<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
----------------
AMENDMENT NO. 1
To
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 April 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 [_] No [X]
The number of shares of the registrant's common stock outstanding as of
April 2, 1999 was 30,422,792 shares of $0.01 par value common stock.
An index of exhibits filed with this Form 10-Q is located on page 20.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
EXPLANATORY NOTE
This amendment is filed solely to correct a filing agent's typographical
error in the Consolidated Condensed Statements of Cash Flows included in the
Registrant's Quarterly Report on Form 10-Q filed with the Securities and
Exchange Commission on May 17, 1999 (the "Original Form 10-Q"). The
Consolidated Condensed Statements of Cash Flows in the Original Form 10-Q
indicated (Amounts in Thousands) that the Registrant had Cash and Cash
Equivalents at the end of the period ending April 2, 1999, of $999,457, which
amount should have been $99,457, the same amount as shown as the Net Increase
in cash and cash equivalents within the period.
<PAGE>
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Six months ended
--------------------------- ---------------------------
April 2, 1999 April 3, 1998 April 2, 1999 April 3, 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenue................. $ 53,205 $105,087 $100,560 $219,375
-------- -------- -------- --------
Operating Costs and
Expenses
Cost of revenue......... 49,431 67,537 84,626 132,322
Research and
development............ 10,492 8,418 18,209 18,245
Marketing............... 9,061 10,104 16,518 21,864
General and
administrative......... 9,130 3,984 16,451 10,591
Restructuring costs..... 2,688 -- 2,688 --
-------- -------- -------- --------
Total Operating Costs
and Expenses........... 80,802 90,043 138,492 183,022
-------- -------- -------- --------
Operating (Loss)
Earnings before Taxes.. (27,597) 15,044 (37,932) 36,353
Tax provision (benefit)
on (loss) earnings..... (8,382) 4,529 (12,020) 10,948
-------- -------- -------- --------
Net (Loss) Earnings..... $(19,215) $ 10,515 $(25,912) $ 25,405
======== ======== ======== ========
Average Shares
Outstanding--Basic... 30,423 30,423 30,423 30,423
======== ======== ======== ========
Average Shares
Outstanding--
Diluted.............. 30,423 30,508 30,423 30,508
======== ======== ======== ========
Net (Loss) Earnings
Per Share--Basic..... $ (0.63) $ 0.35 $ (0.85) $ 0.84
======== ======== ======== ========
Net (Loss) Earnings
Per Share--Diluted... $ (0.63) $ 0.34 $ (0.85) $ 0.83
======== ======== ======== ========
</TABLE>
See accompanying notes to consolidated condensed financial statements.
1
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(Amounts in thousands, except share amounts)
<TABLE>
<CAPTION>
April 2, October
1999 2, 1998
----------- --------
(Unaudited)
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents................................ $ 99,457 $ --
Accounts receivable...................................... 54,507 62,677
Inventories.............................................. 53,848 60,692
Other current assets..................................... 45,012 38,754
-------- --------
Total Current Assets..................................... 252,824 162,123
-------- --------
Property, plant and equipment............................ 84,016 84,128
Accumulated depreciation and amortization................ (49,988) (45,314)
-------- --------
Net property, plant and equipment........................ 34,028 38,814
Deferred taxes........................................... 403 --
Other assets............................................. 22,184 23,689
-------- --------
Total Assets............................................. $309,439 $224,626
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Notes payable............................................ $ 5,036 $ --
Accounts payable......................................... 13,548 10,513
Accrued expenses......................................... 76,432 77,050
Product warranty......................................... 15,159 21,435
Advance payments from customers.......................... 4,723 3,631
-------- --------
Total Current Liabilities................................ 114,898 112,629
Long-term accrued expenses............................... 7,896 6,796
Deferred taxes........................................... -- 1,952
-------- --------
Total Liabilities........................................ 122,794 121,377
-------- --------
Contingencies (Note 11)
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 April 2,
1999.................................................... 304 --
Capital in excess of par value........................... 186,341 --
Divisional equity........................................ -- 103,249
-------- --------
Total Stockholders' Equity............................... 186,645 103,249
-------- --------
Total Liabilities and Stockholders' Equity............... $309,439 $224,626
======== ========
</TABLE>
See accompanying notes to consolidated condensed financial statements.
2
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
<TABLE>
<CAPTION>
For The Six Months Ended
---------------------------
April 2, 1999 April 3, 1998
------------- -------------
<S> <C> <C>
Operating Activities
Net cash used in operating activities.............. $(12,634) $(15,150)
-------- --------
Investing Activities
Purchase of fixed assets........................... (1,421) (10,004)
Reallocation of subsidiary......................... -- 2,531
Purchase of subsidiary............................. -- (8,363)
-------- --------
Net cash used in investing activities.............. (1,421) (15,836)
-------- --------
Financing Activities
Net transfers from Varian Associates, Inc.......... 114,344 29,873
-------- --------
Net cash provided by financing activities.......... 114,344 29,873
-------- --------
Effects of Exchange Rate Changes on Cash........... (832) 1,113
-------- --------
Net increase in cash and cash equivalents.......... 99,457 --
Cash and cash equivalents at beginning of period... -- --
-------- --------
Cash and Cash Equivalents at End of Period......... $ 99,457 $ --
======== ========
</TABLE>
See accompanying notes to consolidated condensed financial statements.
3
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO THE CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
Note 1. Interim Consolidated Condensed Financial Statements
These consolidated condensed 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 consolidated condensed 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 consolidated condensed 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 second quarter and six months ended April 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
Until April 2, 1999, the Company's business was operated as part of Varian
Associates, Inc. ("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 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 consolidated condensed financial statements for periods ended on or
before April 2, 1999 reflect SEB as operated by VAI. The consolidated
condensed financial statements generally reflect the financial position,
operating results and cash flows of SEB as if it were a separate entity for
all periods presented. Where it was practicable to identify specific VAI
corporate amounts with the SEB activities, such amounts have been included in
the accounts reflected in the consolidated condensed financial statements. The
consolidated condensed 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. 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
The loss in the second quarter of fiscal year 1999 was increased by pretax
restructuring and other non-recurring charges of $11.6 million resulting from
actions taken primarily in response to the downturn in the semiconductor
equipment industry.
4
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO THE CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
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.
Research and development expense includes $1.6 million in charges
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 current quarter of $1.5 million
resulted from consolidation and reorganization activities, including office
and employee relocations.
Restructuring costs of $2.7 million includes $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 April 2, 1999, $0.5 million of the termination costs had
been paid with a total accrual balance of $0.7 million remaining.
<TABLE>
<CAPTION>
Total
Restructuring Cash Non-Cash Accrual
Charge Payments Items Balance
------------- -------- -------- -------
(Amounts in millions)
<S> <C> <C> <C> <C>
Facility exit and cancellation of
expansion plans.................. $1.4 $1.2 $ 0 $0.2
Termination costs................. 1.3 0.5 0.1 0.7
</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 during the reporting
period was assumed to be the number of shares outstanding on April 2, 1999,
immediately following the Distribution. Diluted earnings (loss) per share
includes additional dilution from potential common shares such as stock
issuable pursuant to the exercise of stock options outstanding. 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 Three Months Ended
April 2, 1999 April 3, 1998
------------------ ------------------
(Amounts in thousands)
<S> <C> <C>
Shares outstanding................. 30,423 30,423
Effect of dilutive stock options... -- 85
------ ------
Shares used in diluted earnings
(loss) per share.................. 30,423 30,508
====== ======
</TABLE>
All potential common shares were excluded from the computation of diluted
loss per share for the three and six month periods ending April 2, 1999 as
their effect was anti-dilutive. For the three and six month periods ending
April 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.
5
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO THE CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
Note 5. Cash and Cash Equivalents
VSEA received a cash contribution from VAI in connection with the
Distribution such that VSEA's cash and cash equivalents equaled approximately
$100 million as of April 2, 1999. The Company considers all highly liquid
investments purchased with an original maturity of three months or less to be
cash equivalents.
Note 6. Inventories
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 $19.9 million at April 2, 1999 and $18.0 million at October 2,
1998.
The components of inventories are as follows (in millions):
<TABLE>
<CAPTION>
April 2, October 2,
1999 1998
-------- ----------
<S> <C> <C>
Raw materials and parts................................. $23.5 $24.7
Work in process......................................... 23.8 22.5
Finished goods.......................................... 6.5 13.5
----- -----
Total Inventories..................................... $53.8 $60.7
===== =====
</TABLE>
Note 7. Notes Payable
In connection with the Distribution, VSEA assumed $5.0 million of notes
payable.
Note 8. Stockholders' Equity
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. Immediately following the Distribution, the Company had 30,422,792
shares of common stock outstanding.
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 April 2, 1999, VSEA had outstanding options to purchase an aggregate
of 3,478,674 shares of its common stock at a weighted average price of $14.08.
Of these options, options to purchase an aggregate of 2,550,842 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.
Beginning on April 3, 1999 the Company will begin accumulating retained
earnings.
6
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO THE CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
Note 9. Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("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 2000. The impact of the implementation of SFAS No. 133
on the consolidated financial statements of the Company has not yet been
determined.
Note 10. Foreign Exchange Contracts
As of April 2, 1999 VSEA had no forward exchange contracts outstanding.
Note 11. 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, as amended, 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 $1.3 million for the first six
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 April 2, 1999, VAI estimated that the future exposure for
environmental related investigation and remediation costs for these sites
ranged in the aggregate from $21.0 million to $48.3 million. The time frame
over which VAI expects to incur these costs varies at each site and facility,
ranging up to approximately 30 years as of April 2, 1999. VAI's 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,
VAI has accrued $21.0 million in estimated environmental costs as of April 2,
1999. This amount accrued by VAI has not been discounted to present value.
VAI has gained sufficient knowledge to be able to better estimate the scope
and costs of future environmental activities at other sites and facilities. As
of April 2, 1999, VAI estimated that its aggregate future exposure for
environmental-related investigation and remediation costs for these sites
ranged from $39.2 million to $73.0 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 April 2, 1999. As to each of these sites
and facilities, management of VAI has determined: (i) that a particular amount
within the range of estimated costs better
7
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO THE CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
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 $50.6 million at April 2, 1999.
Accordingly, VAI has accrued $21.9 million, which represents management's best
estimate of the future costs discounted at 4%, net of inflation. This accrual
is in addition to the $21.0 million described above.
As of April 2, 1999, the Company's reserve for its portion of environmental
liabilities, based upon future environmental related costs estimated by VAI
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
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 range of cost estimates reflects various uncertainties inherent in
many environmental investigation and remediation activities and the large
number of sites and facilities where VAI is undertaking such investigation and
remediation activities. VAI 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 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.
VAI evaluates its liability for environmental related investigation and
remediation in light of the liability and financial wherewithal of potentially
responsible parties and insurance companies with respect to which VAI believes
that it has rights to 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 various
insurance companies and other third parties. 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 portion of this receivable is $1.2 million
at April 2, 1999. The Company believes that this receivable is recoverable
because it is based on a binding, written
8
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 liability in anticipation of
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, a product line of the Company. Total proceeds received from the
sale of TFS were $145.5 million in cash. A $51.5 million reserve was recorded
to cover, among other items, purchase price disputes, retained liabilities,
transactions costs, employee terminations, facilities separation costs,
indemnification obligations, litigation expense, and other contingencies. The
reserve as of April 2, 1999 was $37.6 million and related to costs associated
with pending litigation and indemnity obligations relating to certain patent
infringement claims by Applied Materials, Inc. as well as purchase price
disputes with Novellus Systems, Inc. arising out of the sale of TFS.
Legal Proceedings
In June 1997, Applied Materials, Inc. ("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 Systems, Inc. ("Novellus") in June 1997. The complaint
requests unspecified money damages and an injunction 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 VAI, VAI 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 VAI 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 VAI for one-third of the costs, liabilities, and
expenses, adjusted for any related tax benefits recognized or realized by VAI,
with respect to certain legal proceedings relating to discontinued operations
of VAI.
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.
9
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO THE CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
Note 12. Retirement Plans
Certain employees of the Company in the United States are eligible to
participate in the VSEA-sponsored defined contribution plan. The Company's
major obligation is to contribute an amount based on a percentage of each
participant's base pay. The Company may also contribute up to 5% of its
consolidated operating earnings, as adjusted for discretionary items, as
discretionary retirement plan profit sharing. Depending upon completion of a
vesting schedule, participants are entitled, upon termination or retirement,
to their portions of the retirement fund assets, which are held by a third-
party trustee. Included in the accompanying consolidated condensed statement
of operations is an allocation of total pension expense for Company employees
under the VAI-sponsored defined contribution plan.
As of the Distribution, the Company assumed responsibility for pension and
post-retirement benefits for active employees of the Company; the
responsibility for all others, principally retirees of VAI, will be assumed by
VMS. An allocation of assets and liabilities for foreign defined benefit
pension, post-employment, and post-retirement benefits, which are not material
to the Company's financial statements, has been included in these consolidated
condensed financial statements.
10
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
On April 2, 1999, Varian Associates, Inc. ("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
Varian Semiconductor Equipment Associates, Inc. ("VSEA" or 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 interim consolidated condensed financial statements of VSEA generally
reflect the results of operations, financial position and cash flows of the
operations which were transferred to the Company in connection with the
Distribution. Accordingly, the VSEA interim consolidated condensed financial
statements have been carved out from the interim consolidated financial
statements of VAI using the historical results of operations and historical
basis of the assets and liabilities of SEB. The interim consolidated condensed
financial statements of VSEA include, among other things, 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 Consolidated
Condensed Financial Statements. The interim consolidated condensed financial
statements do not reflect any changes that may occur in the financing and
operations of VSEA as a result of the Distribution.
This discussion and analysis of financial condition and results of
operations is based upon and should be read in conjunction with the interim
combined financial statements of the Semiconductor Equipment Business and
notes thereto, as well as the information contained under the headings
"Business", "Risk Factors" 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.
Results of Operations
Three Months Ended April 2, 1999 Compared to Three Months Ended April 3, 1998
Revenue. VSEA's revenue of $53.2 million in the second quarter of fiscal
year 1999 was 49% lower than its revenue of $105.1 million in the second
quarter of fiscal year 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, accelerated in the fourth
quarter of fiscal year 1998, and continued into the second quarter of fiscal
year 1999. The decrease in semiconductor manufacturing capacity utilization
resulted in reduced semiconductor equipment demand and these conditions have
adversely affected VSEA's results of operations. While excess capacity in the
semiconductor manufacturing industry remained relatively stable between the
fourth quarter of fiscal year 1998 and the second quarter of fiscal year 1999,
certain market segments for fabrication equipment have stabilized or modestly
improved. The low demand for semiconductor equipment is expected to continue
to influence VSEA's results through the end of fiscal year 1999.
Royalty income of $0.9 million in the second quarter of fiscal year 1999
was 33% below royalty income in the second quarter of fiscal year 1998, mainly
due to the semiconductor industry slowdown.
International revenue was $34.5 million, or 65% of total revenue, in the
second quarter of fiscal year 1999, compared to $69.8 million, or 66% of total
revenue, in the second quarter of fiscal year 1998. VSEA's North American
(primarily U.S.) revenue increased to 35% of revenue in the second quarter of
fiscal year 1999 from 34% of total revenue in the second quarter of fiscal
year 1998, while its European region revenue increased to 23% of total revenue
in the second quarter of fiscal year 1999 from 19% of total revenue in the
second quarter
11
<PAGE>
of fiscal year 1998. The aggregate revenue from Taiwan, Japan, Korea and the
Pacific Rim decreased as a percentage of total revenue, representing 42% of
total revenue in the second quarter of fiscal year 1999 and 47% of total
revenue in the second quarter of fiscal year 1998.
Gross Profit. VSEA's gross profit of $3.8 million in the second quarter of
fiscal year 1999 equaled 7% of revenues of $53.2 million, well below the $37.6
million of gross profit, or 36% of revenues of $105.1 million, in the second
quarter of fiscal year 1998. The decrease in gross profit as a percentage of
revenue from the second quarter of fiscal year 1998 to the second quarter of
fiscal year 1999 was attributable to the slowdown in product demand, excess
capacity, and additional charges of $5.9 million associated primarily with
inventory provisions for the realignment of product offerings and writing down
discontinued product inventory. The under-utilization of manufacturing
facilities, together with costs of current staff recruiting and training for
the anticipated upturn, resulted in unfavorable overhead variances for the
second quarter of fiscal year 1999.
Research and Development. Research and development expenses were $10.5
million, or 20% of revenue, in the second quarter of fiscal year 1999,
compared with $8.4 million, or 8% of revenue, in the second quarter of fiscal
year 1998. Following the acquisition in July 1998 of the high-energy ion
implantation equipment product line of Genus, Inc., ("Genus"), VSEA has
subsequently discontinued a parallel product development research contract,
incurring charges of $1.6 million, which are included in the $10.5 million of
expense for the second quarter of fiscal year 1999.
Marketing. Marketing expenses were $9.1 million, or 17% of revenue, in the
second quarter of fiscal year 1999, down $1.0 million from the $10.1 million,
or 10% of revenue, in the second quarter of fiscal year 1998.
General and Administrative. General and administrative expenses were $9.1
million in the second quarter of fiscal year 1999 compared to $4.0 million in
the second quarter of fiscal year 1998, representing 17% and 4% of revenues,
respectively. Along with the restructuring activity, recorded separately,
there were additional one-time administrative costs associated with the
reorganization, including travel and staff training, office rearrangements and
some staff relocation, mainly incurred within the second quarter. Management
expects some continuing effects of these costs in the third and fourth
quarters.
Restructuring Charges. In the second quarter of fiscal year 1999, VSEA
recorded a restructuring charge of $2.7 million resulting primarily from the
slowdown in the semiconductor industry. Included in the restructuring charge
is $1.4 million to cover the costs expended associated with the cancellation
of the planned expansion of manufacturing facilities in the United States and
Japan. Expenditures of $1.2 million were made in the quarter. The remaining
accrual of $0.2 million is expected to be paid in the third quarter of fiscal
year 1999.
The remainder of the restructuring charge consisted of $1.3 million
recorded in the second quarter of fiscal year 1999 to cover termination costs
for a reduction in workforce of 69 employees, (approximately 5% of worldwide
VSEA employment). As of April 2, 1999, $0.5 million of the termination costs
had been expended. The accrual balance of $0.7 million is expected to be
expended within the following two quarters. The Company does not expect
significant cost savings over the long term, as it is anticipated that
employment levels will increase in other Company locations as the
semiconductor industry recovers.
Taxes on Earnings. VSEA recorded a tax benefit of $8.4 million in the
second quarter of fiscal year 1999, compared to $4.5 million of expense in the
second quarter of fiscal year 1998. The effective income tax rate was 30.4% in
the second quarter of fiscal year 1999, compared to 30.1% in the second
quarter of fiscal year 1998. Following the Distribution, VSEA will 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.
Net Loss. Net loss was $19.2 million, ($0.63) per share, in the second
quarter of fiscal year 1999. This compares to $10.5 million of net earnings,
$0.34 per share, in the second quarter of fiscal year 1998.
12
<PAGE>
Six Months Ended April 2, 1999 Compared to Six Months Ended April 3, 1998
Revenue. VSEA's revenue of $100.6 million for the first six months of 1999
was 54% lower than its revenue of $219.4 million in the first six 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, accelerated in the fourth quarter of fiscal year 1998, and
continued into the second quarter of fiscal year 1999. The decrease in
semiconductor manufacturing capacity utilization resulted in reduced
semiconductor equipment demand and these conditions have adversely affected
VSEA's results of operations. While excess capacity in the semiconductor
manufacturing industry remained relatively stable between the fourth quarter
of fiscal year 1998 and the first six months of 1999, certain market segments
for fabrication equipment have stabilized or modestly improved. The low demand
for semiconductor equipment will continue to influence VSEA's results through
the end of fiscal year 1999.
Royalty income for the first six months of 1999 of $1.9 million decreased
by $6.8 million or 78% from royalty income of $8.7 million for the first six
months of 1998, during which time VSEA received its final royalty payment from
TEL in connection with the termination of the distribution agreement between
TEL and VAI.
International revenue was $60.8 million, or 60% of total revenue, for the
first six months of 1999, compared to $152.3 million, or 69% of total revenue,
for the first six months of 1998. VSEA's North American revenue increased as a
percentage of revenue to 40% of total revenue in the first six months of 1999
from 31% of total revenue for the first six months of 1998, while its European
region revenue increased to 21% of total revenue in the first six months of
1999 from 17% of total revenue in the first six months of 1998. The aggregate
from Taiwan, Japan, Korea and the Pacific Rim decreased as a percentage of
revenue, representing 39% of total revenue in the first six months of 1999 and
52% of total revenue in the first six months of 1998.
The trend during fiscal year 1999 has shown revenue increasing over prior
quarters. Revenue for the first quarter of 1999 was 13% above revenue for the
last quarter of fiscal year 1998, and revenue in the second quarter of this
year was 12% above revenue in the first quarter of this year.
Gross Profit. VSEA's gross profit of $15.9 million in the first six months
of 1999 was 16% of revenue, compared to $87.1 million, or 40% of revenue, in
the first six months of 1998. The decrease in gross profit as a percentage of
revenue from the first six months of 1998 to the first six months of 1999 was
attributable primarily to the industry slowdown in product demand and costs
associated with excess capacity in VSEA's operations, together with $5.9
million in additional 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 anticipated upturn, resulted in unfavorable
overhead variances for the second 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 $18.2 million for the first six months of fiscal
year 1999 and 1998, or 18% and 8% of revenue, respectively. For the first six
months of 1999 research and development expense included $1.6 million in
contract cancellation charges 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 $16.5 million, or 16% of revenue, in the
first six months of 1999 were down 24% from the $21.9 million, or 10% of
revenue, in the first six months of 1998. In part this was a reflection of
cost controls with additional shutdown periods over the past six months.
General and Administrative. General and administrative expenses were $16.5
million in the first six months of 1999 and $10.6 million for the first six
months of 1998, representing 16% and 5% of revenues, respectively. General and
administrative expenses were higher in 1999 because of additional costs
associated
13
<PAGE>
with the actions taken in response to the semiconductor industry downturn,
including a workforce reduction of 69 employees (approximately 5% of VSEA's
employees worldwide). Additional one-time costs were incurred to manage the
separation from VAI and establishment of VSEA.
Taxes on Earnings. VSEA recorded a tax benefit of $12.0 million in the
first half of fiscal year 1999, compared to $10.9 million of expense in the
first six months of fiscal year 1998. The effective income tax rate was 31.7%
in the first half of fiscal year 1999, compared to 30.1% in the first half of
fiscal year 1998. Following the Distribution, VSEA will 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.
Net Loss. Net loss was $25.9 million, ($0.85) per share, for the first six
months of 1999. This compares to $25.4 million of net earnings, $0.83 per
share, for the first six months of 1998.
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("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 VSEA's 1999 fiscal year. The impact of the implementation of SFAS No. 131
on the reporting of VSEA's segment information has not yet been determined.
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 VSEA's
2000 fiscal year. The impact of the implementation of SFAS No. 133 on the
consolidated financial statements of VSEA has not yet been determined.
Liquidity and Capital Resources
VSEA's debt has historically been incurred or managed at the parent level.
In connection with the Distribution, VSEA assumed $5.0 million of VAI's Notes
Payable. VSEA will not be able to rely on the earnings, assets or cash flows
of VMS or IB after the Distribution nor, however, will its earnings, assets or
cash flows be used to contribute to the capital requirements of those
entities.
VAI has used a centralized cash management system to finance its
operations. Cash deposits from most of the businesses are transferred to VAI
on a daily basis, and VAI funds its required disbursements. As the result,
VSEA reported no cash and cash equivalents at October 2, 1998. Pursuant to the
Distribution Agreement, VSEA 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 VSEA's principal source of liquidity for
the foreseeable future.
During the first six months of 1999, VSEA consumed $12.6 million of cash in
operations, compared to the use of $15.2 million in the first six months of
1998.
During the first six months of 1999, VSEA used $1.4 million for investing
activities, compared to $15.8 million that was used during the first six
months of 1998.
As a consequence of the industry slowdown, VSEA currently has no plans to
materially modify or expand its facilities or to make other material capital
expenditures.
VSEA'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 VSEA's cash requirements will
fluctuate based on the timing and extent of these factors, VSEA's management
believes that cash generated
14
<PAGE>
from operations, together with the cash contribution made by VAI to VSEA at
the time of the Distribution and VSEA'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 regulating the discharge of materials into the environment
or otherwise relating to the protection of the environment. This includes
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 such 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 $1.3 million for the first six 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 April 2, 1999, VAI estimated that the future exposure for
environmental related investigation and remediation costs for these sites and
facilities ranged in the aggregate from $21.0 million to $48.3 million. The
time frame over which VAI expects to incur these costs varies with each site
and facility, ranging up to approximately 30 years as of April 2, 1999.
Management of VAI 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 VAI had accrued $21.0 million in estimated environmental costs
as of April 2, 1999. The amount accrued has not been discounted to present
value.
VAI has gained sufficient knowledge to be able to better estimate the scope
and costs of future environmental activities at other sites and facilities. As
of April 2, 1999, VAI estimated that its aggregate future exposure for
environmental-related investigation and remediation costs for these sites and
facilities ranged from $39.2 million to $73.0 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 April 2, 1999. As to each
of these sites or facilities, management of VAI 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 $50.6 million at April 2, 1999. Accordingly,
VAI had accrued $21.9 million as of April 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 $21.0 million described in the
preceding paragraph.
VSEA recorded $8.9 million as its portion of the foregoing estimated future
costs for environmental liability of VAI as of April 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. VAI anticipates that most of these
cost ranges will narrow as investigation and remediation activities progress.
15
<PAGE>
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 VSEA's financial statements,
the likelihood of such occurrence is considered remote. Based on information
currently available to VSEA'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 VSEA.
VAI evaluates its liability for environmental-related investigation and
remediation in light of the liability and financial wherewithal of potentially
responsible parties and insurance companies with respect to which VAI believes
that it has rights to 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 various
insurance companies and other third parties. 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 portion of this receivable is $1.2 million
at April 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 liability in anticipation of 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 internal systems, which 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 system is designed and tested by SAP for Year 2000
capability. Installation of that system has been staged to replace first those
existing systems that are not Year 2000 capable. Installation of the new SAP
system is approximately 70% complete, with 90% completion expected by July
1999 and full completion expected by the end of 1999. Upgrade of enterprise
information systems is approximately 88% complete, with 96% completion
expected by July 1999 and 100% completion expected by December 1999; upgrade
of networking and telecommunications systems is complete; upgrade of factory-
specific information systems is approximately 42% complete, with 67%
completion expected by July 1999 and 94% completion expected by December 1999;
and upgrade of non-IT systems, computers and packaged software is
approximately 65% complete, with 100% completion expected by October 1999
(except in the case of some computers and packaged software, which might not
be completed until December 1999) and upgrade of facilities systems is
approximately 50% complete, with 100% completion expected by July 1999.
16
<PAGE>
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 does not intend to assess
Year 2000 preparedness of every product it has sold, but rather is assessing
products that will be under written warranties or are still relatively early
in their useful life, are more likely to be dependent on non-IT systems that
are not Year 2000 capable and cannot be easily upgraded with readily available
externally-utilized computers and packaged software or with internally
developed software. These assessments are expected to be substantially
completed by June 1999. 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. 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 July
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. 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 might 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 April 2, 1999, VSEA estimates that it had incurred costs less
than $1 million to assess and correct Year 2000 problems. Although difficult
to assess, based on its assessment 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 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 the significant
third parties with which it does business it could experience an interruption
in the
17
<PAGE>
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 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 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 capable upgrade of existing information systems pending
complete installation of the SAP system. That 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 more critical problems that might 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 impact of economic conditions in 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.
18
<PAGE>
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
There have been no material changes in information reported under "Market
Risk" in the Company's Registration Statement on Form 10, as amended,
originally filed with the Securities and Exchange Commission on February 12,
1999.
19
<PAGE>
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
Information required by this Item is provided in Note 11 ("Contingencies")
to the Consolidated Condensed Financial Statements.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<C> <S>
2.1 Distribution Agreement among Varian Associates, Inc., Varian
Semiconductor Equipment Associates, Inc. and Varian, Inc. dated as
of January 14, 1999.+
3.1 Form of Restated Certificate of Incorporation of Varian
Semiconductor Equipment Associates, Inc. to be in effect upon the
effectiveness of the Distribution.+
3.2 Form of By-Laws of Varian Semiconductor Equipment Associates, Inc.
to be in effect upon the effectiveness of the Distribution.+
4.1 Specimen Common Stock Certificate.+
4.2 Rights Agreement dated February 19, 1999.+
10.1 Form of Employee Benefits Allocation Agreement among Varian
Associates, Inc., Varian Semiconductor Equipment Associates, Inc.
and Varian, Inc.+
10.2 Form of Intellectual Property Agreement among Varian Associates,
Inc., Varian Semiconductor Equipment Associates, Inc. and Varian,
Inc.+
10.3 Form of Tax Sharing Agreement among Varian Associates, Inc.,
Varian Semiconductor Equipment Associates, Inc. and Varian, Inc.+
10.4 Form of Transition Services Agreement among Varian Associates,
Inc., Varian Semiconductor Equipment Associates, Inc. and Varian,
Inc.+
10.5 Form of Change in Control Agreement for CEO.+
10.6 Form of Change in Control Agreement for Chief Financial Officer.+
10.7 Form of Change in Control Agreement for Senior Executives.+
10.8 Form of Indemnity Agreement with Directors and Officers.+
10.9 Varian Semiconductor Equipment Associates, Inc. Omnibus Stock
Plan.+
10.10 Varian Semiconductor Equipment Associates, Inc. Management
Incentive Plan.+
10.11 Agreement, dated as of July 24, 1998, between Varian Associates,
Inc. and High Voltage Engineering Europa B.V.+
10.12 Supplemental Retirement Plan adopted February 19, 1999.+
27 Financial Data Schedule.*
</TABLE>
- --------
+ Incorporated by reference to the Company's Registration Statement on Form
10, as amended (SEC File No. 000-25395), originally filed on February 12,
1999.
* Previously filed.
(b) Reports on form 8-K. The Company did not file any reports on Form 8-
K during the quarter ended April 2, 1999.
20
<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 May 27, 1999
21
