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| NVLS > SEC Filings for NVLS > Form 10-Q on 6-May-2009 | All Recent SEC Filings |
6-May-2009
Quarterly Report
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q and certain information incorporated herein by reference contain forward-looking statements within the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. All statements included or incorporated by reference in this Quarterly Report, other than statements that are purely historical, are forward-looking statements. Words such as "anticipate," "expect," "intend," "plan," "believe," "seek," "estimate," and similar expressions also identify forward-looking statements. The forward-looking statements include, without limitation: our intent to hold auction-rate securities to recovery; our belief that most of the impairment related to auction-rate securities is temporary; our belief that we will ultimately be able to liquidate our investments in auction-rate securities without significant loss through successful auctions, redemptions of securities by the issuers or upon maturity; our anticipation to reclassify the accumulated gains (losses) recorded as of March 28, 2009 for cash flow hedges from OCI to net sales within twelve months; our expectation that the adoption of certain accounting pronouncements will not have a significant impact on our Condensed Consolidated Financial Statements; our estimated amortization expense for currently recognized identifiable intangible assets in the for the three remaining quarters of 2009 and for the years ending December 31, 2010, 2011, 2012, 2013 and 2014, respectively; our expectation that the remaining obligations in connection with vacated facilities will be satisfied no later than the expiration dates of the lease terms, which expire on various dates through 2017; our expectation that the ultimate disposition of the Linear litigation will not have a material adverse effect on our business, financial condition or operating results; our expectation that in years 2011 and beyond our income subject to tax in California will be lower and that our deferred tax assets are less likely to be realized due to the recent California tax law change; our plan to continue to assess our tax valuation allowance on our California deferred tax assets in future periods; that of the $29.8 million of unrecognized compensation cost related to unvested stock options, $11.7 million is expected to be recognized in the three remaining quarters of 2009, and $11.4 million, $4.8 million and $1.9 million is expected to be recognized in 2010, 2011 and 2012, respectively; our expectation that of the $28.2 million of unrecognized compensation cost related to restricted stock awards, $10.1 million is expected to be recognized in the three remaining quarters of 2009 and $8.7 million, $ 7.1 million and $2.3 million will be recognized in 2010, 2011 and 2012, respectively; our belief that significant investment in research and development is required to remain competitive; our plan to continue to invest in new products and enhance our current product lines; our intention to continue to seek legal protection through patents and trade secrets for our proprietary technology; our efforts to continue to work closely with our customers and make substantial investments in research and development in order to deliver innovative products which enhance productivity for our customers to utilize the latest technology; our belief that our continued investment in research and development has positioned us for future growth; our expectation that we are not likely to benefit in the short-term from capital spending typically made by our customers due to the continued rapid contraction in the world-wide economy; our belief that in 2009 unit demand for semiconductors is likely to fall for the first time since 2001, leading to a decline in semiconductor revenues and an increase in semiconductor inventories; our expectation that chip unit growth will resume in 2010 and beyond, and with it, spending on semiconductor equipment; our anticipation that revenues in the near term will most likely be generated from technology upgrades and maintenance on, or replacement of, currently deployed equipment rather than capacity additions; our expectation that net orders will fluctuate due to the cyclicality of the semiconductor industry; our continued focus on operational execution and paring down our cost structure to improve operating results; our plans to incur $12 million to $16 million of incremental charges in the second quarter of 2009 as a result of further reductions in operating expenses and the scale back our CMP business operations; our plan to continue managing both our variable and fixed cost structure with the objective of minimizing our net cash outflow during fiscal 2009; our intent to refinance our credit facilities denominated in Euros under a new arrangement; our belief that our current cash position and available borrowing capacity will be sufficient to meet our needs through the next twelve months; our belief that the ultimate outcome of actions that have arisen in the normal course of business will not have a material adverse effect on our business, financial condition or results of operations; our expectation that sales of our products to relatively few customers will continue to account for a high percentage of our net sales in the foreseeable future; our expectation that we will continue to experience significant fluctuations in our quarterly operating results; our intention to use the proceeds from certain credit agreements for working capital and other general corporate purposes, including the repurchase of shares; and our intention to repurchase shares from time to time in the open market, through block purchases or otherwise.
Our expectations, beliefs, objectives, intentions and strategies regarding the future, including, without limitation, those concerning expected operating results, revenues and earnings and current and potential litigation are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially from results contemplated by our forward-looking statements. These risks and uncertainties include, but are not limited to: unanticipated trends with respect to the cyclicality of the semiconductor industry; our inability to reclassify the accumulated gains (losses) from OCI to net sales within-twelve months; inaccuracies regarding growth potential in the Asia region over the long term; a sustained decrease in or leveling off of customer demand; our inability to make adequate inventory valuation adjustments in a timely manner; our inability to manage inventory levels; unexpected changes in the tax regulatory environment; changes in accounting and tax standards or practices; our inability to achieve a tax benefit due to unexpected changes in domestic tax regulations; our inability to predict the impact of the Linear litigation on our business, financial conditions or operating results; our inability to accurately predict the impact of new accounting pronouncements on our Condensed Consolidated Financial Statements; our inability to accurately assess the period in which we will recognize unrecognized compensation related to unvested stock options and restricted stock awards; inaccuracies related to the timing and satisfaction of remaining obligations related to vacated leases; unexpected shipment delays which adversely impact shipment volumes; our inability to meet certain performance conditions that may result in forfeiture of certain restricted stock awards; unexpected increase in costs associated with manufacturing our products; our inability to anticipate cyclical changes in customers' capacity utilization and demand; the negative impact of higher cost of services on gross margins; our inability to realize efficiencies from outsourcing; inefficiencies in the allocation of funds towards our research and development efforts to our existing and new product lines; unexpected difficulties in introducing new and enhanced products in a timely manner in order to remain competitive; unexpected changing product needs of our customers; the loss of a major customer; the need to seek new customers and diversify our customer base; our inability to negotiate and obtain favorable borrowing terms for our credit facilities denominated in Euros; unanticipated need for additional liquid assets in the next twelve months; our failure to accurately predict the effect of the ultimate outcome of current litigation on our business, financial condition, results of operations or material adjustment to our financial statements; inherent uncertainty in the outcome of litigation matters; our potential inability to enforce our patents and protect our trade secrets; our inability to accurately predict recovering the carrying value of our investment in auction-rate securities, market changes negatively affecting auction-rate securities and the government's inability to guarantee the underlying securities; our inability to accurately predict customers capital spending over the long term; further periodic downturns in the semiconductor industry which could have a material adverse effect on the semiconductor industry's demand for semiconductor processing equipment; our inability to accurately predict mega-fabrication trends in memory manufacturing; uncertainties related to the acceptance of new technology into the memory market; the introduction of new products by competitors; our inability to gain and leverage market position during the economic downturn; unexpected shifts in market demands for both memory and logic products; uncertainties related to growth in the electronic industry; and our inability to successfully select, develop, and market new products, or enhance existing products.
The forward-looking statements in this Quarterly Report on Form 10-Q are subject to additional risks and uncertainties set forth under the heading "Risk Factors" in Item 1A of Part II, and are based on information available to us on the date hereof. We assume no obligation to update any forward-looking statements. Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of the filing of this Quarterly Report on Form 10-Q. Readers should also review carefully the cautionary statements and risk factors listed in our Annual Report on Form 10-K for the year ended December 31, 2008 and in our other filings with the SEC, including our Forms 10-Q and 8-K and our Annual Report to Shareholders.
Introduction
The following Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to provide readers with an understanding of our business. The following are included in our MD&A:
• Overview of our Business and Industry;
• Critical Accounting Policies;
• Results of Operations; and
• Liquidity and Capital Resources.
Overview of Our Business and Industry
Novellus Systems, Inc. is a California corporation organized in 1984. At Novellus, we primarily develop, manufacture, sell and support equipment used in the fabrication of integrated circuits, commonly called chips or semiconductors. Customers for these products manufacture chips for sale or for incorporation in their own products, or provide chip-manufacturing services to third parties. The segment of our business serving this area is the Semiconductor Group. Beginning in 2004, Novellus entered into market segments beyond semiconductor manufacturing with the establishment of our Industrial Applications Group through various acquisitions. This segment supports grinding, lapping and polishing equipment for fine-surface optimization and serves a broad spectrum of industrial applications.
In the Semiconductor Group our business depends on capital expenditures made by integrated circuit manufacturers, who in turn are dependent on corporate and consumer demand for integrated circuits and the electronic products which use them. Since the industry in which we operate is driven by spending for electronic products, our business is directly affected by growth or contraction in the global economy as well as by the adoption of new technologies. Demand for personal computers, the expansion of the Internet and telecommunications industries and the emergence of new applications in consumer electronics have a direct impact on our business. In addition, the industry is characterized by intense competition and rapidly changing technology. We continue to work closely with our customers and make substantial investments in research and development in order to deliver innovative products which enhance productivity for our customers and utilize the latest technology. We believe these investments have positioned us for future growth.
In the Industrial Applications Group our business depends on capital expenditures made by manufacturers in sectors such as automotive, aircraft and electronic products, parts and components. At the broadest level, the demand for machine tools is highly sensitive to macroeconomic conditions, as our customer base includes some of the most cyclically sensitive industries in the economy. As a result, such variables as the outlook for overall economic growth, fixed investment and durable goods shipments directly affect the growth of our business. Our industrial business also depends on niche applications in addition to the general machine tool cycle. As we continue to expand our capabilities in this segment, our operations are increasingly impacted by the prime wafer industry which, similar to the semiconductor segment, is also characterized by intense competition and rapidly changing technology.
As a supplier to the global semiconductor and semiconductor-related industries, we are subject to business cycles and trends which are difficult to predict. The demand for our products is affected by the profitability of our customers which is driven by capacity and market supply for their products. Our customers operate principally in the semiconductor memory and logic markets. In fiscal 2006 and 2007, our memory customers grew capacity and those additions outpaced the current rate of demand. The resulting overcapacity and weak pricing combined with tight liquidity in the credit markets caused memory customers to delay capital spending and, in some instances, constrain or retire some of their capacity during 2008. These actions were expected to stabilize average selling prices. However, due to the continued rapid contraction in the world-wide economy combined with the general lack of capital availability, conditions worsened during the fourth quarter of 2008. As a result, we no longer expect to benefit in the short-term from capital spending typically made by our customers to increase capacity in response to the worldwide consumption of chips that has historically grown at an annual rate of 10%. In 2009, unit demand for semiconductors is likely to fall for the first time since 2001, leading to a decline in semiconductor revenues and an increase in semiconductor inventories. This further increases the pressure on semiconductor manufacturers to carefully match capacity with demand which has reduced their spending on capital equipment in 2009. However, in keeping with the historical cyclical nature of the industry, chip unit growth is expected to resume in 2010 and beyond, and with it, spending on semiconductor equipment. We anticipate that revenues in the near term will most likely be generated from technology upgrades and maintenance on, or replacement of, currently deployed equipment rather than capacity additions.
Given the significant downward pressure on revenues, we continue to focus on operational execution and pairing down our cost structure to improve operating results. We plan to continue managing both our variable and fixed cost structure with the objective of minimizing our net cash outflow during fiscal 2009. In April 2009 we announced our plans to further reduce operational expenses and scale back our CMP business operations. We anticipate incurring incremental charges ranging from $12 million to $16 million in the second quarter of 2009 as a result of these actions.
We focus on certain key quarterly financial data to manage our business. Net sales, gross profit, net income and net income per share are the primary measures we use to monitor performance. We also use certain non-GAAP measures, such as shipments and net orders, to assess business trends and performance. Shipments consist of products shipped to customers, without regard to net sales adjustments such as deferrals associated with customer acceptance. Net orders, which are also referred to as bookings, consist of current period orders less current period cancellations and other adjustments. Net orders reported for the first quarter of 2009 and the fourth quarter of 2008 were reduced by $10.6 million and $44.9 million, respectively, due to customer cancellations and backlog adjustments based upon our assessment that certain customers may not be in a financial position to take delivery within the next 12 months. Shipments and net orders are used to forecast and plan future operations. We do not report orders for systems with delivery dates more than 12 months from the latest balance sheet date.
The following table sets forth certain quarterly financial information for the periods indicated (in thousands, except per share data and percentages):
Quarterly Financial Data
2009 2008
First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter
Net sales $ 98,913 $ 188,453 $ 250,098 $ 257,740 $ 314,713
Gross profit $ 25,738 $ 68,517 $ 111,524 $ 110,963 $ 144,940
Net income (loss) $ (66,392 ) $ (130,251 ) $ 1,397 $ (2,385 ) $ 15,529
Net income per share - Diluted $ (0.69 ) $ (1.36 ) $ 0.01 $ (0.02 ) $ 0.15
Shipments $ 92,130 $ 175,635 $ 230,153 $ 240,319 $ 312,857
Change in shipments from prior
quarter (48 )% (24 )% (4 )% (23 )% (14 )%
Net orders $ 77,795 $ 82,695 $ 202,765 $ 234,628 $ 297,025
Change in net orders from prior
quarter (6 )% (59 )% (14 )% (21 )% (13 )%
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We expect that net orders will continue to fluctuate due to the cyclical nature of our industry. The receipt of net orders in a particular quarter affects revenue in subsequent quarters. Net orders result in revenue either at shipment and transfer of title or upon customer acceptance of the equipment. Our revenue recognition policy, as discussed in our Annual Report on Form 10-K for the year ended December 31, 2008, addresses the distinction between the revenue recognized upon shipment and transfer of title and the revenue recognized upon customer acceptance. Equipment is generally shipped within two to six months of receiving the related order and, if applicable, customer acceptance is typically received one to six months after shipment. These time lines are general estimates and actual times may vary depending on specific customer circumstances.
Critical Accounting Policies
The preparation of financial statements in conformity with U.S. GAAP requires that we make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our assumptions and estimates, including those related to recognition of revenue, valuation of inventory, valuation of goodwill and other intangible assets, valuation of deferred tax assets, adequacy of warranty obligations, measurement of restructuring and impairment charges, compliance with hedge accounting for derivatives, measurement of stock-based compensation expense, valuation of investments, adequacy of the allowance for doubtful accounts and adequacy of loss contingencies, including those related to legal matters. We base our estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We discuss our critical accounting policies in Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2008. Except for the critical accounting policy set forth below entitled "Income taxes," there have been no significant changes in our critical accounting policies or estimates since those reported in our Annual Report.
Income Taxes
Because our projected tax rate is unusually volatile, the provision for income taxes in our Condensed Consolidated Statement of Operations for the three months ended March 28, 2009 reflects our actual effective tax rate for the current quarter. We believe our year-to-date tax provision for income taxes is the most reliable estimate of our annual effective tax rate. The effective income tax rate for the current fiscal year will likely be different from the tax rate in effect for the three months ended March 28, 2009 and could be considerably higher or lower, depending largely on our operating results before taxes and the geographic mix of income (loss) for the year. Our future effective income tax rate also depends on other factors, such as tax legislation, non-deductible expenses incurred in connection with acquisitions and other discretely recorded items, including interest expense on uncertain tax positions and deductions for compensation expense related to stock options and restricted stock.
As of March 28, 2009, we had approximately $92.2 million of net deferred tax assets. We currently believe all of our net deferred tax assets will be realized due to anticipated future income and our ability to carry back losses to prior years. We have considered all sources of taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance. If in the future we determine that we would not be able to realize all or part of our net deferred tax assets, a valuation allowance for deferred tax assets would decrease income in the period in which such determination is made. If market conditions change significantly within the next 12 months then it is reasonably possible that our valuation allowance will change.
Results of Operations
Net Sales
Q1 2009
% Change
Three Months Ended From
March 28, December 31, March 29, Q4 Q1
2009 2008 2008 2008 2008
(In thousands)
Semiconductor Group $ 76,579 $ 151,980 $ 270,350 (50 )% (72 )%
Industrial Applications Group 22,334 36,473 44,363 (39 )% (50 )%
Net sales $ 98,913 $ 188,453 $ 314,713 (48 )% (69 )%
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The net sales we report are correlated to shipments and the timing of customer acceptance. Deferred revenue at the end of the first quarter of 2009 was $40.2 million.
Semiconductor Group net sales in the first quarter of 2009 declined by 50% and 72% compared to fourth quarter 2008 and first quarter 2008 net sales, respectively. Net sales have continued to decline compared to prior periods as a result of ongoing weakness in the overall economy and the semiconductor industry in particular.
The primary functional currency of the Industrial Applications Group (IAG) is the Euro. Changes in the exchange rate reduced IAG net sales for the first quarter by 7% compared to the same period in the prior year and did not have a significant effect on IAG net sales compared to the prior quarter. The remaining decline of IAG net sales compared to the prior periods was due to decreased demand as a result of continued deterioration in the global economy.
Geographical net sales as a percentage of total net sales were as follows (based upon the location of our customers' facilities):
Three Months Ended
March 28, December 31, March 29,
2009 2008 2008
Asia 31% 41% 62%
North America 47% 43% 30%
Europe 22% 16% 8%
Gross Profit
Three Months Ended
March 28, December 31, March 29,
2009 2008 2008
(Dollars in thousands)
Gross profit $ 25,738 $ 68,517 $ 144,940
Gross margin 26 % 36 % 46 %
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First quarter 2009 gross margin decreased by 10 and 20 percentage points compared to the fourth quarter of 2008 and first quarter of 2008, respectively. The decrease in gross margin is primarily due to reduced absorption of fixed overhead costs on lower shipment volumes coupled with higher inventory write-downs as a percentage of net sales. Lower absorption had the effect of reducing gross margin by 3 and 7 percentage points in the current quarter compared to the fourth quarter of 2008 and first quarter of 2008, respectively, while the relative increase in inventory write-downs had the effect of reducing gross margin by 5 and 10 percentage points, respectively.
Selling, General and Administrative (SG&A)
Q1 2009
% Change
Three Months Ended From
March 28, December 31, March 29, Q4 Q1
2009 2008 2008 2008 2008
(Dollars in thousands)
SG&A expense $ 43,102 $ 52,061 $ 60,329 (17 )% (29 )%
% of net sales 44 % 28 % 19 %
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SG&A expense includes compensation and benefits for corporate, financial, marketing, sales and administrative personnel as well as travel expenses and professional service fees. Also included are expenses for rents, utilities, and depreciation and amortization related to the assets utilized by these functions.
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