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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 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 June 28, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 0-25395
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
(Exact name of Registrant as Specified in its Charter)
State or other jurisdiction of IRS Employer
Incorporation or organization: Identification No.:
Delaware 77-0501994
35 Dory Road, Gloucester, Massachusetts 01930
(Address of principal executive offices) (Zip code)
(978) 282-2000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
Shares of common stock outstanding at July 26, 2002: 33,753,086.
An index of exhibits filed with this Form 10-Q is located on page 29.
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
INDEX
ITEM PAGE
NUMBER NUMBER
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at June 28, 2002 and September 28, 2001 ......................... 3
Consolidated Statements of Operations for the three and nine month periods
ended June 28, 2002 and June 29, 2001 ....................................................... 4
Consolidated Statements of Cash Flows for the nine month periods ended June 28, 2002 and
June 29, 2001 ............................................................................... 5
Notes to the Consolidated Financial Statements .............................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........... 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk...................................... 27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings .............................................................................. 29
Item 2. Changes in Securities and Use of Proceeds ...................................................... 29
Item 3. Defaults Upon Senior Securities ................................................................ 29
Item 4. Submission of Matters to a Vote of Security Holders ............................................ 29
Item 5. Other Information .............................................................................. 29
Item 6. Exhibits and Reports on Form 8-K................................................................ 29
Signatures................................................................................... 30
2
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
UNAUDITED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
June 28, September 28,
2002 2001
---- ----
ASSETS
CURRENT ASSETS
Cash and cash equivalents ...................................................... $320,686 $278,641
Accounts receivable, net........................................................ 53,827 85,455
Inventories, net................................................................ 92,819 115,689
Deferred income taxes........................................................... 37,130 34,899
Other current assets............................................................ 10,591 9,626
-------- --------
Total current assets.................................................... 515,053 524,310
Property, plant and equipment, net.............................................. 45,628 46,288
Other assets.................................................................... 16,104 17,459
-------- --------
Total assets............................................................ $576,785 $588,057
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Notes payable and other short-term borrowings................................... $5,207 $15,900
Accounts payable ............................................................... 28,810 19,271
Accrued income taxes ........................................................... 13,775 2,900
Accrued expenses ............................................................... 40,881 40,249
Product warranty ............................................................... 10,266 20,075
Deferred revenue ............................................................... 48,381 81,137
-------- --------
Total current liabilities .............................................. 147,320 179,532
Long-term accrued expenses...................................................... 5,676 7,292
Deferred income taxes .......................................................... 1,893 1,788
-------- --------
Total liabilities ...................................................... 154,889 188,612
Commitments and contingencies (Note 9)
STOCKHOLDERS' EQUITY
Preferred stock, par value $.01; authorized 5,000,000 shares, none issued
Common stock, par value $.01; authorized 150,000,000
shares, issued and outstanding 33,730,557 at
June 28, 2002 and 32,628,192 at September 28, 2001 ........................ 337 326
Capital in excess of par value.................................................. 250,512 235,700
Retained earnings .............................................................. 171,047 163,419
-------- --------
Total stockholders' equity.............................................. 421,896 399,445
-------- --------
Total liabilities and stockholders' equity.............................. $576,785 $588,057
======== ========
The accompanying notes to the unaudited consolidated financial statements are an
integral part of these statements.
3
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Fiscal Three Months Ended Fiscal Nine Months Ended
------------------------- ------------------------
June 28, June 29, June 28, June 29,
2002 2001 2002 2001
---- ---- ---- ----
REVENUE
Product revenue .......................................................... $74,834 $122,869 $156,840 $479,201
Service revenue .......................................................... 17,635 20,390 48,843 69,504
Royalty and license revenue .............................................. 2,188 3,909 33,972 13,494
--------- --------- --------- ---------
Total revenue .......................................................... 94,657 147,168 239,655 562,199
COST OF REVENUE
Cost of product revenue .................................................. 48,865 89,432 110,473 302,032
Cost of service revenue .................................................. 8,900 11,703 27,703 43,530
--------- --------- --------- ---------
Total cost of revenue .................................................. 57,765 101,135 138,176 345,562
Gross profit ............................................................. 36,892 46,033 101,479 216,637
OPERATING COSTS AND EXPENSES
Research and development ................................................. 12,515 11,697 37,997 38,476
Marketing, general and administrative .................................... 22,086 24,412 59,451 76,435
Restructuring costs ...................................................... - - 2,200 -
--------- --------- --------- ---------
Total operating expenses ............................................... 34,601 36,109 99,648 114,911
--------- --------- --------- ---------
Operating income ......................................................... 2,291 9,924 1,831 101,726
Interest income, net ..................................................... 1,469 2,270 4,405 6,288
Other income, net ........................................................ - - 5,149 -
--------- --------- --------- ---------
Income before income taxes and cumulative effect of
change in accounting principle ......................................... 3,760 12,194 11,385 108,014
Provision for income taxes ............................................... 1,141 4,024 3,757 35,645
--------- --------- --------- ---------
Income before cumulative effect of change in accounting principle ...... 2,619 8,170 7,628 72,369
Cumulative effect of change in accounting principle, net of tax
of $15,724 ............................................................. - - - (27,038)
--------- --------- --------- ---------
Net income ............................................................... $2,619 $8,170 $7,628 $45,331
========= ========= ========= =========
Weighted average shares outstanding - basic .............................. 33,420 32,340 32,990 32,185
Weighted average shares outstanding - diluted ............................ 35,269 34,457 34,827 33,911
Income per share before cumulative effect of change
in accounting principle - basic ........................................ $0.08 $0.25 $0.23 $2.25
Income per share before cumulative effect of change
in accounting principle - diluted ...................................... $0.07 $0.24 $0.22 $2.13
Cumulative effect of change in accounting principle - basic .............. - - - $(0.84)
Cumulative effect of change in accounting principle - diluted ............ - - - $(0.79)
Net income per share - basic ............................................. $0.08 $0.25 $0.23 $1.41
Net income per share - diluted ........................................... $0.07 $0.24 $0.22 $1.34
The accompanying notes to the unaudited consolidated financial
statements are an integral part of these statements.
4
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Fiscal Nine Months Ended
------------------------
June 28, June 29,
2002 2001
---- ----
Cash flows from operating activities
Net income ........................................................................ $7,628 $45,331
Adjustments to reconcile net income to net cash provided by operating activities
Cumulative effect of change in accounting principle, net of tax ............... - 27,038
Depreciation and amortization ................................................. 10,322 10,394
Non-cash consideration for royalty and license revenue ........................ (22,800) -
Realized gain on investment ................................................... (5,149) -
Tax benefit from exercise of stock options. ................................... 11,633 3,544
Deferred income taxes ......................................................... (2,121) (9,633)
Changes in assets and liabilities
Accounts receivable ........................................................... 31,542 64,045
Inventories ................................................................... 25,094 46,767
Other current assets .......................................................... (963) (2,866)
Accounts payable .............................................................. 9,491 (36,491)
Accrued expenses .............................................................. (1,281) 1,874
Product warranty .............................................................. (9,982) (1,307)
Deferred revenue .............................................................. (32,970) (34,327)
Other ......................................................................... (673) 1,952
--------- ---------
Net cash provided by operating activities ............................................ 19,771 116,321
Cash flows from investing activities
Proceeds from the sale of warrant ................................................. 27,989 -
Purchase of property, plant and equipment ......................................... (10,865) (12,979)
--------- ---------
Net cash provided by (used in) investing activities .................................. 17,124 (12,979)
Cash flows from financing activities
Proceeds from the issuance of common stock for stock option exercises ............. 14,823 4,872
Notes payable and other short-term borrowings ..................................... (9,817) 9,424
--------- ---------
Net cash provided by financing activities ............................................ 5,006 14,296
--------- ---------
Effects of exchange rates on cash .................................................... 144 (1,735)
--------- ---------
Net increase in cash and cash equivalents ............................................ 42,045 115,903
Cash and cash equivalents at beginning of period ..................................... 278,641 121,692
--------- ---------
Cash and cash equivalents at end of period ........................................... $320,686 $237,595
========= =========
The accompanying notes to the unaudited consolidated financial statements
are an integral part of these statements.
5
VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Unaudited Interim Consolidated Financial Statements
These unaudited interim consolidated financial statements have been prepared
pursuant to the rules and regulations of the Securities and Exchange Commission.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to such rules and regulations. These
unaudited interim consolidated financial statements should be read in
conjunction with the financial statements and the notes thereto included in the
annual report on Form 10-K filed by Varian Semiconductor Equipment Associates,
Inc. ("Varian Semiconductor") with the Securities and Exchange Commission for
the fiscal year ended September 28, 2001. In the opinion of Varian
Semiconductor, the unaudited interim consolidated financial statements include
all adjustments, consisting of only normal recurring adjustments, necessary to
present fairly the information required to be set forth therein (except Note 2).
The results of operations for the three and nine-month periods ended June 28,
2002 are not necessarily indicative of the results to be expected for a full
year or for any other period.
Note 2. Description of Business and Basis of Presentation
Varian Semiconductor designs, manufactures, markets and services semiconductor
processing equipment used in the fabrication of integrated circuits.
Revenue Recognition
Product revenue includes established products, new products, and spare parts.
Varian Semiconductor recognizes revenue from product sales upon shipment
provided title and risk of loss has passed to the customer, evidence of an
arrangement exists, fees are contractually fixed or determinable, collectibility
is reasonably assured through historical collection results and regular credit
evaluations and there are no uncertainties regarding customer acceptance.
For established and new products, a portion of the total purchase price is not
due until installation occurs and the customer accepts the product. For
established products, the lesser of the amount allocated to the equipment or the
contractual amount billable upon delivery is recorded as product revenue upon
delivery. The amount deferred is recognized as revenue upon customer acceptance.
For new products, revenue allocated to the equipment is recognized upon customer
acceptance. Revenue related to spare parts sales is recognized upon the later of
delivery or title and risk of loss passes to the customer. Varian Semiconductor
accrues warranty costs upon recognition of product revenue.
Products are classified as established products if post-delivery acceptance
provisions and the installation process have been determined to be routine,
commercially inconsequential and perfunctory, due to the fact that the
acceptance provisions are generally a replication of pre-shipment procedures and
there is an established history of installations. The majority of products are
designed and manufactured to meet the contractual customer specifications. To
ensure customer specifications are satisfied, the systems are tested at Varian
Semiconductor's manufacturing facility prior to shipment. To the extent that
customers' conditions can not be replicated in Varian Semiconductor's facilities
or if there is not a demonstrated history of meeting newer in-field customer
specifications, then the product is classified as new for revenue recognition
purposes.
Service revenue includes maintenance and service contracts, paid service and
installation services. Revenue related to maintenance and service contracts is
recognized ratably over the duration of the contracts. Revenue related to paid
services are recorded when earned and the revenue related to installation is
recorded upon fulfillment of the service obligation. Royalty and license revenue
is recognized when contractual obligations are met, evidence of an arrangement
exists, fees are fixed or determinable and collection is reasonably assured.
Varian Semiconductor's transactions frequently include the sale of systems and
services under multiple element arrangements. Revenue under these arrangements
is allocated to all elements, except systems, based upon the fair market value
of those elements. The amount allocated to installation is based either upon
hourly rates at the estimated time to complete the service or the amount due
upon customer acceptance, whichever is greater. The fair value of all other
elements is based upon the price charged when these amounts are sold separately
and unaccompanied by other elements. The amount of revenue allocated to systems
is done on a residual method basis. Under this method, the total value of the
arrangement is allocated first to the undelivered elements based on their fair
values, with the remainder being allocated to systems revenue. Installation is
not essential to the functionality of the system, as these services do not alter
the equipment's capabilities.
6
Deferred revenue
Deferred revenue includes customer advances and amounts that have been billed
per the contractual terms but have not been recognized as revenue.
Change in Revenue Accounting Principle
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements." SAB 101 summarizes the staff's view in applying generally accepted
accounting principles to selected revenue recognition issues, including the
timing of revenue recognition for sales that involve contractual customer
acceptance provisions and installation of the product if these events occur
after shipment and transfer of title and risk of loss. In October 2000, the SEC
issued Staff Accounting Bulletin No. 101: Revenue Recognition in Financial
Statements--Frequently Asked Questions and Answers ("SAB 101 FAQ"). The SAB 101
FAQ was issued to clarify many of the implementation questions surrounding SAB
101. Varian Semiconductor implemented the provisions of SAB 101 in the fourth
quarter of fiscal year 2001, retroactive to the first quarter of fiscal year
2001.
Varian Semiconductor's previous revenue recognition policy was to recognize
product revenue at the time the customer took title to the product, generally at
the time of shipment. At that time, Varian Semiconductor also accrued the costs
to install the product. For some transactions, a portion of the purchase price
is not due until installation is complete and the product is accepted by the
customer. Under SAB 101 and the new accounting method adopted retroactive to the
first quarter of fiscal year 2001, installation is considered a separate
earnings process, revenue related to new products is recognized upon customer
acceptance and revenue related to established products is accounted for as
multiple element arrangements as described above.
As a result of this change, Varian Semiconductor reported a change in accounting
principle in accordance with APB Opinion No. 20, "Accounting Changes," by a
cumulative effect adjustment. Varian Semiconductor recorded a non-cash charge of
$27.0 million (after reduction for income taxes of $15.7 million), or ($0.79)
per diluted share, to reflect the cumulative effect of the accounting change as
of the beginning of fiscal year 2001. For the third quarter of fiscal year 2002,
Varian Semiconductor recognized $0.9 million in revenue, which is included in
the cumulative effect adjustment recorded during fiscal year 2001. The effect of
that revenue was to increase income by $0.6 million (net of $0.3 million of tax)
for the third quarter of fiscal year 2002. For the nine-month period ended June
28, 2002, Varian Semiconductor recognized $2.9 million in revenue, which is
included in the cumulative effect adjustment recorded during fiscal year 2001.
The effect of that revenue was to increase income by $1.9 million (net of $1.0
million of tax) for the nine-month period ended June 28, 2002.
The results of the three and nine-month periods ended June 29, 2001 have been
adjusted to reflect the adoption of SAB101.
Reclassifications
Certain items in the prior year's consolidated financial statements have been
reclassified to conform to the current presentation of the financial statements.
Note 3. Computation of Net Income Per Share
Basic income per share is calculated based on net income and the weighted
average number of shares outstanding during the reporting period. Diluted income
per share includes additional dilution from stock issuable pursuant to the
exercise of the stock options outstanding. For purposes of the diluted income
per share calculation, the additional shares issuable upon exercise of stock
options were determined using the treasury stock method.
7
A reconciliation of the numerator and denominator used in the income per share
calculations is presented as follows:
Fiscal Three Months Ended Fiscal Nine Months Ended
------------------------- ------------------------
June 28, June 29, June 28, June 29,
2002 2001 2002 2001
---- ---- ---- ----
(In thousands, except per share amounts)
Numerator:
Income before cumulative effect of change in accounting principle ... $2,619 $8,170 $7,628 $72,369
Cumulative effect of change in accounting principle, net of tax ..... -- -- -- (27,038)
------- -------- -------- ---------
Net income .......................................................... $2,619 $8,170 $7,628 $45,331
======= ======== ======== =========
Denominator:
Denominator for basic income per share-
Weighted average shares outstanding ................................. 33,420 32,340 32,990 32,185
Effect of dilutive securities:
Stock options ....................................................... 1,849 2,117 1,837 1,726
------- -------- -------- ---------
Denominator for diluted income per share ............................ 35,269 34,457 34,827 33,911
======= ======== ======== =========
Income per share before cumulative effect of
change in accounting principle - basic ........................ $0.08 $0.25 $0.23 $2.25
Income per share before cumulative effect of
change in accounting principle - diluted ...................... $0.07 $0.24 $0.22 $2.13
Cumulative effect of change in accounting principle - basic - - - $(0.84)
Cumulative effect of change in accounting principle - diluted - - - $(0.79)
Net income per share - basic ........................................ $0.08 $0.25 $0.23 $1.41
Net income per share - diluted ...................................... $0.07 $0.24 $0.22 $1.34
For the three and nine-month periods ended June 28, 2002, options to purchase
751,184 and 680,970 common shares, at a weighted average exercise prices of
$51.48 and $51.92, were excluded from the computation due to their exercise
price exceeding the market value of the underlying common stock. For the three
and nine month periods ended June 29, 2001, options to purchase 671,691 and
973,989 common shares, at a weighted average exercise prices of $53.00 and
$45.75, respectively, were excluded from the computation due to their exercise
price exceeding the market value of the underlying common stock.
As of June 28, 2002, Varian Semiconductor had outstanding options to purchase an
aggregate of 5,687,377 shares of its common stock at a weighted average price of
$23.30. Of these options, options to purchase an aggregate of 3,865,789 shares
at a weighted average price of $18.96 were fully vested and exercisable.
Note 4. Accounts Receivable
Accounts receivable consist of the following:
June 28, September 28,
2002 2001
---- ----
(In thousands)
Billed receivables ..................... $57,300 $92,348
Allowance for doubtful accounts ........ (3,473) (6,893)
-------- --------
Accounts receivable, net ......... $53,827 $85,455
======== ========
8
Note 5. Inventories
The components of inventories are as follows:
June 28, September 28,
2002 2001
---- ----
(In thousands)
Raw materials and parts .......... $22,132 $32,002
Work in process .................. 31,306 13,775
Finished goods ................... 39,381 69,912
-------- ---------
Total inventories ............. $92,819 $115,689
======== =========
Note 6. Notes Payable and Short-term Borrowings
As of June 28, 2002 and September 28, 2001, Varian Semiconductor's subsidiary in
Japan had three credit facilities available with three different financial
institutions. Maximum available borrowings on each of the three loans were as
follows: (Y)590,000,000 ($4.9 million at June 28, 2002), (Y)500,000,000 ($4.2
million at June 28, 2002), and (Y)1,000,000,000 ($8.4 million at June 28, 2002).
The loans are unsecured and contain no restrictive covenants, although each loan
is guaranteed by Varian Semiconductor. Interest rates range from the short-term
prime rate to the Tokyo interbank offered rate + 1.75% (approximately 1.38% to
1.86% at June 28, 2002 and September 28, 2001). The loans mature every 30 to 90
days and are normally rolled over into new 30 to 90 day loans upon maturity.
Total outstanding borrowings at June 28, 2002 were (Y)590,000,000, or $4.9
million, and at September 28, 2001 were (Y)1,790,000,000, or $15.2 million.
Varian Semiconductor also has borrowing capacity in Europe, Korea and Taiwan. In
June 2002, Varian Semiconductor's European subsidiary renewed a credit facility
which includes overdraft protection of Euro 2.5 million ($2.5 million at June
28, 2002). Interest accrues at the Euro base rate + 1.5% (approximately 5.5% to
6.0% at June 28, 2002 and September 28, 2001). In April 2002, Varian
Semiconductor's subsidiary in Korea closed a $3.0 million credit facility. Any
outstanding borrowings accrue interest at the local base rate + 1.6%
(approximately 6.0% to 6.4% at June 28, 2002 and September 28, 2001) and is
payable on demand. In July 2001, Varian Semiconductor's subsidiary in Taiwan
closed a $1.0 million credit facility. The credit facility accrues interest at
the local base rate + 1.3% (approximately 3.25% and 3.95% at June 28, 2002 and
September 28, 2002 and is payable on demand. All three credit facilities are
unsecured and contain no restrictive covenants, although each loan is guaranteed
by Varian Semiconductor. There were no outstanding borrowings as of June 28,
2002 or September 28, 2001 on any of the three loans.
Note 7. Recent Accounting Pronouncements
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which is effective for
Varian Semiconductor in fiscal year 2003. SFAS 142 requires, among other things,
the discontinuance of goodwill amortization and includes provisions for the
reclassification of certain existing recognized intangibles as goodwill,
reassessment of the useful lives of existing recognized intangibles, and
reclassification of certain intangibles out of previously reported goodwill. The
revised standards include transition rules and requirements for identification,
valuation and recognition of a much broader list of intangibles as part of
business combinations than prior practice, most of which will continue to be
amortized.
In October 2001, the FASB issued Statement of Financial Accounting Standards No.
144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived
Assets." The objectives of SFAS 144 are to address significant issues relating
to the implementation of FASB Statement No. 121 ("SFAS 121"), Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and
to develop a single accounting model, based on the framework established in SFAS
121, for long-lived assets to be disposed of by sale, whether previously held
and used or newly acquired. SFAS 144 is effective for Varian Semiconductor
beginning in fiscal year 2003 and, generally, its provisions are to be applied
prospectively.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"). This statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)"("EITF 94-3"). SFAS 146 requires that
a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. EITF 94-3 allowed for an exit cost
liability to be recognized at the date of an entity's commitment to an exit
plan. SFAS 146 also requires that liabilities recorded in connection with exit
plans be initially measured at fair value. The provisions of SFAS are effective
for exit or disposal activities that are initiated after December 31, 2002, with
early adoption encouraged.
9
Varian Semiconductor does not expect the adoption of the above mentioned
pronouncements to have a material impact on Varian Semiconductor's consolidated
financial statements.
Note 8. Operating Segments and Geographic Information
Varian Semiconductor operates in five geographic segments and three operating
segments. The reportable segments were determined based upon the nature of
products and services provided, the geographic areas served and Varian
Semiconductor's management structure. Varian Semiconductor has three reportable
operating segments; Product Segment, Services Segment, and Research and
Development Segment, which includes royalties on licensing of intellectual
property. Varian Semiconductor has five reportable geographic segments, which
include North America, Europe, Japan, Korea and Taiwan. The accounting policies
of the segments are the same as those in all parts of Varian Semiconductor.
Varian Semiconductor primarily measures segment profitability based upon gross
profit. Varian Semiconductor does not have the net income and asset information
for the operating segments listed below. These other disclosures for reportable
segments are impractical to determine for each segment above.
Operating Segments
For the three months ended June 28, 2002 and June 29, 2001(in thousands):
Research and
Development
Product Segment Services Segment Segment Total
--------------- ---------------- ------- -----
FY2002 FY2001 FY2002 FY2001 FY2002 FY2001 FY2002 FY2001
------ ------ ------ ------ ------ ------ ------ ------
Revenues ................ $74,834 $122,869 $17,635 $20,390 $2,188 $3,909 $94,657 $147,168
Gross profit ............ 25,969 33,437 8,735 8,687 2,188 3,909 36,892 46,033
For the nine months ended June 28, 2002 and June 29, 2001 (in thousands):
Research and
Development
Product Segment Services Segment Segment Total
--------------- ---------------- ------- -----
FY2002 FY2001 FY2002 FY2001 FY2002 FY2001 FY2002 FY2001
------ ------ ------ ------ ------ ------ ------ ------
Revenues ................ $156,840 $479,201 $48,843 $69,504 $33,972 $13,494 $239,655 $562,199
Gross profit ............ 46,367 177,169 21,140 25,974 33,972 13,494 101,479 216,637
Geographic Information
Sales to Unaffiliated Customers (by location of the operation, in thousands)
Fiscal Three Months Ended Fiscal Nine Months Ended
------------------------- ------------------------
June 28, 2002 June 29, 2001 June 28, 2002 June 29, 2001
------------- ------------- ------------- -------------
United States ................................ $88,801 $134,554 $222,419 $551,873
International ................................ 37,892 66,158 88,855 241,320
Eliminations & other ......................... (32,036) (53,544) (71,619) (230,994)
--------- --------- --------- ----------
Total .................................. $94,657 $147,168 $239,655 $562,199
========= ========= ========= ==========
10
The following tables summarize revenue, depreciation and amortization and total
assets by reportable geographic segment (in thousands). Total revenue is based
on the final destination of products sold.
North
America Europe Japan Taiwan Korea Other Total
------- ------ ----- ------ ----- ----- -----
Three months ended
June 28, 2002
Revenue ............................... $26,277 $16,515 $9,781 $18,057 $20,490 $3,537 $94,657
Depreciation and amortization ......... 2,754 73 93 14 66 6 3,006
Total assets .......................... 509,969 15,722 30,394 5,606 12,332 2,762 576,785
June 29, 2001
Revenue ............................... $46,208 $23,291 $32,066 $16,496 $18,718 $10,389 $147,168
Depreciation and amortization ........... 3,300 79 59 26 132 6 3,602
Total assets ............................ 491,638 30,951 56,174 2,720 14,579 3,040 599,102
Nine months ended
June 28, 2002
Revenue ................................. $109,129 $ 37,157 $20,041 $24,866 $41,981 $ 6,481 $239,655
Depreciation and amortization ........... 9,740 103 191 46 231 11 10,322
June 29, 2001
Revenue ................................. $166,104 $116,405 $80,492 $78,510 $60,912 $59,776 $562,199
Depreciation and amortization ........... 9,541 330 139 71 294 19 10,394
11
Note 9. Commitments and Contingencies
Varian Semiconductor is currently a defendant in a number of legal actions and
could incur an uninsured liability in one or more of them. In the opinion of
management, the outcome of such litigation will not have a material adverse
effect on the consolidated financial position, results of operations or cash
flows of Varian Semiconductor.
Environmental Remediation
Prior to the spin-off of Varian Semiconductor from Varian Associates, Inc.
("VAI") on April 2, 1999, Varian Semiconductor's business was operated as the
Semiconductor Equipment Business ("SEB") of VAI. On April 2, 1999, VAI
contributed its Instruments Business ("IB") to Varian, Inc. ("VI"), and changed
its name to Varian Medical Systems, Inc. ("VMS"). These transactions were
accomplished under the terms of a distribution agreement by and among Varian
Semiconductor, VI and VAI (collectively, the "Distribution Related Agreements").
VAI has been named by the United States Environmental Protection Agency or third
parties as a potentially responsible party under CERCLA, 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
(including facilities disposed of in connection with VAI's sale of its Electron
Devices business during fiscal year 1995, and the sale of its Thin Film Systems
("TFS") business during fiscal year 1997). Expenditures by VMS (as successor to
VAI) for environmental investigation and remediation amounted to $1.1 million
and $2.6 million in the third quarter and first nine months of fiscal year 2002,
respectively.
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 June 28, 2002, VMS nonetheless estimated that the future
exposure for environmental investigation and remediation costs for these sites
and facilities ranged in the aggregate from $7.7 million to $22.9 million. The
time frame over which these costs are expected to be incurred varies with each
site or facility, ranging up to approximately 30 years as of June 28, 2002.
Management of VMS believes that no amount in the foregoing range of estimated
future costs is more probable of being incurred than any other amount in such
range and therefore VMS has accrued $7.7 million in estimated environmental
costs as of June 28, 2002.
As to other sites and facilities, VMS has gained sufficient knowledge to be able
to better estimate the scope and costs of future environmental activities. As of
June 28, 2002, VMS estimated that the future exposure for environmental
investigation and remediation costs for these sites and facilities ranged in the
aggregate from $35.3 million to $72.3 million. The time frame over which VMS
expects to incur these costs varies with each site and facility, ranging up to
approximately 30 years as of June 28, 2002. As to each of these sites and
facilities, management of VMS 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 future costs were reliably determinable. Together, these amounts
totaled $40.8 million at June 28, 2002. VMS accordingly accrued $27.0 million,
which represents its best estimate of the future costs discounted at 7%, net of
inflation. This reserve is in addition to the $7.7 million described in the
preceding paragraph.
Under the Distribution Related Agreements, Varian Semiconductor has agreed to
indemnify VMS and VI for one-third of these environmental investigation and
remediation costs, as adjusted for insurance proceeds in respect of these
environmental costs and for the tax benefits expected to be realized by VMS upon
the payment of Varian Semiconductor's protection of these environmental costs.
As of June 28, 2002, Varian Semiconductor's reserve for its portion of
environmental liabilities, based upon future environmental related costs
estimated by VMS as of that date and included in long-term and current accrued
expenses amounted to $7.6 million, of which $2.2 million was classified as
current.
The amounts set forth in the foregoing paragraphs are only estimates of
anticipated future environmental related costs, and the amounts actually spent
in the years indicated may be greater or less than such estimates. The aggregate
range of cost estimates reflects various uncertainties inherent in many
environmental investigation and remediation activities and the large number of
sites where VMS is undertaking such investigation and remediation activities.
VMS believes that most of these cost ranges will narrow as investigation and
remediation activities progress. Varian Semiconductor believes that its reserves
are adequate, but as the scope of the obligations becomes more clearly defined,
these reserves may be modified and related charges against income may be made.
12
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 Varian
Semiconductor's financial statements, the likelihood of such occurrence is
considered remote. Based on information currently available to management and
its best assessment of the ultimate amount and timing of environmental related
events, Varian Semiconductor's management believes that the costs of these
environmentally related matters are not reasonably likely to have a material
adverse effect on the combined financial statements of Varian Semiconductor.
Varian Semiconductor evaluates its liability for environmentally related
investigation and remediation in light of the liability and financial
wherewithal of potentially responsible parties and insurance companies where
Varian Semiconductor believes that it has rights to contribution, indemnity
and/or reimbursement. Claims for recovery of environmental investigation and
remediation costs already incurred, and to be incurred in the future, have been
asserted against various insurance companies and other third parties. In 1992,
VAI filed a lawsuit against thirty-six insurance companies with respect to most
of the above-referenced sites and facilities. VAI received certain cash
settlements with respect to these lawsuits in prior years. VMS has also reached
an agreement with an insurance company under which the insurance company agreed
to pay a portion of Varian Semiconductor's past and future environmentally
related expenditures. Varian Semiconductor therefore has a receivable of $1.4
million in other assets at June 28, 2002, as its portion of the insurance
recoveries. Although VMS intends to aggressively pursue additional insurance
recoveries, Varian Semiconductor has not reduced any liability in anticipation
of recovery with respect to claims made against third parties.
Legal Proceedings
In June 1997, Applied Materials filed a civil action against VAI in the United
States District Court for the Northern District of California alleging
infringement of four patents relating to sputter coating systems. Applied
Materials contended that its patents were infringed by the M2i, MB2 and Inova
systems that were manufactured and sold by VAI's TFS prior to VAI's sale of TFS
to Novellus Systems, Inc. in June 1997. The complaint requested unspecified
money damages and an injunction prohibiting further infringement and requested
that any damages awarded be increased up to three-fold for VAI's and Novellus'
alleged willful infringement. Novellus was subsequently added as a defendant in
this action and, as part of the sale of TFS, VAI agreed to indemnify Novellus
for certain damages it may suffer as a result of such litigation and to
reimburse Novellus for up to $7.5 million of its litigation expenses. VAI's
answer denied infringement and asserted that the Applied Materials patents were
invalid and that one of the asserted patents was unenforceable. VAI also filed a
separate suit seeking damages and injunctive relief against Applied Materials
contending that certain of Applied Material's business practices violated
antitrust laws. That action was procedurally related to the infringement case
and was pending before the same judge. Novellus filed a complaint against
Applied Materials which included a claim that Applied Materials had infringed
three of the patents acquired by Novellus from Varian Semiconductor.
In September 2000, Varian Semiconductor and Applied Materials settled their
patent infringement and antitrust litigation. After recording a payment to
Applied Materials and legal expenses, Varian Semiconductor recorded a gain of
$16.0 million ($10.8 million after taxes) relating to this litigation
settlement. Varian Semiconductor maintains a reserve to cover any residual
indemnification obligations described above. Included in current liabilities and
classified as an estimated loss contingency was $2.7 million, as of June 28,
2002 and September 28, 2001.
Varian Semiconductor has agreed to indemnify VMS and IB for any costs,
liabilities or expenses relating to Varian Semiconductor's legal proceedings,
including the Applied Materials matters. Under the Distribution Related
Agreements, Varian Semiconductor has agreed to reimburse VMS for one-third of
the costs, liabilities, and expenses, adjusted for any related tax benefits
recognized or realized by VMS, with respect to certain legal proceedings
relating to discontinued operations of VMS.
Varian Semiconductor's operations are subject to various foreign, federal, state
and/or local laws relating to the protection of the environment. These include
laws regarding discharges into soil, water and air, and the generation,
handling, storage, transportation and disposal of waste and hazardous
substances. In addition, several countries are reviewing proposed regulations
that would require manufacturers to dispose of their products at the end of a
product's useful life. These laws have the effect of increasing costs and
potential liabilities associated with the conduct of certain operations.
Note 10. Settlement and License Agreement
On December 19, 2001, Varian Semiconductor and Lam Research Corporation ("Lam")
resolved the patent infringement litigation between the two parties, which was
originally filed in October 1993, by Varian Semiconductor granting Lam a license
under certain patents. Additionally, all claims and counterclaims have been
dismissed in accordance with the agreement. The lawsuit involved Varian
Semiconductor's assertion that Lam infringed three Varian patents that relate to
the use of low pressure gas to assist in the heating and cooling of
semiconductor wafers during various manufacturing processes, and Lam's denial
that
13
the patents are valid or infringed. Under the agreement, Varian Semiconductor
has granted a license to Lam for the patents in return for the payment of $20.0
million, with $5.0 million paid immediately in exchange for prior use of the
patents. The remaining $15.0 million will be paid in 12 quarterly installments
through December 2005 and is in exchange for future use of the patents. As
further payment for past royalties, Lam issued to Varian Semiconductor a warrant
to purchase 2,000,000 shares of Lam common stock for $21.30 per share,
exercisable at any time prior to December 31, 2005. The fair value of the
warrant was $22.8 million upon receipt on December 19, 2001, and has been
recognized as royalty and license revenue during the first quarter of fiscal
year 2002. In addition, the $5.0 million cash payment was recognized as royalty
and license revenue during the first quarter of fiscal year 2002 and the
remaining $15.0 million in cash payments to be received will be recognized as
royalty and license revenue when due. Under Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities", the warrant was treated as a derivative and was measured at fair
value. At each balance sheet date, the warrant was remeasured at fair value and
all gains and losses are reported in other income, net. A gain was recorded in
other income in the amount of $5.1 million during the first six months of fiscal
year 2002, to reflect the change in fair value of the warrant. On April 1, 2002,
Varian Semiconductor completed the sale of the Lam warrant to an unrelated third
party for $28.0 million in cash.
Note 11. Restructuring Costs
During October 2001, Varian Semiconductor implemented a reduction in force,
primarily in the United States, in which its worldwide workforce was reduced by
approximately 200 employees or 12%. The reduction in force was in response to
the downturn in the industry. As a result, Varian Semiconductor recognized
approximately $2.2 million in restructuring costs during the first quarter of
fiscal year 2002. The restructuring costs were primarily severance related and
were all paid during the first six months of fiscal year 2002.
Note 12. Sale of Receivables
Varian Semiconductor has an agreement with two banks to sell specific Japanese
Yen denominated receivables, subject to recourse provisions. During 2002,
approximately $9.1 million of receivables were sold under these arrangements. As
of June 28, 2002 and September 28, 2001, approximately $4.5 million and $0.7
million, respectively, of receivables sold to the bank remained outstanding.
Varian Semiconductor does not believe it is materially at risk for any losses as
a result of this agreement.
Note 13. Derivative Financial Instruments
Varian Semiconductor uses derivative instruments to protect its interests from
fluctuations in earnings and cash flows caused by volatility in currency
exchange rates. Varian Semiconductor continued its policy of hedging its current
foreign currency exposures and in the second quarter of fiscal year 2002 began
to hedge a portion of its anticipated foreign currency exposures with hedging
instruments having maturities of up to twelve months.
On July 1, 2001, Varian Semiconductor adopted SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 requires
that all derivatives be recorded on the balance sheet at fair value. Changes in
the fair value of derivatives, which do not qualify, or are not effective as
hedges must be recognized currently in earnings. Upon adoption, there was no
impact for Varian Semiconductor as all derivatives were reflected at fair value
on the balance sheet at that date with all gains or losses reflected within the
statement of operations.
Varian Semiconductor's international sales are primarily denominated in United
States dollars. For foreign currency denominated sales, however, the volatility
of the foreign currency markets represents risk to Varian Semiconductor. Upon
forecasting the exposure, Varian Semiconductor enters into hedges with forward
sales contracts whose critical terms are designed to match those of the
underlying exposure. These hedges are evaluated for effectiveness at least
quarterly using the change in value of the forward contracts to the change in
value of the underlying transaction, with the effective portion of the hedge
accumulated in Other Comprehensive Income ("OCI"). Any measured ineffectiveness
is included immediately in marketing, general and administrative in the
Consolidated Statements of Operations. There has been no amount of
ineffectiveness recognized during the year. OCI associated with hedges of
foreign currency sales are reclassified to revenue upon recognition in income of
the underlying hedged exposure. All amounts reported in OCI have been
reclassified to revenue as of June 28, 2002. OCI activity during the year (in
thousands):
Balance, September 28, 2001 ............................. $ --
Effective portion of cash flow hedging instruments .. 11
Reclassified to revenue ............................. (11)
----
Balance, June 28, 2002 .................................. $ --
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Form 10-Q contains certain forward-looking statements. For purposes of the
safe harbor provisions under The Private Securities Litigation Reform Act of
1995, any statements using the terms "believes", "anticipates", "expects",
"plans" or similar expressions, are forward-looking statements. The
forward-looking statements involve risks and uncertainties that could cause
actual results to differ materially from those projected. There are a number of
important factors that could cause Varian Semiconductor's actual results to
differ materially from those indicated by forward-looking statements made in
this report and presented by management from time to time. Some of the important
risks and uncertainties that may cause Varian Semiconductor's financial results
to differ are under the heading "Risk Factors" in this report and in the annual
report on Form 10-K for the fiscal year ended September 28, 2001, filed with the
Securities and Exchange Commission on December 20, 2001.
The following information should be read in conjunction with the unaudited
interim consolidated financial statements and notes thereto included in "Item 1.
- - Consolidated Financial Statements" of this quarterly report and the audited
combined financial statements and notes thereto and the section titled "Item 7.
- - Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Varian Semiconductor's annual report on Form 10-K for the fiscal
year ended September 28, 2001 filed with the Securities and Exchange Commission
on December 20, 2001.
Critical Accounting Policies and Significant Judgments and Accounting Estimates
Varian Semiconductor's discussion and analysis of its financial condition and
results of operations are based upon Varian Semiconductor's consolidated
financial statements, which have been prepared in accordance with the United
States generally accepted accounting principles ("GAAP"). The preparation of
these financial statements requires Varian Semiconductor to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosure of contingent assets and liabilities. On a
continual basis, Varian Semiconductor evaluates its estimates, including those
related to inventories, collectibility of accounts receivable, intangible
assets, income taxes, warranty obligations, post-retirement benefits,
contingencies, and functional currencies. Varian Semiconductor operates in a
highly cyclical and competitive industry that is influenced by a variety of
diverse factors including, but not limited to, technological advances, product
life cycles, customer and supplier lead times, and macroeconomic and geographic
economic trends. Estimating product demand beyond a relatively short forecasting
horizon is difficult and prone to forecasting error due to the cyclical nature
and inherent lack of visibility in the industry. Varian Semiconductor bases its
estimates on historical experience, and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions. See also the factors
discussed below under the section titled "Risk Factors".
Varian Semiconductor believes that the following sets forth the critical
accounting policies used by Varian Semiconductor in the preparation of its
consolidated financial statements.
Revenue Recognition
Product revenue includes established products, new products, and spare parts.
Varian Semiconductor recognizes revenue from product sales upon shipment
provided title and risk of loss has passed to the customer, evidence of an
arrangement exists, fees are contractually fixed or determinable, collectibility
is reasonably assured through historical collection results and regular credit
evaluations and there are no uncertainties regarding customer acceptance.
For established and new products, a portion of the total purchase price is not
due until installation occurs and the customer accepts the product. For
established products, the lesser of the amount allocated to the equipment or the
contractual amount billable upon delivery is recorded as product revenue upon
delivery. The amount deferred is recognized as revenue upon customer acceptance.
For new products, revenue allocated to the equipment is recognized upon customer
acceptance. Revenue related to spare parts sales is recognized upon the later of
delivery or title and risk of loss passes to the customer. Varian Semiconductor
accrues warranty costs upon recognition of product revenue.
Products are classified as established products if post-delivery acceptance
provisions and the installation process have been determined to be routine,
commercially inconsequential and perfunctory, due to the fact that the
acceptance provisions are generally a replication of pre-shipment procedures and
there is an established history of installations. The majority of products are
designed and manufactured to meet the contractual customer specifications. To
ensure customer specifications are satisfied, the systems are
15
tested at Varian Semiconductor's manufacturing facility prior to shipment. To
the extent that customers' conditions can not be replicated in Varian
Semiconductor's facilities or if there is not a demonstrated history of meeting
newer in-field customer specifications, then the product is classified as new
for revenue recognition purposes.
Service revenue includes maintenance and service contracts, paid service and
installation services. Revenue related to maintenance and service contracts is
recognized ratably over the duration of the contracts. Revenue related to paid
service is recorded when earned and the revenue related to installation is
recorded upon fulfillment of the service obligation. Royalty and license revenue
is recognized when contractual obligations are met, evidence of an arrangement
exists, fees are fixed or determinable and collection is reasonably assured.
Varian Semiconductor's transactions frequently include the sale of systems and
services under multiple element arrangements. Revenue under these arrangements
is allocated to all elements, except systems, based upon the fair market value
of those elements. The amount allocated to installation is based either upon
hourly rates at the estimated time to complete the service or the amount due
upon customer acceptance, whichever is greater. The fair value of all other
elements is based upon the price charged when these amounts are sold separately
and unaccompanied by other elements. The amount of revenue allocated to systems
is done on a residual method basis. Under this method, the total value of the
arrangement is allocated first to the undelivered elements based on their fair
values, with the remainder being allocated to systems revenue. Installation is
not essential to the functionality of the system, as these services do not alter
the equipment's capabilities.
Inventory and Purchase Order Commitments
Varian Semiconductor values its inventory at the lower of cost or market. The
determination of lower of cost or market requires that Varian Semiconductor make
significant assumptions about future demand for products (typically a twelve to
twenty-four month future demand horizon) and the transition to new product
offerings from legacy products. Varian Semiconductor also reserves against those
open purchase order commitments in which Varian Semiconductor's estimated
obligation to receive inventory under these commitments exceeds expected
production demand. These assumptions include, but are not limited to, future
manufacturing schedules, customer demand, supplier lead time and technological
and market obsolescence. If market conditions are less favorable than those
projected by management, additional inventory provisions may be required.
Allowance for Doubtful Accounts
Varian Semiconductor maintains allowances for doubtful accounts for estimated
losses resulting from the inability of its customers to make required payments
for products and services. Accounts with prior collectability issues or known
financial issues are first reviewed and specific estimates are recorded. The
remaining account receivable balance is then grouped in categories by the amount
of days the balance is past due and the estimated loss is calculated as a
percentage of the total category based upon past history. If the financial
condition of Varian Semiconductor's customers were to deteriorate, resulting in
their inability to make payments, additional allowances may be required.
Valuation Allowance on Deferred Tax Assets
As required by Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes" Varian Semiconductor evaluates the positive and negative
evidence bearing upon the realizability of its deferred tax assets. Varian
Semiconductor has considered taxable income that can be carried back, future
taxable income and ongoing prudent and feasible tax planning strategies in
assessing the need for the valuation allowance and has concluded that no
valuation allowance is required at this time. An adjustment to the deferred tax
asset would be charged to income in the period such determination was made if
Varian Semiconductor determined that it would not be able to realize all or part
of its deferred tax asset in the future.
Product Warranties
Varian Semiconductor provides for the estimated cost of product warranties,
primarily from historical information, at the time product revenue is
recognized. While Varian Semiconductor engages in extensive product quality
programs and processes, including actively monitoring and evaluating the quality
of its component supplies, Varian Semiconductor's warranty obligation is
affected by product failure rates, utilization levels, material usage, service
delivery costs incurred in correcting a product failure, and supplier warranties
on parts delivered to Varian Semiconductor. Should actual product failure rates,
utilization levels, material usage, service delivery costs or supplier
warranties on parts differ from Varian Semiconductor's estimates, revisions to
the estimated warranty liability would be required.
Environmental Liabilities
Liabilities are recorded when environmental assessments and/or remedial efforts
are probable, and the costs can be reasonably
16
estimated. Generally, the timing of these accruals coincides with completion of
a feasibility study or Varian Semiconductor's commitment to a formal plan of
action. In situations where the various uncertainties make it difficult to
assess the likelihood and scope of further investigation or remediation
activities or to estimate then future costs, the lower limit of an estimated
range is accrued on a non-discounted basis. All other liabilities, which are
usually where Varian Semiconductor has general sufficient knowledge to be able
to better estimate the scope of costs and future activities, are accrued on a
discounted basis. Should new information become available and/or different
assumptions be applied in the estimation of environmental liabilities, revisions
to the accrued environmental liability would be required.
Derivative Financial Instruments
Forward Exchange Contracts
As a multinational company, Varian Semiconductor faces exposure to adverse
movements in foreign currency exchange rates. This exposure may change over time
as Varian Semiconductor's business practices evolve and could have a material
adverse impact on Varian Semiconductor's financial results. Historically, Varian
Semiconductor's primary exposures have resulted from non-United States dollar
denominated sales and purchases in Europe and the Asia-Pacific region. Varian
Semiconductor does not enter into forward exchange contracts for trading
purposes. Varian Semiconductor's forward exchange contracts generally range from
one to six months in original maturity. No forward exchange contract has an
original maturity greater than one year.
Varian Semiconductor hedges currency exposures that are associated with certain
of its assets and liabilities denominated in various non-United States dollar
denominated currencies. Aggregate exchange gains and losses are included in
marketing, general, and administrative expenses. Varian Semiconductor also
hedges currency exposures that are associated with certain of its product sales
denominated in Japanese Yen. In accordance with Statement of Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities", these forward foreign exchange contracts are designated as hedges
of anticipated product sales, and accordingly, the gains and losses resulting
from the impact of currency rate movements on these contracts are not recognized
in income until the underlying hedged transactions are recognized.
Results of Operations
Industry
Varian Semiconductor's business is highly cyclical and depends upon the capital
expenditures of semiconductor manufacturers, which in turn depend on the current
and anticipated market demand for integrated circuits and products utilizing
integrated circuits. In fiscal year 2001, semiconductor equipment manufacturers
experienced a significant contraction in the demand for products due to the
slowdown in economies worldwide, specifically the slowdown in technology sectors
which utilize integrated circuits. Varian Semiconductor's business has been
materially affected by this contraction, as revenues had decreased five
sequential consecutive quarters, from $226.4 million in the first quarter of
fiscal year 2001 to $50.0 million in the first quarter of fiscal year 2002
(excluding the Lam royalty and license revenue, refer to Note 10. Settlement and
License Agreement). However, for the second and third quarters of fiscal year
2002, revenues increased to $67.2 million and $94.7 million, respectively.
Although revenues increased during the second and third quarters of fiscal year,
this is not necessarily evidence that the downturn in the industry is over.
Fluctuations in the timing and mix of product shipments, customer requirements
for systems, and the completion of the installation of the product have a
significant impact on revenue (see also Risk Factors and Critical Accounting
Policies - Revenue Recognition). Varian Semiconductor does not have visibility
as to the length or sustainability of any potential industry recovery.
The third quarter of fiscal year 2002 comprises the three-month period ended
June 28, 2002 and the third quarter of fiscal year 2001 comprises the
three-month period ended June 29, 2001. The nine-month period of fiscal year
2002 comprises the nine-month period ended June 28, 2002 and the nine-month
period of fiscal year 2001 comprises the nine-month period ended June 29, 2001.
Revenue. The following table sets forth total revenue and revenue by operating
segment for the three and nine-month periods ended June 28, 2002 and June 29,
2001, including non-recurring royalty and license revenue of $27.8 million
recognized during the first quarter of fiscal year 2002 received in connection
with the settlement agreement with Lam described in more detail below.
17
(Dollars in millions)
Third Quarter Nine-Month Period
------------- -----------------
Fiscal Fiscal Fiscal Fiscal
Year Year Dollar Percent Year Year Dollar Percent
(In thousands) 2002 2001 Change Change 2002 2001 Change Change
---- ---- ------ ------ ---- ---- ------ ------
Product revenue ......................... $74.8 $122.9 ($48.1) (39.1%) $156.8 $479.2 ($322.4) (67.3%)
Service revenue ......................... 17.7 20.4 (2.7) (13.2%) 48.9 69.5 (20.6) (29.6%)
Royalty and license
Revenue ............................ 2.2 3.9 (1.7) (43.6%) 34.0 13.5 20.5 151.9%
----- ------ ------ ----- ------ ------ -------- -----
Total revenue ........................... $94.7 $147.2 ($52.5) (35.7%) $239.7 $562.2 ($322.5) (57.4%)
The significant decrease in revenue, by 35.7% and 57.4% during the third quarter
and nine-month period of fiscal year 2002, respectively, was a result of the
downturn in the industry, specifically the reduction in capital expenditures by
semiconductor manufacturers and the industry-wide decline in demand for
semiconductor devices.
Royalty and License Revenue
Pursuant to the terms of an agreement between Varian Semiconductor and Lam,
Varian Semiconductor received, during the first quarter of fiscal year 2002, a
warrant to purchase 2,000,000 shares of Lam common stock at $21.30 per share and
a $5.0 million cash payment in exchange for prior use of certain Varian
Semiconductor patents. Total royalty and license revenue recognized from Lam
during the first quarter of fiscal year 2002 includes the warrant, which was
valued at $22.8 million, and the $5.0 million cash payment received. Lam will
continue to make quarterly cash payments of $1.25 million through December 2005
for future use of the patents. Future cash payments will be recognized as
royalty and license revenue in the period they become due. (See Note 10.
Settlement and License Agreement.)
Geographic Segments
The following table reflects revenue by geographic segment for the three month
and nine month periods ended June 28, 2002 and June 29, 2001, including the
non-recurring Lam royalty and license revenue of $27.8 million recognized during
the first quarter of fiscal year 2002 (see "Royalty and License Revenue").
(In thousands)
Third Quarter Nine-Month Period
------------- -----------------
Fiscal Fiscal Fiscal Fiscal
Year 2002 Year 2001 Year 2002 Year 2001
--------- --------- --------- ---------
North America* .................................. $26,277 $46,208 $109,129 $166,104
Europe .......................................... 16,515 23,291 37,157 116,405
Japan ........................................... 9,781 32,066 20,041 80,492
Taiwan .......................................... 18,057 16,496 24,866 78,510
Korea ........................................... 20,490 18,718 41,981 60,912
Other ........................................... 3,537 10,389 6,481 59,776
------- -------- -------- --------
Total revenue ................................... $94,657 $147,168 $239,655 $562,199
======= ======== ======== ========
*Primarily in the United States
The decrease in a majority of the geographic segments during both the nine-month
period of fiscal year 2002 was a result of the downturn in the industry (see
"Industry"). During the third quarter of fiscal year 2002 there was an increase
in revenue in the Taiwan and Korea segments compared to the same quarter a year
ago due to increased capacity requirements for memory devices from a limited
number of customers. Revenue decreased for all other geographic segments during
the third quarter of fiscal year 2002 compared to the third quarter of fiscal
year 2001.
Cost of Product Revenue. Cost of product revenue was $48.9 million and gross
margin was 35% for the third quarter of fiscal year 2002, as compared to cost of
product revenue of $89.4 million and gross margin of 27% for the same period a
year ago. Cost of product revenue was $110.5 million and gross margin was 30%
for the nine-month period ended June 28,2002, as compared to the cost of product
revenue of $302.0 million and gross margin of 37% for the same period a year.
The increase in gross margin of 8% for the third quarter of fiscal year 2002
compared to the same period a year ago was primarily due to better factory
utilization and tight inventory management, somewhat offset by downward pressure
on selling prices of systems. The decrease in
18
gross margin of 7% for the nine-month period ended June 28, 2002, was primarily
a result of the decrease in the volume of product shipments. Gross margin on
product revenue for the fourth quarter of fiscal year 2002 may decrease slightly
from the third quarter due to price pressure.
Cost of Service Revenue. Cost of service revenue was $8.9 million and gross
margin was 50% for the third quarter of fiscal year 2002, as compared to cost of
service revenue of $11.7 million and gross margin of 43% for the same period a
year ago. Cost of service revenue was $27.7 million and gross margin was 43% for
the nine-month period ended June 28, 2002, as compared to the cost of service
revenue of $43.5 million and gross margin of 37% for the same period a year ago.
The increase in gross margin of 7% and 6% for the third quarter of fiscal year
2002 and nine-month period ended June 28, 2002, respectively, was primarily a
result of the product mix of the installations completed and reduced field
costs.
Research and Development. Research and development expenses were $12.5 million
for the third quarter of fiscal year 2002 as compared to $11.7 million for the
same period a year ago, an increase of $0.8 million or 7%. For the nine-month
period ended June 28, 2002, research and development expenses were $38.0
million, as compared to $38.5 million for the same period a year ago. Research
and development expenses are expected to increase during the fourth quarter of
fiscal year 2002, as compared to the third quarter of fiscal year 2002. Varian
Semiconductor continues to be committed to investment in product development,
particularly the shift to 300mm, factory automation, and the transition to
advanced technology nodes.
Marketing, General and Administrative. Marketing, general and administrative
expenses were $22.1 million for the third quarter of fiscal year 2002 as
compared to $24.4 million for the same period a year ago, a decrease of $2.3
million or 9%. For the nine-month period ended June 28, 2002, marketing, general
and administrative expenses were $59.5 million, as compared to $76.4 million for
the same period a year ago. Marketing, general and administrative expenses
decreased from the prior year mainly due to efforts to reduce spending in
response to the industry downturn. Marketing, general and administrative
expenses are expected to approximate the same level in the fourth quarter of
fiscal year 2002 as the third quarter of fiscal year 2002. In addition, Varian
Semiconductor expects to record a restructuring charge, of approximately $1
million, during the fourth quarter of fiscal year 2002 related to the
consolidation of several offices.
Interest Income. During the third quarter of fiscal year 2002, Varian
Semiconductor earned $1.5 million in interest income as compared with $2.3
million for the same period a year ago. During the nine-month period ended June
28, 2002, Varian Semiconductor earned $4.4 million in interest income as
compared with $6.3 million for the same period a year ago. Despite increased
cash balances, interest income decreased from the comparative prior year periods
due to lower short-term interest rates.
Other income. During the six-month period ended March 29, 2002, Varian
Semiconductor recorded a gain of $5.1 million in other income to reflect the
fair value accounting of the Lam warrant. Varian Semiconductor received a
warrant to purchase shares of Lam common stock on December 19, 2001 (See also
Note 10. Settlement and License Agreement). The warrant was treated as a
derivative and was remeasured at fair value at each balance sheet date. Under
fair value accounting, all gains and losses were reported in other income
(expense). The volatility in Lam's stock price and other factors resulted in
changes to the fair value of the Lam warrant. On April 1, 2002, Varian
Semiconductor completed the sale of this warrant to an unrelated third party for
$28.0 million in cash. No other income was recorded during the third quarter of
fiscal year 2002.
Provision for Income Taxes. Varian Semiconductor's effective income tax rate was
33% for the nine-month period ended June 28, 2002, approximately the same as the
prior year. The rate is lower than the United States federal statutory rate
principally due to the tax benefits arising from the use of the extraterritorial
income exclusion and tax credits. Future tax rates may vary from the historic
rates depending on the worldwide allocation of earnings and the continuing
availability of the extraterritorial income exclusion.
Cumulative Effect of Change in Accounting Principle, Net of Tax. Varian
Semiconductor reported a change in accounting principle for the adoption of SAB
101 in accordance with APB Opinion No. 20, "Accounting Changes," by a cumulative
effect adjustment. Varian Semiconductor recorded a non-cash charge of $27.0
million (after reduction for income taxes of $15.7 million), or ($0.79) per
diluted share, to reflect the cumulative effect of the accounting change as of
the beginning of the fiscal year 2001.
Net Income. As a result of the foregoing factors, in the third quarter of fiscal
year 2002 Varian Semiconductor recorded net income of $2.6 million, compared to
net income of $8.2 million for the same period a year ago. The net income per
diluted share was $0.07 for the third quarter of fiscal year 2002, as compared
to net income of $0.24 per diluted share for the same period a year ago. For the
nine-month period ended June 28, 2002, Varian Semiconductor recorded net income
of $7.6 million, compared to net income of $45.3 million for the same period a
year ago. The net income per diluted share was $0.22 for the nine-month period
ended June 28, 2002, as compared to net income per diluted share of $1.34 for
the same period a year ago.
19
Change in Revenue Accounting Principle
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements." SAB 101 summarizes the staff's view in applying generally accepted
accounting principles to selected revenue recognition issues, including the
timing of revenue recognition for sales that involve contractual customer
acceptance provisions and installation of the product if these events occur
after shipment and transfer of title and risk of loss. In October 2000, the SEC
issued Staff Accounting Bulletin No. 101: Revenue Recognition in Financial
Statements--Frequently Asked Questions and Answers ("SAB 101 FAQ"). The SAB 101
FAQ was issued to clarify many of the implementation questions surrounding SAB
101. Varian Semiconductor implemented the provisions of SAB 101 in the fourth
quarter of fiscal year 2001, retroactive to the first quarter of fiscal year
2001.
Varian Semiconductor's previous revenue recognition policy was to recognize
product revenue at the time the customer took title to the product, generally at
the time of shipment. At that time, Varian Semiconductor also accrued the costs
to install the product. For some transactions, a portion of the purchase price
is not due until installation is complete and the product is accepted by the
customer. Under SAB 101 and the new accounting method adopted retroactive to the
first quarter of fiscal year 2001, installation is considered a separate
earnings process, revenue related to new products is recognized upon customer
acceptance and revenue related to established products is accounted for as
multiple element arrangements.
As a result of this change, Varian Semiconductor reported a change in accounting
principle in accordance with APB Opinion No. 20 "Accounting Changes", by a
cumulative effect adjustment. Varian Semiconductor recorded a non-cash charge of
$27.0 million (after reduction for income taxes of $15.7 million), or ($0.79)
per diluted share, to reflect the cumulative effect of the accounting change as
of the beginning of fiscal year 2001. For the third quarter of fiscal year 2002,
Varian Semiconductor recognized $0.9 million in revenue, which is included in
the cumulative effect adjustment recorded during fiscal year 2001. The effect of
that revenue was to increase income by $0.6 million (net of $0.3 million of tax)
for the third quarter of fiscal year 2002. For the nine-month period ended June
28, 2002, Varian Semiconductor recognized $2.9 million in revenue, which is
included in the cumulative effect adjustment recorded during fiscal year 2001.
The effect of that revenue was to increase income by $1.9 million (net of $1.0
million of tax) for the nine-month period ended June 28, 2002.
The results of the three and nine-month periods ended June 29, 2001 have been
adjusted to reflect the adoption of SAB 101.
Liquidity and Capital Resources
Cash provided by operations was $19.8 million during the nine-month period ended
June 28, 2002, as compared to cash provided by operations of $116.3 million
during the nine-month period ended June 29, 2001. In the nine-month period ended
June 28, 2002, cash provided by operations was primarily a result of a decrease
in accounts receivable of $31.5 million and a decrease in inventories of $25.1
million. The increase to cash during the nine-month period ended June 28, 2002
was partially offset by non-cash consideration of $22.8 million in royalty and
license income and a decrease in deferred revenue of $33.0 million. Cash
provided by operations in the nine-month period ended June 29, 2001 came
primarily from net income of $45.3 million, after adjusting for the non-cash
charge of $27.0 million arising from a cumulative effect of a change in
accounting principle, and a decrease in accounts receivable of $64.0 million and
inventory of $46.8 million. The increase in cash was partially offset by
decreases in accounts payable of $36.5 million and deferred revenue of $34.3
million.
Cash provided by investing activities was $17.1 million during the nine-month
period ended June 28, 2002, including $28.0 million that was generated from the
sale of the Lam warrant on April 1, 2002 (refer to Note 10 Settlement and
License Agreement). This was partially offset by purchases of property plant and
equipment of $10.9 million. Varian Semiconductor used $13.0 million of cash
during the nine-month period ended June 29, 2001, all of which was for the
purchase of property, plant and equipment.
During the nine-month period ended June 28, 2002, $5.0 million of cash was
provided by financing activities, of which $14.8 million was generated from the
issuance of stock upon the exercise of stock options. This was partially offset
by $9.8 million in repayments on short-term borrowings. During the nine-month
period ended June 29, 2001, $14.3 million of cash was provided by financing
activities, of which $4.9 million was generated form the issuance of stock upon
the exercise of stock options and $9.4 million was provided by proceeds from
short-term borrowings.
Under GAAP, certain obligations and commitments are not required to be included
in the consolidated balance sheet. These obligations and commitments, while
entered into in the normal course of business, may have a material impact on
liquidity. The following commitments as of June 28, 2002, have not been included
in the unaudited interim consolidated financial statements included under Item
1. Financial Statements, however, they have been disclosed in the following
table in order to provide a more accurate picture of Varian Semiconductor's
financial position and liquidity. Varian Semiconductor does not have any
relationships with unconsolidated entities or financial partnerships, such as
entities often referred to as structured finance or special purpose
20
entities, which would have been established for the purpose of facilitating
off-balance sheet arrangements or other contractually narrow or limited
purposes. As such, Varian Semiconductor is not exposed to any financing,
liquidity, market or credit risk that could arise if Varian Semiconductor had
engaged in such relationships.
(In thousands)
Payments Due by Period
Less than 1 1 - 3 4 - 5 After 5
Total Year Years Years Years
----- ---- ----- ----- -----
Operating leases ............................. $14,435 $3,649 $4,789 $2,174 $3,823
Letter of credit ............................. 1,900 1,900 - - -
------- ------ ------ ------ ------
Total operating lease commitments .......... $16,335 $5,549 $4,789 $2,174 $3,823
======= ====== ====== ====== ======
Varian Semiconductor also enters into purchase order commitments in the normal
course of business, of which the liability is not included in the financial
statements in accordance with GAAP.
As of June 28, 2002 and September 28, 2001, Varian Semiconductor's subsidiary in
Japan had three credit facilities available with three different financial
institutions. Maximum available borrowings on each of the three loans were as
follows: (Y)590,000,000 ($4.9 million at June 28, 2002), (Y)500,000,000 ($4.2
million at June 28, 2002), and (Y)1,000,000,000 ($8.4 million at June 28, 2002).
The loans are unsecured and contain no restrictive covenants, although each loan
is guaranteed by Varian Semiconductor. Interest rates range from the short-term
prime rate to the Tokyo interbank offered rate + 1.75% (approximately 1.38% to
1.86% at June 28, 2002 and September 28, 2001). The loans mature every 30 to 90
days and are normally rolled over into new 30 to 90 day loans upon maturity.
Total outstanding borrowings at June 28, 2002 were (Y)590,000,000, or $4.9
million, and at September 28, 2001 were (Y)1,790,000,000, or $15.2 million.
Varian Semiconductor also has borrowing capacity in Europe, Korea and Taiwan. In
June 2002, Varian Semiconductor's European subsidiary renewed a credit facility
which includes overdraft protection of Euro 2.5 million ($2.5 million at June
28, 2002). Interest accrues at the Euro base rate + 1.5% (approximately 5.5% to
6.0% at June 28, 2002 and September 28, 2001). In April 2002, Varian
Semiconductor's subsidiary in Korea closed a $3.0 million credit facility. Any
outstanding borrowings accrue interest at the local base rate + 1.6%
(approximately 6.0% to 6.4% at June 28, 2002 and September 28, 2001) and is
payable on demand. In July 2001, Varian Semiconductor's subsidiary in Taiwan
closed a $1.0 million credit facility. The credit facility accrues interest at
the local base rate + 1.3% (approximately 3.25% and 3.95% at June 28, 2002 and
September 28, 2002 and is payable on demand. All three credit facilities are
unsecured and contain no restrictive covenants, although each loan is guaranteed
by Varian Semiconductor. There were no outstanding borrowings as of June 28,
2002 or September 28, 2001 on any of the three loans.
Varian Semiconductor has an agreement with two banks to sell specific Japanese
Yen denominated receivables, subject to recourse provisions. During 2002,
approximately $9.1 million of receivables were sold under these arrangements. As
of June 28, 2002 and September 28, 2001, approximately $4.5 million and $0.7
million, respectively, of receivables sold to the bank remained outstanding.
Varian Semiconductor does not believe it is materially at risk for any losses as
a result of this agreement.
Varian Semiconductor's liquidity is affected by many factors, some based on the
normal operations of the business and others related to the uncertainties of the
industry and global economies. Varian Semiconductor believes that cash of $320.7
million at June 28, 2002 will be sufficient to satisfy working capital
requirements, commitments for capital expenditures and other purchase
commitments and cash requirements for the foreseeable future.
Transactions with Affiliates and Related Parties
The unaudited interim consolidated financial statements of Varian Semiconductor
reflect the financial position, results of operations and cash flows of Varian
Semiconductor as of and for the three months and nine months ended June 28, 2002
and June 29, 2001.
Operations prior to the spin off had been part VAI. (See also Note 9.
Commitments and Contingencies.)
Pursuant to the Distribution Related Agreements, Varian Semiconductor received
services from VMS (as successor to VAI), principally information technology
services, for a defined period of time. The Distribution Related Agreements
provide that, from and after the spin-off, VAI, IB, and Varian Semiconductor
will indemnify each and their respective subsidiaries, directors, officers,
employees and agents against all losses arising in connection with shared
liabilities (including certain environmental and legal liabilities). All shared
liabilities will be managed and administered by VAI and expenses and losses, net
of proceeds and other receivables, will be borne one-third each by VAI, IB, and
Varian Semiconductor; the Distribution Related Agreements also provide that
Varian Semiconductor shall assume all of its liabilities, other than shared
liabilities (including accounts payable,
21
accrued payroll, and pension liabilities) in accordance with their terms. For
the periods subsequent to the spin-off, during the first nine months of fiscal
years 2002 and 2001, Varian Semiconductor was charged by VMS $3.2 million and
$2.4 million, respectively, in settlement of these obligations.
Risk Factors
Varian Semiconductor has a limited operating history as an independent company
which may make it difficult to assess its financial performance and its ability
to address the risks associated with its industry.
Until April 2, 1999, Varian Associates, Inc. conducted Varian Semiconductor's
business as one of its divisions. As a result, Varian Semiconductor has only a
limited operating history as an independent company on which its business and
prospects can be evaluated.
Varian Semiconductor's ability to satisfy its obligations and maintain
profitability will depend on its future performance, and Varian Semiconductor
has limited experience in addressing various business challenges without the
support of its corporate parent. Varian Semiconductor will not be able to rely
on the capital resources and cash flow of VAI and will need to generate its own
revenues and secure sources of financing when necessary. In addition, Varian
Semiconductor is a smaller and less diversified company than VAI was prior to
the spin-off which may make Varian Semiconductor more susceptible to economic
downturns in the semiconductor industry. If Varian Semiconductor is unable to
confront the challenges facing stand-alone companies in its market, its business
will suffer.
The semiconductor industry is cyclical, and a slowdown in demand for Varian
Semiconductor's semiconductor manufacturing equipment will negatively impact its
financial results.
The semiconductor industry has been cyclical in nature and has historically
experienced periodic downturns. The industry is currently experiencing extreme
volatility in product pricing and a slowdown in product demand. Volatility and
slowdowns have resulted in significant reductions and delays in the purchase of
semiconductor manufacturing equipment and the construction of new fabrication
facilities which has significantly harmed Varian Semiconductor's financial
results. Even though Varian Semiconductor's revenues have declined, in order to
remain competitive, Varian Semiconductor continues to invest in research and
development and to maintain its worldwide customer service and support
capability. These developments have adversely affected Varian Semiconductor's
financial results and could continue to adversely affect financial results. If
the downturn in the semiconductor industry continues, the decrease in demand for
Varian Semiconductor's products will continue to adversely affect its financial
results.
Varian Semiconductor faces intense competition in the semiconductor equipment
industry.
Significant competitive factors in semiconductor equipment manufacturing include
the strength of customer relationships, pricing, technological performance and
timing, distribution capabilities and financial viability. Varian Semiconductor
believes that in order to remain competitive in this industry, it will need to
devote significant financial resources to product and process research and
development, to offering and marketing a broad range of products, and to
maintaining and enhancing customer service and support centers worldwide. The
semiconductor equipment industry is becoming increasingly dominated by large
manufacturers who have resources to support customers worldwide, and some of
Varian Semiconductor's competitors have substantially greater financial
resources and more extensive engineering, manufacturing, marketing, service and
support than Varian Semiconductor does. With fewer resources, Varian
Semiconductor may not be able to match the product offerings or customer service
and technical support offered by its competitors. In addition, some smaller
equipment manufacturers provide innovative technology which may have performance
advantages over Varian Semiconductor's systems. If these manufacturers continue
to improve their product performance and pricing or enter into strategic
relationships with other large equipment manufacturers, sales of Varian
Semiconductor's products may suffer.
Varian Semiconductor derives a substantial portion of its revenues from a small
number of customers, and its business may be harmed by the loss of any one
significant customer.
As described under "Item 1. - Business" in the annual report on Form 10-K for
the fiscal year ended September 28, 2001, filed with the Securities and Exchange
Commission on December 20, 2001, Varian Semiconductor has historically sold at
least half of its systems in any particular period to its ten largest customers.
In addition, Varian Semiconductor may have difficulty attracting additional
large customers because its sales depend, in large part, upon the decision of a
prospective customer to increase manufacturing capacity in an existing
fabrication facility or to transfer a manufacturing process to a new fabrication
facility, both of which typically involve a significant capital commitment. Once
a semiconductor manufacturer has selected a particular supplier's capital
equipment, the manufacturer generally relies upon that equipment for the
specific production line application and frequently will attempt to consolidate
its other capital equipment requirements with the same supplier. Consequently,
Varian
22
Semiconductor may experience difficulty in selling to a prospective customer if
that customer initially selects a competitor's capital equipment.
Varian Semiconductor's quarterly results of operations are likely to fluctuate,
and as a result, Varian Semiconductor may fail to meet the expectations of its
investors and securities analysts, which may cause the price of its common stock
to decline.
Varian Semiconductor has experienced and expects to continue to experience
significant fluctuations in its quarterly financial results. From time to time,
customers may reschedule or cancel shipments, production difficulties could
delay shipments, or technical difficulties may delay installation of the
product. A delay in shipment or customer acceptance of the product upon
installation in any quarter due to these factors may cause revenues in such
quarters to fall significantly below expectations, which could cause the market
price of Varian Semiconductor's common stock to decline. Varian Semiconductor's
financial results also fluctuate based on gross profits realized on sales. Gross
profit as a percentage of revenue may vary based on a variety of factors,
including the mix and average selling prices of products sold and costs to
manufacture upgrades and customize systems. In addition, a number of other
factors could impact Varian Semiconductor's quarterly financial results,
including the following:
. unexpected procurement or manufacturing difficulties;
. pricing of key components;
. fluctuations in foreign exchange rates;
. adverse weather conditions at its manufacturing facilities; and
. general conditions in the semiconductor equipment industry.
Because Varian Semiconductor's operating expenses are based on anticipated
capacity levels, and a high percentage of Varian Semiconductor's expenses are
relatively fixed, a variation in the timing of recognition of revenue and the
level of gross profit from a single transaction could cause financial results to
vary significantly from quarter to quarter.
Varian Semiconductor's future business depends, in part, on its ability to
successfully introduce and manage the transition to new products, and Varian
Semiconductor may not succeed in accomplishing these goals.
Varian Semiconductor believes that its future success will depend on its ability
to develop, manufacture and successfully introduce new systems and product lines
with improved capabilities and to continue enhancing existing products, in
particular products that respond to the trend toward single wafer processing and
300mm wafer processing. Varian Semiconductor derives virtually all of its
revenue from sales and servicing of ion implantation systems and related
products and services. If Varian Semiconductor's VIISta ion implant platform,
which relies on single wafer processing, does not gain market acceptance, future
financial results will suffer. Varian Semiconductor must accurately forecast the
demand for new products while managing the transition from older products, or it
may otherwise mismanage inventory levels. In addition, Varian Semiconductor may
be unable to complete the development or meet the technical specifications of
new systems or enhancements or to manufacture and ship these systems or
enhancements in volume and on time, which may harm its reputation and business.
In the past, Varian Semiconductor has experienced some delays in manufacturing
and shipping systems and enhancements as well as problems with the reliability
and quality of such systems and enhancements. If any of Varian's Semiconductor's
new products have reliability or quality problems, it may incur additional
warranty and service expenses, experience a decline in product orders or incur
higher manufacturing costs to correct such problems, all of which could
adversely affect financial results.
Economic problems in Asian-Pacific markets could cause sales of Varian
Semiconductor's products to decline.
International sales accounted for 71%, 73%, and 59% of Varian Semiconductor's
revenues in fiscal years 2001, 2000, and 1999, respectively, and specifically,
sales to the Asia-Pacific region have accounted for a substantial portion of
these revenues. Sales to the Asia-Pacific region accounted for 50%, 53%, and 39%
of revenues in fiscal years 2001, 2000, and 1999, respectively. Because Varian
Semiconductor relies on sales to customers in the Asia-Pacific region for a
substantial portion of its revenues, its business is very likely to be adversely
impacted by economic downturns and instability in that region. In fiscal year
1999, Varian Semiconductor's business was harmed by banking and currency
problems in some Asia-Pacific countries. Specifically, the decline in the value
of the Korean won, together with Korean customers' difficulties in obtaining
credit resulted in a decline in the purchasing power of Varian Semiconductor's
Korean customers. This resulted in the cancellation or delay of orders for
Varian Semiconductor's products from Korean customers which adversely affected
financial results in fiscal year 1999. Varian Semiconductor recorded revenues of
$314.5 million to the Asia-Pacific region during fiscal year 2001. The decrease
from prior year was due mainly to a decline in demand for semiconductor devices.
In fiscal year 2000, Varian Semiconductor recorded revenues of $368.6 million in
the Asia-Pacific region, compared with $106.4 million in fiscal year 1999, due
mainly to increased demand for semiconductor devices. Varian Semiconductor's
business in the Asia-Pacific region is affected by demand in each country.
23
If Varian Semiconductor is unable to protect its proprietary rights adequately,
it may lose its ability to compete effectively in the semiconductor equipment
industry.
Varian Semiconductor relies on obtaining and maintaining patent, copyright and
trade secret protection for significant new technologies, products and processes
and obtaining key licenses because of the length of time and expense associated
with bringing new products through the development process to market. Varian
Semiconductor intends to continue to file applications as appropriate for
patents covering new products and manufacturing processes. However, Varian
Semiconductor cannot provide assurance of the following:
. that patents will issue from any pending or future patent applications
owned by, or licensed to, Varian Semiconductor;
. that the claims allowed under any issued patents will be sufficiently
broad to protect Varian Semiconductor's technology position against
competitors;
. that any issued patents owned by or licensed to Varian Semiconductor will
not be challenged, invalidated or circumvented; and
. that the rights granted under Varian Semiconductor's patents will provide
it with competitive advantages.
Varian Semiconductor also has agreements with third parties for licensing of
patented or proprietary technology. These agreements include royalty bearing
licenses and technology cross-licenses. Varian Semiconductor's loss of licensing
agreements with Applied Materials, Tokyo Electron Limited and Lam, could have a
material adverse effect on its business.
In addition, Varian Semiconductor maintains and enforces its trademarks to
increase customer recognition of its products. If its trademarks are used by
unauthorized third parties, its business may be harmed. Varian Semiconductor
also relies on contractual restrictions on disclosure, copying and transferring
title, including confidentiality agreements with vendors, strategic partners,
co-developers, employees, consultants and other third parties to protect its
proprietary rights. If these contractual agreements are breached, Varian
Semiconductor may not have adequate remedies for any such breaches. Varian
Semiconductor also cannot provide assurance that its trade secrets will not
otherwise become known to or be independently developed by others.
Patent claims may be expensive to pursue, defend or settle and may substantially
divert Varian Semiconductor's resources and the attention of management.
Varian Semiconductor could incur substantial costs and diversion of management
resources in defending patent suits brought against it or in asserting its
patent rights against others. If the outcome of any such litigation is
unfavorable to Varian Semiconductor, its business may be harmed. Varian
Semiconductor may not be aware of pending or issued patents held by third
parties that relate to its products or technologies. In the event that a claim
is asserted against Varian Semiconductor, it may need to acquire a license to or
contest the validity of a competitor's patent. Varian Semiconductor cannot be
certain that it could acquire such a license on commercially acceptable terms,
if at all, or that it would prevail in such a proceeding. From time to time,
Varian Semiconductor has received notices from and has issued notices to such
third parties alleging infringement of patent and other intellectual property
rights relating to its products. If Varian Semiconductor is subject to future
claims of patent infringement, it may be required to make substantial settlement
or damages payments and may have to devote substantial resources to
reengineering its products.
It is difficult for Varian Semiconductor to predict the quarter in which it will
be recognizing revenue from large product orders.
During a quarter, Varian Semiconductor customarily sells a relatively small
number of ion implantation systems that typically sell for prices ranging from
approximately $1.6 million to $4.0 million. Consequently, Varian Semiconductor's
revenue and financial results could be negatively impacted for a particular
quarter if anticipated orders from even a few customers are not received in time
to permit shipment and customer acceptance of the installation during that
quarter. Varian Semiconductor recognizes all or a portion of the revenue from a
product shipment at the time the product is installed and meets predetermined
customer specifications. As a result, it is often difficult to determine both
the timing of a product shipment and the completion of the installation of the
product at the customer's location. In addition, Varian Semiconductor's product
order backlog at the beginning of each quarter may not include all systems
needed to achieve expected revenues for that quarter. Because Varian
Semiconductor may build systems according to forecast, the absence of a
significant backlog for an extended period of time could adversely affect
financial results.
Varian Semiconductor depends on limited groups of suppliers or single source
suppliers, the loss of which could impair its ability to manufacture products
and systems.
Varian Semiconductor obtains some of its components and subassemblies included
in its products from a limited group of
24
suppliers, or in some cases a single source supplier, including magnets and high
voltage power supplies and accelerators. The loss of any supplier, including any
single source supplier, would require obtaining one or more replacement
suppliers and may also require devoting significant resources to product
development to incorporate new parts from other sources into its products. The
need to change suppliers or to alternate between suppliers might cause delays in
delivery or significantly increase Varian Semiconductor's costs. Although Varian
Semiconductor has limited insurance to protect against loss due to business
interruption from these and other sources, Varian Semiconductor cannot provide
assurance that such coverage will be adequate or that it will remain available
on commercially acceptable terms. Although Varian Semiconductor seeks to reduce
its dependence on these limited source suppliers, disruption or loss of these
sources could negatively impact its business and damage customer relationships.
Failure to comply with present or future environmental regulations could subject
Varian Semiconductor to penalties and environmental remediation costs.
Varian Semiconductor is subject to a variety of foreign, federal, state and
local laws regulating the discharge of materials into the environment and the
protection of the environment. These regulations include discharges into the
soil, water and air and the generation, handling, storage and transportation and
disposal of waste and hazardous substances. These laws increase the costs and
potential liabilities associated with the conduct of Varian Semiconductor's
operations.
VAI has been named by the United States Environmental Protection Agency or third
parties as a potentially responsible party under the Comprehensive Environmental
Response Compensation and Liability Act of 1980, as amended ("CERCLA"), at eight
sites where VAI is alleged to have shipped manufacturing waste for recycling or
disposal. VAI is also in various stages of environmental investigation and or
remediation under the direction of, or in consultation with foreign, federal,
state and local agencies at certain current or former VAI facilities (including
facilities disposed of in connection with VAI's sale of its Electron Devices
business during fiscal year 1995, and the sale of its TFS business during fiscal
year 1997). Expenditures by VMS (as successor to VAI) for environmental
investigation and remediation amounted to $4.1 million in fiscal year 2001, $5.9
million in fiscal year 2000, and $2.7 million in fiscal year 1999.
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. VMS has accrued $8.3 million in estimated environmental
investigation and remediation costs for these sites and facilities as of
September 28, 2001. As to other sites and facilities, VMS has gained sufficient
knowledge to be able to better estimate the scope and costs of future
environmental activities. VMS has accrued $27.4 million, which represents its
best estimate of the future costs discounted at 7%, net of inflation, to cover
these costs. This reserve is in addition to the $8.3 million previously
described. The Distribution Agreement provides that each of VMS, Varian
Semiconductor and IB will indemnify the others for one-third of these
environmental investigation and remediation costs, as adjusted for any insurance
proceeds and tax benefits expected to be realized upon payment of these costs.
These accrued amounts are only estimates of anticipated future environmental
related costs, and the amounts actually spent may be greater than such
estimates. Accordingly, Varian Semiconductor may need to make additional
payments to cover its indemnification obligations that would exceed current
estimates. In addition, Varian Semiconductor's present and past facilities have
been in operation for many years, and over that time in the course of those
operations, such facilities have used substances which are or might be
considered hazardous. Varian Semiconductor also may have generated and disposed
of wastes which are or might be considered hazardous. Therefore, it is possible
that additional environmental issues may arise in the future that Varian
Semiconductor cannot now predict.
If Varian Semiconductor loses key employees or is unable to attract and retain
key employees, it may be unable to pursue business opportunities.
Varian Semiconductor's future success depends to a significant extent on the
continued service of key managerial, technical and engineering personnel.
Competition for such personnel is intense, particularly in the labor markets
around Varian Semiconductor's facilities in Massachusetts. The available pool of
qualified candidates is limited, and Varian Semiconductor may not be able to
retain its key personnel or to attract, train, assimilate or retain other highly
qualified engineers and technical and managerial personnel in the future. The
loss of these persons or Varian Semiconductor's inability to hire, train or
retrain qualified personnel could harm Varian Semiconductor's business and
results of operations.
Varian Semiconductor's indemnification obligations under the Distribution
Agreement could be substantial, and Varian Semiconductor may not be fully
indemnified in accordance with this agreement for the expenses it incurs.
Under the terms of the Distribution Agreement, each of VMS, IB and Varian
Semiconductor has agreed to indemnify the other parties (and certain related
persons) from and after the spin-off with respect to certain indebtedness,
liabilities and obligations which could be significant. The availability of such
indemnities will depend upon the future financial strength of the companies.
25
There is a risk that one or more of these companies will not be able to satisfy
their indemnification obligations. In addition, the Distribution Agreement
generally provides that if a court prohibits a company from satisfying its
indemnification obligations, then such obligations will be shared equally by the
other companies.
Varian Semiconductor has anti-takeover defenses that could delay or prevent an
acquisition and could adversely affect the price of its common stock.
Provisions of Varian Semiconductor's certificate of incorporation, and by-laws
and of Delaware law could delay, defer or prevent an acquisition or change in
control of Varian Semiconductor or otherwise adversely affect the price of its
common stock. For example, Varian Semiconductor's Board of Directors is
classified into three classes, and stockholders do not have the right to call
special meetings of stockholders. Varian Semiconductor's certificate of
incorporation also permits its board to issue shares of preferred stock without
stockholder approval. In addition to delaying or preventing an acquisition, the
issuance of a substantial number of preferred shares could adversely affect the
price of the common stock. Varian Semiconductor has also adopted a stockholders
rights plan which may significantly dilute the equity interests of a person
seeking to acquire control of Varian Semiconductor without the approval of the
Board of Directors.
Varian Semiconductor does not anticipate paying dividends on its common stock in
the future.
Varian Semiconductor has not paid and does not anticipate paying dividends on
its common stock. Varian Semiconductor's Board of Directors will have discretion
to make decisions to pay dividends to common stockholders in the future which
decision will depend on a number of factors, including results of operations,
financial conditions and contractual restrictions, that the Board, in its
opinion, deems relevant.
Recent Accounting Pronouncements
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which is effective for
Varian Semiconductor in fiscal year 2003. SFAS 142 requires, among other things,
the discontinuance of goodwill amortization and includes provisions for the
reclassification of certain existing recognized intangibles as goodwill,
reassessment of the useful lives of existing recognized intangibles, and
reclassification of certain intangibles out of previously reported goodwill. The
revised standards include transition rules and requirements for identification,
valuation and recognition of a much broader list of intangibles as part of
business combinations than prior practice, most of which will continue to be
amortized. Total amortization in fiscal year 2001 was approximately $1.8
million, this amount will no longer be expensed subsequent to the adoption of
SFAS 142.
In October 2001, the FASB issued Statement of Financial Accounting Standards No.
144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived
Assets." The objectives of SFAS 144 are to address significant issues relating o
the implementation of FASB Statement No. 121 ("SFAS 121"), Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and
to develop a single accounting model, based on the framework established in SFAS
121, for long-lived assets to be disposed of by sale, whether previously held
and used or newly acquired. SFAS 144 is effective for Varian Semiconductor
beginning in fiscal year 2003 and, generally, its provisions are to be applied
prospectively.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"). This statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)"("EITF 94-3"). SFAS 146 requires that
a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. EITF 94-3 allowed for an exit cost
liability to be recognized at the date of an entity's commitment to an exit
plan. SFAS 146 also requires that liabilities recorded in connection with exit
plans be initially measured at fair value. The provisions of SFAS are effective
for exit or disposal activities that are initiated after December 31, 2002, with
early adoption encouraged.
Varian Semiconductor does not expect the adoption of the above mentioned
pronouncements to have a material impact on Varian Semiconductor's consolidated
financial statements.
26
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Foreign Currency Exchange Risk
As a multinational company, Varian Semiconductor faces exposure to adverse
movements in foreign currency exchange rates. This exposure may change over time
as Varian Semiconductor's business practices evolve and could have a material
adverse impact on Varian Semiconductor's financial results. Historically, Varian
Semiconductor's primary exposures have resulted from non-United States dollar
denominated sales and purchases in Europe and the Asia-Pacific region. Varian
Semiconductor does not enter into forward exchange contracts for trading
purposes. Varian Semiconductor's forward exchange contracts generally range from
one to two months in original maturity. No forward exchange contract has an
original maturity greater than one year.
Varian Semiconductor hedges currency exposures that are associated with certain
of its assets and liabilities denominated in various non-U.S dollar denominated
currencies. The aggregate exchange loss included in marketing, general, and
administrative expenses was $49 thousand and $207 thousand for the third quarter
and nine-month period of fiscal year 2002, respectively.
Outstanding forward exchange contracts as of June 28, 2002, hedged against
certain assets and liabilities denominated in non-United States dollar
denominated currencies, are summarized as follows:
Notional Contract Fair
Value Rate Value
----- ---- -----
Foreign currency purchase contracts:
Euro ............................................... $5,323,802 1.07 $5,619,132
British Pound ...................................... 87,420 0.69 91,743
Japanese Yen ....................................... 3,221,368 123.55 3,328,316
New Taiwan Dollar .................................. 214,138 33.95 216,453
Korean Won ......................................... 2,133,127 1219.81 2,172,135
----------- -----------
Total foreign currency purchase contracts .................... $10,979,855 $11,427,779
Foreign currency sell contracts:
Japanese Yen ....................................... $916,104 124.44 $953,337
New Taiwan Dollar .................................. 3,054,383 34.16 3,106,559
Israeli Shekel ..................................... 610,571 4.94 624,547
----------- -----------
Total foreign currency sell contracts ........................ 4,581,058 4,684,443
----------- -----------
Total contracts: ............................................. $15,560,913 $16,112,222
=========== ===========
Varian Semiconductor also hedges currency exposures that are associated with
certain of its product sales denominated in the Japanese Yen. In accordance with
Statement of Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities", these forward foreign exchange contracts
are designated as hedges of anticipated product sales, and accordingly, the
gains and losses resulting from the impact of currency rate movements on these
contracts are not recognized in income until the underlying hedged transactions
are recognized. Upon recognition, such gains and losses are recorded in revenue
as an adjustment to the carrying amount of the underlying transactions in the
period in which these transactions are recognized. Should the hedged anticipated
product sales not occur within two months of the expiration of the forward
foreign exchange contract, any unrealized gain or loss would be recorded in
marketing, general and administrative. There were no forward foreign exchange
contracts designated as hedges of anticipated product sales in Japanese Yen
outstanding at June 28, 2002.
Interest Rate Risk
Although payments under certain of Varian Semiconductor's overseas borrowing
facilities are tied to market indices, Varian Semiconductor is not exposed to
material interest rate risk with these borrowing facilities.
Derivative Financial Instrument
Pursuant to the terms of an agreement between Varian Semiconductor and Lam,
Varian Semiconductor received, during the first quarter of fiscal 2002, a
warrant to purchase 2,000,000 shares of Lam common stock at $21.30 per share,
exercisable at any time prior to December 31, 2005. Under Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities", the warrant is treated as a derivative and has been measured at
fair value. At each balance sheet date, the warrant was remeasured at fair value
and all gains and losses were reported in other income (expense) under fair
value accounting. The volatility in Lam's stock price resulted in changes to the
fair value of the Lam warrants. A $5.1 million gain was recorded in other income
during the six-month period ended March 29, 2002 to reflect the change in fair
value accounting of the warrant. On April 1, 2002,
27
Varian Semiconductor completed the sale of this warrant to an unrelated third
party for $28.0 million in cash.
Concentration of Risk
During the third quarter of fiscal year 2002 two customers represented 10% or
greater of total revenue, accounting for 26% of total revenue. During the
nine-month period ended June 28, 2002, Lam accounted for 13% of total revenue
and three other customers, each representing 10% or greater of total revenue,
accounted for an additional 37% of total revenue (See also Note 10. Settlement
and License Agreement). Excluding the Lam royalty and license revenue, three
customers, each representing 10% or greater of total revenue, accounted for 42%
of total revenue during the nine-month period ended June 28, 2002. During the
third quarter of fiscal year 2001 two customers represented 10% or greater of
total revenue, accounting for 20% of total revenue. During the nine-month period
ended June 29, 2001 no customer represented 10% or greater of total revenue. As
of June 28, 2002 three customers, each representing 10% or greater of the total
accounts receivable balance, accounted for 33% of the total accounts receivable
balance. As of June 29, 2001, one customer, represented 11% of the total
accounts receivable balance. No other customer accounted for 10% or more of the
total accounts receivable as of June 29, 2001.
28
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information required by this Item is provided in Note 9. Commitments and
Contingencies to the Unaudited Interim Consolidated Financial Statements.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
None.
29
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 SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.
Registrant
By: /s/ Robert J. Halliday
----------------------------
Robert J. Halliday
Vice President and Chief Financial Officer
(Principal Financial Officer and Duly Authorized Officer)
Date: August 9, 2002
STATEMENT PURSUANT TO 18 U.S.C. STATEMENT PURSUANT TO 18 U.S.C. (S)1350
Pursuant to 18 U.S.C. (S)1350, each of the undersigned certifies that this
Quarterly Report on Form 10-Q for the period ended June 28, 2002 fully complies
with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act
of 1934 and that the information contained in this report fairly presents, in
all material respects, the financial condition and results of operations of
Varian Semiconductor Equipment Associates, Inc.
/s/ Richard A. Aurelio
------------------------------------------
Dated: August 9, 2002 Richard A. Aurelio
Chairman and Chief Executive Officer
/s/ Robert J. Halliday
------------------------------------------
Dated: August 9, 2002 Robert J. Halliday
Vice President and Chief Financial Officer
30