<PAGE>
- -------------------------------------------------------------------------------
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
----------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended July 2, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 0-25395
----------------
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
(Exact name of Registrant as Specified in its Charter)
<TABLE>
<S> <C>
Delaware 77-0501994
(State or Other Jurisdiction (IRS Employer
of Incorporation or Organization) Identification Number)
35 Dory Road, Gloucester, Massachusetts 01930
(Address of principal executive offices) (Zip Code)
</TABLE>
(978) 282-2000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
The number of shares of the registrant's common stock outstanding as of
August 10, 1999 was 30,441,234 shares of $0.01 par value common stock.
An index of exhibits filed with this Form 10-Q is located on page 21.
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<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
------------------------- -------------------------
July 2, 1999 July 3, 1998 July 2, 1999 July 3, 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenue................... $63,847 $81,766 $164,407 $301,141
------- ------- -------- --------
Operating Costs and
Expenses
Cost of revenue........... 41,926 58,565 126,552 190,887
Research and development.. 9,312 9,945 27,521 28,190
Marketing................. 9,359 8,754 25,877 30,618
General and
administrative........... 9,391 3,508 25,842 14,099
Restructuring costs....... -- -- 2,688 --
------- ------- -------- --------
Total operating costs and
expenses................. 69,988 80,772 208,480 263,794
------- ------- -------- --------
Operating (loss)
earnings................. (6,141) 994 (44,073) 37,347
Interest income........... 1,157 -- 1,157 --
------- ------- -------- --------
(Loss) earnings before
taxes.................... (4,984) 994 (42,916) 37,347
Income tax (benefit)
provision on (loss)
earnings................. (1,580) 93 (13,600) 11,041
------- ------- -------- --------
Net (loss) earnings....... $(3,404) $ 901 $(29,316) $ 26,306
======= ======= ======== ========
Weighted average shares
outstanding--basic..... 30,423 30,423 30,423 30,423
======= ======= ======== ========
Weighted average shares
outstanding--diluted... 30,423 30,508 30,423 30,508
======= ======= ======== ========
Net (loss) earnings per
share--basic........... $ (0.11) $ 0.03 $ (0.96) $ 0.86
======= ======= ======== ========
Net (loss) earnings per
share--diluted......... $ (0.11) $ 0.03 $ (0.96) $ 0.86
======= ======= ======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
1
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share amounts)
<TABLE>
<CAPTION>
July 2, October 2,
1999 1998
----------- ----------
(Unaudited)
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents.............................. $ 89,024 $ --
Accounts receivable, net............................... 60,093 62,677
Inventories............................................ 52,210 60,692
Other current assets................................... 46,397 38,754
-------- --------
Total Current Assets................................... 247,724 162,123
-------- --------
Property, plant and equipment.......................... 88,238 84,128
Accumulated depreciation and amortization.............. (52,033) (45,314)
-------- --------
Net property, plant and equipment...................... 36,205 38,814
Other assets........................................... 23,307 23,689
-------- --------
Total Assets........................................... $307,236 $224,626
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Notes payable.......................................... $ 4,878 $ --
Accounts payable....................................... 13,553 10,513
Accrued expenses....................................... 73,637 77,050
Product warranty....................................... 16,092 21,435
Advance payments from customers........................ 7,194 3,631
-------- --------
Total Current Liabilities.............................. 115,354 112,629
Long-term accrued expenses............................. 7,896 6,796
Deferred taxes......................................... 745 1,952
-------- --------
Total Liabilities...................................... 123,995 121,377
-------- --------
Contingencies (Note 10)
Stockholders' Equity
Preferred stock, par value $.01; authorized 5,000,000
shares, issued none................................... -- --
Common stock, par value $.01; authorized 150,000,000
shares, issued and outstanding 30,422,792 at July 2,
1999.................................................. 304 --
Capital in excess of par value......................... 186,341 --
Divisional equity...................................... -- 103,249
Accumulated deficit.................................... (3,404) --
-------- --------
Total Stockholders' Equity............................. 183,241 103,249
-------- --------
Total Liabilities and Stockholders' Equity............. $307,236 $224,626
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
<TABLE>
<CAPTION>
For The Nine Months Ended
-------------------------
July 2, 1999 July 3, 1998
------------ ------------
<S> <C> <C>
Operating Activities
Net cash (used in)
provided by operating
activities............. $(23,296) $ 11,056
-------- --------
Investing Activities
Purchase of property,
plant and equipment.... (2,466) (11,069)
Reallocation of
subsidiary............. -- 2,531
Acquisition, net of cash
acquired............... -- (8,363)
-------- --------
Net cash used in
investing activities... (2,466) (16,901)
-------- --------
Financing Activities
Net transfers from
Varian Associates,
Inc.................... 114,344 4,795
-------- --------
Net cash provided by
financing activities... 114,344 4,795
-------- --------
Effects of exchange rate
changes on cash........ 442 1,050
-------- --------
Net increase in cash and
cash equivalents....... 89,024 --
Cash and cash
equivalents at
beginning of period.... -- --
-------- --------
Cash and Cash
Equivalents at End of
Period................. $ 89,024 $ --
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Interim Condensed Consolidated Financial Statements
These condensed consolidated financial statements have been prepared
pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. These condensed consolidated financial statements should be read
in conjunction with the financial statements and the notes thereto included in
the report on Form 10/A filed by Varian Semiconductor Equipment Associates,
Inc. ("VSEA" or the "Company") with the Securities and Exchange Commission. In
the opinion of the Company, the condensed consolidated financial statements
include all adjustments, consisting of only normal recurring adjustments,
necessary to present fairly the information required to be set forth therein.
The results of operations for the three and nine months ended July 2, 1999 are
not necessarily indicative of the results to be expected for a full year or
for any other period.
Note 2. Basis of Presentation
The interim condensed consolidated financial statements of the Company
generally reflect the financial position, results of operations and cash flows
of the Company as of and for the three month period ending July 2, 1999,
together with operations prior to April 2, 1999, which had been part of the
former Varian Associates, Inc. ("VAI"). Until April 2, 1999, the Company's
business was operated as part of VAI. On April 2, 1999, VAI contributed its
Semiconductor Equipment Business ("SEB") to the Company, then distributed to
the holders of record of VAI common stock one share of common stock of the
Company for each share of VAI common stock owned on March 24, 1999 (the
"Distribution"). At the same time, VAI contributed its Instruments Business
("IB") to Varian, Inc. 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 Varian Medical Systems, Inc. ("VMS") effective as of April 2,
1999. These transactions were accomplished under the terms of a Distribution
Agreement by and among the Company, VAI, hereafter referred to as VMS for
periods following the Distribution, and IB (the "Distribution Agreement"). For
purposes of providing an orderly transition and to define certain ongoing
relationships between and among the Company, VMS and IB after the
Distribution, the Company, VMS and IB also entered into certain other
agreements which include an Employee Benefits Allocation Agreement, an
Intellectual Property Agreement, a Tax Sharing Agreement and a Transition
Services Agreement (collectively, the "Distribution Related Agreements").
The condensed consolidated financial statements for periods ended on or
before April 2, 1999 reflect SEB as operated by VAI. For periods prior to
April 3, 1999, where it was practicable to identify specific VAI corporate
amounts within the SEB activities, such amounts have been included in the
accounts reflected in the condensed consolidated financial statements. The
condensed consolidated financial statements also include allocations of
certain VAI corporate assets (including pension assets), liabilities
(including profit sharing and pension benefits), and expenses (including
legal, accounting, employee benefits, insurance services, information
technology services, treasury, and other VAI corporate overhead) to SEB
through April 2, 1999. These amounts have been allocated to SEB on the basis
that is considered by management to reflect most fairly or reasonably the
utilization of the services provided to or the benefit obtained by SEB.
Typical measures and activity indicators used for allocation purposes include
headcount, sales revenue, and payroll expense. The Company believes that the
methods used to allocate these amounts are reasonable. However, these
allocations are not necessarily indicative of the amounts that would have been
or that will be recorded by the Company on a stand-alone basis.
Note 3. Nonrecurring Charges/Restructuring
During the second quarter of fiscal year 1999, the Company recognized
pretax restructuring and other non-recurring charges of $11.6 million. The
actions taken were primarily in response to a downturn in the
4
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
semiconductor equipment industry. Year to date cost of revenue includes
charges of $5.9 million resulting from the realignment of product offerings,
including writing down inventory associated with a discontinued product line.
Year to date research and development expense includes $1.6 million in charges
within the second quarter associated with the discontinuance of a parallel
product development research contract following the acquisition in July 1998
of the high-energy ion implantation equipment product line of Genus, Inc.
("Genus"). Other one-time costs incurred in the second quarter of $1.5 million
resulted from consolidation and reorganization activities, including office
and employee relocations.
Year to date restructuring costs of $2.7 million included $1.4 million
resulting from the cancellation of plans for expansion of manufacturing
facilities in the United States and Japan and $1.3 million to cover
termination costs for a reduction in workforce of 69 employees (approximately
5% of worldwide VSEA employment). As of July 2, 1999, $0.8 million of the
termination costs had been paid with a total accrual balance of $0.4 million
remaining. A summary of the related accrued liability balance at July 2, 1999
is as follows:
<TABLE>
<CAPTION>
Total Non-
Restructuring Cash Cash Accrual
Charge Payments Items Balance
------------- -------- ----- -------
(Amounts in millions)
<S> <C> <C> <C> <C>
Lease abandonment and other exit
costs............................... $1.4 $1.4 $ 0 $0.0
Employee termination costs........... 1.3 0.8 0.1 0.4
---- ---- ---- ----
$2.7 $2.2 $0.1 $0.4
==== ==== ==== ====
</TABLE>
Note 4. Earnings Per Share
Basic earnings (loss) per share is calculated based on net earnings (loss)
and the weighted-average number of shares outstanding during the reporting
period. The weighted-average number of shares outstanding as of July 2, 1999
was 30,422,729. The weighted-average number of shares outstanding on and
before April 2, 1999 was assumed to be the number of shares outstanding on
April 2, 1999, immediately following the Distribution. Diluted earnings (loss)
per share is calculated based on net earnings (loss) and the sum of the
weighted-average number of shares outstanding during the reporting period and
the number of potential common shares (when dilutive). For purposes of the
diluted earnings (loss) per share calculation, the additional shares issuable
upon exercise of stock options were determined using the treasury stock method
based on the number of replacement options issuable immediately following the
Distribution.
A reconciliation of the numerator and denominator used in the earnings
(loss) per share calculations is presented as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------- -------------------
July 2, July 3, July 2, July 3,
1999 1998 1999 1998
---------- -------- --------- --------
Numerator (in thousands of
dollars):
<S> <C> <C> <C> <C>
Net (loss) earnings................ $ (3,404) $ 901 $ (29,316) $ 26,306
<CAPTION>
Denominator (in thousands):
<S> <C> <C> <C> <C>
Denominator for basic (loss)
earnings per share--
Weighted average shares
outstanding...................... 30,423 30,423 30,423 30,423
<CAPTION>
Effect if dilutive securities:
<S> <C> <C> <C> <C>
Stock options...................... -- 85 -- 85
--------- -------- --------- --------
Denominator for diluted (loss)
earnings per share................ 30,423 30,508 30,423 30,508
Basic (loss) earnings per share.... $ (0.11) $ 0.03 $ (0.96) $ 0.86
Diluted (loss) earnings per share.. $ (0.11) $ 0.03 $ (0.96) $ 0.86
========= ======== ========= ========
</TABLE>
5
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
Potential common shares in the form of stock options totaling 6.5 million
were excluded from the computation of diluted loss per share for the three and
nine month periods ending July 2, 1999 as their effect was anti-dilutive. For
the three and nine month periods ending July 3, 1998, options to purchase 2.7
million potential common shares with exercise prices in excess of the
underlying market value of the common stock were excluded from the
computation.
Note 5. Inventories
The components of inventories are as follows (in millions):
<TABLE>
<CAPTION>
July 2, October 2,
1999 1998
------- ----------
<S> <C> <C>
Raw materials and parts.................................. $24.9 $24.7
Work in process.......................................... 21.4 22.5
Finished goods........................................... 5.9 13.5
----- -----
Total Inventories...................................... $52.2 $60.7
===== =====
</TABLE>
If the first-in, first-out (FIFO) method had been used for those operations
valuing inventories on a LIFO basis, inventories would have been higher than
reported by $20.2 million at July 2, 1999 and $18.0 million at October 2,
1998.
Note 6. Notes Payable
The $4.9 million of notes payable outstanding at July 2, 1999, payable in
Japanese Yen, were assumed in connection with the Distribution. These notes
are payable in September 1999 and accrue interest at a rate of 0.8% per annum.
The Company plans to renew this note upon maturity.
Note 7. Stockholders' Equity
As of July 2, 1999, the Company had 30,422,792 shares of common stock
outstanding. On April 2, 1999, stockholders of record of VAI on March 24, 1999
received one share of the Company's common stock for each share of VAI common
stock then held.
Upon the Distribution, the majority of outstanding awards under the VAI
Omnibus Stock Plan held by Company employees were replaced by substitute
awards under the VSEA Omnibus Stock Plan. The substitute awards have the same
ratio of the exercise price per share to the market value per share, the same
aggregate difference between market value and exercise price and the same
vesting provisions, life and other terms and conditions as the awards they
replaced.
As of July 2, 1999, the Company had outstanding options to purchase an
aggregate of 6,494,159 shares of its common stock at a weighted average price
of $13.00. Of these options, options to purchase an aggregate of 2,917,461
shares were fully vested and exercisable.
On April 2, 1999, each stockholder also received one Right for each share
of common stock distributed, entitling the stockholder to purchase one one-
thousandth of a share of Participating Preferred Stock, par value $0.01 per
share, for $120.00, subject to adjustment. The Participating Preferred Stock
is designed so that each one one-thousandth of a share has economic and voting
terms similar to those of one share of common stock.
6
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
Note 8. Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income." SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components in a full set of general-
purpose financial statements. SFAS No. 130 is effective for the Company at the
end of fiscal year 1999. The Company has not determined the impact of SFAS No.
130 on the consolidated financial statements.
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of
an Enterprise and Related Information." SFAS No. 131 changes current practice
under SFAS No. 14 by establishing a new framework on which to base segment
reporting (referred to as the "management" approach) and also requires interim
reporting of segment information. SFAS No. 131 is effective for the Company at
the end of fiscal year 1999. The Company has not determined the impact of SFAS
No. 131 on the reporting of the Company's segment information.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes a new model for
accounting for derivatives and hedging activities and is effective for the
Company's fiscal year 2001. The impact of the implementation of SFAS No. 133 on
the consolidated financial statements of the Company has not yet been
determined.
Note 9. Foreign Exchange Contracts
Forward exchange contracts outstanding as of July 2, 1999 are summarized as
follows:
<TABLE>
<CAPTION>
Notional Contract Fair
Value Rate Value
----------- -------- -------
<S> <C> <C> <C>
Purchased put option contracts:
Euro......................................... $ 8,231,556 0.9836 $ 4,116
Japanese Yen................................. $ 4,062,139 127.06 $ 2,031
Korean Won................................... $ 4,410,268 1244.00 $ --
Taiwan Dollar................................ $ 3,992,946 34.34 $ --
Purchased call option contracts:
British Pound................................ $ 315,151 1.69 $ --
Non-deliverable forward:
Singapore Dollar............................. $ 412,528 1.719 $ 5,225
----------- -------
Total........................................ $21,424,588 $11,372
=========== =======
</TABLE>
There were no significant unrealized gains or losses for forward exchange
contracts as of July 2, 1999.
Note 10. Contingencies
Environmental Remediation
In the Distribution Agreement, the Company has agreed to indemnify VMS and
IB for one-third of environmental investigation and remediation costs (after
adjustment for any insurance proceeds and tax benefits expected to be realized
upon the payment of such costs), as further described below.
VAI has been named by the U.S. Environmental Protection Agency or third
parties as a potentially responsible party under the Comprehensive
Environmental Response, Compensation and Liability Act of 1980,
7
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
as amended ("CERCLA"), at eight sites where VAI is alleged to have shipped
waste for recycling or disposal. VAI is also involved in environmental
investigations and/or remediation work pursuant to environmental laws,
generally under the direction of, or in consultation with, federal, state,
and/or local agencies at certain current or former VAI facilities. VAI's
expenditures for environmental investigations and remediation work amounted to
$1.8 million for the first nine months of fiscal 1999 compared to $4.9 million
in fiscal year 1998, $2.3 million in fiscal year 1997 and $5.2 million in
fiscal year 1996.
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 probable future costs of such
activities. As of July 2, 1999, VMS estimated that the future exposure for
environmental related investigation and remediation costs for these sites
ranged in the aggregate from $20.6 million to $48.0 million. The time frame
over which VMS expects to incur these costs varies at each site and facility,
ranging up to approximately 30 years as of July 2, 1999. VMS management
believes that no amount in the foregoing range of estimated future costs is
more likely to be incurred than any other amount in such range, and therefore,
VMS has accrued $20.6 million in estimated environmental costs as of July 2,
1999. This amount accrued by VMS has not been discounted to present value.
VMS has gained sufficient knowledge to better estimate the scope and costs
of future environmental activities at other sites and facilities. As of July
2, 1999, VMS estimated that its aggregate future exposure for environmental-
related investigation and remediation costs for these sites ranged from $39.1
million to $72.9 million. The time frame over which these costs are expected
to be incurred varies with each site or facility, ranging up to approximately
30 years as of July 2, 1999. As to each of these sites and facilities,
management of VMS has determined: (i) that a particular amount within the
range of estimated costs better estimates the future environmental liability
than any other amount within the range; and (ii) that it may reasonably
determine the timing of those future costs. Together, these amounts totaled
$50.4 million at July 2, 1999. Accordingly, VMS has accrued $21.6 million,
which represents management's best estimate of the future costs discounted at
4%, net of inflation. This accrual is in addition to the $20.6 million
described above.
As of July 2, 1999, the Company's reserve for its portion of environmental
liabilities, based upon future environmental related costs estimated by VMS
and the Company as of that date and included in long-term and current accrued
expenses, is calculated as follows:
<TABLE>
<CAPTION>
Total Anticipated
Recurring Non-recurring Future
Fiscal Year Costs Costs Costs
----------- --------- ------------- -----------
(Dollars in millions)
<S> <C> <C> <C>
1999..................................... $ 0.4 $1.0 $ 1.4
2000..................................... 0.5 0.2 0.7
2001..................................... 0.5 -- 0.5
2002..................................... 0.5 -- 0.5
2003..................................... 0.5 -- 0.5
Thereafter............................... 10.6 0.6 11.2
----- ---- -----
Total costs............................ $13.0 $1.8 $14.8
===== ====
Imputed interest......................... (5.9)
-----
Total reserve.......................... $ 8.9
=====
</TABLE>
The amounts set forth in the foregoing table are only estimates of anticipated
future environmental related costs, and the amounts actually spent in the
years indicated may be greater or less than such estimates. The aggregate
8
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
range of cost estimates reflects various uncertainties inherent in many
environmental investigation and remediation activities and the large number of
sites and facilities where VMS is undertaking such investigation and
remediation activities. VMS anticipates that most of these cost ranges will
narrow as investigation and remediation activities progress.
The Company believes that its reserves are adequate, but as the scope of
the obligations becomes more clearly defined, these reserves may be modified
and related charges against earnings may be made. Although any ultimate
liability arising from environmental related matters described herein could
result in significant expenditures that, if aggregated and assumed to occur
within a single fiscal year, would be material to the Company's financial
statements, the likelihood of such an occurrence is considered remote. Based
on information currently available to management and its best assessment of
the ultimate amount and timing of environmental related events, the Company's
management believes that the costs of these environmental related matters are
not reasonably likely to have a material adverse effect on the consolidated
financial statements of the Company.
VMS evaluates its liability for environmental investigation and remediation
in light of the liability and financial resources of potentially responsible
parties and insurance companies against which VMS believes that it has rights
of contribution, indemnity and/or reimbursement. Claims for recovery of
environmental investigation and remediation costs already incurred, and to be
incurred in the future, have been asserted against other parties, including
various insurance companies. In 1992, VAI filed a lawsuit against 36 insurance
companies with respect to most of the above-referenced sites and facilities.
VAI received certain cash settlements during fiscal years 1995, 1996, 1997 and
1998 from defendants in that lawsuit. VAI has also reached an agreement with
another insurance company under which the insurance company has agreed to pay
a portion of VAI's past and future environmental related expenditures. The
Company's share of this receivable is $1.2 million at July 2, 1999. The
Company believes that this receivable is recoverable because it is based on a
binding, written settlement agreement with a solvent and financially viable
insurance company. Although the Company intends to aggressively pursue
additional insurance and other recoveries, the Company has not reduced any
estimate of its liability in anticipation of a recovery with respect to claims
made against third parties.
Sale of Business
In June 1997, VAI completed the sale of its Thin Film Systems ("TFS")
operations to Novellus Systems, Inc. ("Novellus"). The TFS operation was
considered to be part of the SEB and therefore, a product line of the Company.
Total proceeds received from the sale of TFS were $145.5 million in cash.
In order to cover, among other items, indemnification obligations,
litigation expense, purchase price disputes, retained liabilities, transaction
costs, employee terminations, facilities separation costs, and other
contingencies, VMS originally recorded a reserve of $51.5 million. As of April
2, 1999 the remaining reserve of $37.6 million was recorded by the Company as
a current liability and classifed as an estimated loss contingency. This
reserve, which stands at $36.2 million at July 2, 1999, relates to remaining
costs associated with pending litigation and indemnity obligations relating to
certain patent infringment claims by Applied Materials, Inc. ("Applied") as
well as purchase price disputes with Novellus arising out of the sale of TFS.
Legal Proceedings
In June 1997, Applied filed a civil action against VAI in the U.S. District
Court for the Northern District of California alleging infringement of four
patents relating to sputter coating systems. Applied contends that its patents
are infringed by the M2i, MB/2/(TM) and Inova(TM) systems that were
manufactured and sold by TFS prior to VAI's sale of TFS to Novellus in June
1997. The complaint requests unspecified money damages and an injunction
9
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
preventing further alleged infringement and requests that any damages awarded
be increased up to three-fold for VAI's and Novellus' alleged willful
infringement. Novellus was subsequently added as a defendant in this action
and, as part of the sale of TFS, VAI agreed to indemnify Novellus for certain
damages it may suffer as a result of such litigation and to reimburse Novellus
for up to $7.5 million of its litigation expenses. VAI's answer denied
infringement and asserted that the Applied patents that are subject to the
claims are invalid and that one of the asserted patents is unenforceable. VAI
also filed a separate suit seeking damages and injunctive relief against
Applied contending that certain of Applied's business practices violated
antitrust laws. That action has been procedurally related to the infringement
case and is pending before the same judge. Novellus has filed a complaint
against Applied which includes a claim that Applied has infringed three of the
patents acquired by Novellus from the Company. Discovery has begun, but no
date has been set for completion of discovery.
In the event of an outcome unfavorable to the Company, the Company may be
liable for damages for past sales through the June 1997 closing date of the
sale of TFS to Novellus and may be liable to Novellus under the
indemnification obligations described above. In addition, as permitted under
the asset sale agreement between VAI and Novellus for the sale of TFS,
Novellus has demanded an arbitration arising out of disputes over the closing
balance sheet. The Company has accrued certain amounts associated with the
cost of resolving these matters (see above--Sale of Business).
The Company has agreed to indemnify VMS and IB for any costs, liabilities
or expenses relating to the Company's legal proceedings, including the Applied
and Novellus matters. Under the Distribution Related Agreements, the Company
has agreed to reimburse VMS for one-third of the costs, liabilities, and
expenses, adjusted for any related tax benefits recognized or realized by VMS,
with respect to certain legal proceedings relating to discontinued operations
of VMS.
Also, from time to time, the Company is involved in a number of legal
actions and could incur an uninsured liability in one or more of them.
Accordingly, while the ultimate outcome of all of the above legal matters is
not determinable, management believes the resolution of these matters will not
have a material adverse effect on the financial condition or results of
operations of the Company.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The condensed consolidated interim financial statements of Varian
Semiconductor Equipment Associates, Inc., ("VSEA" or the "Company") are
unaudited and generally reflect the results of operations, financial position
and cash flows of the Company for the three month period ending July 2, 1999,
together with operations prior to April 2, 1999, which had been part of the
former Varian Associates, Inc. ("VAI"). On April 2, 1999, VAI reorganized into
three independent publicly-traded companies by spinning off two of its
businesses to stockholders in a tax-free distribution (the "Distribution").
VAI retained its Health Care Systems business and changed its name to Varian
Medical Systems, Inc. ("VMS"). VAI transferred its Instruments Business ("IB")
to Varian, Inc., the stock in which was distributed to VAI's stockholders as
part of the Distribution. VAI transferred its Semiconductor Equipment Business
("SEB") to the Company, the stock in which was also distributed to VAI's
stockholders as part of the Distribution. SEB included VAI's business unit
that designs, manufactures, markets and services semiconductor processing
equipment used in the fabrication of integrated circuits.
The condensed consolidated financial statements of the Company reflect the
results of operations, financial position and cash flows of the SEB operations
which were transferred in connection with the Distribution. Accordingly, the
Company's condensed consolidated financial statements for all periods up to
April 2, 1999, have been part of the consolidated financial statements of VAI
using the historical results of operations and historical basis of the assets
and liabilities of SEB. For the periods up to April 2, 1999, the condensed
consolidated financial statements of the Company include allocations of
certain VAI corporate assets (including pension assets), liabilities
(including profit-sharing and pension benefits) and expenses (including legal,
accounting, employee benefits, insurance services, information technology
services, treasury and other VAI corporate overhead) to SEB using the
allocation methodology described in Note 2 of the Notes to the Condensed
Consolidated Financial Statements.
The following information should be read in conjunction with the condensed
consolidated financial statements and notes thereto included in Item 1 of this
quarterly report and the audited combined financial statements and notes
thereto and management's discussion and analysis of financial condition and
results of operations in the Company's report on Form 10-A filed with the
Securities and Exchange Commission on February 12, 1999.
Results of Operations
Three Months Ended July 2, 1999 Compared to Three Months Ended July 3, 1998
Revenue. Revenue decreased 22% for the quarter ended July 2, 1999 over the
quarter ended July 3, 1998, from $81.8 to $63.8 million. This decrease in
revenue was primarily attributable to the worldwide slowdown in the
semiconductor industry that started in the first half of fiscal year 1998, and
continued into the second quarter of fiscal year 1999. The trend has shown
revenue increasing consistently quarter after quarter since the fourth quarter
of fiscal year 1998. Revenue for the first quarter of 1999 was 13% above
revenue for the last quarter of fiscal year 1998. Revenue in the second
quarter of fiscal year 1999 was 12% above revenue in the first quarter of this
year. Revenue in the third quarter of fiscal year 1999 continued to grow. At
$63.8 million, revenue in the third quarter of fiscal year 1999 was 20% higher
than revenue in the second quarter of fiscal year 1999.
Royalty revenue of $1.6 million in the third quarter of fiscal year 1999
was 3% above royalty income in the third quarter of fiscal year 1998.
International revenue was $43.9 million, or 69% of total revenue, in the
third quarter of fiscal year 1999, compared to $58.7 million, or 72% of total
revenue, in the third quarter of fiscal year 1998. The Company's North
American (primarily U.S.) revenue increased to 31% of revenue in the third
quarter of fiscal year 1999 from 28% of total revenue in the third quarter of
fiscal year 1998, while its European region revenue decreased from 28% of
total revenue in the third quarter of fiscal year 1998 to 25% of total revenue
in the third quarter of
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fiscal year 1999. The aggregate revenue of $28.3 million from Taiwan, Japan,
Korea and the Pacific Rim represented 44% of total revenue in the third
quarter of fiscal year 1999, maintaining the same percentage of total revenue
as in the third quarter of fiscal year 1998.
Gross Profit. The Company's gross profit of $21.9 million in the third
quarter of fiscal year 1999 was 6% below the gross profit of $23.2 million in
the third quarter of fiscal year 1998. Cost of revenue for the third quarter
of fiscal year 1999 was $41.9 million, resulting in a gross margin of 34% on
revenues of $63.8 million compared with cost of revenue for the third quarter
of the prior year of $58.6 million, resulting in a gross margin of 28% on
revenues of $81.8 million. Margins in the third quarter of fiscal year 1999
improved due to the cost reduction measures included in restructuring in the
second quarter of fiscal year 1999, the declining semiconductor market in the
third quarter of fiscal year 1998, and a favorable product mix enhancing
margins in the current quarter.
Research and Development. Research and development expenses were $9.3
million, or 15% of revenue, in the third quarter of fiscal year 1999, compared
with $9.9 million, or 12% of revenue, in the third quarter of fiscal year
1998. Research and development spending remained relatively consistent despite
the slowdown in the semiconductor industry.
Marketing. Marketing expenses were $9.4 million, or 15% of revenue, in the
third quarter of fiscal year 1999, up from $8.8 million or 11% of revenue, in
the third quarter of fiscal year 1998. Marketing expenses in 1998 were lower
than in the current year in the climate of declining demand for semiconductor
equipment in the third quarter of fiscal year 1998.
General and Administrative. In the third quarter of fiscal year 1999,
general and administrative expenses were $9.4 million, or 15% of revenue,
compared to $3.5 million, or 4% of revenue in the third quarter of fiscal year
1998. The expenses in the third quarter of fiscal year 1999 included
additional administrative expenses associated with the establishment of VSEA
as a separate entity.
Interest Income. During the third quarter of fiscal year 1999, the Company
earned $1.2 million in interest and dividend income. This income was earned
primarily on short term investments.
Taxes on Earnings. The Company recorded a tax benefit of $1.6 million in
the third quarter of fiscal year 1999, compared to $0.1 million of expense in
the third quarter of fiscal year 1998. The effective income tax rate was 31.7%
in the third quarter of fiscal year 1999, compared to 9.4% in the third
quarter of fiscal year 1998.
Nine Months Ended July 2, 1999 Compared to Nine Months Ended July 3, 1998
Revenue. The Company's revenue of $164.4 million for the first nine months
of 1999 was 45% lower than its revenue of $301.1 million in the first nine
months of 1998. This decrease in revenue was primarily attributable to the
worldwide slowdown in the semiconductor industry that started in the first
half of fiscal year 1998, and continued into the second quarter of fiscal year
1999.
The trend has shown revenue increasing consistently quarter after quarter
since the fourth quarter of fiscal year 1998. Revenue for the first quarter of
1999 was 13% above revenue for the last quarter of fiscal year 1998. Revenue
in the second quarter of fiscal year 1999 was 12% above revenue in the first
quarter of this year. Revenue in the third quarter of fiscal year 1999
continued to grow. At $63.8 million, revenue in the third quarter of fiscal
year 1999 was 20% higher than revenue in the second quarter of fiscal year
1999.
Royalty revenue, which is included in total revenue, decreased by $6.8
million or 66% from $10.3 million for the first nine months of 1998 to $3.5
million for the nine months ended July 2, 1999, due mainly to the termination
of the license agreement with Tokyo Electron Ltd., ("TEL") as a result of the
termination of the distribution agreement between TEL and VAI.
International revenue was $104.8 million, or 64% of total revenue, for the
first nine months of 1999, compared to $210.9 million, or 70% of total
revenue, for the first nine months of 1998. The Company's North American
revenue increased as a percentage of revenue to 36% of total revenue in the
first nine months of 1999 from 30% of total revenue for the first nine months
of 1998. The European region revenue increased to 23% of total revenue in the
first nine months of 1999 from 20% of total revenue in the first nine months
of 1998.
12
<PAGE>
The aggregate from Taiwan, Japan, Korea and the Pacific Rim decreased as a
percentage of revenue, representing 41% of total revenue in the first nine
months of 1999 and 50% of total revenue in the first nine months of 1998.
Gross Profit. The Company's gross profit of $37.8 million in the first nine
months of 1999 was 23% of revenue, compared to $110.2 million, or 37% of
revenue, in the first nine months of 1998. The decrease in gross profit as a
percentage of revenue from the first nine months of 1998 to the first nine
months of 1999 was attributable primarily to the semiconductor industry
slowdown in product demand, together with charges, primarily with inventory
provisions, for the realignments in product offerings as a result of the
acquisition of Genus products, and writing down discontinued product
inventory. The under-utilization of manufacturing facilities, together with
costs of current staff recruiting and training for the upturn, resulted in
unfavorable overhead variances for the second and third quarter of fiscal year
1999.
Research and Development. Research and development was maintained at a high
level, despite the lower revenues in 1999 compared with 1998. Research and
development expenses were $27.5 million for the first nine months of fiscal
year 1999 and $28.2 million for the first nine months of fiscal year 1998, 17%
and 9% of revenue, respectively. For the first nine months of 1999 research
and development expense included $1.6 million in contract cancellation
charges, during the second quarter of fiscal year 1999, relating to the
discontinuance of a parallel product development research program, following
the acquisition of the high-energy ion implantation product line of Genus,
Inc.
Marketing. Marketing expenses of $25.9 million, or 16% of revenue, in the
first nine months of 1999 were down 15% from the $30.6 million, or 10% of
revenue, in the first nine months of 1998, in the climate of declining demand
for semiconductor equipment since the third quarter of 1998.
General and Administrative. General and administrative expenses were $25.8
million in the first nine months of 1999 and $14.1 million for the first nine
months of 1998, representing 16% and 5% of revenues, respectively. General and
administrative expenses were higher in 1999 because of additional costs
associated with the actions taken in response to the semiconductor industry
downturn. Additional one-time costs were incurred mainly during the second and
third quarters of fiscal year 1999 to manage the separation from VAI and
establishment of VSEA.
Restructuring. During the second quarter of fiscal year 1999 the Company
recognized pretax restructuring charges of $2.7 million, consisting of lease
abandonment and other exit costs of $1.4 million and employee termination
costs of $1.3 million.
Taxes on Earnings. VSEA recorded a tax benefit of $13.6 million in the
first nine months of fiscal year 1999, compared to $11.0 million of expense in
the first nine months of fiscal year 1998. The effective income tax rate was
31.7% in the first nine months of fiscal year 1999, compared to 29.6% in the
first nine months of fiscal year 1998. Following the Distribution, VSEA is
being be taxed as an independent entity in the jurisdictions in which it
operates. As a result, it will be subject to tax in jurisdictions in which it
has profits that cannot be offset by losses in other jurisdictions which could
result in an effective income tax rate higher than that which it experienced
historically.
Liquidity and Capital Resources
VAI historically used a centralized cash management system to finance its
operations. Cash deposits from most of the businesses were transferrred to VAI
on a daily basis, and VAI funded its required disbursements. As a result, the
Company reported no cash or cash equivalents at October 2, 1998. Pursuant to
the Distribution Agreement, as of April 2, 1999, the Company received a cash
contribution from VAI such that VSEA's cash and cash equivalents equaled $99.5
million and its consolidated debt, consisting of notes payable, was $5.0
million. Such cash and cash equivalents are expected to represent the
Company's principal source of liquidity for the foreseeable future.
During the first nine months of 1999, the Company consumed $23.3 million of
cash in operations, compared to the cash provided by operations of $11.1
million in the first nine months of 1998.
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<PAGE>
During the first nine months of 1999, the Company used $2.5 million for
investing activities, compared to $16.9 million that was used for investing
activities during the first nine months of 1998.
The Company's 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. Although the Company's cash requirements
will fluctuate based on the timing and extent of these factors, the Company's
management believes that cash generated from operations, together with
available cash at July 2, 1999 and the Company's borrowing capability, will be
sufficient to satisfy commitments for capital expenditures and other cash
requirements for the current fiscal year and fiscal year 2000.
Environmental Matters
The Company's operations are subject to various foreign, federal, state
and/or local laws relating to the protection of the environment. These include
laws regarding discharges into soil, water and air, and the generation,
handling, storage, transportation and disposal of waste and hazardous
substances. In addition, several countries are reviewing proposed regulations
that would require manufacturers to dispose of their products at the end of a
product's useful life. These laws have the effect of increasing costs and
potential liabilities associated with the conduct of certain operations.
In the Distribution Agreement, the Company has agreed to indemnify VMS and
IB for one-third of environmental investigation and remediation costs (after
adjustment for any insurance proceeds and tax benefits expected to be realized
upon the payment of such costs), as further described below.
VAI has been named by the U.S. Environmental Protection Agency or third
parties as a potentially responsible party under CERCLA at eight sites where
VAI is alleged to have shipped waste for recycling or disposal. VAI is also
involved in environmental investigations and/or remediation work pursuant to
environmental laws, generally under the direction of, or in consultation with,
foreign, federal, state and/or local agencies at certain current or former VAI
facilities. Expenditures by VAI for environmental investigations and
remediation work amounted to $1.8 million for the first nine months of fiscal
1999, compared to $4.9 million in fiscal year 1998, $2.3 million in fiscal
year 1997 and $5.2 million in fiscal year 1996.
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 probable future costs of such
activities. As of July 2, 1999, VMS estimated that the future exposure for
environmental related investigation and remediation costs for these sites and
facilities ranged in the aggregate from $20.6 million to $48.0 million. The
time frame over which VMS expects to incur these costs varies with each site
and facility, ranging up to approximately 30 years as of July 2, 1999.
Management of VMS believes that no amount in the foregoing range of estimated
future costs is more likely to be incurred than any other amount in such range
and therefore VMS had accrued $20.6 million in estimated environmental costs
as of July 2, 1999. The amount accrued has not been discounted to present
value.
VMS has gained sufficient knowledge to better estimate the scope and costs
of future environmental activities at other sites and facilities. As of July
2, 1999, VMS estimated that its aggregate future exposure for environmental-
related investigation and remediation costs for these sites and facilities
ranged from $39.1 million to $72.9 million. The time frame over which these
costs are expected to be incurred varies with each site or facility, ranging
up to approximately 30 years as of July 2, 1999. As to each of these sites or
facilities, management of VMS determined: (i) that a particular amount within
the range of estimated costs better estimates of future environmental
liability than any other amounts within the range; and (ii) that it may
reasonably determine the timing of those future costs. Together, these amounts
totaled $50.4 million at July 2, 1999. Accordingly, VMS had accrued $21.6
million as of July 2, 1999, which represents management's best estimate of the
future costs discounted at 4%, net of inflation. This accrual is in addition
to the $20.6 million described in the preceding paragraph.
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<PAGE>
The Company recorded $8.9 million as its portion of the foregoing estimated
future costs for environmental liability of VMS as of July 2, 1999. The
foregoing amounts are only estimates of anticipated future environmental
related costs, and the amounts actually spent may be greater or less than such
estimates. The aggregate range of cost estimates reflects various
uncertainties inherent in many environmental investigation and remediation
activities and the large number of sites and facilities involved. VMS
anticipates that most of these cost ranges will narrow as investigation and
remediation activities progress.
The Company believes that its reserves are adequate, but as the scope of
its obligation becomes more clearly defined, these reserves may be modified
and related charges against earnings may be made. Although any ultimate
liability arising from environmental related matters described herein could
result in significant expenditures that, if aggregated and assumed to occur
within a single fiscal year, would be material to the Company's financial
statements, the likelihood of such an occurrence is considered remote. Based
on information currently available to the Company's management and its best
assessment of the ultimate amount and timing of environmental related events,
management believes that the costs of these environmental related matters are
not reasonably likely to have a material adverse effect on the consolidated
financial statements of the Company.
VMS evaluates its liability for environmental investigation and remediation
in light of the liability and financial resources of potentially responsible
parties and insurance companies against which VMS believes that it has rights
of contribution, indemnity and/or reimbursement. Claims for recovery of
environmental investigation and remediation costs already incurred, and to be
incurred in the future, have been asserted against other parties, including
various insurance companies. In 1992, VAI filed a lawsuit against 36 insurance
companies with respect to most of the above-referenced sites and facilities.
VAI received certain cash settlements during fiscal years 1995, 1996, 1997 and
1998 from defendants in that lawsuit. VAI has also reached an agreement with
another insurance company under which the insurance company has agreed to pay
a portion of VAI's past and future environmental-related expenditures. The
Company's share of this receivable is $1.2 million at July 2, 1999. The
Company believes that this receivable is recoverable because it is based on a
binding, written settlement agreement with a solvent and financially viable
insurance company. Although the Company intends to aggressively pursue
additional insurance and other recoveries, the Company has not reduced any
estimate of its liability in anticipation of a recovery with respect to claims
made against third parties.
Year 2000
General. The "Year 2000" problem refers to computer systems (hardware,
software and devices) and other equipment with embedded microprocessors ("non-
IT equipment") which use only the last two digits to refer to a year, and
which therefore might not properly recognize a year that begins with "20"
instead of the familiar "19." As a result, those computer systems and non-IT
equipment might be unable to operate or process
accurately certain date-sensitive data before or after January 1, 2000.
Because VSEA relies heavily on computer systems and non-IT equipment, and
relies on third parties which themselves rely on computer systems and non-IT
equipment, the Year 2000 problem if not addressed could adversely effect
VSEA's business, results of operations and financial condition.
State of Readiness. VSEA has initiated a comprehensive assessment of
potential Year 2000 problems with respect to (1) its internal systems, (2) its
products, and (3) significant third parties with which VSEA does business.
VSEA has substantially completed its assessment of potential Year 2000
problems in its internal systems. These systems have been categorized as
follows, in order of importance: (a) enterprise information systems; (b)
enterprise networking and telecommunications; (c) factory-specific information
systems; (d) non-IT systems; (e) computers and packaged software; and (f)
facilities systems. With respect to enterprise information systems, in 1994
VAI initiated replacement of its existing systems with a single company-wide
system supplied by SAP America, Inc., which has been designed and tested by
SAP for Year 2000 capability. Installation of that system has been executed to
replace first those existing systems that are not Year 2000 capable.
Installation of the new SAP system is approximately 70% complete with a full
integration expected by the end of 1999. Upgrade of
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<PAGE>
enterprise information systems is approximately 90% complete, 100% completion
expected by October 1999; upgrade of networking and telecommunications systems
is complete; upgrade of factory-specific information systems is approximately
65% complete with 94% completion expected by December 1999; and upgrade of
non-IT systems, computers and packaged software is approximately 80% complete,
with 100% completion expected by October 1999 (except in the case of some
computers and packaged software, which may not be completed until December
1999) and upgrade of facilities systems is approximately 50% complete, with
100% completion expected by October 1999.
VSEA has initiated an assessment of potential Year 2000 problems in its
current and previously-sold products. With respect to current products, that
assessment and corrective actions are complete, and VSEA believes that all of
its current products are Year 2000 capable; however, that conclusion is based
in part on Year 2000 assurances or warranties from suppliers of computer
programs and non-IT systems which are integrated into or sold with VSEA's
current products.
With respect to previously-sold products, VSEA has completed the majority
of the product assessment which includes products, information systems and
networks. A majority of the systems and products can be upgraded with readily
available externally-utilized computers and packaged software or with
internally developed software. Where VSEA identifies previously sold products
that are not Year 2000 capable, VSEA intends in some cases to develop and
offer to sell upgrades or retrofits, identify corrective measures which the
customer could itself undertake or identify for the customer other suppliers
of upgrades or retrofits. VSEA has been in the process of providing these
upgrade services to our customers. There may be instances where VSEA will be
required to repair and/or upgrade such products at its own expense. Schedules
for completing those corrective actions vary considerably among VSEA's
businesses and products, but are generally expected to be substantially
completed by October 1999.
VSEA is still assessing potential Year 2000 problems of third parties with
which VSEA has material relationships, which are primarily suppliers of
products or services. As of July 2, 1999, all the critical suppliers have been
audited for compliance status and approximately 90% of these suppliers are
Year 2000 capable. These assessments will identify and prioritize critical
suppliers, review those suppliers' written assurances on their own assessments
and correction of Year 2000 problems, and develop appropriate contingency
plans for those suppliers which may not be adequately prepared for Year 2000
problems. In this respect, VSEA is requiring its suppliers to complete a
questionnaire that was prepared and recommended by SEMATECH, an industry group
comprised of U.S. semiconductor manufacturers and designed to assess each
supplier's Year 2000 readiness. Additionally, officials of VSEA plan to visit
and audit the Year 2000 compliance efforts of all sole source suppliers, or
those having a software content in their products. These assessments are
expected to be substantially completed by August 1999.
Costs. As of July 2, 1999, VSEA estimates that it had incurred costs of
less than $1 million to assess and correct Year 2000 problems. Although
difficult to assess, based on its analysis to date, VSEA estimates that it
will incur less than $1 million in additional costs to assess and correct Year
2000 problems, which costs are expected to be incurred throughout fiscal year
1999 and the first half of fiscal year 2000. All of these costs have been and
will continue to be expensed as incurred.
This estimate of future costs has not been reduced by expected recoveries
from certain third parties, which are subject to indemnity, reimbursement or
warranty obligations for Year 2000 problems. In addition, VSEA expects that
certain costs will be offset by revenue generated by the sale of upgrades and
retrofits and other customer support services relating to Year 2000 problems.
However, there can be no assurance that VSEA's actual costs to assess and
correct Year 2000 problems will not be higher than the foregoing estimate.
Risks. Failure of VSEA and its key suppliers to accurately assess and
correct Year 2000 problems, would likely result in interruption of certain of
VSEA's normal business operations, which could have a material adverse effect
on VSEA's business, results of operations and financial condition. If VSEA
does not adequately identify and correct Year 2000 problems in its information
systems it could experience an interruption in its operations, including
manufacturing, order processing, receivables collection and accounting, such
that there
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would be delays in product shipments, lost data and a consequential impact on
revenues, expenditures and financial reporting. If VSEA does not adequately
identify and correct Year 2000 problems in its non-IT systems it could
experience an interruption in its manufacturing and related operations, such
that there would be delays in product shipments and a consequential impact on
revenues. If VSEA does not adequately identify and correct Year 2000 problems
in previously-sold products it could experience warranty or product liability
claims by users of products which do not function correctly. If VSEA does not
adequately identify and correct Year 2000 problems of noted significant third
parties it could experience an interruption in the supply of key components or
services from those parties, such that there would be delays in product
shipments or services and a consequential impact on revenues.
Management believes that appropriate corrective actions have been or will
be accomplished within the cost and time estimates stated above. Although VSEA
does not expect to be 100% Year 2000 compliant by the end of 1999, VSEA does
not currently believe that any Year 2000 non-compliance in VSEA's information
systems will have a material adverse effect on VSEA's business, results of
operations or financial condition. However, given the inherent complexity of
the Year 2000 problem, there can be no assurance that actual costs will not be
higher than currently anticipated or that corrective actions will not take
longer than currently anticipated to complete. Risk factors which might result
in higher costs or delays include the ability to identify and correct these
issues in a timely fashion Year 2000 problems; regulatory or legal obligations
to correct Year 2000 problems in previously-sold products; ability to retain
and hire qualified personnel to perform assessments and corrective actions;
the willingness and ability of critical suppliers to assess and correct their
own Year 2000 problems, including the products they supply to VSEA; and the
additional complexity which will likely be caused by the undertaking during
fiscal year 1999 and fiscal year 2000 the separation of currently shared
enterprise information systems as a result of the Distribution. Because of
uncertainties as to the extent of Year 2000 problems with VSEA's previously-
sold products and the extent of any legal obligation of VSEA to correct Year
2000 problems in those products, VSEA cannot yet assess risks to VSEA with
respect to those products. Because its assessments are not yet complete, VSEA
also cannot yet conclude that the failure of critical suppliers to assess and
correct Year 2000 problems is not reasonably likely to have a material adverse
effect on VSEA's results of operations.
Contingency Plans. With respect to VSEA's enterprise information systems,
VSEA has a contingency plan if the SAP system is not fully installed before
December 31, 1999. That plan primarily involves installation where necessary
of a Year 2000 upgrade of existing information systems pending complete
installation of the SAP system. This upgrade is currently in acceptance
testing, and if functional will be held for contingency purposes.
With respect to products and significant third parties, VSEA intends, as
part of its on-going assessment of potential Year 2000 problems, to develop
contingency plans for key areas that may not have been corrected by December
31, 1999. It is currently anticipated that the focus of these contingency
plans will be the possible interruption of supply of key components or
services from third parties.
Forward Looking Information
This Management's Discussion and Analysis 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. Such risks and uncertainties include: product demand and market
acceptance risks; the effect of general economic conditions and foreign
currency fluctuations; the impact of competitive products and pricing; new
product development and commercialization; the ability to increase operating
margins on higher sales; the ability of suppliers to be responsive to
increasing demand for parts; the impact of economic conditions in Japan, Korea
and other Asian markets on sales in those areas; the timing of renewed growth
in worldwide semiconductor equipment demand; successful implementation by the
Company and certain third parties of corrective action to address the impact
of the Year 2000; and other risks detailed from time to time in the Company's
filings with the Securities and Exchange Commission.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Foreign Currency Exchange Risk
As a global concern, VSEA faces exposure to adverse movements in foreign
currency exchange rates. This exposure may change over time as VSEA's business
practices evolve and could have a material adverse impact on VSEA's financial
results. Historically, VSEA's primary exposures have related to non-U.S.
dollar denominated sales and purchases throughout Europe and Asia.
At the present time, VSEA hedges its currency exposures that are associated
with certain assets and liabilities denominated in non-functional currencies
and with anticipated foreign currency cash flows. VSEA does not enter into
forward exchange contracts for trading purposes. VSEA's forward exchange
contracts generally range from one to three months in original maturity, and
no forward exchange contract has an original maturity greater than one year.
Forward exchange contracts outstanding as of July 2, 1999 are summarized as
follows:
<TABLE>
<CAPTION>
Notional Contract Fair
Value Rate Value
----------- -------- -------
<S> <C> <C> <C>
Purchased put option contracts:
Euro.......................................... $ 8,231,556 0.9836 $ 4,116
Japanese Yen.................................. $ 4,062,139 127.06 $ 2,031
Korean Won.................................... $ 4,410,268 1,244.00 $ --
Taiwan Dollar................................. $ 3,992,946 34.34 $ --
Purchased call option contracts:
British Pound................................. $ 315,151 1.69 $ --
Non-deliverable forward:
Singapore Dollar.............................. $ 412,528 1.719 $ 5,225
----------- -------
Total........................................ $21,424,588 $11,372
=========== =======
</TABLE>
There were no significant unrealized gains or losses for the forward
exchange contracts as of July 2, 1999. The fair value of forward exchange
contracts generally reflects the estimated amounts that VSEA would receive or
pay to terminate the contracts at the reporting date, thereby taking into
account and approximating the current unrealized and realized gains or losses
of open contracts. The notional amounts of forward exchange contracts are not
a measure of VSEA's exposure.
Interest Rate Risk
Although payments under certain of the operating leases for VSEA's
facilities are tied to market indices, VSEA is not exposed to material
interest rate risk associated with its operating leases.
There have been no material changes in information reported under "Market
Risk" in the Company's Registration Statement on Form 10, as amended,
orginally filed with the Securities and Exchange Commission on February 12,
1999.
18
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information required by this Item is provided in Note 10 ("Contingencies")
to the Condensed Consolidated Financial Statements.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<C> <S>
27 Financial Data Schedule.*
</TABLE>
(b) Reports on form 8-K. The Company did not file any reports on Form 8-
K during the quarter ended July 2, 1999.
19
<PAGE>
SIGNATURE
Pursuant to the requirements 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.
Varian Semiconductor Equipment
Associates, Inc.
Registrant
/s/ Ernest L. Godshalk
By: _________________________________
Ernest L. Godshalk
Vice President and Chief
Financial Officer
Date August 16, 1999
20
<PAGE>
INDEX OF EXHIBITS
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<C> <S>
27 Financial Data Schedule.
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONDENSED
CONSOLIDATED STATEMENT OF OPERATIONS AND CONDENSED CONSOLIDATED BALANCE SHEETS
FOR VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC. AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> OCT-01-1999
<PERIOD-START> OCT-03-1998
<PERIOD-END> JUL-02-1999
<CASH> 17,042
<SECURITIES> 71,982
<RECEIVABLES> 61,791
<ALLOWANCES> 1,698
<INVENTORY> 52,210
<CURRENT-ASSETS> 247,724
<PP&E> 88,238
<DEPRECIATION> 52,033
<TOTAL-ASSETS> 307,236
<CURRENT-LIABILITIES> 115,354
<BONDS> 0
0
0
<COMMON> 304
<OTHER-SE> 182,937
<TOTAL-LIABILITY-AND-EQUITY> 307,236
<SALES> 164,407
<TOTAL-REVENUES> 164,407
<CGS> 126,552
<TOTAL-COSTS> 208,480
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (42,916)
<INCOME-TAX> (13,600)
<INCOME-CONTINUING> (29,316)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (29,316)
<EPS-BASIC> (0.96)
<EPS-DILUTED> (0.96)
</TABLE>
