Item 1. Business
GENERAL
Overview and History
Varian, Inc., together with its subsidiaries (collectively, the “Company”), designs, develops, manufactures, markets, sells and services scientific instruments (including analytical instruments, research products and related software, consumable products, accessories and services) and vacuum products (and related accessories and services). For financial reporting purposes, our operations are grouped into two corresponding segments: Scientific Instruments and Vacuum Technologies. These segments, their products and the applications in which they are used are described below.
Varian, Inc. became a separate, public company on April 2, 1999. Until that date, our business was operated as the Instruments business of Varian Associates, Inc. (“VAI”). The Instruments business (which included the business units that designed, developed, manufactured, marketed, sold and serviced scientific instruments and vacuum products, and a business unit that provided contract electronics manufacturing services) was contributed by VAI to us. On that date, VAI distributed to holders of its common stock one share of our common stock and one share of common stock of Varian Semiconductor Equipment Associates, Inc. (“VSEA”), which was formerly operated as the Semiconductor Equipment business of VAI, for each share of VAI common stock outstanding on April 2, 1999 (the “Distribution”). VAI retained its Health Care Systems business and changed its name to Varian Medical Systems, Inc. (“VMS”). These transactions were accomplished under the terms of an Amended and Restated Distribution Agreement dated as of January 14, 1999 by and among us, VAI and VSEA (the “Distribution Agreement”).
On July 26, 2009, Varian, Agilent Technologies, Inc., a Delaware corporation (“Agilent”) and Cobalt Acquisition Corp., a Delaware corporation and a wholly owned subsidiary of Agilent (“Merger Sub”), entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which Merger Sub will, subject to the satisfaction or waiver of the conditions set forth in the Merger Agreement, merge with and into Varian and Varian will survive the merger and continue as a wholly owned subsidiary of Agilent (the “Merger”). Pursuant to the terms of the Merger Agreement and subject to the conditions thereof, at the effective time of the Merger (the “Effective Time”), each share of common stock of Varian issued and outstanding immediately prior to the Effective Time will be converted into the right to receive $52.00 in cash, without interest. On October 5, 2009, Varian’s stockholders approved the Merger. The Merger remains subject to regulatory approvals and the satisfaction or waiver of certain other closing conditions.
Business Segments and Products
For financial reporting purposes, we have two business segments: Scientific Instruments and Vacuum Technologies, which are described below.
The products and activities of these two segments are related in certain important respects, particularly product applications. In many ways, we view, manage, operate and describe our Company as being comprised of a single business. Described below are our products by segment, but then separately described are the primary applications for those products.
Scientific Instruments Products
Our Scientific Instruments segment designs, develops, manufactures, markets, sells and services products used in a broad range of life science (such as pharmaceutical), environmental, energy, and applied research and other applications requiring identification, quantification and analysis of the elemental, molecular, physical or biological composition or structure of liquids, solids or gases. These products include analytical instruments (primarily mass spectrometers, chromatography instruments, optical spectroscopy instruments and dissolution testing equipment), research products (including nuclear magnetic resonance (“NMR”), spectroscopy systems, magnetic resonance (“MR”) imaging systems, Fourier Transform mass spectrometry (“FTMS”) systems, X-ray crystallography systems and superconducting magnets used in certain of these and other scientific instruments), consumable products
(including columns for gas and liquid chromatography and products for the preparation of samples prior to analysis by gas and liquid chromatography) and related software, accessories and services.
Mass spectrometry (“MS”) is a technique for analyzing the individual chemical components of substances by ionizing them and determining their mass-to-charge ratios. Our MS products incorporate various technologies for measuring mass, including single-quadrupole, triple-quadrupole and ion trap mass spectrometers, FTMS systems and mass spectrometer leak detection systems. We combine our mass spectrometers with other instruments to create high-performance instruments such as liquid chromatograph mass spectrometers (“LC/MS”), liquid chromatograph nuclear magnetic resonance mass spectrometers (“LC-NMR/MS”), gas chromatograph mass spectrometers (“GC/MS”) and inductively coupled plasma mass spectrometers (“ICP-MS”). We also offer related software and accessories for these and other similar instruments.
Chromatography is a technique for separating, identifying and quantifying the individual chemical components of substances based on the physical and chemical characteristics specific to each component. Our chromatography instruments include gas chromatographs (“GC”), high-performance liquid chromatographs (“HPLC”), gel permeation chromatographs (“GPC”), flash chromatography instruments and sample automation products. For certain applications, mass spectrometers are sold as a detector for GC or HPLC systems. We also offer related software and accessories for these and other similar instruments.
Optical spectroscopy is a technique for analyzing the individual chemical components of substances based on the absorption or emission of electromagnetic radiation of specific wavelengths of light. Our optical spectroscopy instruments include atomic absorption (“AA”) spectrometers, inductively coupled plasma-optical emissions spectrometers (“ICP-OES”), inductively coupled plasma-mass spectrometers (“ICP-MS”), fluorescence spectrophotometers, ultraviolet-visible (“UV-Vis”) spectrophotometers, Fourier Transform infrared (“FT-IR”) spectrophotometers, near-infrared (“NIR”) spectrophotometers, Raman spectrometers and sample automation products. We also offer related software and accessories for these and other similar instruments.
Dissolution testing is a technique for in-vitro analysis of the rate of release of a drug under controlled conditions. Our dissolution products include dissolution apparatus and other testers, software and accessories used in analyzing the rate of release and testing the physical characteristics of different dosage forms. Our UV-Vis spectrophotometers are often used with these products.
Certain of our software products are used to automate, process, collect, manage, analyze and store data generated by analytical instruments, and are often used for regulatory compliance purposes with respect to such data. These products include chromatography data systems that allow users to control LC and GC instruments from multiple suppliers on a single platform and other software products tailored to specific instruments and applications.
Magnetic resonance is a non-destructive instrumental technique that uses electromagnetic fields to interact with the magnetic property of atomic nuclei in order to determine and analyze the molecular content and structure of liquids and solids. Our NMR spectroscopy systems are used in the study of liquids containing chemical substances, including proteins, nucleic acids (DNA and RNA) and carbohydrates. They are also used for the analysis of solid materials such as membranes, crystals, plastics, rubbers, ceramics and polymers. Our MR imaging systems are used to obtain non-invasive images of primarily biological materials and to probe the chemical processes within these materials. Our MR imaging systems include human and other imaging systems used in research. We also offer probes, imaging gradient coils, consoles, software and other accessories to customers seeking to enhance NMR and MR imaging performance. Our research products also include Fourier Transform mass spectrometer (“FTMS”) systems, which is a technique for determining the function and structural characterization of proteins and other biomolecules. Superconducting magnets are used in our NMR spectroscopy, MR imaging, FTMS and other scientific (including life science) systems. We also sell these magnets directly to original equipment manufacturers (“OEMs”) (such as manufacturers of high-field MR imaging systems) and end-users.
X-ray crystallography is an analytical technique that uses a beam of X-rays to determine the arrangement of atoms within a crystal. X-ray crystallography is used in pharmaceutical and other research
laboratories to determine the structure of both small and large molecules (such as proteins). We also offer related software, accessories and consumable products for these systems.
Certain of our software products are used to automate, process, collect, manage and store data generated by research products. These products include NMR and MR imaging data acquisition, processing, analysis and display software for our complete line of NMR and MR imaging systems, FTMS and X-ray crystallography systems, and other software products tailored to specific instruments and applications.
Our consumable products are used in numerous laboratory applications and include: sample preparation consumables such as solid phase extraction (“SPE”) and filtration products used in tube formats to clean up and extract complex samples for toxicology and environmental applications and in 96-well plate formats for drug discovery and clinical research applications; micro volume SPE pipette tips used in protein research; polymeric particles used in the synthesis and purification of therapeutic compounds, and for clinical diagnostic applications; HPLC and GC columns used to separate target analytes prior to UV detection or mass spectrometry analysis; HPLC columns and media used in health science applications for the analysis of thermally labile compounds; GC columns used in various applications for the analysis and purification of thermally stabile compounds; GPC columns and standards for the analysis of polymers; flash chromatography consumables used in early stage drug research; and other HPLC and GC stationary phase chemistries and column dimensions for a wide range of life science and other applications. Consumable products also include scientific instrument parts and supplies such as filters and fittings for GC and HPLC systems; xenon lamps and cuvettes for UV-Vis-NIR, fluorescence, FT-IR and Raman spectroscopy instruments; and graphite furnace tubes, hollow cathode lamps and specialized sample introduction glassware for our AA, ICP-OES and ICP-MS products. Other consumable products include on-site screening and laboratory-based kits for drugs of abuse testing (“DAT”) on urine or saliva samples, such as in criminal justice and toxicology testing.
Vacuum Technologies Products
Our Vacuum Technologies segment designs, develops, manufactures, markets, sells and services a broad range of products used to create, control, measure and test vacuum environments in life science, environmental, energy, and applied research and other applications where ultra-clean, high-vacuum environments are needed. Vacuum Technologies’ customers are typically OEMs that manufacture equipment for these applications. Products include a wide range of high and ultra-high vacuum pumps (diffusion, turbomolecular and ion getter), intermediate vacuum pumps (rotary vane, sorption and dry scroll), vacuum instrumentation (vacuum control instruments, sensor gauges and meters) and vacuum components (valves, flanges and other mechanical hardware). Its products also include helium mass spectrometry and helium-sensing leak detection instruments used to identify and measure leaks in hermetic or vacuum environments. In addition to product sales, we also offer a wide range of services including an exchange and rebuild program, assistance with the design and integration of vacuum systems, applications support and training in basic and advanced vacuum technologies.
Information Rich Detection Products
We refer to certain of the products described above as “information rich detectors” (“IRD”). IRD products include mass spectrometers, NMR systems, MR imaging systems, X-ray crystallography systems and FT-IR instruments. All of these products provide users with multi-dimensional layers of information and/or higher sensitivity, which are critical to the ability to optimize analyses and processes. IRD instruments typically provide broad-based qualitative capabilities for screening of compounds in complex mixtures, precise quantitative information for determining the relative concentrations of the compounds and dimensions of structural information for confirming the identity of the analytes. Our IRD products also include superconducting magnets and vacuum pumps, consumables and other components and products used either in or with our IRD instruments or sold directly to OEMs and end-users for use in IRD products; we also provide various services in connection with our IRD products.
Customers and Applications
Our products are sold principally for use in life science applications (including the study of biological processes and the testing of biological materials), environmental applications (including food safety and testing of air, water and soil), energy applications (including raw materials), and applied research and other applications. Many of our products are used in more than one of these applications.
Almost all of the Scientific Instruments products described above are or can be used in life science applications, such as by pharmaceutical companies in drug development, manufacturing (including process control) and quality control; and by research hospitals and universities in basic chemistry, biological, biochemistry and health care research. Life science customers include branded and generic pharmaceutical companies, biotechnology and toxicology companies, governmental agencies and numerous academic institutions and research hospitals. The Vacuum Technologies products described above similarly are or can be used in a broad range of life science applications, such as in mass spectrometers for analytical analysis and in linear accelerators for cancer therapy. In fiscal years 2009, 2008 and 2007, sales into life science applications accounted for approximately 40% to 45% of our total sales (these are estimates based on assumptions of how our products are likely to be used by customers, and are provided only as an indication of a historical trend).
Almost all of the Scientific Instruments products described above are or can also be used in environmental, energy, applied research and other applications, such as by environmental laboratories in performing chemical analyses of water, soil, air, solids, and food and other products; by petroleum and natural gas companies in performing chemical analyses in exploration, refining, quality control, distribution and research; in alternative energy, such as biofuels and solar energy; by agricultural, chemical, mining and metallurgy and food and beverage processing companies in conducting research and quality control; and by governmental, academic and other research laboratories in forensic analysis, materials science and general research. The Vacuum Technologies products described above are or can be used in a broad range of applications, such as in the manufacture of flat-panel displays, solar energy panels, CRT tubes, decorative coating, functional coatings, disks for memory storage, architectural glass, optical lenses and automobile components; in food packaging; in the testing of aircraft components, automobile airbags, refrigeration components and industrial processing equipment; in high-energy physics research; in various nuclear energy applications: in nanotechnology applications such as surface scanning and nanomaterials fabrication; and in the manufacture and test of semiconductors and fabrication of metrology equipment.
Marketing and Sales
We market and sell most of our products through our own direct sales organizations, although in certain countries and for certain products and services, sales are made through various sales representative and distributor arrangements. To support this marketing and sales structure, we have sales and service offices in numerous locations around the world.
We sell our products on a global basis. Sales outside of North America accounted for 69%, 68% and 66% of sales for fiscal years 2009, 2008 and 2007, respectively. As a result, our customers increasingly require service and support on a worldwide basis. We have sales and service offices located throughout North America, Europe, Asia Pacific and Latin America. We have invested substantial financial and management resources to develop and maintain international infrastructure to meet the needs of our customers worldwide.
Demand for our products depends on many factors, including the level of capital expenditures of our customers, the rate of economic growth in applications and geographies where we sell our products and competitive considerations. No single customer accounted for 10% or more of our sales in fiscal years 2009, 2008 and 2007.
We experience some cyclical patterns in sales of our products. Generally, sales and earnings in the first quarter of our fiscal year are lower when compared to the preceding fourth fiscal quarter, primarily because there are fewer working days in the first fiscal quarter (October to December). Sales and earnings
in our third fiscal quarter are usually flat to down sequentially compared to the second fiscal quarter, in part because there are a number of holidays in the early part of the quarter, especially in Europe, and the June quarter-end has no significant customer year ends to influence orders. Our fourth fiscal quarter sales and earnings are often the highest in the fiscal year compared to the other three quarters, primarily because many government- and research-related customers spend budgeted money before their own fiscal years end. This cyclical pattern can be influenced by other factors, including the timing of revenue recognition on large systems, general economic conditions, acquisitions, new product introductions and products requiring long manufacturing and installation lead times (such as NMR, MR imaging and FTMS systems and superconducting magnets).
We believe that we differentiate our products from those of our competitors by our responsiveness to customer requirements, as determined through market research. Although specific customer requirements can vary depending on applications, customers generally demand superior performance, ease of use, high quality, high productivity and low cost of ownership. We have responded to these customer demands by regularly introducing new products focused on these requirements.
Backlog
Our recorded backlog was $236 million at October 2, 2009, $235 million at October 3, 2008 and $241 million at September 28, 2007. Orders exceeded revenues in fiscal year 2009, however, the resulting increase in backlog was largely offset by the impact of the stronger U.S dollar on the value of orders denominated in other currencies. The decrease in backlog from September 28, 2007 to October 3, 2008 was primarily due to a net reduction in unfulfilled orders for magnets from third-party OEMs even though orders for these magnets increased in fiscal year 2008 compared to the prior year. This decrease was partially offset by strong order volume for analytical instruments and to a lesser extent the impact of the weaker U.S. dollar on orders denominated in other currencies.
We include in backlog purchase orders or production releases under blanket purchase orders that have firm delivery dates. Recorded backlog is impacted by foreign currency fluctuations on orders denominated in non-U.S. dollars. In addition, recorded backlog might not result in sales because of cancellations or other factors (although such events have historically been infrequent).
Most of our products are shipped soon after they are ordered by customers, with the time between order receipt and shipment being as short as a few days for some products and less than a fiscal quarter for most others. However, other products, in particular certain magnet-based products, can have significantly longer lead times, sometimes in excess of one year. Significant shipments often occur in the last month of each quarter, in part because of how customers place orders and schedule shipments.
We believe that over 85% of orders included in our backlog at October 2, 2009 will result in revenue before the end of fiscal year 2010.
Competition
Competition in our industries is primarily based upon the performance capabilities of products, technical support and after-sales service, the manufacturer’s reputation as a technological leader and product pricing. We believe that performance capabilities are the most important of these criteria.
The markets in which we compete are highly competitive and are characterized by the application of advanced technology. There are numerous companies that specialize in, and a number of larger companies that devote a significant portion of their resources to, the development, manufacture, sale and service of products that compete with those that we manufacture, sell or service. Many of our competitors are well-known manufacturers with a high degree of technical proficiency. In addition, competition is intensified by the ever-changing nature of the technologies in the industries in which we are engaged. The markets for our products are characterized by specialized manufacturers that often have strength in segments or niches of these markets. While the absence of reliable statistics makes it difficult to determine our relative market position in our industry segments, we are one of the principal manufacturers in our primary fields.
We compete with many companies. Our Scientific Instruments segment competes primarily with Agilent, Bruker, JEOL, PerkinElmer, Shimadzu, Thermo Fisher Scientific, Waters and other smaller suppliers. Our Vacuum Technologies segment competes primarily with Adixen (Alcatel), Edwards, INFICON, Oerlikon Leybold, Pfeiffer, Ulvac and other smaller suppliers.
Manufacturing
Our principal manufacturing activities consist of precision assembly, test, calibration and certain specialized machining activities. For most of our products, we subcontract a portion of the assembly and machining, but perform all other assembly, test and calibration functions. For some products, we have subcontracted all manufacturing operations.
We believe that the ability to manufacture reliable products in a cost-effective manner is critical to meeting the “just-in-time” delivery and other demanding requirements of our OEM and end-user customers. We monitor and analyze product lead times, warranty data, process yields, supplier performance, field data on mean time between failures, inventory turns, repair response times and other indicators so that we can continuously improve our manufacturing processes.
We are continuously looking for opportunities to outsource manufacturing to third parties who can provide the same quality at lower costs, and to consolidate our own manufacturing into fewer and lower-cost locations. These initiatives raise certain risks and uncertainties, which are discussed in Item 1A
Item 1A - Risk Factors-Restructuring and Other Efficiency Improvement Activities.
As of October 2, 2009, we operated 12 significant manufacturing facilities located throughout the world. Our Scientific Instruments segment had manufacturing facilities in Walnut Creek, California; Lake Forest, California; Ft. Collins, Colorado; Cary, North Carolina; Melbourne, Australia; Grenoble, France; Middelburg, Netherlands; Wroclaw, Poland; Church Stretton, United Kingdom; and Yarnton, United Kingdom. Our Vacuum Technologies segment had manufacturing facilities in Lexington, Massachusetts, and Turin, Italy.
All of our significant manufacturing facilities, other than our facility in Wroclaw, Poland, have been certified as complying with the International Organization for Standardization Series 9000 Quality Standards (“ISO 9000”).
Raw Materials
Our manufacturing operations require a wide variety of raw materials, electronic and mechanical components, chemical and biochemical materials and other supplies, some of which are occasionally in short supply. In addition, use of certain of our products requires reliable and cost-effective supply of certain raw materials. For example, end-users of our magnet-based products require helium to operate those products. Helium can be, and at various times has been, difficult to source and more expensive. If we or our customers cannot obtain sufficient quantities of helium, it could prevent us from shipping and installing superconducting magnets, which could result in our inability to recognize revenues on magnet-based products. Although we have taken and will continue to take steps to reduce the volume of helium required for the manufacture and use of these products, shortages of helium could result in even higher helium prices, and thus higher operating costs for magnet-based products, which could impact demand for those products as well as our profit margins on those products and related services. Changes in the availability or price of certain other key raw materials (such as copper) or components could increase our costs or our customers’ costs to acquire and operate our products, which could have an adverse effect on our financial condition or results of operations.
We manufacture some components used in our products. Other components, including certain consumables materials and electronic components and subassemblies, are purchased from other manufacturers. Most of the raw materials, components and supplies we purchase are available from a number of different suppliers; however, a number of items-such as wire used in superconducting magnets, electronic subassemblies and final assemblies used in scientific instruments-are purchased from limited or single sources of supply. Disruption of these sources could cause delays or reductions in shipment of our products or increases in our costs, which could have an adverse effect on our financial condition or results of operations.
Research and Development
We are actively engaged in basic and applied research, development and engineering programs designed to develop new products and to improve existing products. During fiscal years 2009, 2008 and 2007, we spent $56.4 million, $71.8 million and $65.2 million, respectively, on research, development and related engineering activities. Over this period, the focus of our research and development activities has been shifting more toward IRD and consumable products. We intend to continue to conduct extensive research and development activities, with a continued emphasis on IRD products such as magnet-based products, mass spectrometers (including vacuum products for use in our mass spectrometers and those of other OEMs) and certain consumable products. There can be no assurance that we will be able to develop and market new products on a cost-effective and timely basis, that such products will compete favorably with products developed by others or that our existing technology will not be superseded by new discoveries or developments.
Customer Service and Support
We believe that our customer service and support are an integral part of our competitive strategy. As part of our support services, our applications and technical support staff provide individual assistance in supporting customers’ specific applications needs, solving analysis problems and integrating vacuum components. We offer training courses and periodically send our customers information on applications development.
Our products generally include a 90-day to one-year warranty, but in some countries and for some products we offer longer warranties. For most of our products, service contracts may be purchased by customers to cover equipment no longer under warranty. Service work not performed under warranty or service contract is generally performed on a time-and-materials basis. We install and service our products primarily through our own field service organization, although certain distributors and sales representatives are contracted to perform some field services.
Patent and Other Intellectual Property Rights
We have a policy of seeking patent, copyright, trademark and trade secret protection in the U.S. and other countries for developments, improvements and inventions originating within our organization that are incorporated in our products or that fall within our fields of interest. As of October 2, 2009, we owned over 380 patents in the U.S. and over 600 patents in other countries, and had numerous patent applications on file with various patent agencies worldwide. We intend to continue to file patent applications as we deem appropriate.
We rely on a combination of copyright, trade secret and other legal, as well as contractual, restrictions on disclosure, copying and transferring title to protect our proprietary rights. We have trademarks, both registered and unregistered, that are maintained and enforced to provide customer recognition for our products in the marketplace. We also have agreements with third parties that provide for licensing of patented or proprietary technology. These agreements frequently include royalty-bearing licenses and technology cross-licenses.
Environmental Matters
Our operations are subject to various federal, state and local laws in the U.S., as well as laws in other countries, regulating the discharge of materials into the environment or otherwise relating to the protection of the environment. These regulations increase the costs and actual and potential liabilities of our operations. However, our compliance with these regulations is not expected to have a material effect upon our capital expenditures, results of operations, financial condition or competitive position. For additional information on environmental matters, see Item 1A - Risk Factors-Environmental Matters and-Governmental Regulations.
Employees
At October 2, 2009, we had approximately 3,500 full-time and temporary employees and contract workers worldwide-approximately 1,200 in North America, 1,400 in Europe, 800 in Asia Pacific and 100 in Latin America.
Executive Officers
The following table sets forth the names and ages of our executive officers, together with positions and offices held within the last five years by such executive officers.
Investor Information
Financial and other information relating to us can be accessed on the Investors page at our website. This can be reached from our main Internet website (http://www.varianinc.com) by clicking on “Investors.” On the Investors page at our website, we make available, free of charge, copies of our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after filing them with or furnishing them to the SEC.
Item 1A. Risk Factors
The Announcement and Pendency of our Agreement to be Acquired by Agilent. On July 26, 2009, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Agilent Technologies, Inc. (“Agilent”) pursuant to which a wholly-owned subsidiary of Agilent will, subject to the satisfaction or waiver of the conditions contained in the Merger Agreement, merge with and into the Company, and the Company will be the successor or surviving corporation of the merger and will become a wholly owned subsidiary of Agilent (“the Merger”). Pursuant to the terms of the Merger Agreement and subject to the
satisfaction or waiver of the closing conditions set forth in the Merger Agreement, at the effective time of the Merger (the “Effective Time”), each share of the Company’s common stock issued and outstanding immediately prior to the Effective Time will be converted into the right to receive $52.00 in cash, without interest. The announcement and pendency of the Merger has adversely affected our business. Revenues and profitability are being adversely affected by customers’ uncertainty and employee and other disruptions as well as intensified competition from our competitors as they attempt to take advantage of the uncertainties. In addition, we have incurred legal and other expenses in connection with the pending Merger. All of these factors are likely to continue to adversely affect our business and have an adverse effect on our financial condition or results of operations.
Under the terms of the Merger Agreement, we have agreed to operate our business in the ordinary course consistent with past practice, as well as to refrain from taking certain actions in the conduct of our business without Agilent’s prior written consent until the consummation of the Merger. Actions that may require Agilent’s consent include, but are not limited to, new indebtedness, capital expenditures, loans and investments, manufacturing and customer agreements, acquisitions, issuance of securities, and the repurchase of shares of the Company’s common stock. These restrictions could adversely affect our business and have an adverse affect on our financial condition or results of operations.
There is no assurance that the Merger with Agilent will occur. If the Merger is not completed, the share price of our common stock will change to the extent that the current market price of the Company’s common stock reflects an assumption that the Merger will be completed. In addition, under circumstances defined in the Merger Agreement, we might be required to pay a termination fee of $46 million. Finally, any disruptions to our business resulting from the announcement and pendency of the Merger will likely continue in the event the Merger is not completed.
Overall Economic Conditions. As a result of current economic uncertainties, including with respect to global capital and credit markets and overall economic growth, our customers could experience financial difficulties and as a result modify, delay or cancel plans to purchase our products or services or be unable to pay us on accounts receivable that are owed to the Company. In addition, our suppliers (including our key suppliers, discussed below), could experience credit or other financial difficulties that could result in delays in their ability to supply us with necessary raw materials, components or finished products. Any of these factors could have an adverse effect on our financial condition or results of operations.
In addition, we might find it more difficult or expensive to secure additional capital or credit to pursue actions we would consider beneficial to the Company or our stockholders, such as acquisitions, capital investments and/or repurchases of our common stock which could have an adverse effect on our financial condition or results of operations.
Customer Demand. Demand for our products depends upon, among other factors, the level of capital expenditures by current and prospective customers, the rate of economic growth in the markets in which we compete, the level of government funding for research and the competitiveness of our products and services. Changes in any of these factors could have an adverse effect on our financial condition or results of operations.
We must continue to assess and predict customer needs, regulatory requirements and evolving technologies. We must develop new products, including enhancements to existing products, new services and new applications, successfully commercialize, manufacture, market and sell these products and protect our intellectual property in these products. If we are unsuccessful in these areas, our financial condition or results of operations could be adversely affected.
Variability of Operating Results. We experience some cyclical patterns in sales of our products. Generally, sales and earnings in the first quarter of our fiscal year are lower when compared to the preceding fourth fiscal quarter, in part, because there are fewer working days in our first fiscal quarter (October to December). Sales and earnings in our third fiscal quarter are usually flat to down sequentially compared to the second fiscal quarter, primarily because there are a number of holidays in the early part of the quarter, especially in Europe, and the June quarter-end has no significant customer year ends to influence orders. Our fourth fiscal quarter sales and earnings are often the highest in the fiscal year
compared to the other three quarters, primarily because many government- and research-related customers spend budgeted money before their own fiscal years end. This cyclical pattern can be influenced by other factors, including the timing of revenue recognition on large systems, general economic conditions, acquisitions, new product introductions and products requiring long manufacturing and installation lead times (such as NMR, MR imaging and FTMS systems and superconducting magnets). Consequently, our results of operations may fluctuate significantly from quarter to quarter, which can make it difficult to anticipate, compare and measure our results of operations on a quarterly basis.
Most of our products are shipped soon after they are ordered by customers, with the time between order receipt and shipment being as short as a few days for some products and less than a fiscal quarter for most others. However, other products, in particular certain magnet-based products, can have significantly longer lead times, sometimes in excess of one year. Significant shipments often occur in the last month of each quarter, in part because of how customers place orders and schedule shipments. This can make it difficult for us to forecast our results of operations.
Certain of our magnet-based products (including NMR, MR imaging and FTMS systems, NMR probes, superconducting magnets and other related components) sell on long lead-times, sometimes in excess of one year. Certain of these systems and components sell for high prices; are complex; require development of new technologies and, therefore, significant research and development resources; are often intended for evolving research applications; often have customer-specific features, capabilities and acceptance criteria; and can be difficult to manufacture and require long lead times. If we are unable to meet these challenges, it could have an adverse effect on our financial condition or results of operations. In addition, all of these factors can make it difficult for us to forecast the timing of revenue recognition and the gross profit on these products.
Changes in our effective tax rate can also create variability in our operating results. Our effective tax rate can be adversely affected by earnings being lower than anticipated in countries having lower statutory rates and higher than anticipated in countries having higher statutory rates, by changes in the valuation of deferred tax assets or liabilities, by changes in tax laws or interpretations thereof or by other discrete tax events. In addition, we are subject to examination of our income tax returns by the U.S. Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our income tax reserves and expense. Should actual events or results differ from our current expectations, charges against or credits to our income tax reserves and/or expense may become necessary or changes in our unrecognized tax benefits could result. Any such adjustments or changes could have an adverse effect on our financial condition or results of operations. All of this can make it difficult for us to forecast our effective tax rate.
Competition. The industries in which we operate are highly competitive. We compete against numerous companies, both U.S. and non-U.S., most with global operations. Some of our competitors have greater financial resources than we have, which may enable them to respond more quickly to new or emerging technologies, take advantage of acquisition opportunities, achieve economies of scale and other cost reductions, compete on price or devote greater resources to research and development, engineering, manufacturing, marketing, sales or managerial activities. Some also have greater name recognition and geographic and market presence or lower cost structures than we do. In addition, weaker demand and excess capacity in our industries could cause greater price competition as our competitors seek to maintain sales volumes and market share. For the foregoing reasons, competition could result in lower revenues due to lost sales or price reductions, lower profit margins and loss of market share, which could have an adverse effect on our financial condition or results of operations.
Although no single customer accounted for 10% or more of our sales in fiscal year 2009, we do have important customers, the loss of which could have an adverse effect on our results of operations.
New Product Development. Technological innovation and new product development are important to maintain the competitive position of our products and to grow our sales and profit margins. We have historically dedicated a significant portion of our resources to research and development efforts as a means of generating new products and improving existing products, and intend to continue to conduct extensive research and development activities, with an emphasis on information rich detection products such as
magnet-based products, mass spectrometers (including vacuum products for use in mass spectrometers) and certain consumable products. However, there can be no assurance that we will be able to improve existing products and/or develop new products on a cost-effective and timely basis, that such products will compete favorably with products developed by others or that our existing technology will not be superseded by new discoveries or developments. If we fail to improve existing products and/or develop new products on a timely basis, we could experience lower revenues and/or lower profit margins, which could have an adverse effect on our financial condition or results of operations.
Key Suppliers and Raw Materials. Some items we purchase for the manufacture of our products, including wire used in superconducting magnets, electronic subassemblies and final assemblies used in scientific instruments, are purchased from limited or single sources of supply. We are undertaking to further outsource manufacturing of certain parts, components, subsystems and even finished products, often to single sources. Disruption of these sources could cause delays or reductions in shipments of our products or increases in our costs, which could have an adverse effect on our financial condition or results of operations.
In addition, the manufacturing and/or use of certain of our products require raw materials for which supply and price can fluctuate significantly. For example, end-users of our magnet-based products require helium to operate those products. Helium can be, and at various times has been, difficult to source and more expensive. If we or our customers cannot obtain sufficient quantities of helium, it could prevent us from shipping and installing superconducting magnets, which could result in our inability to recognize revenues on magnet-based products. In addition, shortages of helium could result in even higher helium prices and thus higher operating costs for magnet-based products, which could impact demand for those products. Changes in the availability or price of certain other key raw materials or components could increase our costs or our customers’ costs to acquire and operate our products, which could have an adverse effect on our financial condition or results of operations.
Business Interruption. Our facilities, operations and systems could be impacted by fire, flood, terrorism or other natural or man-made disasters. In particular, we have significant facilities in areas prone to earthquakes and fires, such as our production facilities and headquarters in California. Due to their limited availability, broad exclusions and prohibitive costs, we do not have insurance policies that would cover losses resulting from an earthquake. If any of our facilities or surrounding areas were to be significantly damaged in an earthquake, fire, flood or other disaster, it could disrupt our operations, delay shipments and cause us to incur significant repair or replacement costs, which could have an adverse effect on our financial condition or results of operations.
Our employees based in certain countries outside of the U.S. are subject to factory-specific and/or industry-wide collective bargaining agreements. Of these, certain of our employees in Australia are subject to collective bargaining agreements that were recently renewed and will need to be again renewed before April 2012. A work stoppage, strike or other labor action at this or other of our facilities could have an adverse effect on our financial condition or results of operations.
Intellectual Property. Our success depends on our intellectual property. We rely on a combination of patents, copyrights, trademarks, trade secrets, confidentiality agreements and licensing arrangements to establish and protect that intellectual property, but these protections might not be available in all countries, might not be enforceable, might not fully protect our intellectual property and might not provide meaningful competitive advantages. Moreover, we might be required to spend significant resources to police and enforce our intellectual property rights, and we might not detect infringements of those intellectual property rights. If we fail to protect our intellectual property and enforce our intellectual property rights, our competitive position could suffer, which could have an adverse effect on our financial condition or results of operations.
Other third parties might claim that we infringe their intellectual property rights, and we may be unaware of intellectual property rights that we are infringing. Any litigation regarding intellectual property of others could be costly and could divert personnel and resources from our operations. Claims of intellectual property infringement might also require us to develop non-infringing alternatives or enter into royalty-bearing license agreements. We might also be required to pay damages or be enjoined from
developing, manufacturing or selling infringing products. We sometimes rely on licenses to mitigate these risks, but we cannot be assured that these licenses will be available in the future or on favorable terms. These risks could have an adverse effect on our financial condition or results of operations.
Acquisitions. We have acquired companies and operations and made minority equity investments in private companies, and may acquire companies and operations (and make minority equity investments in private companies) in the future, as part of our growth strategy. These acquisitions must be carefully evaluated and negotiated if they are to be successful. Once completed, acquired operations must be carefully integrated to realize expected synergies, efficiencies and financial results. Some of the challenges in doing this include retaining key employees, managing operations in new geographic areas, retaining key customers, integrating data systems, assessing (and if necessary implementing or improving) internal control over financial reporting and managing transaction costs. All of this must be done without diverting management and other resources from other operations and activities. With respect to minority equity investments, we often have limited ability to control how their business is conducted. Additionally, goodwill, acquisition-related intangible assets and minority equity investments in private companies are subject to regular impairment testing and potential impairment charges. For all of these reasons, minority equity investments or our failure to successfully evaluate, negotiate and integrate acquisitions could have an adverse effect on our financial condition or results of operations.
Restructuring and Other Efficiency Improvement Activities. We have undertaken restructuring activities (such as the employee reductions and other actions announced in January 2009 and our Northern California operations consolidation) and other efficiency improvement activities (such as our global procurement, lower-cost manufacturing and outsourcing initiatives), and may undertake similar activities in the future, that we expect to result in certain costs and eventual cost savings. These costs and cost savings are based on estimates at the time of plan commitment as to the timing of activities to be completed and the timing and amount of related costs to be incurred. We could experience delays, business disruptions and employee turnover in connection with restructuring and other efficiency improvement activities and our estimates of the costs to complete and savings achieved by these activities could be inaccurate and/or change. As a result, these activities could have an adverse impact on our financial condition or results of operations.
Non-U.S. Operations. A significant portion of our manufacturing activities, customers, suppliers and employees are outside of the U.S. As a result, we are subject to various risks, including the following: duties, tariffs and taxes; restrictions on currency conversions, fund transfers or profit repatriations; import, export and other trade restrictions; protective labor regulations and union contracts; compliance with local laws and regulations, as well as U.S. laws and regulations (such as the Foreign Corrupt Practices Act) as they relate to our non-U.S. operations; travel and transportation difficulties; and adverse developments in political or economic environments in countries where we operate. These risks could have an adverse effect on our financial condition or results of operations.
Currency Exchange Rates. The U.S. dollar value of our sales and product and operating costs varies with currency exchange rate fluctuations. In order of magnitude, our sales are mainly denominated in U.S. dollars, Euros, British pounds and Japanese yen, while our costs are mainly denominated in U.S. dollars, Euros, Australian dollars and British pounds. Because we manufacture and sell in the U.S. and many other countries, the impact that currency exchange rate fluctuations have on us is dependent on the interaction of a number of variables. These variables include, but are not limited to, the relationships between various foreign currencies, the relative amount of our revenues and costs that are denominated in U.S. dollars or in U.S. dollar-linked currencies, customer resistance to currency-driven price changes and the suddenness and severity of changes in certain foreign currency exchange rates. In addition, we hedge most of our balance sheet exposures denominated in other-than-local currencies based upon forecasts of those exposures; in the event that these forecasts are overstated or understated during periods of currency volatility, foreign exchange losses could result. For all of these reasons, currency exchange fluctuations could have an adverse effect on our financial condition or results of operations.
Credit Risk. We extend trade credit to many of our customers. We generally perform credit evaluations of these customers before extending credit. To some extent, we utilize letters of credit to mitigate credit risks. While we believe that we take appropriate steps to manage customer credit risk, our
customers could experience financial difficulties, in particular given current economic conditions, that could result in delays or difficulties in collecting on accounts receivable that are owed to the Company. This could have an adverse effect on our financial condition or results of operations.
We have cash and surplus funds that we invest, primarily in demand deposits, short-term U.S. Treasury securities and money market funds. We also purchase foreign exchange forward contracts in order to minimize the short-term impact of foreign currency fluctuations, which contracts are placed primarily with major financial institutions. We also accept letters of credit from financial institutions to ensure payment for sales of our products. Although we believe that our cash and cash equivalents, our foreign exchange forward contracts and letters of credit provided to us, are invested or placed with secure financial institutions, there is no assurance that these financial institutions will not default on their obligations to us, especially given global financial market conditions. Loss of principal on demand deposits or invested funds or a default on a foreign exchange forward contract or letter of credit could have an adverse effect on our financial condition or results of operations.
Key Personnel. Our success depends upon the efforts and abilities of key personnel, including research and development, engineering, manufacturing, finance, administrative, marketing, sales and management personnel. The availability of qualified personnel and the cost to attract, motivate and retain them can vary significantly based on factors such as the strength of the general economy. However, even in weak economic periods, there is still intense competition for personnel with certain expertise in the geographic areas where we compete for personnel. In addition, certain employees have significant institutional and proprietary technical knowledge, which could be difficult to quickly replace. Failure to attract, motivate and retain qualified personnel, who generally do not have employment agreements or post-employment non-competition agreements, could have an adverse effect on our financial condition or results of operations.
Certain Employee Benefit Plans. Many of our U.S. employees participate in health care plans under which we are self-insured. We maintain a stop-loss insurance policy that covers the cost of certain individually large claims under these plans. Each year, our expenses under these plans are recorded based on actuarial estimates of the number and costs of expected claims, administrative costs and stop-loss premiums. These estimates are then adjusted at the end of each plan year to reflect actual costs incurred. Actual costs under these plans are subject to variability depending primarily upon participant enrollment and demographics, the actual number and costs of claims made and whether and how much the stop-loss insurance we purchase covers the cost of these claims. In the event that our cost estimates differ from actual costs, our financial condition and results of operations could be adversely impacted.
We also maintain defined benefit pension plans for our employees in several countries outside of the U.S. As required by the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification topic (“ASC”) 715-30, Defined Benefit Plans-Pension, we utilize a number of assumptions including the expected long-term rate of return on plan assets and the discount rate in order to determine our defined benefit pension plan costs each year. These assumptions are set based on relevant long-term debt, equity and other market conditions in the countries in which the plans are maintained. We adjust these assumptions each year in response to corresponding changes in underlying market conditions and expectations. Changes in these market conditions and expectations result in corresponding changes in our defined benefit pension plan assumptions, liabilities and costs. We could also curtail these plans, which could result in us incurring curtailment/settlement charges. In addition, changes in relevant government regulations in the countries in which our defined benefit pension plans are located and/or changes in the accounting rules applicable to these plans could also impact our defined benefit pension plan liabilities and costs. Any such changes could have an adverse effect on our financial condition or results of operations.
Environmental Matters. Our operations are subject to various federal, state and local laws in the U.S., as well as laws in other countries, regulating the discharge of materials into the environment or otherwise relating to the protection of the environment. These regulations increase the costs and potential liabilities of our operations. However, we do not currently anticipate that our compliance with these regulations will have a material effect on our capital expenditures, earnings or competitive position.
As is described in Item 1 - Business, we and VSEA are each obligated (under the terms of the Distribution Agreement) to indemnify VMS for one-third of certain costs (after adjusting for any insurance
proceeds and tax benefits recognized or realized by VMS for such costs) relating to (a) environmental investigation, monitoring and/or remediation activities at certain facilities previously operated by VAI and third-party claims made in connection with environmental conditions at those facilities, and (b) U.S. Environmental Protection Agency or third-party claims alleging that VAI or VMS is a potentially responsible party under the Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended (“CERCLA”) in connection with certain sites to which VAI allegedly shipped manufacturing waste for recycling, treatment or disposal (the “CERCLA sites”). With respect to the facilities formerly operated by VAI, VMS is overseeing the environmental investigation, monitoring and/or remediation activities, in most cases under the direction of, or in consultation with, federal, state and/or local agencies, and handling third-party claims. VMS is also handling claims relating to the CERCLA sites.
Various uncertainties make it difficult to estimate future costs for certain of these environmental-related activities, specifically external legal expenses, VMS’ internal oversight costs, third-party claims and a former VAI facility where the likelihood and scope of further environmental-related activities are difficult to assess. As of October 2, 2009, it was nonetheless estimated that our future exposure for these environmental-related costs ranged in the aggregate from $1.0 million to $2.6 million. The time frame over which these costs are expected to be incurred varies with each type of cost, ranging up to approximately 30 years as of October 2, 2009. No amount in the foregoing range of estimated future costs is discounted, and no amount in the range is believed to be more probable of being incurred than any other amount in such range. We therefore had an accrual of $1.0 million as of October 2, 2009 for these future environmental-related costs.
Sufficient knowledge has been gained to be able to better estimate other costs of future environmental-related activities. As of October 2, 2009, it was estimated that our future costs for these environmental-related activities ranged in the aggregate from $2.6 million to $12.7 million. The time frame over which these costs are expected to be incurred varies, ranging up to approximately 30 years as of October 2, 2009. As to each of these ranges of cost estimates, it was determined that a particular amount within the range was a better estimate than any other amount within the range. Together, these amounts totaled $5.5 million at October 2, 2009. Because both the amount and timing of the recurring portion of these costs were reliably determinable, that portion is discounted at 4%, net of inflation. We therefore had an accrual of $4.0 million as of October 2, 2009, which represents our best estimate of these future environmental-related costs after discounting estimated recurring future costs. This accrual is in addition to the $1.0 million described in the preceding paragraph.
At October 2, 2009, our reserve for environmental-related costs, based upon future environmental-related costs estimated by us as of that date, was calculated as follows:
The foregoing amounts 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, monitoring and remediation activities and the large number of sites where such investigation, monitoring and remediation activities are being undertaken.
We have not reduced any environmental-related liability in anticipation of recoveries from third parties. However, an insurance company has agreed to pay a portion of certain of VAI’s (now VMS’) future environmental-related costs, for which we have an indemnification obligation, and we therefore have a long-term receivable of $1.0 million (discounted at 4%, net of inflation) in other assets as of October 2, 2009 for our share of that insurance recovery.
Management believes that our reserves for the foregoing and other environmental-related matters are adequate, but as the scope of our obligation becomes more clearly defined, these reserves may be modified and related charges against or credits to earnings may be made. Although any ultimate liability arising from environmental-related matters could result in significant expenditures that, if aggregated and assumed to occur within a single fiscal year, would be material to our financial statements, the likelihood of such occurrence is considered remote. Based on information currently available and our best assessment of the ultimate amount and timing of environmental-related events, management believes that the costs of environmental-related matters are not reasonably likely to have a material adverse effect on our financial condition or results of operations.
Governmental Regulations. Our businesses are subject to many governmental regulations in the U.S. and other countries, including with respect to protection of the environment, employee health and safety, labor matters, product safety, medical devices, import, export, competition and sales to governmental entities. These regulations are complex and change frequently. We incur significant costs to comply with governmental regulations, costs to comply with new or changed regulations could be significant, and failure to comply could result in suspension of or restrictions on our operations, product recalls, fines, other civil and criminal penalties, private party litigation and damage to our reputation, which could have an adverse effect on our financial condition or results of operations.
In January 2003, the European Union (“EU”) adopted Directive 2002/96/EC on Waste Electrical and Electronic Equipment (the “WEEE Directive”) and Directive 2002/95/EC on Restriction on the Certain Hazardous Substances in Electrical and Electronic Equipment (the “RoHS Directive”). The WEEE Directive requires EU-member countries to adopt implementing legislation imposing certain responsibilities on producers (manufacturers and importers) in the EU of electrical and electronic equipment with respect to the collection and disposal of waste from that equipment and the RoHS Directive bans in the EU the use of certain hazardous materials in electrical and electronic equipment. All EU-member countries where we manufacture or import products have adopted implementing legislation under these Directives. As a result of the WEEE Directive, we are incurring (or will incur) waste collection and disposal costs to comply with implementing legislation under the WEEE Directive; these costs have not been significant to-date and we do not expect them to be significant in the future, but if they are, our financial condition or results of operations could be materially adversely affected. As a result of the RoHS Directive, certain raw materials and components sourced from third parties are no longer available, or will in the future become unavailable, for use in the manufacture of the Company’s products; we have not experienced significant supply disruptions and have not incurred significant costs as a result of the RoHS Directive and we do not expect such disruptions or costs to be significant in the future, but if they are, our financial condition or results of operations could be materially adversely affected. In addition, legislation similar to the WEEE and RoHS Directives have been or could be enacted in other countries outside the EU (such as China), which could have an adverse effect on our financial condition or results of operations.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
As of October 2, 2009, we had manufacturing, warehouse, research and development, sales, service and administrative facilities that had an aggregate floor space of approximately 501,000 square feet in the U.S. and 933,000 square feet outside of the U.S., for a total of approximately 1,434,000 square feet
worldwide. Of these facilities, aggregate floor space of approximately 588,000 square feet was leased, and we owned the remainder. We believe that our facilities and equipment generally are well maintained, in good operating condition, suitable for our purposes and adequate for current operations. In the first quarter of fiscal year 2009, we entered into an agreement with VMS under which we agreed to surrender to them the sublease for our facility in Palo Alto, California which has a total floor space of 210,000 square feet. As of October 2, 2009, we have surrendered approximately 150,000 square feet of floor space to VMS. We expect to fully vacate this facility by the third quarter of fiscal year 2010.
As of October 2, 2009, we owned or leased 12 significant manufacturing facilities located throughout the world. Our Scientific Instruments segment had manufacturing facilities in Walnut Creek, California; Lake Forest, California; Ft. Collins, Colorado; Cary, North Carolina; Melbourne, Australia; Grenoble, France; Middelburg, Netherlands; Wroclaw, Poland; Church Stretton, United Kingdom; and Yarnton, United Kingdom. Our Vacuum Technologies segment had manufacturing facilities in Lexington, Massachusetts; and Turin, Italy. We also owned or leased 49 sales and service facilities located throughout the world, 45 of which were located outside of the U.S., including in Argentina, Australia, Brazil, Canada, China, France, Germany, Hong Kong, India, Italy, Japan, Korea, Mexico, Netherlands, Russia, Singapore, Spain, Sweden, Switzerland, Taiwan and the United Kingdom.
Item 3.
Item 3. Legal Proceedings
We are involved in pending legal proceedings that are ordinary, routine and incidental to our business. While the ultimate outcome of these and other legal matters is not determinable, we believe that these matters are not reasonably likely to have a material adverse effect on our financial condition or results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
At our Special Meeting of Stockholders held on October 5, 2009, our stockholders considered and voted on two matters: (1) the proposal to adopt the Agreement and Plan of Merger, dated as of July 26, 2009, among Varian, Agilent and Merger Sub, as it may be amended from time to time, pursuant to which Varian will be acquired by Agilent; and (2) the proposal to adjourn or postpone the special meeting to a later date or time, if necessary or appropriate, to solicit additional proxies in the event there are insufficient votes to adopt the Agreement and Plan of Merger. Our stockholders’ voting on these matters was as follows:
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
(a) Our high and low common stock selling prices in each of the four quarters of fiscal years 2009 and 2008 follow:
Our common stock is traded on the NASDAQ Global Select Market under the trading symbol VARI.
We have never paid cash dividends on our capital stock and do not currently anticipate paying any cash dividends in the foreseeable future.
There were 2,321 holders of record of our common stock on November 20, 2009.
(b) Not applicable.
(c) Stock Repurchases. During the fiscal quarter ended October 2, 2009, the Company repurchased and retired 500 shares tendered to it by employees in settlement of employee tax withholding obligations due from those employees upon the vesting of restricted stock.
Item 6.
Item 6. Selected Financial Data
(1)
The results for fiscal year 2005 do not reflect share-based compensation expense whereas the results for fiscal years 2006 through 2009 do reflect such expense.
(2)
Until March 11, 2005, we operated an electronics manufacturing business, which was a contract manufacturer of electronic assemblies and subsystems such as printed circuit boards for OEMs. On that date, we sold our Electronics Manufacturing business to Jabil Circuit, Inc. As a result, this business has been treated as a discontinued operation in the fiscal year ended September 30, 2005.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Our fiscal years reported are the 52- or 53-week periods that end on the Friday nearest September 30. Fiscal year 2009 was comprised of the 52-week period that ended on October 2, 2009. Fiscal year 2008 was comprised of the 53-week period that ended on October 3, 2008. Fiscal year 2007 was comprised of the 52-week period that ended on September 28, 2007. While fiscal year 2008 revenue and earnings benefited from the extra week, the benefit was substantially less than a proportionate amount.
On July 26, 2009 we entered into an Agreement and Plan of Merger with Agilent (the “Merger Agreement”), pursuant to which we will, subject to the satisfaction or waiver of the conditions set forth in the Merger Agreement, be acquired by Agilent Technologies, Inc. (“Agilent”) for $52.00 per share in cash. At a special meeting held on October 5, 2009, our stockholders approved the Merger Agreement. The Merger remains subject to regulatory approvals and other closing conditions. Under the terms of the Merger Agreement, we have agreed to operate our business in the ordinary course consistent with past practice, as well as to refrain from taking certain actions in the conduct of our business without Agilent’s prior written consent until the consummation of the Merger. Actions that may require Agilent’s consent include, but are not limited to, new indebtedness, capital expenditures, loans and investments, manufacturing and customer agreements, acquisitions, issuance of securities, and the repurchase of shares of the Company’s common stock.
The discussion below should be read in conjunction with our Consolidated Financial Statements and the accompanying Notes to the Financial Statements included in Item 15 of this report. In addition, this discussion contains forward-looking statements and should be read together with the risks to our business as described in Part I-Caution Regarding Forward-Looking Statements and Item 1A - Risk Factors.
Revision of Prior Period Financial Statements
During the fiscal quarter ended July 3, 2009, we identified a clerical error related to the calculation of the fiscal year 2008 income tax provision. The impact of this error was an understatement of income tax expense and an overstatement of consolidated net earnings of $1.3 million during the fiscal quarter and fiscal year ended October 3, 2008. The error also resulted in an overstatement of current deferred tax assets and retained earnings of $1.3 million at October 3, 2008, January 2, 2009 and April 3, 2009. We assessed the materiality of this error and concluded that the previously issued financial statements are not materially misstated. We have corrected the immaterial error by revising the prior period financial statements. Accordingly, the October 3, 2008 consolidated balance sheet and the consolidated statements of earnings and of stockholders’ equity and comprehensive income for the fiscal year ended October 3, 2008 presented herein have been revised to correct for the immaterial error. The revision did not impact net cash provided by operating activities or net cash used in investing activities or financing activities for the fiscal year ended October 3, 2008.
Results of Operations
Fiscal Year 2009 Compared to Fiscal Year 2008
Segment Results
For financial reporting purposes, our operations are grouped into two reportable business segments: Scientific Instruments and Vacuum Technologies.
The following table presents comparisons of our sales and operating earnings for each of those segments and in total for fiscal years 2009 and 2008:
Scientific Instruments. The decrease in Scientific Instruments sales was primarily attributable to lower sales volume of a broad range of products and the negative impact of the stronger U.S. dollar on reported revenues. The lower volume was primarily due to the impact of the continued global economic weakness on capital equipment spending and to a lesser extent on specific items impacting the comparability of the fourth quarter of fiscal year 2009 with the fourth quarter of fiscal year 2008. Those items included an extra week in fiscal 2008 and the negative impact of customers’ uncertainty and employee and other disruptions related to the announcement and pendency of the acquisition by Agilent. Sales from businesses acquired in fiscal year 2008 positively impacted reported sales by less than 1%.
Scientific Instruments operating earnings for fiscal year 2009 included $2.2 million of costs resulting from the pending acquisition by Agilent, acquisition-related intangible amortization of $7.2 million, amortization of $0.1 million related to inventory written up to fair value in connection with the acquisition of Oxford Diffraction Limited (“Oxford Diffraction”) and restructuring and other related costs of $8.9 million. In comparison, Scientific Instruments operating earnings for fiscal year 2008 included an acquisition-related in-process research and development charge of $1.7 million, acquisition-related intangible amortization of $8.4 million, amortization of $1.4 million related to inventory written up to fair value in connection with certain acquisitions and restructuring and other related costs of $5.5 million. Excluding the impact of these items, Scientific Instruments operating earnings decreased as a percentage of sales due to the negative impact of lower sales volume during fiscal year 2009, partially offset by the positive impact from efficiency improvements implemented in recent years, the benefits of cost reduction activities implemented in the second quarter of fiscal year 2009 and the stronger U.S. dollar (which was unfavorable to reported sales but favorable to reported operating margins).
Vacuum Technologies. The decrease in Vacuum Technologies sales was driven mainly by lower sales volume of products for both industrial and life science applications, primarily due to the negative impacts of continued global economic weakness on capital equipment spending and the stronger U.S. dollar on reported revenues.
Vacuum Technologies operating earnings for fiscal year 2009 included the impact of restructuring and other related costs of $0.8 million. Excluding the impact of these costs, the slight increase in Vacuum Technologies operating earnings as a percentage of sales was primarily due to the positive impact of efficiency improvements implemented in recent years, cost reduction activities implemented during the second quarter of fiscal year 2009 and the stronger U.S. dollar, largely offset by the negative impact of lower sales volume.
Consolidated Results
The following table presents comparisons of our sales and other selected consolidated financial results for fiscal years 2009 and 2008:
Sales. As discussed under the heading Segment Results above, sales by our Scientific Instruments and Vacuum Technologies segments in fiscal year 2009 decreased by 19.5% and 24.4%, respectively, compared to fiscal year 2008. On a consolidated basis, sales declined 20.3% in fiscal year 2009. This decrease was primarily related to lower sales volume of a broad range of products and the negative impact of the stronger U.S. dollar on reported revenues. The lower volume was primarily due to the impact of continued global economic weakness on capital equipment spending and to a lesser extent on specific items impacting the comparability of the fourth quarter of fiscal year 2009 with the fourth quarter of fiscal year 2008. Those items included an extra week in fiscal 2008 and the negative impact of customers’ uncertainty and employee and other disruptions related to the announcement and pendency of the acquisition by Agilent. Reported sales were negatively impacted by the stronger U.S. dollar, which strengthened approximately 6% on a weighted-average basis compared to other currencies in which we sell products and services. Sales from businesses acquired in fiscal year 2008 positively impacted reported sales by less than 1%.
For geographic reporting purposes, we refer to four regions-North America (excluding Mexico), Europe (including the Middle East and Africa), Asia Pacific (including India) and Latin America (including Mexico).
Sales by geographic region in fiscal years 2009 and 2008 were as follows:
Sales volume decreased in all geographic regions for both Scientific Instruments and Vacuum Technologies products primarily due to the impact of continued global economic weakness on capital equipment spending. In addition, reported sales outside North America were unfavorably impacted by the strengthening of the U.S. dollar compared to fiscal year 2008.
Gross Profit. Gross profit for fiscal year 2009 reflects the impact of $6.1 million in amortization expense relating to acquisition-related intangible assets, amortization of $0.1 million related to inventory written up to fair value in connection with the Oxford Diffraction acquisition and $4.1 million in restructuring and other related costs. In comparison, gross profit for fiscal year 2008 reflects the impact of $6.5 million in amortization expense relating to acquisition-related intangible assets, amortization of $1.4 million related to inventory written up to fair value primarily in connection with certain acquisitions and $1.6 million in restructuring and other related costs. Excluding the impact of these items, gross profit as a percentage of sales decreased slightly. The negative impact of lower sales volume was largely offset by the positive impact of efficiency improvements (such as those resulting from lower-cost manufacturing and outsourcing initiatives, global procurement initiatives, and facility relocations/closures) implemented in recent years, the benefits from cost reduction activities implemented in the second quarter of fiscal year 2009, and the favorable impact of the stronger U.S. dollar (which was favorable to reported gross profit margins but unfavorable to reported sales).
Selling, General and Administrative. Selling, general and administrative expenses for fiscal year 2009 included $9.2 million of costs resulting from the pending acquisition by Agilent, $1.1 million in amortization expense relating to acquisition-related intangible assets and $4.8 million in restructuring and other related costs. In comparison, selling, general and administrative expenses for fiscal year 2008 included $1.8 million in amortization expense relating to acquisition-related intangible assets and $2.6 million in restructuring and other related costs. Excluding the impact of these items, the increase in selling, general and administrative expenses as a percentage of sales was primarily due to the negative impact of lower sales volume, partially offset by the favorable impact of the stronger U.S. dollar and cost savings achieved from restructuring activities implemented in recent years (including benefits from cost reduction activities implemented in the second quarter of fiscal year 2009).
Research and Development. Research and development expenses for fiscal year 2009 reflect the impact of $0.8 million in restructuring and other related costs. In comparison, research and development expenses for fiscal year 2008 reflect the impact of $1.3 million in restructuring and other related costs. Excluding the impact of these items, the decrease in research and development expenses as a percentage of sales was primarily due to the favorable impact of the stronger U.S. dollar in fiscal year 2009 and higher costs associated with new product introductions and product transition activities in fiscal year 2008.
Purchased In-Process Research and Development. In connection with the Oxford Diffraction acquisition in fiscal year 2008, we recorded a one-time charge of $1.7 million to immediately expense acquired in-process research and development related to projects that were in-process at the time of acquisition.
Restructuring Activities. We have committed to several restructuring plans in order to improve operational efficiencies, centralize functions, reallocate resources and reduce operating costs. Several of these plans were either initiated or still in process during fiscal year 2009. From the respective inception dates of these plans through October 2, 2009, we have incurred a total of $12.2 million in restructuring expense and a total of $9.9 million in other costs related directly to those plans (comprised primarily of employee retention and relocation costs and accelerated depreciation of assets disposed upon the closure of facilities).
The following table sets forth changes in our aggregate liability relating to all restructuring plans during fiscal year 2009:
In fiscal year 2009, we recorded $3.7 million in other costs related directly to these plans comprised primarily of employee retention and relocation costs and accelerated depreciation of assets to be disposed upon the closure of facilities.
Fiscal Year 2009 Second Quarter Plan. During the second quarter of fiscal year 2009, we committed to a plan to reduce our cost structure, primarily through headcount reductions, due to continuing uncertainties in the global economic environment. The plan primarily involved the elimination of approximately 240 regular employees (primarily in North America and Europe and, to a lesser extent, Asia Pacific and Latin America) and 80 temporary positions in both the Scientific Instruments and Vacuum Technologies segments. In addition, the plan included the closure of one small research and development/manufacturing facility in North America (Lake Forest, California) and two sales offices in Europe (Sweden and Switzerland).
The restructuring costs associated with this plan include one-time termination benefits for employees whose positions were eliminated and lease termination costs on vacated facilities. Other restructuring-related costs include employee retention and relocation costs and facility-related relocation costs and accelerated depreciation of fixed assets to be disposed upon the closure of facilities. These costs are being recorded and included in cost of sales, selling, general and administrative expenses and research and development expenses.
The following table sets forth changes in our restructuring liability relating to the foregoing plan during fiscal year 2009 as well as total restructuring expense and other restructuring-related costs recorded since the inception of the plan:
The restructuring expense of $6.1 million recorded during fiscal year 2009 related to employee termination benefits, of which $5.5 million impacted the Scientific Instruments segment and $0.6 million impacted the Vacuum Technologies segment. We also incurred $0.9 million in other restructuring-related costs during the period, which primarily impacted the Scientific Instruments segment and were comprised of $0.6 million in employee-related costs and a $0.3 million non-cash charge for accelerated depreciation of assets to be disposed upon the closure of facilities. These costs are expected to be settled by the end of fiscal year 2010.
Fiscal Year 2009 First Quarter Plan. During the first quarter of fiscal year 2009, we committed to a separate plan to reduce our employee headcount in order to reduce operating costs and increase margins. The plan involved the termination of approximately 30 employees, mostly located in Europe. The restructuring costs related to this plan primarily consist of one-time termination benefits which are expected to be settled by the end of fiscal year 2010. This restructuring plan did not involve any non-cash components. Costs relating to restructuring activities recorded under this plan have been included in cost of sales, selling, general and administrative expenses and research and development expenses.
The following table sets forth changes in our restructuring liability relating to the foregoing plan during fiscal year 2009 as well as total restructuring expense and other restructuring-related costs recorded since the inception of the plan:
The restructuring expense of $1.4 million recorded during fiscal year 2009 related to employee termination benefits of which $1.2 million impacted the Scientific Instruments segment and $0.2 million impacted the Vacuum Technologies segment. We also incurred $0.1 million in other employee-related costs during the period which impacted the Scientific Instruments segment.
Fiscal Year 2007 Plan. During the third quarter of fiscal year 2007, we committed to a plan to combine and optimize the development and assembly of most of our nuclear magnetic resonance (“NMR”) and mass spectrometry products, to further centralize related administration and other functions and to reallocate certain resources toward more rapidly growing product lines and geographies. As part of the plan, we created an information rich detection (“IRD”) center in Walnut Creek, California, where NMR operations that were previously located in Palo Alto, California were integrated with mass spectrometry operations already located in Walnut Creek. We are investing in a substantial remodel of an existing building and invested in a new 45,000 square foot building there to house the IRD center.
As a result of the plan, a number of employee positions were relocated or eliminated and certain facilities were consolidated. These actions primarily impacted the Scientific Instruments segment and involved the elimination of between approximately 40 and 60 positions.
Restructuring and other related costs associated with this plan include one-time termination benefits, retention and relocation payments, costs to relocate facilities (including decommissioning costs, moving costs and temporary facility/storage costs), accelerated depreciation of fixed assets to be disposed as a result of facilities actions and lease termination costs. These costs are currently estimated to be between $12.5 million and $15.0 million, of which $1.3 million was incurred in fiscal year 2009 and $5.5 million was incurred in fiscal year 2008. The estimated remaining costs are expected to be recorded and settled through the fourth quarter of fiscal year 2010 except for certain lease termination-related costs, which might be settled as late as the fourth quarter of fiscal year 2012. Costs relating to restructuring activities recorded under this plan have been included in cost of sales, selling, general and administrative expenses and research and development expenses. Upon its completion, this plan is expected to result in certain operational improvements and efficiencies, which we anticipate will result in a reduction of our overall cost structure and annual operating expenses.
The following table sets forth changes in our restructuring liability relating to the foregoing plan during fiscal year 2009 as well as total restructuring expense and other restructuring-related costs recorded since the inception of the plan:
The reversals of restructuring expense of $1.5 million recorded during fiscal year 2009 related to changes in estimates relating to certain employee termination benefits and the early cancellation of our lease agreement for a vacated facility. Of the $8.2 million in other restructuring-related costs, we recorded $2.8 million during fiscal year 2009, which were comprised of $1.7 million in employee retention costs and $1.1 million in facilities-related costs including decommissioning costs and a non-cash charge for accelerated depreciation of assets to be disposed upon the closure of facilities.
Restructuring Cost Savings. The following table sets forth the estimated annual cost savings for each plan when they were initiated as well as where those cost savings were expected to be realized:
Restructuring Plan
Estimated Annual
Cost Savings
Fiscal Year 2007 Plan (Scientific Instruments-to combine and optimize the development and assembly on certain products and to centralize functions and reallocate resources to rapidly growing product lines)
$3 million - $5 million
Fiscal Year 2009 First Quarter Plan (Scientific Instruments-to reduce headcount and operating costs and increase operating margins)
$2 million - $3 million
Fiscal Year 2009 Second Quarter Plan (Scientific Instruments and Vacuum Technologies-to reduce cost structure due to global economic uncertainties, primarily through headcount reduction)
$20 million - $24 million
These estimated cost savings are expected to impact cost of sales, selling, general and administrative expenses and research and development expenses. Some of these cost savings have been and will continue to be reinvested in other parts of our business, for example, as part of our continued emphasis on IRD and consumable products. In addition, unrelated cost increases in other areas of our operations have and could in the future offset some or all of these cost savings. Although it is difficult to quantify with any precision our actual cost savings to date from these activities, many of which are still ongoing, we currently believe that the ultimate savings realized will not differ materially from these estimates.
Impairment of Private Company Equity Investment. During fiscal year 2008, we became aware of information which raised substantial doubt about the ability of a small, private company in which we held a cost-method equity investment to continue as a going concern. Based on this information, we determined that the fair value of our investment had declined and that the decline was other-than-temporary. As a result, we wrote off the entire $3.0 million carrying value via an impairment charge in that period.
Interest Income. The decrease in interest income was primarily due to lower interest rates on invested cash during fiscal year 2009 compared to fiscal year 2008.
Income Tax Expense. The effective income tax rate was 34.7% for fiscal year 2009, compared to 36.6% for fiscal year 2008. The lower effective income tax rate in fiscal year 2009 was primarily due to
lower U.S. state taxes, lower U.S. federal taxes on distributed and undistributed foreign earnings and lower non-deductible compensation expense. These factors were partially offset by the impact in fiscal year 2009 of non-deductible costs associated with our pending acquisition by Agilent.
Net Earnings. Net earnings for fiscal year 2009 reflect the after-tax impacts of $9.2 million of costs resulting from the pending acquisition by Agilent, $7.2 million in acquisition-related intangible amortization, amortization of $0.1 million related to inventory written up to fair value in connection with the Oxford Diffraction acquisition and $9.7 million in restructuring and other related costs. Net earnings for fiscal year 2008 reflect a non-deductible acquisition-related in-process research and development charge of $1.7 million and the after-tax impacts of $3.0 million in an impairment of a private company equity investment, $8.4 million in acquisition-related intangible amortization, $1.4 million in amortization related to inventory written up to fair value in connection with certain acquisitions and $5.5 million in restructuring and other related costs. Excluding the after-tax impact of these items, the decrease in net earnings in fiscal year 2009 was primarily attributable to the negative impact of lower sales volume.
Outlook
The diversity of our products, the applications we serve and our worldwide distribution position us well. However, we continue to operate in difficult global economic conditions. The uncertainty of these conditions, as well as customers’ uncertainty and employee and other disruptions related to the announcement and pendency of our acquisition by Agilent, make it difficult for us to project our near-term results of operations. These conditions could further impact our business and have an adverse effect on our financial position, results of operations and/or cash flows. In addition, we have incurred and will continue to incur legal and other expenses in connection with the pending acquisition by Agilent, which could have an adverse effect on our financial position, results of operations and/or cash flows.
Fiscal Year 2008 Compared to Fiscal Year 2007
Segment Results
The following table presents comparisons of our sales and operating earnings for each of our segments and in total for fiscal years 2008 and 2007:
Scientific Instruments. The increase in Scientific Instruments sales was primarily attributable to higher sales volume across a broad range of our analytical instruments and consumable products, partially offset by lower sales of research products. Sales increased for environmental, energy and life science applications. During fiscal year 2008, the U.S. dollar weakened compared to most other foreign currencies in which we sell products and services, which also contributed to the increase in sales. Excluding sales from businesses acquired in fiscal year 2008, Scientific Instruments sales in the fiscal year increased by approximately 9% compared to fiscal year 2007.
Scientific Instruments operating earnings for fiscal year 2008 include an acquisition-related in-process research and development charge of $1.7 million, acquisition-related intangible amortization of $8.4 million, amortization of $1.4 million related to inventory written up to fair value in connection with acquisitions and restructuring and other related costs of $5.5 million. In comparison, Scientific Instruments operating earnings for fiscal year 2007 include acquisition-related intangible amortization of $7.9 million, amortization of $1.3 million related to inventory written up to fair value in connection with an acquisition and restructuring and other related costs of $4.3 million. Excluding the impact of these items, operating earnings were lower as a percentage of sales due to higher transition costs related to the relocation of manufacturing activities for certain products, the weaker U.S. dollar (which was favorable to reported sales but unfavorable to reported operating margins) and higher costs relating to new product introductions. These factors more than offset the positive impact of sales volume leverage.
Vacuum Technologies. The increase in Vacuum Technologies sales was driven by higher sales volume over a broad range of products and services and the positive impact of the weaker U.S. dollar.
The decrease in Vacuum Technologies operating earnings as a percentage of sales was primarily the result of the weaker U.S. dollar, which was only partially offset by the positive impact of sales volume leverage.
Consolidated Results
The following table presents comparisons of our sales and other selected consolidated financial results for fiscal years 2008 and 2007:
Sales. As discussed under the heading Segment Results above, sales by the Scientific Instruments and Vacuum Technologies segments in fiscal year 2008 increased by 10.1% and 9.3%, respectively, compared to fiscal year 2007. The growth in consolidated sales was broad-based, with increases in sales of products for environmental, energy and life science applications. The weaker U.S. dollar and acquisitions also had a positive effect on the reported sales increases. Excluding sales from businesses acquired in fiscal year 2008, sales in fiscal year 2008 increased by approximately 9% compared to fiscal year 2007.
Sales by geographic region in fiscal years 2008 and 2007 were as follows:
The increases in sales in Europe, Asia Pacific and North America were attributable to higher sales by both the Scientific Instruments and Vacuum Technologies segments. The sales increase in Latin America was driven by higher Scientific Instruments sales, with Vacuum Technologies sales essentially flat in that region.
Gross Profit. Gross profit for fiscal year 2008 includes $6.5 million in amortization expense relating to acquisition-related intangible assets, $1.4 million in amortization expense related to inventory written up to fair value in connection with recent acquisitions and $1.6 million in restructuring and other related costs. In comparison, gross profit for fiscal year 2007 includes $5.3 million in amortization expense relating to acquisition-related intangible assets, $1.3 million in amortization expense related to inventory written up to fair value in connection with an acquisition and $1.2 million in restructuring and other related costs. Excluding the impact of these items, gross profit as a percentage of sales decreased slightly due to higher transition costs related to the relocation of manufacturing activities for certain products and the weaker U.S. dollar (which was favorable to reported sales but unfavorable to reported gross profit margins).
Selling, General and Administrative. Selling, general and administrative expenses for fiscal year 2008 include $1.8 million in amortization expense relating to acquisition-related intangible assets and $2.6 million in restructuring and other related costs. In comparison, selling, general and administrative expenses for fiscal year 2007 include $2.6 million in amortization expense relating to acquisition-related intangible assets and $2.4 million in restructuring and other related costs. Excluding the impact of these items, the slight decrease in selling, general and administrative expenses as a percentage of sales was primarily the result of sales volume leverage and lower employee bonus accruals, largely offset by the weaker U.S. dollar and higher costs relating to new product introductions.
Research and Development. Research and development expenses for fiscal year 2008 include $1.3 million in restructuring and other related costs. In comparison, research and development expenses for fiscal year 2007 include $0.8 million in restructuring and other related costs. Excluding the impact of these items, research and development expenses were flat as a percentage of sales.
Purchased In-Process Research and Development. In connection with the Oxford Diffraction acquisition in the third quarter of fiscal year 2008, we recorded a one-time charge of $1.7 million to immediately expense acquired in-process research and development related to projects that were in process at the time of the acquisition.
Restructuring Activities. We have committed to several restructuring plans in order to improve operational efficiencies, centralize functions, reallocate resources and reduce operating costs.
The following table sets forth changes in our aggregate liability during fiscal year 2008 relating to all restructuring plans:
During fiscal year 2008, we also recorded $3.4 million in other costs related directly to these plans which were comprised primarily of employee retention and relocation costs and accelerated depreciation of assets to be disposed upon the closure of facilities).
Fiscal Year 2007 Plan. During the third quarter of fiscal year 2007, we committed to a plan to combine and optimize the development and assembly of most of our nuclear magnetic resonance (“NMR”) and mass spectrometry products, to further centralize related administration and other functions and to reallocate certain resources toward more rapidly growing product lines and geographies.
The following table sets forth changes in our restructuring liability during fiscal year 2008 relating to the foregoing plan:
The restructuring charges of $2.1 million recorded during fiscal year 2008 related to employee termination benefits and costs associated with the closure of leased facilities. We also incurred $3.4 million in other related costs during fiscal year 2008, which were comprised of $2.2 million in employee retention costs and $1.2 million in facilities-related costs including decommissioning costs and a non-cash charge for accelerated depreciation of assets to be disposed upon the closure of facilities.
Impairment of Private Company Equity Investment. During fiscal year 2008, we became aware of information which raised substantial doubt about the ability of a small, private company in which we held a cost-method equity investment to continue as a going concern. Based on this information, we determined that the fair value of our investment had declined and that the decline was other-than-temporary. As a result, we wrote off the entire $3.0 million carrying value via an impairment charge during fiscal year 2008.
Income Tax Expense. The effective income tax rate was 36.6% for fiscal year 2008, compared to 34.3% for fiscal year 2007. The higher effective income tax rate in fiscal year 2008 was primarily due to higher U.S. state taxes, higher U.S. federal taxes on distributed and undistributed foreign earnings, higher non-deductible compensation expense and a non-deductible in-process research and development charge related to an acquisition. These factors were partially offset by the benefit from a reduction in unrecognized tax benefits due to the lapse of certain statutes of limitations in fiscal year 2008 and lower taxes on retained foreign earnings.
Net Earnings. Net earnings for fiscal year 2008 included a non-deductible in-process research and development charge of $1.7 million and the after-tax impacts of an impairment of a private company equity
investment of $3.0 million, $8.4 million in acquisition-related intangible amortization, $1.4 million in amortization related to inventory written up to fair value in connection with recent acquisitions and $5.5 million in restructuring and other related costs. Net earnings for fiscal year 2007 included the after-tax impacts of $7.9 million in acquisition-related intangible amortization, $1.3 million in amortization related to inventory written up to fair value in connection with the acquisition of IonSpec and $4.3 million in restructuring and other related costs. Excluding the after-tax impact of these items, the increase in net earnings in fiscal year 2008 was primarily attributable to higher sales volume (including sales volume leverage on operating expenses), partially offset by higher transition costs related to the relocation of manufacturing activities for certain products and higher costs relating to new product introductions.
Critical Accounting Policies
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires us to exercise certain judgments in selecting and applying accounting policies and methods. The following is a summary of what we consider to be our most critical accounting policies-those that are most important to the portrayal of our financial condition and results of operations and that require our most difficult, subjective or complex judgments-the effects of those accounting policies applied and the judgments made in their application.
Revenue Recognition. We derive revenues from product sales (including accessory sales) and services. We recognize revenue on product sales and accessory sales when persuasive evidence of an arrangement exists, the contract price is fixed or determinable, the product or accessory has been delivered, title and risk of loss have passed to the customer and collection of the resulting receivable is reasonably assured. Our sales are typically not subject to rights of return and, historically, actual sales returns have not been significant. Product sales that do not involve unique customer acceptance terms or new specifications or technology with customer acceptance provisions, but that do involve installation services, are accounted for as multiple-element arrangements, where the larger of the contractual billing holdback or the fair value of the installation service is deferred when the product is delivered and subsequently recognized when the installation is complete. For certain other product sales that do involve unique customer acceptance terms or new specifications or technology with customer acceptance provisions, all revenue is deferred until all contractually required customer acceptance provisions and product specifications have been satisfied. Revenue related to service contracts is recognized ratably over the term of the contracts. Unearned maintenance and service contract revenue is included in accrued liabilities on the accompanying Consolidated Balance Sheet. Revenue related to incident-based paid service and training services is recognized when the related services are provided to the customer.
In all cases, the fair value of undelivered elements is deferred until those items are delivered to the customer. Sales arrangements involving undelivered elements are primarily confined to the Scientific Instruments segment and involve product accessories, installation services and/or training services that are delivered after the related product has been delivered. Product accessories generally enhance the functionality of the product but are not essential to the functionality of the product. In determining relative fair values for product accessories and training services, we utilize published price list values as the basis for allocating the overall arrangement consideration. List prices are representative of fair value, as stand-alone sales of products, product accessories and training have occurred at list price. The fair value of installation services is calculated by applying standard service billing rates to the estimate of the number of hours to install a specific product based on historical experience. Estimates of installation hours have historically been accurate.
In limited cases, product accessories ordered by customers may not have an established list price, as the item may be a new or slightly modified accessory with no prior sales history. In these limited cases, we consider whether a comparable or substitute accessory that provides similar functionality exists for which fair value has been established and then use that comparable or substitute accessory’s list price in estimating the fair value of the undelivered elements. When the fair value of a delivered element has not been established, we use the residual method to allocate revenue if the fair value of all undelivered elements is determinable. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement consideration is allocated to the delivered elements and is recognized as revenue. If we are unable to determine the fair value of an undelivered element, all
arrangement revenue is deferred until the undelivered element is delivered; however, such cases are infrequent and arise from a significant technological advance that creates products or product accessories without a suitable comparable or substitute accessory from which to derive fair value.
We determine when and how much revenue may be recognized on a particular transaction in a particular period based on our best estimates of the fair value of undelivered elements and our judgment of when our performance obligations have been met as outlined above. These judgments and estimates impact reported revenues.
Allowances for Doubtful Accounts Receivable. We sell our products and extend trade credit to a large number of customers. These customers are dispersed across many different industries and geographies and, historically, no single customer has accounted for 10% or more of our total revenues or trade accounts receivable. We perform ongoing credit evaluations of our customers and generally do not require collateral from them. Allowances are established for amounts that are considered to be uncollectible. These allowances represent our best estimates and are based on our judgment after considering a number of factors including third-party credit reports, actual payment history, customer-specific financial information and broader market and economic trends and conditions. In the event that actual uncollectible amounts differ from these best estimates, changes in allowances for doubtful accounts might become necessary.
Inventory Valuation. Inventories are stated at the lower of cost or market, with cost being computed on an average-cost basis. Provisions are made to write down potentially excess, obsolete or slow-moving inventories to their net realizable value. These provisions are based on our best estimates after considering historical demand, projected future demand (including current backlog), inventory purchase commitments, industry and market trends and conditions and other factors. In the event that actual excess, obsolete or slow-moving inventories differ from these best estimates, increases to inventory reserves might become necessary.
Product Warranty. Our products are generally subject to warranties and liabilities are therefore established for the estimated future costs of repair or replacement through charges to cost of sales at the time the related sale is recognized. These liabilities are adjusted based on our best estimates of future warranty costs after considering historical and projected product failure rates and product repair costs. In the event that actual experience differs from these best estimates, changes in our warranty liabilities might become necessary.
Environmental Liabilities. As discussed more fully in Item 1 - Business and Item 1A - Risk Factors-Environmental Matters, we entered into a Distribution Agreement in connection with becoming a separate, public company on April 2, 1999. Under the terms of that Distribution Agreement, we are obligated to indemnify Varian Medical Systems, Inc. (“VMS”) for one-third of certain environmental investigation, monitoring and/or remediation costs (after adjusting for any insurance proceeds and tax benefits recognized or realized by VMS for such costs). The liabilities recorded by us relating to these matters are based on our best estimates after considering currently available information regarding the cost and timing of remediation efforts, related legal matters, insurance recoveries and other environmental-related events. As additional information becomes available, these amounts are adjusted accordingly. Should the cost or timing of remediation efforts, legal matters, insurance recoveries or other environmental-related events (including any which may be currently unidentified) differ from our current expectations and best estimates, changes to our reserves for environmental matters might become necessary.
Share-based Compensation. We measure and recognize compensation expense for all share-based payment awards including employee stock options and shares issued under our employee stock purchase plan based on estimated fair values. We estimate the value of share-based payments on the date of grant using the Black-Scholes model. The determination of the fair value of, and the timing of expense relating to, share-based payment awards on the date of grant using the Black-Scholes model is affected by our stock price as well as assumptions regarding a number of variables including the expected term of awards, expected stock price volatility and expected forfeitures.
In determining the Company’s expected stock price volatility assumption, we review both the historical and implied volatility of the Company’s common stock, with implied volatility based on publicly traded options on the Company’s common stock. We determine the expected stock price volatility assumptions using a combination of historical and implied volatility unless the volume or maturity of these publicly traded options does not satisfy the conditions to use implied volatility. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We estimate expected forfeitures, as well as the expected term of awards, based on historical experience. Future changes in these assumptions, our stock price or certain other factors could result in changes in our share-based compensation expense in future periods.
Income Taxes. We are subject to income taxes in the U.S. and numerous jurisdictions outside of the U.S. Significant judgment is required in evaluating our tax positions and determining our provision for income taxes as well as in assessing the realizability of our deferred tax assets. During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. We establish liabilities for unrecognized tax benefits, as well as reserves for related potential penalties and interest, based on the technical merits of our tax positions and the extent to which additional taxes, penalties and interest will be due. These unrecognized tax benefits are established when, despite our belief that our tax return positions are fully supportable, certain positions can be challenged and may not be sustained on review by tax authorities. These balances are adjusted in light of changing facts and circumstances. Our income tax expense includes the impact of new unrecognized tax benefits recorded as well as changes to existing unrecognized tax benefits that are considered appropriate. Should the ultimate resolution of any tax-related uncertainties (including any which may be currently unidentified) differ from those we used to determine our recorded liabilities, charges against or credits to our unrecognized tax benefits and/or income tax provision will become necessary.
Our judgments regarding the realizability of deferred tax assets are based on, among other things, the relative weight of both positive and negative evidence regarding future taxable income, and may change due to changes in market conditions, tax laws, tax planning strategies or other factors. Should our assumptions and consequently our estimates in this area change in the future, the amount of valuation allowances recorded relating to our deferred tax assets may be increased or decreased, which would result in charges against or credits to our income tax provision.
Liquidity and Capital Resources
We generated $112.9 million of cash from operating activities in fiscal year 2009, compared to $79.0 million generated in fiscal year 2008. The increase in operating cash flows was primarily due to the favorable impact of decreased accounts receivable and inventory balances, partially offset by decreased net earnings after adjustments for non-cash income and expenses and decreased inventory-related liabilities. The decrease in accounts receivable was primarily related to the timing of collections and lower sales. Inventory balances have declined primarily due to reduced inventory purchases to align with current revenue levels.
We used $21.1 million of cash for investing activities in fiscal year 2009, which compares to $77.4 million used for investing activities in fiscal year 2008. The decrease in cash used for investing activities was primarily the result of lower acquisition-related payments, and cash received for the surrender of a building sublease in fiscal year 2009. In October 2008, we entered into an agreement with VMS under which we agreed to surrender to them the sublease for our facility in Palo Alto, California in exchange for $21.0 million in cash payments. We received a $5.0 million non-refundable first surrender payment under this agreement in the first quarter of fiscal year 2009 and will receive the remaining $16.0 million when we fully surrender the facility in the third quarter of fiscal year 2010. In fiscal year 2008, the higher cash used for acquisition-related payments consisted primarily of cash consideration for the acquisition of certain net assets of Analogix, Inc. (the “Analogix Business”) in November 2007 and of Oxford Diffraction in April 2008.
We generated $0.6 million of cash from financing activities in fiscal year 2009, which compares to $94.6 million used for financing activities in fiscal year 2008. Cash used to repurchase and retire common stock was significantly lower in fiscal year 2009 (such expenditures were made in both periods as a result
of an effort to reduce the number of outstanding common shares). Cash proceeds from the issuance of common stock were lower in fiscal year 2009 due to lower stock option exercise volume.
We maintain relationships with banks in many countries from whom we sometimes obtain bank guarantees and short-term standby letters of credit. These guarantees and letters of credit relate primarily to advance payments and deposits made to our subsidiaries by customers for which separate liabilities are recorded in the consolidated balance sheet. As of October 2, 2009, a total of $14.5 million of these bank guarantees and letters of credit were outstanding. No amounts had been drawn by beneficiaries under these or any other outstanding guarantees or letters of credit as of that date.
As of October 2, 2009, we had an $18.8 million term loan outstanding with a U.S. financial institution at a fixed interest rate of 6.7%. The term loan contains certain covenants that limit future borrowings and the payment of cash dividends and require the maintenance of certain levels of working capital and operating results. We were in compliance with all restrictive covenants of the term loan agreement at October 2, 2009.
In connection with the Analogix Business acquisition, we have accrued a portion of the purchase price that has been retained to secure the sellers’ indemnification obligations. As of October 2, 2009, we had retained an aggregate of $1.3 million, which will become payable (net of any indemnification claims) during the first quarter of fiscal year 2010.
As of October 2, 2009, we had outstanding contingent consideration arrangements relating to acquired businesses. Amounts subject to these arrangements can be earned over the respective measurement period, depending on the performance of the acquired business relative to certain financial and operational targets.
The following table summarizes contingent consideration arrangements as of October 2, 2009:
We also have an outstanding contingent consideration arrangement related to the purchase of certain assets. Remaining maximum contingent amounts under this arrangement were $2.6 million as of October 2, 2009.
The Distribution Agreement provides that we are responsible for certain litigation to which VAI was a party, and further provides that we will indemnify VMS and VSEA for one-third of the costs, expenses and other liabilities relating to certain discontinued, former and corporate operations of VAI, including certain environmental liabilities (see Note 13 of the Notes to the Consolidated Financial Statements).
We had no material cancelable or non-cancelable commitments for capital expenditures as of October 2, 2009. In the aggregate, we currently anticipate that our capital expenditures will be approximately 2.0% to 3.0% of sales for fiscal year 2010.
In February 2008, our Board of Directors approved a stock repurchase program under which we are authorized to utilize up to $100 million to repurchase shares of our common stock. This repurchase program is effective through December 31, 2009. As of October 2, 2009, we had remaining authorization to repurchase $37.5 million of our common stock under this repurchase program. However, under the terms of the Merger Agreement with Agilent, the Company is generally prohibited from repurchasing any shares of its common stock without the prior consent of Agilent.
Under the terms of the Merger Agreement, we have agreed to operate our business in the ordinary course consistent with past practice, as well as to refrain from taking certain actions in the conduct of our business without Agilent’s prior written consent until the consummation of the acquisition. Actions that may require Agilent’s consent include, but are not limited to, new indebtedness, capital expenditures, loans and investments, manufacturing and customer agreements, acquisitions, issuance of securities, and the repurchase of shares of the Company’s common stock.
Our liquidity is affected by many other factors, including normal on-going operations of our business, the pending acquisition by Agilent and external economic conditions. Our liquidity has not been materially affected by the deterioration in the global financial markets or global economic conditions in general. However, this deterioration could adversely impact the availability of credit to us as well as to our customers and suppliers.
We have no material exposure to market risk for changes in interest rates or investment valuations. Our outstanding debt carries a fixed interest rate, and we invest our excess cash primarily in depository accounts and money market funds at various financial institutions. While we have not historically needed to borrow to support working capital or capital expenditure requirements, there is no assurance that we might not need to borrow to support these requirements given global economic conditions and whether such financing would be available.
We nonetheless believe that cash generated from operations, together with our current cash and cash equivalents balances and current borrowing capability, will be sufficient to satisfy our cash requirements for the next 12 months. There can be no assurance, however, that our business will continue to generate cash flows at current levels or that credit will be available to us if and when needed. Future operating performance and our ability to obtain credit will be subject to future economic conditions and to financial, business and other factors, including the affect of the pendency of the acquisition by Agilent.
Contractual Obligations and Other Commercial Commitments
The following table summarizes the amount and estimated timing of future cash expenditures relating to principal and interest payments on outstanding long-term debt, minimum rentals due for certain facilities and other leased assets under long-term, non-cancelable operating leases and other long-term liabilities as of October 2, 2009:
As of October 2, 2009, we did not have any off-balance sheet commercial commitments that could result in a significant cash outflow upon the occurrence of some contingent event, except for contingent payments of up to a maximum of $10.1 million related to acquisitions and $2.6 million related to the purchase of certain assets as discussed under Liquidity and Capital Resources above, the specific amounts of which are not currently determinable.
Recent Accounting Standards
In September 2006, the FASB issued new accounting standards for fair value measurements, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. In February 2008, the FASB delayed the effective date of the new accounting standard for all nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008, except for items that are recognized or disclosed at fair value in the financial statements on a
recurring basis (at least annually). We adopted the new accounting standard for fair value measurements effective October 4, 2008 with the exception of the application of the accounting standard to nonrecurring nonfinancial assets and nonfinancial liabilities (see Note 3). We do not expect the adoption in the first quarter of fiscal year 2010 of the provisions deferred to have a material impact on our financial condition or results of operations.
In December 2007, the FASB revised the accounting standards for business combinations, which retains the fundamental requirements of the original pronouncement requiring that the purchase method be used for all business combinations but also provides revised guidance for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed, and any noncontrolling interest in the acquiree. It also requires the recognition of assets acquired and liabilities assumed arising from contingencies, the capitalization of in-process research and development at fair value, and the expensing of acquisition-related costs as incurred. It also requires that certain tax contingencies and adjustments to valuation allowances related to business combinations, which previously were adjusted to goodwill, must be adjusted to income tax expense, regardless of the date of the original business combination. This revised accounting standard is effective for fiscal years beginning after December 15, 2008. We do not expect our adoption in the first quarter of fiscal year 2010 to have a material impact on our financial condition or results of operations. However, in the event that we complete acquisitions subsequent to our adoption of the new guidance, the application of its provisions will likely have a material impact on our results of operations, although we are not currently able to estimate the impact.
In April 2009, the FASB issued a new standard for business combinations that amends the accounting prescribed for assets and liabilities arising from contingencies in business combinations. This accounting standard requires pre-acquisition contingencies to be recognized at fair value if fair value can be reasonably determined during the measurement period. If fair value cannot be reasonably determined, the accounting standard requires measurement based on the recognition and measurement criteria for contingencies. This accounting standard is effective for fiscal years beginning after December 15, 2008. We do not expect our adoption in the first quarter of fiscal year 2010 to have a material impact on our financial condition or results of operations. However, in the event that we complete acquisitions subsequent to our adoption, the application of its provisions will likely have a material impact on our results of operations, although we are not currently able to estimate the impact.
In December 2007, the FASB issued a new accounting standard for non-controlling interests in consolidated financial statements, which requires that ownership interests in subsidiaries held by parties other than the parent and the amount of consolidated net income be clearly identified, labeled and presented in the consolidated financial statements. It also requires once a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be initially measured at fair value. Sufficient disclosures are required to clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. This accounting standard is effective for fiscal years beginning after December 15, 2008, and requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements are applied prospectively. We do not expect the adoption in the first quarter of fiscal year 2010 to have a material impact on our financial condition or results of operations.
In April 2008, the FASB issued a new accounting standard for the determination of the useful life of intangible assets, which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The intent of this new accounting standard is to improve the consistency between the useful life of a recognized intangible asset under the accounting guidance for intangible assets and the period of expected cash flows used to measure the fair value of the asset under the accounting guidance for business combinations. This accounting standard is effective for fiscal years beginning after December 15, 2008, and must be applied prospectively to intangible assets acquired after the effective date. Early adoption is prohibited. Given that this applies to intangible assets acquired after the effective date, we do not expect our adoption in the first quarter of fiscal year 2010 to have a material impact on our financial condition or results of operations.
In June 2008, the FASB issued a new accounting standard for determining whether instruments granted in share-based transactions are participating securities. This new accounting standard states that
unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are participating securities and shall be included in the computation of earnings per share under the two-class method described in the guidance for earnings per share. This accounting standard is effective for fiscal years beginning after December 15, 2008, and interim periods within those years, on a retrospective basis. We do not expect the adoption in the first quarter of fiscal year 2010 to have a material impact on our earnings per share.
In December 2008, the FASB issued additional disclosure requirements for plan assets of a defined benefit pension or other postretirement plan. The required disclosures include a description of the Company’s investment policies and strategies, the fair value of each major category of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs on changes in plan assets and the significant concentrations of risk within plan assets. These additional disclosures are effective for fiscal years ending after December 15, 2009. We do not expect the adoption of the new disclosure requirements in fiscal year 2010 to have a material impact on our financial condition or results of operations.
In October 2009, the FASB issued two new accounting standards that provide guidance for revenue recognition. The first standard revises guidance for arrangements with multiple deliverables. This accounting standard replaces the term fair value in the revenue recognition allocation guidance with selling price and establishes a hierarchy for determining the selling price of a deliverable. The selling price of each deliverable will first be based on vendor specific objective evidence (“VSOE”) if available, second on third-party evidence (“TPE”) if VSOE is not available and third on estimated selling price if neither VSOE nor TPE are available. In addition, the residual method is no longer permitted as vendors are now required to allocate arrangement consideration using the relative selling price method. The second new accounting standard excludes from the scope of software revenue recognition, software components contained in, and essential to the functionality of, tangible products. These new accounting standards require expanded qualitative and quantitative disclosures and are effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. We do not expect the adoption of these accounting standards in the first quarter of fiscal year 2011 to have a material impact on our financial condition or results of operations.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency Exchange Risk. We enter into foreign exchange forward contracts to minimize the short-term impact of foreign currency fluctuations on assets and liabilities denominated in non-functional currencies. From time to time, we also enter into foreign exchange forward contracts to minimize the impact of foreign currency fluctuations on forecasted transactions. The success of our hedging activities depends on our ability to forecast balance sheet exposures and transaction activity in various foreign currencies. To the extent that these forecasts are overstated or understated during periods of currency volatility, we could experience unanticipated currency gains or losses. However, we believe that in most cases any such gains or losses would be substantially offset by losses or gains from the related foreign exchange forward contracts. We therefore believe that the direct effect of an immediate 10% change in the exchange rate between the U.S. dollar and all other currencies is not reasonably likely to have a material adverse effect on our financial condition or results of operations.
During the fiscal year ended October 2, 2009, we were not party to any foreign exchange forward contracts designated as cash flow hedges of forecasted transactions.
Our foreign exchange forward contracts generally do not extend beyond one month in original maturity. A summary of all foreign exchange forward contracts that were outstanding as of October 2, 2009 follows:
Interest Rate Risk. We have no material exposure to market risk for changes in interest rates. We invest any excess cash primarily in depository accounts and money market funds, and changes in interest rates would not be material to our financial condition or results of operations. We enter into debt obligations principally to support general corporate purposes, including working capital requirements, capital expenditures and acquisitions. At October 2, 2009, our debt obligations had fixed interest rates.
Based upon rates currently available to us for debt with similar terms and remaining maturities, the carrying amounts of long-term debt approximate their estimated fair value. Although payments under certain of our operating leases for our facilities are tied to market indices, we are not exposed to material interest rate risk associated with our operating leases.
Debt Obligations.
Principal Amounts and Related Weighted-Average Interest Rates By Year of Maturity
Defined Benefit Retirement Plans. Most of our retirement plans, including all U.S.-based plans, are defined contribution plans. However, we also provide defined benefit pension plans in certain countries outside of the U.S. Our obligations under these defined benefit plans will ultimately be settled in the future and are therefore subject to estimation. Defined benefit pension accounting under FASB Accounting Standard Codification (“ASC”) 715-30, Defined Benefit Plans-Pension, is intended to reflect the recognition of future benefit costs over the employees’ estimated service periods based on the terms of the pension plans and the investment and funding decisions made by us.
For our defined benefit pension plans, we make assumptions regarding several variables including the expected long-term rate of return on plan assets and the discount rate in order to determine defined benefit pension plan expense for the year. This expense is referred to as “net periodic pension cost.” We assess the expected long-term rate of return on plan assets and discount rate assumption for each defined benefit plan based on relevant market conditions and make adjustments to the assumptions as appropriate. On an annual basis, we analyze the rates of return on plan assets and discount rates used and determine that these rates are reasonable. For rates of return, this analysis is based on a review of the nature of the underlying assets, the allocation of those assets and their historical performance and expectations relative to relevant markets in the countries where the related plans are effective. Historically, our assumed asset allocations have not varied significantly from the actual allocations. Discount rates are based on the prevailing market long-
term interest rates in the countries where the related plans are effective. As of October 2, 2009, the estimated long-term rate of return on our defined benefit pension plan assets ranged from 0.3% to 6.5% (weighted-average of 5.1%), and the assumed discount rate for our defined benefit pension plan obligations ranged from 1.8% to 5.6% (weighted-average of 5.4%).
If any of these assumptions were to change, our net periodic pension cost would also change. We incurred net periodic pension cost relating to our defined benefit pension plans of $1.4 million in fiscal year 2009, $1.5 million in fiscal year 2008 and $2.3 million in fiscal year 2007, and expect our net periodic pension cost to be approximately $1.2 million in fiscal year 2010. A 100 basis point decrease in the weighted-average estimated return on plan assets or assumed discount rate would increase our net periodic pension cost for fiscal year 2010 by $0.4 million or $0.5 million, respectively. As of October 2, 2009, our projected benefit obligation relating to defined benefit pension plans was $50.6 million. A 100 basis point decrease in the weighted-average estimated discount rate would increase this obligation by $10.3 million.
During fiscal year 2009, the Company ceased future benefit accruals to a defined benefit pension plan in the United Kingdom. In connection with this action, the Company recorded a curtailment loss of $0.1 million during fiscal year 2009.
Item 8.
Item 8. Financial Statements and Supplementary Data
The information required by this Item is submitted as a separate section to this Report. See Item 15 - Exhibits, Financial Statement Schedules.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Disclosure controls and procedures. Based on the evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) required by Rules 13a-15(b) and 15d-15(b) of the Exchange Act, our Chief Executive Officer and the Chief Financial Officer have concluded that as of the end of the period covered by this Annual Report on Form 10-K (October 2, 2009), our disclosure controls and procedures were effective.
Inherent Limitations on the Effectiveness of Controls. Our management, including the Chief Executive Officer and Chief Financial Officer, do not expect that our disclosure controls or our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well designed and operated, can only provide reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that the benefits of controls must be considered relative to their costs. Due to the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision- making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons or by collusion of two or more people. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Management’s annual report on internal control over financial reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act). Our management (including the Chief Executive Officer and the Chief Financial Officer) evaluated the effectiveness of our internal control over financial reporting as of October 2, 2009 based on the framework defined in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation under this framework, our management concluded that our internal control over financial reporting was effective as of October 2, 2009.
Attestation report of independent registered public accounting firm. PricewaterhouseCoopers LLP, the independent registered public accounting firm that audited the consolidated financial statements included in this Annual Report on Form 10-K, has also audited the effectiveness of our internal control over financial reporting as of October 2, 2009, as stated in their attestation report included on page of this Annual Report on Form 10-K.
Changes in internal control over financial reporting. There was no change in our internal control over financial reporting that occurred during our fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The information required by this Item with respect to our executive officers is incorporated herein by reference from the corresponding information contained in Item 1 of Part I of this Report under the heading Executive Officers.
The information required by this Item with respect to our directors and nominees for director is incorporated herein by reference from the corresponding information provided under the heading Proposal One-Election of Directors in our Proxy Statement (or, if our Proxy Statement is not filed with the SEC on or prior to January 30, 2010, will be set forth in an amendment to this Report to be filed on or prior to January 30, 2010).
The information required by this Item with respect to our audit committee financial expert is incorporated herein by reference from the corresponding information provided under the heading Meetings and Committees of the Board-Audit Committee in our Proxy Statement (or, if our Proxy Statement is not filed with the SEC on or prior to January 30, 2010, will be set forth in an amendment to this Report to be filed on or prior to January 30, 2010).
The information required by Item 405 of Regulation S-K is incorporated herein by reference from the corresponding information provided under the heading Section 16(a) Beneficial Ownership Reporting Compliance in our Proxy Statement (or, if our Proxy Statement is not filed with the SEC on or prior to January 30, 2010, will be set forth in an amendment to this Report to be filed on or prior to January 30, 2010).
Our Corporate Governance Guidelines and the charters of the Audit Committee, Compensation Committee, Nominating and Governance Committee and Stock Committee of our Board of Directors are available at our main Internet website, at http://www.varianinc.com, and can be accessed by clicking on “Investors” and then on “Corporate Governance”. Upon request, we will provide to any person, at no charge, a copy of any of these materials. Such a request must be made in writing to our Secretary at Varian, Inc., 3120 Hansen Way, Palo Alto, CA 94304-1030.
We have adopted a code of ethics that applies to our Chief Executive Officer, Chief Financial Officer and Controller. This code of ethics, which is included in our Code of Business Conduct and Ethics that applies to all officers, directors and employees, is posted on our website. The Code of Business Conduct and Ethics may be found as follows:
1.
From our main website, click on “Investors.”
2.
Next, click on “Corporate Governance.”
3.
Finally, click on “Code of Business Conduct and Ethics.”
We intend to satisfy the disclosure requirement under Item 10 of Form 8-K, regarding any amendment to, or waiver from, a provision of this Code of Business Conduct and Ethics with respect to directors and executive officers, by posting such information on our website, at the address and location specified above.
Item 11.
Item 11. Executive Compensation
The information required by this Item is incorporated herein by reference from the corresponding information provided under the headings Executive Compensation Information and Compensation Committee Report in our Proxy Statement (or, if our Proxy Statement is not filed with the SEC on or prior to January 30, 2010, will be set forth in an amendment to this Report to be filed on or prior to January 30, 2010).
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item is incorporated herein by reference from the corresponding information provided under the headings Equity Compensation Plan Information and Stock Ownership of Certain Beneficial Owners in our Proxy Statement (or, if our Proxy Statement is not filed with the SEC on or prior to January 30, 2010, will be set forth in an amendment to this Report to be filed on or prior to January 30, 2010).
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this Item is incorporated herein by reference from the corresponding information provided under the headings Board Structure and Nominees and Related Party Transactions in our Proxy Statement (or, if our Proxy Statement is not filed with the SEC on or prior to January 30, 2010, will be set forth in an amendment to this Report to be filed on or prior to January 30, 2010).
Item 14.
Item 14. Principal Accounting Fees and Services
The information required by this Item with respect to our principal accounting firm is incorporated herein by reference from the corresponding information provided under the heading Proposal Two-Ratification of Appointment of Independent Registered Public Accounting Firm in our Proxy Statement (or, if our Proxy Statement is not filed with the SEC on or prior to January 30, 2010, will be set forth in an amendment to this Report to be filed on or prior to January 30, 2010).
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a)
(1) Consolidated Financial Statements: (see Index on page of this Report)
•
Report of Independent Registered Public Accounting Firm
•
Consolidated Statement of Earnings for fiscal years 2009, 2008 and 2007
•
Consolidated Balance Sheet at fiscal year end 2009 and 2008
•
Consolidated Statement of Stockholders’ Equity and Comprehensive Income for fiscal years 2009, 2008 and 2007
•
Consolidated Statement of Cash Flows for fiscal years 2009, 2008 and 2007
•
Notes to the Consolidated Financial Statements
(2)
Consolidated Financial Statement Schedule: (see Index on page of this Report)
The following Financial Statement Schedule for fiscal years 2009, 2008 and 2007 is filed as a part of this Report and should be read in conjunction with our Consolidated Financial Statements.
All other required schedules are omitted because of the absence of conditions under which they are required or because the required information is given in the Consolidated Financial Statements or the Notes thereto.
(3)
Exhibits
*
Management contract or compensatory plan or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
VARIAN, INC.
(Registrant)
Dated: November 25, 2009
By:
/s/ G. EDWARD MCCLAMMY
G. Edward McClammy
Senior Vice President and Chief
Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
VARIAN, INC. AND SUBSIDIARY COMPANIES
ANNUAL REPORT ON FORM 10-K
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
The following Consolidated Financial Statements of the Registrant and its subsidiaries are required to be included in Item 8:
The following Consolidated Financial Statement Schedule of the Registrant and its subsidiaries for fiscal years 2009, 2008 and 2007 is filed as a part of this Report as required to be included in Item 15(a) and should be read in conjunction with the Consolidated Financial Statements of the Registrant and its subsidiaries:
All other required schedules are omitted because of the absence of conditions under which they are required or because the required information is given in the Consolidated Financial Statements or the Notes thereto.
VARIAN, INC. AND SUBSIDIARY COMPANIES
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Varian, Inc.:
In our opinion, the consolidated financial statements listed under Item 15(a)(1), present fairly, in all material respects, the financial position of Varian, Inc. and its subsidiaries at October 2, 2009 and October 3, 2008, and the results of their operations and their cash flows for each of the three years in the period ended October 2, 2009 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of October 2, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
As discussed in Note 12 to the consolidated financial statements, effective September 28, 2007, the Company adopted ASC 715 and changed its method of accounting for defined benefit plans.
As discussed in Note 15 to the consolidated financial statements, effective September 29, 2007, the Company adopted ASC 740 and changed its method of accounting for uncertainty in income taxes.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PRICEWATERHOUSECOOPERS LLP
PricewaterhouseCoopers LLP
San Jose, California
November 25, 2009
VARIAN, INC. AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF EARNINGS
(In thousands, except per share amounts)
See accompanying Notes to the Consolidated Financial Statements.
VARIAN, INC. AND SUBSIDIARY COMPANIES
CONSOLIDATED BALANCE SHEET
(In thousands, except par value amounts)
See accompanying Notes to the Consolidated Financial Statements.
VARIAN, INC. AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
AND COMPREHENSIVE INCOME
(In thousands)
See accompanying Notes to the Consolidated Financial Statements.
VARIAN, INC. AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
See accompanying Notes to the Consolidated Financial Statements.
VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Description of Business and Basis of Presentation
Varian, Inc., together with its subsidiaries (collectively, the “Company”), designs, develops, manufactures, markets, sells and services scientific instruments (including analytical instruments, research products and related software, consumable products, accessories and services) and vacuum products (and related accessories and services). These businesses primarily serve life science, environmental, energy, and applied research and other customers.
Until April 2, 1999, the business of the Company was operated as the Instruments business of Varian Associates, Inc. (“VAI”). On that date, VAI distributed to the holders of its common stock one share of common stock of the Company and one share of common stock of Varian Semiconductor Equipment Associates, Inc. (“VSEA”), which was formerly operated as the Semiconductor Equipment business of VAI, for each share of VAI (the “Distribution”). VAI retained its Health Care Systems business and changed its name to Varian Medical Systems, Inc. (“VMS”). Transfers made to VMS under the terms of the Distribution are reflected as financing activities in the Consolidated Statement of Cash Flows.
Merger Agreement. On July 26, 2009, the Company, Agilent Technologies, Inc., a Delaware corporation (“Agilent”), and Cobalt Acquisition Corp., a Delaware corporation and a wholly owned subsidiary of Agilent (“Merger Sub”), entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which Merger Sub will, subject to the satisfaction or waiver of the conditions set forth in the Merger Agreement, merge with and into the Company and the Company will survive the merger and continue as a wholly owned subsidiary of Agilent (the “Merger”). Pursuant to the terms of the Merger Agreement and subject to the conditions thereof, at the effective time of the Merger (the “Effective Time”), each share of common stock of the Company issued and outstanding immediately prior to the Effective Time will be converted into the right to receive $52.00 in cash, without interest.
The Company and Agilent have made certain representations, warranties and covenants in the Merger Agreement, including, among others, covenants that, subject to certain exceptions, (i) the Company will conduct its business in the ordinary course consistent with past practice, and refrain from taking specified actions, during the period between the execution of the Merger Agreement and the Effective Time, (ii) the Board of Directors of the Company will recommend to its stockholders adoption of the Merger Agreement, and (iii) the Company will not solicit, initiate, seek or knowingly encourage or facilitate, any inquiry, proposal or offer from, furnish non-public information to, or participate in any discussions with, or enter into any agreement with, any person or group regarding any alternative transaction.
The Merger Agreement contains certain termination rights for both the Company and Agilent and further provides that, upon termination of the Merger Agreement under specified circumstances, the Company may be required to pay Agilent a termination fee of $46 million.
The Boards of Directors of the Company and Agilent approved the Merger and the Merger Agreement. In addition, concurrently with the execution of the Merger Agreement, all directors and certain executive officers of the Company, who together held less than 1% of the Company’s outstanding common stock as of July 26, 2009, entered into voting agreements whereby they agreed among other things to vote all shares of the Company’s common stock held by them in favor of the adoption of the Merger Agreement.
On October 5, 2009, the Company’s stockholders approved the Merger. The Merger remains subject to regulatory approvals and the satisfaction or waiver of certain other closing conditions.
Fiscal Year. The Company’s fiscal years reported are the 52- or 53-week periods that end on the Friday nearest September 30. Fiscal year 2009 was comprised of the 52-week period that ended on October 2, 2009. Fiscal year 2008 was comprised of the 53-week period that ended on October 3, 2008. Fiscal year 2007 was comprised of the 52-week period that ended on September 28, 2007. Each quarter during fiscal years 2009, 2008 and 2007 was comprised of 13 weeks, respectively, except for the fourth quarter of fiscal year 2008, which was comprised of 14 weeks.
VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Principles of Consolidation. The Consolidated Financial Statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates. The preparation of the Consolidated Financial Statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates in these Consolidated Financial Statements include revenue recognition, allowances for doubtful accounts receivable, inventory valuation reserves, share-based compensation, product warranty reserves, environmental liabilities and income taxes. Actual results could differ from these estimates.
Revision of Prior Period Financial Statements. During the fiscal quarter ended July 3, 2009, the Company identified a clerical error related to the calculation of the fiscal year 2008 income tax provision. The impact of this error was an understatement of income tax expense and an overstatement of consolidated net earnings of $1.3 million during the fiscal quarter and fiscal year ended October 3, 2008. The error also resulted in an overstatement of current deferred tax assets and retained earnings of $1.3 million at October 3, 2008, January 2, 2009 and April 3, 2009. The Company assessed the materiality of this error and concluded that the previously issued financial statements are not materially misstated. The Company has corrected the immaterial error by revising the prior period financial statements. Accordingly, the October 3, 2008 consolidated balance sheet and the consolidated statement of earnings and of stockholders’ equity and comprehensive income for the fiscal year ended October 3, 2008 presented herein have been revised to correct for the immaterial error. The revision did not impact net cash provided by operating activities or net cash used in investing activities or financing activities for the fiscal year ended October 3, 2008.
Subsequent Events. In accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 855, Subsequent Events, the Company has evaluated subsequent events through the time the Company’s Consolidated Financial Statements were issued on November 25, 2009.
Note 2. Summary of Significant Accounting Policies
Revenue Recognition. The Company’s revenues are derived from product sales (including accessory sales) and services. For product sales and accessory sales, revenue is recognized when persuasive evidence of an arrangement exists, the contract price is fixed or determinable, the product or accessory has been delivered, title and risk of loss have passed to the customer and collection of the resulting receivable is reasonably assured. Product sales that do not involve unique customer acceptance terms or new specifications or technology with customer acceptance provisions, but that do involve installation services, are accounted for as multiple-element arrangements, where the larger of the contractual billing holdback or the fair value of the installation service is deferred when the product is delivered and subsequently recognized when the installation is complete. For certain other product sales that do involve unique customer acceptance terms or new specifications or technology with customer acceptance provisions, all revenue is deferred until all contractually required customer acceptance provisions and product specifications have been satisfied. In all cases, the fair value of undelivered elements, such as accessories or services purchased by customers in connection with a product sale, is deferred until the related items are delivered to the customer. Revenue related to service contracts is recognized ratably over the term of the contracts. Unearned maintenance and service contract revenue is included in accrued liabilities on the accompanying Consolidated Balance Sheet. Revenue related to incident-based paid service and training services is recognized when the related services are provided to the customer.
Deferred profit on the accompanying Consolidated Balance Sheet is comprised of the profit (revenue less related cost of sales) on certain transactions that has been deferred under the Company’s revenue
VARIAN, INC. AND SUBSIDIARY COMPANIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
recognition policy. Deferred profit relates to transactions in the Company’s Scientific Instruments segment that typically fit one of the following descriptions:
•
A product has been delivered to a customer but revenue cannot yet be recognized, typically due to non-standard specifications or acceptance requirements that have not yet been demonstrated. In these cases, the revenue and related cost of sales that would ordinarily be recorded in the statement of earnings at the time of delivery are instead recorded to deferred profit. This accounting is reversed and the revenue and related cost of sales are recorded in the statement of earnings once the non-standard specifications or acceptance requirements have been demonstrated and all other revenue recognition criteria have been met.
•
A product has been delivered and 100% of the contract value is billable per the terms of the arrangement but post-delivery obligations (e.g., installation) remain. In these cases, revenue equal to the fair value of the post-delivery obligations is deferred and included in deferred profit when the product is delivered. Once the post-delivery obligations have been met, the deferred revenue is reversed out of deferred profit and recorded as revenue in the statement of earnings. Since installation costs are typically not significant relative to total product costs and the time to complete an installation is usually short, the Company rarely needs to defer installation costs associated with deferred installation revenue.
The following table summarizes the components of deferred profit:
In certain other cases, products are delivered but post-delivery obligations (e.g., installation) remain and a portion of the contract value is not billable until such obligations have been met (the “holdback”). In these cases, recognition of revenue equal to the greater of the holdback or the fair value of the undelivered service element is deferred. However, since holdbacks are not billable until the related undelivered element (typically installation) has been delivered, no invoice is issued and no receivable is recorded for the holdback amount and the related revenue is not recorded. Accordingly, deferred revenue relating to holdbacks is not recorded and does not otherwise impact the accompanying Consolidated Balance Sheet.
The Company sells products and accessories predominantly through its direct sales force. As a result, the use of distributors is generally limited to geographic regions where the Company’s direct sales force is less developed. The Company does not normally offer product return or exchange rights (other than those relating to non-conforming or defective goods under warranty) or price protection allowances to its customers, including its distributors. Payment terms granted to distributors are similar to those granted to other customers and payments are not dependent upon the distributors’ receipt of payment from their end-user customers.
The Company’s products are generally subject to warranties and the Company provides for the estimated future costs of repair or replacement in cost of sales at the time the related sale is recognized.
Foreign Currency Translation. The Company uses the local currency as the functional currency in each country in which it operates subsidiaries. The functional currencies of the Company’s operations are primarily the U.S. dollar and the Euro and, to a lesser extent, the British pound, Australian dollar, Japanese yen and various other currencies. Assets and liabilities of foreign subsidiaries are translated into U.S. dollars at exchange rates at the end of the fiscal period and income and expense items are translated at exchange rates prevailing during the period. Translation gains and losses are included in the cumulative translation adjustment component of accumulated other comprehensive income. Gains and losses arising
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from transactions and translation of period-end balances denominated in currencies other than a subsidiary’s functional currency are reflected in selling, general and administrative expenses.
Concentration of Credit Risk. Financial instruments that potentially subject the Company to concentrations of credit risk include cash equivalents, trade accounts receivable and foreign exchange forward contracts. The Company invests primarily in demand deposits, short-term U.S. Treasury securities and money market funds. The Company sells its products and extends trade credit to a large number of customers, who are dispersed across many different industries and geographies. The Company performs ongoing credit evaluations of these customers and generally does not require collateral from them, although the Company does require letters of credit to mitigate credit risk when considered appropriate. As of both October 2, 2009 and October 3, 2008, trade accounts receivable include allowances for doubtful accounts of $1.3 million. Delinquent account balances are written off when management determines that the likelihood of collection is no longer probable. No single customer represented 10% or more of the Company’s total sales in fiscal year 2009, 2008 and 2007 or trade accounts receivable at fiscal year end 2009 or 2008. The Company seeks to minimize credit risk relating to foreign exchange forward contracts by limiting its counter-parties to major financial institutions.
Cash and Cash Equivalents. The Company includes currency on hand, demand deposits, money market funds and all highly liquid debt securities with an original maturity of three months or less in cash and cash equivalents. The cost basis of cash and cash equivalents approximates fair value due to the short period of time to maturity.
Inventories. Inventories are stated at the lower of cost or market, with cost being computed on an average-cost basis. Provisions are made for potentially excess or slow-moving inventories. When a loss provision is made, a new, lower-cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or an increase in that newly established cost basis.
Property, Plant and Equipment. Property, plant and equipment are stated at cost. Major improvements are capitalized, while maintenance and repairs are expensed as incurred. Real property (land) is not depreciated. Plant and equipment are depreciated over their estimated useful lives using the straight-line method. Machinery and equipment lives vary from three to 10 years and buildings are depreciated over 20 to 40 years. Purchased software is depreciated over five to 10 years. Leasehold improvements are depreciated using the straight-line method over their estimated useful lives or the remaining term of the lease, whichever is less. Depreciation expense totaled $19.7 million, $20.8 million and $21.1 million in fiscal years 2009, 2008 and 2007, respectively. When assets are retired or otherwise disposed of, the capitalized costs are removed from the accounts.
Goodwill and Intangible Assets. Under ASC 350-20-35, Intangibles-Goodwill and Other, goodwill is not amortized, but must be tested for impairment annually and whenever events or circumstances occur indicating that goodwill might be impaired. The process of testing goodwill for impairment consists of a two-step process. The first step is the comparison of the fair value to the carrying value of the reporting unit to determine if the carrying value exceeds the fair value. The second step measures the amount of an impairment loss and is only performed if the carrying value exceeds the fair value of the reporting unit. The Company performed annual goodwill impairment tests during the second quarter of fiscal years 2009, 2008 and 2007 and determined that there was no impairment of goodwill.
Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in each business combination. We conducted our annual evaluation of goodwill by reporting unit during the quarter ended April 3, 2009, and concluded that the estimated fair value of Scientific Instruments and Vacuum Technologies reporting units exceeded their carrying value. Determining the fair value of a reporting unit is judgmental in nature and requires the use of significant estimates and assumptions, including revenue growth rates and operating margins, cash flows, discount rates and future market conditions, among others. Unanticipated changes in revenue, gross margin, long-
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term growth factor, cash flows or discount rate could result in a material impact on the estimated fair values of our reporting units. There have been no significant events or circumstances affecting the valuation of goodwill subsequent to the impairment test performed in the second quarter of the fiscal year ended October 2, 2009.
Identifiable intangible assets recorded in connection with acquisitions are amortized on a straight-line basis over their estimated useful lives, which range from two to 20 years. Acquired in-process research and development is immediately expensed.
Investments in Privately Held Companies. The Company has equity investments in privately held companies which, because of its ownership interest and other factors, are carried at cost. These investments are evaluated under applicable guidance to determine the appropriate accounting treatment, including whether the Company must consolidate the investee company. Based on these evaluations, the Company has determined that no consolidation is required. These investments are included in Other assets in the Consolidated Balance Sheet. The Company monitors these investments for impairment and will make appropriate reductions in carrying values if the Company determines that an impairment charge is required based primarily on the near-term prospects and financial condition of these companies.
During fiscal year 2008, the Company became aware of information which raised substantial doubt about the ability of a small, privately held company in which the Company held a cost-method equity investment to continue as a going concern. Based on this information, the Company determined that the fair value of its investment had declined and that the decline was other-than-temporary. As a result, the Company wrote off the entire $3.0 million carrying value of its investment via an impairment charge in the period.
Long-Lived Assets. The Company evaluates the carrying value of long-lived assets whenever events or circumstances indicate that the carrying amount of an asset may not be fully recoverable. All long-lived assets to be disposed of are reported at the lower of carrying amount or fair market value, less expected selling costs.
Share-Based Compensation. The Company accounts for share-based compensation in accordance with the provisions of ASC 718, Stock Compensation, which establishes the accounting for share-based awards and the inclusion of their fair value in net earnings in the respective periods the awards were earned. Consistent with the provisions of ASC 718, the Company estimates the fair value of stock options and shares issued under its employee stock purchase plan using the Black-Scholes option-pricing model. Fair value is estimated on the date of grant and is then recognized (net of estimated forfeitures) as expense in the Consolidated Statement of Earnings over the requisite service period (generally the vesting period).
The determination of fair value and the timing of expense using option pricing models such as the Black-Scholes model require the input of highly subjective assumptions, including the expected forfeiture rate and life of the option and the expected price volatility of the underlying stock. The Company estimates the expected forfeiture and expected life assumptions based on historical experience. In determining the Company’s expected stock price volatility assumption, the Company reviews both the historical and implied volatility of the Company’s common stock, with implied volatility based on the implied volatility of publicly traded options on the Company’s common stock. The Company determines the expected stock price volatility assumption using a combination of historical and implied volatility unless the volume or maturity of these publicly traded options does not satisfy the conditions to use implied volatility. The Company elected to use the practical transition option (also known as the “short-cut” method) to calculate its historical pool of windfall tax benefits. The practical transition option allows the use of a simplified method to establish the beginning balance of the additional paid-in capital pool (the “APIC pool”), which is available to absorb shortfalls when actual tax deductions are less than the related book share-based compensation cost recognized subsequent to the adoption of ASC 718.
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Research and Development. Research and development costs related to both present and future products are expensed as they are incurred.
Advertising Costs. Advertising costs are included as part of selling, general and administrative expense and are expensed as incurred. Advertising expense was $2.7 million in fiscal year 2009, $4.0 million in fiscal year 2008 and $3.2 million in fiscal year 2007.
Income Taxes. The Company recognizes deferred tax assets and liabilities using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that the related tax benefits will not be realized in the future.
The Company accrues income tax liabilities for unrecognized tax benefits resulting from uncertain tax positions by evaluating whether the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit and then measures the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement. The Company reevaluates these uncertain tax positions on a quarterly basis. Potential interest and penalties associated with such uncertain tax positions are recorded as a component of income tax expense.
Recent Accounting Standards. In September 2006, the FASB issued new accounting standards for fair value measurements, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. In February 2008, the FASB delayed the effective date of the new accounting standard for all nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The Company adopted the new accounting standard for fair value measurements effective October 4, 2008 with the exception of the application of the accounting standard to nonrecurring nonfinancial assets and nonfinancial liabilities (see Note 3). The Company does not expect the adoption in the first quarter of fiscal year 2010 of the provisions deferred to have a material impact on its financial condition or results of operations.
In December 2007, the FASB revised the accounting standards for business combinations, which retains the fundamental requirements of the original pronouncement requiring that the purchase method be used for all business combinations but also provides revised guidance for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed, and any noncontrolling interest in the acquiree. It also requires the recognition of assets acquired and liabilities assumed arising from contingencies, the capitalization of in-process research and development at fair value, and the expensing of acquisition-related costs as incurred. It also requires that certain tax contingencies and adjustments to valuation allowances related to business combinations, which previously were adjusted to goodwill, must be adjusted to income tax expense, regardless of the date of the original business combination. This revised accounting standard is effective for fiscal years beginning after December 15, 2008. The Company does not expect its adoption in the first quarter of fiscal year 2010 to have a material impact on the Company’s financial condition or results of operations. However, in the event that the Company completes acquisitions subsequent to its adoption of the new guidance, the application of its provisions will likely have a material impact on the Company’s results of operations, although the Company is not currently able to estimate the impact.
In April 2009, the FASB issued a new standard for business combinations that amends the accounting prescribed for assets and liabilities arising from contingencies in business combinations. This accounting standard requires pre-acquisition contingencies to be recognized at fair value if fair value can be reasonably determined during the measurement period. If fair value cannot be reasonably determined, the accounting standard requires measurement based on the recognition and measurement criteria for contingencies. This accounting standard is effective for fiscal years beginning after December 15, 2008. The Company does not expect its adoption in the first quarter of fiscal year 2010 to have a material impact on the Company’s
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financial condition or results of operations. However, in the event that the Company completes acquisitions subsequent to its adoption, the application of its provisions will likely have a material impact on the Company’s results of operations, although the Company is not currently able to estimate the impact.
In December 2007, the FASB issued a new accounting standard for non-controlling interests in consolidated financial statements, which requires that ownership interests in subsidiaries held by parties other than the parent and the amount of consolidated net income be clearly identified, labeled and presented in the consolidated financial statements. It also requires once a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be initially measured at fair value. Sufficient disclosures are required to clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. This accounting standard is effective for fiscal years beginning after December 15, 2008, and requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements are applied prospectively. The Company does not expect the adoption in the first quarter of fiscal year 2010 of this accounting standard to have a material impact on its financial condition or results of operations.
In April 2008, the FASB issued a new accounting standard for the determination of the useful life of intangible assets, which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The intent of this new accounting standard is to improve the consistency between the useful life of a recognized intangible asset under the guidance for intangible assets and the period of expected cash flows used to measure the fair value of the asset under the guidance for business combinations. This accounting standard is effective for fiscal years beginning after December 15, 2008, and must be applied prospectively to intangible assets acquired after the effective date. Early adoption is prohibited. Given that this applies to intangible assets acquired after the effective date, the Company does not expect its adoption in the first quarter of fiscal year 2010 to have a material impact on its financial condition or results of operations.
In June 2008, the FASB issued a new accounting standard for determining whether instruments granted in share-based transactions are participating securities. This new accounting standard states that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are participating securities and shall be included in the computation of earnings per share under the two-class method described in the guidance for earnings per share. This accounting standard is effective for fiscal years beginning after December 15, 2008, and interim periods within those years, on a retrospective basis. The Company does not expect the adoption in the first quarter of fiscal year 2010 to have a material impact on its earnings per share.
In December 2008, the FASB issued additional disclosure requirements for plan assets of a defined benefit pension or other postretirement plan. The required disclosures include a description of the Company’s investment policies and strategies, the fair value of each major category of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs on changes in plan assets and the significant concentrations of risk within plan assets. These additional disclosures are effective for fiscal years ending after December 15, 2009. The Company does not expect the adoption of the new disclosure requirements to have a material impact on its financial condition or results of operations.
In October 2009, the FASB issued two new accounting standards that provide guidance for revenue recognition. The first standard revises guidance for arrangements with multiple deliverables. This accounting standard replaces the term fair value in the revenue recognition allocation guidance with selling price and establishes a hierarchy for determining the selling price of a deliverable. The selling price of each deliverable will first be based on vendor specific objective evidence (“VSOE”) if available, second on third-party evidence (“TPE”) if VSOE is not available and third on estimated selling price if neither VSOE nor TPE are available. In addition the residual method is no longer permitted as vendors are now required to allocate arrangement consideration using the relative selling price method. The second new accounting
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standard excludes from the scope of software revenue recognition software components contained in, and essential to the functionality of, tangible products. These new accounting standards require expanded qualitative and quantitative disclosures and are effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. The Company does not expect the adoption of these accounting standards in the first quarter of fiscal year 2011 to have a material impact on its financial condition or results of operations.
Note 3. Fair Value Measurements
Effective October 4, 2008 (the first day of fiscal year 2009), the Company adopted ASC 820, Fair Value Measurements and Disclosures. The Company elected to delay applying ASC 820 to certain non-recurring nonfinancial assets and nonfinancial liabilities until fiscal year 2010, as permitted by the guidance.
On the same date, the Company also adopted ASC 825 Financial Instruments, which permits entities to elect, at specified election dates, to measure eligible financial instruments at fair value. Since its adoption of ASC 825, the Company has not elected the fair value option for any financial assets or liabilities that were not previously measured at fair value.
Fair Value Hierarchy. ASC 820 establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs that may be used to measure fair value are:
Level 1-Observable inputs that reflect quoted prices for identical assets or liabilities in active markets.
Level 2-Other inputs that are directly or indirectly observable in the marketplace.
Level 3-Unobservable inputs which are supported by little or no market activity.
As of October 2, 2009, the Company did not have any financial liabilities that were measured at fair value on a recurring basis.
Financial assets measured at fair value on a recurring basis as of October 2, 2009 follow:
The cost basis of cash and cash equivalents approximates fair value due to the short period of time to maturity.
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Note 4. Balance Sheet Detail
Note 5. Forward Exchange Contracts
Effective January 3, 2009 (the first day of the second quarter of fiscal year 2009), the Company adopted ASC 815, Derivatives and Hedging. The adoption of ASC 815 had no financial impact on the Company’s primary financial statements as it only required additional footnote disclosures. The Company has applied the requirements on a prospective basis. Accordingly, disclosures related to periods prior to the date of adoption have not been presented.
The Company enters into foreign exchange forward contracts to minimize the short-term impact of foreign currency fluctuations on the Company’s legal entities’ monetary assets and liabilities denominated in currencies other than their functional currencies. These foreign currency exposures mainly arise from intercompany transactions by and between the parent company and its various foreign subsidiaries. The Company does not designate its forward exchange contracts as hedging instruments, and these contracts do not qualify for hedge accounting treatment.
The Company’s forward exchange contracts generally have maturities of one month or less and are closed out and rolled over into new contracts at the end of each monthly reporting period. Consequently, the fair value of these contracts has historically not been significant at the end of each reporting period. Typically, realized gains and losses on forward exchange contracts, which arise as a result of closing out the contracts at the end of each reporting period, are substantially offset by revaluation losses and gains on the underlying balances denominated in non-functional currencies. However, an inaccurate forecast of foreign currency assets or liabilities, coupled with a currency movement, would result in a gain or loss on a net basis. Gains and losses on forward exchange contracts and from revaluation of the underlying asset and liability balances denominated in non-functional currencies are recognized in the Consolidated Statement of Earnings in selling, general and administrative expenses.
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During fiscal years 2009, 2008 and 2007, the Company recognized net foreign currency (losses) and gains of $(0.4) million, $2.1 million and $(1.0) million, respectively.
Other than foreign exchange forward contracts, the Company has no other freestanding or embedded derivative instruments, although the Company may use other derivative instruments in the future. The Company has not entered into forward exchange contracts for speculative or trading purposes.
As of October 2, 2009, the Company had foreign exchange forward contracts to purchase the U.S. dollar equivalent of $60.6 million and to sell the U.S. dollar equivalent of $11.6 million in various foreign currencies.
Note 6. Acquisitions
During fiscal year 2008, the Company acquired Oxford Diffraction Ltd. (“Oxford Diffraction”) and certain assets and assumed certain liabilities of Analogix, Inc. (the “Analogix Business”), both of which became part of the Scientific Instruments segment. Oxford Diffraction was acquired for an aggregate purchase price of $39.0 million through October 2, 2009. Of this amount, a total of $4.5 million is being held in escrow and is due to be released to the sellers, net of any indemnification claims, during the first quarter of fiscal year 2010. The Analogix Business was acquired for an aggregate purchase price of $13.0 million through October 2, 2009. Of this amount, $1.3 million was retained by the Company and will become payable, net of any indemnification claims, during the first quarter of fiscal year 2010.
None of the acquisitions made during fiscal year 2008 was material on either an individual or an aggregated basis. As a result, pro forma sales, earnings from operations, net earnings and net earnings per share have not been presented. However, the Company’s Consolidated Statement of Earnings for both fiscal years 2009 and 2008 include the results of operations of the acquired companies described above since the effective dates of their respective purchases.
Contingent Consideration Arrangements. The Company is, from time to time, obligated to pay additional cash purchase price amounts in the event that certain financial or operational milestones are met by acquired businesses. As of October 2, 2009, up to a maximum of $10.1 million could be payable through April 2011 under contingent consideration arrangements relating to acquired businesses. Amounts subject to these arrangements can be earned over the respective measurement period, depending on the performance of the acquired business relative to certain financial and/or operational targets.
The following table summarizes contingent consideration arrangements as of October 2, 2009:
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Note 7. Goodwill and Other Intangible Assets
Changes in the carrying amount of goodwill for each of the Company’s reportable segments in fiscal years 2009 and 2008 follow:
The following intangible assets have been recorded and are being amortized by the Company:
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Actual aggregate amortization expense relating to intangible assets recorded in the three most recent fiscal years as well as estimated amortization expense for the next five fiscal years and thereafter follow:
Note 8. Restructuring Costs
Summary of Restructuring Plans. The Company has committed to several restructuring plans in order to improve operational efficiencies, centralize functions, reallocate resources and reduce operating costs.
The following tables set forth changes in the Company’s aggregate liability relating to all ongoing restructuring plans (including the Fiscal Year 2009 Plans described below) during fiscal years 2009, 2008 and 2007 as well as total restructuring expense and other related costs recorded since the inception of those plans:
(1)
These costs related primarily to employee retention and relocation costs and accelerated depreciation of assets disposed upon the closure of facilities. Of the $9.9 million in other related costs, $3.7 million, $3.4 million and $2.0 million was recorded in fiscal years 2009, 2008 and 2007, respectively.
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Fiscal Year 2009 Second Quarter Plan. During the second quarter of fiscal year 2009, the Company committed to a plan to reduce its cost structure, primarily through headcount reductions, due to continuing uncertainties in the global economic environment. The plan primarily involved the elimination of approximately 240 regular employees (primarily in North America and Europe and, to a lesser extent, Asia Pacific and Latin America) and 80 temporary positions in both the Scientific Instruments and Vacuum Technologies segments. In addition, the plan included the closure of one small research and development/manufacturing facility in North America (Lake Forest, California) and two sales offices in Europe (Sweden and Switzerland).
The restructuring costs associated with this plan include one-time termination benefits for employees whose positions were eliminated and lease termination costs on vacated facilities. Other restructuring-related costs include employee retention and relocation costs, facility-related relocation costs and accelerated depreciation of fixed assets to be disposed upon the closure of facilities. These costs are being recorded and included in cost of sales, selling, general and administrative expenses and research and development expenses.
The following table sets forth changes in the Company’s restructuring liability relating to the foregoing plan during fiscal year 2009:
The restructuring expense of $6.1 million recorded during fiscal year 2009 related to employee termination benefits, of which $5.5 million impacted the Scientific Instruments segment and $0.6 million impacted the Vacuum Technologies segment. The $0.9 million in other restructuring-related costs incurred during fiscal year 2009 were comprised of $0.1 million in employee-related costs which impacted the Vacuum Technologies segment and $0.5 million in employee-related costs and a $0.3 million non-cash charge for accelerated depreciation of assets to be disposed upon the closure of facilities, which impacted the Scientific Instruments segment. These costs are expected to be settled by the end of fiscal year 2010.
Fiscal Year 2009 First Quarter Plan. During the first quarter of fiscal year 2009, the Company committed to a separate plan to reduce its employee headcount in order to reduce operating costs and increase margins. The plan involved the termination of approximately 30 employees, mostly located in Europe. The restructuring costs related to this plan primarily consist of one-time termination benefits, which are expected to be settled by the end of fiscal year 2010. This restructuring plan did not involve any non-cash components. Costs relating to restructuring activities recorded under this plan have been included in cost of sales, selling, general and administrative expenses and research and development expenses.
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The following table sets forth changes in the Company’s restructuring liability relating to the foregoing plan during fiscal year 2009:
The restructuring expense of $1.4 million recorded during fiscal year 2009 related to employee termination benefits, of which $1.2 million impacted the Scientific Instruments segment and $0.2 million impacted the Vacuum Technologies segment. The Company also incurred $0.1 million in other employee-related costs during the period which impacted the Scientific Instruments segment.
Fiscal Year 2007 Plan. During fiscal year 2007, the Company committed to a plan to combine and optimize the development and assembly of most of its nuclear magnetic resonance (“NMR”) and mass spectrometry products, to further centralize related administration and other functions and to reallocate certain resources toward more rapidly growing product lines and geographies. As part of the plan, the Company created an information rich detection (“IRD”) center in Walnut Creek, California, where NMR operations that were previously located in Palo Alto, California were integrated with mass spectrometry operations already located in Walnut Creek. The Company is investing in a substantial remodel of an existing building and invested in a new 45,000 square foot building there to house the IRD center.
As a result of the plan, a number of employee positions were relocated or eliminated and certain facilities were consolidated. These actions primarily impacted the Scientific Instruments segment and involved the elimination of between approximately 40 and 60 positions.
Restructuring and other related costs associated with this plan include one-time termination benefits, retention and relocation payments, costs to relocate facilities (including decommissioning costs, moving costs and temporary facility/storage costs), accelerated depreciation of fixed assets to be disposed as a result of facilities actions and lease termination costs. These costs are currently estimated to be between $12.5 million and $15.0 million, of which $1.3 million was incurred in fiscal year 2009, $5.5 million was incurred in fiscal year 2008 and $4.3 million was incurred in fiscal year 2007. The estimated remaining costs are expected to be recorded and settled through the fourth quarter of fiscal year 2010. Costs relating to restructuring activities recorded under this plan have been included in cost of sales, selling, general and administrative expenses and research and development expenses.
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The following table sets forth changes in the Company’s restructuring liability relating to the foregoing plan during fiscal years 2009, 2008 and 2007:
The net reversals of restructuring expense of $1.5 million recorded during fiscal year 2009 related to changes in estimates of certain employee termination benefits and the early cancellation of a lease agreement for a vacated facility. The restructuring charges of $2.1 million and $2.3 million recorded during fiscal years 2008 and 2007, respectively related to employee termination benefits and costs associated with the closure of leased facilities. The Company also incurred other restructuring-related costs of $2.8 million, $3.4 million and $2.0 million during fiscal years 2009, 2008 and 2007, respectively. These costs were related to employee retention costs and facilities-related costs including decommissioning costs and non-cash charges for accelerated depreciation of assets to be disposed upon the closure of facilities.
Note 9. Warranty and Indemnification Obligations
Product Warranties. The Company’s products are generally subject to warranties. Liabilities for the estimated future costs of repair or replacement are established and charged to cost of sales at the time the related sale is recognized. The amount of liability to be recorded is based on management’s best estimates of future warranty costs after considering historical and projected product failure rates and product repair costs. Changes in the Company’s estimated liability for product warranty during fiscal years 2009 and 2008 follow:
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Indemnification Obligations. ASC 460, Guarantees, requires a guarantor to recognize a liability for and/or disclose obligations it has undertaken in relation to the issuance of the guarantee. Under this guidance, arrangements involving indemnification clauses are subject to the disclosure requirements of ASC 460 only.
The Company is subject to certain indemnification obligations to VMS (formerly VAI) and VSEA in connection with the Instruments business as conducted by VAI prior to the Distribution (described in Note 1). These indemnification obligations cover a variety of aspects of the Company’s business, including, but not limited to, employee, tax, intellectual property, litigation and environmental matters. Certain of the agreements containing these indemnification obligations are disclosed as exhibits to the Company’s Annual Report on Form 10-K. The estimated fair value of these indemnification obligations is not considered to be material.
The Company is subject to certain indemnification obligations to Jabil in connection with the Company’s sale of its Electronics Manufacturing Business to Jabil. These indemnification obligations cover certain aspects of the Company’s conduct of the Electronics Manufacturing Business prior to its sale to Jabil, including, but not limited to, employee, tax, litigation and environmental matters. The agreement containing these indemnification obligations is disclosed as an exhibit to the Company’s Annual Report on Form 10-K. The estimated fair value of these indemnification obligations is not considered to be material.
The Company’s By-Laws require it to indemnify its officers and directors, as well as those who act as directors and officers of other entities at the request of the Company, against expenses, judgments, fines, settlements and other amounts actually and reasonably incurred in connection with any proceedings arising out of their services to the Company. In addition, the Company has entered into separate indemnity agreements with each director and officer that provide for indemnification of these directors and officers under certain circumstances. The form of these indemnity agreements is disclosed as an exhibit to the Company’s Annual Report on Form 10-K. The indemnification obligations are more fully described in these indemnity agreements and the Company’s By-Laws. The Company purchases insurance to cover claims or a portion of any claims made against its directors and officers. Since a maximum obligation is not explicitly stated in the Company’s By-Laws or these indemnity agreements and will depend on the facts and circumstances that arise out of any future claims, the overall maximum amount of the obligations cannot reasonably be estimated. Historically, the Company has not made payments related to these indemnification obligations and the estimated fair value of these indemnification obligations is not considered to be material.
As is customary in the Company’s industry and as provided for in local law in the U.S. and other jurisdictions, many of the Company’s standard contracts provide remedies to customers and other third parties with whom the Company enters into contracts, such as defense, settlement or payment of judgment for intellectual property claims related to the use of its products. From time to time, the Company also agrees to indemnify customers, suppliers, contractors, lessors, lessees and others with whom it enters into contracts, against loss, expense and/or liability arising from various triggering events related to the sale and the use of the Company’s products and services, the use of their goods and services, the use of facilities and other matters covered by such contracts, usually up to a specified maximum amount. In addition, from time to time, the Company sometimes also agrees to indemnify these parties against claims related to undiscovered liabilities, additional product liability or environmental obligations. Claims made under such indemnification obligations have been insignificant and the estimated fair value of these indemnification obligations is not considered to be material.
Note 10. Debt and Credit Facilities
Credit Facilities. The Company maintains relationships with banks in many countries from whom it sometimes obtains bank guarantees and short-term standby letters of credit. These guarantees and letters of credit relate primarily to advance payments and deposits made to the Company’s subsidiaries by customers
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for which separate liabilities are recorded in the Consolidated Financial Statements. As of October 2, 2009, a total of $14.5 million of these bank guarantees and letters of credit were outstanding. No amounts had been drawn by beneficiaries under these or any other outstanding guarantees or letters of credit as of that date.
Long-term Debt. As of both October 2, 2009 and October 3, 2008, the Company had an $18.8 million term loan outstanding with a U.S. financial institution at a fixed interest rate of 6.7%. The term loan contains certain covenants that limit future borrowings and the payment of cash dividends and require the maintenance of certain levels of working capital and operating results. The Company was in compliance with all restrictive covenants of the term loan agreement at October 2, 2009.
The following table summarizes future principal payments on borrowings under long-term debt outstanding as of October 2, 2009:
Based upon rates currently available to the Company for debt with similar terms and remaining maturities, the carrying amount of long-term debt approximates the estimated fair value.
Note 11. Operating Lease Commitments
As of October 2, 2009, the Company was committed to minimum rentals for certain facilities and other leased assets under long-term non-cancelable operating leases (net of non-cancelable sublease income) as follows:
Rent expense for fiscal years 2009, 2008 and 2007, was $17.6 million, $17.4 million and $16.1 million, respectively.
Note 12. Retirement Plans
Certain employees of the Company in the U.S. are eligible to participate in the Company’s sponsored, defined contribution retirement plan. For employee contributions made after certain minimum employment conditions have been met, the Company is obligated to match the participant’s contribution up to 6% of their eligible compensation. Participants are entitled, upon termination or retirement, to receive their account balances, which are held by a third-party trustee. The Company has no defined benefit plans in the U.S. In addition to the U.S. retirement plan, a number of the Company’s non-U.S. subsidiaries have retirement plans for regular full-time employees. Although most of the plans are defined contribution plans, several of them are defined benefit plans. Total expenses for all retirement plans amounted to $11.8 million, $13.0 million and $12.5 million for fiscal years 2009, 2008 and 2007, respectively.
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
As of September 28, 2007, the Company adopted the provisions of ASC 715-30, Defined Benefit Plans-Pension. In accordance with this accounting standard, the Company recognizes the funded status of defined benefit postretirement plans (other than multiemployer plans) as an asset or liability in its consolidated balance sheet and recognizes changes in the funded status in the year in which the changes occur through comprehensive income.
The components of the amount recognized in accumulated other comprehensive income at October 2, 2009 and October 3, 2008 were as follows:
The portion of this amount expected to be amortized into net periodic pension cost in fiscal year 2010 is not significant.
Changes in the projected benefit obligation, fair value of plan assets and funded status relating to the Company’s defined benefit pension plans follows:
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Additional information pertaining to the Company’s defined benefit pension plans as of the end of fiscal years 2009 and 2008 is outlined below:
Information relating to defined benefit pension plans with an accumulated benefit obligation in excess of the fair value of plan assets follows:
Net Periodic Pension Cost. Net periodic pension cost for defined benefit pension plans is determined in accordance with ASC 715-30 and is made up of several components that reflect different aspects of the Company’s pension-related financial arrangements and the cost of benefits earned by participating employees. These components are determined using certain actuarial assumptions.
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The components of the Company’s net periodic pension cost relating to defined benefit pension plans and the weighted-average assumptions used to determine that cost follow:
Basis for Assumptions. The Company utilizes yields on country-specific, long-term Corporate AA bond indices (typically 10- or 15-year indices based on the expected timing of benefit payments) as the basis for its discount rate assumptions for each of its defined benefit pension plans. With regard to the expected return assumption, plan assets in most countries are invested in low-risk, long-term fixed income investments such as direct insurance policies and guaranteed insurance contracts. For these asset types, the expected rate of return is established either by reference to yields on comparable long-term corporate bond indices in that country or the return guaranteed by the issuer of the investment security (net of expenses). The exception to this is in the United Kingdom, where the majority of plan assets are invested in equity securities, with the remainder invested typically in corporate bonds, real estate and cash. Due to the nature of these investments, long-term money and corporate bond yields and an implied equity risk premium are considered in establishing the asset return assumption for the defined benefit pension plan in the United Kingdom.
Defined Benefit Pension Plan Curtailment. During fiscal year 2009, the Company ceased future benefit accruals to its defined benefit pension plan in the United Kingdom. In connection with this action, the Company recorded a curtailment loss of $0.1 million during fiscal year 2009.
Employer Contributions. During fiscal year 2009, the Company made contributions totaling approximately $0.7 million to its defined benefit pension plans. The Company currently anticipates contributing an additional $0.3 million to its defined benefit pension plans in fiscal year 2010.
Estimated Future Benefit Payments. As of October 2, 2009, benefit payments, which reflect expected future service (as appropriate), are expected to be as follows:
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Other Postretirement Benefits. At the Distribution (described in Note 1), the Company assumed responsibility for certain post-employment and postretirement benefits for active employees of the Company; the responsibility for all others, principally retirees of VAI, remained with VMS, although the Company is obligated to reimburse VMS for certain costs relating to certain VAI retirees. The Company’s portion of assets and liabilities as well as related expenses for shared post-employment and postretirement benefits have been included in these Consolidated Financial Statements. As of both October 2, 2009 and October 3, 2008, the Company had accrued $0.9 million in current liabilities relating to these obligations. The Company also had accrued $6.4 million as of October 2, 2009 and $5.6 million as of October 3, 2008, in other non-current liabilities relating to these obligations.
Note 13. Contingencies
Environmental Matters. The Company’s operations are subject to various federal, state and local laws in the U.S. as well as laws in other countries regulating the discharge of materials into the environment or otherwise relating to the protection of the environment. These regulations increase the costs and potential liabilities of the Company’s operations. However, the Company does not currently anticipate that its compliance with these regulations will have a material effect on the Company’s capital expenditures, earnings or competitive position.
The Company and VSEA are each obligated (under the terms of the Distribution described in Note 1) to indemnify VMS for one-third of certain costs (after adjusting for any insurance recoveries and tax benefits recognized or realized by VMS for such costs) relating to (a) environmental investigation, monitoring and/or remediation activities at certain facilities previously operated by VAI and third-party claims made in connection with environmental conditions at those facilities, and (b) U.S. Environmental Protection Agency or third-party claims alleging that VAI or VMS is a potentially responsible party under the Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended (“CERCLA”) in connection with certain sites to which VAI allegedly shipped manufacturing waste for recycling, treatment or disposal (the “CERCLA sites”). With respect to the facilities formerly operated by VAI, VMS is overseeing the environmental investigation, monitoring and/or remediation activities, in most cases under the direction of or in consultation with federal, state and/or local agencies, and handling third-party claims. VMS is also handling claims relating to the CERCLA sites.
Various uncertainties make it difficult to estimate future costs for certain of these environmental-related activities, specifically external legal expenses, VMS’ internal oversight costs, third-party claims and a former VAI facility where the likelihood and scope of further environmental-related activities are difficult to assess. As of October 2, 2009, it was nonetheless estimated that the Company’s future exposure for these environmental-related costs ranged in the aggregate from $1.0 million to $2.6 million. The time frame over which these costs are expected to be incurred varies with each type of cost, ranging up to approximately 30 years as of October 2, 2009. No amount in the foregoing range of estimated future costs is discounted, and no amount in the range is believed to be more probable of being incurred than any other amount in such range. The Company therefore had an accrual of $1.0 million as of October 2, 2009 for these future environmental-related costs.
Sufficient knowledge has been gained to be able to better estimate other costs for future environmental-related activities. As of October 2, 2009, it was estimated that the Company’s future costs for these environmental-related activities ranged in the aggregate from $2.6 million to $12.7 million. The time frame over which these costs are expected to be incurred varies, ranging up to approximately 30 years as of October 2, 2009. As to each of these ranges of cost estimates, it was determined that a particular amount within the range was a better estimate than any other amount within the range. Together, these amounts totaled $5.5 million at October 2, 2009. Because both the amount and timing of the recurring portion of these costs were reliably determinable, that portion is discounted at 4%, net of inflation. The Company therefore had an accrual of $4.0 million as of October 2, 2009, which represents its best estimate of these future environmental-related costs after discounting estimated recurring future costs. This accrual is in addition to the $1.0 million described in the preceding paragraph.
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
At October 2, 2009, the Company’s reserve for environmental-related costs, based upon future environmental-related costs estimated by the Company as of that date, was calculated as follows:
The foregoing amounts 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, monitoring and remediation activities and the large number of sites where such investigation, monitoring and remediation activities are being undertaken.
The Company has not reduced any environmental-related liability in anticipation of recoveries from third parties. However, an insurance company has agreed to pay a portion of certain of VAI’s (now VMS’) future environmental-related costs, for which the Company has an indemnification obligation, and the Company therefore has a long-term receivable of $1.0 million (discounted at 4%, net of inflation) in Other assets as of October 2, 2009, for the Company’s share of that insurance recovery.
The Company believes that its reserves for the foregoing and other environmental-related matters are adequate, but as the scope of its obligation becomes more clearly defined, these reserves may be modified and related charges against or credits to earnings may be made. Although any ultimate liability arising from environmental-related matters could result in significant expenditures that, if aggregated and assumed to occur within a single fiscal year, would be material to the Company’s financial statements, the likelihood of such occurrence is considered remote. Based on information currently available and its best assessment of the ultimate amount and timing of environmental-related events, the Company believes that the costs of environmental-related matters are not reasonably likely to have a material adverse effect on the Company’s financial condition or results of operations.
Legal Proceedings. The Company is involved in pending legal proceedings that are ordinary, routine and incidental to its business. While the ultimate outcome of these legal matters is not determinable, the Company believes that these matters are not reasonably likely to have a material adverse effect on the Company’s financial condition or results of operations.
Note 14. Stockholders’ Equity
Stock Rights, Stock Plans and Stock Repurchase Programs
On April 2, 1999, stockholders of record of VAI on March 24, 1999 received in the Distribution (described in Note 1) one share of the Company’s common stock for each share of VAI common stock held on April 2, 1999. Each stockholder also received one preferred stock purchase right (“Right”) for each
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
share of common stock distributed, entitling the stockholder to purchase one one-thousandth of a share of Participating Preferred Stock, par value $0.01 per share, for $200.00 (subject to adjustment), in the event of certain changes in the Company’s ownership. The Participating Preferred Stock was designed so that each one one-thousandth of a share had economic and voting terms similar to those of one share of common stock. During the second quarter of fiscal year 2009, the Rights expired. As of April 2, 2009, when the Rights had expired, no Rights were eligible to be exercised and none had been exercised through that date.
Omnibus Stock Plan. Effective April 2, 1999, the Company adopted the Omnibus Stock Plan (“OSP”) under which shares of common stock can be issued to officers, directors and employees. The OSP has been approved by the Company’s stockholders and is administered by the Compensation Committee of the Company’s Board of Directors. At October 2, 2009, a total of 3,656,000 shares were available for issuance under the OSP.
Employee Stock Purchase Plan. During fiscal year 2000, the Company’s Board of Directors approved the Employee Stock Purchase Plan (“ESPP”), which was approved by the Company’s stockholders in February 2003. Under the ESPP, eligible Company employees may set aside, through payroll deductions, between 1% and 10% of eligible compensation for purchases of the Company’s common stock. The participants’ purchase price is the lower of 85% of the stock’s market value on the enrollment date or 85% of the stock’s market value on the purchase date. Prior to fiscal year 2006, enrollment dates occurred every six months and purchase dates occurred each quarter. Beginning in fiscal year 2006, the Company reduced the length of each offering period under its ESPP from six months to three months. At October 2, 2009, a total of 46,000 shares were available for issuance under the ESPP.
Stock Repurchase Programs. In February 2008, the Company’s Board of Directors approved a new stock repurchase program under which the Company was authorized to utilize up to $100 million to repurchase shares of its common stock. This repurchase program is effective through December 31, 2009. During fiscal year 2009, the Company repurchased and retired 344,000 shares under this authorization at an aggregate cost of $7.1 million. During fiscal year 2008, the Company repurchased and retired 1,070,000 shares under this authorization at an aggregate cost of $55.4 million. As of October 2, 2009, the Company had remaining authorization to repurchase $37.5 million of its common stock under this program. However, under the terms of the Merger Agreement with Agilent, the Company is generally prohibited from repurchasing any shares of its common stock without the prior consent of Agilent.
In January 2007, the Company’s Board of Directors approved a stock repurchase program under which the Company is authorized to utilize up to $100 million to repurchase shares of its common stock. This repurchase program was effective through December 31, 2008. During fiscal year 2008, the Company repurchased and retired 876,000 shares under this authorization at an aggregate cost of $50.4 million, which completed this repurchase program. During fiscal year 2007, the Company repurchased and retired 862,000 shares under this authorization at an aggregate cost of $49.6 million.
In November 2005, the Company’s Board of Directors approved a stock repurchase program under which the Company was authorized to utilize up to $100 million to repurchase shares of its common stock. This repurchase program was effective through September 30, 2007. During fiscal year 2007, the Company repurchased and retired 820,000 shares under this authorization at an aggregate cost of $37.0 million, which completed this repurchase program.
Other Stock Repurchases. During both fiscal years 2009 and 2008, the Company repurchased and retired approximately 16,000 shares tendered to it by employees in settlement of employee tax withholding obligations due from those employees upon the vesting of restricted stock in each of those respective periods.
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Share-Based Compensation
Stock Options. Under the OSP, the Company periodically grants stock options to officers, directors and employees. The exercise price for stock options granted under the OSP may not be less than 100% of the fair market value at the date of the grant. Options granted are exercisable at the times and on the terms established by the Compensation Committee of the Company’s Board of Directors, but not later than ten years after the date of grant (except in the event of death, after which an option is exercisable for three years). Stock Options generally vest in three equal annual installments over three years from the grant date.
The following table summarizes stock option activity under the OSP for the periods indicated:
(1)
After estimated forfeitures.
The intrinsic value of options exercised in fiscal years 2009, 2008 and 2007 was $2.1 million, $11.4 million and $26.2 million, respectively.
Share-based compensation expense related to stock options was $4.8 million, $5.5 million and $6.7 million in fiscal years 2009, 2008 and 2007, respectively. As of October 2, 2009, the unrecognized share-based compensation balance related to stock options was $3.3 million. This amount will be recognized as expense using the straight-line attribution method over the remaining weighted-average amortization period of 1.2 years.
Restricted (Nonvested) Stock. Under the OSP, the Company also periodically grants restricted (nonvested) common stock to employees. Such grants are valued using the quoted market value of the underlying common stock as of the grant date. The fair value of these shares is then recognized by the Company as share-based compensation expense ratably over their respective vesting periods, which range from one to three years.
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table summarizes restricted (nonvested) common stock activity under the OSP for the periods indicated:
(1)
Includes 63,000 shares for which vesting is subject to both a performance condition and continued service.
(2)
Includes shares tendered to the Company by employees in settlement of employee tax withholding obligations.
The fair value of restricted stock that vested in fiscal years 2009 and 2008 was $2.1 million and $2.8 million, respectively. There was no restricted stock that vested in fiscal year 2007.
Share-based compensation expense related to restricted (nonvested) common stock was $1.9 million, $2.9 million and $2.2 million in fiscal years 2009, 2008 and 2007, respectively. As of October 2, 2009, there was $2.9 million of total unrecognized compensation expense related to restricted (nonvested) common stock granted under the OSP. This expense is expected to be recognized over a weighted-average period of 2.0 years.
Performance Shares. During fiscal year 2008, the Company implemented a long-term performance share program. Under this program, vested shares of the Company’s common stock could be granted under the OSP to certain key employees, depending on the Company’s performance relative to pre-determined long-term earnings per share targets.
As of October 2, 2009, targeted performance shares had been awarded for two performance periods, key aspects of which are summarized below:
As of October 2, 2009, no performance share awards were earned or were expected to be earned based on the pre-determined criteria and no share based compensation expense related to these performance shares has been recognized in fiscal years 2009 or 2008.
Non-Employee Director Stock Units. Under the terms of the OSP, on the first business day following each annual meeting of the Company’s stockholders, each person then serving as a non-employee director is automatically granted stock units having an initial value of $45,000 beginning in fiscal year 2008 and $25,000 prior to fiscal year 2008. The stock units will vest upon termination of the director’s service on the Board of Directors and will then be satisfied by issuance of shares of the Company’s common stock. Each non-employee director who holds stock units does not have rights as a stockholder with respect to the
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
shares issuable thereunder until such shares are paid out. The stock units are not transferable, except to the non-employee director’s designated beneficiary or estate in the event of his or her death. During both fiscal years 2009 and 2008, the Company granted stock units with an aggregate value of $225,000 to non-employee members of its Board of Directors (of which there were five) and recognized the total value of $225,000 as share-based compensation expense at the time of grant in each of those respective periods. During fiscal year 2007, the Company granted stock units with an aggregate value of $125,000 to non-employee members of its Board of Directors (of which there were five) and recognized the total value of $125,000 as share-based compensation expense at the time of grant.
Employee Stock Purchase Plan. Under the ESPP, employees purchased 142,200 shares for $3.6 million, 79,100 shares for $3.9 million and 96,600 shares for $3.8 million, during fiscal years 2009, 2008 and 2007, respectively.
During fiscal year 2009, the weighted-average estimated fair value of the option to purchase a share of the Company’s common stock under the ESPP was $5.98 per share for offering periods during the year. During fiscal year 2008, the weighted-average estimated fair value of the option to purchase a share of the Company’s common stock under the ESPP was $13.88 per share for offering periods during the year. During fiscal year 2007, the weighted-average estimated fair value of the option to purchase a share of the Company’s common stock under the ESPP was $10.87 per share for offering periods during the year.
Share-Based Compensation Expense. The following table summarizes the amount of share-based compensation expense by award type as well as the effect of this expense on income tax expense and net earnings:
Share-based compensation expense included in the preceding table related to restricted (non-vested) stock includes $238,000, $332,000 and $128,000 in fiscal years 2009, 2008 and 2007, respectively, related to shares granted in connection with the Company’s fiscal year 2007 restructuring plan.
Share-based compensation expense recorded has been included in the Company’s Consolidated Statement of Earnings as follows:
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Capitalizable share-based compensation expense relating to inventory or deferred cost of sales (a component of deferred profit) was not significant at October 2, 2009, October 3, 2008 and September 28, 2007.
Valuation Assumptions. The Company estimates the fair value of employee stock options granted under the OSP and shares issued under the ESPP using the Black-Scholes option-pricing model. The fair value of each option grant under the OSP and each share issuance under the ESPP was estimated on the date of grant using the Black-Scholes model with the following weighted-average assumptions:
Option-pricing models require the input of highly subjective assumptions, including the expected forfeiture rate and life of the option and the expected price volatility of the underlying stock. The Company estimates the expected forfeiture and expected life assumptions based on historical experience. In determining the Company’s expected stock price volatility assumption, the Company reviews both the historical and implied volatility of the Company’s common stock, with implied volatility based on the implied volatility of publicly traded options on the Company’s common stock. The Company determines the expected stock price volatility assumption using a combination of historical and implied volatility unless the volume or maturity of these publicly traded options does not satisfy the conditions to use implied volatility. The expected stock price volatility assumption for fiscal years 2009 and 2008 was determined using only the historical volatility of the Company’s common stock. For fiscal year 2007, the expected stock price volatility assumption was determined using a combination of the historical and implied volatility of the Company’s common stock.
Note 15. Income Taxes
The sources of earnings before income taxes follow:
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Income tax expense on earnings consists of the following:
Deferred tax assets and liabilities are recognized for the temporary differences between the tax basis and reported amounts of assets and liabilities, and tax loss and credit carry-forwards. Their significant components follow:
As of October 2, 2009, the Company’s foreign manufacturing and sales subsidiaries had accumulated approximately $151 million of earnings that have been reinvested in their operations. The Company has not provided U.S. tax on these earnings. Determination of the amount of unrecognized deferred tax liability on such earnings is not practicable.
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
As of October 2, 2009, the Company had a U.S. foreign tax credit carry-forward of approximately $1.9 million that expires in 2019. If realized, all of this carry-forward will be accounted for as a credit to stockholders’ equity. None of this carry-forward has been recognized as a deferred tax asset.
As of October 2, 2009, the Company had U.S. federal research and development credit carry-forwards of approximately $1.5 million that begin to expire in 2028 and have been recognized as a deferred tax asset.
As of October 2, 2009, the Company had foreign loss carry-forward of approximately $0.7 million that have been recognized as deferred tax assets. A full valuation allowance has been provided on this loss carry-forward.
The difference between the reported income tax rate on earnings before income taxes and the federal statutory income tax rate is attributable to the following:
In fiscal years 2009 and 2008, accumulated other comprehensive income was increased approximately $0.4 million and decreased approximately $0.6 million, respectively, due to the tax benefit of certain postretirement liabilities recognized during those periods.
Effective September 29, 2007 (the first day of fiscal year 2008), the Company adopted ASC 740, Income Taxes, which addresses accounting for, and disclosure of, uncertain tax positions. ASC 740 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. As a result of the adoption of ASC 740, the Company reduced its liability for unrecognized tax benefits and increased deferred tax assets by $2.4 million and $0.6 million, respectively. These adjustments were aggregated and accounted for as a cumulative effect of a change in accounting principle, which resulted in an increase to retained earnings of $3.0 million. In addition, the Company reclassified certain tax liabilities for unrecognized tax benefits, as well as related potential penalties and interest, from current liabilities to long-term liabilities. The total amount of unrecognized tax benefits excluding interest thereon as of the date of adoption was $6.9 million, substantially all of which would impact the effective tax rate if realized. The Company’s policy to include interest and penalties related to income taxes within income tax expense did not change as a result of implementing ASC 740. As of the date of adoption of ASC 740, the Company had accrued $0.7 million in income taxes payable for the payment of interest and penalties related to unrecognized tax benefits.
At October 2, 2009, the total amount of unrecognized tax benefits excluding interest thereon was $5.4 million, substantially all of which would impact the effective tax rate if realized during the year. The Company accrued $0.2 million and reversed $0.3 million of interest and penalties related to these unrecognized tax benefits during fiscal year 2009. Income taxes payable at October 2, 2009 included accrued interest and penalties of $0.4 million. Although the timing and outcome of income tax audits is highly uncertain, it is possible that certain unrecognized tax benefits could decrease by up to $0.9 million in the next twelve months due to lapse of certain statutes of limitation. Any such reduction could be impacted by other changes in unrecognized tax benefits.
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table summarizes the activity related to unrecognized tax benefits:
The Company’s U.S. federal, state and local and foreign income tax returns are subject to audit by relevant tax authorities. During fiscal year 2008, the U.S. Internal Revenue Service closed its examination of the Company’s fiscal year 2003 federal tax return without assessing additional tax. The Company’s income tax reporting periods beginning with fiscal year 2006 for the U.S. and fiscal year 2004 for the Company’s major foreign jurisdictions remain generally open to audit by relevant tax authorities.
See Note 1 discussing the revision of the fiscal year 2008 income tax expense and related deferred tax asset that is reflected in the above footnote.
Note 16. Net Earnings Per Share
Basic earnings per share are calculated based on net earnings and the weighted-average number of shares of common stock outstanding during the reported period. Diluted earnings per share are calculated similarly, except that the weighted-average number of common shares outstanding during the period is increased by the number of additional shares of common stock that would have been outstanding if the dilutive potential shares of common stock had been issued. The dilutive effect of potential common stock (including outstanding stock options, unvested restricted stock and non-employee director stock units) is reflected in diluted earnings per share by application of the treasury stock method, which includes consideration of share-based compensation and the tax benefit thereon.
In fiscal years 2009, 2008 and 2007, options to purchase approximately 1,635,000, 255,000 and 10,000 shares, respectively, were excluded from the calculation of diluted earnings per share as their effect was anti-dilutive.
A reconciliation of weighted-average basic shares outstanding to weighted-average diluted shares outstanding follows:
Note 17. Industry and Geographic Segments
Industry Segments. For financial reporting purposes, the Company’s operations are grouped into two business segments: Scientific Instruments and Vacuum Technologies. The Scientific Instruments segment designs, develops, manufactures, markets, sells and services equipment and related software, consumable products, accessories and services for a broad range of life science, environmental, energy, and applied
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
research and other applications requiring identification, quantification and analysis of the composition or structure of liquids, solids or gases. The Vacuum Technologies segment designs, develops, manufactures, markets, sells and services vacuum products and related accessories and services used to create, contain, control, measure and test vacuum environments in a broad range of life science, environmental, energy, and applied research and other applications requiring ultra-clean or high-vacuum environments. These segments were determined in accordance with ASC 280, Segment Reporting.
General corporate costs include shared costs of legal, tax, accounting, treasury, insurance and certain other management costs. A portion of the indirect and common costs has been allocated to the segments through the use of estimates. Also, transactions between segments are accounted for at cost and are not included in sales. Accordingly, the following information is provided for purposes of achieving an understanding of operations, but might not be indicative of the financial results of the reported segments were they independent organizations. In addition, comparisons of the Company’s operations to similar operations of other companies might not be meaningful.
The Company operates various manufacturing and marketing operations outside of the U.S. In fiscal years 2009, 2008 and 2007, no single country outside of the U.S. accounted for more than 10% of total sales (based on the geographic location of the customer). Except for the United Kingdom, no single country outside the U.S. accounted for more than 10% of total assets in fiscal years 2009, 2008 and 2007. Transactions between geographic areas are accounted for at cost and are not included in sales.
Included in the total of Other international sales are export sales recorded by U.S. entities of $47 million in fiscal year 2009, and $53 million in both fiscal years 2008 and 2007.
Industry Segments
Geographic Information
(1)
Sales to unaffiliated customers are generally reported based on the geographic location of the customer. No single customer accounted for more than 10% of sales in any of the fiscal years presented.
(2)
Excludes goodwill, intangible assets and long-term deferred tax assets.
(3)
Identifiable asset amounts are included in Other international amounts as they are not individually material.
SCHEDULE II
VARIAN, INC. AND SUBSIDIARY COMPANIES
VALUATION AND QUALIFYING ACCOUNTS
for fiscal years 2009, 2008 and 2007
(In thousands)
VARIAN, INC. AND SUBSIDIARY COMPANIES
Quarterly Consolidated Financial Data (Unaudited)
Amounts for each quarterly period in fiscal years 2009 and 2008 follow:
Net earnings per share for the four quarters of each fiscal year may not sum to the total for the fiscal year because of the different number of shares outstanding during each period.
EXHIBIT INDEX
*
Management contract or compensatory plan or arrangement.