-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FgurmqB3mRb0suRex8Udu7MWQ8h/ylkXuyjNJGtDFCzI654wMyu0PIbrjS5RDw6C ZmPA9UuNBySEYVHkBOx++A== 0000912057-97-008251.txt : 19970311 0000912057-97-008251.hdr.sgml : 19970311 ACCESSION NUMBER: 0000912057-97-008251 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970310 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: TENCOR INSTRUMENTS CENTRAL INDEX KEY: 0000711808 STANDARD INDUSTRIAL CLASSIFICATION: INSTRUMENTS FOR MEAS & TESTING OF ELECTRICITY & ELEC SIGNALS [3825] IRS NUMBER: 942464767 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-20007 FILM NUMBER: 97553155 BUSINESS ADDRESS: STREET 1: 3333 OCTAVIUS STREET CITY: SANTA CLARA STATE: CA ZIP: 95054 BUSINESS PHONE: 4159696784 MAIL ADDRESS: STREET 1: 3333 OCTAVIUS STREET CITY: SANTA CLARA STATE: CA ZIP: 95054 10-K405 1 FORM 10-K405 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 (fee required). For the fiscal year ended DECEMBER 31, 1996 [ ] TRANSITION report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934. For the transition period from _____________ to ____________ COMMISSION FILE NUMBER 0-20007 TENCOR INSTRUMENTS (exact name of registrant as specified in its charter) CALIFORNIA 94-2464767 (State of Incorporation) (I.R.S. Employer Identification No.) ONE TECHNOLOGY DRIVE, MILPITAS, CALIFORNIA 95035 (Address of principal executive offices) (zip code) Registrant's telephone number (408) 571-3000 Securities registered pursuant to Section 12(b) of the Act: Title of Class Name of each exchange on which registered -------------- ----------------------------------------- None None Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK 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 (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO --- --- Aggregate market value of the voting stock held by non affiliates of the registrant as of February 28, 1997: $953,727,955 (1) Number of shares outstanding of each of the issuer's classes of common stock, as of February 28, 1997: 31,246,903 (1) Excludes 1,789,901 shares held by directors and officers at February 28, 1997 and 5,651,000 shares held by shareholders at December 31, 1996 whose ownership exceeded 5% of the outstanding shares at December 31, 1996. Exclusion of such shares should not be construed as indicating that the holders thereof possess the power, direct or indirect, to direct the management or policies of the registrant, or that such person is controlled by or under common control with the registrant. Exhibit Index at page 49 Total pages 59 PART I ITEM 1: BUSINESS MERGER WITH KLA On January 14, 1997, Tencor and KLA Instruments (KLA) jointly announced a definitive merger agreement to create a combined company. Under the terms of the merger agreement, shares and options for KLA common stock will be exchanged for all outstanding shares and options of the Company on the basis of one share of KLA Instruments for each share of the Company. The transaction is intended to qualify as a pooling of interests for financial reporting purposes and structured to qualify as a tax-free reorganization. The transaction is conditioned on obtaining both companies' shareholder approval, regulatory clearance and other customary closing conditions, and is anticipated to close during the quarter ending June 30, 1997. BUSINESS Tencor Instruments ("Tencor" or the "Company"), a California corporation, designs, manufactures, markets and services wafer inspection, film measurement, metrology systems yield measurement and physical measurement standards, primarily for the semiconductor industry. Tencor's systems are used to assist in the start-up of new semiconductor manufacturing facilities and new processes and to monitor semiconductor wafers and processes during production. Certain of Tencor's metrology systems also are sold to the data storage and flat panel display industries. Tencor uses its technical expertise and understanding of customer needs to create what it believes is one of the broadest lines of high performance laser scanning-based wafer inspection, thin film measurement and metrology systems used in the semiconductor industry. Since its founding in 1976, Tencor's products all have shared a common development philosophy: systems and instruments must be user-friendly, generate results that are accurate and easy to interpret, and provide the user with a rapid return on investment resulting in a low cost of ownership. To date, Tencor has introduced over 112 different products for use in the semiconductor and other industries and has shipped more than 10,000 systems, ranging from bench top instruments to complex automated systems. Tencor markets its products worldwide to virtually all of the major semiconductor manufacturers. International sales accounted for approximately 64% of Tencor's revenues in 1996. The Company expects that international sales will continue to represent a significant percentage of revenues. Tencor's operating results have fluctuated in the past and the Company's operating results may fluctuate in the future. The Company's operating results are dependent on many factors, including the economic conditions in the semiconductor industry, the size and timing of the receipt of orders from customers, customer cancellations or delays of shipments, the Company's ability to develop, introduce and market new and enhanced products on a timely basis, the introduction of new products by its competitors, changes in average selling prices and product mix, and exchange rate fluctuations, among others. In addition, the Company's expense levels are based, in part, on expectations of future revenues. If revenue levels in a particular quarter do not meet expectations, operating results could be adversely affected. The Company's results of operations for a particular quarter could be adversely affected if anticipated orders are not received in time to enable shipment during the quarter, if anticipated shipments are delayed or canceled by one or more customers or if shipments are delayed due to manufacturing difficulties. The slowdown in the semiconductor industry and in the construction of new wafer fabrication facilities has resulted in Tencor experiencing a reduction in new orders as well as rescheduled and canceled orders in 1996. There can be no assurance that this slowdown will not continue. There can be no assurance that these and other factors will not materially adversely affect the Company's future business and financial results. Tencor's business depends upon the capital equipment expenditures of semiconductor manufacturers, which in turn depend on the current and anticipated market demand for integrated circuits and products utilizing integrated circuits. In addition, the Company's business depends upon new construction of semiconductor fabrication facilities and, as to existing fabrication facilities, 2 enhancements to improve yields. The semiconductor industry has been cyclical in nature and historically has experienced periodic downturns. The semiconductor industry is presently experiencing a slowdown in terms of product demand and volatility in terms of product pricing. This slowdown and volatility has caused the semiconductor industry to reduce purchases of semiconductor manufacturing equipment and construction of new fabrication facilities. These conditions have adversely affected Tencor and may continue to adversely affect the Company's aggregate bookings, revenues and operating results, and no assurance can be given that the Company's bookings, revenue and operating results will not be adversely affected by future downturns in the semiconductor industry. Even during periods of reduced revenues, in order to remain competitive Tencor will be required to continue to invest in research and development and to maintain extensive ongoing worldwide customer service and support capability which could adversely affect its financial results. WAFER INSPECTION SYSTEMS The Wafer Inspection Division products include unpatterned wafer inspection, patterned wafer inspection, and yield management and defect data analysis systems. Wafer inspection systems are used to find, count and characterize particles and other pattern defects on wafers both in engineering applications and in-line at various stages during the semiconductor and wafer manufacturing processes. Semiconductor manufacturers use wafer inspection systems to monitor their manufacturing processes and to refine those processes to increase the yield of acceptable integrated circuits. Accordingly, semiconductor manufacturers base their purchase of wafer inspection systems on a variety of criteria, including sensitivity, throughput, total cost of ownership, ease of use, degree of automation, system repeatability and correlation, and ability to be integrated into overall yield management systems. Tencor is a recognized leader in the wafer inspection market with its Surfscan family of laser-scanning products. Surfscans are widely used for wafer qualification, process monitoring and equipment monitoring. They provide the high sensitivity, fast throughput and low cost of ownership required in a production environment and are used in virtually all semiconductor manufacturing processes in use today. Surfscans are key components of the defect reduction strategies of many leading semiconductor manufacturers. The systems use a standardized Tencor File Format which allows defect location data to be easily transferred to off-line review stations for defect classification. Surfscans help Tencor's customers transition new designs from engineering to manufacturing and to control manufacturing processes and improve yields of acceptable integrated circuits. The Wafer Inspection Division also produces yield management and defect data analysis software systems. These software systems integrate defect data from multiple sources throughout a fab, providing comprehensive defect data management for advanced excursion monitoring, yield correlation and reporting. The software systems identify data sources, show defect trends and help semiconductor manufacturers develop long-term yield improvement strategies. The division has also partnered with Uniphase Corporation to OEM Uniphase's confocal review station or CRS to provide advanced two- and three-dimensional imaging and defect classification to automate the time-consuming and error-prone procedure of locating and classifying defects. The CRS interfaces with the Company's inspection systems to collect, store and analyze defect data generated by the Surfscan systems. Tencor's sales of wafer inspection systems accounted for approximately 51%, 47% and 45% of total revenues in 1996, 1995 and 1994, respectively. FILM MEASUREMENT SYSTEMS Tencor's Film Measurement Division produces both film thickness and resistivity measurement tools. The Company's film thickness products are used to measure a variety of optical properties of thin films, while the resistivity products measure the resistivity of the various layers used to make integrated circuits. These products are used to control a wide range of wafer fabrication steps, 3 where within-wafer and wafer-to-wafer uniformity of the process is of paramount importance to semiconductor manufacturers achieving high yields at the lowest possible cost. These systems incorporate pattern recognition for automatically positioning the wafer for measurement, communications protocols such as SECSII, contamination- free designs and performance measurement over a wide range of applications. Whenever possible, Tencor also has been able to provide additional benefits to its customers by incorporating multiple measurement capabilities in a single system, thus reducing the number of steps and unnecessary handling of wafers. Tencor uses software technology to enhance the productivity of its Film Measurement systems. These products offer automated wafer mapping utilizing computer-controlled positioning stages that can move the wafer rapidly to hundreds of user programmed measurement locations. In addition, these products are built on the proprietary StatTrax and Summit software platforms, which provide an operator-friendly environment for operation, setup and utilization of all products. Sales of these products accounted for approximately 30%, 32% and 33% of total revenues in 1996, 1995 and 1994, respectively. METROLOGY SYSTEMS Metrology Division systems measure key dimensions and physical properties on wafers. Stylus profilers are used to measure the surface topography of films and etched surfaces and are used in production, R&D and quality control areas. Stress measurement systems detect reliability related problems such as film cracking, voiding and lifting. This division also produces wafer characterization instruments which are used to determine resistivity, thickness and dopant types for a variety of substrates. In recent years the use of surface profiling systems and stress measurement systems has expanded from the engineering laboratory into the production environment. Tencor believes that the automation capabilities of its metrology systems are key strengths for their use in the production setting. Tencor primarily markets metrology systems to the semiconductor industry but also sells to other markets, including data storage and flat panel display markets. Tencor's sales of metrology systems accounted for approximately 12%, 14% and 13% of total revenues in 1996, 1995 and 1994, respectively. PHYSICAL MEASUREMENT STANDARDS Physical measurement standards are used by semiconductor manufacturers and semiconductor equipment manufacturers to calibrate inspection tools and metrology systems. Tencor, through its wholly owned subsidiaries, VLSI Standards, Inc., currently offers a broad line of standards which are traceable, whenever possible, to the standards set by the National Institute for Standards Technology (NIST). The physical measurement standards product line includes surface particle contamination, step height, resistivity, film thickness, linewidth, surface roughness and surface topography standards. VLSI Standards, Inc. also manufactures physical deposition systems. These systems deposit polystyrene spheres that have controlled diameters onto substrates in order to calibrate defect inspection systems, such as Tencor's Surfscan systems. MARKETING, SALES AND SERVICE Tencor sells products through a combination of direct sales and distribution channels. The Company maintains 34 sales and service offices worldwide, with 14 of those in the United States, 7 in Japan, 7 in Europe, 2 in Korea, 1 in Singapore and 1 in Taiwan. International sales accounted for 64% of the Company's revenue for 1996, up from 62% in 1995. The Company's principle customers in 1996 were IBM Corporation, LG International, Samsung, Texas Instruments and Motorola, which 4 accounted for 5.2%, 4.7%, 4.6%, 4.1% and 3.8% respectively. The Company's principal customers in 1995 were Motorola, Siemens, Intel, Micron Technology and Mitsubishi, which accounted for 8.3%, 5.1%, 4.3%, 4.2% and 4.2% of total revenues, respectively. During 1994, the Company's principal customers were Motorola, Texas Instruments, Intel, Samsung and Hyundai who accounted for 7.2%, 5.5% 5.3%, 5.2% and 5.0% of total revenues, respectively. The Company does not consider its business to be seasonal in nature, but it is cyclical with respect to the capital equipment procurement practices of major semiconductor manufacturers. INTERNATIONAL REVENUES International revenues accounted for 64%, 62% and 51% of Tencor's revenues for the years 1996, 1995 and1994, respectively. Tencor expects that international sales will continue to represent a significant percentage of net sales of the Company. The future performance of the Company will be dependent, in part, upon its ability to continue to compete successfully in Asia, one of the largest areas for the sale of yield management in process monitoring equipment. The Company's ability to compete in this area in the future is dependent upon the continuation of favorable trading relationships between the region (especially Japan and Korea) and the United States and the continuing ability of the Company to maintain satisfactory relationships with leading semiconductor companies in the region. International sales and operations may be adversely affected by 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 net sales and income from the Company's international business may be affected by fluctuations in currency exchange rates. Although Tencor attempts to manage near term currency risks through "hedging," there can be no assurance that such efforts will be adequate. These factors could have a material adverse effect on the Company's future business and financial results. BACKLOG At December 31, 1996, the Company's firm backlog totaled $132.5 million, compared to $175.5 million at December 31, 1995. The Company expects to fill the present backlog of orders during fiscal 1997. All orders are subject to cancellation or delay by the customer with limited or no penalty. Tencor, from time to time, has experienced and expects to continue to experience fluctuations in its orders and in its results of operations, particularly on a quarterly basis. 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 affected adversely, which may have an adverse impact on the market price of the Company's Common Stock. A variety of factors have an influence on the Company's orders and operating results in a particular period. These factors include specific economic conditions in the semiconductor industry, the timing of the receipt of orders from major customers, customer cancellations or delays of shipments, specific feature requests by customers, production delays or manufacturing inefficiencies, exchange rate fluctuations, management decisions to commence or discontinue product lines, the Company's ability to design, introduce and manufacture new products on a cost effective and timely basis, the introduction of new products by the Company or its competitors, the selection of the Company's or its competitors' products by semiconductor manufacturers for new generations of fabrication facilities, the lengthening or shortening of order cycle times for the Company's products, the timing of research and development expenditures, and expenses attendant to acquisitions, strategic alliances and the further development of marketing and service capabilities. As a result of fluctuations in orders, backlog as of the end of successive quarters may vary significantly. 5 RESEARCH AND DEVELOPMENT Rapid technological changes in semiconductor manufacturing processes subject the semiconductor equipment manufacturing industry to increased pressure to maintain technological parity with deep submicron process technology. Tencor believes that continued and timely development of new products and enhancements to existing products is necessary to maintain its competitive position. Accordingly, Tencor devotes a significant portion of its personnel and financial resources to research and development programs and seeks to maintain close relationships with customers to remain responsive to their product needs. New product introductions may contribute to fluctuations in operating results, since customers may defer ordering products from existing product lines. If new products have reliability or quality problems, reduced orders, higher manufacturing costs, delays in acceptance of and payment for new products and additional service and warranty expense may result. On occasion, Tencor has experienced reliability and quality problems in connection with certain product introductions, resulting in some of these consequences. There can be no assurance that the Company will successfully develop and manufacture new hardware and software products or that new hardware and software products introduced by the Company will be accepted in the marketplace. If the Company does not successfully introduce new products, its results of operations will be affected adversely. Research and development expenses were $44.3 million, or 11.0% of revenues in 1996, $33.4 million, or 10.1% of revenues in 1995 and $25.3, or 15.6% of revenues in 1994. Research and development expenses consist primarily of salaries, project materials, purchased R&D technologies and other costs associated with Tencor's ongoing efforts of product development and enhancements. MANUFACTURING, RAW MATERIALS AND SUPPLIES In 1996, Tencor's principal manufacturing activities took place in Mountain View and Santa Clara, California. In early 1997, the Company began to occupy the new facility constructed for its use in Milpitas, California. The construction and the related move to the Milpitas Facility are scheduled for completion at the end of March 1997 at which time substantially all of the Company's manufacturing operations will be consolidated at the Milpitas facility. Manufacturing activities consist primarily of assembling and testing components and subassemblies which are acquired from third party vendors and then integrated into Tencor's finished products. Many of the components and subassemblies are standard products, although certain items are made to Tencor specifications. Certain of the components and subassemblies included in Tencor's systems are obtained from a single source or a limited group of suppliers. These specific parts are monitored by management to ensure that adequate supplies are available to maintain manufacturing schedules, should supply for any part be interrupted. The partial or complete loss of certain of these sources could have at least a temporary adverse effect on the Company's results of operations and damage customer relationships. Further, a significant increase in the price of one or more of these components could adversely affect the Company's results of operations. Tencor's physical measurement standards are manufactured in an additional facility in San Jose, California. COMPETITION The semiconductor equipment industry is highly competitive. Tencor has experienced and expects to continue to experience substantial competition throughout the world. The Company believes that to remain competitive, it will require significant financial resources in order 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. Tencor believes that the semiconductor equipment industry is becoming increasingly dominated by large manufacturers such as Applied Material, Inc. ("Applied Materials"), which recently entered the wafer defect inspection market, Hitachi Electronics Engineering Co., LTD. and Tokyo Electron Limited, who have the resources to support customers on a worldwide basis. Many of these competitors have substantially greater financial resources and more extensive engineering, manufacturing, marketing and customer service and support capabilities than Tencor. In addition, there are smaller emerging semiconductor equipment companies which 6 provide innovative technology. The Company expects its 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. No assurance can be given that the Company will be able to continue to compete successfully against its competitors. In addition, in configuring their fabrication plants, semiconductor manufacturers increasingly tend to select specific items of manufacturing equipment for all of the fabrication facilities used to produce each generation of integrated circuits. As a result of this process, the Company's failure to have one or more of its products selected by a semiconductor manufacturer for use in its facilities for a particular generation of integrated circuits may effectively eliminate sales of that product for all of that manufacturer's fabrication plants used for that generation of integrated circuits. The failure to have one or more of Tencor's products selected by a major semiconductor manufacturer, especially one that is a significant customer of Tencor, for a particular generation of its integrated circuit products could have a significant and long-term adverse effect on the Company's results of operations. Although the Company has been relatively successful to date in these selection decisions, not all of the Company's products have been selected by each of its customers for fabrication facilities for each generation of integrated circuits. Further, there can be no assurance that Tencor's products will be selected in the future, or that Tencor will continue to be as successful in connection with selection processes as it has been to date. PATENTS AND LICENSES Tencor's continued success will depend in part on its proprietary technology. While Tencor has attempted to protect its proprietary technology through patents, copyrights and trade secrets, it believes that success will depend more upon the technical expertise, continuing development of new systems, market penetration, installed base and the ability to provide comprehensive support and service to customers. There can be no assurance that the Company will be able to protect its technology or that competitors will not be able to develop similar technology independently. Tencor currently holds 69 U.S. patents and has applied for 17 additional patents in the United States. In addition, Tencor has 21 foreign patents and has applied for 44 additional foreign patents. From time to time the Company acquires license rights under U.S. and foreign patents and other proprietary rights of third parties. No assurance can be given that patents will be issued on any of the applications, that license assignments will be made as anticipated or that the Company's patents, licenses or other proprietary rights will be sufficiently broad to protect its technology. In addition, no assurance can be given that any patents issued to or licensed by the Company will not be challenged, invalidated or circumvented or that the rights granted thereunder will provide competitive advantages to Tencor. The Company and its customers from time to time receive letters from third parties, including competitors, alleging infringement of such parties' patent rights by the Company's products. However, no such letters were received in 1996. Such letters are prevalent in the industry and the Company believes that generally, it is possible to negotiate licenses on commercially reasonable terms. However, there can be no assurance that the Company would prevail in any litigation seeking damages or expenses or to enjoin the Company from selling its products on the basis of such alleged infringement, or that the Company would be able to license any valid and infringed patents on reasonable terms, if at all. ENVIRONMENTAL MATTERS Tencor has learned that the soil and groundwater beneath its leased facilities in Mountain View, California, are contaminated by certain chemicals. Tencor understands that all or most of the contamination occurred prior to the time Tencor began to occupy the premises and resulted either from the activities on the property of a long-time tenant (unaffiliated with Tencor) or from an off- site source. Tencor has a right to indemnification from the owner of the property as to claims brought by third parties with respect to this contamination. There is no assurance, however, that Tencor will not incur investigative costs or other expenses with respect to the property contamination, or that a regulatory agency or third party will not seek to compel Tencor to undertake remedial action, resulting 7 in further costs and expenses, with no assurance that such expenses are recoverable under the indemnity agreement with the owner. EMPLOYEES At December 31, 1996, the Company employed 1,357 full-time and temporary persons worldwide. None of these employees is represented by a union and Tencor has never experienced a work stoppage, slowdown or strike. Tencor considers its employee relations to be good. The future success of the Company is dependent, in part, on its ability to retain certain key personnel. To continue to grow the Company will also need to attract additional skilled personnel in all areas of its business on a worldwide basis. Competition for such personnel is intense. There can be no assurance that the Company will be able to retain its existing key management, engineering and sales personnel or attract additional qualified employees in the future. This could be particularly significant if the Company needs to hire, train and assimilate a large number of new employees. A failure to retain or attract qualified employees could materially adversely affect the business and financial results of the Company. ITEM 2: PROPERTIES Certain information concerning the Company's principal properties at December 31, 1996, is set forth below:
Square Location Type Principal use footage Ownership - -------- ---- ------------- ------- --------- Mountain View, CA Office, plant Research and Engineering, 133,025 leased Marketing, Manufacturing, Sales and Service Santa Clara, CA Office, plant Corporate Headquarters, 189,280 leased Marketing, Research and Engineering, Manufacturing, Sales and Service Milpitas, CA Office Training facility 18,500 leased Naruse, Japan Office Sales, service and 28,417 leased applications support
The Company also leases office space for 32 additional sales and service offices throughout the world: 7 offices are located in Europe, 6 offices are in Japan, 13 offices are in the United States, 2 offices are located in Korea, 1 office is in Singapore and 1 office is in Taiwan. In addition, the company is in the process of opening a sales and service office in Thailand. As a result of the Company's desire to consolidate substantially all of its Silicon Valley operations into a single facility, the Company, in late 1995, entered into two seven year operating lease transactions for land, office and manufacturing facilities to be constructed for its use in Milpitas, California. As of March 7, 1997, construction of the facility has virtually been completed and occupancy is scheduled to be concluded by the end of the first quarter of 1997. As a result, the Company allowed certain of its California leased space to expire in December 1996, with the remainder of leaseholds expiring at various times through September 1998. $6.5 million of estimated future costs, such as rents and utilities, related to unoccupied leased space was reserved for at September 30, 1996. Rent on the Company's new facility will commence on April 1, 1997. 8 The Company believes that its existing leased facilities and the Milpitas facility will be adequate to meet the Company's office and plant space requirements for at least the next twelve months. ITEM 3: LEGAL PROCEEDINGS None ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS IN FOURTH QUARTER OF 1996 None PART II ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS QUARTERLY COMMON STOCK MARKET PRICE: 1996 Quarter ended March 31 June 30 September 30 December 31 - ------------------ -------- ------- ------------ ----------- High 29 26 1/2 19 5/8 28 3/8 Low 16 1/2 17 14 3/4 17 5/8 1995 Quarter ended March 31 June 30 September 30 December 31 - ------------------ -------- ------- ------------ ----------- High 31 5/8 43 1/2 47 1/8 46 Low 17 7/8 28 9/16 39 1/4 24 3/4 The preceding table sets forth the high and low sales prices as reported on the Nasdaq National Market system during the last two years. As of February 28, 1997 there were approximately 842 shareholders of record of the Company's Common Stock. The price for the Company's Common Stock as of the close of business on February 28, 1997 was $40.06 per share. The Company has paid no cash dividends to its shareholders during the past ten years. The Company does not plan to pay cash dividends in the foreseeable future. 9 ITEM 6: SELECTED FINANCIAL DATA FIVE YEAR FINANCIAL HIGHLIGHTS IN THOUSANDS, EXCEPT PER SHARE DATA
Year ended December 31, 1996 1995 1994 1993 1992 - ---------------------------------------------------------------------------------------------------------------- OPERATIONS Net Revenues $403,170 $330,197 $182,330 $107,874 $85,054 Net income $61,288 (2) $65,324 $24,316 (1) $7,158 $2,402 Net income per share $1.93 (2) $2.09 $.90 (1) $0.30 $0.12 Weighted average number of common shares 31,763 31,212 27,162 23,492 20,270 YEAR END STATUS Total assets $484,419 $395,040 $184,549 $91,340 $64,487 Shareholders' equity $365,033 $288,145 $144,729 $70,192 $49,236 Working capital $274,238 $241,082 $122,392 $55,590 $37,759 Current ratio 3.3:1 3.3:1 4.2:1 3.7:1 4.2:1
(1) Includes $2.3 million of expenses related to Tencor's acquisition of Prometrix Corporation. (2) Includes a restructuring charge of $8.5 million. ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Other than statements of historical fact, statements made herein, such as statements regarding financial projections, information or expectations about the Company's products or markets of the Company, or statements about future events, are forward-looking and are subject to a number of risks and uncertainties that could cause actual results to differ materially from the statements made. These include, among others, uncertainties associated with meeting product delivery timetables, acceptance of new products, costs associated with new product introductions and the proposed merger with KLA, as well as other factors described herein, including those uncertainties identified under the heading "Other Factors Affecting Company Results," as well as the matters identified in the discussion of the Company's business in Item 1 hereof. OVERVIEW. The Company finished 1996 with revenues of $403,170,000 an increase of 22% over 1995 revenues of $330,197,000 and 1994 revenues of $182,330,000. During 1996, the Company received net new orders of $360,240,000 and at the end of 1996 had backlog of $132,535,000 compared to backlog at the end of 1995 of $175,465,000. Income from operations was $91,950,000 in 1996 compared to $104,396,000 and $39,476,000 in 1995 and 1994, respectively. The current year's decline in operating income was due primarily to an increase in the Company's product costs, including warranty and installation, resulting in a decline in gross margins as a percentage of revenues, and a restructuring charge of $8,500,000 for costs related to downsizing its worldwide operations and relocating to its new Milpitas facility. The Company's principal market is the semiconductor industry. The Company's revenues are derived primarily from product sales, principally through its direct sales force and, to a lesser extent, through distributors. The Company markets its products to virtually all of the major semiconductor manufacturers worldwide and its level of sales to individual semiconductor manufacturers may vary significantly from period to period depending on a variety of factors. These factors include the amount 10 of manufacturing capacity being added or modernized by a particular manufacturer and the Company's success in having its systems selected to be utilized in connection with such additional or modernized capacity. Revenues from sales of products in 1996, 1995 and 1994 were $379,560,000, $312,450,000 and $170,955,000, respectively. In addition, revenues derived from non-warranty service were $23,610,000, $17,747,000 and $11,375,000 in 1996, 1995 and 1994, respectively. Principal customers in 1996 included IBM, LG International, Samsung, Texas Instruments and Motorola, compared with the Company's principal customers in 1995, Motorola, Siemens, Intel, Micron Technology and Mitsubishi. In 1994, the Company's principal customers included Motorola, Texas Instruments, Intel, Samsung and Hyundai. The Company expects that it will, in the future, continue to experience significant fluctuations from period to period in its level of activity with individual semiconductor manufacturers. The Company has three wholly-owned foreign subsidiaries in Europe, one in Japan and one in Korea for marketing, sales and service of products. In early 1996, the Company established wholly-owned subsidiaries in Singapore and Taiwan for sales and support activities. International sales accounted for 64%, 62% and 51% of the Company's revenues for the years 1996, 1995 and 1994, respectively. The Company believes that foreign sales will continue to account for a significant percentage of revenues. 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 the operating results, the effect of these and other factors could significantly affect the Company's future operating results and stock market value. 11 RESULTS OF OPERATIONS. The following table sets forth certain financial data for the periods indicated as a percentage of revenues: Percentage of Net Revenues 1996 1995 1994 - -------------------------------------------------------------------------------- Revenues 100.0% 100.0% 100.0% Cost of sales 41.2% 36.8% 40.2% - -------------------------------------------------------------------------------- Gross margin 58.8% 63.2% 59.8% - -------------------------------------------------------------------------------- Operating expenses: Research and development 11.0% 10.1% 13.9% Marketing and selling 15.7% 16.1% 17.3% General and administrative 7.2% 5.4% 5.7% Restructuring/merger charges 2.1% --- 1.3% - -------------------------------------------------------------------------------- Total operating expenses 36.0% 31.6% 38.2% - -------------------------------------------------------------------------------- Income from operations 22.8% 31.6% 21.6% Other income, net 1.7% 1.9% .7% - -------------------------------------------------------------------------------- Income before income taxes 24.5% 33.5% 22.3% Provision for income taxes 9.3% 13.7% 9.0% - -------------------------------------------------------------------------------- Net income 15.2% 19.8% 13.3% - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
1996 CHANGE 1995 CHANGE 1994 - ----------------------------------------------------------------------------------------------- IN THOUSANDS, EXCEPT PER SHARE DATA Revenues $403,170 22 % $330,197 81% $182,330 Gross profit 237,047 14 % 208,675 91% 109,087 Operating expenses 145,097 39 % 104,279 50% 69,611 Net income 61,288 (6)% 65,324 169% 24,316 Net income per share 1.93 (8)% 2.09 132% 0.90
YEARS ENDED DECEMBER 31, 1996 AND 1995. REVENUES. Revenues increased by $72,973,000 or 22%, in 1996 versus 1995. The increase in revenues was primarily attributable to increased unit volumes of existing products and increased sales of newer products with higher average selling prices. Products with higher average selling prices include the Surfscan AIT and the UV-1270SE film thickness system. Geographically, the Company's revenue growth in 1996 compared to 1995 was driven by a 56% increase in Korea and a 123% increase in Southeast Asia, principally Singapore and Taiwan. Domestic revenues increased $21,119,000, or 17% in 1996 over 1995. The future performance of the Company will be dependent, in part, on the Company's ability to compete successfully overseas, and in particular, in Asia Pacific, the largest market for semiconductor capital equipment. Factors affecting the Company's ability to compete in foreign markets include continuing free trade between foreign countries and the U.S. and changes in interest and foreign currency rates. Other than for revenues generated in Japan, which in 1996 represented $94,744,000 sales contracts are generally denominated in U.S. dollars. The Company limits its exposures to fluctuations between the U.S. dollar and the yen by purchasing forward contracts and borrowing in yen. 12 GROSS MARGIN. Gross margin decreased to 58.8% in 1996 from 63.2% in 1995. The decrease during the period was due in part to an increase in costs related to new product introductions and in part to an increase in support related costs as the Company continued to add infrastructure to its worldwide customer satisfaction organization to support its growth. The Company anticipates a modest percentage decrease in gross margins in 1997 due, in part, to increased competition in the market place. RESEARCH AND DEVELOPMENT. Research and development expenses were $44,258,000 and $33,427,000 in 1996 and 1995, respectively, or 11.0% and 10.1% of revenues, respectively. The increase in absolute dollars is due primarily to increases in salaries and benefits expenses resulting from a net increase in headcount during the period and increases in new product development spending, particularly related to the Company's Surfscan AIT (Advanced Inspection Technology); Surfscan SP1, the industry's first unpatterned wafer inspection system designed for 300mm wafer and device technologies of 0.25 micron; and HRP-200 High Resolution Profiler, a fully-automated surface profiling system which provides complete, high-resolution global and local analysis of wafer surface topography during development and in-line monitoring of processes such as Chemical-Mechanical Polishing (CMP). The percentage increase was attributable to the Company's 32.4% growth in research and development spending compared to a 22.1% growth in revenues. The Company is committed to technology leadership in the semiconductor equipment industry and expects to increase its research and development expenditures in the coming year. MARKETING AND SELLING. Marketing and selling expenses were $63,478,000 and $53,156,000 in 1996 and 1995, or 15.7% and 16.1% of revenues, respectively. Compared to 1995, in 1996, marketing and selling expenses increased in absolute dollars. This increase can be attributed in part to greater product marketing efforts tied to new product introductions and higher employee compensation- related costs as a result of a net increase in worldwide headcount, and higher commission expense as a result of the increase in revenues. The Company established sales and support operations in both Singapore and Taiwan during 1996, and expects to continue to increase its presence in Asia both through the addition of personnel and the establishment of new sales and support operations. The Company anticipates marketing and selling spending will increase in absolute dollars in 1997. GENERAL AND ADMINISTRATIVE. General and administrative expenses were $28,861,000 and $17,696,000 in 1996 and 1995, or 7.2% and 5.4% of revenues, respectively. The increase in absolute dollars was due in part to increases in expenses resulting from the significant efforts involved with enhancements to the Company's information systems infrastructure including the implementation of the Company's new worldwide information system. The Company anticipates that general and administrative costs will decline in absolute dollars in 1997. RESTRUCTURING COSTS. During the quarter ended September 30, 1996, the Company recorded a charge for restructuring costs of $8.5 million. This charge consists of $2.0 million in employee severance and related costs as a result of downsizing its worldwide operations through a reduction in force of approximately 10% of the Company's regular employees. The restructuring charge also includes costs aggregating $6.5 million associated with the relocation from the Company's current leased facilities to the facility constructed for its use in Milpitas, California. The Company expects complete occupation of its new facility in Milpitas, California, in the early part of 1997. The Company has additional facilities with leases that expire on various dates through September 1998, and as a result of the Company's move to its new facility in Milpitas, certain of these facilities will become unoccupied during the first quarter of 1997. Due to the relatively short terms remaining on certain of these leases, the Company may be unable to sublease all of its unoccupied facilities. Accordingly, the Company has included in its restructuring charge an amount equal to the remaining costs (including rent) due under those leases which are unlikely to be subleased. The Company has also included in its lease exit cost, amounts for estimated leasehold refurbishment costs (net of existing 13 reserves) to return the facilities to their original condition as required by the lease agreements, the decline in net book value of certain of the Company's furniture and fixtures, and various other costs associated with the exit from its current facilities. Of the $8.5 million total restructuring costs, approximately $1.3 million was used as of December 31, 1996 with the majority of the remaining balance of $7.2 million expected to be utilized during the next nine months. OTHER INCOME, NET. Other income, net consisted primarily of interest income on short-term investments less interest expense on bank borrowings. Also included were gains and losses on foreign currency transactions. PROVISION FOR INCOME TAXES. Income taxes as a percentage of income before income taxes were 38.0% in 1996 and 41.0% in 1995, respectively. The decrease was due primarily to a decrease in profits in foreign jurisdictions with higher relative tax rates. The Company expects the income tax rate to decline modestly in 1997. YEARS ENDED DECEMBER 31, 1995 AND 1994. REVENUES. Revenues increased $147,867,000, or 81%, in 1995 versus 1994. The increase in revenues was primarily attributable to increased unit volumes of existing products and sales of newer products with higher average selling prices. Products with higher average selling prices included the Surfscan 6420 bare wafer inspection system, the Surfscan 7700 patterned wafer inspection system, the Prometrix UV-1250SE film thickness system and the Tencor P12 surface profiler. Geographically, the Company's revenue growth in 1995 compared to 1994 was driven by a 210% increase in Europe, principally Germany, a 108% increase in Japan, a 33% increase in Korea and a 41% increase in the U.S. The rest of the world, principally Singapore and Taiwan, increased 212%. GROSS MARGIN. Gross margin increased to 63.2% in 1995 from 59.8% in 1994. The increase during the period was due in part to a shift in product mix to new, higher margin products, and lower costs of sales resulting from direct sales of the Company's thin film and resistivity products in Japan and Europe, manufacturing efficiencies and increased production volumes resulting in better capacity utilization. RESEARCH AND DEVELOPMENT. Research and development expenses were $33,427,000 and $25,325,000 in 1995 and 1994 or 10.1% and 13.9% of revenues, respectively. The increase in absolute dollars is due primarily to increases in salaries and benefits expenses resulting from increased headcount during the period and increases in project material costs associated with new product development, particularly the recently introduced Surfscan AIT and SP1. The percentage decrease was attributable to the Company's 32% growth in research and development spending compared to an 81% growth in revenues. MARKETING AND SELLING. Marketing and selling expenses were $53,156,000 and $31,620,000 in 1995 and 1994, respectively or 16.1% and 17.3% of revenues, respectively. In 1995, compared to 1994, marketing and selling expenses increased in absolute dollars due primarily to increased foreign distributor commissions stemming from increased foreign distributor sales in new markets such as Singapore and Taiwan, offset in part by selling the Company's film measurement products direct in Japan, increased marketing and selling headcount and increased domestic commissions stemming from increased domestic sales. The decline as a percentage of revenues was attributable to the Company's 68% growth in marketing and selling spending compared to an 81% growth in revenues. 14 GENERAL AND ADMINISTRATIVE. General and administrative expenses were $17,696,000 and $10,366,000 in 1995 and 1994 or 5.4% and 5.7% of revenues, respectively. While general and administrative expenses grew in absolute dollars, they declined as a percentage of revenues primarily attributable to the Company's 71% growth in general and administrative spending compared to an 81% growth in revenues. OTHER INCOME, NET. Other income, net consisted primarily of interest income on short-term investments less interest expense on bank borrowings. Also included were gains and losses on foreign currency transactions. PROVISION FOR INCOME TAXES. Income taxes as a percentage of income before income taxes were 41.0% in 1995 and 40.4% in 1994, respectively. The increase was due primarily to increased foreign sales in jurisdictions with higher relative tax rates. LIQUIDITY AND CAPITAL RESOURCES. The Company has financed its growth primarily through cash flows from operations and amounts, net of offering costs, raised in connection with equity offerings in March 1993 ($10,867,000), September 1994 ($38,187,000) and April 1995 ($65,865,000). Net cash provided by operations was $93,685,000 in 1996, an increase of $77,313,000 from cash provided by operations in 1995. The primary factor contributing to the increase in cash generated from operations was the decrease in accounts receivable of $25,180,000 during 1996. This decrease is due in part to improved collections and a decline in revenues in the second half of 1996 compared to the same period in 1995. In addition, collection times in Japan were reduced, partly as a result of the factoring agreement with a local bank to sell, with recourse, certain trade receivables which the Company accounted for as an off-balance sheet arrangement. Working capital was $274,238,000 and $241,082,000 as of December 31, 1996 and 1995, respectively. At December 31, 1996, the Company had $223,777,000 in cash and cash equivalents and short-term investments. For investing activities, the Company's capital requirements typically consist of computers, manufacturing equipment and cleanrooms. Capital expenditures in 1996 and 1995 were $32,788,000 and $16,493,000, respectively. The increase in capital expenditures in 1996 represents the Company's investment in equipment and software for its new information system and improvements of its Milpitas- based training facility and cleanrooms located in the U.S. and Japan. In November 1995, the Company entered into a seven year operating lease transaction for the office and manufacturing facility in Milpitas, California. The Company's obligations under the lease may be collateralized at the Company's option by cash and/or investments in order to reduce its monthly payments. At December 31, 1996, cash and securities collateralized under the lease was $71,300,000 and is expected to reach approximately $90,000,000 upon completion scheduled for early 1997. At December 31, 1996, the Company's principal sources of liquidity consisted of $223,777,000 in cash, cash equivalents and short-term investments and $15,291,000 available under its multi-currency revolving line of credit agreement. Capital expenditures are expected to approximate $29,000,000 in 1997. This amount includes funds for the continuation and completion of facilities expansions, investments in equipment and software for its new information systems and other capital expenditures. 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 1997. 15 The Company believes that success in its industry requires substantial capital in order to maintain the flexibility to take advantage of opportunities as they may arise. The Company may, from time to time, as market and business conditions warrant, invest in or acquire complementary businesses, products or technologies. The Company may effect additional equity or debt financings to fund such activities. The sale of additional equity or convertible debt securities could result in additional dilution to the Company's shareholders. OTHER FACTORS AFFECTING COMPANY RESULTS 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 include specific economic conditions in the semiconductor industry, the timing of the receipt of orders from major customers, customer cancellations or delays of shipments, specific feature requests by customers, production delays or manufacturing inefficiencies, exchange rate fluctuations, management decisions to commence or discontinue product lines, the Company's ability to design, introduce and manufacture new products on a cost effective and timely basis, the introduction of new products by the Company or its competition, the selection of the Company's products by semiconductor manufacturers for new generations of fabrication facilities, the timing of research and development expenditures, and expenses attendant to restructuring, acquisitions, strategic alliances and the further development of marketing and service capabilities. 16 ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Index to Financial Statements Financial Statements: Consolidated Balance Sheets - December 31, 1996 and 1995 . . . . . . . . . .18 Consolidated Statements of Income - December 31, 1996, 1995 and 1994 . . . .19 Consolidated Statements of Shareholder's Equity - December 31, 1996, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . . .20 Consolidated Statements of Cash Flows - December 31, 1996, 1995 and 1994 . .21 Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . .22 Report of Independent Accountants. . . . . . . . . . . . . . . . . . . . . .36 Financial Statement Schedules: All schedules are omitted because they are either not applicable or the required information is shown in the financial statements or notes thereto. 17 TENCOR INSTRUMENTS CONSOLIDATED BALANCE SHEETS December 31, 1996 1995 - ------------------------------------------------------------------------------- In thousands ASSETS Current assets: Cash and cash equivalents $141,407 $ 86,944 Short-term investments 82,370 76,889 Accounts receivable, net 87,623 118,857 Inventories 51,668 46,725 Deferred income taxes 19,056 8,869 Prepaid expenses and other assets 10,165 6,666 - ------------------------------------------------------------------------------- Total current assets 392,289 344,950 - ------------------------------------------------------------------------------- Property and equipment, net 41,601 22,447 Other assets 50,529 27,643 - ------------------------------------------------------------------------------- Total assets $484,419 $395,040 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Bank borrowings $ 28,162 $ 34,123 Accounts payable 11,936 16,858 Accrued compensation 21,496 16,526 Other accrued expenses 33,029 22,816 Income taxes payable 23,428 13,545 - ------------------------------------------------------------------------------- Total current liabilities 118,051 103,868 - ------------------------------------------------------------------------------- Long-term obligations 1,335 3,027 - ------------------------------------------------------------------------------- Commitments and contingencies (Notes 2, 4, 8 and 10) Shareholders' equity: Common stock, no par value: 60,000 shares authorized; 31,053 and 30,751 shares issued and outstanding 152,756 151,675 Retained earnings 200,024 138,736 Accumulated unrealized gain on investments, net 14,602 --- Cumulative translation adjustment (2,349) (2,266) - ------------------------------------------------------------------------------- Total shareholders' equity 365,033 288,145 - ------------------------------------------------------------------------------- Total liabilities and shareholders' equity $484,419 $395,040 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- See accompanying notes to consolidated financial statements. 18 TENCOR INSTRUMENTS CONSOLIDATED STATEMENTS OF INCOME Year ended December 31, 1996 1995 1994 - ------------------------------------------------------------------------------- In thousands, except per share data Revenues $403,170 $330,197 $182,330 Cost of goods sold 166,123 121,522 73,243 - ------------------------------------------------------------------------------- Gross profit 237,047 208,675 109,087 - ------------------------------------------------------------------------------- Operating expenses: Research and development 44,258 33,427 25,325 Marketing and selling 63,478 53,156 31,620 General and administrative 28,861 17,696 10,366 Restructuring/merger charges 8,500 --- 2,300 - ------------------------------------------------------------------------------- Total operating expenses 145,097 104,279 69,611 - ------------------------------------------------------------------------------- Income from operations 91,950 104,396 39,476 Other income, net 6,901 6,322 1,294 - ------------------------------------------------------------------------------- Income before income taxes 98,851 110,718 40,770 Provision for income taxes 37,563 45,394 16,454 - ------------------------------------------------------------------------------- Net income $ 61,288 $ 65,324 $ 24,316 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Net income per share $ 1.93 $ 2.09 $ 0.90 Weighted average common shares and equivalents 31,763 31,212 27,162 See accompanying notes to consolidated financial statements. 19 TENCOR INSTRUMENTS CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Common Stock Accum. Cumulative -------------------- Retained Unrealized Translation Shares Amount Earnings Gain Adjustment Totals - -------------------------------------------------------------------------------------------------------------------------------- In thousands Balances at December 31, 1993 22,990 $21,107 $49,446 --- $(361) $70,192 Adjustment to conform fiscal year of Prometrix --- --- (350) --- --- (350) Net issuance under employee stock plans 1,428 5,511 --- --- --- 5,511 Equity offering, net of offering costs 2,466 38,187 --- --- --- 38,187 Release of FleXus escrowed shares 178 3,422 --- --- --- 3,422 Release of Prometrix escrowed shares 394 --- --- --- --- --- Tax benefits of stock option transactions --- 3,150 --- --- --- 3,150 Cumulative translation adjustment --- --- --- --- 301 301 Net income --- --- 24,316 --- --- 24,316 - -------------------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1994 27,456 71,377 73,412 --- (60) 144,729 Net issuance under employee stock plans 965 5,630 --- --- --- 5,630 Equity offering, net of offering costs 2,330 65,865 --- --- --- 65,865 Tax benefits of stock option transactions --- 8,803 --- --- --- 8,803 Cumulative translation adjustment --- --- --- --- (2,206) (2,206) Net income --- --- 65,324 --- --- 65,324 - -------------------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1995 30,751 151,675 138,736 --- (2,266) 288,145 Net issuance under employee stock plans 552 5,570 --- --- --- 5,570 Repurchase of common stock (250) (5,456) --- --- --- (5,456) Tax benefits of stock option transactions --- 967 --- --- --- 967 Cumulative translation adjustment --- --- --- --- (83) (83) Accum. unrealized gain on investments, net --- --- --- $14,602 --- 14,602 Net income --- --- 61,288 --- --- 61,288 - -------------------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1996 31,053 $152,756 $200,024 $14,602 $(2,349) $365,033 - -------------------------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 20 TENCOR INSTRUMENTS CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31, 1996 1995 1994 - --------------------------------------------------------------------------------------------------------- In thousands Cash flows from operating activities: Net income $ 61,288 $ 65,324 $ 24,316 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 16,459 7,635 3,120 Deferred income taxes (12,425) (4,231) (4,262) Adjustment to conform Prometrix fiscal year --- --- (350) Non-cash acquisition of in-process R&D --- --- 1,200 Changes in assets and liabilities: Accounts receivable, net 25,180 (67,271) (32,709) Inventories (6,483) (25,200) (5,010) Prepaid expenses and other assets (1,771) (4,400) (72) Accounts payable (4,830) 8,956 3,318 Accrued compensation 5,204 7,028 4,881 Other accrued expenses 7,963 12,170 3,586 Income taxes payable 3,100 16,361 6,546 - --------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 93,685 16,372 4,564 - --------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Purchase of property and equipment (32,788) (16,493) (6,972) Purchases of short-term investments (90,255) (48,061) (56,391) Proceeds from sale of short-term investments 84,632 7,876 38,104 Long-term equity investment --- (10,732) --- - --------------------------------------------------------------------------------------------------------- Net cash used in investing activities (38,411) (67,410) (25,259) - --------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Issuance of common stock, net 5,570 5,630 7,203 Proceeds from equity offerings, net --- 65,865 38,187 Stock repurchases (5,456) --- --- Payments under debt obligations (44,436) --- --- Borrowings under debt obligations 41,403 29,693 --- - --------------------------------------------------------------------------------------------------------- Net cash provided by (used in) financing activities (2,919) 101,188 45,390 - --------------------------------------------------------------------------------------------------------- Effect of exchange rate changes on cash and cash equivalents 2,108 (327) (706) - --------------------------------------------------------------------------------------------------------- Net increase in cash and cash equivalents 54,463 49,823 23,989 Cash and cash equivalents at beginning of period 86,944 37,121 13,132 - --------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of period $ 141,407 $ 86,944 $ 37,121 - --------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------- Supplemental cash flow disclosures: Income taxes paid $ 47,849 $ 34,712 $ 12,425 Interest paid $ 1,325 $ 437 $ 197 Supplemental non-cash investing cash flow disclosures: Tax benefits from stock option transactions $ 967 $ 8,803 $ 3,150 Accumulated unrealized gain on investment, net $ 14,602 --- ---
See accompanying notes to consolidated financial statements. 21 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the financial statements of Tencor Instruments and its wholly owned subsidiaries (the "Company"). All significant intercompany transactions and accounts have been eliminated. 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. STOCK BASED COMPENSATION PLANS The Company accounts for its employee 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". In 1995, the Financial Accounting Standards Board released FAS 123, "Accounting for Stock-Based Compensation". FAS 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 additional disclosure required by FAS 123. Accordingly, FAS 123 did not have any impact on the Company's financial position or results of operations. Refer to Note 7 of Notes to Consolidated Financial Statements. CASH EQUIVALENTS Cash equivalents are highly liquid investments which are valued at cost, which approximates market, and have original maturity dates of three months or less. Cash equivalents generally consist of treasury notes and money market deposits. INVESTMENTS Investments in debt and equity securities are classified as "available-for- sale." Short-term investments consist primarily of U.S. government and municipal bonds and corporate notes which are recorded at fair market value. The long-term equity investments consist of an investment in common stock which is recorded at fair market value. Net unrealized gains and losses are recorded as a separate component of shareholders' equity. Interest income is accrued as earned. REVENUE RECOGNITION Revenue is generally recognized upon shipment. Revenues from distributors are recognized upon shipment as no right of return, stock rotation or price protection is given. 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 standard cost, which approximates actual cost (on a first-in, first-out basis), or market. Self-constructed demonstration units are stated at their manufacturing costs and reserves are recorded to state the demonstration units at their net realizable value. 22 PROPERTY AND EQUIPMENT Property and equipment are recorded at cost. Depreciation of property and equipment is based on the straight-line method over the shorter of the estimated lives of the assets, generally three to seven years, or the lease terms. INTANGIBLE ASSETS Purchased patents and licenses are amortized over their remaining estimated useful lives on a straight-line basis. Purchased product technologies are amortized over their estimated useful lives of three to seven years on a straight-line basis. Goodwill is amortized over ten years on a straight-line basis. The Company periodically reviews the recoverability of intangible assets based upon the present value of estimated future cash flows. CONCENTRATION OF CREDIT RISK Financial instruments which potentially subject the Company to credit risk consist of cash equivalents, short-term investments and marketable equity securities, accounts receivable and financial instruments used in hedging activities. Cash equivalents and short-term investments are maintained with high quality institutions, the composition and maturities of which are regularly monitored by management. Generally, these securities maintain a highly liquid market and may be redeemed upon demand and, therefore, bear minimal risk. 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 are 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. The write-offs related to credit losses have been insignificant. OFF-BALANCE SHEET RISK The Company enters into foreign currency forward exchange contracts to reduce the impact of currency fluctuations of intercompany balance sheet positions. The objectives of these contracts is to neutralize the impact of foreign currency exchange rate movements on the Company's operating results. The gains and losses on forward exchange contracts are included in earnings when the underlying foreign currency denominated transaction is recognized. 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. The foreign exchange forward contracts described above generally require the Company to sell foreign currencies for U.S. dollars at rates agreed to at the inception of the contracts. The forward contracts generally have maturities of three months or less. These contracts generally do not subject the Company to significant market risk from exchange rate movements because the contracts are designed to offset gains and losses on the balances and transactions being hedged. At December 31, 1996, the Company had forward contracts to sell approximately $6.4 million in Japanese Yen. The fair value of forward exchange contracts, based upon current market rates, totaled approximately $6.2 million at December 31, 1996. The Company does not anticipate any material adverse effect on its financial position resulting from the use of these instruments. 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 for cash and cash equivalents, investments and bank borrowings reasonably estimate their fair value. 23 INCOME TAXES Deferred tax assets and liabilities are recognized for the expected future tax consequences related to temporary differences between the tax bases of the assets and liabilities and the amounts reported in the Company's financial statements. In estimating future tax consequences, the Company generally considers all expected future events other than enactment of changes in the tax law or rates. 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. FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS The Company has several foreign subsidiaries. The functional currencies of the Company's foreign subsidiaries are the local currencies. Accordingly, all assets and liabilities of the foreign operations are translated to U.S. dollars at the 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 shareholders' equity under the caption "cumulative translation adjustment." Foreign currency transaction gains and losses have not been significant. NOTE 2 - MERGER On January 14, 1997, the Company and KLA Instruments Corporation jointly announced a definitive merger agreement to create a combined company. Under the terms of the merger agreement, shares and options for KLA Instruments common stock will be exchanged for all outstanding shares and options of the Company on the basis of one share of KLA Instruments for each share of the Company. The transaction is intended to qualify as pooling of interests for financial reporting purposes and structured to qualify as a tax-free reorganization. The transaction is conditioned on obtaining both companies' shareholder approval, regulatory clearance and other customary closing conditions. The merger is expected to close during the June 30, 1997 quarter. 24 NOTE 3 - BALANCE SHEET COMPONENTS December 31, 1996 1995 - --------------------------------------------------------------------------- (in thousands) Short-term investments available for sale: U.S. government notes and bonds $33,904 $40,040 Municipal notes and bonds 48,466 31,762 Corporate notes and bonds --- 5,087 ---------------------- $82,370 $76,889 ---------------------- ---------------------- Short-term investments of $38,905 mature in less than one year, $30,952 have maturities between one and five years and $12,513 have maturities greater than five years. Inventories: Raw materials $26,010 $24,829 Work-in-process 15,100 12,948 Finished goods 10,558 8,948 ---------------------- $51,668 $46,725 ---------------------- ---------------------- Property and equipment: Machinery and equipment $54,617 $28,845 Office furniture and fixtures 7,228 5,705 Leasehold improvements 11,385 8,035 Less: accumulated depreciation and amortization (31,629) (20,138) ---------------------- $41,601 $22,447 ---------------------- ---------------------- Other assets: Long-term equity investments $34,355 $10,732 Purchased patents and technology, net 5,537 7,492 Goodwill, net 3,084 3,485 Deferred income taxes 4,183 1,946 Other 3,370 3,988 ---------------------- $50,529 $27,643 ---------------------- ---------------------- Other accrued expenses: Warranty and retrofit $ 9,215 $ 6,685 Representative sales commissions 4,650 4,597 Restructuring charges 7,179 --- Other accrued expenses 11,985 11,534 ---------------------- $33,029 $22,816 ---------------------- ---------------------- NOTE 4 - BORROWING ARRANGEMENTS AND OTHER LIABILITIES The Company has a $20.0 million unsecured multi-currency revolving line of credit agreement with a bank which expires in June 1997. As of December 31, 1996, borrowings under the line of credit were $4.3 million and incur interest charges at the London Interbank Offering Rate (LIBOR) plus 1.0%, or approximately 7% at December 31, 1996. The line of credit requires compliance with certain financial covenants. The Company's Japanese subsidiary has loan arrangements with local banks. As of December 31, 1996 the aggregate bank borrowings are the Yen equivalent of $24.1 million. These borrowings 25 incur interest charges at the LIBOR plus bank premium, which, during 1996, ranged from 1.1% to 1.6%. The Company's Japanese subsidiary has an agreement with a local bank to sell, with recourse, certain of its trade receivables. The total amount of the facility is three billion yen, or approximately $25.9 million at December 31, 1996. The Company has accounted for the sale of certain of these receivables, for which the related product has been technologically accepted by its customers, as an off balance sheet financing arrangement. During 1996, a total of the yen equivalent of approximately $42.4 million of receivables were sold under this arrangement. As of December 31, 1996, the yen equivalent of $23.2 million remains uncollected. Of the total amount uncollected, the yen equivalent of $20.9 million was accounted for as an off-balance sheet financing arrangement and the yen equivalent of $2.3 million has been treated as a borrowing. The Company does not believe it is materially at risk for any losses as a result of this agreement. The Company also has obligations of approximately $3.2 million related primarily to the purchase of certain product technology. Future payments under these obligations are as follows: Year ending December 31, (in thousands) 1997 $ 1,867 1998 1,272 1999 32 2000 31 -------- Total minimum payments 3,202 Less: current portion (1,867) -------- Long-term obligations, less current portion $ 1,335 -------- -------- 26 NOTE 5 - RESTRUCTURING COSTS During the quarter ended September 30, 1996, the Company recorded a charge for restructuring costs of $8.5 million. This charge consists of $2.0 million in employee severance and related costs as a result of downsizing its worldwide operations through a reduction in force of approximately 10% of the Company's regular employees. The restructuring charge also includes costs aggregating $6.5 million associated with the relocation from the Company's current leased facilities to the facility constructed for its use in Milpitas, California. The Company expects complete occupation of its new facility in Milpitas, California, in the early part of 1997. The Company maintains facilities with leases that expire on various dates through September 1998. As a result of the Company's move to its new facility in Milpitas, certain of these leased facilities will become unoccupied during the first quarter of 1997. Due to the relatively short terms remaining on certain of these leases, the Company may be unable to sublease all of its unoccupied facilities. Accordingly, the Company has included in its restructuring charge an amount equal to the remaining costs (including rent) due under those leases which are unlikely to be subleased. The Company has also included in its lease exit cost, amounts for the decline in net book value of certain of the Company's furniture and fixtures, estimated leasehold refurbishment costs (net of existing reserves) to return the facilities to their original condition as required by the lease agreements, and various other costs associated with the exit from its current facilities. Of the $8.5 million total restructuring costs, approximately $1.3 million was used as of December 31, 1996 with the majority of the remaining balance of $7.2 million expected to be utilized during the next nine months. A summary of charges for restructuring costs along with the respective remaining reserves which are included in accrued liabilities, follows (in thousands): Charge Recorded Remaining Reserves September 30, 1996 Payments December 31, 1996 ------------------------------------------------------- Downsizing $1,983 $( 1,151) $ 832 Lease exit costs 6,517 ( 170) 6,347 ------ -------- ------- Total $8,500 $( 1,321) $ 7,179 ------ -------- ------- ------ -------- ------- 27 NOTE 6 - INCOME TAXES December 31, 1996 1995 1994 - ------------------------------------------------------------------------------ (in thousands) The components of income before income taxes are as follows: Domestic income before income taxes $96,202 $101,116 $28,221 Foreign income before income taxes 2,649 9,602 12,549 ------------------------------- $98,851 $110,718 $40,770 ------------------------------- ------------------------------- The provision (benefit) for income taxes is comprised of the following: Current: Federal $39,503 $ 37,704 $15,771 State 5,752 6,194 2,357 Foreign 2,898 5,727 2,572 ------------------------------- 48,153 49,625 20,700 ------------------------------- Deferred: Federal (9,310) (3,100) (2,601) State (761) (264) (1,645) Foreign (519) (867) --- ------------------------------- (10,590) (4,231) ( 4,246) ------------------------------- Provision for income taxes $37,563 $ 45,394 $16,454 ------------------------------- ------------------------------- The significant components of deferred income tax assets are as follows: Inventories and other reserves $ 5,373 $ 2,755 Warranty and employee benefit accruals 6,186 4,105 Depreciation and amortization 3,504 360 Other 6,342 3,595 ------------------- $21,405 $ 10,815 ------------------- ------------------- The reconciliation of the United States federal statutory income tax rate to the Company's effective income tax rate is as follows: Federal statutory rate 35.0% 35.0% 35.0% State income taxes, net of federal benefit 3.8 3.6 3.8 Effect of foreign operations taxed at various rates 2.0 3.1 2.6 Benefit from foreign sales corporation (3.5) (3.1) (3.0) Research and development tax credit --- --- (0.2) Merger costs --- --- 1.7 Other 0.7 2.4 0.5 ---- ---- ---- 38.0% 41.0% 40.4% ---- ---- ---- ---- ---- ---- NOTE 7 - SHAREHOLDERS' EQUITY In February 1996, the Company repurchased 250,000 shares of its Common Stock for $5.5 million. In June 1996, employees holding options to purchase shares of the Company's Common Stock were offered the opportunity to exchange their existing options ranging in prices from $17.875 per share to $46.875 per share for options at the then current market price of $17.625 per share. The Company granted new replacement stock options of 831,171 shares in exchange for the cancellation of the entire unexercised portion of the options being replaced. 28 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 awards in the form of stock options, stock appreciation rights, stock purchase rights, and performance shares. As of December 31, 1996, only stock options have been awarded under the plans. Options to purchase Common Stock have been granted at no less than 85% of their fair market value on the date of grant. The activity under the option plans, combined, was as follows:
Option Weighted- Available Options Price Average For Grant Outstanding per Share Exercise Price --------- ----------- --------- -------------- Balances at December 31, 1993 1,267,664 3,005,096 $ 1.13 - $ 6.00 $ 3.37 Additional shares reserved 1,000,000 --- --- --- Options granted (1,316,690) 1,316,690 4.83 - 23.57 11.71 Options canceled 130,252 (130,252) 1.13 - 13.32 4.33 Options exercised --- (1,314,774) 1.13 - 5.88 3.20 Options expired (623,928) --- --- --- ---------- ---------- Balances at December 31, 1994 457,298 2,876,760 $ 1.29 - $23.57 $ 7.19 Additional shares reserved 800,000 --- --- --- Options granted (974,477) 974,477 17.88 - 46.89 37.01 Options canceled 94,051 (94,051) 1.29 - 38.25 19.10 Options exercised --- (811,796) 1.29 - 13.31 4.46 Options expired (12,921) --- --- --- ---------- ---------- Balances at December 31, 1995 363,951 2,945,390 $ 1.29 - $46.89 $17.43 Additional shares reserved 1,550,000 --- --- --- Options granted (1,787,420) 1,787,420 15.94 - 29.00 18.33 Options canceled 1,196,776 (1,196,776) 1.45 - 46.89 31.88 Options exercised --- (310,683) 1.29 - 22.31 5.62 Options expired (14,547) --- --- --- ---------- ---------- Balances at December 31, 1996 1,308,760 3,225,351 $ 1.45 - $40.00 $13.70 ---------- ---------- ---------- ----------
29 The options outstanding at December 31, 1996 have been segregated into ranges for additional disclosure as follows:
Options Outstanding Options Vested and Exercisable ------------------------------------------------- ------------------------------------ Number Weighted-Average Weighted- Number Vested Range of Outstanding Remaining Average and Exercisable Weighted-Average Exercise Prices at 12/31/96 Contractual Life Exercise Price at 12/31/96 Exercise Price --------------- ----------- ---------------- -------------- ----------- -------------- $ 1.45 - $ 5.88 639,429 4.38 $ 3.81 549,049 $ 4.07 $ 6.00 - $ 8.50 326,096 7.25 7.16 279,709 $ 7.16 $ 13.31 - $13.31 598,527 7.61 13.31 372,404 $13.31 $ 15.94 - $17.06 10,800 9.54 16.45 0 $ 0.00 $ 17.63 - $17.63 958,912 9.49 17.63 850 $17.63 $ 17.75 - $40.00 691,887 9.62 20.78 48,173 $29.75 ------------------------------------------------------------------------------------------------------------- $ 1.45 - $40.00 3,225,351 7.93 $13.70 1,250,185 $ 8.51 ------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------
The weighted average fair value of options granted in 1996 and 1995 is $9.11 and $18.53, respectively. EMPLOYEE STOCK PURCHASE PLAN. The Company's employee stock purchase plan provides that eligible employees may contribute up to 10% of their base earnings towards the quarterly purchase of the Company's Common Stock. 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 1996 and 1995, 242,713 and 159,042 shares, respectively, had been purchased by employees. At December 31, 1996, 522,919 shares were reserved and available for issuance under this plan. PRO FORMA INFORMATION. As of December 31, 1996, the Company has various stock- based compensation plans which are discussed above. The Company has elected to follow APB 25 and related interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under SFAS 123 requires use of option valuation models that were not developed for use in valuing employee stock options and employee stock purchase plans. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of the grant, no compensation expense is recognized. 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 December 31, 1994 under the fair value method of SFAS 123. The fair value for these options was estimated at the date of grant using the Black-Scholes option pricing model for the single option approach with the following weighted-average assumptions for 1995 and 1996, respectively: risk-free interest rate of approximately 5.7% for both years; volatility factor of the expected market price of the Company's Common Stock of .58 for both years and a weighted-average expected life of the options of approximately 3.5 for both years. 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 Company's employee stock options and employee stock 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 the Company's employee stock options and the employee stock purchase plan. 30 For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows (in thousands except for earnings per share information): 1996 1995 ---- ---- Net income: Historical 61,288 65,324 Pro forma 55,355 63,764 Earnings per share: Historical $ 1.93 $ 2.09 Pro forma $ 1.79 $ 2.06 OTHER EMPLOYEE BENEFIT PLANS. The Company has a profit sharing program for eligible employees. The program accumulates and distributes, on a six-month basis, a percentage of pretax profits, as determined by the Board of Directors. In addition, the Company has an employee savings plan (the Savings Plan) that qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code. During 1996, 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) programs aggregated approximately $6.6 million, $6.3 million and $2.5 million in 1996, 1995 and 1994, respectively. NOTE 8 - COMMITMENTS AND CONTINGENCIES The Company leases its principal facilities under non-cancelable operating leases. The leases expire at various times beginning in December 1996 through November 2004, with renewal options at fair market value for additional periods. The Company also leases equipment and other facilities under operating leases. In late 1995, the Company entered into two seven-year operating leases for land, office and manufacturing facilities being constructed for its use in Milpitas, California. As of December 31, 1996, the lessor has funded a total of $71.3 million and has committed to fund up to $90.0 million. The leases provide for monthly payments which vary based upon the total constructed costs of the properties and the London Interbank offering rate (LIBOR). The Company's lease obligations under the leases may be collateralized at the Company's option in order to reduce the monthly payments. Payments under these leases will commence upon the Company's occupation and completion of the buildings in the second quarter of 1997. The leases 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 $72.9 million. In addition, under the terms of the leases, the Company must maintain compliance with certain financial covenants. As of December 31, 1996, the Company was in compliance with these 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. Total operating lease expense was $5.3 million, $5.2 million and $3.3 million for the years ended December 31, 1996, 1995 and 1994, respectively. 31 Future minimum lease payments under non-cancelable operating leases, which include estimated lease payments for its Milpitas, California facilities using a LIBOR rate of approximately 6.0% and total construction costs of $90.0 million, are as follows (in thousands): 1997 $ 9,782 1998 8,648 1999 7,513 2000 7,209 2001 6,778 Thereafter 17,243 ------- Total net minimum lease payments $57,173 ------- ------- Because a large number of patents exist in the semiconductor field and new patents are issued frequently, the Company from time to time, in the normal course of business, receives and makes inquiries with regard to possible patent infringement. The Company believes that it is unlikely that the outcome of these inquiries will have a material adverse effect on the Company's financial position. The Company intends to be active in the protection of its intellectual property, including its patents. 32 NOTE 9 - INDUSTRY AND GEOGRAPHIC INFORMATION No single customer accounted for more than 10% of net revenues in 1996 and 1995. International sales accounted for 64%, 62% and 51% of the Company's revenues in 1996, 1995 and 1994, respectively. The Company designs, manufactures, markets and services wafer defect 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 December 31, 1996 1995 1994 - ----------------------- ---- ---- ---- (In thousands) Revenues: Sales to unaffiliated customers: Domestic $147,197 $126,078 $ 89,269 International: Japan 94,744 86,112 41,482 Korea 49,063 31,481 23,699 Taiwan 29,194 16,937 --- Singapore 13,957 2,461 --- Europe 54,521 60,871 19,649 ROW 14,494 6,257 8,231 -------------------------------------- Total sales to unaffiliated customers 403,170 330,197 182,330 Intercompany sales among geographic areas: United States 3,615 2,868 1,244 Japan 67,785 52,350 17,292 Singapore 1,727 --- --- Europe 39,404 37,740 8,448 Consolidation eliminations (112,531) (92,958) (26,984) -------------------------------------- Revenues $403,170 $330,197 $182,330 -------------------------------------- -------------------------------------- Income from operations: United States $ 5,856 $ 12,985 $ 26,913 Japan 32,614 37,884 8,755 Korea 13,160 11,204 755 Taiwan 9,998 7,610 --- Singapore 4,279 1,121 --- Europe 26,043 33,592 3,053 -------------------------------------- Income from operations $ 91,950 $104,396 $ 39,476 -------------------------------------- -------------------------------------- Identifiable assets at December 31: United States $210,496 $153,717 $ 81,019 Japan 27,817 51,397 23,183 Korea 3,029 1,958 378 Taiwan 402 --- --- Singapore 887 --- --- Europe 18,011 24,135 6,143 General corporate assets consisting of cash, cash equivalents and short-term investments 223,777 163,833 73,826 -------------------------------------- Total assets $484,419 $395,040 $184,549 -------------------------------------- --------------------------------------
Intercompany sales among the Company's geographic areas are recorded on the basis of intercompany prices established by the Company. 33 At December 31, 1996, 1995 and 1994, total foreign liabilities (excluding intercompany balances) were $35.9 million, $42.6 million and $10.6 million, respectively. For fiscal years 1996, 1995 and 1994, foreign capital expenditures and depreciation expense were $3.3 million and $542,000, $1.4 million and $331,000 and $642,000 and $299,000, respectively. Certain reclassifications have been made to amounts in 1995 in order to be comparative to the presentation in 1996. 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) and, as a result, 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 and the Company has recorded the purchase of Uniphase common stock as a long-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 $14.3 million related to the increase in fair market value of the Company's investment in Uniphase common stock as of December 31, 1996. ACQUISITIONS. On February 25, 1994, a subsidiary of the Company completed its merger with Prometrix Corporation ("Prometrix). As a result of conforming Prometrix's fiscal year to that of the Company's, Prometrix's loss for the two months ended December 31, 1993 of $350,000 was charged to retained earnings effective January 1, 1994. Also, in connection with the merger, $2.3 million of merger costs and expenses were incurred and charged to merger expense in 1994. On March 3, 1992, the Company acquired FleXus, Inc. (FleXus) . A portion of the stock was escrowed pending revenues from FleXus products achieving agreed upon levels, and in 1994, the Company recorded the release of escrowed common stock at a value of $3.4 million. PARK SCIENTIFIC LICENSE. The Company expensed the purchase of an in-process R&D technology licensing agreement with Park Scientific (PSI) in the amount of $1.2 million to R&D expense in 1994. 34 NOTE 11 - QUARTERLY CONSOLIDATED RESULTS OF OPERATIONS (UNAUDITED) (In thousands, except per share amounts) March 31 June 30 September 30 December 31 1996: Revenues $106,283 $109,417 $ 96,986 $ 90,484 Gross profit 65,436 65,193 55,774 50,644 Income from operations 31,369 28,393 13,214(1) 18,974 Net income 20,251 18,546 9,603(1) 12,888 Net income per share $ 0.64 $ 0.59 $ 0.30(1) $ 0.40 1995: Revenues $ 67,608 $ 78,664 $ 88,003 $ 95,922 Gross profit 42,558 50,229 55,502 60,386 Income from operations 20,831 24,565 29,150 29,850 Net income 12,876 15,495 18,174 18,779 Net income per share $ 0.44 $ 0.49 $ 0.57 $ 0.59 (1) Includes an $8.5 million restructuring charge. 35 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Tencor Instruments In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of shareholders' equity and of cash flows present fairly, in all material respects, the financial position of Tencor Instruments and its subsidiaries at December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, 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 February 7, 1997 _________________________________ 36 ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT DIRECTORS The following table sets forth certain information as of March 7, 1997, with respect to the Company's Board of Directors: NAME AGE POSITION ---- --- -------- Jon D. Tompkins 56 Chairman of the Board, President and Chief Executive Officer Richard J. Elkus, Jr. 62 Vice Chairman of the Board James W. Bagley 58 Director Dean O. Morton 64 Director Dr. Calvin F. Quate 73 Director Lida Urbanek 53 Director Renn Zaphiropoulos 70 Director JON D. TOMPKINS Mr. Tompkins was appointed President and Chief Executive Officer of Tencor in April 1991. He has served on Tencor's Board of Directors since May 1991 and was appointed Chairman of the Board of Directors in November 1993. Mr. Tompkins also serves on the Boards of Directors of Fusion Systems, Varian and SEMI/SEMATECH, a private research and development consortium of U.S. semiconductor equipment and materials companies. RICHARD J. ELKUS, JR. Mr. Elkus has been Vice Chairman of the Board of Tencor since February 1994 to the present. Mr. Elkus is currently serving on the Board of Directors of OnTrak Systems, Inc. and Voyan Technology. Mr. Elkus was Executive Vice President of Tencor from February 1994 to September 1996, and was one of the founders of Prometrix Corporation, which was acquired by Tencor in February 1994. Mr. Elkus was the Chairman of the Board and Chief Executive Officer of Prometrix from 1983 until February 1994. JAMES W. BAGLEY Mr. Bagley has been a director of Tencor since June 1993. Mr. Bagley is Chairman and Chief Executive Officer of OnTrak Systems, Inc. Previously, Mr. Bagley was Vice Chairman of Applied Materials, Inc., the largest supplier of wafer fabrication systems to the semiconductor industry, until May, 1996. Prior to joining Applied Materials, Mr. Bagley was with Texas Instruments Incorporated for more than 15 years. Mr. Bagley also serves on the Board of Directors of Teradyne, Inc., Kulicke & Soffa Industries, Inc., and Extraction Systems, Inc. DEAN O. MORTON Mr. Morton has been a director of Tencor since June 1993. Mr. Morton retired in October 1992 as Executive Vice President and Chief Operating Officer and as a director of Hewlett- Packard Company, a computer and instruments manufacturer, where he had held various positions since 1960. Mr. Morton is a director of ALZA Corporation, Centigram Communications Corporation, The Clorox Company and Raychem Corporation. He is also a director of the Metropolitan Series Fund and 37 MetLife Portfolios, a trustee of the MetLife State Street and State Street Research funds and a director of the Kaiser Foundation Health Plan and Hospitals. Mr. Morton also serves on the Board of Associates, Harvard Business School and is a Trustee of the David and Lucille Packard Foundation. DR. CALVIN F. QUATE Dr. Quate has been a director of Tencor since 1989. Dr. Quate has been a Professor of Applied Physics and Teaching Research at Stanford University since 1960. Since 1981, he has also served as Senior Research Fellow at the Xerox Palo Alto Research Center. From May 1992 to July 1992 Dr. Quate served as a consultant to SEMATECH, a semiconductor research consortium equally funded by the U.S. Government and a group of United States semiconductor manufacturers. LIDA URBANEK Mrs. Urbanek has been a director of Tencor since August 1991. Mrs. Urbanek is the widow of Dr. Karel Urbanek, founder of the Company and its president from November 1976 until April 1991. RENN ZAPHIROPOULOS Mr. Zaphiropoulos has been a director of Tencor since 1988. Mr. Zaphiropoulos was President and Chief Executive Officer of Versatec, Inc. (a Xerox Company) from 1969 until his retirement in 1988, and Corporate Vice President of Xerox Corporation from 1984 until his retirement in 1988. Mr. Zaphiropoulos is currently a director of Optical Coating Laboratory, Inc. and various privately-held corporations and holds executive seminars in management worldwide. EXECUTIVE OFFICERS The following table and notes thereto identify and set forth certain information with respect to the Company's executive officers: Name of Individual Age Position - ------------------ --- -------- Jon D. Tompkins (1) 56 Chairman of the Board, President and Chief Executive Officer Dr. Graham J. Siddall (2) 50 Executive Vice President and Chief Operating Officer Bruce R. Wright (3) 48 Senior Vice President, Finance and Administration, and Chief Financial Officer Woody Spedden (4) 59 Senior Vice President, Field Operations Gary Bultman (5) 40 Vice President, Corporate Marketing Dr. David Alles (6) 57 Vice President and Chief Technical Officer Dr. Michael E. Kahn (7) 58 Vice President, Film Measurement Division Dennis J. Fortino (8) 50 Vice President, Metrology Division William A. Colby (9) 51 Vice President, Customer Satisfaction Dr. Seiji Yoshii (10) 59 Vice President, President, Tencor Japan Frederick A. Ball (11) 34 Vice President, Corporate Controller and Secretary ( 1) See the information about Mr. Tompkins under "Directors and Executive Officers of the Registrant", above. ( 2) Dr. Siddall was appointed Executive Vice President and Chief Operating Officer in December 1995. Previously Dr. Siddall served as Senior Vice President for the Wafer Inspection Division from November 1994 to December 1995 and has been a Vice President since joining Tencor in 1988. Prior to joining Tencor, Dr. Siddall served in a number of key roles at GCA corporation, Hewlett Packard Laboratories and Rank Taylor Hobson. ( 3) Mr. Wright was appointed Senior Vice President Finance and Administration and Chief Financial Officer in November 1994. Mr. Wright joined Tencor in December 1991 as Vice President and Chief Financial Officer. Prior to joining Tencor, from 1988 to 1991, Mr. Wright served as Chief Financial Officer of Teknekron, a Nevada-based venture capital holding company. ( 4) Mr. Spedden was appointed senior vice president of worldwide sales in July 1996. His role was expanded in October 1996 to encompass the worldwide customer satisfaction organization including customer service and support. Prior to joining Tencor, he most recently served as president and chief executive officer of Credence Systems from 1991 through 1995. Prior to joining Credence in 1989, Spedden spent 18 years in a variety of sales 38 and marketing management roles at Teradyne, Inc. His background also includes sales and engineering roles at Hewlett-Packard and the Applied Physics Laboratory of Johns Hopkins University. He serves on the board of directors for Advanced Energy Industries, Inc. and Integrated Sensor Solutions, a privately held company. ( 5) Mr. Bultman was appointed Vice President of Corporate Marketing in May 1995. Prior to that time, Mr. Bultman was Vice President of Marketing for the Film Measurement Division of the Company and for Prometrix Corporation prior to its acquisition in February 1994. Prior to joining Prometrix Corporation in 1993, Mr. Bultman spent 10 years with Applied Materials in a variety of technical, marketing and sales roles, including head of marketing for Applied Materials HTCVD division. ( 6) Dr. Alles was appointed to the newly created post of chief technical officer in July 1996. Working closely with the research and engineering groups in Tencor's three divisions, he is responsible for driving strategic technical and advanced research initiatives company- wide. Alles joined Tencor from AT&T Bell Labs where he spent nearly 25 years in a variety of engineering and managerial roles, most recently as director of the R&D Planning and Administration Center. Alles' work at Bell Labs was instrumental in the development of the electron beam exposure system (EBES), which remains the dominant technology for photomask production. ( 7) Dr. Kahn was appointed Vice President and General Manager, Film Measurement Division in September 1995. Dr. Kahn joined Tencor as Vice President in May 1993. Prior to joining Tencor, Dr. Kahn was President and Chief Executive Officer of Gamma MicroWave, Inc., a manufacturer of microwave components and systems, from April 1991 until January 1993, and President of Teradyne Laser Systems, a manufacturer of semiconductor manufacturing equipment, from February 1989 until March 1990. ( 8) Mr. Fortino was appointed Vice President, Metrology Division in November 1995. Prior to joining Tencor, Mr. Fortino spent four years with Spectra-Physics Lasers, Inc. as Vice President of the Laser Systems Business Unit. Prior to that he served in a variety of executive positions including Division General Manager of Spectra Physics' Industrial laser division and president of Rofin-Sinar,Inc. (a division of Siemens). ( 9) Mr. Colby joined Tencor in June 1995 and was appointed Vice President, Customer Satisfaction in December 1995. Prior to joining Tencor, Mr. Colby was the Director of service for Nikon Precision, a leading supplier of semiconductor wafer steppers. Mr. Colby also has nine years of experience with Ultratech Stepper in a variety of management positions. (10) Dr. Yoshii was appointed a Vice President of Tencor in May 1991. He joined Tencor in May 1990 as President of Tencor Japan. From October 1989 to April 1990, Dr. Yoshii served as Vice President and General Manager of Applied Materials Japan, the Japanese subsidiary of the largest supplier of wafer fabrication systems to the semiconductor industry. From February 1987 to October 1989, he was Managing Director and General Manager of the Implant Product Division of Applied Materials Japan. (11) Mr. Ball joined Tencor as corporate controller in March 1995 and was promoted to corporate vice president in January of 1996. At that time, he also added the role of corporate secretary to his responsibilities which include all accounting functions within the company. Mr. Ball joined the company from Price Waterhouse LLP, where he worked with a number of high technology companies. During his 10 years with Price Waterhouse he held a succession of management positions, both in the United States and abroad. 39 COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934 Section 16(a) of the Securities Exchange Act of 1934 requires the Company's directors and executive officers, and persons who own more than 10% of the outstanding shares of the Company's Common Stock, to file with the Securities and Exchange Commission initial reports of ownership (Form 3) and changes in ownership of such stock (Forms 4 and 5). To the Company's knowledge, based solely upon review of the copies of such reports and certain representations furnished to it, all Section 16(a) filing requirements applicable to its executive officers and directors were complied with during the year ended December 31, 1994. 40 ITEM 11: EXECUTIVE COMPENSATION BOARD COMPENSATION Non-management directors currently are compensated at a rate of $15,000 per year, payable quarterly, plus $1,000 per Board meeting attended and $500 per Board committee meeting attended separate from Board meetings. Directors also are reimbursed for their reasonable expenses incurred in attending Board and committee meetings. Non- management directors are also entitled to receive a mandatory initial option grant of 10,000 shares and mandatory annual option grants of 5,000 shares pursuant to Tencor's 1993 Non-employee Directors Stock Option Plan. EXECUTIVE COMPENSATION The following table sets forth the total compensation for 1996, 1995, and 1994 of the Chief Executive Officer and each of the other four most highly compensated executive officers of Tencor whose total salary and bonus for 1996 exceeded $100,000: SUMMARY COMPENSATION TABLE
LONG-TERM COMP. ANNUAL COMPENSATION AWARDS ------------------- ------ SECURITIES UNDERLYING ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS($) OPTIONS (#) COMP. ($) --------------------------- ---- ----------- -------- ----------- --------- Jon D. Tompkins 1996 352,067 381,562 71,999 12,291(1) Chief Executive Officer 1995 307,475 422,115 40,000 12,582(1) 1994 284,900 217,308 100,000 13,373(1) Dr. Graham Siddall 1996 292,062 214,132 87,999 1,500(2) Senior Vice President, Wafer 1995 191,580 242,074 5,000 1,000(2) Inspection Division 1994 162,540 125,953 90,000 1,000(2) Bruce R. Wright 1996 195,417 157,810 58,999 1,500(2) Senior Vice President, Finance and 1995 179,175 207,505 30,000 1,000(2) Administration, and Chief 1994 159,775 84,916 80,000 1,000(2) Financial Officer Dr. Seiji Yoshii 1996 298,127 152,800 40,999 _ Vice President, President of 1995 278,360 192,677 20,000 _ Tencor Japan 1994 241,990 101,381 28,000 _ Dennis Fortino 1996 187,589 132,295 139,999 1,500(2) Vice President, Metrology 1995 31,667 62,000 50,000 1,000(2) Division 1994 _ _ _ _
(1) Includes $12,373 in 1994, $11,582 in 1995 and $10,879 in 1996 of forgiveness of principal and interest due under a loan made by Tencor in connection with Mr. Tompkins' employment which was being retired over a five-year period which ended in 1996. Includes $1,500 of matching contributions made by Tencor to Tencor's 401(k) Plan on behalf of Mr. Tompkins. (2) Matching contributions made by Tencor to Tencor's 401(k) Plan on behalf of the Participant. 41 The following table sets forth certain information with respect to the options granted to the executive officers named in the Summary Compensation Table during 1996:
OPTION GRANTS IN LAST FISCAL YEAR Individual Grants ------------------ Potential Realizable Value Number of % of Total at Assumed Annual Rates Securities Options of Stock Price Appreciation Underlying Granted to Exercise or for Option Term(2) Options Employees In Base Price Expiration --------------------------- Name Granted (#)(1) Fiscal Year ($/sh) Date 5% ($) 10% ($) - ---- ----------------------------------------------------------------------------------------- Jon D. Tompkins 71,999 4.1% $17.625 6/27/06 $798,056 $2,022,431 Dr. Graham Siddall 87,999 5.0% $17.625 6/27/06 $975,404 $2,471,866 Bruce R. Wright 58,999 3.3% $17.625 6/27/06 $653,960 $1,657,264 Dr. Seiji Yoshii 40,999 2.3% $17.625 6/27/06 $454,443 $1,151,650 Dennis Fortino 39,999 2.3% $17.625 6/27/06 $443,360 $1,123,560
(1) The options granted in June 1996, with terms of 10 years, vest at the rate of 25% per year beginning one year after grant. Payments by the optionees on exercise (including any taxes Tencor is required to withhold) may be made in cash, by a full recourse promissory note or by the tender of shares. All options were granted at the fair market value of Tencor's Common Stock on the date of grant. (2) Potential realizable value is based on certain assumed rates of appreciation over the term of the option. The amounts are calculated based on rules of the Securities and Exchange Commission and do not represent the Company's estimate of future stock price growth. The following table sets forth certain information with respect to the options exercised by the executive officers named in the Summary Compensation Table during 1996 and options outstanding at fiscal year end. 42
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION VALUES Value of Unexercised Shares Value Number of Unexercised In-the-Money Options Acquired on Realized Options at FY-End (#) at FY-End ($) Name Exercise (#) ($)(1) Vested/Unvested Vested/Unvested (2) ---- ------------ ----- --------------- ------------------- Jon D. Tompkins -- -- 113,121 / 122,001 $2,321,643 / $1,283,142 Dr. Graham Siddall 10,955 $155,099 65,823 / 110,201 $1,193,834 / $1,105,005 Bruce R. Wright -- -- 131,498 / 80,001 $2,620,349 / $ 828,080 Dr. Seiji Yoshii 2,070 $ 27,945 53,466 / 55,001 $1,067,312 / $ 541,642 Dennis Fortino -- -- -- / 39,999 -- / $ 349,991
_________ (1) Market value of underlying securities at exercise date less the exercise price. (2) Market value of underlying securities at fiscal year-end minus the exercise price of "in the money" options. 43 ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information regarding the beneficial ownership of Tencor's Common Stock as of January 31, 1997: (i) by each person who is known by Tencor to own beneficially more than 5% of the outstanding shares of Common Stock; (ii) by each of Tencor's directors; (iii) by each of Tencor's executive officers named in the Summary Compensation Table herein; and (iv) by all directors and executive officers as a group. Except as otherwise indicated, Tencor believes that the beneficial owners of the securities listed below, based on information furnished by such owners, have sole investment and voting power with respect to the Common Stock shown as being beneficially owned by them. Shares Beneficially Owned ---------------------------- Name of Beneficial Owner Number (1) Percent - ------------------------ ---------------------------- Pioneering Management Corporation (2) 2,940,000 9.5% 60 State Street Boston MA 02109 J.W. Seligman & Co. Incorporated (2) 2,711,000 8.7% 100 Park Avenue - 8th Floor New York NY 10006 Jon D. Tompkins (3) 119,751 * Richard Elkus 75,000 * James Bagley (4) 14,443 * Dean O. Morton (5) 13,243 * Calvin Quate (6) 31,415 * Lida Urbanek (7) 812,897 2.6% Renn Zaphiropoulos (8) 5,138 * Graham Siddall (9) 93,197 * Bruce R. Wright (10) 147,995 * Dr. Seiji Yoshii (11) 55,536 * Dennis Fortino 1,185 * All executive officers and directors as a group (21 persons) (12) 1,789,901 5.8% * Less than 1%. (1) The number of shares of Common Stock and calculation of percent of ownership takes into account those underlying stock options held by the named individual or group that are vested and exercisable within 60 days of January 31, 1997. (2) The number of shares is as of December 31, 1996, and is based on Schedule 13G filed by each of the named shareholders. (3) Includes 113,121 shares issuable upon exercise of outstanding options. (4) Consists of 14,443 shares issuable upon exercise of outstanding options. (5) Includes 10,835 shares issuable upon exercise of outstanding options. (6) Includes 14,165 shares issuable upon exercise of outstanding options. (7) Includes 647,232 shares held by a trust of which Mrs. Urbanek is a trustee. Also includes 14,165 shares issuable upon exercise of outstanding options. (8) Consists of 5,138 shares issuable upon exercise of outstanding options. (9) Includes 73,023 shares issuable upon exercise of outstanding options. (10) Includes 137,498 shares issuable upon exercise of outstanding options. (11) Includes 53,466 shares issuable upon exercise of outstanding options. (12) Includes 619,624 shares issuable upon exercise of outstanding options. 44 ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS In June 1993, Tencor loaned Bruce Wright, its Senior Vice President, Finance and Administration and Chief Financial Officer, $400,000 pursuant to a promissory note secured by his principal residence, which bears interest at 5.5% per annum and is due in May 2002. In November 1996, Tencor loaned David Alles, its Vice President and Chief Technology Officer, $200,000 pursuant to a promissory note secured by his principal residence, which bears interest at 6.52% per annum and is due October 2003. 45 PART IV ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) (1, 2) See item 8. (3) Exhibits. See Exhibit Index on page 49 of this report. The following exhibits are filed as part of this Form 10-K. 2.1 Agreement and Plan of Reorganization dated January 14, 1997, among Registrant, KLA Instruments Corporation and Tiger Acquisition Corporation. (9) 3.1 Copy of Registrant's Articles of Incorporation as amended (7) 3.2 Copy of Registrant's Bylaws, as amended (8) 10.1 Registrant's Second Amended and Restated 1984 Stock Option Plan (2)* 10.2 Registrant's Form of Option Agreement* 10.5 Master Lease for the premises at 2400-2476 Charleston Road dated July 5, 1988 between the Company and Meridian Point Realty Trust '83 (1) 10.6 Lease for the premises at 2370 Charleston Road dated October 7, 1983 between the Company and E&K Properties, as amended by Addendum No.1 dated October 31,1983 and letters dated May 12, 1987 and June 30, 1988 (1) 10.8 Form of indemnification Agreement between the Company and its officers and directors, as amended. (1) 10.11 Registrant's 401(k) Plan (1) 10.12 Prometrix Corporation's 401(k) Plan (8) 10.15 Description of Registrant's Senior Executive Incentive Program (5)* 10.16 Registrant's 1993 Equity Incentive Plan, as amended (4)* 10.17 Registrant's 1993 Nonemployee Directors Stock Option Plan (4)* 10.18 Registrant's Employee Stock Purchase Plan (4) 10.19 Registrant's Foreign Employee Stock Purchase Plan (2) 10.20 Prometrix 1983 Employee Incentive Stock Option Plan, as amended (6)* 10.21 Prometrix 1993 Employee Incentive Stock Option Plan (6)* 10.25 Leases for the premises at 3233 Scott Blvd., Santa Clara, California (8) 10.26 Multi-currency loan agreement with Bank of Boston dated June 15, 1995 (10) 46 10.27 Phase IIA and Phase IIB Leases for Milpitas Facility dated December 29, 1995 (10) 21.1 Subsidiaries of the Registrant 23.1 Consent of Price Waterhouse LLP, Independent Accountants (1) In addition to the Amendment to Indemnification Agreement attached hereto as Exhibit 10.8, previously filed as an exhibit, with corresponding exhibit number, to Registration Statement on Form S-1 (33-46799) filed March 27, 1992, as amended. (2) Previously filed as exhibit to Registration Statement on Form S-8 (33-62986) filed May 20, 1993. (3) Previously filed as exhibit 28 to Registration Statement on Form S-8 (33-60690) filed April 8, 1993. (4) Previously filed as exhibit to Registration Statement on Form S-8 (333-08785) filed July 25, 1996. (5) Previously filed as an exhibit, with corresponding exhibit number, to Registrant's Annual report on Form 10- K for the fiscal year ended December 31, 1993. (6) Previously filed as an exhibit, with corresponding exhibit number, to Registration Statement on Form S-4 (33-73586) filed December 30, 1993, as amended. (7) In addition to the Certificate of Amendment to Articles of Incorporation filed with the California Secretary of State on May 31, 1995, a copy of which is attached hereto as Exhibit 3.1 previously filed as an exhibit 3.1 to the Registration Statement identified in footnote (1) above, except for a Certificate of Amendment thereto filed as exhibit 3.3 to the Annual Report on Form 10-K identified in footnote (5) above and a Certificate of Amendment filed as exhibit 3.1 to Registration Statement on Form S- 3 (33-83014) filed August 19, 1994, as amended. (8) Previously filed as an exhibit, with corresponding exhibit number, to Registration Statement on Form S-3 identified in footnote (7) above. (9) Previously filed as an exhibit, with corresponding exhibit number, to current report on Form 8-K filed January 22, 1997. (10) Previously filed as an exhibit, with corresponding exhibit number, to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1995. * Management contract or compensatory plans. (b) No reports on Form 8-K were filed during the Company's fiscal quarter ended December 31, 1996. On January 22, 1997, the Company filed a report on Form 8-K related to the proposed merger between the Company and KLA Instruments Corp. (c) Exhibits: The exhibits listed in Item (a)(3) above, if not noted as previously filed, are submitted as a separate section of this report. (d) The individual financial statements of the registrant have been omitted since the registrant is primarily an operating company and all subsidiaries are included in the consolidated financial statements. 47 SIGNATURES 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 on March 7, 1997. TENCOR INSTRUMENTS By /s/ Bruce R. Wright ------------------------------- Bruce R. Wright Senior Vice President and Chief Financial 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. Title Date /s/ Jon D. Tompkins Chairman of the Board, President March 7, 1997 - ------------------------- and Chief Executive Officer Jon D. Tompkins (Principal Executive Officer) /s/ Bruce R. Wright Senior Vice President, Chief Financial March 7, 1997 - ------------------------- Officer (Principal Financial Officer) Bruce R. Wright /s/ Frederick A. Ball Vice President, Corporate Controller - ------------------------- and Secretary (Principal March 7, 1997 Frederick A. Ball Accounting Officer) /s/ Richard J. Elkus, Jr. Vice Chairman of the Board March 7, 1997 - ------------------------- Richard J. Elkus, Jr. /s/ James W. Bagley Director March 7, 1997 - ------------------------- James W. Bagley /s/ Dean O. Morton Director March 7, 1997 - ------------------------- Dean O. Morton /s/ Dr. Calvin F. Quate Director March 7, 1997 - ------------------------- Dr. Calvin F, Quate /s/ Lida Urbanek Director March 7, 1997 - ------------------------- Lida Urbanek /s/ Renn Zaphiropoulos Director March 7, 1997 - ------------------------- Renn Zaphiropoulos 48 INDEX TO EXHIBITS 3.1 Certificate of Amendment to Articles of Incorporation 10.2 Registrants' Form of Option Agreements 10.8 Registrants' Form of Amendment to Indemnification Agreement 21.1 Subsidiaries of Registrant 23.1 Consent of Price Waterhouse LLP, Independent Accountants 49 EX-3.1 2 CERTIFICATE OF AMENDEMENT TO ARTICLES OF INCORP EXHIBIT 3.1 CERTIFICATE OF AMENDMENT OF ARTICLES OF INCORPORATION JON D. TOMPKINS and CLAUDIA CASEY certify that: 1. They are the President and the Secretary, respectively, of TENCOR INSTRUMENTS, a California corporation. 2. Article Third of the Articles of Incorporation of this corporation is amended in its entirety to read as follows: THIRD: This corporation is authorized to issue two classes of shares which shall be known as Common Stock and Preferred Stock. The total number of shares of Common Stock which this corporation is authorized to issue is 60,000,000. The total number of shares of Preferred Stock which this corporation is authorized to issue is 1,000,000. Upon the amendment of this article, each outstanding share of Common Stock is split up and converted into two (2) shares of Common Stock. 3. The foregoing amendment of the Articles of Incorporation has been duly approved by the Board of Directors. 4. The corporation has only one class of shares outstanding and, in accordance with Section 902 of the California Corporations Code, the foregoing amendment of the Articles of Incorporation did not require the approval of the outstanding shares. We further declare under penalty of perjury under the laws of the State of California that the matters set forth in this Certificate are true and correct of our own knowledge. Dated: May 25, 1995 /s/ Jon D. Tompkins ----------------------------------------- JON D. TOMPKINS, President /s/ Claudia Casey ----------------------------------------- CLAUDIA CASEY, Secretary EX-10.2 3 REGISTRANTS' FORM OF OPTION AGREEMENTS EXHIBIT 10.2 TENCOR INSTRUMENTS NONSTATUTORY STOCK OPTION AGREEMENT (A) Name of Optionee: ___________________ (B) Grant Date: _________________________ (C) Number of Shares: ___________________ (D) Exercise Price: _____________________ (E) Effective Date: _____________________ (F) Percentage to Vest at end Year One: ___% (G) Percentage to Vest Monthly/Annually After Year One: ___% THIS NONSTATUTORY STOCK OPTION AGREEMENT (the "Agreement") is made and entered into as of the date set forth in Item E above (the "Effective Date") between Tencor Instruments, a California corporation (the "Company"), and the person named in Item A above ("Optionee"). This option will not be treated as an "incentive stock option" within the meaning of Section 422 of the Internal Revenue Code. 1. GRANT. The Company hereby grants to Optionee pursuant to the Company's 1993 Amended and Restated Equity Incentive Plan (the "Plan"), the terms and conditions of which are incorporated herein by this reference, an option (the "Option") to purchase the number of shares (the "Option Shares") of the Company's common stock listed in Item C above on the terms and conditions set forth herein and in the Plan. 2. VESTING OF OPTION SHARES. The vesting base date (the "Vesting Base Date") shall be the same date as the grant date set forth in Item B above; the Option Shares shall vest on the first anniversary of the Vesting Base Date at the rate specified in Item F above; the Option Shares shall vest at the end of each full period thereafter at the rate specified in Item G above. 3. EXERCISE OF THE OPTION. This Option may be exercised in whole or part at any time. The exercise price shall be the price set forth in Item D above (the "Exercise Price"). Optionee hereby agrees that in the event that the Company deems it necessary or advisable in the exercise of its discretion, the issuance of Option Shares may be conditioned upon certain representations and acknowledgments by the person exercising the Option. a. EXERCISE BEFORE VESTING. The Optionee may exercise the Option before vesting of the Option Shares by delivering to the Company: (i) the Exercise Price, (ii) an executed copy of the Notice of Exercise attached hereto as Exhibit 1, and (iii) an executed copy of the Acknowledgment and Statement of Decision Regarding Election attached hereto as Exhibit 2. Share certificates representing Option Shares purchased before vesting shall be held in escrow and released to the Optionee upon vesting, or at the Company's sole discretion, Option Shares purchased before vesting may be issued in book entry form without certification. The Company shall instruct the person maintaining the book entry system that such Option Shares shall not be available for transfer until such Option Shares are vested or the Company's right of repurchase (as provided in Section 4 below) has otherwise terminated. As a condition to exercising the Option before vesting of the Option Shares, the Optionee shall execute such documents as are reasonably necessary to carry out the intent of this Section, including -1- execution of an escrow agreement, the terms and conditions of which shall be determined by the Company at its sole discretion. b. EXERCISE AFTER VESTING. The Optionee may exercise the Option after vesting of the Option Shares by delivering to the Company: (i) the Exercise Price, and (ii) an executed copy of the Notice of Exercise attached hereto as Exhibit 1. 4. RIGHT OF REPURCHASE. The Company shall have a right to repurchase (the "Right of Repurchase"), at the price paid by the Optionee, any Option Shares that have not vested. The Right of Repurchase shall terminate upon the later of: (i) 45 days after the date on which the Optionee ceases to be employed by, or a consultant to, the Company, or (ii) 30 days after the Option is exercised. Upon exercise of the Right of Repurchase, the Optionee shall endorse and deliver to the Company the stock certificates, if any, representing the Option Shares being repurchased and the Company shall pay the Optionee the repurchase price. Upon receipt of payment from the Company, the Optionee shall have no rights whatsoever in any Option Shares repurchased by the Company. Option Shares subject to the Right of Repurchase shall not be assigned, pledged, transferred, hypothecated or otherwise disposed of by the Optionee and shall bear the following legend: "The securities represented hereby are subject to the terms of an agreement between Tencor Instruments and the holder of such securities. Pursuant to the terms of such agreement, Tencor Instruments has the rights to purchase such securities under certain conditions. A copy of the agreement can be obtained from the Secretary of Tencor Instruments." 5. TERM. The Option expires and ceases to be exercisable upon the earlier of (i) ten years after the grant date specified in Item B above, or (ii) three months after the Optionee's employment or consultancy relationship with the Company is terminated. 6. TAXES. The Optionee acknowledges that (i) the Optionee has not been given by the Company and is not relying upon representations of the Company as to tax consequences of the grant or exercise of this Option, (ii) the foregoing tax consequences are known to be complex and dependent in part upon Optionee's particular circumstances, and (ii) the Optionee has consulted, and will consult at appropriate times, with Optionee's own tax adviser regarding such tax consequences. IN WITNESS WHEREOF, the parties have executed this Nonstatutory Stock Option Agreement as of the Effective Date. ----------------------------------------- TENCOR INSTRUMENTS Optionee By -------------------------------- ----------------------------------------- Title Optionee's Spouse* ----------------------------- * Optionee's spouse indicates by the execution of this Agreement his or her consent to be bound by the terms thereof as to his or her interests, whether as community property or otherwise, if any, in the option granted hereunder, and in any Option Shares purchased pursuant to this Agreement. -2- TENCOR INSTRUMENTS INCENTIVE STOCK OPTION AGREEMENT (A) Name of Optionee: ___________________ (B) Grant Date: _________________________ (C) Number of Shares: ___________________ (D) Exercise Price: _____________________ (E) Effective Date: _____________________ (F) Percentage to Vest at end Year One: ___% (G) Percentage to Vest Monthly/Annually After Year One: ___% THIS INCENTIVE STOCK OPTION AGREEMENT (the "Agreement") is made and entered into as of the date set forth in Item E above (the "Effective Date") between Tencor Instruments, a California corporation (the "Company"), and the person named in Item A above ("Optionee"). 1. GRANT. The Company hereby grants to Optionee pursuant to the Company's 1993 Amended and Restated Equity Incentive Plan (the "Plan"), the terms and conditions of which are incorporated herein by this reference, an option (the "ISO") to purchase the number of shares (the "ISO Shares") of the Company's common stock listed in Item C above on the terms and conditions set forth herein and in the Plan. 2. VESTING OF ISO SHARES. The vesting base date (the "Vesting Base Date") shall be the same date as the grant date set forth in Item B above; the ISO Shares shall vest on the first anniversary of the Vesting Base Date at the rate specified in Item F above; the ISO Shares shall vest at the end of each full period thereafter at the rate specified in Item G above. 3. EXERCISE OF THE ISO. This ISO may be exercised in whole or part at any time. The exercise price shall be the price set forth in Item D above (the "Exercise Price"). Optionee hereby agrees that, in the event that the Company deems it necessary or advisable in the exercise of its discretion, the issuance of ISO Shares may be conditioned upon certain representations and acknowledgments by the person exercising the ISO. a. EXERCISE BEFORE VESTING. The Optionee may exercise the ISO before vesting of the ISO Shares by delivering to the Company: (i) the Exercise Price, (ii) an executed copy of the Notice of Exercise attached hereto as Exhibit 1, and (iii) an executed copy of the Acknowledgment and Statement of Decision Regarding Election attached hereto as Exhibit 2. Share certificates representing ISO Shares purchased before vesting shall be held in escrow and released to the Optionee upon vesting, or at the Company's sole discretion, ISO Shares purchased before vesting may be issued in book-entry form without certification. The Company shall instruct the person maintaining the book-entry system that such ISO Shares shall not be transferred until such ISO Shares are vested or the Company's right of repurchase (as provided in Section 4 below) has otherwise terminated. As a condition to exercising the ISO before vesting of the ISO Shares, the Optionee shall execute such documents as are reasonably necessary to carry out the intent of this Section, including execution of an escrow agreement, the terms and conditions of which shall be determined by the Company at its sole discretion. b. EXERCISE AFTER VESTING. The Optionee may exercise the ISO after vesting of the ISO Shares by delivering to the Company: (i) the Exercise Price, and (ii) an executed copy of the Notice of Exercise attached hereto as Exhibit 1. 4. RIGHT OF REPURCHASE. The Company shall have a right to repurchase (the "Right of Repurchase"), at the price paid by the Optionee, any ISO Shares that have not vested. The Right of Repurchase shall terminate upon the later of: (i) 45 days after the date on which the Optionee ceases to be employed by, or a consultant to, the Company, or (ii) 30 days after the ISO is exercised. Upon exercise of the Right of Repurchase, the Optionee shall endorse and deliver to the Company the stock certificates, if any, representing the ISO Shares being repurchased and the Company shall pay the Optionee the repurchase price. Upon receipt of payment from the Company, the Optionee shall have no rights whatsoever in any ISO Shares repurchased by the Company. ISO Shares subject to the Right of Repurchase shall not be assigned, pledged, transferred, hypothecated or otherwise disposed of by the Optionee and shall bear the following legend: "The securities represented hereby are subject to the terms of an agreement between Tencor Instruments and the holder of such securities. Pursuant to the terms of such agreement, Tencor Instruments has the rights to purchase such securities under certain conditions. A copy of the agreement can be obtained from the Secretary of Tencor Instruments." 5. TERM. The ISO expires and ceases to be exercisable upon the earlier of (i) ten years after the grant date specified in Item B above, or (ii) three months after the Optionee's employment or consultancy relationship with the Company is terminated. 6. TAXES. The Optionee acknowledges that (i) the Optionee has not been given by the Company and is not relying upon representations of the Company as to tax consequences of the grant or exercise of this Option, (ii) the foregoing tax consequences are known to be complex and dependent in part upon Optionee's particular circumstances, and (iii) the Optionee has consulted, and will consult at appropriate times, with Optionee's own tax adviser regarding such tax consequences. IN WITNESS WHEREOF, the parties have executed this Incentive Stock Option Agreement as of the Effective Date. ----------------------------------------- TENCOR INSTRUMENTS Optionee By -------------------------------- ----------------------------------------- Title Optionee's Spouse* ----------------------------- * Optionee's spouse indicates by the execution of this Agreement his or her consent to be bound by the terms thereof as to his or her interests, whether as community property or otherwise, if any, in the option granted hereunder, and in any ISO Shares purchased pursuant to this Agreement. -2- EX-10.8 4 REGISTRANTS' FORM OF AMENDMENT TO INDEMNIFICATION Exhibit 10.8 AMENDMENT TO INDEMNIFICATION AGREEMENT THIS AMENDMENT TO INDEMNIFICATION AGREEMENT (the "Amendment") is dated as of January 13, 1997, by and between TENCOR INSTRUMENTS, a California corporation (the "Company"), and DENNIS J. FORTINO (the "Indemnitee"). WHEREAS, the Company and the Indemnitee have previously entered into an Indemnification Agreement (the "Agreement"); and WHEREAS, the Company and the Indemnitee desire to amend and supplement the Agreement, all on the terms and conditions provided herein. NOW, THEREFORE, the Company and the indemnitee hereby agree as follows: 1. SUBSECTION 2(a) - ADVANCES OF EXPENSES. The following shall be added at the end of Subsection 2(a) of the Agreement: Any dispute concerning the advancement of expenses shall be resolved by arbitration before an arbitrator selected by Indemnitee and approved by the Company. If the parties cannot agree on a single arbitrator, then the claim shall be heard by a panel of three arbitrators, with one selected by Indemnitee, one selected by the Company and one selected jointly by the foregoing two arbitrators. Each of the arbitrators shall be a litigation or corporate attorney with experience in the field of officer and director indemnification. The arbitrators shall be selected within fifteen (15) days after demand for arbitration and shall render a decision within forty-five (45) days after selection, unless good cause is shown for requiring a longer decision period. The Company shall act in utmost good faith to provide timely information to the arbitrators and insure Indemnitee a full opportunity to defend against the Company's claim that Indemnitee is not entitled to an advance of expenses. The Company shall indemnify Indemnity against all expenses incurred by Indemnitee under the dispute resolutions proceedings set forth in this Subsection 2(a), unless a court of competent jurisdiction finds that each of the claims and/or defenses by indemnitee in the action or proceeding for which an advance is sought was frivolous or made in bad faith. 2. SUBSECTION 2(c) - PROCEDURE. The third sentence of Subsection 2(c) of the agreement shall be amended in its entirety to read as follows: It shall be a defense to any such action (other than an action brought to enforce a claim for expenses incurred in connection with any action or proceeding in advance of its final disposition) that Indemnitee has not met the standards of conduct which make it permissible under applicable law for the Company to indemnify Indemnitee for the amount claimed, but it shall be presumed that Indemnitee has met any applicable standard of conduct required for indemnification, unless the Company has affirmatively shown that Indemnitee did not meet that standard, and Indemnitee shall be entitled to receive interim payments of expenses pursuant to Subsection 2(a), unless and until such defense may be finally adjudicated by court order or judgment from which no further right of appeal exists. 3. SUBSECTION 2(d) - NOTICE TO INSURERS. The following shall be added at the end of Subsection 2(d) of the Agreement: The Company shall indemnify Indemnitee against any reasonable direct or indirect costs (including, without limitation, attorneys' fees and disbursements) incurred by Indemnitee in connection with any successful action brought by Indemnitee for recovery under any insurance policies referred to in this Subsection 2(d) and shall advance to Indemnitee the costs of such action in the manner provided in Subsection 2(a) hereof. 4. NO FURTHER AMENDMENT. Except as specifically provided herein, the Agreement shall not be amended and shall remain in full force and effect. IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the date first above written. COMPANY: TENCOR INSTRUMENTS By: _______________________________ Its: INDEMNITEE: EX-21.1 5 SUBSIDIARIES OF REGISTRANT Exhibit 21.1 Subsidiaries of Registrant VLSI Standards Incorporated California, USA Tencor Instruments Japan Co. Ltd. Japan Tencor Instruments Korea Korea Tencor Instruments GmbH Germany Tencor Instruments, Sarl France Tencor Instruments, Ltd. United Kingdom Tencor Instruments (S) Pte. Ltd. * Singapore Tencor Instruments (S) Pte. Ltd. * Taiwan - -------------------------- * established in 1996 EX-23.1 6 CONSENT OF PRICE WATERHOUSE LLP Exhibit 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Forms S-8 (No. 33-62988, No. 33-60690, No. 33-77104, No. 33-83176, No. 33-94360 and No. 333-08785) of our report dated February 7, 1997 appearing on page 36 of Tencor Instruments Annual Report on Form 10-K for the year ended December 31, 1996. Price Waterhouse LLP San Jose, California March 6, 1997 EX-27 7 FDS
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS FOUND ON PAGES 19 AND 20 OF THE COMPANY'S 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 141,407 82,370 87,623 0 51,668 392,289 41,601 0 484,419 118,051 0 0 0 152,756 212,277 484,419 403,170 403,170 166,123 166,123 145,097 0 0 98,851 37,563 61,288 0 0 0 61,288 1.93 1.92
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