ------
In thousands
Inventories:
Customer service parts $ 26,078 $ 31,387
Raw materials 54,602 36,829
Work-in-process 64,532 71,998
Demonstration equipment 47,349 20,580
Finished goods 5,242 13,840
$197,803 $174,634
Property and equipment:
Land $ 10,502 $ 10,502
Buildings and improvements 30,353 11,053
Machinery and equipment 99,307 129,869
Office furniture and fixtures 15,622 17,849
Leasehold improvements 21,301 38,805
177,085 208,078
Less: accumulated depreciation
and amortization (72,248) (90,483)
$ 104,837 $ 117,595
Other current liabilities:
Warranty, installation and retrofit $ 44,021 $ 50,569
Compensation and benefits 65,286 76,955
Income taxes payable 45,288 62,784
Other accrued expenses 43,074 68,175
$ 197,669 $ 258,483
NOTE 4 - COMMITMENTS AND CONTINGENCIES
The Company has an agreement with a bank to sell, with recourse, certain of its
trade receivables. The total amount of the facility is the yen equivalent of
approximately $106 million based upon exchange rates as of June 30, 1997. The
Company has accounted for the sale of certain of these receivables as an off-
balance sheet financing arrangement. During fiscal 1997, a total of the yen
equivalent of approximately $138 million of receivables were sold under this
arrangement. As of June 30, 1997, the yen equivalent of $50 million remains
uncollected. The Company does not believe it is materially at risk for any
losses as a result of this agreement.
The Company has entered into various operating leases for land, office and
manufacturing facilities constructed for its use in Milpitas and San Jose,
California. Monthly rent payments under these leases vary based upon the London
Interbank Offering Rate (LIBOR). Under certain of these leases the Company's
obligation has been collateralized at the Company's option in order to reduce
the monthly payments. The leases for the Milpitas and San Jose facilities
provide the Company with the option at the end of each lease of either acquiring
the properties at their original cost or arranging for the properties to be
acquired. If the Company does not purchase the properties at the end of the
leases, the Company will be contingently liable to the lessor for residual value
guarantees aggregating $103 million. In addition, under the terms of the leases,
the Company must maintain compliance with certain financial covenants. As of
June 30, 1997, the Company was in compliance with all of its covenants.
Management believes that the contingent liability relating to the residual value
guarantees does not currently have a material adverse effect on the Company's
financial position or results of operations.
The Company leases several other facilities under operating leases that expire
at various times through fiscal 2012, with renewal options at the fair market
value for additional periods up to five years. The Company also leases equipment
and other facilities under operating leases.
Total rent expense under all operating leases was $14.9 million, $10.3 million
and $6.4 million for the years ended June 30, 1997, 1996 and 1995, respectively.
Future minimum lease commitments under these operating leases at June 30, 1997
(which include estimated lease payments for the Company's Milpitas and San Jose,
California facilities using a LIBOR of approximately 6%
and total construction costs of $126 million), are $68 million, representing
$13.7 million, $12.7 million, $11.2 million, $9.3 million, $6.6 million and
$13.5 million in fiscal 1998 through 2002 and thereafter, respectively.
NOTE 5 - MERGER, RESTRUCTURING AND OTHER CHARGES
The Company recorded charges totaling $60.6 million for merger, restructuring
and other non-recurring events that occurred during the year ended June 30,
1997.
During the quarter ended June 30, 1997, the Company recorded a pre-tax charge of
$52.1 million for merger, restructuring and other costs. This charge consisted
of merger and restructuring costs of $46.0 million as a result of the business
combination of KLA and Tencor, which was effective on April 30, 1997. This
charge included direct merger costs of $19.4 million, which consisted of
professional fees and other transaction costs associated with the merger, $4.2
million for severance related costs, $13.5 million for non-cash write-offs of
certain redundant property, equipment and other assets, $2.6 million for the
elimination and/or relocation of duplicate sales and service facilities
worldwide and $6.3 million of other costs, primarily fees for merger-related
consulting services providing no expected future benefit to the Company. In
addition, the Company incurred a pre-tax charge of $6.1 million as a result of
the write-off of a bad debt for shipments made to a Thailand company in fiscal
1997. Of the $52.1 million total merger, restructuring and other costs recorded
during the quarter ended June 30, 1997, approximately $30 million was used as of
June 30, 1997, with the remaining balance of $22 million expected to be utilized
during the next twelve months.
During the quarter ended September 30, 1996, the Company recorded a charge for
restructuring costs of $8.5 million. This charge consisted of $2.0 million in
employee severance and related costs and $6.5 million in lease exit costs
associated with the abandonment of certain of the Company's leased facilities.
During the quarter ended March 31, 1997, the Company completed occupation of its
new facility in Milpitas, California. Of the $8.5 million total restructuring
costs, approximately $2.1 million remained as of June 30, 1997, and is expected
to be utilized during the next three months.
NOTE 6 - INVESTMENTS
The amortized cost and estimated fair value of securities available for sale as
of June 30, 1996 and 1997, are as follows (in thousands):
Gross Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
June 30, 1996
U.S. Treasuries $ 36,375 $ 97 $ 319 $ 36,153
Municipal bonds 184,081 549 318 184,312
Corporate debt
securities 32,654 50 320 32,384
Other 190,299 17,302 547 207,054
443,409 17,998 1,504 459,903
Less:
Cash equivalents (194,373) (50) (1,291) (193,132)
Short-term investments (108,435) (56) (200) (108,291)
Long-term investments $ 140,601 $ 17,892 $ 13 $ 158,480
June 30, 1997
U.S. Treasuries $ 70,777 $ 236 $ 373 $ 70,640
Municipal bonds 273,391 1,010 494 273,907
Corporate debt
securities 26,120 63 228 25,955
Other 245,178 28,111 26 273,263
615,466 29,420 1,121 643,765
Less:
Cash equivalents (235,622) (135) (16) (235,741)
Short-term investments (42,159) (28,517) (1,070) (69,606)
Long-term investments $ 337,685 $ 768 $ 35 $ 338,418
The contractual maturities of securities classified as available for sale as of
June 30, 1997, regardless of the consolidated balance sheet classification, are
as follows (in thousands):
Estimated
Fair Value
----------
Due within one year $264,342
Due after one year through five years 191,237
Due after five years 188,186
$643,765
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. The realized gains and losses for the years ended June 30, 1997 and
1996, were not material to the Company's financial position or results of
operations.
NOTE 7 - INCOME TAXES
Year ended June 30, 1995 1996 1997
-------- -------- --------
In thousands
The components of income before income taxes are as follows:
Domestic income before
income taxes $144,117 $290,199 $152,778
Foreign income before
income taxes 22,909 23,901 21,201
$167,026 $314,100 $173,979
The provision (benefit) for income taxes is comprised of
the following:
Current:
Federal $ 63,250 $ 109,420 $ 66,439
State 10,258 18,193 10,603
Foreign 6,788 9,557 8,808
80,296 137,170 85,850
Deferred:
Federal (17,291) (19,162) (15,238)
State (1,791) (1,787) (1,766)
Foreign 1,001 1,245 (263)
(18,081) (19,704) (17,267)
Provision for income taxes $ 62,215 $ 117,466 $ 68,583
Actual current tax liabilities are lower than reflected above for 1995, 1996 and
1997 by $23.3, $9.8 and $9.6 million, respectively, due 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:
Deferred tax assets:
Federal and state loss and
credit carryforwards $ 3,034 $ 2,820
State tax 1,765 597
Nondeductible reserves and other 51,579 73,767
56,378 77,184
Deferred tax liabilities:
Depreciation (1,870) (4,105)
Unremitted earnings of foreign
subsidiaries (10,634) (11,239)
Unrealized (gain) loss on investments 83 (11,036)
Other (2,097) (2,713)
(14,518) (29,093)
Valuation allowance (4,576) (4,576)
Net deferred tax assets $ 37,284 $ 43,515
The reconciliation of the United States federal statutory income tax rate to the
Company's effective income tax rate is as follows:
1995 1996 1997
---- ---- ----
Federal statutory rate 35.0% 35.0% 35.0%
State income taxes, net
of federal benefit 3.6 3.5 3.3
Effect of foreign operations
taxed at various rates 0.9 0.4 0.7
Benefit from foreign sales
corporation (2.8) (2.9) (3.3)
Realized deferred tax assets
previously reserved (1.4) (0.4) --
Merger related costs 0.4 -- 4.5
Other 1.5 1.7 (0.8)
37.2% 37.3% 39.4%
Undistributed earnings of certain of the Company's foreign subsidiaries, for
which no U.S. federal income taxes have been provided, aggregated approximately
$11.2 million at June 30, 1997. The amount of the unrecognized deferred tax
expense related to the investments in foreign subsidiaries is estimated at
approximately $4.0 million at June 30,1997.
The IRS is currently auditing the Company's federal income tax returns for
fiscal 1985 to 1992 and 1995 to 1996. The Company received a notice of proposed
tax deficiency for the years 1985 through 1992 and filed a tax protest letter
with the IRS on June 10, 1996 in response to that IRS notice. Final proposed
adjustments have not been received for these years. Management believes
sufficient taxes have been provided in prior years and that the ultimate outcome
of the IRS audits will not have a material adverse impact on the Company's
financial position or results of operations.
NOTE 8 - STOCKHOLDERS' EQUITY AND EMPLOYEE BENEFITS
In March 1989, the Company implemented a plan to protect stockholders' rights in
the event of a proposed takeover of the Company. The plan provides that if any
person or group acquires 15% or more of the Company's Common Stock, each right
not owned by such person or group will entitle its holder to purchase, at the
then-current exercise price, shares of the Company's Common Stock which have a
value of twice that exercise price. The rights are redeemable by the Company and
expire in April 2006.
Stock Option and Incentive Plans. The Company has various stock option and
management incentive plans for selected employees, officers, directors, and
consultants. The plans provide for grants in the form of stock options, stock
appreciation rights, stock purchase rights, and performance shares. As of June
30, 1997, only stock options have been granted under the plans.
In calendar 1996, the Company offered employees the right to reprice certain
stock options issued to employees during the period from August 1994 through
August 1996. The repricing was done in the form of an exchange, whereby eligible
optionees could cancel their current options in exchange for new options with
exercise prices at the fair market value on the date of grant.
The activity under the option plans, combined, was as
follows:
Weighted-
Available Options Average
For Grant Outstanding Exercise Price
---------- ----------- --------------
Balances at June 30, 1994 2,062,457 6,985,033 $ 4.57
Additional shares reserved 4,000,000 -- --
Options granted (3,753,693) 3,753,693 19.68
Options canceled 429,850 (477,628) 8.24
Options exercised -- (2,523,668) 3.72
Balances at June 30, 1995 2,738,614 7,737,430 11.82
Additional shares reserved 3,700,000 -- --
Options granted (3,283,370) 3,283,370 30.62
Options canceled 1,240,116 (1,253,098) 32.03
Options exercised -- (906,797) 5.40
Balances at June 30, 1996 4,395,360 8,860,905 16.70
Additional shares reserved 1,600,000 -- --
Options granted (4,479,879) 4,479,879 30.15
Options canceled 610,357 (1,992,129) 31.22
Options exercised -- (1,087,689) 8.20
Balances at June 30, 1997 2,125,838 10,260,966 $ 20.65
The options outstanding and exercisable at June 30, 1997 have been segregated
into ranges for additional disclosure as follows:
Options Outstanding Options Vested and Exercisable
------------------- ----------------------------------------
Number Weighted-Average Weighted - Number Vested Weighted-
Range of Outstanding Remaining Average and Exercisable Average
Exercise Prices at 06/30/97 Contractual Life Exercise Price at 06/30/97 Exercise Price
- --------------------------- ---------------- -------------- -------------------------- ---------
$1.45 - $ 3.75 1,415,825 3.98 $ 3.46 1,295,526 $ 3.51
$4.13 - $ 9.63 742,599 5.99 $ 6.08 661,801 $ 6.07
$10.13 - $17.63 1,511,118 8.25 $16.01 1,476,570 $ 16.07
$17.75 - $21.63 3,581,439 8.17 $19.58 943,459 $ 18.98
$21.88 - $30.06 1,038,634 8.78 $23.52 156,484 $ 24.78
$33.81 - $46.56 1,971,351 9.71 $42.49 59,123 $ 39.24
$1.45 - $46.56 10,260,966 7.80 $20.65 4,592,963 $ 12.28
The weighted average fair value of options granted in 1997 and 1996 as defined
by SFAS 123 is $14.61 and $14.56, respectively.
Employee Stock Purchase Plan The Company's employee stock purchase plan provides
that eligible employees may contribute up to 10% of their earnings toward the
purchase of the Company's Common Stock twice a year. The employee's purchase
price is derived from a formula based on the fair market value of the Common
Stock. No compensation expense is recorded in connection with the plan. In 1997,
1996 and 1995, 925,311, 697,203 and 322,332 shares, respectively, had been
purchased by employees. At June 30, 1997, 1,001,044 shares were reserved and
available for issuance under this plan.
Pro Forma Net Income and Earnings Per Share. Pro forma information regarding net
income and net income per share is required by SFAS 123, and has been determined
as if the Company had accounted for its employee stock purchase plan and
employee stock options granted subsequent to June 30, 1995, under the fair value
method of SFAS 123. The fair value of each option grant is estimated on the date
of grant using the Black-Scholes model with the following weighted average
assumptions:
1996 1997
---- ----
Stock option plan:
Expected stock price volatility 50.0% 50.0%
Risk free interest rate 6.4% 6.2%
Expected life of options (years) 5.4 5.4
Stock purchase plan:
Expected stock price volatility 50.0% 50.0%
Risk free interest rate 5.7% 5.6%
Expected life of options (years) 1-2 1-2
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the options granted pursuant to the Company's employee stock option and
purchase plan have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of such
Company options.
For purposes of pro forma disclosures required by SFAS 123, the estimated fair
value of the options is amortized to expense over the options' vesting periods.
The Company's pro forma information for the years ended June 30, 1996 and 1997
follows (in thousands except for earnings per share information):
1996 1997
----------- -----------
Net income:
Historical $ 196,634 $ 105,396
Pro forma $ 189,331 $ 89,608
Earnings per share:
Historical $ 2.34 $ 1.24
Pro forma $ 2.27 $ 1.07
The pro forma effect on net income and earnings per share for fiscal 1997 and
fiscal 1996 is not representative of the pro forma effect on net income in
future years because it does not take into consideration pro forma compensation
expense related to grants made prior to fiscal 1996.
Other Employee Benefit Plans. The Company has a profit sharing program for
eligible employees which distributes, on a quarterly basis, a percentage of
pretax profits. In addition, the Company has an employee savings plan that
qualifies as a deferred salary arrangement under Section 401(k) of the Internal
Revenue Code. During 1997, the Company matched
dollar-for-dollar up to $1,500 of an eligible employee's contribution. The total
charge to operations under the profit sharing and 401(k) plans aggregated
approximately $23.9 million, $32.0 million and $20.5 million in 1997, 1996 and
1995, respectively.
The Company has a non-qualified deferred compensation plan whereby certain key
executives may defer a portion of their salary and bonus. Participants direct
the investment of their account balances among mutual funds selected by the
participants. Distributions commence following a participant's retirement or
termination of employment. At June 30, 1997, the Company had a deferred
compensation liability under the plan of $15.3 million.
NOTE 9 - INDUSTRY AND GEOGRAPHIC INFORMATION
No single customer accounted for more than 10% of net revenues in 1997, 1996 and
1995. International sales accounted for 65%, 66% and 65% of the Company's
revenues in 1997, 1996 and 1995, respectively. The Company designs,
manufactures, markets and services wafer defect inspection systems, reticle
inspection systems, thin film measurement and metrology systems used primarily
in the manufacture of integrated circuits by the semiconductor industry.
The following is a summary of the Company's geographic operations:
Year ended June 30, 1995 1996 1997
----------- ----------- -----------
In thousands
Sales to unaffiliated customers:
United States $ 245,666 $ 375,639 $ 364,162
International:
Western Europe 83,077 141,062 116,461
Japan 217,488 352,080 257,382
Asia Pacific 141,469 222,957 272,966
ROW 8,250 2,754 20,853
Total 695,950 1,094,492 1,031,824
Intercompany sales among geographic areas:
United States 60,861 90,561 5,548
Western Europe 32,157 54,059 85,075
Japan 28,225 81,494 124,998
Asia Pacific 10,225 18,627 6,337
Consolidation eliminations (131,468) (244,741) (221,958)
Total $ 695,950 $ 1,094,492 $ 1,031,824
Operating results:
United States $ 53,037 $ 75,597 $ 40,802
Western Europe 25,980 54,436 39,344
Japan 68,595 124,100 68,835
Asia Pacific 53,337 67,085 62,685
General corporate 200,949 321,218 211,666
expenses (44,340) (24,952) (65,834)
Income from operations $ 156,609 $ 296,266 $ 145,832
Identifiable assets:
United States $ 250,026 $ 423,560 $ 822,067
Western Europe 43,007 51,045 49,417
Japan 113,565 124,839 100,311
Asia Pacific 46,377 81,724 22,680
General corporate
assets 397,431 476,751 348,832
Total assets $ 850,406 $ 1,157,919 $ 1,343,307
Intercompany sales among the Company's geographic areas are recorded on the
basis of intercompany prices established by the Company. At June 30, 1997, 1996
and 1995, total foreign liabilities (excluding intercompany balances) were $85
million, $76 million and $54 million, respectively. For fiscal years 1997, 1996
and 1995, foreign capital expenditures and depreciation expense were $4 million,
$7 million and $3 million and $2 million, $1 million and $1, respectively.
NOTE 10 - CERTAIN TRANSACTIONS
Uniphase In November 1995, the Company entered into agreements with Uniphase
Corporation (Uniphase) to license certain technology, provide partial funding
for research and development and purchase 665,568 shares of Uniphase's common
stock (adjusted to reflect a two-for-one stock split in June 1996). Under these
agreements, the Company became the exclusive OEM reseller of Uniphase's laser
imaging defect review station and automatic defect classification (ADC)
software. The Company recorded the license as acquired product technology and is
amortizing the cost over its estimated useful life of three years. The research
and development funding is charged to research and development expense over the
term of the funding agreement. The Company has recorded the purchase of Uniphase
common stock as a short-term marketable equity investment at its fair value at
the time of the purchase. Included under the caption "Accumulated unrealized
gain on investments, net" is $17.7 million related to the increase in fair
market value of the Company's investment in Uniphase common stock as of June 30,
1997.
Metrologix
In December 1994, the Company acquired Metrologix Inc., a manufacturer of
advanced electron beam measurement equipment. The acquisition was accounted for
as a purchase. A significant portion of the acquisition cost was allocated to
acquired in-process technology that was written off at the time of the
acquisition, because further substantial research and development investment was
necessary to complete the new product development then underway. This resulted
in a pre-tax charge of $25.2 million.
NOTE 11 - QUARTERLY CONSOLIDATED
RESULTS OF OPERATIONS (UNAUDITED)
Sept. 30 Dec. 31 March 31 June 30
-------- -------- -------- --------
In thousands, except per share amounts
1997:
Revenues $261,140 $242,155 $252,346 $276,183
Gross profit 145,776 127,281 135,241 151,616
Income from
operations 46,165(1) 47,750 49,000 2,917(2)
Net income 33,580(1) 34,219 36,995 602(2)
Net income
per share $ 0.40(1) $ 0.40 $ 0.43 $ 0.01(2)
1996:
Revenues $237,079 $261,672 $293,777 $301,964
Gross profit 137,906 150,784 167,715 168,406
Income from
operations 68,078 72,765 79,051 76,372
Net income 45,500 48,614 52,068 50,452
Net income
per share $ 0.54 $ 0.58 $ 0.62 $ 0.61
(1) Includes restructuring costs of $8.5 million. Net income and
net income per share would have been $39.0 million and $0.46, respectively,
excluding these costs.
(2) Includes merger, restructuring and other costs of $52.1 million. Net
income and net income per share would have been $42 million and $0.48,
respectively, excluding these costs.
QUARTERLY COMMON STOCK MARKET PRICE:
1997 Quarter ended Sept. 30 Dec. 31 March 31 June 30
-------- ------- -------- -------
High 24 3/4 40 3/4 49 3/4 53 1/8
Low 14 3/4 17 5/8 25 1/2 35 1/2
1996 Quarter ended Sept. 30 Dec. 31 March 31 June 30
-------- ------- -------- -------
High 47 1/8 46 3/4 35 1/4 31 1/4
Low 38 1/2 24 3/4 16 1/2 17 1/4
The preceding table sets forth the high and low closing prices as reported on
the Nasdaq National Market System during the last two years. As of September 2,
1997, there were approximately 1,833 stockholders of record of the Company's
Common Stock. The price for the Company's Common Stock as of the close of
business on September 2, 1997 was $71.38 per share. The Company has never paid
cash dividends to its stockholders. The Company does not plan to pay cash
dividends in the foreseeable future.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of KLA-Tencor Corporation
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, of stockholders' equity and of cash flows
present fairly, in all material respects, the financial position of KLA-Tencor
Corporation and its subsidiaries at June 30, 1997 and 1996, and the results of
their operations and their cash flows for each of the three years in the period
ended June 30, 1997, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit 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 the opinion expressed
above.
PRICE WATERHOUSE LLP
San Jose, California
July 28, 1997