<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 December 31, 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
February 4, 2000 was 30,945,611 shares of $0.01 par value common stock.
An index of exhibits filed with this Form 10-Q is located on page 22.
- -------------------------------------------------------------------------------
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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 data)
(Unaudited)
<TABLE>
<CAPTION>
Fiscal Three Months Ended
---------------------------------
December 31, 1999 January 1, 1999
----------------- ---------------
<S> <C> <C>
Revenue
Product revenue............................. $ 97,015 $ 36,577
Service revenue............................. 11,968 9,731
Royalties................................... 810 1,047
-------- --------
Total revenue............................... 109,793 47,355
-------- --------
Operating Costs and Expenses
Cost of product and service revenue......... 69,766 35,195
Research and development.................... 11,168 7,717
Marketing, general and administrative....... 21,481 14,778
-------- --------
Total operating costs and expenses.......... 102,415 57,690
-------- --------
Operating earnings (loss)................... 7,378 (10,335)
Interest income............................. 773 --
-------- --------
Earnings (loss) before taxes................ 8,151 (10,335)
Income tax provision (benefit) on earnings
(loss)..................................... 2,853 (3,638)
-------- --------
Net earnings (loss)......................... $ 5,298 $ (6,697)
======== ========
Weighted average shares outstanding--
basic.................................... 30,555 30,423
======== ========
Weighted average shares outstanding--
diluted.................................. 32,472 30,423
======== ========
Net earnings (loss) per share--basic...... $ 0.17 $ (0.22)
======== ========
Net earnings (loss) per share--diluted.... $ 0.16 $ (0.22)
======== ========
</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 data)
<TABLE>
<CAPTION>
December 31, October 1,
1999 1999
------------ ----------
(Unaudited)
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents.............................. $ 53,080 $ 65,968
Restricted cash........................................ 500 1,000
Accounts receivable, net............................... 103,369 100,497
Inventories, net....................................... 88,236 70,437
Deferred taxes......................................... 33,583 32,536
Other current assets................................... 3,287 2,887
-------- --------
Total Current Assets................................... 282,055 273,325
-------- --------
Property, plant and equipment.......................... 94,734 92,364
Accumulated depreciation and amortization.............. (56,021) (54,066)
-------- --------
Net property, plant and equipment...................... 38,713 38,298
Other assets........................................... 21,543 22,521
-------- --------
Total Assets........................................... $342,311 $334,144
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Notes payable.......................................... $ 5,787 $ 5,523
Accounts payable....................................... 30,736 30,709
Accrued expenses....................................... 77,021 76,455
Product warranty....................................... 15,929 15,899
Advance payments from customers........................ 3,672 4,212
-------- --------
Total Current Liabilities.............................. 133,145 132,798
Long-term accrued expenses............................. 7,276 7,176
Deferred taxes......................................... 1,210 985
-------- --------
Total Liabilities...................................... 141,631 140,959
-------- --------
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 30,648,525 at December
31, 1999 and 30,474,492 at October 1, 1999............ 306 305
Capital in excess of par value......................... 182,371 180,175
Retained earnings...................................... 18,003 12,705
-------- --------
Total Stockholders' Equity............................. 200,680 193,185
-------- --------
Total Liabilities and Stockholders' Equity............. $342,311 $334,144
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(Amounts in thousands)
<TABLE>
<CAPTION>
Fiscal Three Months Ended
---------------------------------
December 31, 1999 January 1, 1999
----------------- ---------------
<S> <C> <C>
Operating Activities
Net cash used in Operating Activities........ $(12,881) $(4,952)
-------- -------
Investing Activities
Purchase of property, plant and equipment... (3,595) --
Proceeds from disposal of fixed assets...... 753 --
Restricted cash received.................... 500 --
-------- -------
Net cash used in Investing Activities........ (2,342) --
======== =======
Financing Activities
Proceeds from issuance of notes payable...... 518 --
Proceeds from the issuance of common stock... 2,197 --
Net transfers from Varian Associates, Inc.... -- 6,419
-------- -------
Net cash provided by Financing Activities.... 2,715 6,419
-------- -------
Effects of exchange rate changes on cash..... (380) (1,467)
-------- -------
Net decrease in cash and cash equivalents.... (12,888) --
Cash and cash equivalents at beginning of
period...................................... 65,968 --
-------- -------
Cash and cash equivalents at end of period... $53,080 $ --
======== =======
Detail of net cash provided by (used in)
Operating Activities
Net earnings (loss)......................... $5,298 $(6,697)
Adjustments to reconcile net earnings (loss)
to net cash provided by
(used in) operating activities
Depreciation and amortization............. 3,092 2,212
Provision for doubtful accounts........... 169 --
Deferred taxes............................ (822) 88
Changes in assets and liabilities,
Accounts receivable....................... (2,904) 2,745
Inventories............................... (17,799) 4,290
Other current assets...................... (400) 191
Accounts payable.......................... 67 (7,941)
Accrued expenses.......................... 545 630
Product warranty.......................... 56 (4,758)
Advance payments from customers........... (596) 3,646
Long term accrued expenses................ 100 151
Other..................................... 313 491
-------- -------
Net cash used in Operating Activities........ $(12,881) $(4,952)
======== =======
</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-K filed by Varian Semiconductor Equipment Associates,
Inc. ("VSEA" or the "Company") with the Securities and Exchange Commission for
the fiscal year ended October 1, 1999. 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 months ended December 31, 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 fiscal period ending December 31,
1999. The interim condensed consolidated financial statements as of and for
the three month fiscal period ending January 1, 1999, reflect operations when
the Company's business was operated as the Semiconductor Equipment Business
("SEB"), a part of the former 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, 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.
4
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
Note 3. 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 for the period ended
December 31, 1999 was 30,555,445. 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>
Fiscal Three Months Ended
----------------------------
December 31, January 1,
1999 1999
------------- ------------
<S> <C> <C>
Numerator (in thousands of dollars):
Net earnings (loss)......................... $ 5,298 $ (6,697)
Denominator (in thousands):
Denominator for basic earnings (loss) per
share--
Weighted average shares outstanding........ 30,555 30,423
Effect of dilutive securities:
Stock options............................... 1,917 --
------------ ------------
Denominator for diluted earnings (loss) per
share...................................... 32,472 30,423
Basic earnings (loss) per share............. $ 0.17 $ (0.22)
Diluted earnings (loss) per share........... $ 0.16 $ (0.22)
============ ============
</TABLE>
For the three month period ending December 31, 1999, options to purchase
30,189 common shares at a weighted average exercise price of $25.84 were
excluded from the computation due to their exercise price exceeding the market
value of the underlying common stock. For the three month period ending
January 1, 1999, options to purchase 2.7 million shares at a weighted average
exercise price of $15.52 were excluded due to their exercise price exceeding
the market value of the underlying common stock. Potential common shares in
the form of additional stock options totaling 2.1 million were excluded from
the computation of diluted loss per share for the three month period ending
January 1, 1999 as their effect was anti-dilutive.
Note 4. Inventories
The components of inventories are as follows (in millions):
<TABLE>
<CAPTION>
December 31, October 1,
1999 1999
------------ ----------
<S> <C> <C>
Raw materials and parts............................. $52.1 $36.7
Work in process..................................... 29.8 23.1
Finished goods...................................... 6.3 10.6
----- -----
Total Inventories................................. $88.2 $70.4
===== =====
</TABLE>
5
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
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 $20.8 million at December 31, 1999 and $20.9 million at October 1,
1999.
Note 5. Notes Payable
On October 1, 1999, the Company had a 90-day revolving note payable in
Japanese Yen amounting to an equivalent of $5.5 million U.S. Dollars at an
interest rate of 1.85% per year. In November, 1999, the Company renewed this
borrowing for an amount in Japanese Yen equivalent to $5.8 million for an
additional six months at an interest rate of 2.02%. The note is unsecured and
carries no restrictive covenants. The Company plans to renew this note upon
maturity.
Note 6. Stockholders' Equity
As of December 31, 1999, the Company had 30,648,525 shares of common stock
outstanding. On April 2, 1999, stockholders of record of VAI on March 24, 1999
had 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.
For the three month period ending December 31, 1999, the company issued
174,033 shares of common stock upon the exercise of stock options for an
aggregate exercise price of $2.2 million.
As of December 31, 1999, the Company had outstanding options to purchase an
aggregate of 6,202,120 shares of its common stock at a weighted average price
of $13.35. Of these options, options to purchase an aggregate of 3,237,076
shares at a weighted average price of $13.90 were fully vested and
exercisable.
Note 7. Recent Accounting Pronouncements
Accounting for Derivative Instruments and Hedging Activities
In June 1998, the Financial Accounting and Standards Board issued SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS 133
requires derivatives to be measured at fair value and to be recorded as assets
or liabilities on the balance sheet. The accounting for gains or losses
resulting from changes in the fair values of those derivatives would be
dependent upon the use of the derivative and whether it qualifies for hedge
accounting. SFAS 133 is effective for the Company's fiscal year 2001. The
Company has not yet determined the impact of its implementation on the
Company's consolidated financial statements.
Revenue Recognition in Financial Statements
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in
Financial Statements." SAB 101 summarizes the SEC's view in applying generally
accepted accounting principles to selected revenue recognition issues. The
application of the guidance in SAB 101 will be required in the Company's first
quarter of the fiscal year 2001. The Company does not expect the adoption of
SAB 101 to have a material effect on their financial statements, however the
final evaluation of SAB 101 is not yet complete.
6
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
Note 8. Foreign Exchange Contracts
As a multinational firm, the Company faces exposure to adverse movements in
foreign currency exchange rates. This exposure may change over time as the
Company's business practices evolve and could have a material adverse impact
on the Company's financial results. Historically, the Company's primary
exposures have resulted from non-U.S. dollar denominated sales and purchases
in Asia and Europe.
At the present time, the Company hedges currency exposures that are
associated with certain of its assets and liabilities denominated in various
non-functional currencies and with anticipated foreign currency cash flows.
The Company does not enter into forward exchange contracts for trading
purposes. The Company's forward exchange contracts generally range from one to
two months in original maturity. No forward exchange contract has an original
maturity greater than one year.
Forward exchange contracts outstanding as of December 31, 1999 are
summarized as follows:
<TABLE>
<CAPTION>
Notional Contract Fair
Value Rate Value
----------- -------- -----------
<S> <C> <C> <C>
Foreign Currency Purchase Contracts:
Singapore Dollar......................... $ 625,000 1.6690 $ 624,626
Euro..................................... 3,116,740 1.0054 3,131,310
----------- -----------
Total.................................... 3,741,740 3,755,936
----------- -----------
Foreign Currency Sell Contracts:
Japanese Yen............................. $16,065,300 102.91 $16,161,095
Euro..................................... 11,300,000 1.0054 11,352,825
New Taiwan Dollar........................ 8,600,946 31.70 8,683,121
Korean Won............................... 7,909,507 1136.0 7,864,508
----------- -----------
Total.................................... 43,875,753 44,061,549
=========== ===========
Total Contracts............................ $47,617,493 $47,817,485
=========== ===========
</TABLE>
There were no significant unrealized gains or losses for the forward
exchange contracts as of December 31, 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.
Note 9. Operating Segments and Geographic Information.
The Company adopted SFAS 131, "Disclosures About Segments of an Enterprise
and Related Information," during the fourth quarter of fiscal year 1999. SFAS
131 established standards on reporting information about operating segments in
annual financial statements and also requires interim reporting of segment
information. It also established standards for related disclosures about
products and services.
The Company operates in five principal operating segments, which are
research and development, services, semiconductor equipment manufacturing and
product sales for Japan, Korea and Rest of World. These operating segments
were determined based upon the nature of products and services provided as
well as the geographic areas served and the Company's management structure.
The Company has three reportable segments; Product
7
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
Segment, Services Segment, and Research and Development Segment, which
includes royalties on licensing of intellectual property. The accounting
policies of the business segments are the same as those in all parts of the
Company.
Operating Segments
(Dollars in millions)
<TABLE>
<CAPTION>
Research and
Product Services Development Corporate and
Segment Segment Segment Unallocated Total
------------- ------------- ------------- -------------- -------------
FY2000 FY1999 FY2000 FY1999 FY2000 FY1999 FY2000 FY1999 FY2000 FY1999
Qtr 1 Qtr 1 Qtr 1 Qtr 1 Qtr 1 Qtr 1 Qtr 1 Qtr 1 Qtr 1 Qtr 1
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues ............... $97.0 $36.6 $12.0 $9.7 $0.8 $1.1 $ -- $ -- $109.8 $47.4
Gross profit (loss)..... 51.6 17.8 4.3 2.9 0.8 1.1 (16.7) (9.6) 40.0 12.2
</TABLE>
The Company primarily measures segment profitability based upon gross profit
excluding costs for warranty, installation and other unallocated costs of
goods sold. These unallocated costs are included in the "Corporate and
Unallocated" column above. Other than depreciation and amortization for the
Research and Development Segment, which was $1.0 million for the first quarter
of fiscal year 2000 and $1.1 million for the first quarter of fiscal year
1999, the Company does not have the other information about Profit or Loss and
Assets that are included in the measure of segment profit or loss or segment
assets. These other disclosures for reportable segments are impracticable to
determine for each segment above.
Geographic Information
(Dollars in millions)
Sales to Unaffiliated Customers (by location of the operation)
<TABLE>
<CAPTION>
FY2000 FY1999
Qtr 1 Qtr 1
------ ------
<S> <C> <C>
United States................................................ $ 97.2 $ 41.0
International................................................ 53.7 18.3
Eliminations & Other......................................... (41.1) (11.9)
------ ------
Total...................................................... $109.8 $ 47.4
====== ======
</TABLE>
Total sales is based on the location of the operation furnishing goods and
services. International sales based on final destination of products sold are
$91 million in the first quarter of fiscal year 2000 and $26 million in the
first quarter of fiscal year 1999. Because a substantial portion of the
Company's sales are derived from the sales of products manufactured in the
United States, long-lived assets located outside the United States are less
than 10%.
For the first quarter of fiscal year 2000, revenue of the Company from
customers in the United States, Europe and Asia were approximately 17%, 27%
and 56%, respectively, of the Company's total revenue. For the first quarter
of fiscal year 1999, revenue of the Company from customers in the United
States, Europe and Asia were approximately 44%, 20% and 36%, respectively, of
the Company's total revenue.
In the first quarter of fiscal year 2000, revenue from one customer based in
Asia represented 11% of total revenue. No other customer accounted for revenue
in excess of 10% in the first quarter of fiscal year 2000. No one customer
accounted for revenue in excess of 10% of total revenue in the first quarter
of fiscal year 1999.
8
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
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, 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. VMS (formerly VAI) expenditures
for environmental investigations and remediation work amounted to $0.9 million
for the first three months of fiscal 2000 compared to $2.7 million in fiscal
year 1999, $4.9 million in fiscal year 1998 and $2.3 million in fiscal year
1997.
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 December 31, 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 $50.1 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 December 31, 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 December
31, 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
December 31, 1999, VMS estimated that its aggregate future exposure for
environmental-related investigation and remediation costs for these sites
ranged from $38.8 million to $66.2 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 December 31, 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 $45.3 million at December 31, 1999. Accordingly, VMS has
accrued $20.0 million, which represents management's best estimate of the
future costs discounted at 7%, net of inflation. This accrual is in addition
to the $20.6 million described above.
9
<PAGE>
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
As of December 31, 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>
2000..................................... $ 0.3 $0.8 $ 1.1
2001..................................... 0.5 0.4 0.9
2002..................................... 0.5 -- 0.5
2003..................................... 0.5 -- 0.5
2004..................................... 0.5 -- 0.5
Thereafter............................... 9.6 0.5 10.1
----- ---- -----
Total costs............................ $11.9 $1.7 $13.6
===== ====
Imputed interest......................... (4.8)
-----
Total reserve.......................... $ 8.8
=====
</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 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 $1.3 million at December 31, 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.
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VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
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. The
gain on the sale was $33.2 million (net of income taxes of $17.8 million).
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, VAI 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 $27.5 million at December 31, 1999, relates to
remaining costs associated with pending litigation and indemnity obligations
relating to certain patent infringment claims by Applied Materials, Inc.
("Applied Materials").
Legal Proceedings
In June 1997, Applied Materials 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 Materials
contends that its patents are infringed by the M2i, MB2(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 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 Materials 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 Materials contending that certain of Applied Materials'
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 Materials which includes a
claim that Applied Materials 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.
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
Materials 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 December 31,
1999. Prior to April 2, 1999, the Company's business 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-K filed with the
Securities and Exchange Commission on December 30, 1999 and the Company's
report on Form 10/A filed on February 12, 1999.
Results of Operations
Three Months Ended December 31, 1999 Compared to Three Months Ended January
1, 1999
Revenue. The Company's strong revenue growth continued into the first
quarter of fiscal year 2000. Total revenue increased from $47.4 million to
$109.8 million, or 132%, for the quarter ended December 31, 1999 compared to
the quarter ended January 1, 1999. This increase in revenue was primarily due
to strong demand for the Company's products, as the semiconductor industry
recovery that started in the second half of fiscal year 1999 continued into
fiscal year 2000. The trend has shown revenue increasing consistently, quarter
after quarter, since the fourth quarter of fiscal year 1998: revenue for the
first quarter of fiscal year 1999 was 14% 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 fiscal year 1999; revenue in the third
quarter of fiscal year 1999 was 20% higher than revenue in the second quarter
of fiscal year 1999; and revenue in the fourth quarter of fiscal year 1999, at
$85.3 million (after adjustment for $22.2 million of non-recurring royalty
revenue) was 34% above revenue in the third quarter of fiscal year 1999. At
$109.8 million for the first quarter of fiscal year 2000, total revenue
increased 29% above revenue for the fourth quarter of fiscal year 1999,
excluding non-recurring royalty revenue.
Service revenue in the first quarter of fiscal year 2000 was $12.0 million,
23% higher than service revenue of $9.7 million in the first quarter of fiscal
year 1999, primarily due to the increase in sales of systems.
Royalty revenue of $0.8 million in the first quarter of fiscal year 2000 was
20% below royalty revenue of $1.0 million in the first quarter of fiscal year
1999.
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International revenue was $90.8 million, or 83% of total revenue, in the
first quarter of fiscal year 2000, compared to $26.3 million, or 56% of total
revenue, in the first quarter of fiscal year 1999. The Company's North
American (primarily U.S.) revenue decreased to $19.0 million from $21.0
million, while its European region revenue increased by $20.3 million, from
$9.3 million in the first quarter of fiscal year 1999 to $29.6 million in the
first quarter of fiscal year 2000.
The aggregate revenue of $61.2 million from Taiwan, Japan, Korea and the
Pacific Rim represented 56% of total revenue in the first quarter of fiscal
year 2000, up from $17.0 million, or 36% of total revenue, in the first
quarter of fiscal year 1999. Taiwan was particularly strong, representing 29%
of total revenue in the first quarter of fiscal year 2000, up from
approximately 10% of total revenue in the first quarter of fiscal year 1999.
Gross Profit. The Company's gross profit of $40.0 million in the first
quarter of fiscal year 2000 increased 328% compared to gross profit of $12.2
million for the first quarter of fiscal year 1999. Cost of revenue for the
first quarter of fiscal year 2000 was $69.8 million, resulting in a gross
margin of 36.5% on revenues of $109.8 million, compared with cost of revenue
for the first quarter of the prior year of $35.2 million, resulting in a gross
margin of 25.7% on revenues of $47.4 million. Margins in the first quarter of
fiscal year 2000 improved due to improved capacity utilization due to
increased manufacturing activity, offset by the costs of initial training and
other product and volume-driven costs to respond to the increased demand for
the Company's products.
Research and development. Research and development expenses were $11.2
million for the first three months of fiscal year 2000, equivalent to 10.2% of
total revenue, and were 45% above the research and development expenses of
$7.7 million for the first three months of fiscal year 1999, equivalent to 16%
of total revenue. The reduction in percentage is mainly due to the increase in
revenue for the period. The Company continues to invest in new product
development.
Marketing, General and Administrative. Marketing, general and administrative
expenses of $21.5 million, or 20% of total revenue, in the first three months
of fiscal year 2000 were 45% above the level of marketing, general and
administrative expenses of $14.8 million, or 31% of total revenue, in the
first quarter of fiscal year 1999. The higher expense in the first quarter of
fiscal year 2000 was due in part to the increase in sales and marketing
activity and costs associated with being an independent public company.
Interest Income. During the first quarter of fiscal year 2000, the Company
earned $0.8 million in interest income. This income was earned primarily on
short term investments. Interest income did not accrue to the Company in the
first quarter of fiscal year 1999.
Net Earnings Before Taxes. During the first quarter of fiscal year 2000 the
Company recognized pretax earnings of $8.2 million and for the first quarter
of fiscal year 1999 incurred a pre-tax loss of $10.3 million.
Taxes on Earnings. VSEA recorded a tax provision of $2.9 million on earnings
in the first quarter of fiscal year 2000 compared with a tax benefit of $3.6
million in the first three months of fiscal year 1999. The effective income
tax rate was 35.0% in the first three months of fiscal year 2000, compared to
35.2% in the first three months of fiscal year 1999.
Net Earnings. Net earnings were $5.3 million, or $0.16 per diluted share,
for the first quarter of fiscal year 2000, compared with a net loss of $6.7
million, or $0.22 loss per share, during the first quarter of fiscal year
1999. The increase in net earnings primarily reflects the growth in revenues
in fiscal year 2000, and the other factors described above.
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 their required disbursements. As a result,
the Company reported no cash or cash equivalents prior to April 2, 1999.
Pursuant to the Distribution
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Agreement, as of April 2, 1999, the Company received a cash contribution from
VAI such that VSEA's cash and cash equivalents equaled $94.5 million,
restricted cash totaling $5.5 million and its consolidated debt, consisting of
notes payable, was $5.0 million. Such cash and cash equivalents were expected
to represent the Company's principal source of liquidity for the foreseeable
future.
During the first three months of fiscal year 2000, the Company used $12.9
million of cash in operations, compared to $5.0 million in cash used in
operations in the first three months of fiscal year 1999. The primary uses of
cash during the first quarter of fiscal year 2000 were additions to inventory
of $17.8 million to respond to the increased demand for products, and $2.9
million in increased receivables from higher sales.
During the first three months of fiscal year 2000, the Company used $2.3
million for investing activities, primarily for purchase of property, plant
and equipment, and generated $2.7 million in financing activities, primarily
from stock options exercised.
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 December 31, 1999 and the Company's borrowing capability,
will be sufficient to satisfy commitments for capital expenditures and other
cash requirements for the foreseeable future.
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 the Comprehensive
Environmental Response, Compensation and Liability Act of 1980, 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. VMS (formerly VAI) expenditures
for environmental investigations and remediation work amounted to $0.9 million
for the first three months of fiscal 2000 compared to $2.7 million in fiscal
year 1999, $4.9 million in fiscal year 1998 and $2.3 million in fiscal year
1997.
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 December 31, 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 $50.1 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 December 31, 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 December
31, 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
December 31, 1999, VMS estimated that its aggregate future exposure
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for environmental-related investigation and remediation costs for these sites
ranged from $38.8 million to $66.2 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 December 31, 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 $45.3 million at December 31, 1999. Accordingly, VMS has
accrued $20.0 million, which represents management's best estimate of the
future costs discounted at 7%, net of inflation. This accrual is in addition
to the $20.6 million described above.
The Company recorded $8.8 million as its portion of the foregoing estimated
future costs for environmental liability of VMS as of December, 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 $1.3 million at December 31, 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
Year 2000 Definition
The Company relies heavily on its existing application software and
operating systems. The Year 2000 computer problem refers to the potential for
system and processing failures of date-related data as a result of computer-
controlled systems using two digits rather than four to define the applicable
year. For example, computer programs that have time-sensitive software may
recognize a date represented as "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruption of operations.
The Company uses a significant number of computer software programs and
operating systems in internal operations, including applications used in
financial, product development, order management and manufacturing systems, as
well as in the products the Company manufactures and sells. Additionally, the
Company is dependent
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upon its critical suppliers, contract manufacturers, other vendors, and
customers to determine if their operations, products, services and the
payments they provide are Year 2000 ready.
Project Overview
To address the Year 2000 issue, the Company assembled a task force to review
and assess internal software, data management, accounting, manufacturing and
operational systems to ensure that they do not malfunction as a result of the
Year 2000 date transition. The Company's Year 2000 project began in October
1998 with a designated Year 2000 project manager and a team of Year 2000
project coordinators. The overall project comprises project planning and
awareness, inventory assessment, triage, resolution, test planning and
execution, deployment and fallout and contingency planning. The Company's
planning and corrective measures are proceeding in parallel with respect to
(1) its internal systems, (2) its products, and (3) significant third parties
with which the Company does business. These reviews and corrective measures
are intended to encompass significant categories of internal systems used by
the Company, including data management, accounting, manufacturing, sales,
human resources and operational software and systems.
Transition into the Year 2000
The Company implemented and executed its Year 2000 project plan. Global
coverage and tracking of the Company's primary business office, supplier and
customer equipment locations commenced starting at 7:00am EST December 31st,
1999 and concluded at 7:00am EST January 1, 2000 to accommodate the global
transition into the new year and allow time for reactionary measures. Our
internal business system and facilities were on-line and operational at the
start of our first business day January 3, 2000.
To date, none of our significant systems, applications, equipment or
facilities have experienced any material difficulties from the transition to
Year 2000, nor have we been notified that any of our suppliers or customers
have had any such difficulties.
Due the complexity of potential issues related to the Year 2000, the Company
will continue to monitor related activities and future dates throughout the
remainder of the calendar year. Although the Company believes it has addressed
all significant issues and does not anticipate or foresee any significant
problems in the future, no final determination has been made and actual
results could differ materially from our plan.
Internal Systems
The Company has completed its assessment of potential Year 2000 problems in
its internal systems and had transitioned into the Year 2000 without any major
incidents. 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 modules is complete in all VSEA locations globally except Europe,
which has the SAP Finance modules integrated with a European distribution
system (IBS), which is Y2K compliant. Upgrade of networking and
telecommunications systems, factory information systems, non-IT systems,
computers and packaged software and facilities systems is complete.
Product Compliance
The Company has completed its assessment of potential Year 2000 problems in
its current and previously sold products, and has transitioned into the Year
2000 without any major incidents. With respect to current products, the
assessment and corrective actions are complete, and the Company believes that
all of its current
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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 the Company's current
products.
With respect to compliance of the products the Company supplies to its
customers, the Company adheres to Year 2000 test case scenarios established by
SEMATECH, an industry group comprised of US semiconductor manufacturers. The
Company's compliance efforts, and review and identification of corrective
measures and contingency planning (where necessary), are complete. The Company
has over 2700 installed tools at its customers' sites. The Company's field
service engineers and product support specialists have surveyed and audited
the configuration of the tools determine what needs to be done to bring the
products to Year 2000 compliance. Readiness, upgrade requirements or "never
ready" status has been reviewed through a series of system audits and an
implementation plan put in place as required for each of the products.
Information regarding the readiness of the Company's products is made
available on the corporate web site at www.vsea.com. This program has covered
several key areas including date inspections, operating system investigations,
runtime tests, software inspections and third party software component
verification. The Company has completed the product assessment, which includes
products, information systems and networks. A substantial majority of the
systems and products can be upgraded with readily available externally
utilized computers and packaged software or with internally developed
software. Where the Company identifies previously sold products that are not
Year 2000 capable, the Company intends in some cases to develop and offer to
sell upgrades or retrofits, identify corrective measures which the customer
could undertake, or identify for the customer other suppliers of upgrades or
retrofits.
The Company has substantially completed these upgrade services to its
customers. There may be instances where the Company will be required to repair
and/or upgrade such products at the Company's expense.
Supply Chain
The Company has completed the audit of all the critical suppliers. The
Company considers all of these suppliers Year 2000 capable, and has
transitioned into the Year 2000 without any major incidents. The Company will
continue to monitor any addition of new suppliers to assure readiness is
maintained. However, because the Company's readiness is dependent on timely
Year 2000 readiness of third parties, there can be no assurances that its
efforts alone will resolve all future Year 2000 issues applicable to the
Company's internal processes or products.
Third Party Assessment
In November 1999, the Company contracted an external consulting firm to
conduct a third-party assessment of the Company's project completeness. The
assessment process covered the aspects outlined in the Company's Year 2000
project. The Company is considered to be overall compliant of Year 2000
readiness, as described in the consultant's assessment report.
Costs
As of January 1, 2000, the Company estimates that it had incurred costs of
less than $1 million to assess and correct Year 2000 problems, primarily
during fiscal year 1999. Although difficult to assess, based on its analysis
to date, the Company 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 the first half of fiscal year 2000. All of
these costs have been and will continue to be expensed as incurred. However,
the actual future incremental spending may prove to be higher. Also, this
estimate does not include the costs that could be incurred if one or more of
the significant third party service providers fail to achieve Year 2000
readiness throughout the remainder of the calendar year. The Company has not
separately identified the costs incurred for its Year 2000 readiness program
that are the result of use of internal resources and therefore, these costs
are not included in the above estimates.
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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, the Company 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 the Company's actual costs
to assess and correct Year 2000 problems will not be higher than the foregoing
estimate.
Contingency Plans
The Company regards contingency planning for the Year 2000 compliance as one
of the most critical components of its Year 2000 project. The Company has
developed contingency plans to maintain operations under a number of
hypothetical scenarios. The Company had begun the development of a contingency
plan in mid 1999 and finalized all aspects of the contingency plan at the end
of November 1999. The contingency plan covers not only the issues specific to
Year 2000 but also any natural disaster that may be of potential occurrence to
the Company. The Company also has developed contingency response management
for the "worst case scenarios", such as power outage, water and gas
disruption, network failure. The Company has implemented the necessary and
appropriate actions for these scenarios and has made the transition into the
Year 2000 without any major incidents.
The Company's spare inventory, distribution system and customer support
organization, as well as the contingency plans implemented by the Company, are
intended to ensure that temporary disruptions to regional and global
infrastructure systems will have no materially adverse effect on the Company's
operations and financial performance. Although the Company has transitioned
into the Year 2000 without any major incidents, extended disruptions in these
systems beyond the Company's control or ability to remedy, such as described
above, could impact the Company's ability to deliver product and services to
our customers on schedule and to maintain Company operations and provide
appropriate employee support (including payroll and benefits), and would,
thereby, potentially have a materially adverse effect on the Company's
operations and financial performance.
The Company believes that Year 2000 problems will not have a material
adverse effect on the Company's financial condition or overall trends in the
results of operations. However, there can be no assurance that delays or
problems, including the failure to ensure Year 2000 compliance beyond January
1, 2000, by systems or products supplied to the Company by a third party, will
not have an adverse effect on the Company, its financial performance or the
competitiveness or customer acceptance of its products. Further, the Company's
current understanding of expected costs is subject to change as potential
contingency planning proceeds and does not include potential costs related to
actual customer claims or the cost of internal software and hardware replaced
in the normal course of business (whose installation otherwise in the normal
course of business may be accelerated to provide solutions to Year 2000
compliance issues).
With respect to products and significant third parties, the Company believes
it has identified all critical systems necessary to the Company's internal
system operations and has requested suppliers to provide assurances that such
systems are Year 2000-compliant, or to identify replacement or upgrade
systems. With respect to Year 2000 compliance of its suppliers' systems, the
Company has completed the process of evaluating and assessing the adequacy of
responses from its various suppliers with the assurance that all of its
critical suppliers are and will remain Year 2000 compliant, and has
transitioned into the Year 2000 without any major incidents.
Based on its transition into the Year 2000, the Company believes the
Company's existing internal systems encompassing core manufacturing, service,
sales, inventory and warranty operations are currently, and will continue to
be, Year 2000-compliant. Some of the Company's payroll operations are handled
on an out-sourced basis, and the Company has received written assurances from
its providers that the systems providing these outsource services are and will
continue to be Year 2000-compliant.
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Risks
Failure of the Company and its key suppliers to accurately assess and
correct future Year 2000 problems would likely result in interruption of
certain of the Company's normal business operations, which could have a
material adverse effect on the Company's business, results of operations and
financial condition. If the Company 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, which could cause delays in product
shipments, lost data and a consequential impact on revenues, expenditures and
financial reporting. If the Company does not adequately identify and correct
unforeseen or future 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 the Company does not adequately identify and correct unforeseen
or future 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 the Company 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 the
Company believes that it is Year 2000 compliant, it does not currently believe
that any unforeseen or future Year 2000 non-compliance in the Company's
information systems will have a material adverse effect on the Company'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 the company; and the additional complexity which will
likely be caused by the undertaking during the remainder of fiscal year 2000
the separation of currently shared enterprise information systems as a result
of the Distribution.
Due to the uncertainties as to the extent of Year 2000 problems beyond the
January 1, 2000 transition with the Company's previously sold products and the
extent of any legal obligation of the Company to correct Year 2000 problems in
those products, the Company cannot yet assess risks to the Company with
respect to those products. The Company has completed assessments of its
critical suppliers and has concluded that the failure of critical suppliers to
assess and correct remaining unforeseen Year 2000 problems is not reasonably
likely, and therefore is not expected to have a material adverse effect on the
Company's results of operations.
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.
19
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Foreign Currency Exchange Risk
As a multinational firm, the Company faces exposure to adverse movements in
foreign currency exchange rates. This exposure may change over time as the
Company's business practices evolve and could have a material adverse impact
on the Company's financial results. Historically, the Company's primary
exposures have resulted from non-U.S. dollar denominated sales and purchases
in Asia and Europe.
At the present time, the Company hedges currency exposures that are
associated with certain of its assets and liabilities denominated in various
non-functional currencies and with anticipated foreign currency cash flows.
The Company does not enter into forward exchange contracts for trading
purposes. The Company's forward exchange contracts generally range from one to
two months in original maturity. No forward exchange contract has an original
maturity greater than one year.
Forward exchange contracts outstanding as of December 31, 1999 are
summarized as follows:
<TABLE>
<CAPTION>
Notional Contract Fair
Value Rate Value
----------- -------- -----------
<S> <C> <C> <C>
Foreign Currency Purchase Contracts:
Singapore Dollar......................... $ 625,000 1.6690 $ 624,626
Euro..................................... 3,116,740 1.0054 3,131,310
----------- -----------
Total.................................. 3,741,740 3,755,936
----------- -----------
Foreign Currency Sell Contracts:
Japanese Yen............................. $16,065,300 102.91 $16,161,095
Euro..................................... 11,300,000 1.0054 11,352,825
New Taiwan Dollar........................ 8,600,946 31.70 8,683,121
Korean Won............................... 7,909,507 1136.0 7,864,508
----------- -----------
Total.................................. 43,875,753 44,061,549
=========== ===========
Total Contracts............................ $47,617,493 $47,817,485
=========== ===========
</TABLE>
There were no significant unrealized gains or losses for the forward
exchange contracts as of December 31, 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 "Item 7A.
Quantitative and Qualitative Disclosures About Market Risk" in the Company's
Report on Form 10-K for the fiscal year ended on October 1, 1999, filed with
the Securities and Exchange Commission.
Concentration of Risk
During the first quarter of fiscal year 2000, one customer based in Asia
accounted for 11% of total revenue and two customers each accounted for 10% of
total accounts receivable outstanding as of December 31, 1999. One customer
was based in Europe and the other was based in Asia. No one customer accounted
for 10% of revenue in the first quarter of fiscal year 1999. One customer,
based primarily in the United States, accounted for 10% of total accounts
receivable outstanding as of January 1, 1999.
20
<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 5. OTHER INFORMATION
Operating Segments and Geographic Information
The Company adopted SFAS 131, "Disclosures About Segments of an Enterprise
and Related Information," during the fourth quarter of fiscal year 1999. SFAS
131 established standards on reporting information about operating segments in
annual financial statements and also requires interim reporting of segment
information. It also established standards for related disclosures about
products and services.
The Company operates in five principal operating segments, which are
research and development, services, semiconductor equipment manufacturing and
product sales for Japan, Korea and Rest of World. These operating segments
were determined based upon the nature of products and services provided as
well as the geographic areas served and the Company's management structure.
The Company has three reportable segments: Product Segment, Services Segment,
and Research and Development Segment, which includes royalties on licensing of
intellectual property. The accounting policies of the business segments are
the same as those in all parts of the Company.
Operating Segment and Geographic Information for the first quarter of fiscal
year 2000 and the comparative first quarter of fiscal year 1999 are contained
in "PART I FINANCIAL INFORMATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS, Note 9. Operating Segments and Geographic Information." Operating
Segment and Geographic Information for all quarters of fiscal year 1999
follow.
Operating Segments
(Dollars in millions)
<TABLE>
<CAPTION>
Fiscal Year 1999
-------------------------------------
First Second Third Fourth Total
Operating Segment Quarter Quarter Quarter Quarter Year
----------------- ------- ------- ------- ------- -----
<S> <C> <C> <C> <C> <C>
Revenue
Product Segment..................... $ 37 $ 42 $ 55 $ 72 $206
Services Segment.................... 10 10 7 10 37
Research and Development Segment.... 1 1 2 25 29
Corporate and Unallocated........... -- -- -- -- --
---- ---- ---- ---- ----
Total Revenue...................... $ 48 $ 53 $ 64 $107 $272
---- ---- ---- ---- ----
Gross Profit
Product Segment..................... $ 18 $ 18 $ 31 $ 37 $104
Services Segment.................... 3 4 1 2 10
Research and Development Segment.... 1 1 2 25 29
Corporate and Unallocated........... (10) (19) (12) (13) (54)
---- ---- ---- ---- ----
Total gross profit................. $ 12 $ 4 $ 22 $ 51 $ 89
---- ---- ---- ---- ----
</TABLE>
The Company primarily measures segment profitability based upon gross profit
excluding costs for warranty, installation and other unallocated costs of
goods sold. These unallocated costs are included in the "Corporate and
Unallocated" row above. Other than depreciation and amortization for the
Research and Development Segment, which was $1.1 million in the first quarter
of fiscal year 1999, and $1.0 million in each of the following
21
<PAGE>
quarters, the Company does not have the other information about Profit or Loss
and Assets that are included in the measure of segment profit or loss or
segment assets. These other disclosures for reportable segments are
impracticable to determine for each segment above.
Geographic Information
(Dollars in millions)
<TABLE>
<CAPTION>
Fiscal year 1999
-------------------------------------
First Second Third Fourth Total
Quarter Quarter Quarter Quarter Year
------- ------- ------- ------- -----
<S> <C> <C> <C> <C> <C>
United States......................... $ 41 $ 49 $ 61 $104 $255
International......................... 18 23 30 40 111
Eliminations & Other.................. (11) (19) (27) (37) (94)
---- ---- ---- ---- ----
Total............................... $ 48 $ 53 $ 64 $107 $272
---- ---- ---- ---- ----
</TABLE>
Total sales above is based on the location of the operation furnishing goods
and services. International sales based on final destination of products sold
are $26 million, $34 million, $44 million and $56 million for the first,
second, third and fourth quarters of fiscal year 1999, respectively. Total
international sales in fiscal year 1999 were $161 million. Because a
substantial portion of the Company's sales are derived from the sales of
products manufactured in the United States, long-lived assets located outside
the United States are less than 10% of total assets.
For fiscal 1999, revenue of the Company from customers in the United States,
Europe and Asia were approximately 41%, 20% and 39%, respectively, of the
Company's total revenue.
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
December 31, 1999.
22
<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
Date: February 8, 2000 By: /s/ Ernest L. Godshalk III
----------------------------------
Ernest L. Godshalk III
Vice President and Chief Financial
Officer
(Principal Financial Officer)
Date: February 8, 2000 By: /s/ Seth H. Bagshaw
----------------------------------
Seth H. Bagshaw
Vice President and Corporate
Controller
(Principal Accounting Officer)
23
<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> 3-MOS
<FISCAL-YEAR-END> SEP-29-2000
<PERIOD-START> OCT-02-1999
<PERIOD-END> DEC-31-1999
<CASH> 7,412
<SECURITIES> 45,668
<RECEIVABLES> 106,217
<ALLOWANCES> 2,848
<INVENTORY> 88,236
<CURRENT-ASSETS> 282,055
<PP&E> 94,734
<DEPRECIATION> 56,021
<TOTAL-ASSETS> 342,311
<CURRENT-LIABILITIES> 133,145
<BONDS> 0
0
0
<COMMON> 306
<OTHER-SE> 200,374
<TOTAL-LIABILITY-AND-EQUITY> 342,311
<SALES> 97,015
<TOTAL-REVENUES> 109,793
<CGS> 69,766
<TOTAL-COSTS> 102,415
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (773)
<INCOME-PRETAX> 8,151
<INCOME-TAX> 2,853
<INCOME-CONTINUING> 5,298
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,298
<EPS-BASIC> 0.17
<EPS-DILUTED> 0.16
</TABLE>
