Back to GetFilings.com

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended March 29, 2003

OR

For the transition period from             to           

Commission File Number 000-17157

NOVELLUS SYSTEMS, INC.

4000 North First Street, San Jose, California 95134
(Address of principal executive offices including zip code)

(408) 943-9700
(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

YES     X           NO

As of May 9, 2003, 149,910,708 shares of the Registrant’s common stock, no par value, were issued and outstanding.

Table of Contents

NOVELLUS SYSTEMS, INC.
FORM 10-Q
QUARTER ENDED MARCH 29, 2003

TABLE OF CONTENTS

2

Table of Contents

PART I: FINANCIAL INFORMATION

ITEM 1: CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOVELLUS SYSTEMS, INC.

See accompanying notes to the condensed consolidated financial statements.

3

Table of Contents

NOVELLUS SYSTEMS, INC.

*

Amounts as of December 31, 2002 are derived from the December 31, 2002 audited financial statements.

See accompanying notes to the condensed consolidated financial statements.

4

Table of Contents

NOVELLUS SYSTEMS, INC.

See accompanying notes to the condensed consolidated financial statements.

5

Table of Contents

NOVELLUS SYSTEMS, INC.

1. BASIS OF PRESENTATION

The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to the Quarterly Report on Form 10-Q and Article 10 of Regulation S-X. The interim financial information is unaudited and does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America 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 months ended March 29, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. For further information, refer to the Consolidated Financial Statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2002.

On December 6, 2002, we acquired SpeedFam-IPEC, Inc., a global supplier of chemical mechanical planarization (CMP) systems used in the fabrication of advanced copper interconnects. The acquisition was accounted for as a purchase business combination and qualifies as a tax-free reorganization under IRS regulations. Our condensed consolidated financial statements for the first quarter of 2003 include the financial position, results of operations and cash flows of SpeedFam-IPEC, Inc.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the related disclosures of contingent assets and liabilities. We evaluate our estimates on an ongoing basis, including those related to revenue recognition, allowance for doubtful accounts, inventory valuation, deferred tax assets, property and equipment, goodwill and other intangible assets, warranty obligations, restructuring and impairment charges, contingencies and litigation and stock-based compensation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the current 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. Our intent is to accurately state our assets given facts known at the time of valuation. Our assumptions may prove incorrect as facts change in the future. Actual results may differ from these estimates under different assumptions or conditions.

The accompanying condensed consolidated financial statements include our accounts and the accounts of our wholly-owned subsidiaries after elimination of all significant intercompany account balances and transactions. Certain amounts presented in the comparative financial statements for prior periods have been reclassified to conform to the current period’s presentation.

2. INVENTORIES

Inventories are stated at the lower of cost (first-in, first-out) or market. As of the balance date, inventories consisted of the following (in thousands):

6

Table of Contents

3. NET INCOME PER SHARE

Basic net income per share is computed by dividing net income by the weighted-average number of common shares outstanding during the period. For purposes of computing basic net income per share, the weighted-average number of outstanding shares of common stock excludes shares of restricted stock subject to repurchase.

Diluted net income per share is computed using the weighted-average number of shares of common stock outstanding, including shares of restricted common stock subject to repurchase and, when dilutive, potential shares from stock options to purchase common stock using the treasury stock method and from convertible securities on an as-if-converted basis.

The following table provides a reconciliation of the numerators and denominators of the basic and diluted per share computations (in thousands, except for per share amounts):

Options to purchase 12,697,000 and 1,818,000 shares of common stock at weighted-average exercise prices of $40.03 and $52.66 per share were outstanding as of March 29, 2003 and March 30, 2002, respectively, but were not included in the computation of diluted net income per common share because the respective exercise price of these options was greater than the average respective market price of the common shares and, therefore, the effect would be anti-dilutive.

4. COMMITMENTS AND GUARANTEES

Operating Leases

We lease nearly all of our facilities under operating leases, including synthetic leases, which expire at various dates through 2017. Our synthetic leases are primarily for properties in San Jose, California and Tualatin, Oregon. A synthetic lease is a form of operating lease wherein a third party lessor funds 100% of the acquisition and construction costs relating to one or more properties to be leased to a lessee. The lessor is the owner of the leased property and must provide at least 3% of the required funds in the form of at-risk equity. The lessor generally borrows the balance of the funds necessary to fund the acquisition and construction. Under our synthetic lease agreements, we are obligated to lend approximately 87% of the cost of the leased asset to the lessor upon completion of construction. The leases with this requirement are known as defeased or self-funded transactions. In addition, our synthetic leases require us to maintain collateral for the benefit of the lessor.

7

Table of Contents

Summary information about our synthetic lease arrangements is as follows as of March 29, 2003 (square feet and dollar amounts in thousands):

In January 2003, the Financial Accounting Standards Board (FASB) issued Financial Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,” or FIN 46. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003.

We are currently evaluating our synthetic leases and seeking additional information from the lessor and its advisors as to whether the lessor should be characterized as a variable interest entity. Our preliminary conclusion is that the lessor is a variable interest entity and that we are the primary beneficiary of the variable interest entity. As such, to the extent we do not exercise our purchase options or renew the leases with a voting interest lessor or a variable interest lessor where we are not the primary beneficiary, we expect to be required to consolidate the variable interest lessor in the third quarter of 2003. Additionally, since each of the other lessees involved with this lessor has a variable interest in specified assets of the variable interest lessor, we would only be required to record the specific assets and liabilities associated with our synthetic leases in our financial statements for the third quarter of 2003 beginning on June 29, 2003. We are currently researching our options for refinancing our synthetic leases with a voting interest lessor or a variable interest lessor where we are not the primary beneficiary. Upon completion of this research we will decide to either refinance with an entity with which we would not be required to consolidate, consolidate our portion of the variable interest entity or purchase the properties by exercising our purchase options.

If we consolidate our portion of the variable interest entity, we would record a non-cash charge of approximately $90 million to $120 million as a cumulative effect of a change in accounting principle, which would represent depreciation that would have been recorded had we owned these assets from inception. In addition, our annual depreciation expense would increase by approximately $30.0 million to $35.0 million beginning in the third quarter of 2003, and rent expense and interest income would each decrease by approximately $13.4 million per year, based on current interest rates.

If we exercise options to purchase the San Jose and Tualatin properties, the transactions would increase our property and equipment by the lower of the purchase price or the then fair market value of the properties. As of March 29, 2003, we believe that the fair market value for each property is equal to or greater than the purchase option price for each property. We estimate the cumulative fair market value of all properties to be approximately $456.4 million as of March 29, 2003. If we were to purchase the properties, our notes receivable and collateral in a total amount of $456.4 million would be returned to us as cash or used to offset the purchase price of the properties. As a result of the purchase, annual depreciation expense would increase by approximately $30.0 million to $35.0 million beginning in the third quarter of 2003, and rent expense and interest income would each decrease by approximately $13.4

8

Table of Contents

million per year, based on current interest rates. If we purchased the properties at the end of their respective lease terms or earlier, there would be no material impact on our liquidity, as the cash paid to purchase the properties would be offset by the notes receivable and collateral associated with our participation in these synthetic leases.

Product Warranty

We record the estimated cost of warranty as a component of cost of sales upon system shipment. The estimated cost is determined by the warranty term as well as the average historical labor and material costs for a specific product. Should actual product failure rates or material usage differ from our estimate, revisions to the estimated warranty liability may be required. We review the actual product failure rates and material usage on a quarterly basis and adjust our warranty liability as necessary. Effective December 31, 2002, we adopted the provisions of FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Indebtedness of Others,” which requires changes to the accounting and disclosure of guarantees, including product warranty. Changes in our accrued warranty liability were as follows (in thousands):