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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 January 2, 2009
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 000-25393
VARIAN, INC.
(Exact Name of Registrant as Specified in its Charter)
Delaware | 77-0501995 | |
(State or Other Jurisdiction of Incorporation or Organization) | (IRS Employer Identification No.) | |
3120 Hansen Way, Palo Alto, California | 94304-1030 | |
(Address of Principal Executive Offices) | (Zip Code) |
(650) 213-8000
(Telephone Number)
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 ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act :
Large accelerated filer x | Accelerated filer ¨ | |
Non-accelerated filer ¨ (Do not check if a smaller reporting company) | Smaller reporting company ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of shares of the registrant’s common stock outstanding as of February 6, 2009 was 28,993,962.
Table of Contents
VARIAN, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JANUARY 2, 2009
Page | ||||
PART I | Financial Information | |||
Item 1. | Financial Statements: | |||
3 | ||||
4 | ||||
5 | ||||
Notes to the Unaudited Condensed Consolidated Financial Statements | 6 | |||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 22 | ||
Item 3. | 32 | |||
Item 4. | 34 | |||
PART II | Other Information | |||
Item 1A. | 35 | |||
Item 2. | 35 | |||
Item 6. | 35 |
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PART I
FINANCIAL INFORMATION
Item 1. | Financial Statements |
VARIAN, INC. AND SUBSIDIARY COMPANIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF EARNINGS
(In thousands, except per share amounts)
Fiscal Quarter Ended | ||||||||
January 2, 2009 | December 28, 2007 | |||||||
Sales | ||||||||
Products | $ | 175,854 | $ | 204,175 | ||||
Services | 32,382 | 33,256 | ||||||
Total sales | 208,236 | 237,431 | ||||||
Cost of sales | ||||||||
Products | 94,523 | 111,157 | ||||||
Services | 18,392 | 18,972 | ||||||
Total cost of sales | 112,915 | 130,129 | ||||||
Gross profit | 95,321 | 107,302 | ||||||
Operating expenses | ||||||||
Selling, general and administrative | 60,916 | 65,980 | ||||||
Research and development | 14,514 | 17,180 | ||||||
Total operating expenses | 75,430 | 83,160 | ||||||
Operating earnings | 19,891 | 24,142 | ||||||
Interest income | 587 | 1,937 | ||||||
Interest expense | (322 | ) | (449 | ) | ||||
Earnings before income taxes | 20,156 | 25,630 | ||||||
Income tax expense | 7,115 | 8,046 | ||||||
Net earnings | $ | 13,041 | $ | 17,584 | ||||
Net earnings per share: | ||||||||
Basic | $ | 0.45 | $ | 0.58 | ||||
Diluted | $ | 0.45 | $ | 0.57 | ||||
Shares used in per share calculation: | ||||||||
Basic | 28,854 | 30,330 | ||||||
Diluted | 28,950 | 30,900 | ||||||
See accompanying Notes to the Unaudited Condensed Consolidated Financial Statements.
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VARIAN, INC. AND SUBSIDIARY COMPANIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET
(In thousands, except par value amounts)
January 2, 2009 | October 3, 2008 | |||||
ASSETS | ||||||
Current assets | ||||||
Cash and cash equivalents | $ | 116,929 | $ | 103,895 | ||
Accounts receivable, net | 169,815 | 199,420 | ||||
Inventories | 159,626 | 161,039 | ||||
Deferred taxes | 33,605 | 33,618 | ||||
Prepaid expenses and other current assets | 15,112 | 15,663 | ||||
Total current assets | 495,087 | 513,635 | ||||
Property, plant and equipment, net | 109,499 | 110,343 | ||||
Goodwill | 205,513 | 218,208 | ||||
Intangible assets, net | 31,197 | 36,972 | ||||
Other assets | 25,035 | 24,089 | ||||
Total assets | $ | 866,331 | $ | 903,247 | ||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||
Current liabilities | ||||||
Accounts payable | $ | 65,097 | $ | 70,923 | ||
Deferred profit | 11,037 | 10,957 | ||||
Accrued liabilities | 149,639 | 167,173 | ||||
Total current liabilities | 225,773 | 249,053 | ||||
Long-term debt | 18,750 | 18,750 | ||||
Deferred taxes | 3,923 | 4,341 | ||||
Other liabilities | 46,912 | 43,431 | ||||
Total liabilities | 295,358 | 315,575 | ||||
Commitments and contingencies (Notes 6, 7, 9, 10, 11, 12, 13, 15 and 19) | ||||||
Stockholders’ equity | ||||||
Preferred stock—par value $0.01, authorized—1,000 shares; issued—none | — | — | ||||
Common stock—par value $0.01, authorized—99,000 shares; issued and outstanding—28,954 shares at January 2, 2009 and 28,917 shares at October 3, 2008 | 359,201 | 356,192 | ||||
Retained earnings | 198,870 | 186,009 | ||||
Accumulated other comprehensive income | 12,902 | 45,471 | ||||
Total stockholders’ equity | 570,973 | 587,672 | ||||
Total liabilities and stockholders’ equity | $ | 866,331 | $ | 903,247 | ||
See accompanying Notes to the Unaudited Condensed Consolidated Financial Statements.
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VARIAN, INC. AND SUBSIDIARY COMPANIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
Fiscal Quarter Ended | ||||||||
January 2, 2009 | December 28, 2007 | |||||||
Cash flows from operating activities | ||||||||
Net earnings | $ | 13,041 | $ | 17,584 | ||||
Adjustments to reconcile net earnings to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 6,843 | 6,834 | ||||||
Gain on disposition of property, plant and equipment | (27 | ) | (222 | ) | ||||
Share-based compensation expense | 2,366 | 1,719 | ||||||
Deferred taxes | 113 | 765 | ||||||
Unrealized gain on currency remeasurement | (6,686 | ) | (329 | ) | ||||
Changes in assets and liabilities, excluding effects of acquisitions: | ||||||||
Accounts receivable, net | 24,570 | 13,773 | ||||||
Inventories | (7,942 | ) | (15,152 | ) | ||||
Prepaid expenses and other current assets | (107 | ) | 272 | |||||
Other assets | (1,029 | ) | (24 | ) | ||||
Accounts payable | (3,618 | ) | (1,372 | ) | ||||
Deferred profit | 303 | (2,254 | ) | |||||
Accrued liabilities | (15,619 | ) | (3,319 | ) | ||||
Other liabilities | 4,723 | (1,172 | ) | |||||
Net cash provided by operating activities | 16,931 | 17,103 | ||||||
Cash flows from investing activities | ||||||||
Proceeds from sale of property, plant and equipment | 5,166 | 341 | ||||||
Purchase of property, plant and equipment | (6,943 | ) | (3,459 | ) | ||||
Purchase of businesses, net of cash acquired | (726 | ) | (9,987 | ) | ||||
Net cash used in investing activities | (2,503 | ) | (13,105 | ) | ||||
Cash flows from financing activities | ||||||||
Repurchase of common stock | (279 | ) | (15,102 | ) | ||||
Issuance of common stock | 909 | 9,518 | ||||||
Excess tax benefit from share-based plans | — | 2,390 | ||||||
Transfers to Varian Medical Systems, Inc. | (146 | ) | (212 | ) | ||||
Net cash provided by (used in) financing activities | 484 | (3,406 | ) | |||||
Effects of exchange rate changes on cash and cash equivalents | (1,878 | ) | 692 | |||||
Net increase in cash and cash equivalents | 13,034 | 1,284 | ||||||
Cash and cash equivalents at beginning of period | 103,895 | 196,396 | ||||||
Cash and cash equivalents at end of period | $ | 116,929 | $ | 197,680 | ||||
See accompanying Notes to the Unaudited Condensed Consolidated Financial Statements.
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VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. | Unaudited Interim Condensed Consolidated Financial Statements |
These unaudited interim condensed consolidated financial statements of Varian, Inc. and its subsidiary companies (collectively, the “Company”) have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations. The October 3, 2008 balance sheet data was derived from audited financial statements, but does not include all disclosures required in audited financial statements by U.S. GAAP. These unaudited interim condensed consolidated financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended October 3, 2008 filed with the SEC. In the opinion of the Company’s management, the unaudited interim condensed consolidated financial statements include all normal recurring adjustments necessary to present fairly the information required to be set forth therein. The results of operations for the fiscal quarter ended January 2, 2009 are not necessarily indicative of the results to be expected for a full year or for any other periods.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Note 2. | Description of Business and Basis of Presentation |
The Company designs, develops, manufactures, markets, sells and services scientific instruments (including analytical instruments, research products and related software, consumable products, accessories and services) and vacuum products (including related accessories and services). These businesses primarily serve life science, environmental, energy, and applied research and other customers.
Until April 2, 1999, the business of the Company was operated as the Instruments Business of Varian Associates, Inc. (“VAI”). On that date, VAI distributed to the holders of its common stock one share of common stock of the Company and one share of common stock of Varian Semiconductor Equipment Associates, Inc. (“VSEA”), which was formerly operated as the Semiconductor Equipment business of VAI, for each share of VAI (the “Distribution”). VAI retained its Health Care Systems business and changed its name to Varian Medical Systems, Inc. (“VMS”). Transfers made to VMS under the terms of the Distribution are reflected as financing activities in the Unaudited Condensed Consolidated Statement of Cash Flows.
Note 3. | Summary of Significant Accounting Policies |
Fiscal Periods. The Company’s fiscal years reported are the 52- or 53-week periods ending on the Friday nearest September 30. Fiscal year 2009 will comprise the 52-week period ending October 2, 2009, and fiscal year 2008 was comprised of the 53-week period ended October 3, 2008. The fiscal quarters ended January 2, 2009 and December 28, 2007 each comprised 13 weeks.
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VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Comprehensive Income.A summary of the components of the Company’s comprehensive income follows:
Fiscal Quarter Ended | |||||||
January 2, 2009 | December 28, 2007 | ||||||
(in thousands) | |||||||
Net earnings | $ | 13,041 | $ | 17,584 | |||
Other comprehensive (loss) income: | |||||||
Currency translation adjustment | (32,569 | ) | 824 | ||||
Total other comprehensive (loss) income | (32,569 | ) | 824 | ||||
Total comprehensive (loss) income | $ | (19,528 | ) | $ | 18,408 | ||
Note 4. | Fair Value Measurements |
Effective October 4, 2008 (the first day of fiscal year 2009), the Company adopted Statement of Financial Accounting Standards No. (“SFAS”) 157,Fair Value Measurements. The Company elected to delay applying SFAS 157 to certain non-recurring nonfinancial assets and nonfinancial liabilities until fiscal year 2010, as permitted by FASB Staff Position (“FSP”) 157-2,Effective Date of FASB Statement No. 157.
On the same date, the Company also adopted SFAS 159,The Fair Value Option for Financial Assets and Liabilities, which permits entities to elect, at specified election dates, to measure eligible financial instruments at fair value. The Company did not elect the fair value option under SFAS 159 for any financial assets and liabilities that were not previously measured at fair value.
Fair Value Hierarchy.SFAS 157 establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs that may be used to measure fair value are:
Level 1—Observable inputs that reflect quoted prices for identical assets or liabilities in active markets.
Level 2—Other inputs that are directly or indirectly observable in the marketplace.
Level 3—Unobservable inputs which are supported by little or no market activity.
As of January 2, 2009, the Company did not have any financial liabilities that were measured at fair value on a recurring basis. Financial assets measured at fair value on a recurring basis as of January 2, 2009 were as follow:
Fair Value Measurements Using Input Type | ||||||||||||
Level 1 | Level 2 | Level 3 | Total | |||||||||
(in thousands) | ||||||||||||
Assets: | ||||||||||||
Money market funds (cash equivalents) | $ | 25,095 | $ | — | $ | — | $ | 25,095 | ||||
Total financial assets | $ | 25,095 | $ | — | $ | — | $ | 25,095 | ||||
The fair value of the Company’s money market funds were derived from quoted market prices in active markets and accordingly were classified within Level 1 of the fair value hierarchy.
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VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Note 5. | Balance Sheet Detail |
January 2, 2009 | October 3, 2008 | |||||
(in thousands) | ||||||
Inventories | ||||||
Raw materials and parts | $ | 77,966 | $ | 77,447 | ||
Work in process | 22,815 | 25,091 | ||||
Finished goods | 58,845 | 58,501 | ||||
Total | $ | 159,626 | $ | 161,039 | ||
Note 6. | Forward Exchange Contracts |
The Company enters into foreign exchange forward contracts to minimize the short-term impact of foreign currency fluctuations on assets and liabilities denominated in non-functional currencies. Typically, gains and losses on these contracts are substantially offset by transaction losses and gains on the underlying balances being hedged. During the fiscal quarter ended January 2, 2009, net foreign currency losses relating to these arrangements were $1.1 million. During the fiscal quarter ended December 28, 2007, net foreign currency gains relating to these arrangements were $0.3 million.
The Company’s foreign exchange forward contracts generally range from one to 12 months in original maturity. A summary follows of all foreign exchange forward contracts that were outstanding as of January 2, 2009:
Notional Value Sold | Notional Value Purchased | |||||
(in thousands) | ||||||
Australian dollar | $ | — | $ | 45,869 | ||
Euro | — | 32,594 | ||||
British pound | — | 15,238 | ||||
Japanese yen | 3,751 | — | ||||
Korean won | 3,079 | — | ||||
Brazilian real | 1,654 | — | ||||
Canadian dollar | 1,313 | — | ||||
Mexican peso | — | 1,119 | ||||
Swedish krona | 1,050 | — | ||||
Polish zloty | — | 473 | ||||
Total | $ | 10,847 | $ | 95,293 | ||
Note 7. | Acquisitions |
Contingent Consideration Arrangements. The Company is, from time to time, obligated to pay additional cash purchase price amounts in the event that certain financial or operational milestones are met by acquired businesses. As of January 2, 2009, up to a maximum of $28.1 million could be payable through April 2011 under contingent consideration arrangements relating to acquired businesses. Amounts subject to these arrangements can be earned over the respective measurement period, depending on the performance of the acquired business relative to certain financial and/or operational targets.
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VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The following table summarizes contingent consideration arrangements as of January 2, 2009:
Acquired Company/Business | Remaining Amount Available (maximum) | Measurement Period | Measurement Period End Date | ||||
(in millions | ) | ||||||
IonSpec Corporation | 14.0 | 3 years | April 2009 | ||||
Oxford Diffraction Limited | 10.0 | 3 years | April 2011 | ||||
Analogix Business | 3.5 | 3 years | December 2010 | ||||
Other | 0.6 | 2 years | July 2010 | ||||
Total | $28.1 | ||||||
During the first quarter of fiscal year 2009, the Company paid $0.5 million in contingent consideration to the seller of the Analogix Business.
Note 8. | Goodwill and Other Intangible Assets |
Changes in the carrying amount of goodwill for each of the Company’s reporting segments in the first quarter of fiscal year 2009 were as follow:
Scientific Instruments | Vacuum Technologies | Total Company | |||||||||
(in thousands) | |||||||||||
Balance as of October 3, 2008 | $ | 217,242 | $ | 966 | $ | 218,208 | |||||
Contingent payments on prior-year acquisitions | 500 | — | 500 | ||||||||
Foreign currency impacts and other adjustments | (13,195 | ) | — | (13,195 | ) | ||||||
Balance as of January 2, 2009 | $ | 204,547 | $ | 966 | $ | 205,513 | |||||
The following intangible assets have been recorded and are being amortized by the Company:
January 2, 2009 | ||||||||||
Gross | Accumulated Amortization | Net | ||||||||
(in thousands) | ||||||||||
Intangible assets | ||||||||||
Existing technology | $ | 14,907 | $ | (9,523 | ) | $ | 5,384 | |||
Patents and core technology | 36,562 | (13,826 | ) | 22,736 | ||||||
Trade names and trademarks | 2,382 | (1,982 | ) | 400 | ||||||
Customer lists | 12,317 | (10,046 | ) | 2,271 | ||||||
Other | 2,905 | (2,499 | ) | 406 | ||||||
Total | $ | 69,073 | $ | (37,876 | ) | $ | 31,197 | |||
October 3, 2008 | ||||||||||
Gross | Accumulated Amortization | Net | ||||||||
(in thousands) | ||||||||||
Intangible assets | ||||||||||
Existing technology | $ | 16,503 | $ | (9,699 | ) | $ | 6,804 | |||
Patents and core technology | 40,680 | (14,253 | ) | 26,427 | ||||||
Trade names and trademarks | 2,425 | (1,946 | ) | 479 | ||||||
Customer lists | 13,090 | (10,278 | ) | 2,812 | ||||||
Other | 2,972 | (2,522 | ) | 450 | ||||||
Total | $ | 75,670 | $ | (38,698 | ) | $ | 36,972 | |||
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VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Amortization expense relating to intangible assets was $2.1 million and $1.9 million during the fiscal quarters ended January 2, 2009 and December 28, 2007, respectively. At January 2, 2009, estimated amortization expense for the remainder of fiscal year 2009 and for each of the five succeeding fiscal years and thereafter follows:
(in thousands) | |||
Estimated amortization expense | |||
Nine months ending October 2, 2009 | $ | 5,094 | |
Fiscal year 2010 | 6,569 | ||
Fiscal year 2011 | 4,658 | ||
Fiscal year 2012 | 3,767 | ||
Fiscal year 2013 | 3,266 | ||
Fiscal year 2014 | 3,117 | ||
Thereafter | 4,726 | ||
Total | $ | 31,197 | |
Note 9. | Restructuring Activities |
Summary of Restructuring Plans.The Company has committed to several restructuring plans in order to adjust its organizational structure, improve operational efficiencies and eliminate redundant or excess costs resulting from acquisitions or dispositions during those periods.
The following table sets forth changes in the Company’s aggregate liability relating to all ongoing restructuring plans during the first quarter of fiscal year 2009 as well as total restructuring expense and other related costs recorded since the inception of those plans:
Employee- Related | Facilities- Related | Total | ||||||||||
(in thousands) | ||||||||||||
Balance at October 3, 2008 | $ | 1,840 | $ | 982 | $ | 2,822 | ||||||
Charges to expense, net | 925 | — | 925 | |||||||||
Cash payments | (601 | ) | (38 | ) | (639 | ) | ||||||
Foreign currency impacts and other adjustments | 47 | (56 | ) | (9 | ) | |||||||
Balance at January 2, 2009 | $ | 2,211 | $ | 888 | $ | 3,099 | ||||||
Total expense since inception of plans | ||||||||||||
(in millions) | ||||||||||||
Restructuring expense |
| $ | 7.1 | |||||||||
Other restructuring-related costs(1) |
| $ | 6.9 | |||||||||
(1) | These costs related primarily to employee retention and relocation costs and accelerated depreciation of assets disposed upon the closure of facilities. Of the $6.9 million in other restructuring-related costs, $0.8 million was recorded in the first quarter of fiscal year 2009. |
Fiscal Year 2009 First Quarter Plan. During the first quarter of fiscal year 2009, the Company committed to a plan to reduce its employee headcount in order to reduce operating costs and increase margins. The plan
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VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
involves the termination of approximately 35 employees, mostly located in Europe. The restructuring costs related to this plan primarily consist of one-time termination benefits. This restructuring plan did not involve any non-cash components. Costs relating to restructuring activities recorded under this plan have been included in cost of sales, selling, general and administrative expenses and research and development expenses.
The following table sets forth changes in the Company’s restructuring liability relating to the foregoing plan during the first quarter of fiscal year 2009:
Employee- Related | Facilities- Related | Total | |||||||||
(in thousands) | |||||||||||
Balance at October 3, 2008 | $ | — | $ | — | $ | — | |||||
Charges to expense, net | 1,312 | — | 1,312 | ||||||||
Cash payments | (601 | ) | — | (601 | ) | ||||||
Foreign currency impacts and other adjustments | 49 | — | 49 | ||||||||
Balance at January 2, 2009 | $ | 760 | $ | — | $ | 760 | |||||
Total expense since inception of plan | |||||||||||
(in millions) | |||||||||||
Restructuring expense | $ | 1.3 | |||||||||
Fiscal Year 2007 Plan. During fiscal year 2007, the Company committed to a plan to combine and optimize the development and assembly of most of its nuclear resonance (“NMR”) and mass spectrometry products, to further centralize related administration and other functions and to reallocate certain resources toward more rapidly growing product lines and geographies. As part of the plan, the Company is creating an information rich detection (“IRD”) center in Walnut Creek, California, where NMR operations are being integrated with mass spectrometry operations already located in Walnut Creek. The Company is investing in a new 45,000 square foot building and a substantial remodel of an existing building there to house the IRD center.
As a result of the plan, a number of employee positions have been or will be relocated or eliminated and certain facilities will be consolidated. These actions primarily impact the Scientific Instruments segment and involve the elimination of between approximately 40 and 60 positions.
Restructuring and other related costs associated with this plan include one-time termination benefits, retention payments, costs to relocate facilities (including decommissioning costs, moving costs and temporary facility/storage costs), accelerated depreciation of fixed assets to be disposed as a result of facilities actions and lease termination costs. Costs relating to restructuring activities recorded under this plan have been included in cost of sales, selling, general and administrative expenses and research and development expenses.
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VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The following table sets forth changes in the Company’s restructuring liability relating to the foregoing plan during the first quarter of fiscal year 2009:
Employee- Related | Facilities- Related | Total | ||||||||||
(in thousands) | ||||||||||||
Balance at October 3, 2008 | $ | 1,840 | $ | 551 | $ | 2,391 | ||||||
Reversals of expense, net | (387 | ) | — | (387 | ) | |||||||
Cash payments | — | (38 | ) | (38 | ) | |||||||
Foreign currency impacts and other adjustments | (2 | ) | 17 | 15 | ||||||||
Balance at January 2, 2009 | $ | 1,451 | $ | 530 | $ | 1,981 | ||||||
Total expense since inception of plans | ||||||||||||
(in millions) | ||||||||||||
Restructuring expense |
| $ | 4.0 | |||||||||
Other restructuring-related costs |
| $ | 6.2 | |||||||||
The reversals of restructuring expense of $0.4 million recorded during the fiscal quarter ended January 2, 2009 related to changes in estimates of certain employee termination benefits. The Company also incurred $0.8 million in other restructuring-related costs during the fiscal quarter ended January 2, 2009. These costs were related to employee retention costs and facilities-related costs including decommissioning costs and non-cash charges for accelerated depreciation of assets to be disposed upon the closure of facilities.
Note 10. | Warranty and Indemnification Obligations |
Product Warranties. The Company’s products are generally subject to warranties. Liabilities for the estimated future costs of repair or replacement are established and charged to cost of sales at the time the related sale is recognized. The amount of liability to be recorded is based on management’s best estimates of future warranty costs after considering historical and projected product failure rates and product repair costs.
Changes in the Company’s estimated liability for product warranty during the fiscal quarters ended January 2, 2009 and December 28, 2007 follow:
Fiscal Quarter Ended | ||||||||
January 2, 2009 | December 28, 2007 | |||||||
(in thousands) | ||||||||
Beginning balance | $ | 13,867 | $ | 12,454 | ||||
Charges to costs and expenses | 5,037 | 4,921 | ||||||
Warranty expenditures and other adjustments | (5,720 | ) | (4,849 | ) | ||||
Ending balance | $ | 13,184 | $ | 12,526 | ||||
Indemnification Obligations. Financial Accounting Standards Board (“FASB”) Interpretation No. (“FIN”) 45,Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, requires a guarantor to recognize a liability for and/or disclose obligations it has undertaken in relation to the issuance of the guarantee. Under this guidance, arrangements involving indemnification clauses are subject to the disclosure requirements of FIN 45 only.
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VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The Company is subject to certain indemnification obligations to VMS (formerly VAI) and VSEA in connection with the Instruments business as conducted by VAI prior to the Distribution (described in Note 2). These indemnification obligations cover a variety of aspects of the Company’s business, including, but not limited to, employee, tax, intellectual property, litigation and environmental matters. Certain of the agreements containing these indemnification obligations are disclosed as exhibits to the Company’s Annual Report on Form 10-K. The estimated fair value of these indemnification obligations is not considered to be material.
The Company is subject to certain indemnification obligations to Jabil Circuit, Inc. (“Jabil”) in connection with the Company’s sale of its Electronics Manufacturing Business to Jabil. These indemnification obligations cover certain aspects of the Company’s conduct of the Electronics Manufacturing Business prior to its sale to Jabil, including, but not limited to, tax and environmental matters. The agreement containing these indemnification obligations is disclosed as an exhibit to the Company’s Annual Report on Form 10-K. The estimated fair value of these indemnification obligations is not considered to be material.
The Company’s By-Laws require it to indemnify its officers and directors, as well as those who act as directors and officers of other entities at the request of the Company, against expenses, judgments, fines, settlements and other amounts actually and reasonably incurred in connection with any proceedings arising out of their services to the Company. In addition, the Company has entered into separate indemnity agreements with each director and officer that provide for indemnification of these directors and officers under certain circumstances. The form of these indemnity agreements is disclosed as an exhibit to the Company’s Annual Report on Form 10-K. The indemnification obligations are more fully described in these indemnity agreements and the Company’s By-Laws. The Company purchases insurance to cover claims or a portion of any claims made against its directors and officers. Since a maximum obligation is not explicitly stated in the Company’s By-Laws or these indemnity agreements and will depend on the facts and circumstances that arise out of any future claims, the overall maximum amount of the obligations cannot reasonably be estimated. Historically, the Company has not made payments related to these indemnification obligations and the estimated fair value of these indemnification obligations is not considered to be material.
As is customary in the Company’s industry and as provided for in local law in the U.S. and other jurisdictions, many of the Company’s standard contracts provide remedies to customers and other third parties with whom the Company enters into contracts, such as defense, settlement or payment of judgment for intellectual property claims related to the use of its products. From time to time, the Company also agrees to indemnify customers, suppliers, contractors, lessors, lessees and others with whom it enters into contracts, against loss, expense and/or liability arising from various triggering events related to the sale and the use of the Company’s products and services, the use of their goods and services, the use of facilities and other matters covered by such contracts, usually up to a specified maximum amount. In addition, from time to time, the Company also agrees to indemnify these parties against claims related to undiscovered liabilities, additional product liability or environmental obligations. Claims made under such indemnification obligations have been insignificant and the estimated fair value of these indemnification obligations is not considered to be material.
Note 11. | Debt and Credit Facilities |
Credit Facilities. The Company maintains relationships with banks in many countries from whom it sometimes obtains bank guarantees and short-term standby letters of credit. These guarantees and letters of credit relate primarily to advance payments and deposits made to the Company’s subsidiaries by customers for which separate liabilities are recorded in the unaudited condensed consolidated financial statements. As of January 2, 2009, a total of $20.5 million of these bank guarantees and letters of credit were outstanding. No amounts had been drawn by beneficiaries under these or any other outstanding guarantees or letters of credit as of that date.
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VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Long-term Debt. As of both January 2, 2009 and October 3, 2008, the Company had an $18.8 million term loan outstanding with a U.S. financial institution at a fixed interest rate of 6.7%. The term loan contains certain covenants that limit future borrowings and the payment of cash dividends and require the maintenance of certain levels of working capital and operating results. The Company was in compliance with all restrictive covenants of the term loan agreement at January 2, 2009.
The following table summarizes future principal payments on borrowings under long-term debt outstanding as of January 2, 2009:
Nine Months Ending Oct. 2, 2009 | Fiscal Years | |||||||||||||||||||||||
2010 | 2011 | 2012 | 2013 | 2014 | Thereafter | Total | ||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Long-term debt | $ | — | $ | 6,250 | $ | — | $ | 6,250 | $ | — | $ | 6,250 | $ | — | $ | 18,750 | ||||||||
Based upon rates currently available to the Company for debt with similar terms and remaining maturities, the carrying amount of long-term debt approximates the estimated fair value.
Note 12. | Defined Benefit Retirement Plans |
Net Periodic Pension Cost. The components of net periodic pension cost relating to the Company’s defined benefit retirement plans follow:
Fiscal Quarter Ended | ||||||||
January 2, 2009 | December 28, 2007 | |||||||
(in thousands) | ||||||||
Service cost | $ | 249 | $ | 343 | ||||
Interest cost | 705 | 723 | ||||||
Expected return on plan assets | (570 | ) | (653 | ) | ||||
Amortization of prior service cost and actuarial gains and losses | 17 | — | ||||||
Net periodic pension cost | $ | 401 | $ | 413 | ||||
Employer Contributions. During the fiscal quarter ended January 2, 2009, the Company made contributions totaling $0.3 million to its defined benefit pension plans. The Company currently anticipates contributing an additional $0.9 million to these plans in the remaining nine months of fiscal year 2009.
Note 13. | Contingencies |
Environmental Matters. The Company’s operations are subject to various federal, state and local laws in the U.S. as well as laws in other countries regulating the discharge of materials into the environment or otherwise relating to the protection of the environment. These regulations increase the costs and potential liabilities of the Company’s operations. However, the Company does not currently anticipate that its compliance with these regulations will have a material effect on the Company’s capital expenditures, earnings or competitive position.
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VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The Company and VSEA are each obligated (under the terms of the Distribution described in Note 2) to indemnify VMS for one-third of certain costs (after adjusting for any insurance recoveries and tax benefits recognized or realized by VMS for such costs) relating to (a) environmental investigation, monitoring and/or remediation activities at certain facilities previously operated by VAI and third-party claims made in connection with environmental conditions at those facilities, and (b) U.S. Environmental Protection Agency or third-party claims alleging that VAI or VMS is a potentially responsible party under the Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended (“CERCLA”) in connection with certain sites to which VAI allegedly shipped manufacturing waste for recycling, treatment or disposal (the “CERCLA sites”). With respect to the facilities formerly operated by VAI, VMS is overseeing the environmental investigation, monitoring and/or remediation activities, in most cases under the direction of or in consultation with federal, state and/or local agencies, and handling third-party claims. VMS is also handling claims relating to the CERCLA sites. The Company is also undertaking environmental investigation and/or monitoring activities at one of its facilities under the direction of or in consultation with governmental agencies.
Various uncertainties make it difficult to estimate future costs for certain of these environmental-related activities, specifically external legal expenses, VMS’ internal oversight costs, third-party claims and a former VAI facility where the likelihood and scope of further environmental-related activities are difficult to assess. As of January 2, 2009, it was nonetheless estimated that the Company’s future exposure for these environmental-related costs ranged in the aggregate from $1.1 million to $2.6 million. The time frame over which these costs are expected to be incurred varies with each type of cost, ranging up to approximately 30 years as of January 2, 2009. No amount in the foregoing range of estimated future costs is discounted, and no amount in the range is believed to be more probable of being incurred than any other amount in such range. The Company therefore had an accrual of $1.1 million as of January 2, 2009 for these future environmental-related costs.
Sufficient knowledge has been gained to be able to better estimate other costs for future environmental-related activities. As of January 2, 2009, it was estimated that the Company’s future costs for these environmental-related activities ranged in the aggregate from $2.2 million to $13.1 million. The time frame over which these costs are expected to be incurred varies, ranging up to approximately 30 years as of January 2, 2009. As to each of these ranges of cost estimates, it was determined that a particular amount within the range was a better estimate than any other amount within the range. Together, these amounts totaled $5.7 million at January 2, 2009. Because both the amount and timing of the recurring portion of these costs were reliably determinable, that portion is discounted at 4%, net of inflation. The Company therefore had an accrual of $4.1 million as of January 2, 2009, which represents its best estimate of these future environmental-related costs after discounting estimated recurring future costs. This accrual is in addition to the $1.1 million described in the preceding paragraph.
The Company has not reduced any environmental-related liability in anticipation of recoveries from third parties. However, an insurance company has agreed to pay a portion of certain of VAI’s (now VMS’) future environmental-related costs, for which the Company has an indemnification obligation, and the Company therefore has a long-term receivable of $1.0 million (discounted at 4%, net of inflation) in Other assets as of January 2, 2009, for the Company’s share of that insurance recovery.
The Company believes that its reserves for the foregoing and other environmental-related matters are adequate, but as the scope of its obligation becomes more clearly defined, these reserves may be modified and related charges against or credits to earnings may be made. Although any ultimate liability arising from environmental-related matters could result in significant expenditures that, if aggregated and assumed to occur within a single fiscal year, would be material to the Company’s financial statements, the likelihood of such occurrence is considered remote. Based on information currently available and its best assessment of the ultimate
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VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
amount and timing of environmental-related events, the Company believes that the costs of environmental-related matters are not reasonably likely to have a material adverse effect on the Company’s financial condition or results of operations.
Legal Proceedings. The Company is involved in pending legal proceedings that are ordinary, routine and incidental to its business. While the ultimate outcome of these legal matters is not determinable, the Company believes that these matters are not reasonably likely to have a material adverse effect on the Company’s financial condition or results of operations.
Note 14. | Stockholders’ Equity and Stock Plans |
Share-Based Compensation Expense. The following table summarizes the amount of share-based compensation expense by award type as well as the effect of this expense on income tax expense and net earnings:
Fiscal Quarter Ended | ||||||||
January 2, 2009 | December 28, 2007 | |||||||
(in thousands, except per share amounts) | ||||||||
Share-based compensation expense by award type: | ||||||||
Employee and non-employee director stock options | $ | (1,365 | ) | $ | (968 | ) | ||
Employee stock purchase plan | (336 | ) | (310 | ) | ||||
Restricted (nonvested) stock | (665 | ) | (441 | ) | ||||
Total share-based compensation expense (effect on earnings before income taxes) | (2,366 | ) | (1,719 | ) | ||||
Effect on income tax expense | 773 | 564 | ||||||
Effect on net earnings | $ | (1,593 | ) | $ | (1,155 | ) | ||
Share-based compensation expense included in the preceding table related to restricted (non-vested) stock includes $0.1 million in both the fiscal quarter ended January 2, 2009 and the fiscal quarter ended December 28, 2007, related to restricted stock granted in connection with the Company’s fiscal year 2007 restructuring plan.
Share-based compensation expense has been included in the Company’s unaudited condensed consolidated statement of earnings as follows:
Fiscal Quarter Ended | ||||||
January 2, 2009 | December 28, 2007 | |||||
(in thousands) | ||||||
Cost of sales | $ | 133 | $ | 124 | ||
Selling, general and administrative | 2,119 | 1,461 | ||||
Research and development | 114 | 134 | ||||
Total | $ | 2,366 | $ | 1,719 | ||
Stock Options.Under the Omnibus Stock Plan (“OSP”), the Company periodically grants stock options to officers, directors and employees. The exercise price for stock options granted under the OSP may not be less than 100% of the fair market value at the date of the grant. Options granted are exercisable at the times and on
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VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
the terms established by the Compensation Committee, but not later than ten years after the date of grant (except in the event of death, after which an option is exercisable for three years). Options granted generally become exercisable in cumulative installments of one-third each year commencing one year following the date of grant.
The following table summarizes stock option activity under the OSP for the fiscal quarter ended January 2, 2009:
Shares | Weighted Average Exercise Price | Aggregate Grant Date Fair Value (1) | |||||||
(in thousands) | (in millions) | ||||||||
Outstanding at October 3, 2008 | 1,660 | $ | 44.21 | ||||||
Granted | 314 | $ | 35.91 | $ | 3.4 | ||||
Exercised | (1 | ) | $ | 9.50 | |||||
Cancelled or expired | (23 | ) | $ | 43.90 | |||||
Outstanding at January 2, 2009 | 1,950 | $ | 42.88 | ||||||
(1) | After estimated forfeitures. |
As of January 2, 2009, the unrecognized share-based compensation balance related to stock options was $6.6 million. This amount will be recognized as expense using the straight-line attribution method over a weighted-average amortization period of 1.4 years.
Restricted (Nonvested) Stock.Under the OSP, the Company also periodically grants restricted (nonvested) common stock to employees. Such grants are valued as of the grant date. These amounts are recognized by the Company as share-based compensation expense ratably over their respective vesting periods, which range from one to three years.
The following table summarizes restricted (nonvested) common stock activity under the OSP for the fiscal quarter ended January 2, 2009:
Shares | Weighted Average Grant Date Fair Value | Aggregate Grant Date Fair Value | |||||||
(in thousands) | (in millions) | ||||||||
Outstanding and unvested at October 3, 2008 | 105 | $ | 54.51 | ||||||
Granted | 17 | $ | 35.97 | $ | 0.6 | ||||
Vested(1) | (53 | ) | $ | 49.83 | |||||
Forfeited | (1 | ) | $ | 55.50 | |||||
Outstanding and unvested at January 2, 2009 | 68 | $ | 53.50 | ||||||
(1) | Includes shares tendered to the Company by employees in settlement of employee tax withholding obligations. |
As of January 2, 2009, there was a total of $1.9 million in unrecognized share-based compensation expense related to restricted stock granted under the OSP. This expense will be recognized over a weighted-average amortization period of 1.4 years.
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VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Employee Stock Purchase Plan.During the fiscal quarters ended January 2, 2009 and December 28, 2007, employees purchased approximately 27,100 shares for $0.9 million and 20,000 shares for $0.9 million, respectively, under the Company’s Employee Stock Purchase Plan (“ESPP”). As of January 2, 2009, a total of approximately 161,000 shares remained available for issuance under the ESPP.
Stock Repurchase Programs. In February 2008, the Company’s Board of Directors approved a stock repurchase program under which the Company is authorized to utilize up to $100 million to repurchase shares of its common stock. This repurchase program is effective through December 31, 2009. During the fiscal quarter ended January 2, 2009, the Company did not repurchase any shares of its common stock under this authorization. As of January 2, 2009, the Company had remaining authorization to repurchase $44.6 million of its common stock under this program.
Other Stock Repurchases.During the fiscal quarter ended January 2, 2009, the Company repurchased and retired 8,000 shares tendered to it by employees in settlement of employee tax withholding obligations due from those employees upon the vesting of restricted stock.
Note 15. | Income Taxes |
The Company’s U.S. federal, state and local and foreign income tax returns are subject to audit by relevant tax authorities. Although the timing and outcome of income tax audits is highly uncertain, the Company has reasonably recorded liabilities for associated unrecognized tax benefits. It is possible that certain unrecognized tax benefits could decrease by $1.1 million in the next twelve months due to the lapse of certain statutes of limitation and result in a reduction in income tax expense. Any such reduction could be impacted by other changes in unrecognized tax benefits.
Note 16. | Net Earnings Per Share |
Basic earnings per share are calculated based on net earnings and the weighted-average number of shares of common stock outstanding during the reported period. Diluted earnings per share are calculated similarly, except that the weighted-average number of common shares outstanding during the period is increased by the number of additional shares of common stock that would have been outstanding if the dilutive potential shares of common stock had been issued. The dilutive effect of potential common stock (including outstanding stock options, unvested restricted stock and non-employee director stock units) is reflected in diluted earnings per share by application of the treasury stock method, which includes consideration of share-based compensation and the tax benefit thereon as required by SFAS 123(R).
For the fiscal quarters ended January 2, 2009 and December 28, 2007, options to purchase 1,790,000 and 256,000 shares, respectively, were excluded from the calculation of diluted earnings per share as their effect was anti-dilutive.
A reconciliation of weighted-average basic shares outstanding to weighted-average diluted shares outstanding follows:
Fiscal Quarter Ended | ||||
January 2, 2009 | December 28, 2007 | |||
(in thousands) | ||||
Weighted-average basic shares outstanding | 28,854 | 30,330 | ||
Net effect of dilutive potential common stock | 96 | 570 | ||
Weighted-average diluted shares outstanding | 28,950 | 30,900 | ||
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VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Note 17. | Industry Segments |
For financial reporting purposes, the Company’s operations are grouped into two business segments: Scientific Instruments and Vacuum Technologies. The Scientific Instruments segment designs, develops, manufactures, markets, sells and services equipment and related software, consumable products, accessories and services for a broad range of life science, environmental, energy, and applied research and other applications requiring identification, quantification and analysis of the composition or structure of liquids, solids or gases. The Vacuum Technologies segment designs, develops, manufactures, markets, sells and services vacuum products and related accessories and services used to create, contain, control, measure and test vacuum environments in a broad range of life science, industrial and other applications requiring ultra-clean or high-vacuum environments. These segments were determined in accordance with SFAS 131,Disclosures about Segments of an Enterprise and Related Information.
General corporate costs include shared costs of legal, tax, accounting, treasury, insurance and certain other management costs. A portion of the indirect and common costs has been allocated to the segments through the use of estimates. Also, transactions between segments are accounted for at cost and are not included in sales. Accordingly, the following information is provided for purposes of achieving an understanding of operations, but might not be indicative of the financial results of the reported segments were they independent organizations. In addition, comparisons of the Company’s operations to similar operations of other companies might not be meaningful.
Sales | Pretax Earnings | |||||||||||||
Fiscal Quarter Ended | Fiscal Quarter Ended | |||||||||||||
January 2, 2009 | December 28, 2007 | January 2, 2009 | December 28, 2007 | |||||||||||
(in millions) | ||||||||||||||
Scientific Instruments | $ | 171.8 | $ | 197.0 | $ | 16.4 | $ | 19.8 | ||||||
Vacuum Technologies | 36.4 | 40.4 | 7.0 | 7.7 | ||||||||||
Total industry segments | 208.2 | 237.4 | 23.4 | 27.5 | ||||||||||
General corporate | — | — | (3.6 | ) | (3.4 | ) | ||||||||
Interest income | — | — | 0.6 | 1.9 | ||||||||||
Interest expense | — | — | (0.3 | ) | (0.4 | ) | ||||||||
Total | $ | 208.2 | $ | 237.4 | $ | 20.1 | $ | 25.6 | ||||||
Note 18. | Recent Accounting Pronouncements |
In September 2006, the FASB issued SFAS 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. In February 2008, the FASB issued FSP 157-2,Effective Date of FASB Statement No. 157,which delays the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The Company adopted SFAS 157 effective October 4, 2008 with the exception of the application of the statement to nonrecurring nonfinancial assets and nonfinancial liabilities (see Note 4). The Company does not expect the adoption of the provisions deferred by FSP 157-2 to have a material impact on its financial condition or results of operations.
In December 2007, the FASB issued SFAS 141 (revised 2007),Business Combinations, (“SFAS 141(R)”). SFAS 141(R) retains the fundamental requirements of the original pronouncement requiring that the purchase
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VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
method be used for all business combinations but also provides revised guidance for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed, and any noncontrolling interest in the acquiree. It also requires the recognition of assets acquired and liabilities assumed arising from contingencies, the capitalization of in-process research and development at fair value, and the expensing of acquisition-related costs as incurred.SFAS 141(R) also requires that certain tax contingencies and adjustments to valuation allowances related to business combinations, which previously were adjusted to goodwill, must be adjusted to income tax expense, regardless of the date of the original business combination. SFAS 141(R) is effective for fiscal years beginning after December 15, 2008. The Company does not expect its adoption in the first quarter of fiscal year 2010 to have a material impact on the Company’s financial condition or results of operations. However, in the event that the Company completes acquisitions subsequent to its adoption of SFAS 141(R), the application of its provisions will likely have a material impact on the Company’s results of operations, although the Company is not currently able to estimate that impact.
In December 2007, the FASB issued SFAS 160,Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51. SFAS 160 requires that ownership interests in subsidiaries held by parties other than the parent and the amount of consolidated net income be clearly identified, labeled and presented in the consolidated financial statements. It also requires once a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be initially measured at fair value. Sufficient disclosures are required to clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 is effective for fiscal years beginning after December 15, 2008, and requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements are applied prospectively. The Company does not expect the adoption of SFAS 160 to have a material impact on its financial condition or results of operations.
In March 2008, the FASB issued SFAS 161,Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133,which requires additional disclosures about the objectives and strategies of derivative instruments and hedging activities, the method of accounting for such instruments under SFAS 133 and its related interpretations, and a tabular disclosure of the effects of such instruments and related hedged items on the Company’s financial condition and results of operations. SFAS 161 is effective for fiscal years beginning after November 15, 2008. The Company does not expect the adoption of SFAS 161 to have a material impact on its financial condition or results of operations.
In April 2008, the FASB issued FSP 142-3,Determination of the Useful Life of Intangible Assets, which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The intent of FSP 142-3 is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142,Goodwill and Other Intangible Assets, and the period of expected cash flows used to measure the fair value of the asset under SFAS 141(R),Business Combinations, and other accounting literature. FSP 142-3 is effective for fiscal years beginning after December 15, 2008, and must be applied prospectively to intangible assets acquired after the effective date. Early adoption is prohibited. Given that FSP 142-3 applies to intangible assets acquired after the effective date, the Company does not expect its adoption to have a material impact on its financial condition or results of operations.
In December 2008, the FASB issued FSP 132(R)-1,Employers’ Disclosures about Postretirement Benefit Plan Assets. FSP 132(R)-1 amends SFAS 132 (revised 2003),Employers’ Disclosures about Pensions and Other Postretirement Benefits, to provide guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. This FSP is effective for fiscal years ending after December 15, 2009. The Company does not expect the adoption of FSP 132(R)-1 to have a material impact on its financial condition or results of operations.
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VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Note 19. | Subsequent Event |
During the second quarter of fiscal year 2009, the Company committed to a plan to reduce its cost structure, primarily through headcount reductions, due to continuing uncertainty in the global economic environment. The plan primarily involved the elimination of approximately 240 regular employee and 80 temporary positions (primarily in North America and Europe and, to a lesser extent, Asia Pacific and Latin America) in both the Scientific Instruments and Vacuum Technologies segments. In addition, the plan included the closure of one small R&D/manufacturing facility in North America (Lake Forest, California) and two sales offices in Europe (Sweden and Switzerland).
Restructuring and other related costs expected to be incurred in connection with this plan are currently estimated to be between $8.5 million and $10.5 million, of which between $8.0 million and $9.5 million is expected to impact the Scientific Instruments segment and between $0.5 million and $1.0 million is expected to impact the Vacuum Technologies segment. The restructuring costs are expected to include one-time termination benefits for employees whose positions are being eliminated of between $7.5 million and $9.0 million and lease termination costs of between $0.1 million and $0.2 million (including future lease payments on vacated facilities). Other restructuring-related costs are expected to include employee retention and relocation costs of between $0.3 million and $1.0 million and facility-related relocation costs and accelerated depreciation of fixed assets to be disposed upon the closure of facilities of between $0.1 million and $0.3 million. These costs will be recorded and included in cost of sales, selling, general and administrative expenses and research and development expenses.
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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Caution Regarding Forward-Looking Statements
Throughout this Report, and particularly in thisItem 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations, there are forward-looking statements that are based upon our current expectations, estimates and projections and that reflect our beliefs and assumptions based upon information available to us at the date of this Report. In some cases, you can identify these statements by words such as “may,” “might,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue,” and other similar terms. These forward-looking statements include (but are not limited to) those relating to the timing and amount of anticipated restructuring and other related costs and related cost savings as well as anticipated capital expenditures in fiscal year 2009.
We caution investors that forward-looking statements are only our current expectations about future events. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties, and assumptions that are difficult to predict. Our actual results, performance or achievements could differ materially from those expressed or implied by the forward-looking statements. Some of the important factors that could cause our results to differ are discussed inItem 1A—Risk Factors in our Annual Report on Form 10-K for the fiscal year ended October 3, 2008. We encourage you to read that section carefully.
Other risks and uncertainties that could cause actual results to differ materially from those in our forward-looking statements include, but are not limited to, the following: when and how quickly global economic conditions improve, and whether conditions worsen before they improve, whether we will succeed in new product development, release, commercialization, performance and acceptance; whether we can achieve continued growth in sales for life science, environmental, energy and/or applied research and other applications; whether we can achieve sales growth in Europe, North America, Asia Pacific and/or Latin America; risks arising from the timing of shipments, installations and the recognition of revenues on certain research products, including nuclear magnetic resonance (“NMR”) spectroscopy systems, magnetic resonance (“MR”) imaging systems and fourier transform mass spectrometry (“FTMS”) systems and superconducting magnets; the impact of shifting product mix on profit margins; competitive products and pricing; economic conditions in our various product and geographic markets; whether we will see continued and timely delivery of key raw materials and components by suppliers; foreign currency fluctuations that could adversely impact revenue growth and/or earnings; whether we will see continued investment in capital equipment, in particular given the global liquidity and credit crisis; whether we will see reduced demand from customers that operate in cyclical industries; whether the global liquidity and credit crisis will impact the collectability of accounts receivable from our customers; the impact of any delay or reduction in government funding for research; our ability to successfully evaluate, negotiate and integrate acquisitions, in particular given the greater difficulty to borrow in the current credit environment; the actual costs, timing and benefits of restructuring activities (such as the employee reductions and other actions announced on January 16, 2009 and our Northern California operations consolidation) and other efficiency improvement activities (such as our global procurement, lower-cost manufacturing and outsourcing initiatives); variability in our effective income tax rate (due to factors including the timing and amount of discrete tax events and changes to unrecognized tax benefits); the timing and amount of share-based compensation; and other risks detailed from time to time in our filings with the U.S. Securities and Exchange Commission (the “SEC”). We undertake no special obligation to update any forward-looking statements, whether in response to new information, future events or otherwise.
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Results of Operations
First Quarter of Fiscal Year 2009 Compared to First Quarter of Fiscal Year 2008
Segment Results
For financial reporting purposes, our operations are grouped into two reportable business segments: Scientific Instruments and Vacuum Technologies. The following table presents comparisons of our sales and operating earnings for each of those segments and in total for the first quarter of fiscal years 2009 and 2008:
Fiscal Quarter Ended | Increase (Decrease) | ||||||||||||||||||||
January 2, 2009 | December 28, 2007 | ||||||||||||||||||||
$ | % of Sales | $ | % of Sales | $ | % | ||||||||||||||||
(dollars in millions) | |||||||||||||||||||||
Sales by Segment: | |||||||||||||||||||||
Scientific Instruments | $ | 171.8 | 82.5 | % | $ | 197.0 | 83.0 | % | $ | (25.2 | ) | (12.8 | )% | ||||||||
Vacuum Technologies | 36.4 | 17.5 | 40.4 | 17.0 | (4.0 | ) | (9.9 | ) | |||||||||||||
Total company | $ | 208.2 | 100.0 | % | $ | 237.4 | 100.0 | % | $ | (29.2 | ) | (12.3 | )% | ||||||||
Operating Earnings by Segment: | |||||||||||||||||||||
Scientific Instruments | $ | 16.4 | 9.6 | % | $ | 19.8 | 10.1 | % | $ | (3.4 | ) | (17.1 | )% | ||||||||
Vacuum Technologies | 7.1 | 19.3 | 7.7 | 19.1 | (0.6 | ) | (9.0 | ) | |||||||||||||
Total segments | 23.5 | 11.3 | 27.5 | 11.6 | (4.0 | ) | (14.8 | ) | |||||||||||||
General corporate | (3.6 | ) | (1.7 | ) | (3.4 | ) | (1.4 | ) | (0.2 | ) | (5.2 | ) | |||||||||
Total company | $ | 19.9 | 9.6 | % | $ | 24.1 | 10.2 | % | $ | (4.2 | ) | (17.6 | )% | ||||||||
Scientific Instruments. The decrease in Scientific Instruments sales was primarily attributable to lower sales volume of our research products (in particular, NMR and imaging systems), products for traditional energy and raw material applications, and the negative impact of the stronger U.S. dollar on reported revenues. The timing of research products sales is often impacted by factors such as laboratory readiness and access to customer sites, duration of installations and availability of key components and installation personnel. The lower volume of research product sales in the first quarter of fiscal year 2009 was primarily due to delays due to some of these factors, compounded by the shorter working month and customer shutdowns in December 2008. Sales from businesses acquired in fiscal year 2008 positively impacted reported sales by approximately 2%.
Scientific Instruments operating earnings for the first quarter of fiscal year 2009 included acquisition-related intangible amortization of $2.1 million and restructuring and other related costs of $1.6 million. In comparison, Scientific Instruments operating earnings for the first quarter of fiscal year 2008 included acquisition-related intangible amortization of $1.8 million, amortization of $0.5 million related to inventory written up to fair value primarily in connection with the acquisition of IonSpec Corporation (“IonSpec”) and restructuring and other related costs of $2.0 million. Excluding the impact of these items, operating earnings decreased as a percentage of sales due to the negative impact of lower sales volume, partially offset by the positive impact of efficiency improvements implemented in recent years and the stronger U.S. dollar (which was unfavorable to reported sales but favorable to reported operating margins).
Vacuum Technologies. The decrease in Vacuum Technologies sales was driven by lower sales volume of products for industrial applications and by the negative impact of the stronger U.S. dollar on reported revenues.
Vacuum Technologies operating earnings for the first quarter of fiscal year 2009 included the impact of restructuring and other related costs of $0.1 million. Excluding the impact of this item, the increase in Vacuum
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Technologies operating earnings as a percentage of sales was primarily due to the positive impact of efficiency improvements implemented in recent years and the stronger U.S. dollar, partially offset by the negative impact of lower sales volume.
Consolidated Results
The following table presents comparisons of our sales and other selected consolidated financial results for the first quarter of fiscal years 2009 and 2008:
Fiscal Quarter Ended | Increase (Decrease) | ||||||||||||||||||||
January 2, 2009 | December 28, 2007 | ||||||||||||||||||||
$ | % of Sales | $ | % of Sales | $ | % | ||||||||||||||||
(dollars in millions, except per share data) | |||||||||||||||||||||
Sales: | $ | 208.2 | 100.0 | % | $ | 237.4 | 100.0 | % | $ | (29.2 | ) | (12.3 | )% | ||||||||
Gross profit | 95.3 | 45.8 | 107.3 | 45.2 | (12.0 | ) | (11.2 | ) | |||||||||||||
Operating expenses: | |||||||||||||||||||||
Selling, general and administrative | 60.9 | 29.2 | 66.0 | 27.8 | % | (5.1 | ) | (7.7 | ) | ||||||||||||
Research and development | 14.5 | 7.0 | 17.2 | 7.2 | (2.7 | ) | (15.5 | ) | |||||||||||||
Total operating expenses | 75.4 | 36.2 | 83.2 | 35.0 | (7.8 | ) | (9.3 | ) | |||||||||||||
Operating earnings | 19.9 | 9.6 | 24.1 | 10.2 | (4.2 | ) | (17.6 | ) | |||||||||||||
Interest income | 0.5 | 0.3 | 1.9 | 0.8 | (1.4 | ) | (69.7 | ) | |||||||||||||
Interest expense | (0.3 | ) | (0.2 | ) | (0.4 | ) | (0.2 | ) | 0.1 | 28.5 | |||||||||||
Income tax expense | (7.1 | ) | (3.4 | ) | (8.0 | ) | (3.4 | ) | 0.9 | 11.6 | |||||||||||
Net earnings | $ | 13.0 | 6.3 | % | $ | 17.6 | 7.4 | % | $ | (4.6 | ) | (25.8 | )% | ||||||||
Net earnings per diluted share | $ | 0.45 | $ | 0.57 | $ | (0.12 | ) | ||||||||||||||
Sales. As discussed under the headingSegment Results above, sales by our Scientific Instruments and Vacuum Technologies segments in the first quarter of fiscal year 2009 decreased by 12.8% and 9.9%, respectively, compared to the prior-year quarter. On a consolidated basis, sales declined 12.3% in the first quarter of fiscal year 2009. This decrease was primarily due to lower sales of research products, but also reflects a decline in the sales volume of certain vacuum and analytical products. Reported sales were also negatively impacted by the stronger U.S. dollar, which strengthened approximately 5% on a weighted-average basis compared to currencies in which we sell products and services. Sales from businesses acquired in fiscal year 2008 positively impacted reported sales by approximately 2%.
For geographic reporting purposes, we use four regions—North America (excluding Mexico), Europe (including the Middle East and Africa), Asia Pacific (including India) and Latin America (including Mexico). Sales by geographic region in the first quarters of fiscal years 2009 and 2008 were as follows:
Fiscal Quarter Ended | Increase (Decrease) | ||||||||||||||||||
January 2, 2009 | December 28, 2007 | ||||||||||||||||||
$ | % of Sales | $ | % of Sales | $ | % | ||||||||||||||
(dollars in millions) | |||||||||||||||||||
Geographic Region | |||||||||||||||||||
North America | $ | 65.2 | 31.3 | % | $ | 80.6 | 34.0 | % | $ | (15.4 | ) | (19.2 | )% | ||||||
Europe | 83.9 | 40.3 | 96.2 | 40.5 | (12.3 | ) | (12.8 | ) | |||||||||||
Asia Pacific | 47.1 | 22.6 | 47.8 | 20.1 | (0.7 | ) | (1.4 | ) | |||||||||||
Latin America | 12.0 | 5.8 | 12.8 | 5.4 | (0.8 | ) | (6.1 | ) | |||||||||||
Total company | $ | 208.2 | 100.0 | % | $ | 237.4 | 100.0 | % | $ | (29.2 | ) | (12.3 | )% | ||||||
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The decrease in sales in North America was primarily attributable to lower Scientific Instruments sales (in particular, sales of research products) and, to a lesser extent, lower Vacuum Technologies sales. Reported sales outside North America were unfavorably impacted by the strengthening of the U.S. dollar compared to the first quarter of fiscal year 2008. The decrease in sales in Europe was also attributable to lower sales volume of both Scientific Instruments and Vacuum Technologies products. Sales volume in Asia Pacific decreased slightly due to lower Vacuum Technologies sales, while sales volume in Latin America decreased slightly due to lower Scientific Instruments sales.
The sales decrease in North America was more pronounced compared to the prior-year quarter due to the timing of sales of certain low-volume, high-selling price research products. We do not consider this to be indicative of any particular trend for magnet-based products as a whole, but rather to be reflective of the variability in results that these low-volume, high-selling price magnet-based products can create.
Gross Profit. Gross profit for the first quarter of fiscal year 2009 reflects the impact of $1.6 million in amortization expense relating to acquisition-related intangible assets and $0.9 million in restructuring and other related costs. In comparison, gross profit for the first quarter of fiscal year 2008 reflects the impact of $1.4 million in amortization expense relating to acquisition-related intangible assets, amortization of $0.5 million related to inventory written up to fair value primarily in connection with the IonSpec acquisition and $0.5 million in restructuring and other related costs. Excluding the impact of these items, the increase in gross profit as a percentage of sales was primarily the result of the stronger U.S. dollar (which was favorable to reported gross profit margins but unfavorable to reported sales) and the positive impact of efficiency improvements (such as those resulting from lower-cost manufacturing and outsourcing initiatives, global procurement initiatives, and facility relocations/closures) implemented in recent years.
Selling, General and Administrative. Selling, general and administrative expenses for the first quarter of fiscal year 2009 included $0.5 million in amortization expense relating to acquisition-related intangible assets and $0.6 million in restructuring and other related costs. In comparison, selling, general and administrative expenses for the first quarter of fiscal year 2008 included $0.4 million in amortization expense relating to acquisition-related intangible assets and $1.2 million in restructuring and other related costs. Excluding the impact of these items, the increase in selling, general and administrative expenses as a percentage of sales was primarily due to the negative impact of lower sales volume, partially offset by the favorable impact of the stronger U.S. dollar and the cost savings achieved from restructuring activities implemented in recent years.
Research and Development. Research and development expenses for the first quarter of fiscal year 2009 reflect the impact of restructuring and other related costs of $0.2 million. In comparison, research and development expenses for the first quarter of fiscal year 2008 reflect the impact of restructuring and other related costs of $0.3 million. Excluding the impact of these items, the decrease in research and development expenses as a percentage of sales was primarily due to the stronger U.S. dollar and lower costs associated with new product introductions compared to the first quarter of fiscal year 2008.
Restructuring Activities. We have committed to several restructuring plans in order to adjust our organizational structure, improve operational efficiencies, eliminate redundant or excess costs resulting from acquisitions or dispositions during those periods, and to otherwise reduce our costs.From the respective inception dates of these plans through January 2, 2009, we have incurred a total of $7.1 million in restructuring expense and a total of $6.9 million in other costs related directly to those plans (comprised primarily of employee retention and relocation costs and accelerated depreciation of assets disposed upon the closure of facilities). During the first quarter of fiscal year 2009, there was no significant activity under these plans except for the fiscal year 2007 plan and the fiscal year 2009 first quarter plan as described below.
Fiscal Year 2007 Plan. During the third quarter of fiscal year 2007, we committed to a plan to combine and optimize the development and assembly of most of our nuclear magnetic resonance (“NMR”) and mass spectrometry products, to further centralize related administration and other functions and to reallocate certain
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resources toward more rapidly growing product lines and geographies. As part of the plan, we are creating an information rich detection (“IRD”) center in Walnut Creek, California, where NMR operations are being integrated with mass spectrometry operations already located in Walnut Creek. Merging our IRD talent base into this single location will capitalize on our strength in NMR and mass spectrometry and enhance our ability to develop innovative IRD solutions that are more powerful, complementary, routine and user-friendly. Underscoring our commitment to IRD and the benefits that a combined location and organization will provide, we are investing in a new 45,000 square foot building and a substantial remodel of an existing building there to house the IRD center.
As a result of the plan, a number of employee positions have been or will be relocated or eliminated and certain facilities have been, or will be, consolidated. These actions primarily impact the Scientific Instruments segment and involve the elimination of between approximately 40 and 60 positions. We expect these activities to be completed during fiscal year 2009.
Restructuring and other related costs associated with this plan include one-time employee termination benefits, employee retention payments, costs to relocate facilities (including decommissioning costs, moving costs and temporary facility/storage costs), accelerated depreciation of fixed assets to be disposed as a result of facilities actions and lease termination costs.
The following table sets forth changes in our restructuring liability relating to the foregoing plan during the first quarter of fiscal year 2009 as well as total restructuring expense and other restructuring-related costs recorded since the inception of the plan:
Employee- Related | Facilities- Related | Total | ||||||||||
(in thousands) | ||||||||||||
Balance at October 3, 2008 | $ | 1,840 | $ | 551 | $ | 2,391 | ||||||
Reversals of expense, net | (387 | ) | — | (387 | ) | |||||||
Cash payments | — | (38 | ) | (38 | ) | |||||||
Foreign currency impacts and other adjustments | (2 | ) | 17 | 15 | ||||||||
Balance at January 2, 2009 | $ | 1,451 | $ | 530 | $ | 1,981 | ||||||
Total expense since inception of plan | ||||||||||||
(in millions) | ||||||||||||
Restructuring expense |
| $ | 4.0 | |||||||||
Other restructuring-related costs |
| $ | 6.2 | |||||||||
The reversals of restructuring expense of $0.4 million recorded during the first quarter of fiscal year 2009 related to changes in estimates relating to certain employee termination benefits. We also incurred $0.8 million in other restructuring-related costs during the quarter, which were comprised of $0.6 million in employee retention costs and $0.2 million in facilities-related costs including decommissioning costs and a non-cash charge for accelerated depreciation of assets to be disposed upon the closure of facilities.
Fiscal Year 2009 First Quarter Plan. During the first quarter of fiscal year 2009, we committed to a plan to reduce our employee headcount in order to reduce operating costs and increase margins. The plan involves the termination of approximately 35 employees, mostly located in Europe. The restructuring costs related to this plan primarily consist of one-time termination benefits which are expected to be settled by the end of fiscal year 2011. This restructuring plan did not involve any non-cash components. Costs relating to restructuring activities recorded under this plan have been included in cost of sales, selling, general and administrative expenses and research and development expenses.
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The following table sets forth changes in our restructuring liability relating to the foregoing plan during the first quarter of fiscal year 2009:
Employee- Related | Facilities- Related | Total | |||||||||
(in thousands) | |||||||||||
Balance at October 3, 2008 | $ | — | $ | — | $ | — | |||||
Charges to expense, net | 1,312 | — | 1,312 | ||||||||
Cash payments | (601 | ) | — | (601 | ) | ||||||
Foreign currency impacts and other adjustments | 49 | — | 49 | ||||||||
Balance at January 2, 2009 | $ | 760 | $ | — | $ | 760 | |||||
Total expense since inception of plan | |||||||||||
(in millions) | |||||||||||
Restructuring expense | $ | 1.3 | |||||||||
Fiscal Year 2009 Second Quarter Plan (Subsequent Event). During the second quarter of fiscal year 2009, we committed to a separate plan to reduce our cost structure, primarily through headcount reductions, due to continuing uncertainties in the global economic environment. The plan primarily involves the elimination of approximately 240 regular employees (primarily in North America and Europe and to a lesser extent Asia Pacific and Latin America) and 80 temporary positions in both the Scientific Instruments and Vacuum Technologies segments. In addition, the plan includes the closure of one small R&D/manufacturing facility in North America (Lake Forest, California) and two sales offices in Europe (Sweden and Switzerland).
Restructuring and other related costs expected to be incurred in connection with this plan are currently estimated to be between $8.5 million and $10.5 million, of which between $8.0 million and $9.5 million is expected to impact the Scientific Instruments segment and between $0.5 million and $1.0 million is expected to impact the Vacuum Technologies segment. The restructuring costs are expected to include one-time termination benefits for employees whose positions are being eliminated of between $7.5 million and $9.0 million and lease termination costs of between $0.1 million and $0.2 million (including future lease payments on vacated facilities). Other restructuring-related costs are expected to include employee retention and relocation costs of between $0.3 million and $1.0 million and facility-related relocation costs and accelerated depreciation of fixed assets to be disposed upon the closure of facilities of between $0.1 million and $0.3 million. These costs will be recorded and included in cost of sales, selling, general and administrative expenses and research and development expenses.
Most of these costs are expected to be recorded and settled during fiscal year 2009, although certain one-time termination benefits are expected to be settled in fiscal year 2010. Non-cash costs are not expected to be material under the plan.
Restructuring Cost Savings. The following table sets forth the estimated annual cost savings for each plan, when they were initiated, as well as where those cost savings were expected to be realized:
Restructuring Plan | Estimated Annual Cost Savings | |
Fiscal Year 2007 Plan (Scientific Instruments - to combine and optimize the development and assembly on certain products and to centralize functions and reallocate resources to rapidly growing product lines) | $3 million - $5 million | |
Fiscal Year 2009 First Quarter Plan (Scientific Instruments - to reduce headcount and operating costs and increase operating margins) | $2 million - $3 million | |
Fiscal Year 2009 Second Quarter Plan (Scientific Instruments and Vacuum Technologies - to reduce its cost structure, primarily through headcount reduction) | $20 million - $24 million |
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These estimated cost savings are expected to impact cost of sales, selling, general and administrative expenses and research and development expenses. Some of these cost savings have been and will continue to be reinvested in other parts of our business, for example, as part of our continued emphasis on IRD and consumable products. In addition, unrelated cost increases in other areas of our operations have and could in the future offset some or all of these cost savings. Although it is difficult to quantify with any precision our actual cost savings to date from these activities, many of which are still ongoing, we currently believe that the ultimate savings realized will not differ materially from these estimates.
Interest Income.The decrease in interest income was primarily due to lower average invested cash balances and lower rates of interest on those balances during the first quarter of fiscal year 2009 compared to the first quarter of fiscal year 2008.
Income Tax Expense.The effective income tax rate was 35.3% for the first quarter of fiscal year 2009, compared to 31.4% for the first quarter of fiscal year 2008. The lower effective income tax rate in the first quarter of fiscal year 2008 was primarily due to the release of $1.5 million in tax reserves resulting from the positive outcome of tax uncertainties during that period.
Net Earnings. Net earnings for the first quarter of fiscal year 2009 reflect the after-tax impacts of $2.1 million in pre-tax acquisition-related intangible amortization and $1.7 million in pre-tax restructuring and other related costs. Net earnings for the first quarter of fiscal year 2008 reflect the after-tax impacts of $1.8 million in acquisition-related intangible amortization, $0.5 million in amortization related to inventory written up to fair value in connection with the acquisition of IonSpec and $2.0 million in restructuring and other related costs. Excluding the after-tax impact of these items, the decrease in net earnings in the first quarter of fiscal year 2009 was primarily attributable to the negative impact of lower sales volume.
Outlook
We believe that we are well-positioned from an earnings and cash flow standpoint, with a broad portfolio of products and applications, a global distribution network, recurring revenues from after-sales consumable products and services, a reduced cost structure and, if they hold, improved currency exchange rates relative to the U.S. dollar. However, we are operating in difficult global economic conditions and are facing unprecedented economic uncertainties that make it difficult for us to project our near-term results of operations. We experienced a year-over-year decline in customer orders at the end of our first quarter of fiscal year 2009, which weakness continued to a lesser extent through the first month of the second quarter of fiscal year 2009. Given this order weakness and global economic conditions, our results in the first quarter of fiscal year 2009 might not be indicative of our future results. These conditions could worsen and have an adverse effect on our financial position, results of operations and/or cash flows.
Liquidity and Capital Resources
We generated $16.9 million of cash from operating activities in the first quarter of fiscal year 2009, compared to $17.1 million generated in the first quarter of fiscal year 2008. Despite lower net earnings and higher payments related to payroll-related accruals in the first quarter of fiscal year 2009, operating cash flows were comparable to the prior-year quarter due primarily to the favorable impact of increased cash collections (from higher prior-quarter revenues) and reduced inventory purchases (to align with current-quarter revenue levels).
We used $2.5 million of cash for investing activities in the first quarter of fiscal year 2009, which compares to $13.1 million used for investing activities in the first quarter of fiscal year 2008. In October 2008, we entered into an agreement with VMS under which we agreed to surrender to them the sublease for our facility in Palo Alto, California in exchange for $21.0 million. We received a $5.0 million non-refundable first surrender payment under this agreement in the first quarter of fiscal year 2009 and will receive the remaining $16.0 million
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when we fully surrender the facility in the third quarter of fiscal year 2010. During the first quarter of fiscal year 2009, we also made investments totaling $6.9 million related to property, plant and equipment, which primarily related to the construction of our new IRD facility in Walnut Creek, California. Cash used for investing activities in the first quarter of fiscal year 2008 consisted primarily of consideration for the acquisition of the Analogix Business in November 2007.
We generated $0.5 million of cash from financing activities in the first quarter of fiscal year 2009, which compares to $3.4 million used for financing activities in the first quarter of fiscal year 2008. Cash used for financing activities in the first quarter of fiscal year 2008 was higher primarily as a result of higher expenditures to repurchase and retire common stock (such expenditures were made in the period as a result of an effort to utilize excess cash to reduce the number of outstanding common shares), partially offset by higher proceeds from the issuance of common stock (due to higher stock option exercise volume).
We maintain relationships with banks in many countries from whom we sometimes obtain bank guarantees and short-term standby letters of credit. These guarantees and letters of credit relate primarily to advance payments and deposits made to our subsidiaries by customers for which separate liabilities are recorded in the unaudited condensed consolidated financial statements. As of January 2, 2009, a total of $20.5 million of these bank guarantees and letters of credit were outstanding. No amounts had been drawn by beneficiaries under these or any other outstanding guarantees or letters of credit as of that date.
As of both January 2, 2009 and October 3, 2008, we had an $18.8 million term loan outstanding with a U.S. financial institution at a fixed interest rate of 6.7%. The term loan contains certain covenants that limit future borrowings and the payment of cash dividends and require the maintenance of certain levels of working capital and operating results. We were in compliance with all restrictive covenants of the term loan agreement at January 2, 2009.
In connection with certain acquisitions, we have accrued a portion of the purchase price that has been retained to secure the sellers’ indemnification obligations. As of January 2, 2009 we had retained an aggregate of $1.6 million, which will become payable (net of any indemnification claims) between April and November 2009.
As of January 2, 2009, we had several outstanding contingent consideration arrangements relating to acquired businesses. Amounts subject to these arrangements can be earned over the respective measurement period, depending on the performance of the acquired business relative to certain financial and/or operational targets.
The following table summarizes contingent consideration arrangements as of January 2, 2009:
Acquired Company/ Business | Remaining Amount (maximum) | Measurement Period | Measurement Period End | |||
(in millions) | ||||||
IonSpec Corporation | 14.0 | 3 years | April 2009 | |||
Oxford Diffraction Limited | 10.0 | 3 years | April 2011 | |||
Analogix Business | 3.5 | 3 years | December 2010 | |||
Other | 0.6 | 2 years | July 2010 | |||
Total | $28.1 | |||||
During the first quarter of fiscal year 2009, we paid $0.5 million in contingent consideration to the seller of the Analogix Business.
The Distribution Agreement provides that we are responsible for certain litigation to which VAI was a party, and further provides that we will indemnify VMS and VSEA for one-third of the costs, expenses and other
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liabilities relating to certain discontinued, former and corporate operations of VAI, including certain environmental liabilities (see Note 13 of the Notes to the Unaudited Condensed Consolidated Financial Statements).
As of January 2, 2009, we had cancelable commitments to a contractor for capital expenditures totaling approximately $12.1 million relating to the construction of our IRD center in Walnut Creek, California. In the event that these commitments are canceled for reasons other than the contractor’s default, we may be responsible for reimbursement of actual costs incurred by the contractor. We had no material non-cancelable commitments for capital expenditures as of January 2, 2009. In the aggregate, we currently anticipate that our capital expenditures will be approximately 2.5% to 3.0% of sales for fiscal year 2009.
As discussed above under the headingRestructuring Activities, in April 2007, we committed to a plan to combine and optimize the development and assembly of most of our NMR and mass spectrometry products, to further centralize related administration and other functions and to reallocate certain resources toward more rapidly growing product lines and geographies. In connection with this plan, we expect to make capital expenditures of up to $30.7 million, of which $15.1 million has been spent through January 2, 2009. These capital expenditures began in the fourth quarter of fiscal year 2007 and will continue through fiscal year 2009.
In connection with all of our restructuring plans, including the fiscal year 2009 second quarter plan, we expect to make cash payments for restructuring and other related costs totaling between approximately $10 million and $14 million during fiscal year 2009, of which $1.0 million was paid during the first quarter of fiscal year 2009.
In February 2008, our Board of Directors approved a stock repurchase program under which we are authorized to utilize up to $100 million to repurchase shares of our common stock. This repurchase program is effective through December 31, 2009. During the first quarter of fiscal year 2009, we did not purchase any shares under this authorization. As of January 2, 2009, we had remaining authorization to repurchase $44.6 million of our common stock under this repurchase program.
Our liquidity is affected by many other factors, some based on the normal ongoing operations of our business and others related to external economic conditions. Our liquidity has not been materially affected by the recent deterioration in the global financial markets or global economic conditions in general. However, this deterioration has adversely impacted the availability of credit to us as well as to our customers and suppliers.
We have no material exposure to market risk for changes in interest rates or investment valuations. Our outstanding debt carries a fixed interest rate, and we invest our excess cash primarily in depository accounts and money market funds at various financial institutions. While we have not historically needed to borrow to support working capital or capital expenditure requirements, there is no assurance that we might not need to borrow to support these requirements given global economic conditions. This could also adversely affect our ability to complete acquisitions and repurchase our common stock.
We nonetheless believe that cash generated from operations, together with our current cash and cash equivalents balances and current borrowing capability, will be sufficient to satisfy our cash requirements for the next 12 months. There can be no assurance, however, that our business will continue to generate cash flows at current levels or that credit will be available to us if and when needed. Future operating performance and our ability to obtain credit will be subject to future economic conditions and to financial, business and other factors.
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Contractual Obligations and Other Commercial Commitments
The following table summarizes the amount and estimated timing of future cash expenditures relating to principal and interest payments on outstanding long-term debt, minimum rentals due for certain facilities and other leased assets under long-term, non-cancelable operating leases and other long-term liabilities as of January 2, 2009:
Nine Months Ending Oct. 2, 2009 | Fiscal Years | Total | ||||||||||||||||||||||
2010 | 2011 | 2012 | 2013 | 2014 | Thereafter | |||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Operating leases | $ | 6,967 | $ | 7,204 | $ | 3,987 | $ | 2,373 | $ | 3,262 | $ | — | $ | 1,899 | $ | 25,692 | ||||||||
Long-term debt | — | 6,250 | — | 6,250 | — | 6,250 | — | 18,750 | ||||||||||||||||
Interest on long-term debt | 942 | 1,152 | 838 | 733 | 419 | 314 | — | 4,398 | ||||||||||||||||
Other long-term liabilities | 2,461 | 8,611 | 3,626 | 3,010 | 2,728 | 2,619 | 23,857 | 46,912 | ||||||||||||||||
Total | $ | 7,909 | $ | 25,678 | $ | 8,451 | $ | 12,366 | $ | 6,409 | $ | 9,183 | $ | 25,756 | $ | 95,752 | ||||||||
As of January 2, 2009, we did not have any off-balance sheet commercial commitments that could result in a significant cash outflow upon the occurrence of some contingent event, except for contingent payments of up to a maximum of $28.1 million related to acquisitions as discussed underLiquidity and Capital Resources above, the specific amounts of which are not currently determinable.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. In February 2008, the FASB issued FSP 157-2,Effective Date of FASB Statement No. 157,which delays the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). We adopted SFAS 157 effective October 4, 2008 with the exception of the application of the statement to nonrecurring nonfinancial assets and nonfinancial liabilities (see Note 4). We do not expect the adoption of the provisions deferred by FSP 157-2 to have a material impact on our financial condition or results of operations.
In December 2007, the FASB issued SFAS 141 (revised 2007),Business Combinations, (“SFAS 141(R)”). SFAS 141(R) retains the fundamental requirements of the original pronouncement requiring that the purchase method be used for all business combinations but also provides revised guidance for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed, and any noncontrolling interest in the acquiree. It also requires the recognition of assets acquired and liabilities assumed arising from contingencies, the capitalization of in-process research and development at fair value, and the expensing of acquisition-related costs as incurred.SFAS 141(R) is effective for fiscal years beginning after December 15, 2008. We do not expect its adoption in the first quarter of fiscal year 2010 to have a material impact on our financial condition or results of operations. However, in the event that we complete acquisitions subsequent to our adoption of SFAS 141(R), the application of its provisions will likely have a material impact on our results of operations, although we are not currently able to estimate that impact.
In December 2007, the FASB issued SFAS 160,Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51. SFAS 160 requires that ownership interests in subsidiaries held by parties other than the parent and the amount of consolidated net income be clearly identified, labeled and presented in the consolidated financial statements. It also requires once a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be initially measured at fair value. Sufficient
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disclosures are required to clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 is effective for fiscal years beginning after December 15, 2008, and requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements are applied prospectively. We do not expect the adoption of SFAS 160 to have a material impact on our financial condition or results of operations.
In March 2008, the FASB issued SFAS 161,Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133,which requires additional disclosures about the objectives and strategies of derivative instruments and hedging activities, the method of accounting for such instruments under SFAS 133 and its related interpretations, and a tabular disclosure of the effects of such instruments and related hedged items on our financial condition and results of operations. SFAS 161 is effective for fiscal years beginning after November 15, 2008. We do not expect the adoption of SFAS 161 to have a material impact on our financial condition or results of operations.
In April 2008, the FASB issued FSP 142-3,Determination of the Useful Life of Intangible Assets, which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The intent of FSP 142-3 is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142,Goodwill and Other Intangible Assets, and the period of expected cash flows used to measure the fair value of the asset under SFAS 141(R),Business Combinations, and other accounting literature. FSP 142-3 is effective for fiscal years beginning after December 15, 2008 and must be applied prospectively to intangible assets acquired after the effective date. Early adoption is prohibited. Given that FSP 142-3 applies to intangible assets acquired after the effective date, we do not expect its adoption to have a material impact on our financial condition or results of operations.
In December 2008, the FASB issued FSP 132(R)-1,Employers’ Disclosures about Postretirement Benefit Plan Assets. FSP 132(R)-1 amends SFAS 132 (revised 2003),Employers’ Disclosures about Pensions and Other Postretirement Benefits, to provide guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. This FSP is effective for fiscal years ending after December 15, 2009. We do not expect the adoption of FSP 132(R)-1 to have a material impact on our financial condition or results of operations.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Foreign Currency Exchange Risk. We enter into foreign exchange forward contracts to minimize the short-term impact of foreign currency fluctuations on assets and liabilities denominated in non-functional currencies. From time to time, we also enter into foreign exchange forward contracts to minimize the impact of foreign currency fluctuations on forecasted transactions. The success of our hedging activities depends on our ability to forecast balance sheet exposures and transaction activity in various foreign currencies. To the extent that these forecasts are overstated or understated during periods of currency volatility, we could experience unanticipated currency gains or losses. However, we believe that in most cases any such gains or losses would be substantially offset by losses or gains from the related foreign exchange forward contracts. We therefore believe that the direct effect of an immediate 10% change in the exchange rate between the U.S. dollar and all other currencies is not reasonably likely to have a material adverse effect on our financial condition or results of operations.
At January 2, 2009, there were no outstanding forward contracts designated as cash flow hedges of forecasted transactions. During the first quarter of fiscal year 2009, no foreign exchange gains or losses from cash flow hedge ineffectiveness were recognized.
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Our foreign exchange forward contracts generally range from one to 12 months in original maturity. A summary of all foreign exchange forward contracts that were outstanding as of January 2, 2009 follows:
Notional Value Sold | Notional Value Purchased | |||||
(in thousands) | ||||||
Australian dollar | $ | — | $ | 45,869 | ||
Euro | — | 32,594 | ||||
British pound | — | 15,238 | ||||
Japanese yen | 3,751 | — | ||||
Korean won | 3,079 | — | ||||
Brazilian real | 1,654 | — | ||||
Canadian dollar | 1,313 | — | ||||
Mexican peso | — | 1,119 | ||||
Swedish krona | 1,050 | — | ||||
Polish zloty | — | 473 | ||||
Total | $ | 10,847 | $ | 95,293 | ||
Interest Rate Risk. We have no material exposure to market risk for changes in interest rates. We invest any excess cash primarily in depository accounts and money market funds, and changes in interest rates would not be material to our financial condition or results of operations. We enter into debt obligations principally to support general corporate purposes, including working capital requirements, capital expenditures and acquisitions. At January 2, 2009, our debt obligations had fixed interest rates.
Based upon rates currently available to us for debt with similar terms and remaining maturities, the carrying amounts of long-term debt approximate their estimated fair values. Although payments under certain of our operating leases for our facilities are tied to market indices, we are not exposed to material interest rate risk associated with our operating leases.
Debt Obligations.
Principal Amounts and Related Weighted-Average Interest Rates By Year of Maturity
Nine Months Ending Oct. 2, | Fiscal Years | |||||||||||||||||||||||||||||||
2009 | 2010 | 2011 | 2012 | 2013 | 2014 | Thereafter | Total | |||||||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||||||||||
Long-term debt | $ | — | $ | 6,250 | $ | — | $ | 6,250 | $ | — | $ | 6,250 | $ | — | $ | 18,750 | ||||||||||||||||
Average interest rate | — | % | 6.7 | % | — | % | 6.7 | % | — | % | 6.7 | % | — | % | 6.7 | % |
Defined Benefit Retirement Plans. Most of our retirement plans, including all U.S.-based plans, are defined contribution plans. However, we also provide defined benefit pension plans in certain countries outside of the U.S. Our obligations under these defined benefit plans will ultimately be settled in the future and are therefore subject to estimation. Defined benefit pension accounting under SFAS 87,Employers’ Accounting for Pensions, is intended to reflect the recognition of future benefit costs over the employees’ estimated service periods based on the terms of the pension plans and the investment and funding decisions made by us.
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For our defined benefit pension plans, we make assumptions regarding several variables including the expected long-term rate of return on plan assets and the discount rate in order to determine defined benefit pension plan expense for the year. This expense is referred to as “net periodic pension cost.” We assess the expected long-term rate of return on plan assets and discount rate assumption for each defined benefit plan based on relevant market conditions as prescribed by SFAS 87 and make adjustments to the assumptions as appropriate. On an annual basis, we analyze the rates of return on plan assets and discount rates used and determine that these rates are reasonable. For rates of return, this analysis is based on a review of the nature of the underlying assets, the allocation of those assets and their historical performance and expectations relative to relevant markets in the countries where the related plans are effective. Historically, our assumed asset allocations have not varied significantly from the actual allocations. Discount rates are based on the prevailing market long-term interest rates in the countries where the related plans are effective. As of October 3, 2008, the estimated long-term rate of return on our defined benefit pension plan assets ranged from 0.8% to 7.1% (weighted-average of 5.8%), and the assumed discount rate for our defined benefit pension plan obligations ranged from 2.0% to 6.1% (weighted-average of 6.0%).
If any of these assumptions were to change, our net periodic pension cost would also change. We incurred net periodic pension cost relating to our defined benefit pension plans of $1.5 million in fiscal year 2008, $2.3 million in fiscal year 2007 and $2.3 million in fiscal year 2006, and expect our net periodic pension cost to be approximately $1.6 million in fiscal year 2009. A one percent decrease in the weighted-average estimated return on plan assets or assumed discount rate would increase our net periodic pension cost for fiscal year 2009 by $1.0 million or $0.4 million, respectively. As of October 3, 2008, our projected benefit obligation relating to defined benefit pension plans was $47.7 million. A one percent decrease in the weighted-average estimated discount rate would increase this obligation by $9.8 million.
Item 4. | Controls and Procedures |
Disclosure Controls and Procedures. Based on the evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) required by Rules 13a-15(b) and 15d-15(b) of the Exchange Act, our Chief Executive Officer and the Chief Financial Officer have concluded that as of the end of the period covered by this Quarterly Report on Form 10-Q (for the period ended January 2, 2009), our disclosure controls and procedures were effective.
Inherent Limitations on the Effectiveness of Controls. The Company’s management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well designed and operated, can only provide reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that the benefits of controls must be considered relative to their costs. Due to the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons or by collusion of two or more people. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Changes in Internal Control over Financial Reporting. There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during the first quarter of our fiscal year 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II
OTHER INFORMATION
Item 1A. | Risk Factors |
See Item 1A—Risk Factors presented in our Annual Report on Form 10-K for the fiscal year ended October 3, 2008, which we encourage you to carefully consider.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
(c) During the fiscal quarter ended January 2, 2009, the Company repurchased and retired 8,000 shares tendered to it by employees in settlement of employee tax withholding obligations due from those employees upon the vesting of restricted stock.
Item 6. | Exhibits |
(a) Exhibits.
Incorporated by Reference | Filed Herewith | |||||||||
Exhibit | Exhibit Description | Form | Date | Exhibit Number | ||||||
10.31* | Description of Compensatory Arrangements between Varian, Inc. and Non-Employee Director | X | ||||||||
31.1 | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | X | ||||||||
31.2 | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | X | ||||||||
32.1 | Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |||||||||
32.2 | Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
* | Director compensatory plan or arrangement. |
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SIGNATURES
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, INC. (Registrant) | ||||||
Date: February 11, 2009 | By: | /S/ G. EDWARD MCCLAMMY | ||||
G. Edward McClammy Senior Vice President and Chief Financial Officer (Duly Authorized Officer and Principal Financial Officer) |
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