Next target in corporate governance hunting season: Applied Materials ( AMAT).

Heading into the firm's annual shareholder meeting Wednesday, concerns center on Applied Materials' allegedly excessive executive compensation, use of options and the independence of its auditor. Citing such concerns, both San Francisco-based proxy adviser Glass Lewis and the California Public Employees' Retirement System are opposing several of the company's directors as well as a proposed increase in its stock compensation plan.

Applied Materials has already made some concessions, but its shareholders have an opportunity to send another stern message to corporate America, although it's unlikely they'll seize the moment as, say, shareholders of Disney ( DIS). (Earlier this month, some 43% of Disney shareholders withheld their votes for Chairman and CEO Michael Eisner.)

Applied posted a loss in fiscal 2003, reversing a profit from the previous year as its revenue slipped 11.6%, noted Greg Taxin, CEO of Glass Lewis. Meanwhile, Glass Lewis estimates that Applied's employees saw about $355 million in gains from exercising stock options last year.

"That's the sort of thing that gives us heartburn," Taxin said. "Their employees have been very handsomely rewarded during a period when their business has not been very successful."

In its proxy report issued last month, Glass Lewis also took aim at Applied's audit committee. Over the last two years, Applied has paid PricewaterhouseCoopers substantial fees for nonaudit services, Taxin noted. For instance, Applied paid PricewaterhouseCoopers $940,000 for tax advice and planning services in fiscal 2003, or 40.2% of the total amount it paid the accounting firm.

That fact creates a potential conflict of interest and could compromise the integrity of PricewaterhouseCoopers' audits, Taxin said. "No firm that is generating a lot of revenue from tax and consulting services is likely to be harsh on the public accounting side."

In an email exchange, AMAT spokesman Jeff Lettes defended the company and its board. All members of the company's audit and compensation committees are independent of the company and work in the best interest of shareholders, Lettes said. Meanwhile, any assessment of the company's compensation practices is bound to be skewed because Applied hired a new CEO last year, he said.

Applied granted its new CEO, Michael Splinter, 300,000 restricted shares and 1.2 million stock options in fiscal 2003. The restricted stock grant, worth an estimated $4.1 million, and the options were part of a signing bonus, the company said in its proxy filing.

Institutional Shareholder Services, Glass Lewis' chief rival, is recommending that shareholders vote for all members of the company's board and in favor of its stock options plan, Lettes noted.

Still, the company does seem to be listening to its critics. In letters to investors in recent days, Applied has pledged to limit the nonauditing services performed by its auditor. It also has promised to allow shareholders to vote on any material changes to its employee stock plan -- such as a repricing of shares.

Despite the company's promises, Calpers still plans to vote against the members of Applied's audit committee and its stock plan proposal, as does its sister pension fund, the California State Teachers Retirement System (Calstrs).

"While I appreciate their letter-writing campaign, this is a day late and a penny short," Taxin said.


Equally controversial among the pension funds and Glass Lewis is Applied's proposal to increase its stock compensation plan. If approved by shareholders, the plan would increase the numbers of shares that Applied could issue for stock options, restricted stock awards and other grants by 70 million shares, or 4.2%.

The key for Glass Lewis was the historical costs, but other factors also weighed against the plan, Taxin said. Even without the proposed share increase, Applied already has enough shares available for grant under its stock plan to last it until at least next year, according to Glass Lewis. If shareholders approve the proposal, Applied's pool would be enough to last it for more than five years. That's too large a pool to play with, Glass Lewis argues.

Further, Applied doesn't expense the cost of stock options, Taxin noted.

"This options expense is essentially hidden from investors," he said. "It's hidden and large. Those are bad in combination."

Later this month, accounting regulators expect to release a proposal that would require public companies to expense stock options. Compensation critics believe that the new rule will force companies to limit their options grants, once it goes into effect next year.

Calstrs and Calpers also opposed the options increase, noting that greater than 5% of the company's net grant last year went to top executives. The pension funds also charged that the total dilution caused by Applied's plan was too high. Including the proposed 70 million-share increase, the total shares available under Applied's stock plan amount to 23.5% of outstanding shares, according to the Investor Responsibility Research Center.

Applied tries to limit the amount of stock options it hands out to executives each year to no more than 5% of stock grants, said Lettes.

To be sure, the opposition of Glass Lewis and the big pension funds may not mean much. Even when critics have voiced significant opposition, a majority of shareholders has rarely withheld votes from a sitting director of a public company.

New regulations will require institutional shareholders to release their proxy votes later this year. But some of Applied's largest shareholders declined to say how they planned to vote their shares.

Among those who demurred: representatives of Barclays Global Investors, Fidelity and TCW, the company's third, fifth and sixth largest investors, respectively. Collectively, those companies hold about 8% of Applied's shares, according to FactSet Research's LionShares service.

AMAT shares rose 16 cents, or 0.8%, to $20.36 Tuesday, 21.5% down from their 52-week high, reached in November.

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