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.
In addition to our efforts to develop new technologies from internal sources, we also seek to 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 issues and costs in connection with the integration of the operations and personnel, technologies and products of the acquired companies, the 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 seriously harm our business.
From time to time we are involved in litigation of various types, including litigation alleging infringement of intellectual property rights and other claims. 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.
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 and may delay any recovery in the general economy. Any delay in the recovery of the economy and the semiconductor industry could adversely affect our business. Increased international political instability, as demonstrated by the September 2001 terrorist attacks, disruption in air transportation and further enhanced security measures as a result of the 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.
Recently enacted and proposed changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002, will increase our expenses as we evaluate the implications of new rules and devote resources to respond to the new requirements. Sarbanes- Oxley Act mandates, among other things, that companies adopt new corporate governance measures and imposes comprehensive reporting and disclosure requirements, sets stricter independence and financial expertise standards for audit committee members and imposes increased civil and criminal penalties for companies, their chief executive officers and chief financial officers and directors for securities law violations.
In particular, we expect to incur additional administrative expense as we implement Section 404 of the Sarbanes-Oxley Act, which requires management to report on, and our Independent Registered Public Accounting Firm to attest to, our internal control over financial reporting. In addition, The Nasdaq National Market, on which our common stock is listed, has also adopted comprehensive rules and regulations relating to corporate governance. 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. We also expect these developments to make it more difficult and more expensive for us to obtain director and officer liability insurance in the future, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. Further, our board members, Chief Executive Officer and Chief Financial Officer could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficultly attracting and retaining qualified board members and executive officers, which would adversely affect our business.
Earthquake and Other Uninsured Risks
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 costs 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 the 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.
Future Changes in Accounting and Taxation Standards or Practices
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 our reporting of transactions completed before the change is effective. New accounting pronouncements and taxation rules and varying interpretations of accounting pronouncements and taxation practice 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 SFAS No. 123(R) which 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 had a material impact on our consolidated financial statements as reported under generally accepted accounting principles in the United States.
Exposure to various risks related to the regulatory environment.
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.
Exposure to fluctuations in foreign currency exchange rates
We have some exposure to fluctuations in foreign currency exchange rates. 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 fluctuations. However, we may still be adversely affected by changes in foreign currency exchange rates or declining economic conditions in these countries.
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Computer viruses may disrupt our operations
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.
Effects of Recent Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment.” SFAS No. 123(R) which 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 March 2005, the SEC issued SAB 107, which provides the Staff’s views regarding interactions between SFAS No. 123(R) and certain SEC rules and regulations and provides interpretations of the valuation of share-based payments for public companies. The adoption of SFAS No. 123(R) requires additional accounting related to the income tax effects and additional disclosure regarding the cash flow effects resulting from share-based payment arrangements. The adoption of SFAS No. 123(R) during the first quarter of fiscal year 2006 had a material impact on our consolidated results of operations, financial position and statement of cash flows. For more information on stock-based compensation costs during the three months ended September 30, 2005, refer to Note 6 “Stock Based Compensation” of the Notes to the Condensed Consolidated Financial Statements included in Item 1 of this quarterly report.
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 were 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 accounting changes made in fiscal years beginning after December 15, 2005; however, the Statement does not change the transition provisions of any existing accounting pronouncements. The adoption of SFAS No. 154 did not have a material effect on our consolidated financial position, results of operations or cash flows.
In March 2005, the FASB published FASB Interpretation No. 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 us 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.
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In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of 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 fiscal year beginning July 1, 2005. The adoption of SFAS No. 151 did not have a material impact on our consolidated financial position, results of operations and cash flows.
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES 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. 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 at September 30, 2005. Actual results may differ materially.
As of September 30, 2005, we had an investment portfolio of fixed income securities of $1.3 billion, excluding those classified as cash and cash equivalents. 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 September 30, 2005, the fair value of the portfolio would have declined by $7 million.
As of September 30, 2005, we had net forward contracts to sell $351 million in foreign currency in order to hedge currency exposures (see Note 11 of the Notes to the Condensed Consolidated Financial Statements under “Derivative Instruments”). If we had entered into these contracts on September 30, 2005, the U.S. dollar equivalent would be $342 million. A 10% adverse move in all currency exchange rates affecting the contracts would decrease the fair value of the contracts by $47 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 the hedging of our foreign currency exposure should have no material impact on net income or cash flows.
ITEM 4. | CONTROLS AND PROCEDURES |
Evaluation of Disclosure Controls and Procedures and Related CEO and CFO Certifications
We conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (Disclosure Controls) as of the end of the period covered by this Quarterly Report. The controls evaluation was conducted under the supervision and with the participation of management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO). Based on this evaluation, our CEO and our CFO have concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
Attached as exhibits to this Quarterly Report are certifications of the CEO and the 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.
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Definition of Disclosure Controls
Disclosure Controls are controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure Controls are also designed to ensure that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Our Disclosure Controls include components of our internal control over financial reporting, which consists of control processes designed to provide reasonable assurance regarding the reliability of our 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 our internal control over financial reporting are included within our Disclosure Controls, they are included in the scope of our quarterly controls evaluation.
Limitations on the Effectiveness of Controls
The Company’s management, including the CEO and CFO, does not expect that our Disclosure Controls or our 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 controls over financial reporting
There were no changes in our internal controls over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
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 complex legal proceedings are difficult to predict.
ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
Following is a summary of stock repurchases for the quarter ended September 30, 2005.(1)
Period | | Total Number
of Shares (or
Units) Purchased(2) | | Average Price
Paid per Share
(or Unit) | | Maximum Number
of Shares (or Units)
that May Yet Be
Purchased Under the
Plans or Programs(3) | |
| |
|
| |
|
| |
|
| |
July 1, 2005 to July 31, 2005 | | | 284,500 | | $ | 46.21 | | | 8,065,500 | |
August 1, 2005 to August 31, 2005 | | | 216,000 | | $ | 49.37 | | | 7,849,500 | |
September 1, 2005 to September 30, 2005 | | | 238,000 | | $ | 49.06 | | | 7,611,500 | |
| |
|
| |
|
| |
|
| |
Total | | | 738,500 | | $ | 48.05 | | | | |
| |
|
| |
|
| |
|
| |
|
(1) | In July 1997, the Board of Directors authorized KLA-Tencor to systematically repurchase shares of its common stock in the open market. This program was entered in order to reduce the dilution from KLA-Tencor’s employee benefit and incentive plans such as the stock option and employee stock purchase plans. Since the inception of the repurchase program in 1997 through September 30, 2005 the Board of Directors had authorized KLA-Tencor to repurchase a total of 27.8 million shares. All such shares remain as treasury shares and are retired. |
(2) | All shares were purchased pursuant to the program publicly announced in July 1997 and as extended by the Board of Directors most recently in February 2005 by an additional 10.0 million shares. |
(3) | The stock repurchase program has no expiration date. We intend to continue making further purchases under the stock repurchase program. |
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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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SIGNATURES
Pursuant to the requirements 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 |
| (Registrant) |
| |
November 7, 2005 | /s/ KENNETH L. SCHROEDER |
(Date) |
|
| Kenneth L. Schroeder |
| Chief Executive Officer |
| (Principal Executive Officer) |
| |
| |
| |
November 7, 2005 | /s/ JOHN H. KISPERT |
(Date) |
|
| John H. Kispert |
| Executive Vice President |
| and Chief Financial Officer |
| (Principal Accounting Officer) |
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KLA-TENCOR CORPORATION
EXHIBIT INDEX
| | | | Incorporated by Reference |
| | | |
|
Exhibit
Number | | Exhibit Description | | Form | | File No. | | Exhibit Number | | Filing Date |
| |
| |
| |
| |
| |
|
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. 0-9992 | | 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* | | 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 |
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10.9 | | Severance Agreement and General Release | | 10-K | | No. 000-09992 | | 10.9 | | August 30, 2004 |
| | | | | | | | | | |
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 | | Agreement by and between KLA-Tencor Corporation and Kenneth L. Schroeder* | | 8-K | | No. 000-09992 | | 10.1 | | February 23, 2005 |
| | | | | | | | | | |
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 | | | | | | | | |
|
* Denotes a management contract, plan or arrangement |
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