- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
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 April 2, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 000-25393
----------------
VARIAN, INC.
(Exact Name of Registrant as Specified in its Charter)
Delaware 77-0501995
(State or Other Jurisdiction (IRS Employer
of Incorporation or Organization) Identification Number)
3120 Hansen Way, Palo Alto, California 94304-1030
(Address of principal executive offices) (Zip Code)
(650) 213-8000
(Registrant's telephone number, including area code)
3050 Hansen Way, Palo Alto, California 94304-1000
(Former Address)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 of 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [_] No [X]
The number of shares of the Registrant's common stock outstanding as of May
7, 1999 was 30,422,792 shares of $0.01 par value common stock.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
TABLE OF CONTENTS
Part I. Financial Information.......................................... 1
Item 1. Financial Statements........................................... 1
Combined Statements of Operations.............................. 1
Combined Balance Sheets........................................ 2
Combined Condensed Statements of Cash Flows.................... 3
Notes to the Combined Financial Statements..................... 4
Management's Discussion and Analysis of Financial Condition and
Item 2. Results of Operations.......................................... 10
Item 3. Quantitative and Qualitative Disclosure about Market Risk...... 19
Part II. Other Information.............................................. 20
Item 5. Other Information.............................................. 20
Item 6. Exhibits and Reports on Form 8-K............................... 20
RISK FACTORS RELATING TO FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains "forward-looking" statements
within the meaning of the Private Securities Litigation Reform Act of 1995
which provides a "safe harbor" for these types of statements. These forward-
looking statements are subject to risks and uncertainties that could cause
actual results of Varian, Inc. (the "Company") to differ materially from
management's current expectations. Those risks and uncertainties include,
without limitation: new product development and commercialization; demand and
acceptance for the Company's products; competitive products and pricing;
economic conditions in the Company's product and geographic markets, including
Asia markets; foreign currency fluctuations; market investment in capital
equipment; the ability to realize anticipated cost-savings from the recently-
initiated reorganization and restructuring; increasing operating margins on
higher sales; costs of investigating and remediating environmentally-
contaminated sites; successful implementation by the Company and certain third
parties of corrective action to address the impact of the Year 2000; the risks
detailed in the Company's registration statement on Form 10/A filed with the
Securities and Exchange Commission; and other risks detailed from time to time
in the Company's filings with the Securities and Exchange Commission. The
Company assumes and undertakes no obligation to update or revise any forward-
looking statement, whether as a result of new information, future events or
otherwise.
PART I.
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Varian, Inc. and Subsidiary Companies
Combined Statements of Operations
(In thousands, except per share amounts)
(Unaudited)
Quarter Ended Six Months Ended
--------------------------- ---------------------------
April 2, 1999 April 3, 1998 April 2, 1999 April 3, 1998
------------- ------------- ------------- -------------
Sales $ 148,936 $ 140,965 $ 282,232 $ 281,913
--------- --------- --------- ---------
Operating Costs and
Expenses
Cost of sales 101,712 85,228 182,378 171,660
Research and development 9,277 7,775 16,440 15,005
Marketing 34,180 28,068 64,276 55,340
General and
administrative 10,760 9,246 18,462 19,630
Restructuring charges 10,974 -- 10,974 --
--------- --------- --------- ---------
Total Operating Expenses 166,903 130,317 292,530 261,635
--------- --------- --------- ---------
Operating Earnings
(Loss) Before Taxes (17,967) 10,648 (10,298) 20,278
Income tax (benefit)
expense (7,993) 4,248 (4,580) 8,117
--------- --------- --------- ---------
Net Earnings (Loss) $ (9,974) $ 6,400 $ (5,718) $ 12,161
========= ========= ========= =========
Pro Forma Net Earnings
(Loss) Per Share:
Basic $ (0.33) $ 0.21 $ (0.19) $ 0.40
========= ========= ========= =========
Diluted $ (0.33) $ 0.21 $ (0.19) $ 0.40
========= ========= ========= =========
Shares Used in Pro Forma
Per Share Computations:
Basic 30,423 30,423 30,423 30,423
========= ========= ========= =========
Diluted 30,423 30,587 30,423 30,587
========= ========= ========= =========
See accompanying Notes to the Combined Financial Statements.
1
Varian, Inc. and Subsidiary Companies
Combined Balance Sheets
(In thousands, except share and par value amounts)
April 2, October 2,
1999 1998
----------- ----------
(Unaudited)
ASSETS
Current Assets
Cash and cash equivalents $ 12,093 $ --
Accounts receivable 142,974 143,836
Inventories 67,482 71,575
Other current assets 31,834 26,260
--------- ---------
Total Current Assets 254,383 241,671
Property, plant and equipment 194,087 219,385
Accumulated depreciation and amortization (108,073) (124,666)
--------- ---------
Net Property, Plant and Equipment 86,014 94,719
Other Assets 66,425 67,709
--------- ---------
Total Assets $ 406,822 $ 404,099
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Notes payable $ 11,428 $ --
Accounts payable--trade 28,347 34,320
Accrued expenses 111,243 102,470
Product warranty 7,907 7,608
Advance payments from customers 8,234 5,180
--------- ---------
Total Current Liabilities 167,159 149,578
Long-Term Accrued Expenses 7,929 6,862
Deferred Taxes 4,460 4,192
Notes Payable 52,517 --
--------- ---------
Total Liabilities 232,065 160,632
--------- ---------
Contingencies (Note 7)
Stockholders' Equity
Preferred Stock--par value $.01, authorized --
1,000,000 shares; issued--none -- --
Common Stock -- par value $.01, authorized --
99,000,000 shares; issued and outstanding--30,422,792
shares at April 2, 1999 and none historical 304 --
Capital in excess of par value 174,453 --
Divisional equity -- 243,467
--------- ---------
Total Stockholders' Equity 174,757 243,467
--------- ---------
Total Liabilities and Stockholders' Equity $ 406,822 $ 404,099
========= =========
See accompanying Notes to the Combined Financial Statements.
2
Varian, Inc. and Subsidiary Companies
Combined Condensed Statements of Cash Flows
(In thousands)
(Unaudited)
Six Months Ended
---------------------------
April 2, 1999 April 3, 1998
------------- -------------
Net Cash Provided by Operating Activities $ 8,584 $ 19,407
-------- --------
Investing Activities
Purchase of property, plant and equipment (10,546) (9,710)
-------- --------
Net Cash Used in Investing Activities (10,546) (9,710)
-------- --------
Financing Activities
Net transfers from (to) Varian Associates, Inc. 14,792 (10,139)
-------- --------
Net Cash Provided by (Used in) Financing
Activities 14,792 (10,139)
-------- --------
Effects of Exchange Rate Changes on Cash (737) 442
-------- --------
Net increase (decrease) in cash and cash
equivalents 12,093 --
Cash and cash equivalents at beginning of
period -- --
-------- --------
Cash and Cash Equivalents at End of Period $ 12,093 $ --
======== ========
Non-Cash Investing and Financing Activities:
Debt assumed/transferred from Varian
Associates, Inc. $ 77,100
========
Transfer of property, plant and equipment $ 9,900
========
See accompanying Notes to the Combined Financial Statements.
3
VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE COMBINED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Interim Combined Financial Statements
These interim combined financial statements of Varian, Inc. and its
subsidiary companies (collectively, the "Company") have been prepared pursuant
to the rules and regulations of the Securities and Exchange Commission.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. The year ended October 2, 1998 balance sheet data was derived
from audited financial statements, but does not include all disclosures
required by generally accepted accounting principles. These interim combined
financial statements should be read in conjunction with the financial
statements and the notes thereto included in the registration statement on the
Company's Form 10/A filed with the Securities and Exchange Commission. In the
opinion of the Company's management, the interim combined 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 second quarter and six months ended April 2, 1999 are not necessarily
indicative of the results to be expected for a full year or for any other
periods.
Note 2. Basis of Presentation
Until April 2, 1999, the Company's business was operated as part of Varian
Associates, Inc. ("VAI"). VAI contributed its Instruments business ("IB") to
the Company, then on April 2, 1999 distributed to the holders of record of VAI
common stock on March 24, 1999 one share of common stock of the Company for
each share of VAI common stock outstanding on April 2, 1999 (the
"Distribution"). At the same time, VAI contributed its Semiconductor Equipment
business to Varian Semiconductor Equipment Associates, Inc. ("VSEA") and
distributed to the holders of record of VAI common stock on March 24, 1999 one
share of common stock of VSEA for each share of VAI common stock outstanding
on April 2, 1999. VAI retained its Health Care Systems business and changed
its name to Varian Medical Systems, Inc. ("VMS") effective as of April 3,
1999. These transactions were accomplished under the terms of an Amended and
Restated Distribution Agreement dated as of January 14, 1999 by and among the
Company, VAI and VSEA (the "Distribution Agreement"). For purposes of
providing an orderly transition and to define certain ongoing relationships
between and among the Company, VMS and VSEA after the Distribution, the
Company, VMS and VSEA also entered into certain other agreements which include
an Employee Benefits Allocation Agreement, an Intellectual Property Agreement,
a Tax Sharing Agreement and a Transition Services Agreement (collectively, the
"Distribution Related Agreements").
The interim combined financial statements generally reflect the results of
operations, financial position and cash flows of IB, which was transferred to
the Company in connection with the Distribution. Accordingly, the interim
combined financial statements have been carved out from the interim financial
statements of VAI using the historical results of operations and historical
bases of the assets and liabilities of IB. The statements include the accounts
of IB after elimination of inter-business balances and transactions. The
interim combined financial statements include, among other things, allocations
of certain VAI corporate assets (including pension assets), liabilities
(including profit sharing and pension benefits), and expenses (including
legal, accounting, employee benefits, insurance services, information
technology services, treasury and other corporate overhead) to IB. These
amounts have been allocated to IB on the basis that is considered by
management to reflect most fairly or reasonably the utilization of the
services provided to or the benefit obtained by IB. Typical measures and
activity indicators used for allocation purposes include headcount, sales
revenue and payroll expense. The Company's management believes that the
methods used to allocate these amounts are reasonable. However, these
allocations are not necessarily indicative of the amounts that would have been
or that will be recorded by the Company on a stand-alone basis. The interim
combined financial statements do not reflect any changes that may occur in the
financing and operations of the Company as a result of the Distribution.
The Company's fiscal year is the 52- or 53-week period ending on the Friday
nearest September 30. Fiscal year 1999 will comprise the 52-week period ending
October 1, 1999, and fiscal year 1998 comprises the 53-week
4
VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE COMBINED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
period ended October 2, 1998. The fiscal quarters ended April 2, 1999 and
April 3, 1998 each comprise 13 weeks. For purposes of interim reporting, the
six-month period ended April 2, 1999 comprises 26 weeks, and the six-month
period ended April 3, 1998 comprises 27 weeks.
Note 3. Balance Sheet Detail
Inventories
April 2, October 2,
1999 1998
-------- ----------
(Dollars in
millions)
Raw materials and parts............................... $35.9 $32.1
Work in process....................................... 5.6 6.7
Finished goods........................................ 26.0 32.8
----- -----
Total inventories................................... $67.5 $71.6
===== =====
Inventories are valued at the lower of cost or market (net realizable
value) using the last-in, first-out (LIFO) cost for the U.S. inventories. All
other inventories are valued principally at average cost. If the first-in,
first-out (FIFO) method had been used for those operations valuing inventories
on a LIFO basis, inventories would have been higher than reported by $14.2
million at April 2, 1999 and $13.7 million at October 2, 1998.
Other Assets
April 2, October 2,
1999 1998
-------- ----------
(Dollars in
millions)
Net goodwill........................................... $60.2 $59.6
Other.................................................. 6.2 8.1
----- -----
Total other assets................................... $66.4 $67.7
===== =====
Accrued Expenses
April 2, October 2,
1999 1998
-------- ----------
(Dollars in
millions)
Payroll and employee benefits.......................... $ 29.8 $ 33.1
Foreign income taxes payable........................... 6.5 19.2
Deferred income........................................ 16.2 14.7
Group and risk insurance............................... 7.2 7.7
Net amount due to VMS/VSEA............................. 13.2 --
Restructuring.......................................... 7.1 --
Other.................................................. 31.2 27.8
------ ------
$111.2 $102.5
====== ======
Note 4. Forward Exchange Contracts
IB has entered and the Company will enter into forward exchange contracts
to mitigate the balance sheet exposures to fluctuations in foreign currency
exchange rates. When these foreign exchange contracts hedge operational
exposure, the effects of movements in currency exchange rates on these
instruments are recognized in income when the related revenue and expenses are
recognized. When foreign exchange contracts hedge
5
VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE COMBINED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
balance sheet exposure, such effects are recognized in income when the
exchange rate changes. Because the impact of movements in currency exchange
rates on foreign exchange contracts generally offsets the related impact on
the underlying items being hedged, these instruments do not subject IB or the
Company to risk that would otherwise result from changes in currency exchange
rates. Gains and losses on hedges of existing assets or liabilities are
included in the carrying amounts of those assets or liabilities and are
ultimately recognized in income as part of those carrying amounts. Gains and
losses related to qualifying hedges of firm commitments also are deferred and
are recognized in income or as adjustments of carrying amounts when the hedged
transaction occurs. Any deferred gains or losses are included in accrued
expenses in the balance sheet. If a hedging instrument is sold or terminated
prior to maturity, gains and losses continue to be deferred until the hedged
item is recognized in income. If a hedging instrument ceases to qualify as a
hedge, any subsequent gains and losses are recognized currently in income.
There were no significant forward exchange contracts outstanding as of April
2, 1999.
Note 5. Pro Forma Net Earnings (Loss) Per Share
IB's pro forma basic earnings (loss) per share is calculated based on net
earnings (loss) and the weighted-average number of shares outstanding during
the reported period. For purposes of the pro forma calculation, the weighted-
average number of shares outstanding during the reporting period was assumed
to be the number of shares of common stock outstanding as of the Distribution
on April 2, 1999. Pro forma diluted earnings (loss) per share includes
additional dilution from potential common stock shares such as common stock
issuable pursuant to the exercise of outstanding stock options. For purposes
of the pro forma diluted earnings (loss) per share calculation, the additional
shares issuable upon exercise of stock options were determined using the
treasury stock method based on the number of replacement stock options issued
as of the Distribution on April 2, 1999.
All options to purchase common stock were excluded from the computation of
diluted loss per share for the quarter and six-month period ended April 2,
1999 because their effect was anti-dilutive. For the quarter and six-month
period ended April 3, 1998, options to purchase 3,030,355 potential common
stock shares with exercise prices in excess of the market value on April 2,
1999 of such common stock were excluded from the computation.
Note 6. Debt and Credit Facilities
The Distribution Agreement provided for the division among the Company,
VSEA and VMS of VAI's cash and debt as of April 2, 1999. Under the
Distribution Agreement, the Company was to assume 50% of VAI's term loans and
receive an amount of cash from VAI such that it would have net debt (defined
in the Distribution Agreement as the amount outstanding under the term loans
and notes payable, less cash and cash equivalents) equal to approximately 50%
of the net debt of the Company and VMS, subject to such adjustment as was
necessary to provide VMS with a net worth (as defined in the Distribution
Agreement) of between 40% and 50% of the aggregate net worth of the Company
and VMS, and subject to further adjustment to reflect the Company's
approximately 50% share of the estimated proceeds, if any, to be received by
VMS after the Distribution from the sale of VAI's long-term leasehold interest
at certain of its Palo Alto facilities, together with certain related
buildings and other corporate assets and the Company's obligation for
approximately 50% of any estimated transaction expenses to be paid by VMS
after the Distribution (in each case reduced for estimated taxes payable or
tax benefits received from all sales and transaction expenses). Since the
amounts transferred immediately prior to the Distribution were based on
estimates, adjustments may be required within 180 days following the
Distribution. In addition, certain other pre-Distribution transactions may
require
6
VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE COMBINED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
adjustment within 90 days following the Distribution under the provisions of
the Distribution Agreement. As a result of these adjustments, the Company may
be required to make cash payments to VMS or may be entitled to receive cash
payments from VMS. The amount of any such adjustments cannot be estimated.
As part of the Distribution, a total of $63.9 million in debt was assumed
by or transferred to the Company, which debt consisted of $58.5 million in
term loans and $5.4 million in notes payable. As of April 2, 1999, interest
rates on the term loans ranged from 6.70% to 7.49%, and the weighted average
interest rate on the term loans was 7.02%. As of April 2, 1999, interest rates
on the notes payable ranged from 1.50% to 4.00%, and the weighted average
interest rate on the notes payable was 2.95%. The term loans contain 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.
As of April 2, 1999, the Company entered into $40.0 million in uncommitted
credit facilities for working capital purposes. As of April 2, 1999, none of
these credit facilities were utilized and no amount was outstanding. Following
April 2, 1999, the Company entered into additional uncommitted credit
facilities for $15.0 million for working capital purposes. All of these credit
facilities contain certain conditions and events of default customary for such
facilities.
Future principal payments on notes payable and long-term debt outstanding
on April 2, 1999 will be $8.4 million, $6.0 million, $6.0 million, $6.0
million, $2.5 million, $2.5 million and $32.5 million during the six months
ended October 1, 1999, the fiscal years ended 2000, 2001, 2002, 2003, 2004,
and thereafter, respectively.
Note 7. Contingencies
Environmental Matters
In the Distribution Agreement, the Company agreed to indemnify VMS and VSEA
for one-third of certain environmental investigation and remediation costs
(after adjusting for any insurance proceeds and tax benefits recognized or
realized for such costs), as further described below.
VAI has been named by the U.S. Environmental Protection Agency or third
parties as a potentially responsible party under the Comprehensive
Environmental Response Compensation and Liability Act of 1980, as amended, at
eight sites where VAI is alleged to have shipped manufacturing waste for
recycling or disposal. VAI is also involved in various stages of environmental
investigation and/or remediation under the direction of, or in consultation
with, foreign, federal, state and/or local agencies at certain current or
former VAI facilities.
For certain of these sites and facilities, various uncertainties make it
difficult to assess the likelihood and scope of further investigation or
remediation activities or to estimate the future costs of such activities if
undertaken. As of April 2,1999, it was nonetheless estimated that the future
exposure for environmental-related investigation and remediation costs for
these sites and facilities ranged in the aggregate from $21.0 million to $48.3
million. The time frame over which these costs are expected to be incurred
varies with each site and facility, ranging up to approximately 30 years as of
April 2, 1999. No amount in the foregoing range of estimated future costs is
believed to be more probable of being incurred than any other amount in such
range and therefore VAI accrued $21.0 million in estimated environmental costs
as of April 2, 1999. The amount accrued was not discounted to present value.
7
VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE COMBINED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
As to other sites and facilities, sufficient knowledge has been gained to
be able to better estimate the scope and costs of future environmental
activities. As of April 2, 1999, it was estimated that the future exposure for
environmental related investigation and remediation costs for these sites and
facilities ranged in the aggregate from $39.2 million to $73.0 million. The
time frame over which these costs are expected to be incurred varies with each
site and facility, ranging up to approximately 30 years as of April 2, 1999.
As to each of these sites and facilities, it was determined that a particular
amount within the range of estimated costs was a better estimate of the future
environmental liability than any other amount within the range, and that the
amount and timing of these futures costs were reliably determinable. Together,
these amounts totaled $50.6 million at April 2, 1999. Accordingly, VAI accrued
$21.9 million as of April 2, 1999, which represents the best estimate of the
future costs discounted at 4%, net of inflation. This accrual is in addition
to the $21.0 million described in the preceding paragraph.
Since the Company is obligated to reimburse VMS for one-third of the
foregoing environmental-related costs and expenses (after adjusting for any
insurance proceeds and tax benefits recognized or realized by VMS for such
costs or expenses) that are paid after April 2, 1999, IB recorded $7.7 million
as its portion of these estimated future costs and expenses as of April 2,
1999. The foregoing amounts are only estimates of anticipated future
environmental-related costs, and the amounts actually spent may be greater or
less than such estimates. The aggregate range of cost estimates reflects
various uncertainties inherent in many environmental investigation and
remediation activities and the large number of sites and facilities involved.
The Company believes that most of these cost ranges will narrow as
investigation and remediation activities progress.
The Company's management believes that its reserves for the foregoing and
certain 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 earnings may be made. Although any ultimate
liability arising from environmental-related matters described herein could
result in significant expenditures that, if aggregated and assumed to occur
within a single fiscal year, would be material to the Company's financial
statements, the likelihood of such occurrence is considered remote. Based on
information currently available and its best assessment of the ultimate amount
and timing of environmental-related events, the Company's management believes
that the costs of these environmental-related matters are not reasonably
likely to have a material adverse effect on the Company's financial
statements.
Legal Proceedings
In the Distribution Agreement, the Company agreed to reimburse VMS for one-
third of certain costs and expenses (adjusted for any insurance proceeds and
tax benefits recognized or realized by VMS for such costs and expenses) that
are paid after April 2, 1999 and arise from actual or potential claims or
legal proceedings relating to discontinued, former or corporate operations of
VAI. These shared liabilities will generally be managed by VMS, and expenses
and losses (adjusted for any insurance proceeds and tax benefits recognized or
realized by VMS for such costs and expenses) will generally be borne one-third
each by the Company, VMS and VSEA. Also, from time to time, the Company is
involved in a number of legal actions and could incur an uninsured liability
in one or more of them. While the ultimate outcome of all of the above legal
matters is not determinable, management believes that the resolution of these
matters will not have a material adverse effect on the Company's financial
condition, results of operations or cash flows.
Note 8. Stockholders' Equity
On April 2, 1999, stockholders of record of VAI on March 24, 1999 received
in the Distribution one share of the Company's common stock for each share of
VAI common stock held on April 2, 1999. Immediately following the
Distribution, the Company had 30,422,792 shares of common stock outstanding.
8
VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE COMBINED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
Each stockholder also received one Right for each share of common stock
distributed, entitling the stockholder to purchase one one-thousandth of a
share of Participating Preferred Stock, par value $0.01 per share, for $75.00,
subject to adjustment. The Participating Preferred Stock is designed so that
each one one-thousandth of share has economic and voting terms similar to
those of one share of common stock.
The Company will begin accumulating retained earnings on April 3, 1999, the
date after the Distribution.
In connection with the Distribution, certain holders of options to purchase
shares of VAI common stock received replacement options from the Company to
purchase shares of the Company's common stock. The Company granted such
replacement options to purchase 4,299,639 shares of the Company's common stock
with an average exercise price of $11.16 per share. Such stock options vest
over the same vesting periods as the original VAI stock options, typically
three years. At issuance, options to purchase 3,459,508 shares with an average
exercise price of $10.66 were immediately exercisable.
Note 9. Restructuring Charges
During the second quarter of fiscal year 1999, IB's management approved a
program to consolidate field sales and service organizations in Europe,
Australia and the United States so as to fall within the direct responsibility
of management at IB's principal factories in those countries in order to
reduce costs, simplify management structure and benefit from the
infrastructure existing in those factories. This restructuring entailed
consolidating certain sales, service and support operations. The consolidation
resulted in exiting of a product line, closing or downsizing of sales offices
and termination of approximately 100 personnel. The following table sets forth
certain details associated with this restructuring during the second quarter
of fiscal year 1999:
Cash Accrual at
Restructuring Payments/Other April 2,
Charges Reductions 1999
------------- -------------- ----------
(Dollars in thousands)
Lease payments and other facility
expenses............................. $ 2,205 $ 240 $1,965
Severance and other related employee
benefits............................. 7,171 1,988 5,183
Exited product line................... 1,598 1,598 --
------- ------ ------
Total............................... $10,974 $3,826 $7,148
======= ====== ======
Note 10. Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures
about Segments of an Enterprise and Related Information." This statement
changes standards for the way that public business enterprises identify and
report operating segments in annual and interim financial statements. This
statement requires selected information about an enterprise's operating
segments and related disclosure about products and services, geographic areas
and major customers. The Company expects to report multiple segments when it
adopts SFAS No. 131 at fiscal year-end 1999.
In June 1998, FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes accounting and
reporting standards for derivative instruments and requires recognition of all
derivatives as assets or liabilities in the statement of financial position
and measurement of those instruments at fair value. This statement is
effective for fiscal years beginning after June 15, 1999. The Company will
adopt SFAS No. 133 in the first quarter of fiscal year 2000 and is in the
process of determining the impact that adoption will have on its consolidated
financial statements.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Until April 2, 1999, the Company's business was operated as part of Varian
Associates, Inc. ("VAI"). VAI contributed its Instruments business ("IB") to
the Company, then on April 2, 1999 distributed to the holders of record of VAI
common stock on March 24, 1999 one share of common stock of the Company for
each share of VAI common stock outstanding on April 2, 1999 (the
"Distribution"). At the same time, VAI contributed its Semiconductor Equipment
business to Varian Semiconductor Equipment Associates, Inc. ("VSEA") and
distributed to the holders of record of VAI common stock on March 24, 1999 one
share of common stock of VSEA for each share of VAI common stock outstanding
on April 2, 1999. VAI retained its Health Care Systems business and changed
its name to Varian Medical Systems, Inc. ("VMS") effective as of April 3,
1999. IB includes VAI's business units that design, manufacture, sell and
service analytical and research instrumentation and vacuum technologies, and a
business unit that provides contract electronics assembly.
These transactions were accomplished under the terms of an Amended and
Restated Distribution Agreement dated as of January 14, 1999 by and among the
Company, VAI and VSEA (the "Distribution Agreement"). For purposes of
providing an orderly transition and to define certain ongoing relationships
between and among the Company, VMS and VSEA after the Distribution, the
Company, VMS and VSEA also entered into certain other agreements which include
an Employee Benefits Allocation Agreement, an Intellectual Property Agreement,
a Tax Sharing Agreement and a Transition Services Agreement (collectively, the
"Distribution Related Agreements").
The interim combined financial statements generally reflect the results of
operations, financial position and cash flows of IB, which was transferred to
the Company in connection with the Distribution. Accordingly, the interim
combined financial statements have been carved out from the interim financial
statements of VAI using the historical results of operations and historical
bases of the assets and liabilities of IB. The statements include the accounts
of IB after elimination of inter-business balances and transactions. The
interim combined financial statements include, among other things, allocations
of certain VAI corporate assets (including pension assets), liabilities
(including profit-sharing and pension benefits) and expenses (including legal,
accounting, employee benefits, insurance services, information technology
services, treasury and other corporate overhead) to IB using the allocation
methodology described in Note 2 of the Notes to the Company's interim combined
financial statements. The Company's management believes that the methods used
to allocate these amounts are reasonable. The interim combined financial
statements do not reflect any changes that may occur in the financing and
operations of the Company as a result of the Distribution.
This discussion and analysis of financial condition and results of
operations is based upon and should be read in conjunction with the interim
combined financial statements of the Company and the notes thereto, as well as
the Instruments Business of Varian Associates, Inc. Combined Financial
Statements and notes thereto and the information contained under the headings
"Business," "Risk Factors" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in the Company's registration
statement on Form 10/A filed with the Securities and Exchange Commission.
The Company's fiscal year is the 52- or 53-week period ending on the Friday
nearest September 30. Fiscal year 1999 comprises the 52-week period ending
October 1, 1999, and fiscal year 1998 comprises the 53-week period ended
October 2, 1998. The fiscal quarters ended April 2, 1999 and April 3, 1998
each comprise 13 weeks. For purposes of interim reporting, the six-month
period ended April 2, 1999 comprises 26 weeks, and the six-month period ended
April 3, 1998 comprises 27 weeks.
Results of Operations
Second Quarter of Fiscal Year 1999 Compared to Second Quarter of Fiscal Year
1998
Sales. IB's sales were $148.9 million in the second quarter of fiscal year
1999, compared to sales of $141.0 million in the second quarter of fiscal year
1998. The primary reasons for this 5.7% increase in sales
10
were higher volume in the Analytical Instruments business (driven in large
part by Chrompack International B.V. ("Chrompack"), which was acquired in the
fourth quarter of fiscal year 1998), and an increase in sales by IB's
Electronics Manufacturing (formerly Tempe Electronics Center) business. These
increases were partially off-set by lower sales in the Vacuum Technologies
(formerly Vacuum Products) business, which declined largely due to the
continuing slow-down in capital spending, particularly in Asian markets, and
continuing weakness in semiconductor equipment demand. NMR Systems (formerly
NMR Instruments) also experienced lower sales due to the timing of shipments
of NMR Systems products.
Geographically, sales in North America of $80.1 million and Europe of $49.1
million in the second quarter of fiscal year 1999 represented increases of
2.0% and 29.0%, respectively, from the second quarter of fiscal year 1998,
while sales in Asia of $14.0 million in the second quarter of fiscal year 1999
represented a decrease of 18.0% from the second quarter of fiscal year 1998.
The increase in Europe resulted largely from the acquisition of Chrompack in
the fourth quarter of fiscal year 1998, and the decrease in Asia resulted
largely from weak economic conditions in that region.
IB's orders during the second quarter of fiscal year 1999 were $154.2
million, compared to $138.5 million in the first quarter of fiscal year 1999
and $136.4 million in the second quarter of fiscal year 1998. All IB
businesses contributed to the sequential orders growth, with only the Vacuum
Technologies business showing a slight decline compared to the year-ago
quarter (although it showed a 33% sequential increase).
Gross Profit. IB's gross profit was $47.2 million (representing 31.7% of
sales) in the second quarter of fiscal year 1999, compared to $55.7 million
(representing 39.5% of sales) in the second quarter of fiscal year 1998. The
decline in gross profit resulted primarily from actions taken as part of an
overall reorganization of IB, which included actions to prepare IB to separate
from VAI and become a stand-alone company, other organizational changes and a
comprehensive product review, which resulted in a decision to accelerate
transition from certain older to newer products necessitating the writedown of
certain excess and obsolete inventories and the lowering of prices to
accelerate the liquidation of older products. The impact on gross profit of
these actions were in addition to the restructuring charges discussed below.
The decline in gross profit was also the result of lower sales of Vacuum
Technologies products.
Research and Development. IB's research and development expenses were $9.3
million (representing 6.2% of sales) in the second quarter of fiscal year
1999, compared to research and development expenses of $7.8 million
(representing 5.5% of sales) in the second quarter of fiscal year 1998. This
increase related primarily to the research and development expenses of
Chrompack, which was acquired in the fourth quarter of fiscal year 1998, and
accelerated development costs incurred to complete a new gas chromatograph
product.
Marketing. IB's marketing expenses were $34.2 million (representing 22.9%
of sales) in the second quarter of fiscal year 1999, compared to $28.1 million
(representing 19.9% of sales) in the second quarter of fiscal year 1998. Some
of the increase was due to marketing expenses of Chrompack, which was acquired
in the fourth quarter of fiscal year 1998. Additionally, the increase in
marketing expenses resulted from actions taken as part of the above-described
reorganization, including costs to move people and equipment to new
consolidated locations, writedown of field demonstration equipment following
the accelerated transition to newer products, and other higher than normal
costs related to the reorganization. These charges were in addition to the
restructuring charges discussed below.
General and Administrative. IB's general and administrative expenses were
$10.8 million (representing 7.2% of sales) in the second quarter of fiscal
year 1999, compared to $9.2 million (representing 6.5% of sales) in the second
quarter of fiscal year 1998. The primary reason for this increase was the
additional general and administrative costs of Chrompack, which was acquired
in the fourth fiscal quarter of fiscal 1998.
Restructuring Charges. During the second quarter of fiscal year 1999, IB's
management approved a program to consolidate field sales and service
organizations in Europe, Australia and the United States so as to fall within
the direct responsibility of management at IB's principal factories in those
countries in order to reduce
11
costs, simplify management structure and benefit from the infrastructure
existing in those factories. This restructuring entailed consolidating certain
sales, service and support operations. The consolidation resulted in exiting
of a product line, closing or downsizing of sales offices and termination of
approximately 100 personnel. The following table sets forth certain details
associated with this restructuring in the second quarter of fiscal year 1999:
Cash Accrual at
Restructuring Payments/Other April 2,
Charges Reductions 1999
------------- -------------- ----------
(Dollars in thousands)
Lease payments and other facility
expenses........................ $ 2,205 $ 240 $1,965
Severance and other related
employee benefits............... 7,171 1,988 5,183
Exited product line.............. 1,598 1,598 --
------- ------ ------
Total.......................... $10,974 $3,826 $7,148
======= ====== ======
Taxes on Earnings. IB's effective income tax rate was 44.5% in the second
quarter of fiscal year 1999, compared to 40.0% in the second quarter of fiscal
year 1998. The fiscal year 1999 rate is higher than the fiscal year 1998 rate
because the Company expects to realize a larger proportion of high-tax foreign
country income during fiscal year 1999 than it did during fiscal year 1998.
Net Loss. The net loss of $10.0 million ($0.33 pro forma net loss per
share) in the second quarter of fiscal year 1999 was the result of IB's
overall reorganization described above, which resulted in incremental costs
primarily included in cost of sales, marketing and restructuring charges.
Although some of these costs will continue at significantly reduced levels for
several quarters, management believes that the Company will return to
profitability during the third quarter of fiscal year 1999.
First Half of Fiscal Year 1999 Compared to First Half of Fiscal Year 1998
Sales. IB's sales were $282 million in the first half of fiscal year 1999,
the same as in the first half of fiscal year 1998. Sales by the Analytical
Instruments and the Electronics Manufacturing businesses were higher during
the six-month period relative to the year-ago period, in the case of the
former due in part to Chrompack, which was acquired in the fourth quarter of
fiscal year 1998. These increases were off-set by lower sales in the Vacuum
Technology business, which declined largely due to the continuing slow-down in
capital spending, particularly in Asian markets, and continuing weakness in
semiconductor equipment demand. NMR Systems also experienced lower sales, due
to the timing of shipments of NMR Systems products.
Geographically, sales in North America of $149.3 million and Europe of
$92.0 million in the first half of fiscal year 1999 represented a decline of
4.5% and an increase of 15.3%, respectively, as compared to the first half of
fiscal year 1998, while sales in Asia of $29.0 million in the first half of
fiscal year 1999 declined by 11.7% from the first half of fiscal year 1998,
reflecting the general slow-down in Asian markets. The decline in North
America was predominantly due to the slow-down in the semiconductor equipment
industry.
IB's orders in the first half of fiscal year 1999 were $292.7 million,
compared to $270.3 million in the first half of fiscal year 1998. All IB
businesses except the Vacuum Technologies business contributed to the orders
growth.
Gross Profit. IB's gross profit was $99.9 million (representing 35.4% of
sales) in the first half of fiscal year 1999, compared to $110.3 million
(representing 39.1% of sales) in the first half of fiscal year 1998. The
decline in gross profit resulted primarily from actions taken as part of an
overall reorganization of IB, which included actions to prepare IB to separate
from VAI and become a stand-alone company, other organizational changes and a
comprehensive product review, which resulted in a decision to accelerate
transition from certain older to newer products necessitating the writedown of
certain excess and obsolete inventories and the lowering
12
of prices to accelerate the liquidation of older products. The impact on gross
profit of these actions were in addition to the restructuring charges
discussed below. The decline in gross profit was also the result of lower
sales of Vacuum Technologies products.
Research and Development. IB's research and development expenses were $16.4
million (representing 5.8% of sales) in the first half of fiscal year 1999,
compared to research and development expenses of $15.0 million (representing
5.3% of sales) in the first half of fiscal year 1998. The increase related
primarily to the additional research and development expense of Chrompack,
which was acquired in the fourth quarter of fiscal year 1998, and accelerated
development costs incurred to complete a new gas chromatograph product.
Marketing. IB's marketing expenses were $64.3 million (representing 22.8%
of sales) in the first half of fiscal year 1999, compared to $55.3 million
(representing 19.6% of sales) in the first half of fiscal year 1998. Some of
the increase was due to marketing expenses of Chrompack, which was acquired in
the fourth quarter of fiscal year 1998. Additionally, the increase in
marketing expenses resulting from actions taken as part of the above-described
reorganization, including costs to move people and equipment to new
consolidated locations, writedown of field demonstration equipment following
the accelerated transition to newer products, and other higher than normal
costs related to the reorganization. These charges were in addition to the
restructuring charges discussed below.
General and Administrative. IB's general and administrative expenses were
$18.5 million (representing 6.5% of sales) in the first half of fiscal year
1999, compared to $19.6 million (representing 7.0% of sales) in the first half
of fiscal year 1998. The primary reason for this decrease was due to lower
profit-sharing and management incentive compensation costs in the first half
of fiscal year 1999, the additional general and administrative costs of
Chrompack, which was acquired in the fourth quarter of fiscal year 1998.
Restructuring Charges. During the second quarter of fiscal year 1999, IB's
management approved a program to consolidate field sales and service
organizations in Europe, Australia and the United States so as to fall within
the direct responsibility of management at IB's principal factories in those
countries in order to reduce costs, simplify management structure and benefit
from the infrastructure existing in those factories. This restructuring
entailed consolidating certain sales, service and support operations. The
consolidation resulted in exiting of a product line, closing or downsizing of
sales offices and termination of approximately 100 personnel. The following
table sets forth certain details associated with this restructuring during the
second quarter of fiscal year 1999:
Cash Accrual at
Restructuring Payments/Other April 2,
Charges Reductions 1999
------------- -------------- ----------
(Dollars in thousands)
Lease payments and other facility
expenses........................ $ 2,205 $ 240 $1,965
Severance and other related
employee benefits............... 7,171 1,988 5,183
Exited product line ............. 1,598 1,598 --
------- ------ ------
Total.......................... $10,974 $3,826 $7,148
======= ====== ======
Taxes on Earnings. IB's effective income tax rate was 44.5% in the first
half of fiscal year 1999, compared to 40.0% in the first half of fiscal year
1998. The fiscal year 1999 rate is higher than the fiscal year 1998 rate
because the Company expects to realize a larger proportion of high-tax foreign
country income during fiscal year 1999 than it did during fiscal year 1998.
Net Loss. The net loss of $5.7 million ($0.19 pro forma net loss per share)
in the first half of fiscal year 1999 was the result of IB's overall
reorganization described above, which resulted in incremental costs primarily
included in cost of sales, marketing and restructuring charges.
Liquidity and Capital Resources
VAI Cash and Debt Allocations. The Distribution Agreement provided for the
division among the Company, VSEA and VMS of VAI's cash and debt as of April 2,
1999. Under the Distribution Agreement, the
13
Company was to assume 50% of VAI's term loans and receive an amount of cash
from VAI such that it would have net debt (defined in the Distribution
Agreement as the amount outstanding under the term loans and notes payable,
less cash and cash equivalents) equal to approximately 50% of the net debt of
the Company and VMS, subject to such adjustment as was necessary to provide
VMS with a net worth (as defined in the Distribution Agreement) of between 40%
and 50% of the aggregate net worth of the Company and VMS, and subject to
further adjustment to reflect the Company's approximately 50% share of the
estimated proceeds, if any, to be received by VMS after the Distribution from
the sale of VAI's long-term leasehold interest at certain of its Palo Alto
facilities, together with certain related buildings and other corporate assets
and the Company's obligation for approximately 50% of any estimated
transaction expenses to be paid by VMS after the Distribution (in each case
reduced for estimated taxes payable or tax benefits received from all sales
and transaction expenses). Since the amounts transferred immediately prior to
the Distribution were based on estimates, adjustments may be required within
180 days following the Distribution. In addition, certain other pre-
Distribution transactions may require adjustment within 90 days following the
Distribution under the provisions of the Distribution Agreement. As a result
of these adjustments, the Company may be required to make cash payments to VMS
or may be entitled to receive cash payments from VMS. The amount of any such
adjustments cannot be estimated.
Debt and Credit Facilities. IB's debt was historically incurred or managed
by VAI. In connection with the Distribution, a portion of VAI's debt was
assumed by the Company as of April 2, 1999. In addition, the Company entered
into new debt arrangements as of and after April 2, 1999.
As part of the Distribution, a total of $63.9 million in debt was assumed
by or transferred to the Company, which debt consisted of $58.5 million in
term loans and $5.4 million in notes payable. As of April 2, 1999, interest
rates on the term loans ranged from 6.70% to 7.49%, and the weighted average
interest rate on the term loans was 7.02%. As of April 2, 1999, interest rates
on the notes payable ranged from 1.50% to 4.00%, and the weighted average
interest rate on the notes payable was 2.95%. The term loans contain 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.
As of April 2, 1999, the Company entered into $40.0 million in uncommitted
credit facilities for working capital purposes. As of April 2, 1999, none of
these credit facilities were utilized and no amount was outstanding. Following
April 2, 1999, the Company entered into additional uncommitted credit
facilities for $15.0 million for working capital purposes. All of these credit
facilities contain certain conditions and events of default customary for such
facilities.
Future principal payments on notes payable and long-term debt outstanding
on April 2, 1999 will be $8.4 million, $6.0 million, $6.0 million, $6.0
million, $2.5 million, $2.5 million and $32.5 million during the six months
ended October 1, 1999, the fiscal years ended 2000, 2001, 2002, 2003, 2004,
and thereafter, respectively.
Cash and Cash Equivalents. Pursuant to the Distribution Agreement as
described above, the Company received a cash contribution from VAI in the
amount of $12.1 million as of April 2, 1999.
IB generated $8.6 million of cash from operations in the first half of
fiscal year 1999, which compares to $19.4 million in the first half of fiscal
year 1998. The primary reason for this decrease in cash generated was the
lower earnings which reflect increased spending from the reorganization
activities. IB used $10.5 million of cash for investing activities in the
first half of fiscal year 1999, which compares to $9.7 million in the first
half of fiscal year 1998. The primary reason for this increase was capital
equipment expenditures by Chrompack.
The cash flow impact of certain actions relating to the above-described
overall reorganization of IB will occur for several more quarters after April
2, 1999. Management believes that the cash flow impact will be approximately
$4.8 million in the remainder of fiscal year 1999 and $2.4 million in fiscal
year 2000.
The Company currently has no plans to materially modify or expand its
facilities or to make other material capital expenditures.
14
The Distribution Agreement provides that the Company is responsible for
certain litigation to which VAI was a party, and further provides that the
Company will indemnify VMS and VSEA for one-third of the costs, expenses and
other liabilities relating to certain discontinued, former and corporate
operations of VAI, including certain environmental liabilities (see
"Environmental Matters" below).
The Company's liquidity is affected by many other factors, some based on
the normal ongoing operations of the business and others related to the
uncertainties of the industry and global economies. Although the Company's
cash requirements will fluctuate based on the timing and extent of these
factors, management believes that cash generated from operations, together
with the Company's borrowing capability, will be sufficient to satisfy
commitments for capital expenditures and other cash requirements for the
current fiscal year and fiscal year 2000.
Environmental Matters
The Company's operations are subject to various foreign, federal, state
and/or local laws regulating the discharge of materials into the environment
or otherwise relating to the protection of the environment. This includes
discharges into soil, water and air, and the generation, handling, storage,
transportation and disposal of waste and hazardous substances. In addition,
several countries are reviewing proposed regulations that would require
manufacturers to dispose of their products at the end of their useful life.
These laws have the effect of increasing costs and potential liabilities
associated with the conduct of such operations.
In addition, under the Distribution Agreement, the Company agreed to
indemnify VMS and VSEA for one-third of environmental investigation and
remediation costs (after adjusting for any insurance proceeds and tax benefits
recognized or realized for such costs), as further described below.
VAI has been named by the U.S. Environmental Protection Agency or third
parties as a potentially responsible party under the Comprehensive
Environmental Response Compensation and Liability Act of 1980, as amended, at
eight sites where VAI is alleged to have shipped manufacturing waste for
recycling or disposal. VAI is also involved in various stages of environmental
investigation and/or remediation under the direction of, or in consultation
with, foreign, federal, state and/or local agencies at certain current or
former VAI facilities.
For certain of these sites and facilities, various uncertainties make it
difficult to assess the likelihood and scope of further investigation or
remediation activities or to estimate the future costs of such activities if
undertaken. As of April 2,1999, it was nonetheless estimated that the future
exposure for environmental-related investigation and remediation costs for
these sites and facilities ranged in the aggregate from $21.0 million to $48.3
million. The time frame over which these costs are expected to be incurred
varies with each site and facility, ranging up to approximately 30 years as of
April 2, 1999. No amount in the foregoing range of estimated future costs is
believed to be more probable of being incurred than any other amount in such
range and therefore VAI accrued $21.0 million in estimated environmental costs
as of April 2, 1999. The amount accrued was not discounted to present value.
As to other sites and facilities, sufficient knowledge has been gained to
be able to better estimate the scope and costs of future environmental
activities. As of April 2, 1999, it was estimated that the future exposure for
environmental related investigation and remediation costs for these sites and
facilities ranged in the aggregate from $39.2 million to $73.0 million. The
time frame over which these costs are expected to be incurred varies with each
site and facility, ranging up to approximately 30 years as of April 2, 1999.
As to each of these sites and facilities, it was determined that a particular
amount within the range of estimated costs was a better estimate of the future
environmental liability than any other amount within the range, and that the
amount and timing of these futures costs were reliably determinable. Together,
these amounts totaled $50.6 million at April 2, 1999. Accordingly, VAI accrued
$21.9 million as of April 2, 1999, which represents the best estimate of the
future costs discounted at 4%, net of inflation. This accrual is in addition
to the $21.0 million described in the preceding paragraph.
15
Since the Company is obligated to reimburse VMS for one-third of the
foregoing environmental-related costs and expenses (after adjusting for any
insurance proceeds and tax benefits recognized or realized by VMS for such
costs or expenses) that are paid after April 2, 1999, IB recorded $7.7 million
as its portion of these estimated future costs for environmental liabilities
of VAI as of April 2, 1999. The foregoing amounts are only estimates of
anticipated future environmental-related costs, and the amounts actually spent
may be greater or less than such estimates. The aggregate range of cost
estimates reflects various uncertainties inherent in many environmental
investigation and remediation activities and the large number of sites and
facilities involved. Management believes that most of these cost ranges will
narrow as investigation and remediation activities progress.
Management believes that its reserves for the foregoing and certain 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 earnings may be made. Although any ultimate liability arising
from environmental-related matters described herein could result in
significant expenditures that, if aggregated and assumed to occur within a
single fiscal year, would be material to the Company's financial statements,
the likelihood of such occurrence is considered remote. Based on information
currently available and its best assessment of the ultimate amount and timing
of environmental-related events, management believes that the costs of these
environmental-related matters are not reasonably likely to have a material
adverse effect on the Company's financial statements.
Year 2000
General. The "Year 2000" problem refers to computer programs and other
equipment with embedded microprocessors ("non-IT systems") which use only the
last two digits to refer to a year, and which therefore might not properly
recognize a year that begins with "20" instead of the familiar "19." As a
result, those computer programs and non-IT systems might be unable to operate
or process accurately certain date-sensitive data before or after January 1,
2000. Because the Company relies heavily on computer programs and non-IT
systems, and relies on third parties which themselves rely on computer
programs and non-IT systems, the Year 2000 problem, if not addressed, could
adversely effect the Company's business, results of operations and financial
condition.
State of Readiness. VAI and IB previously initiated a comprehensive
assessment of potential Year 2000 problems with respect to (1) IB's internal
systems, (2) IB's products, and (3) significant third parties with which the
IB does business. The Company is continuing that assessment for its
businesses, although under the terms of the Transition Services Agreement
among VMS, VSEA and the Company, VMS is taking certain actions and otherwise
assisting the Company with respect to certain Year 2000 implications with
internal systems.
IB has substantially completed its assessment of potential Year 2000
problems in internal systems, which systems have been categorized as follows,
in order of importance: (a) enterprise information systems; (b) enterprise
networking and telecommunications; (c) factory-specific information systems;
(d) non-IT systems; (e) computers and packaged software; and (f) facilities
systems. With respect to enterprise information systems, VAI initiated in 1994
replacement of its existing systems with a single company-wide system supplied
by SAP America, Inc., which system is designed and tested by SAP for Year 2000
capability. Installation of the SAP enterprise information system has been
staged to replace first those existing systems that are not Year 2000 capable.
Installation of the SAP system is approximately 70% complete, with 90%
completion expected by July 1999 and full completion expected by the end of
1999; upgrade of networking and telecommunications systems is complete;
upgrade of factory-specific information systems is approximately 90% complete,
with 95% completion expected by July 1999 and 100% completion expected by
December 1999; and upgrade of non-IT systems, computers and packaged software,
and facilities systems are approximately 95% complete, with 100% completion
expected by July 1999.
The Company has initiated an assessment of potential Year 2000 problems in
its current and previously-sold products. With respect to current products,
that assessment and corrective actions are complete, and the Company believes
that all of its current products are Year 2000 capable; however, that
conclusion is based in
16
part on Year 2000 assurances or warranties from suppliers of computer programs
and non-IT systems which are integrated into or sold with the Company's
current products. With respect to previously-sold products, the Company does
not intend to assess Year 2000 preparedness of every product it has ever sold,
but rather is focusing its assessments on products that will be under written
warranties or are still relatively early in their useful life, are more likely
to be dependent on non-IT systems that are not Year 2000 capable, and/or
cannot be easily upgraded with readily available externally-utilized computers
and packaged software. These assessments are expected to be substantially
completed by July 1999. Where the Company identifies previously-sold products
that are not Year 2000 capable, the Company intends in some cases to develop
and offer to sell upgrades or retrofits, identify corrective measures which
the customer could itself undertake or identify for the customer other
suppliers of upgrades or retrofits. There may be instances where the Company
will be required to repair and/or upgrade such products at its own expense.
Schedules for completing those corrective actions vary considerably among the
Company's businesses and products, but are generally expected to be
substantially completed by July 1999.
The Company is still assessing potential Year 2000 problems of third
parties with which the Company has material relationships, which will be
primarily suppliers of products or services. These assessments will identify
and prioritize critical suppliers, review those suppliers' written assurances
on their own assessments and correction of Year 2000 problems and develop
appropriate contingency plans for those suppliers which might not be
adequately prepared for Year 2000 problems. These assessments are expected to
be substantially completed by August 1999.
Costs. The Company estimates that IB had incurred approximately $1,021,000
as of April 2, 1999 to assess and correct Year 2000 problems. Although
difficult to assess, based on its assessment to date, the Company estimates
that it will incur approximately $350,000 in additional costs to assess and
correct Year 2000 problems, which costs are expected to be incurred throughout
fiscal year 1999 and the first half of fiscal year 2000. All of these costs
have been and will continue to be expensed as incurred.
This estimate of future costs has not been reduced by expected recoveries
from certain third parties, which are subject to indemnity, reimbursement or
warranty obligations for Year 2000 problems. In addition, the Company expects
that certain costs will be offset by revenues generated by the sale of
upgrades and retrofits and other customer support services relating to Year
2000 problems. However, there can be no assurance that the Company's actual
costs to assess and correct Year 2000 problems will not be higher than the
foregoing estimate.
Risks. Failure by the Company or its key suppliers to accurately assess and
correct Year 2000 problems would likely result in interruption of certain of
the Company's normal business operations, which could have a material adverse
effect on the Company's business, results of operations and financial
condition. If the Company does not adequately identify and correct Year 2000
problems in its information systems, it could experience an interruption in
its operations, including manufacturing, order processing, receivables
collection, cash management and accounting, such that there would be delays in
product shipments, lost data and a consequential impact on revenues,
expenditures, cashflow and financial reporting. If the Company does not
adequately Risks. Failure by the Company or its key suppliers to accurately
assess and correct Year 2000 problems would likely result in interruption of
certain of the Company's normal business operations, which could have a
material adverse effect on the Company's business, results of operations and
financial condition. If the Company does not adequately identify and correct
Year 2000 problems in its information systems, it could experience an
interruption in its operations, including manufacturing, order processing,
receivables collection, cash management and accounting, such that there would
be delays in product shipments, lost data and a consequential impact on
revenues, expenditures, cashflow and financial reporting. If the Company does
not adequately identify and correct Year 2000 problems in its non-IT systems,
it could experience an interruption in its manufacturing and related
operations, such that there would be delays in product shipments and a
consequential impact on revenues. If the Company does not adequately identify
and correct Year 2000 problems in previously-sold products, it could
experience warranty or product liability claims by users of products which do
not function correctly. If the Company does not adequately identify and
correct Year 2000 problems of the significant third parties with which it does
business, it could experience an interruption in the supply of key components
or services from those parties, such that there would be delays in product
shipments or services and a consequential
17
impact on revenues. The most difficult risks to assess and prepare for relate
to basic infrastructure services (such as electricity, water, gas,
telecommunications, transportation, distribution and banking) provided by
third parties.
Management believes that the assessments and corrective actions described
above have been or will be accomplished within the cost and time estimates
stated. Although it is not expected that the Company will be 100% Year 2000
compliant by the end of 1999, management does not currently believe that any
Year 2000 non-compliance in the Company's information systems would have a
material adverse effect on the Company's business, results of operations or
financial condition. However, given the inherent complexity and implications
of the Year 2000 problem, there can be no assurance that actual costs will not
be higher than currently anticipated or that corrective actions will not take
longer than currently anticipated to complete. Risk factors which might result
in higher costs or delays include the ability to identify and correct in a
timely fashion Year 2000 problems; regulatory or legal obligations to correct
Year 2000 problems in previously-sold products; ability to retain and hire
qualified personnel to perform assessments and corrective actions; the
willingness and ability of critical suppliers to assess and correct their own
Year 2000 problems, including the products they supply to the Company; and the
additional complexity which will likely be caused by undertaking during fiscal
year 1999 and fiscal year 2000 the separation (as a result of the
Distribution) of enterprise information systems which the Company currently
shares with VMS and VSEA.
Because of uncertainties as to the extent of Year 2000 problems with the
Company's previously-sold products and the extent of any legal obligation for
the Company to correct Year 2000 problems in those products, the Company
cannot yet assess risks to the Company with respect to those products. Because
its assessments are not yet complete, the Company also cannot yet conclude
that the failure of critical suppliers to assess and correct Year 2000
problems is not reasonably likely to have a material adverse effect on the
Company's results of operations, and indeed the failure of certain suppliers
to provide essential infrastructure services will likely have a material
adverse effect on the Company's business, results of operations and financial
condition.
Contingency Plans. With respect to the Company's enterprise information
systems, the Company has a contingency plan if the SAP system is not fully
installed before December 31, 1999. That plan primarily involves installation
where necessary of a Year 2000 capable upgrade of existing information systems
pending complete installation of the SAP system. That upgrade is currently in
acceptance testing, and, if functional, will be held for contingency purposes.
With respect to products and significant third parties, the Company
intends, as part of its on-going assessment of potential Year 2000 problems,
to develop contingency plans for the more critical problems that might not be
corrected December 31, 1999. It is currently anticipated that the focus of
these contingency plans will be the possible interruption of supply of key
components or services from third parties.
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures
about Segments of an Enterprise and Related Information." This statement
changes standards for the way that public business enterprises identify and
report operating segments in annual and interim financial statements. This
statement requires selected information about an enterprise's operating
segments and related disclosure about products and services, geographic areas
and major customers. The Company expects to report multiple segments when it
adopts SFAS No. 131 at fiscal year-end 1999.
In June 1998, FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes accounting and
reporting standards for derivative instruments and requires recognition of all
derivatives as assets or liabilities in the statement of financial position
and measurement of those instruments at fair value. This statement is
effective for fiscal years beginning after June 15, 1999. The Company will
adopt SFAS No. 133 in the first quarter of fiscal year 2000 and is in the
process of determining the impact that adoption will have on its combined
financial statements.
18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Foreign Currency Exchange Risk
With global operations and activities, the Company faces exposure to
adverse movements in foreign currency exchange rates. This exposure may change
over time as the Company's business practices evolve and could have a material
adverse impact on the Company's financial results. Historically, IB's primary
exposures have related to non-U.S. dollar denominated sales and purchases
throughout Europe and Asia. The Euro was adopted as a common currency for
members of the European Monetary Union on January 1, 1999. The Company is
evaluating, among other issues, the impact of the Euro conversion on its
foreign currency exposure. Based on its evaluation to date, the Company does
not expect the Euro conversion to create any change in its currency exposure
due to the Company's existing hedging practices.
IB historically hedged its currency exposures associated with certain
assets and liabilities denominated in non-functional currencies and with
anticipated foreign currency cash flows. IB did not enter into forward
exchange contracts for trading purposes. IB's forward exchange contracts
generally ranged from one to three months in original maturity, and no forward
exchange contract had an original maturity greater than one year. There were
no significant forward exchange contracts outstanding as of April 2, 1999.
Interest Rate Risk
The Company's exposure to market risk for changes in interest rates relates
primarily to the Company's investment portfolio, notes payable and long-term
debt obligations. The Company does not use derivative financial instruments in
its investment portfolio, and the Company's investment portfolio only includes
highly liquid instruments with an original maturity to the Company of three
months or less. The Company primarily enters into debt obligations to support
general corporate purposes, including working capital requirements, capital
expenditures and acquisitions.
The Company is subject to fluctuating interest rates that may impact,
adversely or otherwise, its results of operations or cash flows for its
variable rate notes payable and cash and cash equivalents. Fluctuations in
interest rates may also impact, adversely or otherwise, the estimated fair
value of the Company's fixed rate long-term obligations. The Company has no
cash flow exposure due to rate changes for long-term debt obligations.
The table below presents principal amounts and related weighted-average
interest rates by year of maturity for the Company's cash and cash equivalents
and debt obligations.
Six months Fiscal year
ended Oct. 1, ----------------------------------------------
1999 2000 2001 2002 2003 2004 Thereafter Total
------------- ---- ---- ---- ---- ---- ---------- -----
(Dollars in millions)
Assets
Cash and cash
equivalents(1)....... $12.1 -- -- -- -- -- -- $12.1
Liabilities
Notes payable......... $ 5.4 -- -- -- -- -- -- $ 5.4
Average interest
rate............... 3.0% -- -- -- -- -- -- 3.0%
Long-term debt
(including current
portion)............. $ 3.0 $6.0 $6.0 $6.0 $2.5 $2.5 $32.5 $58.5
Average interest
rate............... 7.3% 7.3% 7.3% 7.3% 7.2% 7.2% 6.8% 7.0%
- --------
(1) Cash and cash equivalents primarily consist of non-interest bearing
operating accounts located throughout the foreign subsidiaries.
The estimated fair value of the Company's cash and cash equivalents
approximates the principal amounts reflected above based on the short
maturities of these financial instruments. The estimated fair value of the
Company's debt obligations approximates the principal amounts reflected above
based on rates currently available to the Company for debt with similar terms
and remaining maturities.
Although payments under certain of the Company's operating leases for its
facilities are tied to market indices, the Company is not exposed to material
interest rate risk associated with its operating leases.
19
PART II.
OTHER INFORMATION
ITEM 5. OTHER INFORMATION
Pursuant to the Company's By-Laws, and in accordance with Securities and
Exchange Commission ("SEC") Rule 14a-5(e), (1) stockholder proposals submitted
pursuant to the requirements of SEC Rule 14a-8 must be received by the
Company's Secretary not later than September 17, 1999 at the Company's address
set forth on the cover page of this Form 10-Q and must otherwise meet the
requirements of SEC Rule 14a-8, and (2) stockholder proposal submitted outside
the processes of SEC Rule 14a-8 must be received by the Company's Secretary
not later than November 16, 1999 and not earlier than October 17, 1999 at the
Company's address set forth on the cover page of this Form 10-Q and must
otherwise meet the requirements set forth in the Company's By-Laws. In
addition, in accordance with SEC Rule 14a-4(c)(1), stockholder proxies
obtained by the Board of Directors of the Company in connection with the
Company's 2000 Annual Meeting of Stockholders will confer on the proxy holders
discretionary authority to vote on any matters presented at the meeting,
unless notice of the matter is provided to the Company's Secretary not later
than December 1, 1999 and the Company's address set forth on the cover page of
this Form 10-Q.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits required to be filed by Item 601 of Regulation S-K:
Exhibit No. Description
----------- -----------
2.1 Amended and Restated Distribution Agreement among Varian
Associates, Inc., Varian Semiconductor Equipment Associates,
Inc. and Varian, Inc. dated as of January 14, 1999.*
3.1 Restated Certificate of Incorporation of Varian, Inc.
3.2 Certificate of Designation and Terms of Participating Preferred
Stock of Varian, Inc.
3.3 By-Laws of Varian, Inc.
10.1 Employee Benefits Allocation Agreement dated as of April 2, 1999
among Varian Associates, Inc., Varian Semiconductor Equipment
Associates, Inc. and Varian, Inc.*
10.2 Intellectual Property Agreement dated as of April 2, 1999 among
Varian Associates, Inc., Varian Semiconductor Equipment
Associates, Inc. and Varian, Inc.*
10.3 Tax Sharing Agreement dated as of April 2, 1999 among Varian
Associates, Inc., Varian Semiconductor Equipment Associates,
Inc. and Varian, Inc.
10.4 Transition Services Agreement dated as of April 2, 1999 among
Varian Associates, Inc., Varian Semiconductor Equipment
Associates, Inc. and Varian, Inc.*
10.5 Supplemental Retirement Plan of Varian, Inc.
10.6 Varian, Inc. Amended and Restated Note Purchase and Private
Shelf Agreement and Assumption Dated as of April 2, 1999.*
27.1 Financial Data Schedule.
- --------
* Certain exhibits and schedules omitted.
(b) Reports on Form 8-K filed during the quarter ended April 2, 1999:
None.
20
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
VARIAN, INC.
(Registrant)
/s/ G. Edward McClammy
By __________________________________
G. Edward McClammy
Vice President and Chief Financial
Officer
(Duly Authorized Officer and
Principal Financial Officer)
Date: May 17, 1999
21
INDEX TO EXHIBITS
Exhibit No. Description
----------- -----------
2.1 Amended and Restated Distribution Agreement among Varian
Associates, Inc., Varian Semiconductor Equipment Associates, Inc.
and Varian, Inc. dated as of January 14, 1999.*
3.1 Restated Certificate of Incorporation of Varian, Inc.
3.2 Certificate of Designation and Terms of Participating Preferred
Stock of Varian, Inc.
3.3 By-Laws of Varian, Inc.
10.1 Employee Benefits Allocation Agreement dated as of April 2, 1999
among Varian Associates, Inc., Varian Semiconductor Equipment
Associates, Inc. and Varian, Inc.*
10.2 Intellectual Property Agreement dated as of April 2, 1999 among
Varian Associates, Inc., Varian Semiconductor Equipment
Associates, Inc. and Varian, Inc.*
10.3 Tax Sharing Agreement dated as of April 2, 1999 among Varian
Associates, Inc., Varian Semiconductor Equipment Associates, Inc.
and Varian, Inc.
10.4 Transition Services Agreement dated as of April 2, 1999 among
Varian Associates, Inc., Varian Semiconductor Equipment
Associates, Inc. and Varian, Inc.*
10.5 Supplemental Retirement Plan of Varian, Inc.
10.6 Varian, Inc. Amended and Restated Note Purchase and Private Shelf
Agreement and Assumption Dated as of April 2, 1999.*
27.1 Financial Data Schedule.
- --------
* Certain exhibits and schedules omitted.