<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 26, 1998
OR
( ) 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
0-17157
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Novellus Systems, Inc.
----------------------
(Exact name of Registrant as specified in its charter)
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<S> <C>
California 77-0024666
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(State or other jurisdiction (I.R.S. Employer
of incorporation of Identification
organization) Number)
3970 North First Street
San Jose, California 95134
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(Address of principal (Zip Code)
executive offices)
</TABLE>
Registrant's telephone number, including area code:
(408) 943-9700
- --------------
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
--- ---
As of October 30, 1998 34,172,926 shares of the Registrant's common stock, no
par value, were issued and outstanding.
1
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NOVELLUS SYSTEMS, INC.
FORM 10-Q
QUARTER ENDED SEPTEMBER 26, 1998
INDEX
Part I: Financial Information
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<CAPTION>
Page
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<S> <C> <C> <C>
Item 1: Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets at
September 26, 1998 and December 31, 1997. 3
Condensed Consolidated Statements of Operations
for the three and nine months ended September 26,
1998 and September 27, 1997. 4
Condensed Consolidated Statements of Cash Flows for
nine months ended September 26, 1998
and September 27, 1997. 5
Notes to Condensed Consolidated Financial
Statements. 6
Item 2: Management's Discussion and Analysis of
Financial Condition and Results of
Operations 9
Item 3: Quantitative and Qualitative Disclosure About
Market Risks 16
Part II: Other Information
Item 1: Legal Proceedings 16
Item 6: Exhibits and Reports on Form 8-K 16
Signatures 17
</TABLE>
2
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PART I: FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
NOVELLUS SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------
September 26, December 31,
1998 1997 (1)
Assets (unaudited)
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<S> <C> <C>
Current assets:
Cash and cash equivalents $66,757 $59,265
Short-term investments 44,537 38,824
Accounts receivable, net 158,963 133,925
Inventories 81,731 82,133
Deferred income taxes 24,896 22,241
Prepaid and other current assets 7,964 14,621
-----------------------
Total current assets 384,848 351,009
Property and equipment:
Machinery and equipment 106,218 83,972
Furniture and fixtures 8,196 6,456
Leasehold improvements 51,636 47,294
-----------------------
166,050 137,722
Less accumulated depreciation and amortization 61,548 44,382
-----------------------
104,502 93,340
Deferred income taxes 27,241 29,498
Other assets 28,287 19,453
-----------------------
Total Assets $544,878 $493,300
=======================
Liabilities and Shareholders' Equity
- --------------------------------------------------------------------------------------
Current liabilities:
Accounts payable $27,201 $22,865
Accrued payroll and related expenses 9,158 20,632
Accrued warranty 30,430 37,836
Other accrued liabilities 27,493 34,314
Income taxes payable 19,422 --
Current obligations under lines of credit 11,318 11,652
------------------------
Total current liabilities 125,022 127,299
Long-term debt 65,000 65,000
Commitments and contingencies
Shareholders' equity:
Common stock 164,519 154,167
Accumulated other comprehensive income (3,202) (2,227)
Retained earnings 193,539 149,061
------------------------
Total shareholders' equity 354,856 301,001
------------------------
Total Liabilities and Shareholders' Equity $544,878 $493,300
========================
</TABLE>
See accompanying notes.
(1) Derived from the December 31, 1997 audited financial statements.
3
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NOVELLUS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
- --------------------------------------------------------------------- -------------------
(in thousands, except per share data) Three Months Ended Nine Months Ended
(unaudited) Sept. 26, Sept. 27, Sept. 26, Sept. 27,
1998 1997 1998 1997
- --------------------------------------------------------------------- -------------------
<S> <C> <C> <C> <C>
Net sales $106,704 $155,080 $412,761 $371,174
Cost of sales 50,622 72,888 188,182 170,130
-------------------- -------------------
Gross profit 56,082 82,192 224,579 201,044
Operating expenses
Research and development 23,392 25,199 83,047 61,696
Selling, general and administrative 21,478 25,991 74,577 62,117
In-process research and development -- -- -- 119,246
Restructuring and other costs -- -- -- 14,243
Litigation settlement and related legal costs -- -- -- 84,021
Bad debt write-off -- -- -- 17,700
-------------------- -------------------
Total operating expenses 44,870 51,190 157,624 359,023
-------------------- -------------------
Operating income (loss) 11,212 31,002 66,955 (157,979)
Interest income (expense), net 342 (580) 759 2,923
-------------------- -------------------
Income (loss) before income taxes 11,554 30,422 67,714 (155,056)
Provision (benefit) for income taxes 3,931 10,343 23,025 (37,008)
-------------------- -------------------
Net income (loss) $7,623 $20,079 $44,689 ($118,048)
==================== ===================
Basic earnings (loss) per share (1) $0.22 $0.60 $1.32 ($3.57)
==================== ===================
Diluted earnings (loss) per share (1) $0.22 $0.57 $1.28 ($3.57)
==================== ===================
Shares used in basic
per share calculations (1) 34,095 33,546 33,948 33,108
==================== ===================
Shares used in diluted
per share calculations (1) 34,659 35,276 34,854 33,108
==================== ===================
</TABLE>
See accompanying notes.
(1) The earnings (loss) per share amounts reflect the 2 for 1 split effective
October 1997. See note 6.
4
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NOVELLUS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------
(in thousands) Nine Months Ended
(unaudited) Sept. 26, Sept. 27,
1998 1997
- -------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows provided by operating activities:
Net income (loss) $44,689 ($118,048)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
In-process research and development -- 119,246
Restructuring & other costs -- 14,243
Bad debt write-off -- 17,700
Deferred income taxes (398) (24,674)
Depreciation and amortization 17,166 12,807
Changes in operating assets and liabilities:
Accounts receivable (25,038) (25,878)
Inventories (111) (8,585)
Prepaid and other current assets 6,657 (7,868)
Accounts payable 4,336 (5,210)
Accrued payroll and related expenses (11,474) (2,251)
Accrued warranty (7,406) 2,028
Other accrued liabilities (6,821) 13,856
Income taxes payable (refundable) 19,422 (7,334)
-----------------------
Total adjustments (3,667) 98,080
-----------------------
Net cash provided by (used in) operating activities 41,022 (19,968)
-----------------------
Cash flows from investing activities:
Maturities and sales (purchases) of available-for-sale
debt securities, net (5,713) 81,930
Purchase of the net assets of the Thin Film Systems
business of Varian Associates -- (148,325)
Capital expenditures (28,840) (22,266)
Decrease (increase) in other assets (8,834) 1,792
-----------------------
Net cash used for investing activities (43,387) (86,869)
-----------------------
Cash flows from financing activities:
Payments on lines of credit, net (334) (883)
Borrowings under long-term debt -- 65,000
Repurchase of common stock (161) (145)
Proceeds from sale of common stock 10,352 15,707
-----------------------
Net cash provided by financing activities 9,857 79,679
-----------------------
Net increase (decrease) in cash and cash equivalents 7,492 (27,158)
Cash and cash equivalents at the beginning of the period 59,265 65,762
-----------------------
Cash and cash equivalents at the end of the period $66,757 $38,604
=======================
Supplemental Disclosures Cash paid during the period for:
Interest $3,493 $568
Income taxes $500 $--
Other noncash charges:
Income tax benefits from employee stock plans $1,087 $4,053
</TABLE>
See accompanying notes.
5
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NOVELLUS SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
only of normal recurring accruals) considered necessary for a fair presentation
have been included. Operating results for the three and nine month periods ended
September 26, 1998 are not necessarily indicative of the results that may be
expected for the year ending December 31, 1998. For further information, refer
to the consolidated financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 1997.
Certain amounts in the prior year balance sheet have been reclassified to
conform to current year presentation.
2. INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out) or market.
Inventories consisted of the following (in thousands):
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<CAPTION>
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Sept. 26, 1998 Dec. 31, 1997
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<S> <C> <C>
Purchased parts $52,113 $45,556
Work-in-process 21,725 30,326
Finished goods 7,893 6,251
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$81,731 $82,133
======== =========
</TABLE>
3. LINES OF CREDIT
The Company has lines of credit with four banks under which the Company can
borrow up to $13,318,000 at the banks' prime rate which expire at various dates
through June 2002. A portion of this facility ($11,318,000) is available to the
Company's Japanese subsidiary, Nippon Novellus Systems K.K. Borrowings by the
subsidiary are at the banks' offshore reference rate. At September 26, 1998 and
December 31, 1997, the amounts outstanding were $11.3 million and $11.7 million,
respectively. All borrowings outstanding under the line of credit were by Nippon
Novellus.
4. EARNINGS (LOSS) PER SHARE
In accordance with Statement on Financial Accounting Standards No. 128,
"Earnings per Share," basic earnings per common share is computed based on
weighted average common shares outstanding during the period. Diluted earnings
per share is computed using the weighted average common and dilutive common
equivalent shares outstanding during the period. Stock options are considered
common stock equivalents and are included in the weighted average shares
computation using the treasury stock method.
6
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NOVELLUS SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) CONTINUED
The following table sets forth the computation of basic and diluted earnings
(loss) per share (in thousands, except per share amounts):
<TABLE>
<CAPTION>
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Three Months Ended Nine Months Ended
Sept. 26, Sept. 27, Sept. 26, Sept. 27,
1998 1997 1998 1997
------------------------------ ------------------------------
------------------------------ ------------------------------
<S> <C> <C> <C> <C>
Numerator:
Net Income (loss) $7,623 $20,079 $44,689 $(118,048)
Denominator:
Denominator for basic earnings (loss) per
share-weighted-average shares
outstanding 34,095 33,546 33,948 33,108
Employee stock options 564 1,730 906 ---
-------------- --------------- -------------- ---------------
Denominator for diluted earnings (loss) per
share-adjusted weighted-average shares
outstanding
34,659 35,276 34,854 33,108
-------------- --------------- -------------- ---------------
Basic Earnings (loss) per share $0.22 $0.60 $1.32 $(3.57)
Diluted Earnings (loss) per share $0.22 $0.57 $1.28 $(3.57)
============== =============== ============== ===============
</TABLE>
5. LONG-TERM DEBT
In June 1997, the Company entered into a five year $125 million Senior Credit
Facility structured as an unsecured revolving credit line. Borrowings, at the
option of the Company, bear interest at either a base rate plus a margin or the
London Interbank Offering Rate ("LIBOR") plus a margin for interest periods of
one to six months. As of September 26, 1998, total borrowings under the
revolving credit line were $65 million. The weighted average interest rate at
September 26, 1998 was approximately 6.7%. The Senior Credit facility requires
the Company maintain compliance with certain financial covenants. At September
26, 1998, the Company was in compliance with these financial covenants. The
Senior Credit Facility currently prohibits the Company from paying dividends.
6. STOCK SPLIT
On September 22, 1997 the Company announced that its Board of Directors had
approved a two-for-one split of Novellus' common stock. Each shareholder of
record as of the close of business on Monday, September 29, 1997 has received
one additional share of common stock for every share held. Net earnings (loss)
per share amounts and the number of shares used in the computations, presented
in this filing, give effect to the two-for-one split.
7. COMPREHENSIVE INCOME (LOSS)
As of January 1, 1998, the Company adopted the Statement on Financial Accounting
Standards No. 130 (SFAS 130), "Reporting Comprehensive Income." SFAS 130
establishes new rules for the reporting and display of comprehensive income and
its components; however adoption of this Statement had no impact on the
Company's net income or shareholders' equity. SFAS 130 requires unrealized gains
or losses on the Company's available-for-sale securities and foreign
7
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NOVELLUS SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) CONTINUED
currency translation adjustments to be included in other comprehensive income.
Prior to adoption, unrealized gains or losses related to foreign currency
translation adjustments were reported as a separate component of shareholders'
equity.
The following are the components of comprehensive income (loss):
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Nine Months Ended
Sept. 26, 1998 Sept. 27, 1997
- --------------------------------------------------------------------------------
<S> <C> <C>
Net income (loss) $44,689 $(118,048)
Foreign currency translation adjustment (975) (123)
-------- -----------
Comprehensive income (loss) $43,714 $(118,171)
======== ===========
</TABLE>
The component of accumulated other comprehensive income, net of related tax is
as follows:
<TABLE>
<CAPTION>
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Sept. 26, 1998 Dec. 31, 1997
- --------------------------------------------------------------------------------
<S> <C> <C>
Foreign currency translation adjustment $(3,202) $(2,227)
======== ========
</TABLE>
8
<PAGE> 9
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Net sales for the three and nine months ended September 26, 1998 were $106.7 and
$412.8 million respectively, compared with $142.8 million for the immediately
preceding quarter. Net sales for the three and nine months ended September 27,
1997 were $155.1 and $371.2 million, respectively. The decrease in net sales
from the same quarter in the previous year and immediately preceding quarter
reflect the slowdown in capital spending by semiconductor manufacturers,
particularly for capacity purchases. The increase in net sales from the same
nine month period in the previous year is primarily the result of six months of
incremental sales of PVD products from the acquisition of the Thin Films Systems
(TFS) of Varian Associaties, Inc. in June 1997. Bookings for the third quarter
of 1998 fell short of achieving a 1:1 book to bill ratio, consistent with the
current industry environment. The Company expects net sales for the fourth
quarter to be consistent with the third quarter levels.
International net sales (including export sales) for the three and nine months
ended September 26, 1998, were 48.5% and 51.8%, respectively, as a percentage of
total net sales, which compares to the prior year periods of 40.3% and 41.3%,
respectively, and 61.9% for the immediately preceding quarter. The increase from
the same periods in the previous year relates to higher net sales in Europe and
the Pacific Rim.
Gross profit as a percentage of net sales for the three and nine months ended
September 26, 1998 were 52.6% and 54.4%, respectively, compared with the 53.0%
and 54.2% for the comparable year-ago periods and 55.0% for the immediately
preceding quarter. The decrease in gross profit during the third quarter, as
compared to the preceding quarter, was due mainly to lower absorption of fixed
overhead costs resulting from decreased shipment volume partially offset by cost
reduction efforts. The Company expects gross margin levels in the fourth quarter
of 1998 to be consistent with the third quarter of 1998.
Research and development expenses for the three and nine months ended September
26, 1998 were $23.4 million and $83.0 million, respectively, a decrease of $1.8
million when compared with the comparable year ago quarter, an increase of $21.4
million when compared with the comparable year ago nine-month period and a
decrease of $5.4 million when compared with the immediately preceding quarter.
Research and development expenses as a percentage of net sales for the three and
nine months ended September 26, 1998 were 21.9% and 20.1%, respectively,
compared with the 16.2% and 16.6%, respectively, for the comparable year-ago
periods, and 20.1% for the immediately preceding quarter. The decrease in
research and development expenses from both the comparable year ago and
immediately preceding quarter are due to the Company's cost-cutting measures.
The increases in research and development expenses as a percentage of net sales
reflects the Company's continued commitment to the development of new products,
including additional Concept Two modules, advanced PVD systems, advanced "gap
fill" technology, primary conductor metals, low K dielectric materials and
additional advanced technologies for the next generation of smaller geometry
fabrication lines, as well as equipment to process 300mm wafers.
Selling, general, and administrative expenses for the three and nine months
ended September 26, 1998 were $21.5 million and $74.6 million, respectively,
compared with $26.0 million and $62.1 million, respectively, in the comparable
year-ago quarter, and $25.8 million from the immediately preceding quarter.
Selling, general, and administrative expenses as a percentage of net sales for
the three and nine months ended September 26, 1998 were 20.1% and 18.1%,
9
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS CONTINUED
respectively, compared with 16.8% and 16.7%, respectively, for the comparable
year-ago periods, and 18.0% for the immediately preceding quarter. The decrease
in selling, general, and administrative expenses from the comparable and
immediately preceding quarter are due to the Company's ongoing cost cutting
efforts. The increase in absolute dollars from the nine months ended September
27, 1997 as compared to the nine months ended September 26, 1998, is related to
incremental expenses associated with selling and supporting the acquired PVD
product line. The Company is continuing its efforts to control and minimize
selling, general and administrative costs.
Net interest income for the three and nine months ended September 26, 1998 was
$342,000 and $759,000, respectively, compared with net interest expense of
$580,000 and net interest income of $2.9 million, respectively, for the
comparable year-ago periods, and net interest income of $386,000 for the
immediately preceding quarter. The increase in net interest income compared with
the comparable year ago quarter is primarily due to increased average cash and
short term investment balances over the past year. The decrease in net interest
income for the nine months ended September 26, 1998 when compared to comparable
year ago period is due to lower cash balances as a result of the settlement
payment and other costs of $84.0 million for the TEOS patent litigation in May
1997 and the acquisition of TFS, financed through the use of $80.5 million of
existing cash, and long-term borrowings of $65.0 million.
The Company's effective tax rate for the three and nine months ended September
26, 1998 was 34% compared with 26% for the comparable year ago periods. The
increase is primarily attributable to a valuation reserve established against a
portion of the deferred tax asset arising from the write-off of purchased
in-process research and development which resulted in a lower tax rate in the
prior year. The effective tax rate for the immediately preceding quarter was
34%.
Net deferred tax assets were $52.1 and $51.7 million at September 26, 1998 and
December 31, 1997, respectively. Deferred tax assets of $77.8 and $78.9 million
were offset by valuation allowances of $18.5 and $20.0 million and deferred tax
liabilities of $7.2 million at September 26, 1998 and December 31, 1997. The
valuation allowances relate to capitalized in-process research and development
which is deductible for tax purposes over a 15 year period, and reduces the
deferred tax asset for this item by approximately 50%. While other deferred tax
assets are realizable because of offsetting deferred tax liabilities and
potential tax carry-back availability, realization of the capitalized in-process
research and development is dependent on future taxable income. Because of the
inherent risks and uncertainties in the Company's business described under Other
Cautionary Statements in the Company's periodic reports filed under the
Securities Exchange Act of 1934, as amended, management determined that
approximately 50% of this asset is more likely than not realizable.
Net income for the three and nine months ended September 26, 1998 was $7.6
million and $44.7 million or $0.22 and $1.28 per share, respectively, compared
with net income of $20.1 million and net loss of $(118.0) million or $0.57 and
$(3.57) per share, respectively, for the comparable year-ago periods, and net
income of $16.1 million or $0.46 per share for the immediately preceding
quarter. The decrease in net income compared with the comparable year ago
quarter and immediately preceding quarter is due to the decrease in net sales
resulting from the slowdown in capital spending by semiconductor manufacturers.
The change from a net loss for the nine months ended June 28, 1997 to net income
for the nine months ended September 26, 1998 is attributable to the impact of
the charges of $119.2 million related to the write-off of acquired in-process
research and development and $14.2 million attributed to restructuring charges,
in connection with the acquisition of TFS, and charges of $84.0 million and
$17.7 million related to the settlement
10
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS CONTINUED
of the Applied Materials CVD patent suit and a customer account write-off,
recorded in the three months ended June 28, 1997. Without the one time charges,
net income for the nine months ended September 26, 1997 would have been $52.9
million or $1.53 per share.
The number of shares used in the per share calculations for the three and nine
months ended September 26, 1998 was 34.7 and 34.9 million compared with 35.3 and
33.1 million for the comparable year-ago periods. The decrease in shares used
compared to the comparable year-ago quarter is primarily due to a decreased
number of common stock equivalents.
YEAR 2000
The Company is aware of the issues associated with the operation of information
technology ("IT") and non-information technology ("Non-IT") systems as the
millennium (year 2000) approaches. The "Year 2000" problem is pervasive and
complex, with the possibility to affect many IT and Non-IT systems, as the
result of the rollover of the two digit year value from "99" to "00". The
concern is whether such systems will properly recognize data sensitive
information when the year changes to 2000. Systems that do not properly
recognize such information could generate erroneous data or fail. In addition to
the Company's own systems, the Company relies, directly and indirectly, on
external systems of its customers, suppliers, creditors, financial
organizations, utilities providers and governmental entities, both domestic and
internationally (collectively, "Third Parties"). Consequently, the Company could
be affected through disruptions in the operations of the Third Parties with
which the Company interacts. Furthermore, the purchasing frequency and volume of
customers or potential customers may be affected by Year 2000 issues as
companies expend significant resources to make their current systems Year 2000
compliant.
The Company is utilizing both internal and external resources to address (a) the
Company's state of readiness (including the readiness of Third Parties, with
which the Company interacts) with respect to the Year 2000 problem, (b) the
costs to the Company to address Year 2000 issues related to internal IT and
Non-IT systems, which, if uncorrected, could have a material adverse effect on
the business, financial condition or results of operations of the Company, (c)
the known risks related to the consequences of any failure to correct any Year
2000 problems identified by the Company, and (d) what contingency plans, if any,
should be adopted by the Company should any identified Year 2000 problems not be
corrected.
State of Readiness.
The following discussion broadly addresses the Company's efforts to identify and
address its and applicable Third Parties' Year 2000 problems with respect to (a)
the Company's products, (b) the Company's information technology systems,
including facilities and infrastructure, and (c) the Company's suppliers.
However, it would be impracticable for the Company to attempt to address all
Year 2000 problems of Third Parties that have been or may in the future be
identified. Specifically, Year 2000 problems have been or may in the future be
identified with respect to the IT and Non-IT systems of Third Parties having
widespread national and international interactions with persons and entities
generally (for example, certain IT and Non-IT systems of governmental agencies,
utilities and telecommunications, information and financial networks) that, if
uncorrected, could have a material adverse impact on the Company's business,
financial condition or results of operations. Notwithstanding anything set forth
below, the Company is not in a position to address any such Year 2000 problems.
11
<PAGE> 12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS CONTINUED
(a) The Company's products.
The Company has completed a Year 2000 compliance evaluation of all of its
products utilizing testing guidelines prepared by Sematech, a consortium of
suppliers to the worldwide semiconductor manufacturers that assists its
members with strategic marketing opportunities. It is the Company's plan to
comply with Sematech's guidelines for Year 2000 compliance. The Company's
new products are designed to be Year 2000 compliant. However, some of the
Company's older products will require upgrades for Year 2000 compliance. At
this time, software upgrades have been or will be provided to all Novellus
customers products free of charge. Any hardware needed to achieve Year 2000
compliance on out of warranty systems will need to be purchased from
Novellus. However, notwithstanding such efforts, any failure of the
Company's products to perform, including system malfunctions due to the
onset of Year 2000, could result in claims against the Company, which could
have a material adverse effect on the Company's business, results of
operations or financial condition. Moreover, the Company's customers could
choose to convert to other Year 2000 compliant products in order to avoid
such malfunctions, which could have a material adverse effect on the
Company's business, financial condition or results of operations.
In June of 1997, the Company acquired the Thin Films Systems division of
Varian Associates, Inc. (TFS). During the Company's evaluation of Year 2000
readiness for its products, it was determined that some of the TFS products
acquired from Varian Associates, Inc. are not, and will not be Year 2000
compliant prior to December 31, 1999. The Company is taking measures to
inform its applicable customers of that fact. The Company currently
anticipates that the failure of such products to be Year 2000 compliant
will not have a material adverse effect on the Company's business, results
of operations or financial condition.
(b) Information technology systems including facilities and infrastructure.
The Company currently uses standard mass-market vendor supplied software on
its desktop systems and laptops. These standard software applications limit
the number of information technology vendors that Novellus must work with
to ensure Year 2000 readiness. Many of these vendors are still implementing
their Year 2000 compliance programs. Novellus maintains maintenance
contracts with all information technology vendors and will implement the
Year 2000 compliant versions of hardware and/or software as required when
those solutions are available. However, no assurance can be provided that
all such programs will be timely implemented or that the failure to so
implement such programs will not have a material adverse effect on the
Company's business, results of operations or financial condition.
The Company is in the process of assessing its Year 2000 risk with respect
to building automation systems, electronic security systems, utility and
water systems. Formal queries to landlords, local fire departments, water
and utility providers for the Company's domestic and international
locations will be sent by March 1999.
(c) Suppliers.
Novellus has contacted those suppliers that could have a material adverse
impact on Novellus' ability to provide uninterrupted service to its
customers should the IT or Non-IT systems of such suppliers have
uncorrected Year 2000 problems.
By the end of September 1998, 90% of these suppliers had documentation with
respect to their Year 2000 readiness on file with Novellus. The
12
<PAGE> 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS CONTINUED
rest are being contacted to complete the Sematech Year 2000 Readiness
Supplier Questionnaire or to document their Year 2000 compliance status as
is appropriate for their business. However, such documentation does not
assure Year 2000 compliance of the IT and Non-IT systems used by such
suppliers, but instead provides only a description of their relevant
systems and the status of efforts, if any, by such suppliers to make such
systems Year 2000 compliant. Accordingly, no assurance can be provided that
(a) the IT and Non-IT systems of Company suppliers (including those
suppliers who have provided documentation to the Company regarding their
Year 2000 compliance) will be Year 2000 compliant, (b) that such
documentation accurately and fully reflects the Year 2000 compliance status
of such suppliers' systems, or (c) that the failure by any such suppliers'
systems to be Year 2000 compliant will not have a material adverse effect
on the Company's business, results of operations or financial condition.
Costs to Address Year 2000 Issues.
The Company currently expects to incur total software, hardware and
systems-related costs of approximately $3.0 million in connection with
remediations of Year 2000 compliance issues. There can be no assurance that the
cost estimates associated with the Company's Year 2000 issues will prove to be
accurate or that the actual costs will not have a material adverse effect on the
Company's business, results of operations or financial condition.
Known Risks.
The Company currently anticipates that any identified Year 2000 problem
affecting its own systems or that of its significant customers, suppliers,
creditors, financial organizations and utilities providers will be either
corrected by December 31, 1999 or will not have a material adverse affect on the
Company's business, financial condition or results of operations. Moreover, the
Company is working to minimize any disruption to the business of its vendors and
suppliers due to Year 2000 problems that may have a material adverse affect on
the Company's business, financial condition or results of its operations.
However, notwithstanding the Company's efforts to identify and correct such Year
2000 problems, there can be no assurance that the Company will be successful in
addressing the year 2000 problems as they pertain to its products and its
internal systems, and that the failure to do so would not have a material
adverse effect on the Company's business, financial condition or results of
operations. In addition, notwithstanding such efforts, there can be no assurance
that the systems of Third Parties with which the Company interacts will not
suffer from Year 2000 problems, or that such problems would not have a material
adverse effect on the Company's business, financial condition or results of
operations. In particular, Year 2000 problems that have been or may in the
future be identified with respect to the IT and Non-IT systems of Third Parties
having widespread national and international interactions with persons and
entities generally (for example, certain IT and Non-IT Systems of governmental
agencies, utilities and information and financial networks) could have a
material adverse impact on the Company's business, financial condition or
results of operations.
Contingency Plans.
The Company currently is in the process of reviewing its Year 2000 compliance
plans to determine what contingency plans, if any, are appropriate. The Company
does not currently have any contingency plans. The Company anticipates
completing such review and preparing contingency plans, if appropriate, by
September 1999. There can be no assurance that such measures will prevent the
occurrence of Year 2000 problems, which could have a material adverse effect
upon the Company's business, results of operations or financial condition.
13
<PAGE> 14
EURO CONVERSION
On January 1, 1999, several member countries of the European Union will
establish fixed conversion rates between their existing sovereign currencies and
adopt the Euro as their new common legal currency. As of that date, the Euro
will trade on currency exchanges and the legacy currencies will remain legal
tender in the participating countries for a transition period between January 1,
1999 and January 1, 2002. During the transition period, noncash payments can be
made in the Euro, and parties can elect to pay for goods and services and
transact business using either the Euro or legacy currency. Between January 1,
1999 and January 1, 2002 the participating countries will introduce Euro notes
and coins and withdraw all legacy currencies so that they will no longer be
available. The Euro conversion may affect cross-border competition by creating
cross-border transparency. The Company is assessing its pricing/marketing
strategy in order to insure that it remains competitive in a broader European
market. The Company is also assessing its information technology systems to
allow for transactions to take place in both legacy currencies and the Euro and
the eventual elimination of the legacy currencies, and reviewing whether certain
existing contracts will be need to be modified. The Company's currency risk and
risk management for operations in participating countries may be reduced as the
legacy currencies are converted to the Euro. Final accounting, tax and
governmental legal and regulatory guidance is not available. The Company will
continue to evaluate issues involving introduction of the Euro. Based on current
information and the Company's current assessment, it does not expect that the
Euro conversion will have a material adverse effect on its business, results of
operations or financial condition.
14
<PAGE> 15
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically financed its operations and capital resources
through cash flow from operations, sales of equity securities and borrowings.
The Company's primary sources of funds at September 26, 1998 consisted of $111.3
million of cash, cash equivalents and short-term investments. This amount
represents an increase of $13.2 million from the December 31, 1997 balance of
$98.1 million. During the second quarter of 1997, the Company entered into a
five year $125 million Senior Credit Facility structured as an unsecured
revolving credit line. The borrowings, at the option of the Company, bear
interest at either a base rate plus a margin or LIBOR plus a margin for interest
periods of one to six months. As of September 26, 1998, total borrowings under
the Senior Credit Facility were $65 million with a weighted average interest
rate of approximately 6.7%. The Senior Credit facility requires the Company to
be in compliance with certain financial covenants. At September 26, 1998, the
Company was in compliance with these financial covenants. The Senior Credit
Facility currently prohibits the Company from paying dividends. In addition, at
September 26, 1998, there was $13.3 million available under bank lines of credit
that expire at various dates through June 2002. At September 26, 1998
approximately $11.3 million was outstanding under these bank lines of credit
which bear interest at the banks' prime lending rates or offshore reference
rates.
During the nine months ended September 26, 1998, the Company's cash and cash
equivalents increased $7.5 million to $66.8 million from $59.3 million at
December 31, 1997. Net cash provided by operating activities during the first
nine months of 1998 was $41.0 million due primarily to net income of $44.7
million, non-cash depreciation and amortization charges of $17.2 million, and
increases in prepaids and other assets and income tax payable of $6.7 million
and $19.4 million, respectively. These amounts were partially offset by
increases in accounts receivable of $25.0 million, decreases in accrued payroll
and related expenses of $11.5 million, and a decrease in accrued warranty of
$7.4 million. The increase in accounts receivable was due to longer collection
cycles on certain Asian accounts and the timing of shipments during the quarter.
Net cash flows used for investing activities was $43.4 million during the first
nine months of 1998. During this period, the Company had capital expenditures of
$28.8 million and purchases of available-for-sale debt securities of $5.7
million.
The Company expects investments in property and equipment in the current fiscal
year to approximate $37.7 million of which $28.8 million has been incurred as of
September 26, 1998. The Company intends to finance these investments from
existing cash balances and cash flows from operations.
The Company believes that its current cash position and cash generated through
operations, if any, will be sufficient to meet the Company's needs through at
least the next twelve months.
15
<PAGE> 16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS
Not Applicable.
The statements contained in this Report on Form 10-Q that are not purely
historical in nature are "forward looking statements" within the meaning of
Section 27A of the Securities Act of 1933 and Section 21 E of the Securities
Exchange Act of 1934, including without limitation, statements regarding the
Company's estimations, anticipations, determinations, commitments, expectations,
plans, hopes, beliefs, intentions or strategies regarding the future. These
forward-looking statements involve risks and uncertainties including, but not
limited to, domestic and international economic conditions, product demand and
industry capacity, competitive products and pricing, manufacturing efficiencies,
new product development, ability to enforce patents, the availability of raw
materials and critical manufacturing equipment, new plant startups, the
regulatory and trade environment, and other risks indicated in filings with the
Securities and Exchange Commission (SEC). Actual results may differ materially.
Novellus assumes no obligation to update this information. For more details,
please refer to other SEC filings, including the Company's most recent Annual
Report on Form 10-K and Quarterly Reports on Form 10-Q.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Semitool, Inc. v. Novellus Systems, Inc.
On August 10, 1998, Semitool sued the Company for patent infringement in the
United States District Court for the Northern District of California. Semitool
alleges that the Company's SABRE(TM) copper deposition system infringes two
Semitool patents, U.S. Patent No. 5,222,310, issued June 29, 1993, entitled
"Single Wafer Processor with a Frame," and U.S. Patent No. 5,377,708, issued
January 3, 1995, entitled "Multi-Station Semiconductor Processor with
Volatilization." Semitool seeks an injunction against the Company's manufacture
and sale of SABRE(TM) systems, and seeks damages for past infringement. Semitool
also seeks enhanced damages for alleged willful infringement. Semitool also
seeks its attorneys' fees and costs, and interest on any judgement.
16
<PAGE> 17
The Company believes that there are meritorious defenses to Semitool's
allegations, including among other things, that the Company's operations
(including SABRE(TM) products and systems) do not infringe the Semitool Patents
and/or that the Semitool Patents are invalid and/or unenforceable. But the
resolution of intellectual property disputes is often fact intensive and, like
most other litigation matters, inherently uncertain. Although the Company
believes that the ultimate outcome of the dispute with Semitool will not have a
material adverse effect on the Company's business or results of operations
(taking into account the defenses available to the Company), there can be no
assurances that Semitool will not ultimately prevail in this dispute.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Not Applicable
(b) No reports on Form 8-K have been filed by the Company during
the quarter for which this report was filed.
(c) Financial Data Schedule
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NOVELLUS SYSTEMS, INC.
REGISTRANT
/s/ Robert H. Smith
----------------------------------------
Robert H. Smith
Executive Vice President
Finance and Administration
/s/ J. Michael Dodson
----------------------------------------
J. Michael Dodson
Vice President and Corporate
Controller (Chief Accounting
Officer)
November 10, 1998
----------------------------------------
Date
17
<PAGE> 18
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------ -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-26-1998
<CASH> 66,757
<SECURITIES> 44,537
<RECEIVABLES> 162,187
<ALLOWANCES> 3,224
<INVENTORY> 81,731
<CURRENT-ASSETS> 384,848
<PP&E> 166,050
<DEPRECIATION> 61,548
<TOTAL-ASSETS> 544,878
<CURRENT-LIABILITIES> 125,022
<BONDS> 65,000
0
0
<COMMON> 164,519
<OTHER-SE> 190,337
<TOTAL-LIABILITY-AND-EQUITY> 544,878
<SALES> 412,761
<TOTAL-REVENUES> 412,761
<CGS> 188,182
<TOTAL-COSTS> 157,624
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,200
<INCOME-PRETAX> 67,714
<INCOME-TAX> 23,025
<INCOME-CONTINUING> 44,689
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 44,689
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
