Varian Semiconductor Equipment Associates 10-K 2010
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission File Number: 0-25395
VARIAN SEMICONDUCTOR EQUIPMENT
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code (978) 282-2000
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by checkmark 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrants 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 is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ¨
Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
The aggregate market value of the registrants common stock held by non-affiliates as of April 2, 2010 was $2,440,068,364.
The registrant had 74,002,736 shares of common stock outstanding as of November 15, 2010.
An index of exhibits filed with this Form 10-K is located on page 41.
DOCUMENTS INCORPORATED BY REFERENCE:
FOR THE FISCAL YEAR ENDED OCTOBER 1, 2010
TABLE OF CONTENTS
We are the leading supplier of ion implantation systems, which we refer to as tools, used in the fabrication of integrated circuits, which we refer to as microchips or chips. We design, manufacture, market and service semiconductor processing equipment for virtually all of the major semiconductor manufacturers worldwide. The VIISta ion implanter products are designed to leverage single wafer processing technology for the full range of semiconductor implant applications. We have shipped more than 1,200 VIISta systems and more than 4,100 systems overall worldwide.
Our business is cyclical and depends upon semiconductor manufacturers expectations and resulting capacity investments for future integrated circuit demand. From 2005 to 2007, the total available market for ion implanters grew as memory manufacturers increased capacity to meet demand. During this time, we also realized significant market share gains through a superior product portfolio. In 2008, the semiconductor capital equipment industry entered a cyclical, supply-side driven downturn resulting from the significant capacity expansions of the previous three years. The downturn was exacerbated by a drop in demand due to a worsening worldwide macro-economic environment. In 2009, the total available market for the entire capital equipment industry decreased by 56% from the prior year, as reported by Gartner Dataquest. While we realized market share growth in 2009, it did not offset the substantial drop in demand during that period. In 2010, the total available market for the entire capital equipment industry is expected to increase by over 120% from the prior year, as reported by Gartner Dataquest.
We maintain a website at www.vsea.com. The information contained on the our website is not included in, or incorporated by reference into, this Annual Report on Form 10-K. Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to these reports, are made available through our website, free of charge, as soon as reasonably practicable following the electronic filing or furnishing of such materials by us to the Securities and Exchange Commission, or SEC, and are available at the SECs website at www.sec.gov.
Our logo and all product and service names used in this report are either registered trademarks or trademarks of Varian Semiconductor Equipment Associates, Inc. in the United States and/or other countries. All other marks mentioned herein are the property of their respective holders.
All references to fiscal years apply to our fiscal years, which ended October 1, 2010, October 2, 2009 and October 3, 2008.
The semiconductor industry is essentially two different, but connected industries microchip and capital equipment, or capex. The microchip industry is where microprocessors, dynamic random access memory, or DRAM, flash memory, or flash, signal processors, and hundreds of other electronic circuits are created on small squares of silicon known as chips or die. The manufacturers of these circuits can be categorized as either logic, memory, foundry, analog or discrete. Logic, memory and foundry represent the bulk of the industry. Logic manufacturers design and make chips that process information. Memory manufacturers design and make chips that store information. Foundry manufacturers are contractors that take chip designs from other companies and make the chips for them. Over the last several years, the demand for memory chips has outstripped the demand for logic chips. As the demand for memory-intensive applications such as cameras, phones and MP3 players grows, it is expected that memory will continue to represent the bulk of chips made worldwide.
We participate in the capex industry. The capex industry is comprised of companies that manufacture equipment used in the production of microchips. The two segments of the capex industry are known as front end of the line, or FEOL, and back end of the line, or BEOL. In the FEOL, the various circuit components such as transistors,
diodes, resistors and capacitors are formed. In the BEOL, the wires, or interconnect, that join all of the components together to form the circuit are created. We manufacture tools that have traditionally been used to form the circuit components in the FEOL. In the last few years we have developed applications in precision materials modification that are also used in the BEOL. The semiconductor industry strives to provide more functionality for a lower cost. In order to achieve this dynamic and be successful, capex companies must innovate through aggressive research and development. Capex companies develop the technology and applications that drive the entire semiconductor industry.
Semiconductor manufacturing is highly competitive with each manufacturer seeking to provide products that consume the least amount of power, have the lowest cost and fastest processing speed. Integrated circuit manufacturers generally rely on equipment suppliers for the timely development of equipment and processes to meet their rapidly changing and complex requirements. Today, a semiconductor fabrication factory, or fab, can cost over $3.0 billion. As the industry transitions to 32nm (32 billionths of a meter) devices, these costs are expected to increase.
The fabrication of integrated circuits requires a number of complex and repetitive processing steps, including deposition, photolithography, etch, metrology, thermal anneal and ion implantation. Deposition is a process in which a film of either electrically insulating or electrically conductive material is deposited on the surface of a wafer. Photolithography is used to transfer a circuit pattern onto a light-sensitive material called photo-resist that, after development, can be used in turn to transfer the pattern onto the silicon surface. The etch process completes the transfer of the pattern into the various thin films used to make the integrated circuit. Metrology measures critical features and properties of the device to ensure correct fabrication. Thermal anneal is used to incorporate implanted impurities into the silicon crystal matrix and make them electrically active. Ion implantation provides a means for introducing impurities into the silicon, typically into selected areas defined by the photolithographic process. The selective implanting of ions creates defined areas with different levels of conductivity that form the transistors of the integrated circuits.
Semiconductor manufacturers have historically sought to increase the number of transistors on each microchip by shrinking device structures. Through this relentless miniaturization, microchips have increased their processing capability or memory storage capacity. This is accomplished by exploiting advancements in photolithography. Each new advancement in photolithography is described by the minimum resolvable geometry and is commonly referred to as a device node. State-of-the-art production is now accomplished at 45nm nodes with 32nm nodes currently in development at more technologically advanced fabs. As advances in photolithography have become more challenging, ion implant has expanded its application portfolio to provide enabling capability in microchip device performance and yield, particularly in the area of damage engineering.
Improved productivity has been accomplished by transitioning to larger and larger silicon substrates, or wafers. From 25mm wafers used in the 1970s to the current stateof-the-art wafer size at 300mm, each successive generation increases the number of microchips per wafer thereby increasing productivity. The use of a larger wafer generally requires a great deal of infrastructure changes in equipment and factory automation systems, so transitions only occur about every ten years. The use of 200mm wafers in production began at the end of the 1980s. The migration from 200mm to 300mm began at the end of the 1990s. 300mm tool sales now represent the majority of all new tool sales.
To achieve higher yields, implant systems must be capable of repeating the original process on a consistent basis for all devices on the wafer and for every wafer. These characteristics are known in the industry as uniformity and repeatability. In addition, implant systems must process wafers without damaging the device structures or introducing device-damaging contamination, which is typically characterized by cross contamination levels and particle defect adders. In many cases, implant performance is measured directly from the electrical performance of actual devices or device test structures. This is called electrical parametrics. In production fabs, there are typically multiple ion implantation systems performing the same processes in order to meet the production demands of the fab. In order to allow the greatest flexibility, semiconductor manufacturers require that each
system perform equally well on each device step. This characteristic is known as tool-to-tool matching. In
advanced device production, semiconductor manufacturers will often adjust the implant processes to compensate for variability in processes upstream from the implanter, making the implanters accuracy another important attribute. Uniformity, repeatability, accuracy, cross contamination, defect adders, parametrics and tool-to-tool matching are all critical in achieving commercially acceptable yields.
Semiconductor manufacturers generally measure the cost performance of their production equipment in terms of cost of ownership, which is determined by factoring in the fixed costs for acquisition and installation of the equipment, its variable operating costs and total wafer output. Equipment with higher wafer throughput increases total output and allows the semiconductor manufacturer to recover the purchase and installation costs of the equipment over a greater number of wafers and thereby reduces the cost of ownership of the equipment, on a per wafer basis. Throughput is most accurately measured on a net or overall basis, which takes into account the processing speed of the equipment and any system setup and non-operational downtime for cleaning, maintenance or other repairs. The increased difficulty of achieving desired transistor performance at advanced nodes has made high yields important in selecting processing equipment. The most desired systems are those that can achieve process results within critical tolerance limits and still operate at desired throughput rates.
The continuing evolution of semiconductor devices to smaller geometries and more complex multi-level circuitry has significantly increased the cost and performance requirements of the capital equipment used to manufacture these devices. As wafer fabs are projected to increase in cost substantially for each subsequent device node, yield losses and depreciation costs will become a much larger percentage of the aggregate production costs for semiconductor manufacturers relative to labor, materials and other variable manufacturing costs. As a result, there has been an increased focus by the semiconductor industry on obtaining increased capability and productivity to maintain returns from semiconductor manufacturing equipment, thereby increasing the revenue generated and reducing the effective cost of ownership of such systems.
We design, market, manufacture and service ion implantation systems which are used to build the transistors that are the basis of integrated circuits or microchips. Ion implanters have the ability to implant selected elements into silicon wafers at precise locations and depths. Ion implanters create a beam of electrically charged particles called ions. Ions are created by taking elements like phosphorous or boron and adding or removing an electron from the elements atomic structure giving the ion an electric charge. The charge on the ion enables it to be moved, accelerated and focused using electromagnetic fields. The ion implanter creates an ion beam that embeds the ions into a silicon wafer, which is the substrate upon which chips are fabricated. The embedded ions change the electrical properties of the silicon. Implanted ions that are selectively placed form transistors which are a building block of all electronic circuits.
The most advanced microchip fabrication factories might have as many as 30 separate implant steps. An implant is characterized by the dose (amount of dopant) and the energy (depth that dopant goes into the silicon wafer). We provide five different single wafer implanter products, which cover the full range of required applications in these implant sectors: medium currentlow dose, medium energy; high currenthigh dose, low energy; high energylow dose, very high energy and ultra high dosevery high dose, very low energy. There is some overlap of each implanters application coverage with the next. However, each implanter is designed to provide maximum productivity and yield within their respective application ranges. Additionally in fiscal year 2010, we introduced a solar cell ion implant product, Solion, as described below.
We currently offer the following products:
Recognized as the industry benchmark for medium current performance and productivity, our single wafer VIISta 900XP series of ion implanters provide superior overall throughput, precision doping capability and unmatched contamination control. These systems excel at threshold voltage, or Vt, channel, retrograde well,
pocket, and halo implants. Our other medium current systems include the VIISta 810XP, VIISta 810XE and VIISta 900XPT ion implanters. In addition, we continue to provide support for our older generation VIISta and legacy medium current ion implanters still in use by our customers.
To achieve higher device speeds, chip designers often increase manufacturing process complexity by utilizing multiple transistor designs in the same integrated circuit. Multiple transistors require multiple implants, particularly the Vt implant. Additionally, energies are decreasing for all implant recipes as chips become more complex. This allows certain retrograde well implants, which are normally run on a high energy implanter, to be processed on more productive, less expensive medium current tools.
Medium current implanters are used in logic, memory and foundry manufacturers. In calendar year 2009, medium current represented about 28%, or $96.0 million, of the total available market, or TAM, for ion implant.
The high current VIISta HCS series provides the industrys highest productivity and best contamination performance. In addition, these systems feature superior implant angle accuracy, beam steering correction and high-tilt angle capabilityall of which are required for advanced device fabrication. The VIISta HCS has excellent process control capability for advanced ultra shallow junction applications, and can be used for source/drain, source/drain extension, gate doping, pre-amorphization, and materials modification applications.
In fiscal year 2010, we introduced the VIISta Trident High Current Ion Implant tool, or Trident, which is designed to maximize performance in three key areas: device performance and yield, energy purity and productivity, especially for leading edge devices. Tridents advanced beam-line design also provides the industrys best global and local uniformity, or microuniformity and the tightest angle control. Trident provides a unique combination of lowest particle count and highest energy purity, down to the lowest energies our customers have on their roadmap and higher productivity than any other high-current tool, particularly for low energy implants.
In addition, we continue to provide support for our older generation VIISta and legacy high current ion implanters still in use by our customers.
The high current sector is expected to grow relative to the overall implant market due to an increase in the number of implant steps needed to produce many advanced microchips. Due to the very low energies and high dose concentrations that are necessary for increased transistor speed and lower device power consumption, the productivity of high current systems tends to decline with advancing technology nodes, requiring more high current implanters. We were the first to introduce single wafer systems to this market sector through our VIISta platform.
High current implanters are used in logic, memory and foundry manufacturers. In calendar year 2009, high current represented about 46%, or $159.0 million, of the TAM for ion implant.
The high energy VIISta HE and VIISta 3000 feature True ZeroTM degree implant and low contamination. Our high energy portfolios True ZeroTM capability provides a distinct advantage for semiconductor manufacturers that need increased device packing density in high-performance devices. The VIISta HE has outstanding process accuracy, offers excellent productivity, uniformity, angle control and medium current back-up flexibility. Our high energy products cover retrograde well, triple well, buried layers, and pocket applications. In addition, we continue to provide support for our older generation VIISta and legacy high energy ion implanters still in use by our customers.
High energy implanters are used in most wafer fabs, but predominantly by memory manufacturers. In calendar year 2009, high energy represented about 15%, or $51.0 million, of the TAM for ion implant.
Ultra High Dose
Medium current, high current and high energy tools utilize a focused ion beam to achieve the desired dose and energy for particular implant specie. For ultra high dose applications, the VIISta PLAD tool uses an altogether different technology. A plasma, or ionized gas, of the desired specie is created in a chamber where the wafer is held to a platen. A pulsed DC voltage is applied to the wafer platen which draws ions to the wafer at an energy level proportional to the DC pulse. This approach creates very high dose rates at low energies and provides conformal doping capability where the dopant covers all the angled surface features of the wafer uniformly. We have implemented many advanced control features on VIISta PLAD such as closed loop dosimetry to ensure accurate dosing of the wafer. With throughput up to six times greater than traditional beamline or modified-source beamline technologies, the VIISta PLAD has become an attractive solution for new critical very low-energy, very high-dose applications, such as dual poly gate.
In the past, ultra high dose systems were used only by DRAM memory manufacturers. Our VIISta PLAD has been used by certain new flash memory applications, since fiscal year 2009. Other applications for VIISta PLAD may be developed in the future. In calendar year 2009, ultra high dose represented about 12%, or $41.0 million, of the TAM for ion implant.
In fiscal year 2010, we entered the solar cell manufacturing market with the introduction of Solion, our solar cell ion implant tool. Solion is based on our proven VIISta platform and utilizes our established ion implant technology with a redesigned wafer handling and automation system. Solar cell implant differs from traditional implant as solar cell wafers are square as opposed to round and require higher throughput and in-situ patterning to enable higher value. Solion provides innovative and proprietary Precision Patterned Implant technology, or PPI, enabling exceptional junction engineering capability which is critical for all high efficiency cell designs. We believe PPI provides our customers with greater solar cell efficiency and reduced process steps resulting in lower manufacturing costs and a higher yield.
The VIISta 900XP, VIISta HCS, VIISta HE, VIISta PLAD and Solion are based on the same platform, thereby providing a high degree of commonality in subsystems and overall architecture. The VIISta platform provides customers with a great deal of flexibility in managing overall bay productivity, resulting in a reduction in customers time to first silicon, greater productivity across all applications, and an increase on their return on investment. We have shipped more than 1,200 VIISta systems, worldwide. The VIISta platform of ion implanters is the only single wafer platform solution for all production applications. The VIISta products feature the Varian Control System, or VCS, the Varian Positioning Systems, or VPS, and the VIISta single wafer end-station. This high degree of commonality across the VIISta platform facilitates process matching throughout the system set, and provides flexibility in managing capacity, product mix changes, spare parts and training.
Previous generations of implant products have benefitted from product upgrades that focused exclusively on improvements to productivity. Implant has now become a device performance and yield enabling technology for advanced technology nodes in large part because of product upgrades. For example, we offer Superscan, Process Temperature Control II, or PTC II, and Carborane as enabling product upgrades. SuperScan is a software-driven upgrade that compensates for variability inherent in other process steps. Superscan can be used to alter the polish rate of a chemical mechanical planarization process across the wafer surface so the final result will yield a flatter
wafer. PTC II is a recently announced product upgrade that enables implants at very low wafer temperatures. Carborane is a molecular implant upgrade that improves device performance and unlike other molecular species does not require a specialized ion source. Both Carborane and PTC II are used for damage engineering applications that improve device performance and speed and reduce leakage current providing longer battery life.
For fiscal years 2010, 2009 and 2008, our product revenue which includes revenue from tools, upgrades and spare parts was $769.6 million, $309.2 million and $752.6 million, respectively.
Customer Support and Services
We provide support services designed to maximize the productivity of our customers equipment and to increase uptime through the effective management of machine maintenance, parts inventory and product support. All of these services provide a direct link to our manufacturing facility and research centers.
We provide a wide range of programs, from a complete turnkey solution that supports the wafer fabs ion implant performance, to economical service plans for those who require less support. These programs are customized to specific customer requirements, provide dedicated labor to maintain and troubleshoot the ion implanter, and make available on-call 24/7 service. Since 1984, we have been developing upgrades for the installed base that extends the life of the capital equipment. These upgrades provide our customers with benefits that are focused around increasing productivity and reducing cost-of-ownership. Specifically, the benefits are realized as enhancements to throughput, yield, uptime, maintenance and ergonomic improvements.
For parts management, we have approximately 30 parts banks strategically placed around the world that support more than 200 customer fabs. The use of a global enterprise resource planning system provides us with a distribution structure that efficiently manages inventory, delivery and logistics services. We also offer a comprehensive consumable and non-consumable parts program that can be tailored to individual fab needs to minimize our customers cost of ownership from the ordering of individual piece parts over our eCommerce site, vShop, to complete stocking and inventory management programs like Fab Specific Parts Programs.
Through VEDoc, an electronic documentation system, customers can easily access information about their Varian ion implanters. All assembly drawings, schematics, parts lists, maintenance and operation manuals, and video-illustrated maintenance procedures are available in a CD-ROM format.
Our commitment to customer service also includes extensive and comprehensive customer training programs. We offer a full range of technical training, from the basic operation and maintenance of the tool to electronic troubleshooting and alignments. Training is available for all tool types manufactured at our facility with specialized courses available in process applications.
Over the years we have come to recognize the importance and value of customer support and service. We believe that there is a direct correlation between the quality of the support and service we offer and growth in our tool sales. We believe that growth in our market share and revenue over the last several years was partly attributable to a company-wide commitment to service and support. For 13 of the last 14 years we have won the VLSI Research award for Customer Satisfaction in large Semiconductor Capital Equipment, which we believe validates the success of our commitment. We are focused on improving our model of customer support and service. In the past, we were tuned to a model that fixed broken equipment and tried to reduce equipment downtime. Now we utilize a more progressive value-oriented model, where through product upgrades and high value service offerings that enhance our customers device performance and yield, we bring enabling value into the fab.
For fiscal years 2010, 2009 and 2008, our service revenue which includes revenue from maintenance, service contracts, extended warranties, paid service and system installation services was $62.2 million, $52.9 million and $81.4 million, respectively.
Marketing and Sales
We market, sell, install and service ion implantation systems directly to semiconductor industry manufacturers and have sold ion implantation products to most of the 20 largest semiconductor manufacturers in the world. Our sales objective is to work closely with customers to secure purchases of multiple systems as customers expand capacity, update existing facilities, introduce new manufacturing processes or build new wafer manufacturing facilities. We seek to build customer loyalty and to achieve a high level of repeat business by offering highly reliable products that give our customers a competitive edge, comprehensive field support and responsive parts replacement and service programs.
We have historically sold at least half of our systems in any particular period to a relatively small number of customers, some of which include GlobalFoundries Inc., Elpida Memory Inc., or Elpida, Hynix Semiconductor Inc., or Hynix, Hynix-Numonyx Semiconductor Ltd., or Hynix-Numonyx, IM Flash Technologies LLC., or IM Flash, Inotera Memories Inc., or Inotera, Intel Corp., or Intel, International Business Machines Corp., or IBM, Micron Technology Inc., or Micron, Nanya Technology Corporation, or Nanya, Samsung Electronics Company Ltd., or Samsung, Taiwan Semiconductor Manufacturing Corp. Ltd., or tsmc, Sony Corporation, or Sony, and United Microelectronics Corp., or UMC. Some of these customers have individually accounted for more than 10% of our total revenue in some periods. We expect that sales of our products to relatively few customers will continue to account for a high percentage of our revenue in the foreseeable future.
Revenue from our ten largest customers in fiscal years 2010, 2009 and 2008 accounted for approximately 80%, 73% and 74% of total revenue, respectively. In fiscal year 2010, revenue from tsmc and Samsung accounted for 23% and 13%, respectively, of our total revenue. In fiscal year 2009, revenue from Intel and tsmc accounted for 21% and 16%, respectively, of our total revenue. In fiscal year 2008, revenue from Samsung and Intel accounted for 16% and 13%, respectively of our total revenue.
None of our customers have entered into a long-term agreement requiring them to purchase our products. Although our largest customers have varied from year to year, the loss of a significant customer or a reduction in orders from any significant customer, including reductions due to market, economic or competitive conditions in the semiconductor industry or in the industries that manufacture products utilizing integrated circuits, could adversely affect our business, financial condition and results of operations. In addition, sales of our systems depend, significantly in part, upon the decision of a prospective customer to increase manufacturing capacity in an existing fab facility, to introduce a new manufacturing process or to transfer a manufacturing process to a new fab facility, all of which typically involve a significant capital commitment. Due to these and other factors, our products typically have a lengthy sales cycle during which we may expend substantial funds and management effort.
Our ability to respond with prompt and effective field support is critical to our sales efforts. Due to substantial operational and financial commitments, customers who purchase ion implantation systems require assurance that the manufacturer can provide the necessary installation and operational support. Our strategy of supporting our installed base through our customer support and research, development and engineering groups has served to encourage the use of our systems in production applications and has accelerated penetration of certain key accounts. We believe that our marketing efforts are enhanced by the technical expertise of our research, development and engineering personnel, who provide customer process support and participate in a number of industry forums.
We market, sell, distribute and service our products directly. We have 36 sales and service offices worldwide. Our sales, marketing and service engineers are linked through our information technology systems, allowing us to review bookings and sales forecasts globally against detailed account management plans.
International sales accounted for 85% of our total revenue in fiscal year 2010. In fiscal years 2009 and 2008, international sales accounted for 72% and 78% of our total revenues, respectively. More specifically, sales to Asia Pacific have accounted for 78%, 63% and 70% of total revenues in fiscal years 2010, 2009 and 2008, respectively. Refer to Note 24. Operating Segments and Geographic Information for additional information on
the geographic distribution of revenues and long-lived assets and Risk Factors in Item 1A for additional information on the risks related to our foreign operations.
Our business is generally not seasonal in nature, but it is cyclical based on the capital equipment investment expenditures of major semiconductor manufacturers. These expenditure patterns are based on many factors, including anticipated market demand for integrated circuits, the development of new technologies and global economic conditions.
We had backlog of $275.1 million and $117.8 million as of October 1, 2010 and October 2, 2009, respectively. We include in our backlog only those orders for which we have accepted purchase orders and assigned system shipment dates within the following twelve months. Orders are typically subject to cancellation or rescheduling by customers. Due to possible changes in system delivery schedules, cancellation of orders and delays in systems shipments, our backlog at any particular date is not necessarily an accurate predictor of revenue for any succeeding period.
We manufacture our products at our facility in Gloucester, Massachusetts. We benefit from the use of advanced manufacturing methods and technologies, including lean manufacturing and demand flow technology.
We purchase materials from multiple suppliers worldwide. We closely monitor overall demand and supply processes worldwide to ensure continuous availability. Additionally, long-lead agreements with suppliers are employed to provide a strategic safety stock at supplier locations.
We concentrate on product design characterization, high-level assembly and tests to reduce cycle time and improve our responsiveness in an inherently cyclical capital equipment market. We believe that outsourcing non-core competency assemblies enables us to minimize our fixed costs and capital expenditures, while also providing the flexibility to increase or decrease production capacity. We purchase materials and components that are either standard products or built to our specifications. This strategy also allows us to focus on product differentiation through system design and quality control. Our manufactured subsystems incorporate advanced technologies in robotics, vacuum and personal computers. We work closely with our suppliers to achieve mutual cost reductions through joint design efforts. We manufacture and test selected components and systems in clean-room environments that are similar to the clean-rooms used by semiconductor manufacturers for wafer fabrication. This procedure is intended to reduce installation and production qualification times and the amount of particulates and other contaminants in the assembled system, which in turn improves yield and reduces downtime for the customer.
Our quality efforts begin with product development. We use three dimensional computer-aided design, finite element analysis and other computer-based modeling methods to engineer and validate new designs. Product design is tested throughout all stages of development and validated through use of a phase-gate product introduction process before the first production system is built. Concurrent engineering programs coupled with product transition strategies integrate new designs into manufacturing quickly and successfully.
The semiconductor capital equipment market is highly competitive and is characterized by a small number of large companies. The larger companies include Applied Materials Inc., ASML Holding N.V., Tokyo Electron Limited, KLA-Tencor Corporation, or KLA-Tencor, Lam Research Corporation, Nikon Corporation, Dainippon Screen Mfg. co., Ltd., Hitachi High Technologies Corporation, Novellus Systems, Inc., and Canon Inc. We face significant competition in the ion implantation market. Within ion implant, multiple implant suppliers participate
in one or more implant segments. Generally, for each system selection, we compete with one or more major competitors. As reported by Gartner Dataquest for calendar year 2009, our revenue market share for ion implantation equipment was significantly higher than all of our competitors, including Nissin Electric Company, Ltd., Sumitomo Eaton Nova Corporation, Axcelis Technologies, Inc., or Axcelis, Advanced Ion Beam Technology, Inc., Ulvac Technologies, Inc., and Applied Materials, Inc. Market share data is also published by VLSI Research Inc. The VLSI published results were similar to the Gartner Dataquest report.
There are significant competitive factors in the ion implantation market that affect a companys ability to succeed. Primary factors include the ability to provide highly productive, technically enabling solutions, the quality of strategic relationships with customers, the cost of ownership of the equipment, performance reliability of the equipment, the quality and cost of customer support, speed and cost-effectiveness of distribution and financial viability of the supplier. Secondary factors include: size of manufacturer, installed customer base and breadth of product line. Due to the constant innovation that has characterized semiconductor manufacturers, it is possible that the application needs and manufacturing technologies used by customers may change, significantly disrupting historical trends in the market. We believe we compete favorably in the ion implant business. To remain competitive, we recognize we may 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.
Research, Development and Engineering
The semiconductor manufacturing industry is subject to rapid technological change requiring new product introductions and enhancements. Our ability to remain competitive in this market will depend in part upon our ability to develop new and enhanced systems and to introduce these systems at competitive prices and on a timely and cost-effective basis. Accordingly, we devote a significant portion of our personnel and financial resources to research, development and engineering programs and seek to maintain close relationships with our customers to remain responsive to their product needs.
Our current research, development and engineering efforts are directed at development of new systems and processes and improving existing system capabilities. We currently focus our research, development and engineering efforts on the enhancement of our VIISta platform. The VIISta platform is designed to cover the complete range of implants required for the next several generations of integrated circuits. The VIISta single wafer platform allows customers to use a single platform for all implant applications including high current, ultra high dose, medium current and high energy. In fiscal year 2010, research, development and engineering investments were made in growth opportunities in implant and materials modification.
Our expenditures for research, development and engineering during fiscal years 2010, 2009 and 2008 were $98.2 million, $80.1 million, and $111.2 million, respectively. We expect in future years that research, development and engineering expenditures will continue to represent a substantial percentage of operating expenses. In addition to developing new high current, ultra high dose and high energy products, we continue to focus on maintaining our leadership position in the market for medium current, high current and ultra high dose implanters, improving our position in the high energy business and continuing to invest in new and next generation products in both implant and materials modification.
Patent and Other Proprietary Rights
We pursue a policy of seeking patent, copyright, trademark and trade secret protection in the United States, or U.S. and other countries for developments, improvements and inventions originating within our organization that are incorporated in our products or that fall within our fields of interest. As of November 15, 2010, we owned approximately 242 patents in the U.S., 167 patents in other countries, and had 804 patent applications on file with various patent agencies worldwide. We intend to file additional patent applications as appropriate.
We rely on a combination of patent, copyright, trademark, trade secret and other laws, and contractual restrictions on disclosure, copying and transferring title to protect our rights. We have trademarks, both registered and unregistered, that are maintained and enforced to provide customer recognition for our products in the marketplace. We also have agreements with third parties that provide for licensing of patented or proprietary technology. These agreements include royalty-bearing licenses and technology cross-licenses. The termination of certain of such licenses could have a material adverse effect on our business.
Our competitors, like many companies in the high-technology business, routinely review the products of others for possible conflict with their own patent rights. There has also been substantial litigation regarding patent and other intellectual property rights in semiconductor-related industries. Varian Semiconductor, our customers or suppliers could be subject to additional claims of patent infringement, and any such claim could require that we pay substantial damages or remove certain features from our products or both.
In fiscal years 2010, 2009 and 2008, we recorded less than $0.1 million in royalty and license revenues.
For a discussion of environmental matters, see Risk Factors, in Item 1A and Note 22. Commitments, Contingencies and Guarantees in Item 15.
On April 2, 1999, Varian Semiconductor was spun-off from Varian Associates, Inc., or VAI. Our business was operated as the Semiconductor Equipment Business, or SEB, of VAI. VAI contributed the SEB to us, then distributed to the holders of record of VAI common stock, one share of common stock of Varian Semiconductor for each share of VAI common stock owned.
Our role in the semiconductor manufacturing market can be traced to VAIs pioneering work in ultra-high vacuum technology. In the 1960s, this technology was applied to many physics and space research projects requiring ultra-high vacuum environments. This technology proved critical in the semiconductor manufacturing process. SEB was successful in developing methods for controlling electron beams and ions in ultra-high vacuum environments and in depositing materials onto silicon wafers to create switching devices.
SEB entered the ion implantation business in fiscal year 1975 through the acquisition of Extrion Corporation in Gloucester, Massachusetts. Since then, we have developed a complete line of medium and high current ion implanters, added the high energy product line in fiscal year 1998 through the acquisition of Genus, Inc., and added the ultra high dose product in early 2007. These systems introduce precise quantities of dopant materials into silicon wafers, creating desired electrical characteristics. In 2010, we introduced an ion implant product to manufacture silicon solar cells.
As of October 29, 2010, we had 1,462 full-time employees worldwide1,072 in North America, 317 in Asia Pacific and 73 in Europe. None of our employees based in the U.S. are subject to collective bargaining agreements and we have never experienced a work stoppage, slowdown or strike. None of our employees is represented by a labor union and we consider our employee relations to be good.
Executive Officers of the Registrant
Our current executive officers are listed below. Executive officers are elected on an annual basis and serve at the discretion of the Board of Directors.
We face intense competition in the semiconductor equipment industry.
Significant competitive factors in semiconductor equipment manufacturing include the strength of customer relationships, pricing, technological performance and timing, distribution capabilities and financial viability. We believe that in order to remain competitive in this industry, we will need to devote significant financial resources to research and development, to develop and market a broad range of products and maintain and enhance customer service and support centers worldwide. The semiconductor equipment industry is increasingly dominated by large manufacturers who have resources to support customers worldwide, and some of our competitors have substantially greater financial resources and more extensive engineering, manufacturing, marketing, service and support than we do. With fewer resources, we may not be able to match the product offerings or customer service and technical support offered by our competitors. In addition, there are several smaller companies that provide innovative technology that may have performance advantages over our systems. If these manufacturers continue to improve their product performance and pricing, enter into strategic relationships, expand their current targeted geographic territory or consolidate with large equipment manufacturers, sales of our products may be adversely affected.
Our business and results of operations may be negatively impacted by general global economic and financial market conditions, and such conditions may increase the other risks that affect our business.
In 2009, turmoil in the worlds financial markets materially and adversely impacted the availability of financing to a wide variety of businesses and the resulting uncertainty led to reductions in capital investments and overall spending levels across industries and markets. Despite recent signs of economic recovery in some markets, many of the markets in which we operate are still in an economic downturn that we believe has had and may continue to have a negative impact on our business. These trends could have a material and adverse impact on the demand for our products and services and our financial results from operations.
We derive a substantial portion of our revenues from a small number of customers, and our business may be harmed by the loss of any one significant customer.
From time to time within the same accounting period, we have sold significant percentages of our systems to our major customers, some of which include GlobalFoundries, Elpida, Fujitsu, Hynix, Hynix-Numonyx, IBM, IM Flash, Inotera, Intel, Micron, Nanya, Samsung, Sony, tsmc and UMC. During some quarters, some of these customers have individually accounted for more than 10% of our total revenue. We expect that sales of our products to relatively few customers will continue to account for a high percentage of our revenue in the foreseeable future. Furthermore, we may have difficulty attracting additional large customers because our sales depend, in large part, upon the decision of a prospective customer to increase manufacturing capacity in an existing fabrication facility or to transfer a manufacturing process to a new fabrication facility, both of which typically involve a significant capital commitment. Once a semiconductor manufacturer has selected a particular suppliers capital equipment, the manufacturer generally relies upon that equipment for the specific production line application. Consequently, we may experience difficulty in selling to a prospective customer if that customer initially selects a competitors capital equipment.
Our quarterly results of operations are likely to fluctuate, and as a result, we may fail to meet the expectations of our investors and securities analysts, which may cause the price of our common stock to decline.
We have experienced and expect to continue to experience significant fluctuations in our quarterly financial results. From time to time, customers may accelerate, postpone or cancel shipments, or production difficulties may delay shipments. A cancellation, delay in shipment or delay in customer acceptance of the product upon installation in any quarter may cause revenue in such quarter to fall significantly below expectations, which could cause the market price of our common stock to decline. Our financial results also fluctuate based on gross profit realized on sales. Gross profit as a percentage of revenue may vary based on a variety of factors, including the mix and average selling prices of products sold, costs to manufacture and customize systems and inventory management. In addition, a number of other factors may impact our quarterly financial results, including, but not limited to the following:
Our operating expenses also fluctuate on a quarterly basis. A high percentage of our expenses are relatively fixed, thus, even a minimal number of cancelled, postponed or delayed shipments could have a significant adverse impact on financial results. In addition, we may continue to heavily invest in areas such as research and development, despite lower revenue levels. As such, financial results could be adversely impacted.
It is difficult for us to predict the quarter in which we will be recognizing revenue from large product orders.
We customarily sell a relatively small number of systems within any period. Consequently, our revenue and financial results could be negatively impacted for a particular quarter if anticipated orders from even a few customers are not received in time to permit shipment and/or there are delays in customer acceptance of the product upon installation or future obligations included in the contract do not permit revenue to be recognized on current tool shipments under generally accepted accounting principles, or GAAP. Generally, we recognize all or a portion of the revenue from a product upon shipment provided title and risk of loss has passed to the customer, evidence of an arrangement exists, fees are contractually fixed or determinable, collectibility is reasonably assured through historical collection results and regular credit evaluations, and there are no uncertainties regarding customer acceptance. Please refer to the full revenue recognition policy in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations in the Critical Accounting Policies and Significant Judgments and Accounting Estimates section of this Annual Report on Form 10-K. As a result, it is often difficult to determine the timing of product revenue recognition. In addition, our product order backlog at the beginning of each quarter may not include all systems needed to achieve expected revenues for that quarter. Because we may build systems according to forecast, the absence of a significant backlog for an extended period of time could adversely affect financial results.
Our future business depends, in part, on our ability to successfully introduce and manage the transition to new products, and we may not succeed in accomplishing these goals.
We believe that our future success will depend on our ability to develop, manufacture and successfully introduce new systems and product lines with improved capabilities and to continue enhancing existing products; in particular, products that respond to the trend toward single wafer processing and 300mm wafer processing at more advanced nodes. We derive virtually all of our revenue from sales and servicing of systems and related products and services. We must accurately forecast the demand for new products while managing the transition from older products. In addition, we may be unable to complete the development or meet the technical specifications of new systems or enhancements or to manufacture and ship these systems or enhancements in volume and on time, which may harm our reputation and business. If any of our new products have reliability or quality problems, we may incur additional warranty and service expenses, experience a decline in product orders or incur higher manufacturing costs to correct such problems, all of which could adversely affect financial results.
We have recently entered the capital equipment market for solar cell manufacturing with the introduction of Solion, our solar cell ion implant tool. The solar industry is subject to unique challenges and if we are unable to manage these challenges, our Solion product may not succeed and our business, financial condition and results of operations could be materially and adversely affected.
The emerging solar market is subject to the macroeconomic and financial challenges of the solar industry and the risks specific to the solar industry, including but not limited to:
We are subject to the risks of operating internationally and we derive a substantial portion of our revenues from outside the U.S.
International revenues account for a substantial portion of our revenue. Because we rely on sales to customers in Asia Pacific for a significant portion of our revenue, our business is very likely to be adversely impacted by economic downturns and instability in that region. Our business in Asia Pacific is affected by demand in each country. In addition, international sales are subject to risks, including, but not limited to:
If we are unable to protect our proprietary rights adequately, we may lose our ability to compete effectively in the semiconductor equipment industry.
We rely on obtaining and maintaining patent, copyright and trade secret protection for significant new technologies, products and processes and obtaining key licenses because of the length of time and expense associated with bringing new products through the development process to market. We intend to continue to file applications as appropriate for patents covering new products and manufacturing processes. However, we cannot provide assurance of the following:
We also have agreements with third parties for licensing of patented or proprietary technology. These agreements include royalty-bearing licenses and technology cross-licenses.
In addition, we maintain and enforce our trademarks to increase customer recognition of our products. If our trademarks are used by unauthorized third parties, our business may be harmed. We also rely on contractual
restrictions on disclosure, copying and transferring title, including confidentiality agreements with vendors, strategic partners, co-developers, employees, consultants and other third parties to protect our proprietary rights. If these contractual agreements are breached, we may not have adequate remedies for any such breaches. We also cannot provide assurance that our trade secrets will not otherwise become known to or be independently developed by others.
Patent claims may be expensive to pursue, defend or settle and may substantially divert our resources and the attention of management.
We could incur substantial costs and diversion of management resources in defending patent suits brought against us or in asserting our patent rights against others. If the outcome of any such litigation is unfavorable to us, our business may be harmed. We may not be aware of pending or issued patents held by third parties that relate to our products or technologies. In the event that a claim is asserted against us, we may need to acquire a license to or contest the validity of a competitors patent. We cannot be certain that we could acquire such a license on commercially acceptable terms, if at all, or that it would prevail in such a proceeding. From time to time, we have received notices from and have issued notices to such third parties alleging infringement of patent and other intellectual property rights relating to our products. If we are subject to future claims of patent infringement, we may be required to make substantial settlement or damage payments and may have to devote substantial resources to reengineering our products.
We depend on limited groups of suppliers or single source suppliers, the loss of which could impair our ability to manufacture products and systems.
We obtain some of the components and subassemblies included in our products from a limited group of suppliers, or in some cases, a single source supplier. The loss of any supplier (or the temporary inability of any supplier to meet our production requirements, including any single source supplier) would require obtaining one or more replacement suppliers and may also require devoting significant resources to product development to incorporate new parts from other sources into our products. The need to change suppliers or to alternate between suppliers might cause delays in delivery or significantly increase our costs. Although we have insurance to protect against loss due to business interruption from some sources as necessary, we cannot provide assurance that such coverage will be adequate or that it will remain available on commercially acceptable terms. Although we seek to reduce our dependence on these limited source suppliers, disruption or loss of these sources could negatively impact our business and damage customer relationships.
Our outsource providers may fail to perform as we expect.
Outsource providers have an increasing role in our manufacturing operations, research, development and engineering initiatives and in transactional and administrative functions. Although we aim at selecting reputable providers and securing their performance on terms documented in written contracts, it is possible that one or more of these providers could fail to perform as we expect and such failure could have an adverse impact on our business. In addition, the expansive role of outsource providers has required and will continue to require us to implement changes to our existing operations and to adopt new procedures to deal with and manage the performance of these outsource providers. Any delay or failure in the implementation of our operational changes and new procedures could adversely affect our customer relationships and/or have a negative effect on our operating results.
Our indemnification obligations under the Distribution Related Agreements could be substantial, and we may not be fully indemnified in accordance with the Distribution Related Agreements for the expenses we incur.
Under the terms of the Distribution Related Agreements, each of Varian Medical Systems, Inc., or VMS (formerly VAI), Varian, Inc., or VI and Varian Semiconductor has agreed to indemnify the other parties, and
certain related persons, from and after the spin-off with respect to certain indebtedness, liabilities and obligations, which could be significant. The availability of such indemnities will depend upon the future financial strength of the companies. There is a risk that one or more of these companies will not be able to satisfy their indemnification obligations. In addition, the Distribution Related Agreements generally provide that if a court prohibits a company from satisfying its indemnification obligations, then such obligations will be shared equally by the other companies.
Failure to comply with present or future environmental regulations could subject us to penalties and environmental remediation costs.
We are subject to a variety of foreign, federal, state and local laws regulating the discharge of materials into the environment and the protection of the environment. These regulations include discharges into the soil, water and air and the generation, handling, storage and transportation and disposal of waste and hazardous substances. These laws increase the costs and potential liabilities associated with the conduct of our operations.
VAI has been named by the U.S. Environmental Protection Agency and third parties as a potentially responsible party under the Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, or CERCLA, at eight sites where VAI is alleged to have shipped manufacturing waste for recycling or disposal. VAI is also in various stages of environmental investigation and/or remediation under the direction of, or in consultation with foreign, federal, state and local agencies at certain current or former VAI facilities. The Distribution Related Agreements provide that each of VMS, Varian Semiconductor and VI will indemnify the others for one-third of these environmental investigation and remediation costs, as adjusted for any insurance proceeds and tax benefits expected to be realized upon payment of these costs.
For certain of these sites and facilities, various uncertainties make it difficult to assess the likelihood and scope of further investigation or remediation activities or to estimate the future costs of such activities if undertaken. We have accrued estimated environmental investigation and remediation costs for these sites and facilities. As to other sites and facilities, sufficient knowledge has been gained to be able to reasonably estimate the scope and costs of future environmental activities. As such, we have sufficient accruals to cover our portion of these costs.
Accrued amounts are only estimates of anticipated future environmental-related costs, and the amounts actually spent may be greater than such estimates. Accordingly, we may need to make additional accruals and subsequent payments to cover our indemnification obligations that would exceed current estimates. In addition, our present and past facilities have been in operation for many years, and over that time in the course of those operations, such facilities have used substances which are or might be considered hazardous. We also may have generated and disposed of wastes which are or might be considered hazardous. Therefore, it is possible that additional environmental issues may arise in the future that we cannot now predict.
Our ability to manage potential growth or decline, integration of potential acquisitions, and potential disposition of product lines and technologies creates risks.
The cyclical nature of the semiconductor industry may cause us to experience rapid growth or decline in demand for products and services. As a result, we may face significant challenges in maintaining adequate financial and business controls, materials management, management processes, information systems and procedures on a timely basis, training, managing and appropriately sizing the work force. There can be no assurance that we will be able to perform such actions successfully.
An important element of our management strategy is to review acquisition prospects that would complement existing products, augment market coverage and distribution ability, or enhance technological capabilities. In the future, we may make acquisitions of complementary companies, products or technologies, or may reduce or dispose of certain product lines or technologies that no longer fit our long-term strategies. Managing an acquired business, disposing of product technologies or reducing personnel entails numerous operational and financial
risks, including difficulties in assimilating acquired operations and new personnel or separating existing business or product groups, diversion of managements attention to other business concerns, amortization of acquired intangible assets, the incurrence of debt and contingent liabilities and potential loss of key employees or customers of acquired or disposed operations, among others. Our success will depend, to a significant extent, on the ability of our executive officers and other members of our senior management to identify and respond to these challenges effectively. In addition, any acquisitions could result in dilutive issuances of equity securities. There can be no assurance that we will be able to achieve and manage successfully any such growth, decline, integration of potential acquisitions, disposition of product lines or technologies, or reduction in personnel, or that management, personnel or systems will be adequate to support continued operations. Any such inabilities or inadequacies may have a material adverse effect on our business, operating results, financial condition, cash flows and/or the price of our common stock.
We manufacture our products at one primary manufacturing facility and are thus subject to risk of disruption.
We have one primary manufacturing facility, located in Gloucester, Massachusetts, and our operations are subject to disruption for a variety of reasons, including, but not limited to natural disasters, work stoppages, operational facility constraints and terrorism. Such disruption may cause delays in shipments of products to our customers and may result in cancellation of orders or loss of customers and could seriously harm our business.
If we lose key employees or are unable to attract and retain key employees, we may be unable to pursue business opportunities.
Our future success depends to a significant extent on the continued service of key managerial, technical and engineering personnel. Competition for such personnel is intense, particularly in the labor markets around our facilities in Massachusetts. The available pool of qualified candidates is limited and we may not be able to retain our key personnel or to attract, train, assimilate or retain other highly qualified engineers and technical and managerial personnel in the future. The loss of these persons or our inability to hire, train or retrain qualified personnel could harm our business and results of operations.
We have anti-takeover defenses that could delay or prevent an acquisition and could adversely affect the price of our common stock.
Provisions of our certificate of incorporation and by-laws and of Delaware law could delay, defer or prevent an acquisition or change in control of Varian Semiconductor or otherwise adversely affect the price of our common stock. For example, our Board of Directors is classified into three classes, and stockholders do not have the right to call special meetings of stockholders. Our certificate of incorporation also permits our Board of Directors to issue shares of preferred stock without stockholder approval. In addition to delaying or preventing an acquisition, the issuance of a substantial number of preferred shares could adversely affect the price of the common stock.
We do not anticipate paying dividends on our common stock in the future.
We have not paid and do not anticipate paying dividends on our common stock. Our Board of Directors has discretion to make decisions to pay dividends to common stockholders in the future. The decision will depend on a number of factors, including results of operations, financial conditions and contractual restrictions that the Board, in its opinion, deems relevant.
Our financial results may be adversely impacted by higher than expected income tax expense or exposure to additional income tax liabilities.
As a global company, our effective tax rate is highly dependent upon the geographic composition of worldwide earnings and the tax laws governing each jurisdiction in which we conduct business. We are subject to income
taxes in both the U.S. and various foreign jurisdictions. Significant judgment is required to determine worldwide tax liabilities. Our effective tax rate, tax liability and tax expense could be adversely affected by changes in the distribution of earnings between countries with differing statutory tax rates, in the valuation of deferred tax assets, in tax law or by audit assessments, which could affect profitability. In particular, due to the global business realignment, the distribution of worldwide earnings has changed and has caused the tax rate to become more sensitive to the geographic distribution of profits. We could face significant challenges regarding the geographic composition of these earnings from one or more jurisdictions upon audit. Our effective tax rate has benefited from the research and development, or R & D, tax credit in the U.S. which expired on December 31, 2009. It is unclear at this time whether the R & D tax credit will be extended. The carrying value of deferred tax assets, which are predominantly in the U.S., is dependent on our ability to generate future taxable income in the U.S. or carry-back losses to prior profitable periods. Our tax returns are currently under audit by the Internal Revenue Service, or IRS, and could be audited by other tax authorities. The IRS and other tax authorities have increasingly focused attention on intercompany transfer pricing with respect to sales of products, services, and the use of intangible assets. We could face significant future challenges related to past years on these transfer pricing issues in one or more jurisdictions. We regularly assess the likelihood of favorable or unfavorable outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. Although we believe that our tax estimates are reasonable, there can be no assurance that any final determination by a government tax authority will not be materially different from the treatment reflected in our income tax provisions and accruals.
The U.S. Government has announced a number of tax proposals in the past year which, if enacted, would cause us to re-evaluate the structure of our international operations. We may incur additional costs to modify our international structure and be required to pay additional taxes if all or any of the proposals become law. Until further details on the proposals are provided in actual legislation, it is not possible to estimate the potential impact of these proposals on the results of our operations.
Strategic alliances may have negative effects on our business.
Increasingly, semiconductor companies are entering into strategic alliances with one another to expedite the development of processes and other manufacturing technologies. Often, one of the outcomes of such an alliance is the definition of a particular tool set for a certain function or a series of process steps that use a specific set of manufacturing equipment. While this could work to our advantage if our equipment becomes the basis for the function or process, it could work to our disadvantage if a competitors tools or equipment become the standard equipment for such function or process. In the latter case, even if our equipment was previously used by a customer, that equipment may be displaced in current and future applications by the tools standardized by an alliance of companies.
Similarly, our customers may team with, or follow the lead of, educational or research institutions that establish processes for accomplishing various tasks or manufacturing steps. If those institutions utilize a competitors equipment when they establish those processes, it is likely that customers will use the same equipment in setting up their own manufacturing lines. These actions could adversely impact our market share and subsequent business.
The semiconductor equipment industry is highly cyclical. The purchasing decisions of our customers are highly dependent on the economies of both the local markets in which they are located and the semiconductor industry worldwide. If we fail to respond to industry cycles, our business could be seriously harmed.
The timing, length and severity of the up-and-down cycles in the semiconductor equipment industry are difficult to predict. The cyclical nature of the industry in which we operate is largely a function of our customers capital spending patterns and need for expanded manufacturing capacity, which in turn are affected by factors such as capacity utilization, consumer demand for products, inventory levels and our customers access to capital. This
cyclicality affects our ability to accurately predict future revenue, and in some cases, future expense levels. In the current environment, our ability to accurately predict our future operating results is particularly limited. During down cycles in our industry, the financial results of our customers may be negatively impacted, which could result not only in a decrease in, or cancellation or delay of, orders (which are generally subject to cancellation or delay by the customer with limited or no penalty) but also a weakening of their financial condition that could impair their ability to pay for our products or our ability to recognize revenue from certain customers. When cyclical fluctuations result in lower than expected revenue levels, operating results may be adversely affected and cost reduction measures may be necessary in order for us to remain competitive and financially sound. During periods of declining revenues, as was experienced during fiscal year 2009, we must be in a position to adjust our cost and expense structure to prevailing market conditions and to continue to motivate and retain our key employees. If we fail to respond, or if our attempts to respond (such as the global workforce reductions and cost-reduction efforts that we announced in fiscal years 2008 and 2009) fail to accomplish our intended results, then our business could be seriously harmed. Furthermore, any workforce reductions and cost-reduction actions that we adopt in response to down cycles may result in additional restructuring charges, disruptions in our operations and loss of key personnel. In addition, during periods of rapid growth, we must be able to increase manufacturing capacity and personnel to meet customer demand. We can provide no assurance that these objectives can be met in a timely manner in response to industry cycles. Each of these factors could adversely impact our operating results and financial condition.
In addition, the semiconductor equipment industry is constantly developing and changing over time. These changes currently, or in the future may, include the increasing cost of building and operating fabrication facilities and the impact of such increases on our customers investment decisions; the variability of future growth rates in the semiconductor industry; the ever-increasing cost and complexity involved in the adoption by our customers of technology advances and the potential impact that may have on their rate of adoption; pricing trends in the end-markets for consumer electronics and other products, which places a growing emphasis on our customers cost of ownership; overall changes in capital spending patterns by our customers; and demand by semiconductor manufacturers for shorter cycle times for developing, manufacturing and installing capital equipment. If we do not successfully manage the risks resulting from any of these or other potential changes in our industry, our business, financial condition and operating results could be adversely impacted.
Our headquarters and manufacturing facility is located in Gloucester, Massachusetts. In addition, we have four sales and service offices located in the U.S. and 32 located outside of the U.S., including offices in France, Germany, the Netherlands (three), Japan (ten), Korea (four), Taiwan (six), China (three), Switzerland, Singapore and Malaysia (two). These offices and facilities aggregate approximately 673 thousand square feet, of which 232 thousand square feet is leased. Since fiscal year 1994, the manufacturing facilities have been registered to the internationally recognized Quality Management System ISO 9001 standard. ISO 9001:2008 revised certification was obtained in fiscal year 2010. The most recent recertification obtained in August 2010 encompasses design, development, manufacture of ion implanters, including customer training and support.
Our management does not believe there is any material, long-term, excess capacity in our facilities, although utilization is subject to change based on customer demand. Furthermore, our management believes that our facilities and equipment generally are well maintained, in good operating condition, suitable for our purposes, and adequate for our present operations.
The following table reflects our locations by geographic segment:
We are currently a party to legal disputes. While we believe we have meritorious claims and/or defenses with respect to each dispute, the outcomes are not determinable. Management believes that the ultimate outcome of these disputes, individually and in the aggregate, will not have a material adverse effect on our financial condition or results of our operations.
Since April 5, 1999, our common stock has traded on The NASDAQ Global Select Market under the symbol VSEA.
The range of share prices reflected in the following table represents the high and low closing prices for our common stock on the NASDAQ Global Select Market for the periods indicated.
The reported closing price of our common stock on The NASDAQ Global Select Market on October 1, 2010 was $28.90 per share. The number of stockholders of record on November 15, 2010 was 2,555.
We have never declared or paid cash dividends on our common stock and do not expect to pay any cash dividends on our common stock in the foreseeable future.
In October 2004, our board of directors authorized the repurchase, from time to time, of up to $100.0 million of our common stock on the open market. Subsequently, our board of directors voted to increase the amount of funds that may be expended in repurchasing our common stock to a total of $800.0 million. On November 19, 2010 our board of directors voted to increase the amount of funds that may be expended in repurchasing our common stock by $100.0 million. The program does not have a fixed expiration date. During fiscal year 2010, we spent $18.0 million on the repurchase of 671,700 shares at a weighted-average price per share of $26.74. As of October 1, 2010, $67.7 million remained available for repurchase under the existing repurchase authorization. Also, we repurchased 421,385 shares from October 2, 2010 through November 15, 2010, the latest practicable date prior to the filing date.
See Part III Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters for information regarding securities authorized for issuance under our equity compensation plans.
The following table provides information about our purchases during the quarter ended October 1, 2010 of equity securities that are registered by Varian Semiconductor pursuant to Section 12 of the Securities Exchange Act of 1934:
ISSUER PURCHASES OF EQUITY SECURITIES
COMPARISON OF FIVE-YEAR CUMULATIVE STOCKHOLDERS RETURNS
PERFORMANCE GRAPH FOR VARIAN SEMICONDUCTOR
The comparative stock performance graph below compares the cumulative stockholder return on our common stock from September 30, 2005, through October 1, 2010; with the cumulative total return on (1) the Nasdaq Global Select Market Composite and (2) the S&P Semiconductor Equipment Index, which is a published industry index. The cumulative total return computations set forth in the performance graph assume the investment of $100 in our common stock and each of the indices from September 30, 2005, to October 1, 2010, including the reinvestment of dividends. The stock price performance shown on the graph and table below is not necessarily indicative of future price performance.
The information included in the following table reflects selected consolidated summary financial data for each of the last five fiscal years. The selected data has been revised to reflect the adjustments that are disclosed in Note 2 Basis of Presentation and Summary of Significant Accounting Policies and Note 18 Computation of Net Income (Loss) Per Share of the consolidated financial statements. This data should be read in conjunction with the consolidated financial statements and notes thereto included in Item 15-Exhibits and Financial Statement Schedules, and with Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations below.
QUARTERLY FINANCIAL DATA
Selected Quarterly Results of Operations
The following tables set forth unaudited quarterly condensed consolidated statements of operations data for each of the four fiscal quarters in the period ended October 1, 2010 and October 2, 2009. This data has been revised to reflect the adjustments that are disclosed in Note 2 Basis of Presentation and Summary of Significant Accounting Policies and Note 18 Computation of Net Income (Loss) Per Share of the consolidated financial statements. This quarterly data should be read in conjunction with the consolidated financial statements and notes thereto included in Item 15-Exhibits and Financial Statement Schedules, and with Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations below.
This Annual Report on Form 10-K contains certain forward-looking statements. For purposes of the safe harbor provisions under The Private Securities Litigation Reform Act of 1995, any statements using the terms believes, anticipates, expects, plans or similar expressions, are forward-looking statements. The forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected. There are a number of important factors that could cause our actual results to differ materially from those indicated by forward-looking statements made in this report and presented by management from time to time. Some of the important risks and uncertainties that may cause our financial results to differ are described in Item 1A. Risk Factors.
We are the leading supplier of ion implantation equipment used in the fabrication of semiconductor chips. We design, manufacture, market and service semiconductor processing equipment for virtually all of the major semiconductor manufacturers in the world. The VIISta ion implanter products are designed to leverage single wafer processing technology for the full range of semiconductor implant applications. We have shipped more than 4,100 systems worldwide.
We provide support, training, and after-market products and services that help our customers obtain high utilization and productivity, reduce operating costs and extend capital productivity of investments through multiple product generations. In fiscal year 2010, we were ranked number one in customer satisfaction in VLSI Research Inc.s customer survey for all large suppliers of wafer processing equipment, an honor received in thirteen of the past fourteen years.
Our industry is cyclical. The business depends upon semiconductor manufacturers expectations and resulting capacity investments for future integrated circuit demand. Historically, our business has experienced significant volatility and we believe the semiconductor capital equipment business will continue to be volatile, largely due to fluctuations in the level of investment by foundry and memory manufacturers. During fiscal year 2010, we experienced an increase in revenues of 130% compared to fiscal year 2009. Conversely, we experienced a decline of approximately 57% in revenue from fiscal year 2008 to fiscal year 2009. We believe that continued overcapacity in the memory markets, along with the global credit crisis and the decline in end-user demand for semiconductors, resulted in the rapid decline in revenue from fiscal year 2008 to 2009. These factors continued to negatively impact our business through the first quarter of fiscal year 2010. Our after-market business was also adversely affected as fabs were running at lower utilization levels, thus requiring fewer parts, upgrades and services. We believe that an improvement in end-user demand for semiconductor devices was the primary driver for the increase in our revenue from fiscal year 2009 to fiscal year 2010. Our overall results improved from fiscal year 2009 to fiscal year 2010 primarily due to our increased revenue, improved factory and field utilization, better leverage of our fixed costs and implants more rapid growth as compared to overall wafer fabrication equipment.
We believe that our management team has the industry experience to quickly and effectively react to sizing adjustments required by the volatility in the market. As such, we began resizing our business in fiscal year 2008 and continued through fiscal year 2009. We do not expect any further significant restructuring activities at this time, but do plan to continue to closely monitor the industry.
We believe that we have the financial strength and liquidity to continue investing in product development such that we can continue to maintain our leading industry position. As of October 1, 2010, we had $395.9 million in cash and investments and $1.6 million in debt. Furthermore, cash from operations was approximately $89.7 million in fiscal year 2010.
Our business is tied closely to our market share and the total available market for ion implanters. Calendar year 2009 semiconductor capital expenditure reports show that the total available market for ion implanters decreased
by approximately 57% versus calendar year 2008. In addition, based mainly on references to leading industry analyst reports and current customer buying patterns, we believe that reports will show that semiconductor capital equipment spending has increased in calendar year 2010 from calendar year 2009.
Wafer size and market. Most advanced devices below 90nm are produced on 300mm wafers. Memory manufacturers typically produce integrated circuits used for flash and dynamic random access memory, or DRAM, which store and retrieve information, while logic manufacturers typically produce integrated circuits used to process data. Foundry manufacturers have the capability to produce both memory and logic wafers.
Market Share and Total Available Market. The table below shows our calendar year 2009 and 2008 market share, as reported by Gartner Dataquest in April 2010 and April 2009, respectively. Market share estimates are calculated on a subset of revenue, and information reported by Gartner Dataquest may not be consistent on a company by company basis. The table below also shows the total available market for ion implanter sales in calendar years 2009 and 2008, also reported by Gartner Dataquest in April 2010 and April 2009, respectively. The total available market represents estimated worldwide total revenue for ion implanters sold during each calendar year.
Market share and total available market research data is also published by VLSI Research Inc. In April 2010, VLSI Research Inc. reported that our overall market share was 76.1% and that the total available market was $350.7 million for calendar year 2009. In May 2009, VLSI Research Inc. reported that our overall market share was 65% and that the total available market was $757.8 million for calendar year 2008. Calendar year 2010 market share reports are expected to be released in April 2011.
We estimate our market share on a regular basis. We do so based on extensive information, including our own revenues, competitor orders and other key information such as tool move-ins at the fabs. Our market share estimates are usually closely aligned with those of Gartner Dataquest.
For 2009, Gartner Dataquest reported our medium current market share as 78%, a 36 percentage point increase from 2008, primarily due to sales of our VIISta 900XP medium current tool, which has become the industry standard. We believe that our medium current market share was a little lower and our high energy market share, which was reported as 30%, was a little higher as several of our tools were segmented as medium current that we classify and sell in the high energy market. We continue to hold our leading position in the high current market and in 2009 we increased our share by 8 percentage points to 86% from 2008, with the introduction of our VIISTa HCS-XP. In the ultra high-dose market, we have maintained 100% market share due to the success of our plasma doping tool, known as the VIISta PLAD, which is mainly used by memory manufacturers.
Revenue recognition disparities do not normally cause significant swings in calculations of market share. However, we believe the significant decline in semiconductor capital equipment business in 2008 caused revenue recognition delays from 2007 shipments to distort 2008 market share metrics. Our information indicates that based on a competitors delayed revenue recognition, a significant portion of their medium current tool shipments in 2007 was not recognized as revenue until 2008.
During the quarter ended October 2, 2009, we identified certain instances dating back to fiscal year 1999 in which deferred income taxes and long-term tax liabilities were not properly recorded in our financial statements. These adjustments individually and in the aggregate were not material to our financial statements for all periods impacted. We have revised our historical financial statements to properly reflect these adjustments.
We recorded adjustments to increase deferred tax assets or reduce long-term tax liabilities and decrease income tax expense, resulting in an increase of net income, or reduction in net loss, by $1.8 million, $1.1 million and $2.2 million for the three months ended July 3, 2009 and fiscal years 2008 and 2007, respectively.
Critical Accounting Policies and Significant Accounting Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles, or GAAP in the U.S. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On a continual basis, we evaluate our estimates, including those related to revenues, inventories, accounts receivable, long-lived assets, income taxes, warranty obligations, deferred revenue, post-retirement benefits, contingencies, stock-based compensation and foreign currencies. We operate in a highly cyclical and competitive industry that is influenced by a variety of diverse factors including, but not limited to, technological advances, product life cycles, customer and supplier lead times, and geographic and macroeconomic trends. Estimating product demand beyond a relatively short forecasting horizon is difficult and prone to forecasting error due to the cyclical nature and inherent lack of visibility in the industry. We base our estimates on historical experience and on various other 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. See also the factors discussed in Item 1ARisk Factors.
We believe that the following sets forth our critical accounting policies used in the preparation of our consolidated financial statements.
Product revenue is comprised of established and new products including tools, upgrades and spare parts.
We recognize revenue from tool sales upon shipment, provided that title and risk of loss has passed to the customer, evidence of an arrangement exists, fees are contractually fixed or determinable, collectability is reasonably assured and there are no uncertainties regarding customer acceptance. Our tool transactions frequently include the sale of systems and services under multiple element arrangements.
We generally follow predetermined criteria for changing the classification of a new tool to an established tool. We generally recognize tools as established after demonstrating success in achieving customer acceptance of the same tool type and specification, for the same or similar application. In most circumstances, once a new tool achieves the predetermined criteria, the tool is considered established. Furthermore, prior installation costs on the tool type can also influence the evaluation of tool maturity on a going forward basis.
Tools are classified as established if the installation process and the post-delivery acceptance provisions are deemed routine, and there is a demonstrated history of achieving the predetermined established tool criteria. The majority of tools are designed and manufactured to meet contractual customer specifications, and established tools must have been demonstrated to meet customer specifications before shipment.
For established and new tools, a portion of the total purchase price is typically not due until installation occurs and the customer accepts the product. For established tools, the lesser of the amount allocated to the equipment or the contractual amount due upon delivery is recorded as product revenue upon delivery. The amount deferred for installation is recognized as service revenue upon customer acceptance and any remaining deferral is recognized as product revenue. For new tools, revenue is not recognized until customer acceptance. Spare parts and upgrade sales are typically recognized as revenue upon the later of delivery or the transfer of title and risk of loss to the customer.
Service revenue includes revenue from maintenance and service contracts, extended warranties, paid service and system installation services. Revenue related to maintenance and service contracts is recognized ratably over the duration of the contracts. Extended warranty revenue is deferred and recognized ratably over the applicable warranty term. Revenue related to paid service is recorded when earned and revenue related to installation is recorded upon fulfillment of the service obligation and customer acceptance. It generally takes approximately three to six weeks for our technicians to complete the installation of our products and perform tests agreed to with customers. Certain customers formally document their acceptance of our products at this time. Other customers elect to perform additional internal testing prior to formal acceptance, and this process generally takes eight to twelve weeks.
In October 2009, the Financial Accounting Standards Board, or FASB, issued new accounting guidance for revenue recognition for multiple element arrangements. The new accounting guidance is effective for fiscal years beginning on or after June 15, 2010, with early adoption permitted. We adopted the new accounting guidance in the third quarter of fiscal year 2010. In accordance with the new guidance, we applied the adoption prospectively from the beginning of fiscal year 2010. There was no significant impact on our financial position, results of operations or cash flows upon implementation and we do not expect the adoption of this guidance to have a material impact on our future reporting periods based on our current practices. The new accounting guidance impacts the determination of when the individual elements included in a multiple element arrangement may be treated as separate units of accounting and modifies the manner in which the transaction consideration is allocated across the separately identified elements by requiring the use of the relative selling price method and no longer permitting the use of the residual method to allocate arrangement consideration. Additionally, the new accounting guidance modifies the fair value requirements by allowing the use of estimated selling prices, or ESP, of elements if the entity does not have vendor-specific objective evidence, or VSOE, or third-party evidence, or TPE, of a selling price. A selling price hierarchy must be followed in which an entity must first determine that it does not have VSOE or TPE before using ESP to allocate revenue to the elements in an arrangement.
For transactions that originated through October 2, 2009 and were not materially modified after that date, revenue was allocated to systems on a residual method basis. Under this method, the total value of the arrangement was allocated first to the undelivered elements based on their fair values, with the remainder being allocated to systems revenue. For transactions that originated or were materially modified after October 2, 2009, we use the relative selling price method. The total consideration for an arrangement is allocated among the separate elements in the arrangement based on relative selling price as determined using the selling price hierarchy. We regularly review the method used to determine our relative selling price and update any estimates accordingly.
In October 2009, the FASB issued new accounting guidance for certain revenue arrangements that include software elements. The new accounting guidance amends the scope of pre-existing software revenue guidance by removing from the guidance non-software components of tangible products and certain software components of tangible products. The new accounting guidance is effective for fiscal years beginning on or after June 15, 2010, with early adoption permitted, and must be adopted in the same period as the new accounting guidance for revenue recognition for multiple element arrangements. Accordingly, we adopted the new accounting guidance in the third quarter of fiscal year 2010. The adoption of this new guidance had no impact on our financial position, results of operations or cash flows.
Deferred revenue includes customer advances and amounts that have been billed pursuant to contractual terms but have not been recognized as revenue. We also defer the fair value of extended warranties bundled with equipment sales as deferred revenue. Deferred revenue for extended warranties is recognized ratably over the applicable warranty term, which generally is from 13 to 24 months from the date the customer accepts the products.
We periodically supply evaluation tools to potential new customers, usually for a period of six months to one year. While the tool is at the customers semiconductor manufacturing factory, or fab, we work closely with the customer on complex processes to qualify the tool for that particular customers requirements. Until it is determined that a sale is probable, qualification costs are included in marketing, general and administrative expenses in the period incurred and we amortize the carrying value of the evaluation tool ratably over a period of typically four years. These costs are recorded as marketing, general and administrative expenses and the carrying value of the evaluation tool is included in inventory. Once it is determined a sale is probable, future qualification costs are added to the carrying value of the tool and the amortization of the carrying value is terminated. Customer evaluations are often successful and upon fulfillment of all four revenue recognition criteria, we recognize the revenue from the evaluation tool and remaining tool costs through revenue and cost of product revenue, respectively.
Inventory and Purchase Order Commitments
We value our inventory at the lower of cost or market. The determination of lower of cost or market requires that we make significant assumptions about future demand for products and the transition to new product offerings from legacy products. We also provide for losses on those open purchase order commitments in which our estimated obligation to receive inventory under the commitments exceed expected production demand. These assumptions include, but are not limited to, future manufacturing schedules, customer demand, supplier lead time and technological and market obsolescence. Once inventory is written down and a new cost basis has been established, it is not written back up if demand increases. If market conditions are less favorable than those projected by management, additional inventory provisions may be required. If market conditions are more favorable than those projected by management, and specific inventory previously written down is subsequently sold, gross profit could benefit by the amount of the specific write-down to carrying value previously recorded. In the case of purchase order commitments, more favorable market conditions or successful negotiations with suppliers will result in a reduction of provisions in the period the excess purchase order commitments are reduced.
Valuation Allowance on Deferred Tax Assets and Income Tax Provision
We record a valuation allowance against deferred tax assets if it is more likely than not that a portion of the deferred tax asset will not be realized. On a quarterly basis, we evaluate both the positive and negative evidence bearing upon the realizability of our deferred tax assets. We consider future taxable income, ongoing prudent and feasible tax planning strategies, and the ability to utilize tax losses and credits in assessing the need for a valuation allowance. A valuation allowance related to certain state tax credit and state net operating loss carryforwards has been recorded. Management has concluded that it is more likely than not that a portion of these credits will not be utilized since historically the annual amount of state credits generated exceeds the amount of credits that can be used. We record a benefit to the tax provision and corresponding reduction in the valuation allowance related to the utilization of state tax credits generated in prior years. Should we determine that we are not able to realize all or part of our other deferred tax assets in the future, a valuation allowance would be required resulting in an expense recorded within the provision for income taxes in the statement of operations in the period in which such determination was made. It is possible that the amount of the deferred tax asset considered realizable could be reduced in the near term if our forecast of future taxable income is reduced.
Our effective tax rate is affected by levels of taxable income in domestic and foreign tax jurisdictions, U.S. tax credits generated and utilized for research and development expenditures, U.S. foreign income exclusion, investment tax credits and other tax incentives specific to domestic and foreign operations.
We provide for the estimated cost of product warranties, the amount of which is based primarily upon historical information, at the time product revenue is recognized. While we engage in extensive product quality programs and processes including actively monitoring and evaluating the quality of our component suppliers, our warranty obligation is affected by product failure rates, utilization levels, material usage, service delivery costs incurred in correcting a product failure, and supplier warranties on parts delivered to us. Should actual product failure rates, utilization levels, material usage, service delivery costs incurred in correcting a product failure, or supplier warranties on parts differ from our estimates, revisions to the estimated warranty liability would be required.
Compensation cost for stock-based awards exchanged for employee and director services is measured at grant date and is based on the fair value of the award. The straight-line method is applied to all grants with service conditions, while the graded vesting method is applied to all grants with both service and performance conditions.
The choice of a valuation technique and the approach utilized to develop the underlying assumptions for that technique, involve significant judgments. These judgments reflect managements assessment of the most accurate method of valuing the stock options we issue based on historical experience, knowledge of current conditions, and beliefs of what could occur in the future given available information. Our judgments could change over time if the facts underlying these assumptions change, or as additional information becomes available. Any change in judgments could have a material impact on our financial statements. We believe that these estimates incorporate all relevant information and represent a reasonable approximation in light of the difficulties involved in valuing non-traded stock options.
Our fiscal year is a 52-week or 53-week period that ends on the Friday nearest September 30. Fiscal year 2010 was comprised of a 52-week period that ended on October 1, 2010. Fiscal year 2009 was comprised of a 52-week period ended on October 2, 2009. Fiscal year 2008 was comprised of a 53-week period ended on October 3, 2008.
Fiscal Year 2010 Compared to Fiscal Year 2009 and
Fiscal Year 2009 Compared to Fiscal Year 2008
The following table sets forth revenue by revenue category and territory for fiscal years 2010, 2009 and 2008:
The increase in product sales was $460.3 million, or 149%, during fiscal year 2010 as compared to fiscal year 2009. Our increase in product sales in fiscal year 2010 reflects the improvements in the global business environment, an increased demand for end-user semiconductor devices and implants more rapid growth compared to overall wafer fabrication equipment. In fiscal year 2009, overcapacity in the memory market, along with the global credit crisis and the decline in end-user demand for semiconductors, caused our customers to significantly decrease their spending for our products. On a unit basis, the number of tools recorded in revenue increased 199% during fiscal year 2010 compared to fiscal year 2009. This increase was most notable in the high current and medium current markets. In addition, revenue from parts and upgrades sales during fiscal year 2010 increased 75% compared to fiscal year 2009, due to higher fab utilization levels at most customers.
In fiscal year 2009, our product sales decreased $443.4 million, or 59%, from fiscal year 2008, due to the factors described above. On a unit basis, the number of tools recorded in revenue declined 62% during fiscal year 2009 as compared to fiscal year 2008. In addition, revenue from parts and upgrades sales during fiscal year 2009 decreased 46% as compared to fiscal year 2008, due to lower fab utilization levels at most customers.
Service revenue increased $9.4 million, or 18%, in fiscal year 2010 as compared to fiscal year 2009, primarily related to higher installation revenue from a greater volume of tool sales. Revenues from paid service also increased mainly due to the de-installation, relocation and re-installation of our previously installed tools at customer sites. Partially offsetting these increases to service revenue in fiscal year 2010 was lower service contract revenue. During fiscal year 2009, many customers cancelled or reduced fixed-priced service contract arrangements, we believe, to reduce fab operating costs during the global economic crisis, which had an impact on our service contract revenue in fiscal year 2010. Service revenue decreased $28.6 million, or 35%, in fiscal year 2009 as compared to fiscal year 2008, primarily related to a decrease in installation revenue due to fewer tool shipments and a decrease in service contract revenue as a result of customer fab closures and lower utilization levels.
Revenue by Territory
The Asia Pacific region has historically accounted for a significant percentage of our revenue. The increase in revenue from this region in fiscal year 2010 as compared to fiscal year 2009 was due to increased demand from our foundry and memory customers. The decrease in revenue from this region in fiscal year 2009 as compared to fiscal year 2008 was due to the worldwide decrease in semiconductor manufacturing, particularly among memory and foundry customers in the Asia Pacific region. Sales to North American customers in fiscal year 2010 increased compared to fiscal year 2009 due to increased demand from logic customers. Sales to North America decreased in fiscal year 2009 as compared to fiscal year 2008, primarily on account of a reduction in sales to both memory and logic customers. Sales to European customers in fiscal year 2010 increased compared to fiscal year 2009 due to increased demand from foundry and memory customers. Sales to European customers in fiscal year 2009 decreased compared to fiscal year 2008 due to decreased demand primarily from memory customers. Overall, the most significant driver of change from fiscal year 2009 to fiscal year 2010 was the increase in foundry business, which we believe was caused by an increase in end-user demand for electronics. The most predominant reason for the decrease in all regions from fiscal year 2008 to 2009 was the substantial drop in memory business.
Revenue from our ten largest customers in fiscal years 2010, 2009 and 2008 accounted for approximately 80%, 73% and 74% of total revenue, respectively. In fiscal year 2010, revenue from tsmc and Samsung accounted for 23% and 13%, respectively, of our total revenue. We expect that sales of our products to relatively few customers will continue to account for a high percentage of our revenue for the foreseeable future. In fiscal year 2009, revenue from Intel and tsmc accounted for 21% and 16%, respectively of our total revenue. In fiscal year 2008, revenue from Samsung and Intel accounted for 16% and 13%, respectively, of our total revenue.
Our accounts receivable is comprised of relatively few customer accounts. As of October 1, 2010, four customers accounted for 12%, 11%, 11% and 10% of the accounts receivable balance, respectively. As of October 2, 2009, two customers accounted for 23% and 21% of the accounts receivable balance, respectively.
Our tools are used by logic, memory and foundry manufacturers of integrated circuits. Logic manufacturers make chips that process information, while memory manufacturers make chips that store information. Both memory and logic manufacturers are owned by the companies that design the chips. Foundry manufacturers are contractors that take chip designs from other companies and make the chips for them. For several years, up to and including 2007, the demand for memory chips outstripped the demand for logic chips due to the growth in memory intensive applications such as cameras, phones and MP3 players. We believe that substantial capacity additions by memory customers through fiscal year 2007 led to excess supply of memory devices. In turn, this excess capacity led to a significant decrease in tool purchases from memory manufacturers in fiscal years 2008 and 2009. In fiscal year 2010, there was an increase in end-user demand for semiconductor devices which increased fab utilization. Virtually all of our tool shipments are 300 mm tools, which began to replace 200 mm tools at the end of the 1990s. The following table sets forth tool shipments by market, as a percent of total tool shipments, for fiscal years 2010, 2009 and 2008. Percentages are based on the number of tools shipped during the respective period.
Cost of Product Revenue
Our gross margins fluctuate with changes in revenue levels, changes in product mix, and our ability to absorb certain fixed costs. Cost of product revenue was $384.0 million and product gross margin was 50% for fiscal year 2010, compared to cost of product revenue of $185.5 million and product gross margin of 40% for fiscal year 2009. We experienced improved product gross margins in fiscal year 2010 as compared to fiscal year 2009, primarily due to improved factory and field utilization and better leverage of our fixed costs, which increased our product gross margins by 6% compared to the same period a year ago. Charges related to product transitions and reductions in the demand for parts and upgrades did not have a material impact on product gross margin in fiscal year 2010, although these factors did result in a decrease of approximately 3% in product gross margin in fiscal year 2009.
For fiscal year 2009, cost of product revenue was $185.5 million and product gross margin was 40%, compared to the cost of product revenue of $386.7 million and product gross margin of 49% for fiscal year 2008. The primary reason for the decrease in product gross margin for fiscal year 2009 versus fiscal year 2008 was under utilization of the factory due to significantly lower manufacturing volume. We decided to maintain a minimum number of employees in the factory despite the lower volume to ensure our ability to quickly add capacity when the industry recovered. Costs were managed through multiple efforts, including a reduced workforce and mandatory shutdowns. The under utilized factory impacted gross profit by $10.3 million, or 3%, from fiscal year 2009 to fiscal year 2008. In addition, charges related to product transitions and reductions in the demand for legacy parts and upgrades resulted in approximately 3% and 1% reductions in product gross margin during fiscal years 2009 and 2008, respectively. The impact of lower purchase volume reduced product gross margin approximately 1% in fiscal year 2009 compared to fiscal year 2008. A lower sales mix of tools versus upgrades and parts partially offset the negative impact on product gross margins for fiscal year 2009 versus fiscal year 2008. Tools typically are sold at lower margins than upgrades and parts. Furthermore, an unfavorable product mix, notably a higher concentration of high energy tools and some used tool sales, negatively affected product gross margin along with slightly lower margins on upgrades and parts sales in fiscal year 2009.
Cost of Service Revenue
Cost of service revenue was $40.4 million and service gross margin was 35% for fiscal year 2010, compared to cost of service revenue of $33.9 million and service gross margin of 36% for fiscal year 2009. Cost of service revenue primarily consists of service contract costs and installation costs. Thus, fluctuations in service margins are mainly attributed to the change in service contract margins and installation margins. Cost of service contracts is influenced by contract type and regional mix, while the cost of installation is influenced by product and regional mix. The reductions in installation margins and service contract margins for fiscal year 2010 were due to a lower mix of higher-margin service contracts and installations than in fiscal year 2009.
In fiscal year 2009, cost of service revenue was $33.9 million and service gross margin was 36%, compared to $51.6 million and service gross margin of 37% for fiscal year 2008. In fiscal year 2009, lower service margins were mainly due to a lower mix of high margin service contracts, partially offset by a favorable mix of installations.
Research, Development and Engineering
Research, development and engineering expenses were $98.2 million for fiscal year 2010, compared to $80.1 million for fiscal year 2009, an increase of $18.1 million, or 23%. The increase in research, development and engineering spending was due to our continued investment in new product development and growth initiatives.
Research, development and engineering expenses were $80.1 million for fiscal year 2009, compared to $111.2 million for fiscal year 2008, a decrease of $31.2 million, or 28%. The decrease in research, development and engineering spending was attributable to the cost reduction efforts we implemented, such as lower levels of headcount, mandatory shutdowns and reduced compensation plans.
Marketing, General and Administrative
Marketing, general, and administrative expense for fiscal year 2010 was $121.7 million, compared to $96.2 million in fiscal year 2009, an increase of $25.5 million, or 27%. The increase was mainly due to higher levels of tool evaluation activity, additional headcount to support growth activities and the reinstatement of variable compensation plans in fiscal year 2010 that were suspended in fiscal year 2009.
Marketing, general and administrative expenses were $96.2 million for fiscal year 2009, compared to $130.7 million for fiscal year 2008, a decrease of $34.5 million, or 26%. The decrease from fiscal year 2008 to fiscal year 2009 was primarily due to cost reduction efforts implemented during the industry downturn. Compensation plans were significantly reduced and/or suspended and cost reduction efforts resulted in lower levels of headcount and associated costs, such as travel. In addition, we mandated shutdowns for several weeks each quarter during fiscal year 2009.
The semiconductor industry has historically experienced periodic downturns and we have historically recorded restructuring charges in connection with cost reduction initiatives implemented in response to the industry downturns. Restructuring charges typically consist of severance, benefits and outplacement services offered to terminated employees and sometimes include charges for remaining lease payments on facilities that are closed. Prior to any restructuring announcements, the restructuring is approved by the appropriate level of management necessary to commit to the specific actions of the reduction in force.
We began relocating our European operations in Houten, the Netherlands to Schaffhausen, Switzerland, in the fiscal fourth quarter of 2008. The restructuring charge is comprised primarily of one-time termination benefits and contract termination expense related to a facility lease. European restructuring activity, is significantly complete. The recognized cost of the European restructuring activity from the date of its commencement to October 1, 2010 is $2.5 million.
Exclusive of cash outlays of $0.7 million related to severance and contract termination costs to exit the Houten facility, there was no significant restructuring activity during fiscal year 2010. Cash outlays related to contract termination costs to exit the Houten facility will continue through fiscal year 2014.
The following table summarizes the restructuring activity for fiscal years 2009 and 2008.
Interest income for fiscal years 2010, 2009 and 2008 was $3.9 million, $5.3 million and $10.5 million, respectively. The decrease in interest income of $1.4 million for fiscal year 2010 compared to fiscal year 2009 was primarily attributable to significantly lower interest rates partially offset by an increase in average cash and investment balances.
The decrease in interest income of $5.2 million for fiscal year 2009 compared to fiscal year 2008 was primarily attributable to significantly lower interest rates partially offset by an increase in average cash and investment balances. At fiscal year end 2009, we had $4.6 million in investments, which earned interest that was exempt from U.S. federal taxation, which are generally lower than rates earned on comparable fully-taxable investments.
During fiscal years 2010, 2009 and 2008, interest expense was $0.3 million, $1.0 million and $1.7 million, respectively. In fiscal year 2010, the decrease of $0.7 million in interest expense compared to fiscal year 2009 was primarily due to the expense and fees associated with the termination of a line of credit in fiscal year 2009.
In fiscal year 2009, the decrease of $0.7 million in interest expense compared to fiscal year 2008, was primarily due to lower finance charges on forward contracts used to hedge balance sheet related foreign exchange exposure.
Other Expense, Net
During fiscal years 2010, 2009 and 2008, we recorded other expense, net, of $1.1 million, $1.1 million and $0.1 million, respectively. Other expense, net includes foreign currency exchange gains and losses, which primarily drive fluctuations between comparable periods.
Provision for Income Taxes
Our effective tax rate is based on the tax laws and statutory rates applied to the income for the year in each jurisdiction throughout the world.
Our effective income tax rate was 16% in fiscal year 2010, 4% in fiscal year 2009 and 38% in fiscal year 2008. The fiscal year 2010, 2009 and 2008 tax provisions were impacted by tax charges related to our realignment of our global business structure and establishment of international operations that provide operational and financial services to all of our international locations. A significant element of the new structure involves the sharing of certain expenses related to the ongoing development of intangible property.
The fiscal year 2010 effective tax rate includes discrete benefits of approximately $1.2 million related to tax return adjustments, discrete benefits of $1.8 million due to the expirations of the statute of limitations in various jurisdictions, and other discrete benefits of $1.3 million, offset by a $1.6 million charge related to interest accrued on uncertain tax positions. The fiscal year 2009 effective tax rate includes discrete charges of approximately $1.1 million related to tax return adjustments, $1.3 million related to interest accrued on uncertain tax positions and a discrete benefit of $2.1 million due to the expiration of the statute of limitations, primarily with respect to our U.S. federal tax filings for fiscal year 2005. The fiscal year 2008 effective tax rate includes discrete benefits of approximately $4.7 million related to current and prior year research and development tax credits, other discrete benefits of $0.3 million and a discrete charge of approximately $1.0 million to write-down the deferred tax asset for start-up losses of our Swiss subsidiary, upon receipt of the final incentive ruling from Switzerland.
We benefit from tax incentives on approved investments in Singapore and Switzerland. The Singapore tax incentive expired on September 30, 2010. The Switzerland tax incentives are for periods ranging from five to ten years and are scheduled to expire within three to seven years. As a result of the tax incentives, our net income
was higher by $14.6 million ($0.20 per share), lower by $0.9 million ($0.01 per share) and higher by $2.4 million ($0.03 per share) for fiscal years 2010, 2009 and 2008, respectively. The benefit of losses incurred in Switzerland in fiscal year 2009 at a reduced rate resulted in an overall negative impact of the tax incentives to the consolidated financial statements in that year. We do not expect the expiration of the Singapore incentive to have a material effect on the tax rate in the future.
The net increase in the reserve for unrecognized tax benefits during fiscal year 2010 was $7.6 million for positions taken in the current year. Of the $62.6 million of unrecognized tax benefits, $60.9 million would impact the effective tax rate, if recognized. The difference between the total amount of unrecognized tax benefits and the amount that would impact the effective rate consists of items that are offset by deferred tax assets, relating to state tax credits which are fully offset by a valuation allowance. As of fiscal year end 2010 and 2009, we accrued $5.2 million and $4.1 million, respectively, of interest and penalties related to unrecognized tax benefits. We include interest and penalties related to unrecognized tax benefits within our provision for income taxes.
We and our subsidiaries are subject to examination by federal, state and foreign tax authorities. The statute of limitations for our tax filings with federal, state and foreign tax authorities is generally open for fiscal years 2003 through the present. The Internal Revenue Service, or IRS, commenced an examination of fiscal year 2007 in December 2008. The IRS completed examinations of certain refund claims filed for fiscal years 2002 to 2004 and we filed a protest of the refund claim audit findings with the Appeals Office of the IRS. The IRS audit of fiscal year 2007 is continuing and has been extended to include fiscal year 2009. It is unknown whether agreement on the refund claims or resolution of the IRS audit of fiscal years 2007 and 2009 will be reached within the next twelve months, or whether the resolution will result in additional assessments beyond existing reserves or release of reserves. The favorable resolution of the claims filed with the Appeals Office could result in a maximum benefit to the tax provision of up to $5.8 million, excluding interest. Based on the status of the IRS audit, it is not possible to estimate the impact of the amount of any changes to our previously recorded uncertain tax positions. It is possible that up to $26.8 million of unrecognized tax positions, excluding interest and penalties, may be recognized within one year as the result of the lapse of statutes of limitations.
Net Income (Loss)
As a result of the foregoing factors, for fiscal year 2010, we recorded net income of $159.6 million compared to a net loss of $38.0 million for fiscal year 2009 and net income of $99.5 million for fiscal year 2008. In fiscal year 2010, net income per diluted share was $2.12 compared to a net loss per diluted share of $0.52 per fiscal year 2009 and net income per diluted share of $1.32 for fiscal year 2008.
Liquidity and Capital Resources
Our liquidity is affected by many factors, some based on the normal operations of the business and others related to the uncertainties of the industry and global economies. We believe that cash, cash equivalents and investments of $395.9 million as of October 1, 2010 will be sufficient to satisfy working capital requirements, commitments for capital expenditures, any future common stock repurchases and other purchase commitments, environmental contingencies and cash requirements for fiscal year 2011. We believe that we have the ability to hold cash equivalents and investments through maturity and therefore believe that any reduction in value of investments is temporary. We have an investment policy which limits the types, amounts and maturities of the financial instruments that we invest in. The overall objective of this policy is to preserve capital and ensure that there is sufficient liquidity to meet the working capital needs of our business. We monitor our cash, cash equivalents and investments daily to ensure that this objective is met.
Cash from operations was $89.7 million for fiscal year 2010, compared to $41.7 million for fiscal year 2009. Cash from operations in fiscal year 2010 included net income of $159.6 million, an increase in accrued expenses of $36.5 million and an increase in accounts payable of $26.9 million. The increase in accrued expenses is mainly due to an increase in our long-term tax liabilities and the reinstatement of variable compensation plans, which
were suspended in fiscal year 2009 due to the economic downturn. Partially offsetting these items were an increase in accounts receivable, net of $106.0 million due to our increased business volume and revenue growth, and an increase in inventory of $95.8 million due to increased customer demand for tools, parts and upgrades.
Cash from operations was $41.7 million during fiscal year 2009 compared to $168.0 million during fiscal year 2008. Cash provided by operations in fiscal year 2009 included reductions in inventory of $56.1 million and a decrease in accounts receivables of $16.8 million, partially offset by a net loss of $38.0 million and decreases of $17.6 million in accrued expenses and $9.7 million in deferred revenue. Accrued expenses decreased mainly due to the payout of incentive compensation following the end of the fiscal year 2008. The decrease in inventory was primarily due to lower material receipts for the lower build plan and the decrease in accounts receivable was due to substantially lower sales volumes. Accounts receivable did not decrease as much as inventory partially due to extended payment terms.
Cash used in investing activities was $44.8 million during fiscal year 2010, compared to $4.5 million generated in fiscal year 2009. In fiscal year 2010, we purchased $133.1 million of investments and $12.5 million of property, plant and equipment; partially offset by proceeds from maturities and sales of investments of $100.7 million. An increase in cash generated by operations contributed to the increased purchase of investments during fiscal year 2010. During fiscal year 2009, we generated $82.1 million from the sale and maturity of investments, $70.5 million for the purchase of investments and used $7.1 million for the purchase of plant, property and equipment. During fiscal year 2008, we received $150.5 million from the sale and maturity of investments, $107.7 million for the purchase of investments and used $9.5 million for the purchase of plant, property and equipment. In fiscal year 2009, cash received from the net sale and maturity of investments decreased compared to fiscal year 2008 due to the timing of maturities and because fewer securities were purchased in the later part of fiscal year 2008 due to the market environment.
In October 2004, our board of directors authorized the repurchase, from time to time, of up to $100.0 million of our common stock on the open market. Subsequently, our board of directors voted increased the amount of funds that may be expended in repurchasing our common stock to a total of $800.0 million. On November 19, 2010 our board of directors voted to increase the amount of funds that may be expended in repurchasing our common stock by $100.0 million. The program does not have a fixed expiration date. As of fiscal year end 2010, $67.7 million remained available for repurchase under the existing repurchase authorization. Our stock repurchase plan is influenced by our growth and investment plans, stage in the industry cycle, attractiveness of share price and liquidity needs.
During fiscal year 2010, we generated $0.3 million of cash from financing activities, primarily due to $16.3 million of cash received from the issuance of common stock upon the exercise of stock options and $2.6 million in excess tax benefits related to stock-based compensation. During fiscal year 2010, we used $18.0 million to repurchase 0.7 million shares at a weighted-average price per share of $26.74. During fiscal year 2009, we generated $8.4 million of cash from financing activities, primarily from $8.0 million of cash received from the issuance of common stock upon the exercise of stock options. We did not purchase any shares of our common stock during fiscal year 2009, due to our interest in preserving cash during the industry downturn. In fiscal year 2008, we used $170.1 million of cash for financing activities. During fiscal year 2008, we used $179.5 million to repurchase 4.8 million shares of stock at a weighted-average price per share of $37.74. This was partially offset by the issuance of stock upon the exercise of stock options and under the employee stock purchase plan of $7.3 million and the excess tax benefit from stock based compensation of $2.5 million.
On May 23, 2008, we entered into a credit agreement with multiple financial institutions providing for borrowings of a maximum principal amount of up to $100.0 million under an unsecured revolving credit facility. Amounts could be borrowed, repaid and re-borrowed from time to time during the five year commitment period ending May 23, 2013. Borrowings would bear interest at a rate per annum equal to either: (1) the greater of (a) the prime rate and (b) the federal funds rate plus 0.50%; or (2) the sum of (a) LIBOR, with certain adjustments and (b) an applicable rate, defined in the credit agreement as a percentage spread based on our leverage ratio. The credit agreement contained events of default and covenants. The credit facility was intended to provide ongoing working capital and cash for acquisitions, repurchases of common stock, capital expenditures
and other general corporate purposes. We terminated this credit agreement effective March 27, 2009, pursuant to the terms of the credit agreement. The termination of this credit facility did not materially impact our liquidity.
Our subsidiary in Japan had one credit facility during fiscal years 2010 and 2009. Maximum available borrowing under the facility was Yen 400,000,000 ($4.8 million) at fiscal year end 2010. The loan is not collateralized and contains no restrictive covenants, although the loan is guaranteed by us. The interest rate for the facility is the 3-month Tokyo interbank offered rate (TIBOR) plus 1.00%, which was approximately 1.4% and 1.6% as of October 1, 2010 and October 2, 2009, respectively. There were no outstanding borrowings as of October 1, 2010 and as of October 2, 2009 under this facility. Our subsidiary in Japan also had an additional credit facility during fiscal year 2009, which was terminated in that year. The termination of this credit facility did not materially impact our liquidity.
Our subsidiary in Taiwan terminated its credit facility of $1.0 million during fiscal year 2009. Any outstanding U.S. Dollar borrowings under the Taiwan facility accrued interest at the local base rate plus 2.0% plus taxes, which was approximately 7.4% at fiscal year end 2008. Any New Taiwan Dollar borrowings accrued interest at the local base rate plus 2.0% plus taxes, which was approximately 4.1% as of October 3, 2008. There were no outstanding borrowings as of October 3, 2008 under this facility. The termination of this credit facility did not materially impact our liquidity.
Our subsidiary in Europe maintains a credit facility that includes overdraft protection of Euro 2.5 million which at October 1, 2010 translated to $3.4 million. Interest accrues at the Euro base rate plus 1.5% and was approximately 6.1% and 6.4% at October 1, 2010 and October 2, 2009, respectively. Borrowings under this facility are payable on demand. The credit facility is not collateralized nor does it contain any restrictive covenants, although the facility is guaranteed by us. There were no outstanding borrowings as of October 1, 2010 and as of October 2, 2009 under this facility.
In February 2003, we purchased our previously leased facility located in Newburyport, Massachusetts. The purchase price consisted of cash payments totaling $3.4 million, the assumption of the sellers outstanding loan of $5.1 million and the transfer of other prepaid assets of $0.8 million. The $1.6 million carrying amount of the loan had an estimated fair value of $1.7 million as of October 1, 2010. The fair value of the loan was estimated using a discounted cash flow analysis. The interest rate was estimated based on current market conditions and our financial condition as of October 1, 2010.
Off-Balance Sheet Arrangements
We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance-sheet arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.
Under GAAP, some obligations and commitments are not required to be included in the consolidated balance sheets and statements of operations. These obligations and commitments, while entered into in the normal course of business, may have a material impact on liquidity. The following commitments as of October 1, 2010 may have not been included in the consolidated balance sheets and statements of operations included under Item 8. Financial Statements and Supplementary Data. We have various contractual obligations impacting our liquidity. The following table summarizes our future payments under contractual obligations as of October 1, 2010:
In addition, we maintain vendor liability agreements whereby product can be delivered within our lead time requirements. As of October 1, 2010, our maximum liability under these arrangements was approximately $30.0 million.
Transactions with Affiliates and Related Parties
Operations prior to April 2, 1999 had been part of the former VAI, which now operates as VMS. On April 2, 1999, VAI contributed its SEB to Varian Semiconductor, then distributed to the holders of record of VAI common stock one share of common stock of Varian Semiconductor for each share of VAI common stock owned on March 24, 1999. At the same time, VAI contributed its Instruments Business, or IB, to VI and distributed to the holders of record of VAI common stock one share of common stock of IB for each share of VAI common stock owned on March 24, 1999. VAI retained its Health Care Systems business and changed its name to VMS effective as of April 2, 1999. These transactions were accomplished under the terms of a Distribution Agreement by and among Varian Semiconductor, VAI, hereafter referred to as VMS for periods following the spin-off and VI, or the Distribution Agreement. For purposes of providing an orderly transition and to define certain ongoing relationships between and among Varian Semiconductor, VMS and VI after the spin-off, Varian Semiconductor, VMS and VI also entered into the Distribution Related Agreements. In May 2010, VI became a wholly owned subsidiary of Agilent Technologies, Inc.
The Distribution Related Agreements provide that from and after the spin-off, VMS, VI and Varian Semiconductor will indemnify each and their respective subsidiaries, directors, officers, employees and agents
against all losses arising in connection with shared liabilities (including certain environmental and legal liabilities). All shared liabilities will be managed and administered by VMS and expenses and losses, net of proceeds and other receivables, will be borne one-third each by VMS, VI, and Varian Semiconductor. The Distribution Related Agreements also provide that we shall assume all of our liabilities, other than shared liabilities (including accounts payable, accrued payroll and pension liabilities) in accordance with their terms. During fiscal years 2010, 2009 and 2008, we were charged $1.1 million, $0.8 million and $1.0 million, respectively, by VMS in settlement of these obligations.
Recent Accounting Pronouncements
In January 2010, the FASB issued authoritative guidance which requires enhanced disclosure of activity in Level 3 fair value measurements. This guidance states that the reporting entity should disclose separately information about purchases, sales, issuances and settlements in the reconciliation for fair value measurements using significant unobservable inputs, or Level 3 inputs. The guidance for Level 3 fair value measurements disclosures becomes effective for us in the first quarter of fiscal year 2011. We do not expect this guidance to have an impact on our consolidated financial statements.
Foreign Currency Exchange Risk
As a multinational company, we face exposure to adverse movements in foreign currency exchange rates. This exposure may change over time as our business practices evolve and could impact our financial results. We use derivative instruments to protect our foreign operations from fluctuations in earnings and cash flows caused by volatility in currency exchange rates. We hedge our current exposures and a portion of our anticipated foreign currency exposures with foreign currency forward contracts having terms of up to twelve months.
We have established balance sheet and forecasted transaction currency risk management programs to protect against fluctuations in fair value and the volatility of future cash flows caused by changes in the exchange rates. These programs reduce, but do not always entirely eliminate, the impact of currency exchange movements. Historically, our primary exposures have resulted from non-U.S. dollar denominated sales and purchases in Asia Pacific and Europe. We do not use derivative instruments for trading or speculative purposes.
We hedge currency exposures that are associated with certain of our assets and liabilities denominated in various non-U.S. dollar currencies. Net foreign losses for fiscal years 2010, 2009 and 2008 were $0.9 million, $0.4 million and $0.3 million, respectively.
Our international sales, except for those in Japan, are primarily denominated in the U.S. dollar. For foreign currency-denominated sales, however, the volatility of the foreign currency markets represents risk to us. Upon forecasting the exposure, we enter into hedges with forward sales contracts whose critical terms are designed to match those of the underlying exposure. These hedges are evaluated for effectiveness at least quarterly using the change in value of the forward contracts to the change in value of the underlying transaction, with the effective portion of the hedge accumulated in other comprehensive income. Any measured ineffectiveness is included immediately in other income and expense in the consolidated statements of operations. There was an immaterial amount of ineffectiveness recognized during fiscal years 2010 and 2009.
The table below presents the notional amounts (at the contract exchange rates), the weighted-average contractual foreign currency exchange rates and the estimated fair value of our contracts outstanding as of October 1, 2010 and October 2, 2009.
Interest Rate Risk
Although payments under certain of our overseas borrowing facilities are tied to market indices, we are not exposed to material interest rate risk from these borrowing facilities. We have no material cash flow exposure due to rate changes for cash equivalents and short-term investments. We do not believe that a one percent change in interest rates would have a material impact on the fair value of our investment portfolio or our interest income. We maintain cash investments primarily in U.S. Treasury, government agency and investment-grade corporate and municipal securities, as well as short-term time deposits with investment grade financial institutions. Cash equivalents at October 1, 2010 and October 2, 2009 were $150.3 million and $164.5 million, respectively. As of October 1, 2010 and October 2, 2009, our short-term investments were $60.9 million and $44.0 million, respectively, and consisted primarily of corporate bonds, certificates of deposit and government agency and U.S. Treasury securities. As of October 1, 2010 and October 2, 2009, our long-term investments were $101.3 million and $86.4 million, respectively, and consisted primarily of U.S. Treasury, government agency and corporate.
Commodity Price Risk
We are not exposed to material commodity price risk.
The response to this item is submitted as a separate section to this report. See Item 15. Exhibits and Financial Statement Schedules.
Disclosure Controls and Procedures
The management of Varian Semiconductor, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the disclosure controls and procedures of Varian Semiconductor as of October 1, 2010. The term disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SECs rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the companys management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of Varian Semiconductors disclosure controls and procedures as of October 1, 2010, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, Varian Semiconductors disclosure controls and procedures were effective at the reasonable assurance level.
Changes in Internal Control over Financial Reporting
No change in Varian Semiconductors internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended October 1, 2010 that has materially affected, or is reasonably likely to materially affect, Varian Semiconductors internal control over financial reporting.
Managements Report on Internal Control over Financial Reporting
Management of Varian Semiconductor is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Management, with the participation our Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of Varian Semiconductors internal control over financial reporting as of October 1, 2010. In their evaluation, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO in Internal ControlIntegrated Framework.
Based on managements evaluation using the COSO criteria, management concludes that Varian Semiconductor maintained effective internal control over financial reporting as of October 1, 2010. This evaluation has been audited by PricewaterhouseCoopers LLP, an independent registered accounting firm, as stated in their report which appears herein.
The response to this item is contained in part under the caption Executive Officers of the Registrant in Part I of this Annual Report on Form 10-K and in part in Varian Semiconductors Proxy Statement for the Annual Meeting of Stockholders to be held on January 20, 2011 (the 2011 Proxy Statement) under the captions Election of Directors, Information About Stockholder Proposals for 2011 Annual Meeting and Corporate Governance which sections are incorporated herein by this reference.
The information required by this Item pursuant to Item 405 of Regulation S-K will appear under the heading Section 16(a) Beneficial Ownership Reporting Compliance in the 2011 Proxy Statement, which section is incorporated herein by reference.
Varian Semiconductor has adopted a written code of ethics that applies to our principal executive officer, principal financial officer, and principal accounting officer or controller, or persons performing similar functions. Our code of ethics, which also applies to our directors and all of our officers and employees, can be found on our web site, which is located at www.vsea.com, and is also an exhibit to this report. We intend to make all required disclosures concerning any amendments to or waivers from, our code of business conduct and ethics on our web site.
The response to this item is contained in the 2011 Proxy Statement under the captions Executive Compensation, Compensation Discussion and Analysis, Potential Payments Upon Termination or Change in Control, Director Compensation, Compensation Committee Interlocks and Insider Participation and Compensation Committee Report which sections are incorporated herein by this reference.
The response to this item is contained in the 2011 Proxy Statement under the caption Security Ownership of Certain Beneficial Owners and Equity Compensation Plan Information, which sections are incorporated herein by this reference.
The response to this item is contained in the 2011 Proxy Statement under the captions Director Independence, Policies and Procedures for Related Person Transactions and Transactions with Related Persons, which section is incorporated herein by this reference.
The response to this item is contained in the 2011 Proxy Statement under the caption Independent Registered Public Accounting Firms Fees, which section is incorporated herein by this reference.
The following documents are filed as part of this Annual Report on Form 10-K:
The following financial statement schedule of Varian Semiconductor and its subsidiaries for fiscal years 2010, 2009 and 2008 is filed as a part of this Annual Report on Form 10-K and should be read in conjunction with the consolidated financial statements of Varian Semiconductor and its subsidiaries.
All other required schedules are omitted because of the absence of conditions under which they are required or because the required information is given in the financial statements or the notes thereto.
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.
Date: November 22, 2010
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.
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
The following financial statements of the Registrant and its subsidiaries are required to be included in Item 8:
All other required schedules are omitted because of the absence of conditions under which they are required or because the required information is given in the financial statements or the notes thereto.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
Varian Semiconductor Equipment Associates, Inc.:
In our opinion, the consolidated financial statements listed in the index appearing under Item 15(1) present fairly, in all material respects, the financial position of Varian Semiconductor Equipment Associates, Inc. and its subsidiaries (the Company) at October 1, 2010 and October 2, 2009, and the results of their operations and their cash flows for each of the three years in the period ended October 1, 2010 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of October 1, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Companys management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Managements Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Companys internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included 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. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
As discussed in Note 2 to the consolidated financial statements, the Company changed the manner in which it accounts for fair value measurements in fiscal year 2009.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/S/ PRICEWATERHOUSECOOPERS LLP
November 22, 2010
CONSOLIDATED BALANCE SHEETS
The accompanying notes to the consolidated financial statements are an integral part of these statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes to the consolidated financial statements are an integral part of these statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes to the consolidated financial statements are an integral part of these statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME (LOSS)