Page 1
United States
Securities and Exchange Commission
Washington, D.C. 20549
Form 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the period ended September 30, 1998
------------------
Commission file number 0-23628
-------
Fusion Systems Corporation
- -------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 52-0915080
- -------------------------------------------------------------
(State of incorporation) (I.R.S. Employer
Identification No.)
7600 Standish Place, Rockville, MD 20855
- -------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(301) 251-0300
- -------------------------------------------------------------
(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 twelve months
and (2) has been subject to such filing requirements for the past
ninety days. Yes X
---
The registrant meets the conditions set forth in General Instruction
H(1)(a) and (b) of Form 10-Q and is therefore filing this form with
the reduced disclosure format.
There were 10 Common Shares outstanding as of September 30, 1998
which were held by Eaton Corporation.
<PAGE>
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Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Fusion Systems Corporation and Subsidiaries
(wholly-owned subsidiaries of Eaton Corporation)
<TABLE>
Condensed Consolidated Balance Sheets
<CAPTION>
Sept. 30, Dec. 31,
(Thousands) 1998 1997
---- ----
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $ 2,544
Short-term marketable securities 16 $ 16,329
Accounts receivable 11,021 17,296
Note receivable from Eaton Corporation 85,009 72,784
Due from Eaton Corporation 9,392 4,269
Inventories 17,413 16,012
Deferred income taxes and other
current assets 3,578 3,391
-------- --------
128,973 130,081
Property, plant and equipment 13,602 14,998
Intangible assets 33,333 37,619
Excess of cost over net assets of
business acquired 50,473 51,351
Other assets 4,445 3,750
-------- --------
$230,826 $237,799
======== ========
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities
Accounts payable and other current
liabilities $ 15,800 $ 9,943
-------- --------
15,800 9,943
Other liabilities 40
Deferred income taxes 12,191 13,166
Shareholder's equity 202,795 214,690
-------- --------
$230,826 $237,799
======== ========
</TABLE>
See accompanying notes.
<PAGE>
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Fusion Systems Corporation and Subsidiaries
(wholly-owned subsidiaries of Eaton Corporation)
<TABLE>
Statements of Consolidated Operations
<CAPTION>
Three Months Ended Nine Months Ended
-------------------- --------------------
Sept. 30, Sept. 26, Sept. 30, Sept. 26,
(Thousands) 1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales $ 8,728 $ 23,670 $ 34,247 $ 64,759
Costs and expenses
Cost of products sold 9,623 13,384 27,900 33,194
Selling, general & administrative 4,105 8,423 11,763 16,636
Research, development & engineering 4,600 5,674 15,161 13,971
Liquidation of stock options 13,748 13,748
Purchased in-process research &
development 85,000 85,000
-------- -------- -------- --------
18,328 126,229 54,824 162,549
-------- -------- -------- --------
Loss from operations (9,600) (102,559) (20,577) (97,790)
Other income (expense)
Interest income, net 1,052 1,088 3,571 4,070
Other--net (739) 57 (1,132) 41
-------- -------- -------- --------
313 1,145 2,439 4,111
-------- -------- -------- --------
Loss before income taxes (9,287) (101,414) (18,138) (93,679)
Income tax benefit (3,321) (4,383) (6,067) (1,598)
-------- -------- -------- --------
Net loss $ (5,966) $(97,031) $(12,071) $(92,081)
======== ======== ======== ========
</TABLE>
See accompanying notes.
<PAGE>
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Fusion Systems Corporation and Subsidiaries
(wholly-owned subsidiaries of Eaton Corporation)
<TABLE>
Condensed Statements of Consolidated Cash Flows
<CAPTION>
Nine Months Ended
----------------------
Sept. 30, Sept. 26,
(Thousands) 1998 1997
---- ----
<S> <C> <C>
Net cash used in operating activities
Net loss $(12,071) $(92,081)
Adjustments to reconcile to net cash
used in operating activities
Depreciation and amortization 9,874 4,308
Write-off of purchased in-process research
and development 85,000
Changes in operating assets and liabilities (10,137) (82,999)
-------- --------
(12,334) (85,772)
Net cash provided by investing activities
Expenditures for property, plant and equipment (1,611) (3,666)
Payments related to sale of discontinued operations (1,047)
Sales of short-term investments--net 16,313 52,566
Foreign currency translation adjustment 176 (56)
Other--net (1,021)
-------- --------
14,878 46,776
Net cash provided by financing activities
Proceeds from exercise of stock options and
stock sale--net of income tax benefit 551
-------- --------
0 551
-------- --------
Increase (decrease) in cash and cash equivalents 2,544 (38,445)
Cash and cash equivalents at beginning of year 38,445
-------- --------
Cash and cash equivalents at end of period $ 2,544 $ 0
======== ========
</TABLE>
See accompanying notes.
<PAGE>
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The following notes are included in accordance with the requirements
of Regulation S-X and Form 10-Q:
(dollar amounts in thousands)
Preparation of Financial Statements
- -----------------------------------
The condensed consolidated financial statements of Fusion Systems
Corporation (Fusion or the Company) are unaudited. However, in the
opinion of management, all adjustments have been made which are
necessary for a fair presentation of financial position, results of
operations and cash flows for the stated periods. These financial
statements should be read in conjunction with the consolidated
financial statements and related notes included in the Company's
1997 Annual Report on Form 10-K. The interim period results are not
necessarily indicative of the results to be expected for the full
year. Information relating to earnings per share is not presented
because the registrant is a wholly-owned subsidiary of Eaton
Corporation (Eaton).
Acquisition by Eaton Corporation
- --------------------------------
On August 4, 1997, the Company was purchased by Eaton Corporation
for $293 million, before a reduction for cash acquired of $90
million. The purchase price allocation included $85 million for
purchased in-process research and development which was determined
through an independent valuation. This amount was expensed at the
date of acquisition because technological feasibility had not been
established and no alternative commercial use had been identified.
Therefore, the third quarter of 1997 includes the write-off of $85
million for purchased in-process research and development, with no
income tax benefit.
A special charge of $13.7 million ($8.9 million, net of income tax
benefit) for the liquidation of Fusion's outstanding stock options
and other charges related to the purchase of the Company by Eaton
was recorded in operations in the third quarter of 1997.
Inventories
- -----------
Sept. 30, Dec. 31,
1998 1997
---- ----
Raw materials and purchased parts $11,909 $ 5,528
Work-in-process and
finished goods 5,504 10,484
------- -------
Total inventories $17,413 $16,012
======= =======
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Comprehensive Income
- --------------------
On January 1, 1998, the Company adopted Statement of Financial
Accounting Standard (SFAS) No. 130, 'Reporting Comprehensive
Income'. SFAS No. 130 establishes new standards for reporting
comprehensive income and its components; however, the adoption
of SFAS No. 130 has no impact on the Company's net income or share-
holder's equity. For the Company, the principal difference between
net income as historically reported in the statements of
consolidated operations and comprehensive income are foreign
currency translation adjustments recorded in shareholder's equity.
Comprehensive income is as follows:
Three Months Ended
------------------
Sept. 30, Sept. 26,
1998 1997
---- ----
Net loss $ (5,966) $(97,031)
Foreign currency translation 2 (42)
-------- --------
Comprehensive loss $ (5,964) $(97,073)
======== ========
Nine Months Ended
------------------
Sept. 30, Sept. 26,
1998 1997
---- ----
Net loss $(12,071) $(92,081)
Foreign currency translation 176 (56)
-------- --------
Comprehensive loss $(11,895) $(92,137)
======== ========
Recently Issued Accounting Pronouncements
- -----------------------------------------
In June 1998, SFAS No.133, 'Accounting for Derivative Instruments
and Hedging Activities', was issued. The Company must adopt the
standard by the beginning of the first quarter of the year 2000.
Because of the Company's minimal use of derivatives, management
does not anticipate that the adoption of SFAS No.133 will have a
significant effect on earnings or the financial position of the
Company.
Information Concerning Geographic Regions
- -----------------------------------------
Net Sales by Geographic Region
The Company sells its products in several geographic regions. Net
sales by the location of the Company's customers for the first nine
months of 1998 and 1997 are as follows:
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1998 1997
---- ----
North America $16,395 $37,706
Europe 10,311 12,825
Pacific Region 7,541 14,228
------- -------
Total sales $34,247 $64,759
======= =======
Operating Locations
The Company manufactures its products in the United States. The
Company's foreign operations consist primarily of sales and service
activities. A significant portion of the Company's sales from its
sales and service offices in Europe and the Pacific Region represent
equipment sales shipped directly from U.S. facilities. A summary of
net sales by operating location for the first nine months of 1998
and 1997 is as follows:
1998 1997
---- ----
North America $22,040 $49,553
Europe 11,647 12,685
Pacific Region 560 2,521
------- -------
Total sales $34,247 $64,759
======= =======
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Results of Operations
- ---------------------
Net sales, consisting of revenues from system sales, spare parts and
service and royalty revenues, decreased 63% and 47%, respectively,
in the third quarter and the first nine months of 1998 compared to
the same periods in 1997. The decrease was primarily due to the
decline in the worldwide semiconductor equipment market which
seriously affected the Company's results in 1998. The Company has
made operating adjustments including a 34% reduction in headcount
and a 67% reduction in budgeted 1998 capital spending.
As a result of the severe conditions in the semiconductor equipment
industry, the Company has lowered 1998 sales expectations. During
the third quarter of 1998, the Company recorded a nonrecurring
pretax charge of $3.4 million to restructure the business which
included workforce reductions, asset write-downs and other
restructuring charges.
In the third quarter of 1997, the Company took a one-time charge of
$85 million, with no income tax benefit, to write-off the purchased
in-process research and development associated with the acquisition
of the Company by Eaton. The Company also liquidated certain
outstanding stock options resulting in a charge of $14 million in
the third quarter of 1997.
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Cost of products sold reflects amortization expense of $2,199 in the
third quarter of 1998 and $6,867 in the first nine months of 1998
related to excess cost over the net assets of business acquired and
related intangible assets resulting from Eaton's acquisition of
Fusion in August 1997. The Company also recorded restructuring
charges in the third quarter of 1998 as described above.
Selling, general and administrative expenses decreased 51% in the
third quarter of 1998 and 29% in the first nine months of 1998
compared to the same periods in 1997. The decrease was primarily
due to operating adjustments, including a reduction in headcount,
made to offset the decline in the semiconductor equipment market.
Research, development and engineering expenses decreased 19% and
increased 9%, respectively, in the third quarter and first nine
months of 1998 compared to the same periods in 1997. The year-to-
date increase was primarily due to a substantial increase in the
level of effort needed to develop advanced products including a new
300mm platform, and to support and improve existing products. In
July 1998, the Company introduced the new 300mm product suite which
includes the PS3 Photostabilizer and the ES3 Enhanced Strip Plasma
Asher.
The Company's effective tax rate was 36% for the third quarter of
1998 and 33% for the first nine months of 1998 compared to 4% and
2%, respectively, for the same periods in 1997. The change in the
rate, when compared to 1997, was primarily due to the $85 million
non-deductible write-off of purchased in-process research and
development.
Year 2000 Readiness Disclosure
- ------------------------------
Computer software that uses two digits rather than four to identify
the applicable year may be unable to interpret appropriately the
calendar Year 2000, and thus could cause disruption of normal
business activities. The Company uses software in various aspects
of the business, including certain products, manufacturing, product
development and many administrative functions. Much of this
software may be unable to interpret the calendar Year 2000
appropriately unless it is modified or replaced.
The Company has approached the Year 2000 issue through Eaton's
corporate-wide initiative led by the Eaton's Vice President-
Information Technologies and involving program managers from each
business unit. The activities associated with the corporate-wide
initiative include reviewing date-sensitive products and critical
information technology (IT) and non-IT systems, such as those which
interface with major customers, suppliers, and other third parties.
Eaton's Year 2000 compliance efforts encompass the following focus
areas:
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Business Management Systems: This area includes information systems
and applications relating to manufacturing, marketing, sales,
purchasing, product development and design systems. These systems
have been identified as very important to the support of the Eaton's
operations and have been given the highest priority toward becoming
Year 2000 compliant.
Enterprise Network Infrastructure: Eaton utilizes one enterprise
network throughout the organization which will be upgraded by the
end of 1998 to become Year 2000 compliant. All personal/desktop
computers and related software will also be made compliant.
Administrative Systems: This area includes systems associated with
human resources, cash management and financial accounting and
reporting. Eaton operates a highly centralized systems environment
in North America and throughout much of Europe and is working
towards full compliance of these systems by mid-year 1999.
Shop Floor Equipment and Facilities Infrastructure: Eaton is
auditing the machinery and equipment used both in manufacturing
and in support operations at each location. This audit will
establish Year 2000 readiness and measure the risk of non-compliance
so as to determine the best remediation plan to be followed in
avoiding potential disruptions in production.
Software in Products: All of Eaton's products which are currently
marketed, and the vast majority of the products which have been
marketed in the past, are either not date-sensitive or do not
require remediation. With respect to certain previously-marketed
products of Eaton's Semiconductor Equipment business segment and
Eaton's Cutler- Hammer business, remediation programs are being
pursued that are consistent with its warranty requirements or is
offering product upgrades or remediations.
Supplier Assurance: To determine Year 2000 readiness, Eaton
undertook a supplier assurance program in 1997, which includes
surveying its suppliers and evaluating their responses. Based on
this evaluation and the criticality of the items or services
provided by the suppliers, Eaton is auditing their compliance and
working with them towards assuring compliance or, if needed, the
development of contingency plans.
Customer Assurance: Eaton is working with the Automotive Industry
Action Group, various other trade organizations and customers to
ensure that a common Year 2000 compliance approach is applied across
those respective industries. Continuous interaction with these
trade organizations is helping to identify the issues requiring
attention and to develop appropriate solutions.
Eaton's Year 2000 program activities include the identification of
affected hardware and software, the development of a plan for
correcting those systems in the most effective manner, the execution
of that plan and the monitoring of its success. Although Eaton's
various locations are at differing stages of readiness with respect
<PAGE>
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to the various areas, Eaton has substantially completed the
identification and plan development phases of the project. Eaton is
well underway in the execution phase and anticipates completing the
majority of the program by mid-year 1999 although certain
applications at certain business units may not be completed until
late in 1999. Continuous review and testing is being conducted
throughout all phases of the program to help ensure that Eaton
achieves and maintains compliance as the Year 2000 approaches.
The program, as it relates to IT, involves a combination of hardware
and software modifications, upgrades and replacements. In many
instances, Eaton will replace non-compliant systems with newer
systems which will significantly improve functionality as well as
appropriately interpret the calendar year 2000 and beyond. Although
the timing of these actions may have been influenced by the Year
2000 issue, in virtually all instances they will involve capital
expenditures that would have occurred in the normal course of
business. As part of reengineering and other initiatives, Eaton
is also currently upgrading and replacing other systems to provide
significantly enhanced functionality; however, these upgrades and
replacements are unrelated to the Year 2000 issue.
As part of Eaton's Year 2000 program, detailed contingency plans are
being formalized as the target date for completion approaches.
Business disruption scenarios are currently being identified and
appropriate strategies are being evaluated in the development of
these various plans.
Fusion is a participant in Eaton's corporate-wide Year 2000 program
and current estimated costs for Eaton's program are $95 million.
Approximately $70 million of those costs represent replacement costs
of certain hardware and software which will provide significantly
enhanced functionality over the systems that are currently being
used. The remaining $25 million represents costs associated with
modifying and upgrading existing systems. To date, approximately
two thirds of the estimated costs have been incurred. Purchased
hardware and software will be capitalized in accordance with normal
Eaton policy while other remediation costs will be expensed as
incurred. Cash flow related to these costs will be satisfied with
funds from operations that are normally budgeted for procurement
and maintenance of Eaton's information systems and production and
facilities equipment as well as operating cash flows. Eaton
requires regular project status reporting, and cost estimates will
be revised as more refined estimates become available.
Eaton believes that it has an effective program in place to resolve
the Year 2000 issue in a timely manner. However, satisfactory
completion of Eaton's program may not prevent business disruptions
resulting from actions of Eaton's critical suppliers and customers.
Such disruptions would impair Eaton's ability to obtain necessary
materials for production or sell products to customers. If such a
disruption occurred, Eaton may experience lost or delayed sales and
profits depending on the duration of the disruption. Key aspects of
Eaton's program are addressing this uncertainty but its ability to
be fully confident of conditions related to third parties is limited.
Currently, Eaton cannot reasonably estimate the amount of potential
lost or delayed sales and profits.
<PAGE>
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Euro
- ----
On January 1, 1999, eleven of the fifteen member countries of the
European Monetary Union (EMU) will begin a three-year transition
phase during which a common currency called the Euro will be adopted
as their legal currency. The Euro will then trade on currency
exchanges and be available for non-cash transactions. During the
transition period, public and private parties may pay for goods and
services using either the Euro or the participating country's legacy
currency on a "no compulsion, no prohibition" basis. The conversion
rates between the existing legacy currencies and the Euro will be
fixed on January 1, 1999. The legacy currencies will remain legal
tender for cash transactions between January 1, 1999 and January 1,
2002 at which time all legacy currencies will be withdrawn from
circulation and the new Euro denominated bills and coins will be
used for cash transactions.
Fusion has operations in Italy which is one of the eleven
participating countries that will be utilizing the Euro as their
local currency in 1999. Additionally, Fusion's operations in the
United Kingdom and the Pacific Region will be conducting business
transactions with customers and suppliers that will be denominated
in the Euro. Eaton has established Euro denominated bank accounts
to accommodate Euro transactions that may be utilized by Fusion.
Fusion's exposure to changes in foreign exchange rates may be
reduced as a result of the Euro conversion. Conversely, changes
in the value of the Euro in US Dollars may have a greater impact
because there will be less diversity in Fusion's exposure to
foreign currencies.
Fusion has approached the Euro conversion through Eaton's steering
committee which was established to review strategic and tactical
areas arising from the Euro conversion. Eaton has focused immediate
efforts on aspects of the Euro conversion that require adjustment or
compliance by January 1, 1999. These aspects include transacting
business in the Euro, the competitive impact on product pricing and
adjustments to billing systems to handle parallel currencies. Eaton
has determined that these systems have the capability to handle Euro
transactions. Continuing analysis and development efforts by the
steering committee and project teams at Eaton's business units will
help ensure that the implementation of the Euro meets the timetable
and regulations established by the EMU.
Based on current estimates, Fusion does not expect the costs
incurred to address the Euro will have a material impact on the
financial condition or results of operations.
Forward-Looking Statements
- --------------------------
The forward-looking statements in this Form 10-Q should be used with
caution. They are subject to various risks and uncertainties, many
of which are outside the control of the Company. Important factors
which could cause actual results to differ materially from those in
the forward-looking statements include changes in global economic
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and financial conditions, the market for semiconductor capital
equipment, costs and disruptions associated with the Year 2000
issue, and the impact of the conversion to the Euro currency.
The Company assumes no obligation to update these forward-looking
statements.
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PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits - See Exhibit Index attached.
(b) Reports on Form 8-K.
1. On October 8, 1998, Eaton filed a Current Report on Form
8-K concerning lowering 1998 expectation for sales and
earnings of their Semiconductor Equipment Operations (SEO)
and a $50 million charge to restructure SEO. The Company
is included in Eaton's Semiconductor Equipment business
segment.
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Signature
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Fusion Systems Corporation
----------------------------
Registrant
Date: November 12, 1998 /s/ Adrian T. Dillon
----------------------------
Adrian T. Dillon
Vice President and Chief
Financial Officer and Chief
Accounting Officer
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FUSION SYSTEMS CORPORATION AND SUBSIDIARIES
EXHIBIT INDEX
Regulation S-K,
Item 601 - Exhibit
Reference Number Exhibit
- ------------------ -------
10 Material Contracts
The Agreement and Plan of Merger,
together with the Exhibits
thereto, dated June 30, 1997
included as Exhibit I to the
Company's Schedule 14d-9
Statement filed on July 7, 1997
is incorporated herein by
reference to such Schedule 14d-9.
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Consolidated Balance Sheets and the Statements of Consolidated Operations and is
qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 2,544
<SECURITIES> 16
<RECEIVABLES> 11,284
<ALLOWANCES> 263
<INVENTORY> 17,413
<CURRENT-ASSETS> 128,973
<PP&E> 17,115
<DEPRECIATION> 3,513
<TOTAL-ASSETS> 230,826
<CURRENT-LIABILITIES> 15,800
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 202,795
<TOTAL-LIABILITY-AND-EQUITY> 230,826
<SALES> 34,247
<TOTAL-REVENUES> 34,247
<CGS> 27,900
<TOTAL-COSTS> 54,824
<OTHER-EXPENSES> (2,439)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (18,138)
<INCOME-TAX> (6,067)
<INCOME-CONTINUING> (12,071)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (12,071)
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
