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<SEC-DOCUMENT>0001012870-98-003275.txt : 19990101
<SEC-HEADER>0001012870-98-003275.hdr.sgml : 19990101
ACCESSION NUMBER: 0001012870-98-003275
CONFORMED SUBMISSION TYPE: 10-K405
PUBLIC DOCUMENT COUNT: 7
CONFORMED PERIOD OF REPORT: 19981002
FILED AS OF DATE: 19981231
FILER:
COMPANY DATA:
COMPANY CONFORMED NAME: VARIAN ASSOCIATES INC /DE/
CENTRAL INDEX KEY: 0000203527
STANDARD INDUSTRIAL CLASSIFICATION: SPECIAL INDUSTRY MACHINERY, NEC [3559]
IRS NUMBER: 942359345
STATE OF INCORPORATION: DE
FISCAL YEAR END: 0930
FILING VALUES:
FORM TYPE: 10-K405
SEC ACT:
SEC FILE NUMBER: 001-07598
FILM NUMBER: 98779036
BUSINESS ADDRESS:
STREET 1: 3050 HANSEN WAY
STREET 2: MAIL STOP E 224
CITY: PALO ALTO
STATE: CA
ZIP: 94304-1000
BUSINESS PHONE: 6504934000
MAIL ADDRESS:
STREET 1: 3050 HANSEN WAY
STREET 2: MAIL STOP E 224
CITY: PALO ALTO
STATE: CA
ZIP: 94304-1000
FORMER COMPANY:
FORMER CONFORMED NAME: VARIAN DELAWARE INC
DATE OF NAME CHANGE: 19761123
</SEC-HEADER>
<DOCUMENT>
<TYPE>10-K405
<SEQUENCE>1
<DESCRIPTION>FORM 10-K405
<TEXT>
<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED OCTOBER 2, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 1-7598
EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER:
VARIAN ASSOCIATES, INC.
STATE OR OTHER JURISDICTION OF IRS EMPLOYER
INCORPORATION OR ORGANIZATION: IDENTIFICATION NO.:
DELAWARE 94-2359345
ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES:
3050 HANSEN WAY, PALO ALTO, CALIFORNIA 94304-1000
(650) 493-4000
SECURITIES REGISTERED PURSUANT TO SECTION 12(B)OF THE ACT:
<TABLE>
<CAPTION>
TITLE OF EACH
CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------- -----------------------------------------
<S> <C>
COMMON STOCK, NEW YORK STOCK EXCHANGE
$1 PAR VALUE PACIFIC EXCHANGE
PREFERRED STOCK NEW YORK STOCK EXCHANGE
PURCHASE RIGHTS PACIFIC EXCHANGE
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(G)OF THE ACT:
NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incoporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the registrant's common stock held by non-
affiliates as of December 15, 1998 was $1,060,660,000.
The number of shares of the registrants's common stock outstanding as of
December 15, 1998 was 29,909,061 shares of $1 par value common stock.
An index of exhibits filed with this Form 10-K is located on page 38.
<TABLE>
<CAPTION>
DOCUMENTS INCORPORATED BY REFERENCE:
------------------------------------
DOCUMENT DESCRIPTION 10-K PART
- -------------------- ---------
<S> <C>
Certain sections, identified by caption, of the Definitive Proxy
Statement for the Registrant's 1999 Annual Meeting of Stockholders
(the "Proxy Statement")............................................ III
</TABLE>
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<PAGE>
VARIAN ASSOCIATES, INC
FORM 10-K
FOR THE FISCAL YEAR ENDED OCTOBER 2, 1998
TABLE OF CONTENTS
<TABLE>
<S> <C> <C>
PART I
Item 1. Business ............................................................................... 1
Item 2. Properties.............................................................................. 24
Item 3. Legal Proceedings ...................................................................... 24
Item 4. Submission of Matters to a Vote of Security Holders .................................... 24
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters .............. 25
Item 6. Selected Financial Data ................................................................ 25
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations .. 26
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.............................. 34
Item 8. Financial Statements and Supplementary Data ............................................ 36
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ... 36
PART III
Item 10. Directors and Executive Officers of the Registrant ..................................... 37
Item 11. Executive Compensation ................................................................. 37
Item 12. Security Ownership of Certain Beneficial Owners and Management.......................... 37
Item 13. Certain Relationships and Related Transactions ......................................... 37
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........................ 37
</TABLE>
<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL
OVERVIEW
Varian Associates, Inc. together with its subsidiaries (hereinafter referred
to as "Varian," the "Company" or the "Registrant") is a high-technology
enterprise that was incorporated in 1948. It is engaged in the research,
development, manufacture, and marketing of products and services for health
care, scientific and industrial research, environmental monitoring and
semiconductor fabrication. The Company's principal business segments are health
care systems, instruments, and semiconductor equipment. Its foreign
subsidiaries engage in one or more of the aforementioned businesses and market
the Company's products outside the United States.
The Company sells its products throughout the world and has 30 field sales
offices in the United States and 68 sales offices in other countries. In
general, its markets are quite competitive, characterized by the application of
advanced technology and by the development of new products and applications.
Many of the Company's competitors are large, well-known manufacturers, but
there is no competitor that competes across all of the Company's segments.
Additional information regarding the Company's competitors is set forth under
the headings "The Instruments Business," "The Semiconductor Equipment
Business," and "The Health Care Systems Business" in this Part I.
There were no material changes in the kinds of products produced or in the
methods of distribution since the beginning of the fiscal year. The Company
anticipates adequate availability of raw materials. Additional information
regarding the Company's products, methods of distribution and availability of
raw materials is set forth under the headings "The Instruments Business," "The
Semiconductor Equipment Business," and "The Health Care Systems Business" in
this Part I.
The Company's operations are subject to various federal, state and/or local
laws regulating the discharge of materials into the environment or otherwise
relating to the protection of the environment. The Company is also involved in
various stages of environmental investigation and/or remediation under the
direction of or in consultation with federal, state, and/or local agencies at
certain current or former Company facilities (see Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Environmental Matters" herein and "Contingencies," in the Notes to the
Consolidated Financial Statements for additional information).
The Company's operations are grouped into three segments, the Instruments
business ("IB"), the Semiconductor Equipment business ("SEB"), and the Health
Care Systems business ("HCS"). These segments, their products, and the markets
they serve are described under the headings "The Instruments Business," "The
Semiconductor Equipment Business," and "The Health Care Systems Business" in
this Part I.
INTERNATIONAL SALES
The Company's sales to customers outside of the United States were $767
million for fiscal year 1998, 54% of total Company sales. International sales
were $720 million for fiscal year 1997, 50% of total sales and $918 million for
fiscal year 1996, 57% of total Company sales. Additional information regarding
the Company's sales to customers outside of the United States is set forth
under the headings "The Instruments Business," "The Semiconductor Equipment
Business," and "The Health Care Systems Business" in this Part I. The
profitability of such sales is subject to greater fluctuation than U.S. sales
because of generally higher marketing costs and changes in the relative value
of currencies. Additional information concerning the method of accounting for
Varian's foreign currency translation is set forth under the headings "Foreign
Currency Translation" and "Forward Exchange Contracts," in the Notes to the
Consolidated Financial Statements. No single customer accounted for 10% or more
of the Company's sales in fiscal year 1998.
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RESEARCH AND DEVELOPMENT
The Company is actively engaged in basic and applied research, development
and engineering programs designed to develop new products and to improve
existing products. During fiscal years 1998, 1997 and 1996, the Company spent
$107 million, $111 million and $110 million, respectively (net of customer
funding), on company-sponsored research, development and engineering
activities. Although the Company intends to continue extensive research and
development activities, there can be no assurance that it 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
Varian's existing technology will not be superceded by new discoveries or
developments. Information regarding Varian's research and development costs is
provided under the heading "Research and Development," in the Notes to the
Consolidated Financial Statements.
PATENT AND OTHER PROPRIETARY RIGHTS
The Company employs in-house patent attorneys, holds numerous patents in the
United States and in other countries, and has many patent applications pending
in the United States and in other countries. The Company considers the
development of patents through creative research and the maintenance of an
active patent program to be advantageous in the conduct of its business, but
does not regard the holding of any particular patent as essential to its
operations. The Company grants licenses to reliable manufacturers on various
terms and enters into cross-licensing arrangements with other parties.
Information regarding the Company's patents is provided under the headings "The
Instruments Business," "The Semiconductor Equipment Business," and "The Health
Care Systems Business" in this Part I.
EMPLOYEES
At October 2, 1998, Varian had approximately 6,900 employees worldwide
located in North America, Western Europe, Asia, Australia and Latin America.
None of the Company's employees based in the United States is subject to
collective bargaining agreements. The Company's employees based in certain
foreign countries may, from time to time, be subject to collective bargaining
agreements. Varian employees based in Australia conducted a strike in 1997,
which was quickly resolved. Those employees are subject to a collective
bargaining agreement that is scheduled for renewal in early 1999. Varian
currently considers its employee relations to be good.
Varian's success depends to a significant extent upon a limited number of key
employees and other members of senior management of the Company. The loss of
the service of one or more of these key employees could have a material adverse
effect on the Company. The success of Varian's future operations depends in
large part on the Company's ability to recruit and retain engineers and
technicians, as well as marketing, sales, service and other key personnel, who
in each case are in great demand. The Company's inability to attract and retain
the personnel it requires could have a material adverse effect on the Company's
results of operations.
SALE OF BUSINESS
Effective in June 1997, SEB completed the sale of its Thin Film Systems
("TFS") business. Total proceeds received from the sale were $145.5 million in
cash. A $51.5 million reserve was recorded to cover, among other items,
purchase price disputes, retained liabilities, transaction costs, employee
terminations, facilities separation costs, indemnification obligations,
litigation expense and other contingencies. The gain on the sale was $33.2
million (net of income taxes of $17.8 million).
2
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RECENT DEVELOPMENTS
On August 21, 1998, the Company's Board of Directors approved the development
of a detailed plan to reorganize the Company's core businesses into three
separate companies by spinning off IB and SEB to stockholders through a tax-
free distribution (the "Distribution"). The final plan is subject to
stockholder approval as well as a favorable ruling from the U.S. Internal
Revenue Service confirming the tax-free nature of the proposed spin-offs for
the Company and its stockholders. The Company expects to complete the
reorganization by the end of fiscal year 1999. Management estimates that one-
time net cash outlays of approximately $50 million will be required to complete
this reorganization.
While the capital structures of the three separate companies have not been
determined, it is expected that, upon consummation of the spin-off, each of HCS
and IB will have between $50 and $100 million of outstanding indebtedness under
the Company's term loans and notes payable, and that the Company will
contribute cash to SEB so that SEB will have approximately $100 million in cash
and cash equivalents and consolidated debt not exceeding $5 million.
This Annual Report on Form 10-K presents information with respect to the
business of the Company as a whole. In connection with the Distribution, a
Proxy Statement is being mailed to the stockholders of the Company, which
contains detailed information with respect to each of IB, SEB, and HCS under
the headings "Business of IB," "Business of SEB," and "Business of HCS."
Information regarding the Company's lines of business and international
operations is provided under the headings "The Instruments Business," "The
Semiconductor Equipment Business," and "The Health Care Systems Business" in
this Part I, and under the headings "Industry Segments," and "Geographic
Segments," in the Notes to the Consolidated Financial Statements.
THE INSTRUMENTS BUSINESS
OVERVIEW
IB develops, manufactures, sells and services a variety of scientific
instruments and equipment. IB is a major supplier of analytical and research
instruments and related equipment for studying the chemical composition of
myriad substances, including metals, inorganic materials, organic compounds,
polymers, natural substances and biochemicals. IB also develops, manufactures,
sells and services nuclear magnetic resonance spectrometers for probing the
structural properties of molecules and for producing non-invasive three-
dimensional images of biomedical materials. IB also develops, manufactures,
sells and services high vacuum products that serve a wide range of industrial
and scientific applications, such as high-energy physics, surface analysis,
scientific and industrial coating processes, analytical instrumentation and
semiconductor manufacturing. IB is also a state-of-the-art contract
manufacturer of advanced electronic assemblies and subsystems such as printed
circuit boards.
PRODUCTS
IB's products can be broadly classified into the following categories:
analytical instruments, nuclear magnetic resonance instruments, vacuum products
and electronic components assembly.
Analytical Instruments
Analytical Instruments includes Chromatography Systems and Optical
Spectroscopy Instruments operations, which manufacture liquid and gas
chromatographs, gas chromatograph/mass spectrometers, ultraviolet/visible/near-
infrared spectrometers, atomic absorption spectrometers, inductively coupled
plasma spectrometers, inductively coupled plasma/mass spectrometers, data
management systems and small disposable tools used to prepare chemical samples
for analysis. These products are used in environmental monitoring and analysis,
biological and biochemical research, and quality control and research in such
industries as
3
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pharmaceuticals, foods, metals, chemicals, petroleum and in independent test
laboratories. They are employed in analyzing chemical substances including
metals, inorganic materials, organic compounds, polymers, natural substances
and biochemicals.
The Chromatography Systems operation ("CS") is a major international supplier
of gas and liquid chromatographs, data management systems and gas
chromatograph/mass spectrometer systems, as well as sample preparation products
and other consumable supplies. Chromatography is a technique that separates a
mixture of substances by taking advantage of the characteristics specific to
each component. CS's systems are used for chemical analysis, industrial
hygiene, pollution monitoring, pharmaceutical analysis and drug discovery and
monitoring applications. CS supplies a complete line of products to provide all
analytical and preparative requirements. CS's manufacturing facilities are
located in Walnut Creek, California, Woburn, Massachusetts, Middelburg, The
Netherlands and Harbor City, California.
The Optical Spectroscopy Instruments operation of Analytical Instruments
("OSI") is a leading worldwide supplier of atomic absorption, inductively
coupled plasma, and inductively coupled plasma/mass spectrometers and
ultraviolet/ visible/near infrared spectrophotometers--instruments that are
used to measure compounds and some 66 different metals in various substances.
Optical spectroscopy is a method of chemical analysis based on the absorption,
or emission, by matter of electromagnetic radiation of a specific wavelength or
frequency. OSI's manufacturing facility is located in Melbourne, Australia.
Nuclear Magnetic Resonance Instruments
Nuclear Magnetic Resonance Instruments ("NMRI") is a leading worldwide
supplier of nuclear magnetic resonance ("NMR") spectrometers for advanced
biomolecular, chemical and material science research, as well as for the more
routine analytical work typically performed in industrial and academic
environments. NMRI's manufacturing facilities are located in Palo Alto,
California, and Fort Collins, Colorado.
NMR spectroscopy gives researchers the ability to determine the structure of
many biomolecules including proteins, nucleic acids (DNA and RNA) and
carbohydrates. NMRI's systems are used in a variety of laboratories, including
those conducting basic research and larger facilities that are creating new
pharmaceuticals. NMRI's systems can be found in all major pharmaceutical
companies worldwide where they are key tools in developing new drugs to fight
disease.
Approximately 80% of NMRI's systems are used for analysis on liquids, 15% on
solids and 5% on imaging (producing pictures). The imaging capability of NMR
allows researchers to non-invasively capture a cross-sectional view of an
object, for example the brain, to map and understand its various parts. Solid
sample NMR research allows researchers to determine the microstructure of
crystals, plastics, rubbers, ceramics, polymers and other solids.
Vacuum Products
Vacuum Products is a worldwide supplier of products used to create, maintain
and contain a vacuum environment. These include vacuum pumps, helium leak
detectors and related instruments and gauges, which are used in many commercial
and scientific applications, including industrial processes, semiconductor
manufacturing, high-energy physics, surface analysis and space research. Vacuum
Products' manufacturing facilities are located in Lexington, Massachusetts and
Torino, Italy.
Vacuum Products offers four types of vacuum pumps: primary, diffusion, turbo-
molecular and ion. Primary pumps include rotary vane and dry diaphragm
mechanical pumps, sorption pumps and dry scroll pumps. Diffusion pumps include
the VHS-Series products. Turbo-molecular pumps provide a high speed/compression
ratio in a compact package. Ion pumps, used to achieve ultra-high vacuum
environments, are used primarily to create ultra-high vacuum in a variety of
applications, from electron microscopes to linear accelerators.
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Vacuum Products is also a worldwide leader in helium mass spectrometer leak
detectors since the 1960s. These products are used in many commercial and
scientific applications, including industrial processes, analytical instruments
and high-energy physics.
Vacuum Products also produces an extensive line of vacuum instruments and
gauges. Its gauge controllers and gauge tubes are designed for industrial use,
where simplicity of operation and rugged design are important, as well as for
research applications.
Electronic Components Assembly
Tempe Electronics Center ("TEC") is a contract electronic manufacturer of
printed wiring assemblies. It supplies components to each of the Company's
businesses; however, 80% of its sales are to customers other than the Company.
Services range from design layout to total system integration, shipping to end
customers and repair depot facilities. TEC has expertise in high-mix
manufacturing, producing up to 1,800 different products each month. In addition
to printed wiring assemblies, TEC performs electronic subassembly contract
manufacturing and integrates complete systems. TEC serves a wide range of
industries, including telecommunications, medical, network products, gaming,
industrial controls, avionics and satellite communications. TEC manufactures in
Tempe, Arizona.
MARKETING AND SALES
In the United States, IB markets the largest portion of its products directly
through its own sales and distribution organizations, although certain products
are marketed through independent distributors and sales representatives. Sales
to major markets outside the United States are generally made by IB's foreign
based sales and service staff, although some sales are made directly from the
United States to foreign customers. In certain foreign countries, sales are
made through various representative and distributorship arrangements. IB owns
or leases sales and service offices in strategic regional locations in the
United States and in foreign countries through its foreign sales subsidiaries
and distribution operations. None of IB's products are distributed through
retail outlets.
The markets in which IB competes are globalized. In addition to the United
States, IB has manufacturing operations in Australia, Italy and The Netherlands
as well as sales and service offices located throughout Europe, Asia and Latin
America. IB has invested substantial financial and management resources to
develop an international infrastructure to meet the needs of its customers
worldwide. IB intends to continue to expand its presence in international
markets.
Demand for IB's products is dependent upon the size of the markets for its
products, the level of capital expenditures of IB's customers, the rate of
economic growth in IB's major markets and competitive considerations. IB
believes that demand for its products does not exhibit any significant seasonal
pattern.
Virtually all new analytical methods and tests originate in academic research
in universities and medical schools. If the utility of a new method or test is
demonstrated by fundamental research, it often will then be used by
pharmaceutical investigators, biotechnology companies, teaching hospitals or
specialized clinical laboratories in an investigatory mode. In some cases,
these new techniques eventually emerge in routine, high volume clinical testing
at hospitals and reference labs. Generally, devices used at each stage from
research to routine clinical applications employ the same fundamental processes
but may differ in operating features such as number of tests performed per hour
and degree of automation. By serving several customer groups with differing
needs related through common science and technology, IB has the opportunity to
broadly apply and leverage its expertise. IB's customers are continually
searching for processes and systems that can perform tests faster, more
efficiently and at lower costs. IB believes that its focus on automated and
high throughput systems position it to capitalize on this need.
BACKLOG
IB's recorded backlog was $125 million at October 2, 1998 and $132 million at
September 26, 1997. It is IB's general policy to include in backlog only
purchase orders or production releases that have firm delivery
5
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dates within one year. Recorded backlog may not result in sales because of
cancellation or other factors. It is anticipated that all orders included in
the current backlog will be delivered before the close of fiscal year 1999.
COMPETITION
Competition in IB's markets is based upon the performance capabilities of
IB's products, technical support and after-market service, the manufacturer's
reputation as a technological leader and the selling price. Management believes
that performance capabilities are the most important of these criteria. The
markets in which IB competes are highly competitive and are characterized by
the application of mature but 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, and sale of
products that compete with those manufactured or sold by IB. Many of IB's
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 IB is engaged. The
markets for IB's products are characterized by specialized manufacturers that
often have strength in narrow segments of these markets. While the absence of
reliable statistics makes it difficult to determine IB's relative market
position in its industry segments, IB is confident it is one of the principal
manufacturers in its primary fields.
Each of IB's major businesses competes with many companies that address the
same markets. In Analytical Instruments, IB competes with Hewlett-Packard,
Waters Corporation, Perkin-Elmer, Thermo Electron, Shimadzu Corporation and
numerous local suppliers. NMRI has two major competitors: Bruker and JEOL. In
Vacuum Products, the primary competitors are Edwards High Vacuum, Pfeiffer,
Leybold-Balzers and Alcatel. High-mix contract manufacturers that compete with
the Tempe Electronics Center include EFTCX Corporation, Xetel Corporation, CMC
Industries, Sigmatron International and Smartflex Systems.
MANUFACTURING
IB's principal manufacturing activities consist of precision assembly, test,
calibration and machining activities. IB subcontracts a portion of its
assembly, machining and printed circuit board assembly and testing. All other
assembly, test and calibration functions are performed by IB. Some critical
assembly activities are performed in clean-room environments at IB's
facilities.
IB believes 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 its original equipment manufacturer ("OEM") and end-
use customers. IB monitors and analyzes product lead times, warranty data,
process yields, supplier performance, field data on mean time between failures,
inventory turns, repair response time and other indicators so that it can
continuously improve its manufacturing processes. IB has adopted a total
quality management process.
IB has ten manufacturing facilities located throughout the world. Analytical
Instruments has manufacturing facilities in Walnut Creek, California, Woburn,
Massachusetts, Middelburg, The Netherlands, Harbor City, California, and
Melbourne, Australia. NMRI has manufacturing facilities in Palo Alto,
California, and Fort Collins, Colorado. Vacuum Products has manufacturing
facilities in Lexington, Massachusetts, and Torino, Italy. Tempe Electronics
Center has manufacturing facilities in Tempe, Arizona.
In 1993, the member states of the European Union ("EU") began implementation
of their plan for a new unified EU market with reduced trade barriers and
harmonized regulations. The EU adopted a significant international quality
standard, the International Organization for Standardization Series 9000
Quality Standards ("ISO 9000"). All of IB's manufacturing facilities have been
certified as complying with the requirements of IS 9001.
RAW MATERIALS
There are no specialized raw materials that are particularly essential to the
operation of IB's business. IB's 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 found
to be in short supply.
6
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Many components used in IB's products, including proprietary analog and
digital circuitry, are manufactured by IB. Other components, including
packaging materials, superconducting magnets, integrated circuits,
microprocessors, microcomputers and certain detector and data analysis modules,
are acquired from other manufacturers. Most of the raw materials, components
and supplies purchased by IB are available from a number of different
suppliers; however, a number of items are purchased from limited or single
sources of supply, and disruption of these sources could have a temporary
adverse effect on shipments and the financial results of IB. IB believes
alternative sources could ordinarily be obtained to supply these materials, but
a prolonged inability to obtain certain materials or components could have an
adverse effect on IB's financial condition or results of operations and could
result in damage to its relationship with its customers.
CUSTOMER SUPPORT AND SERVICE
IB believes that its customer service and support are an integral part of its
competitive strategy. As part of its support services, IB's technical support
staff provides, typically at no additional cost, individual assistance in
solving analysis problems, integrating vacuum components, designing circuit
boards, etc., depending on the business. IB offers training courses and
periodically sends its customers information on applications development. IB's
products generally include a 90-day to one-year warranty, installation and
certain user training, all at no additional cost. Service contracts may be
purchased by customers to cover equipment no longer under warranty. Service
work not performed under warranty or service contracts is performed on a time
and materials basis. IB installs and services its products primarily through
its own field service organization.
PATENT AND OTHER PROPRIETARY RIGHTS
As a leader in the manufacture and sale of analytical and research
instruments and vacuum products, IB has pursued a policy of seeking patent,
copyright, trademark and trade secret protection in the United States and other
countries for developments, improvements and inventions originating within its
organization that are incorporated in IB's products or that fall within its
fields of interest. As of October 2, 1998, IB owned approximately 205 patents
in the United States and approximately 260 patents throughout the world, and
had approximately 272 patent applications on file with various patent agencies
worldwide. IB intends to file additional patent applications as appropriate.
IB relies on a combination of copyright, trade secret and other laws, and
contractual restrictions on disclosure, copying and transferring title to
protect its proprietary rights. IB has trademarks, both registered and
unregistered, that are maintained and enforced to provide customer recognition
for its products in the marketplace. IB also has agreements with third parties
that provide for licensing of patented or proprietary technology. These
agreements include royalty-bearing licenses and technology cross-licenses.
While IB places considerable importance on its licensed technology, IB does not
believe that the loss of any license would have a material adverse effect on
IB's business.
IB's competitors, like companies in many high-technology businesses,
routinely review the products of others for possible conflict with their own
patent rights. Although IB has from time to time received notices of claims
from others alleging patent infringement, IB believes that there are no pending
patent infringement claims that might have a material adverse effect on the
business of IB.
7
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THE SEMICONDUCTOR EQUIPMENT BUSINESS
OVERVIEW
SEB designs, manufactures, markets and services semiconductor processing
equipment used in the fabrication of integrated circuits. SEB is a leading
supplier of ion implantation systems, key pieces of capital equipment used to
manufacture semiconductor chips. SEB has shipped more than 2,500 systems
worldwide, and more SEB ion implanters are at work than those from all other
manufacturers combined.
SEB provides customers with world-class products and support. SEB achieved
the number one ranking for the second consecutive year in VLSI Research Inc.'s
1998 customer satisfaction survey. The annual study surveys semiconductor
manufacturing customers worldwide. SEB was ranked as the industry's top large
supplier of wafer processing capital equipment and received the highest overall
point total ever achieved by a large equipment supplier.
SEB equipment is used by virtually every major semiconductor manufacturer in
the U.S., Europe, Japan, Korea and throughout the Asia Pacific region. Its
award-winning support network offers chip producers round-the-clock, worldwide
service, training and process support. SEB has become an industry leader in
providing after-market products and services which reduce operating costs and
extend the cost-effective life of its products.
SEB's business depends upon the capital expenditures of semiconductor
manufacturers, which in turn depend on the current and anticipated market
demand for integrated circuits and products utilizing integrated circuits. The
semiconductor industry has been experiencing a slowdown resulting from
depressed DRAM pricing, manufacturing over-capacity and the economic
difficulties affecting many Asian countries. This has caused semiconductor
manufacturers to reduce their capital equipment investments, and in certain
cases customers have either rescheduled or canceled capital equipment
purchases.
BACKGROUND
SEB
SEB's role in the semiconductor fabrication market can be traced to the
Company's pioneering work in ultra-high vacuum technology. In the 1960s, this
ability to create ultra-high vacuum environments was applied to physics and
space research projects. Since chip fabrication must also be performed in
ultra-clean environments, the Company's vacuum expertise proved critical to the
development of many of today's sophisticated systems. As the needs of the
burgeoning semiconductor industry grew, SEB developed methods for controlling
electron beams and ions in ultra-clean environments. It also conducted research
into methods of manipulating and depositing new materials onto silicon wafers.
SEB entered the ion implantation business in 1975 through the acquisition of
Extrion Corporation, in Gloucester, Massachusetts. Since then, SEB has produced
a complete line of medium and high current implanters. These systems introduce
precise quantities of dopant materials into the wafers, creating desired
electrical characteristics. In June 1997, SEB sold its TFS business, which
makes physical vapor deposition equipment, also known as sputtering systems, to
Novellus. In July 1998, SEB acquired the high-energy ion implantation equipment
product line of Genus, Inc. ("Genus").
The Industry
The semiconductor industry has experienced significant growth in recent years
due to the continued increase of the personal computer market, the expansion of
the telecommunications industry, the emergence of new applications such as
consumer electronics products, wireless communications devices and portable
computers and the increased semiconductor content in these electronics systems.
Significant performance advantages and lower prices for integrated circuits
have contributed to the growth and expansion of the
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semiconductor industry. In response to the growth in demand for integrated
circuits, the semiconductor industry has significantly increased its
manufacturing capacity through the expansion of existing facilities and
construction of new facilities.
The fabrication of integrated circuits requires a number of complex and
repetitive processing steps, including deposition, photolithography, etch and
ion implantation. Deposition is a process in which a film of either
electrically insulating, or electrically conductive, material is deposited on
the surface of a wafer. Photolithography is used to transfer a device or
circuit pattern into a light-sensitive, resist layer which, after development,
can be used in turn to transfer the pattern onto the silicon surface. The etch
process completes the transfer of the pattern into the various thin films used
to make the integrated circuit. Finally, ion implantation provides a means for
introducing dopant material into the silicon surface, typically into selected
areas defined by the photolithographic process. These selectively doped areas
become the electrical components of the integrated circuits.
Semiconductor manufacturers generally measure the cost performance of their
production equipment in terms of "cost per wafer," which is determined by
factoring in the fixed costs for acquisition and installation of the system,
its variable operating costs and its net throughput rate. A system with higher
throughput allows the semiconductor manufacturer to recover the purchase price
of the system over a greater number of wafers and thereby reduce the cost of
ownership of the system on a per wafer basis. Throughput is most accurately
measured on a net or overall basis, which takes into account the processing
speed of the system and any non-operational downtime for cleaning, maintenance
or other repairs. The increased costs of larger and more complex semiconductor
wafers have made high yields extremely important in selecting processing
equipment. To achieve higher yields and better film quality, implant systems
must be capable of repeating the original process on a consistent basis without
a disqualifying level of defects. This characteristic, known in the industry as
"repeatability," is extremely important in achieving commercially acceptable
yields. Repeatability is more easily achieved in those systems that can operate
at desired throughput rates without requiring the system to approach its
critical tolerance limits.
The continuing evolution of semiconductor devices to smaller geometries and
more complex multi-level circuitry has significantly increased the cost and
performance requirements of the capital equipment used to manufacture these
devices. Many of the advanced 200mm fabrication lines that are currently
planned, or in construction, will cost over $1 billion each, representing a
substantial increase over the costs of prior generation fabrication facilities.
Increased capital depreciation costs will continue to become a much larger
percentage of the aggregate production costs for semiconductor manufacturers
relative to labor, materials and other variable manufacturing costs. As a
result, there has been an increasing focus by the semiconductor industry on
obtaining increased productivity and higher returns from its semiconductor
manufacturing equipment, thereby reducing the effective cost of ownership of
such systems.
PRODUCTS
SEB designs and manufactures a broad range of implant tools, using data-
driven quality processes to produce reliable systems and provide total support
to its customers. SEB's products are used for ion implantation in semiconductor
manufacturing. During ion implantation, silicon wafers are bombarded by a high-
velocity beam of electrically charged ions. These ions penetrate film materials
at selected sites, changing their electrical properties.
SEB entered the medium current portion of the implantation market in 1971.
Its medium current ion implanters include the VIISta 810 (a 300mm-compatible
product), the EHP-220, and the EHP-500. The EHP-220 and EHP-500 are the third
evolutionary generations of the E-series, the world's most widely accepted
medium current machines.
SEB entered the high-current portion of the implant market in 1981. Its high
current ion implanters include the VIISta 80 and the SHC-80 (both 300mm-
compatible products), the VIISion 80 LE and the VIISion 200 LE. VIISion LE is
acknowledged as the most economical batch system available today. It offers
tripled
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low-energy boron beam currents, increased mechanical throughput, and an
improved particle specification. The SHC-80 is the world's first, serial-
process, high current implanter. It is compatible with both 200mm wafers and
300mm wafers for advanced processes. The SHC-80 promises throughput
improvements up to 30 percent greater than the same process on batch machines.
The VIISta 80 extends the SHC-80's performance to sub-KeV energy levels.
SEB's high-energy (MeV) ion implantation equipment product line, purchased
from Genus in fiscal year 1998, represents an excellent fit with SEB's existing
medium and high current product lines, and offers a rapid entry to the fast
growing, high-energy sector of the industry.
Over 85 percent of the SEB implanters shipped since 1975 are still in use
through a comprehensive upgrade and refurbishment program and world-class
support network that continually improves the capability of older systems.
CUSTOMER SUPPORT AND SERVICES
SEB provides a range of innovative customer support products designed to
improve the productivity of its worldwide customers as well as to provide a
direct link to SEB factories and research centers.
Remote Assist is a completely new semiconductor equipment service capability
that quickly puts product experts virtually' into customer fabrication
facilities. This offering uses advanced video conferencing capabilities and a
new video helmet for linking on-site engineers with SEB support offices and
factories.
The Introduction Support Teams and Productivity Transfer Teams assist the
customer in bringing SEB implanters up, and in making them productive as
quickly as possible. These teams speed process qualification and smooth
integration into the production environment, often reducing installation time
by anywhere from two to more than five weeks.
FAB Care Plus is a unique program which encourages customers to tailor an
overall support program that meets a company's specific needs--whether it be
for a research facility or an offshore production facility. FAB Care Plus
solutions can be implemented around the world to provide consistent and
reliable support.
For parts management, SEB has strategically placed Parts Banks throughout the
world to provide carefully regulated inventory, and global delivery and
logistics services. SEB also offers a comprehensive consumable parts program
that can be tailored to the individual fabrication facility.
Through VEDoc, an electronic documentation system, customers can easily
access information about its implanters. All assembly drawings, schematics,
parts lists, maintenance and operation manuals, and video-illustrated
maintenance procedures are available in this easy-to-follow CD-ROM format.
SEB's commitment to customer service extends to training and support. It
operates applications laboratories on three continents that contain not only
the latest equipment, but the latest technology. For instance, SEB's Ion
Implant Systems VIP facility, with a class 1/10 clean room, a post-implant
process laboratory, process training and applications support is available to
handle customer wafers for process evaluation and to assist with new process
requirements.
MARKETING AND SALES
SEB has sold one or more ion implantation product to each of the 20 largest
semiconductor manufacturers in the world. Sales for this class of products and
services were $338 million, $345 million, and $474 million for fiscal 1998,
1997, and 1996, respectively. SEB's sales objective is to work closely with
customers to secure purchase orders for multiple systems as such customers
expand existing facilities and build next-generation, wafer facilities. SEB
seeks to build customer loyalty and achieve a high level of repeat business by
offering highly reliable products, comprehensive field support and a responsive
parts replacement and service program.
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None of SEB's customers has entered into a long-term agreement requiring it
to purchase SEB's products. SEB believes that sales to certain of its customers
will decrease in the near future as those customers complete current purchasing
requirements for new or expanded fabrication facilities. Although the
composition of the group comprising SEB's largest customers has varied from
year to year, the loss of a significant customer or any reduction in orders
from any significant customer, including reductions due to customer departures
from recent buying patterns, market, economic or competitive conditions in the
semiconductor industry or in the industries that manufacture products utilizing
integrated circuits, could adversely affect SEB's business, financial condition
and results of operations. In addition, sales of SEB's systems depend, in
significant part, upon the decision of a prospective customer to increase
manufacturing capacity in an existing fabrication facility or to transfer a
manufacturing process to a new fabrication facility, both of which typically
involve a significant capital commitment. In addition, SEB has from time to
time experienced delays in finalizing system sales following initial system's
qualification. Due to these and other factors, SEB's systems typically have a
lengthy sales cycle during which SEB may expend substantial funds and
management effort.
The ability to provide prompt and effective field support is critical to
SEB's sales efforts, due to the substantial operational and financial
commitments made by customers which purchase ion implantation systems. SEB's
strategy of supporting its installed base through both its customer support and
research and development groups has served to encourage use of SEB's systems in
production applications and has accelerated penetration of certain key
accounts. SEB believes that its marketing efforts are enhanced by the technical
expertise of its research and development personnel who provide customer
process support and participate in a number of industry forums such as
conferences and technical publications.
SEB has sales and service offices located in the United States, Western
Europe and Asia. SEB has a global infrastructure of sales, marketing and
service engineers linked through SEB's Knowledge Network, Lotus Notes and SAP
operating systems, allowing SEB to globally review bookings and sales forecasts
against detailed account management plans. SEB's spare parts distribution
capability has been benchmarked by Intel as the best in the industry. Through
modeling of parts usage by equipment type, installed based distribution,
freight, routes and specific customs regulations, SEB has developed an
infrastructure of parts distribution and warehousing through partnering with
Federal Express.
SEB has a long and direct presence in Europe. From 1978 to 1996, the
Company's semiconductor equipment was sold and serviced in Japan by Tokyo
Electron Ltd. ("TEL"). During much of the 18-year relationship, a joint
venture, TEL-Varian Ltd., manufactured or customized equipment in Japan for
SEB. In December 1996, the Company and TEL revised their relationship to enable
Japanese customers to have more direct access to SEB's product, engineering and
support organizations worldwide. Shortly thereafter, the Company formed a
wholly-owned subsidiary, Varian Japan, K.K., that today provides direct support
of SEB's growing Japanese customer base.
Using the original TEL joint venture relationship as a model, the Company
formed Varian Korea Ltd. ("VKL") in 1985 with its distributor there. What
started as a venture for handling sales and service of semiconductor equipment
and vacuum products in Korea was expanded to include manufacturing in 1989. Its
63,000-square-foot factory in Songtan City includes a Class 10,000
manufacturing area. In January, 1998, the Company purchased the remaining 39%
of the VKL joint venture held by the original joint venture partner.
Managing global operations and sites located throughout the world presents
challenges associated with cultural diversities and organizational alignment.
Moreover, each region in the global semiconductor equipment market exhibits
unique characteristics that can cause capital equipment investment patterns to
vary significantly from period to period. Although international markets
provide SEB with significant growth opportunities, periodic economic downturns,
trade balance issues, political instability and fluctuations in interest and
foreign currency exchange rates are all risks that could affect global product
and service demand. Many Pacific Rim countries are currently experiencing a
significant economic downturn and are continuing to experience further banking
and currency difficulties that could lead to a deepening of the economic
recession in those countries. Specifically, the decline in value of the Korean
currency, together with difficulties obtaining credit, have
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resulted in a decline in the purchasing power of SEB's Korean customers. This
in turn has resulted in the cancellation or delay of orders for SEB's products
from Korean customers, thus adversely affecting SEB's results of operations. In
addition, if Japan's economy weakens further, investments by Japanese customers
may be negatively affected, and it is possible that economic recovery in other
Pacific Rim countries could be delayed. SEB actively manages its exposure to
changes in foreign currency exchange rates, but there can be no assurance that
future changes in foreign currency exchange rates will not have a material
adverse effect on its results of operations or financial condition.
SEB's business is not seasonal in nature, but it is cyclical based on the
capital equipment investment expenditures of major semiconductor manufacturers.
These expenditure patterns are based on many factors, including anticipated
market demand for integrated circuits, the development of new technologies and
global economic conditions. The cyclicality in the semiconductor equipment
market over the last several years has resulted in a decline in sales since
1996, with orders and backlog under continuous pressure. This situation is the
combined result of an oversupply in memory chips, a decline in PC demand and
the rippling of the Asian financial crises through the Korean, Taiwanese and
Japanese markets.
BACKLOG
As of October 2, 1998, SEB's backlog was $80 million, as compared to a
backlog of $151 million at September 26, 1997. SEB includes in its backlog only
those orders for which it has accepted purchase orders and assigned shipment
dates within twelve months. All orders are subject to cancellation or
rescheduling by customers with limited or no penalties. Due to possible changes
in system delivery schedules, cancellations of orders and delays in systems
shipments, SEB's backlog at any particular date is not necessarily indicative
of actual sales for any succeeding period.
MANUFACTURING
SEB manufactures its products at its production facilities in Gloucester,
Massachusetts; Newburyport, Massachusetts (recently acquired); Songtan, Korea;
and Yamanashi, Japan. SEB's Gloucester facility has become the low-cost
manufacturer of ion implanters through the use of advanced manufacturing
methods and technologies, including, just-in-time, demand flow technology,
statistical process control and solids modeling. Despite operating in a
cyclical and competitive market, SEB has strengthened its profitability by
steadily increasing efficiency and reducing operating expenses. SEB has also
significantly reduced its costs through a reduction in rework, scrap, warranty
and testing costs.
SEB's manufacturing activities consist primarily of assembling and testing
components and subassemblies, which are acquired from third-party suppliers and
then integrated into a finished system by SEB. SEB utilizes an outsourcing
strategy for the manufacture of major subassemblies and performs system design,
assembly and testing in-house. SEB believes that outsourcing enables it to
minimize its fixed costs and capital expenditures while also providing the
flexibility to increase production capacity. This strategy also allows SEB to
focus on product differentiation through system design and quality control.
Through the use of manufacturing specialists, SEB believes that its subsystems
incorporate advanced technologies in robotics, vacuum and microcomputers. SEB
works closely with its suppliers on achieving mutual cost reduction through
joint design efforts.
SEB manufactures its systems in clean-room environments which are similar to
the clean rooms used by semiconductor manufacturers for wafer fabrication. This
procedure is intended to reduce installation and production qualification times
and the amount of particulates and other contaminants in the assembled system,
which in turn improves yield and reduces downtime for the customer. Following
disassembly, the tested system is packaged in multiple layers of plastic
shrink-wrap to maintain cleanroom standards during shipment.
SEB uses outsourcing to take advantage of economies of scale at outside
manufacturing facilities and to alleviate manufacturing bottlenecks. SEB
purchases material and components from various suppliers that are either
standard products or built to SEB specifications. Some of the components and
subassemblies included in
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SEB's products are obtained from a limited group of suppliers. Although SEB
seeks to reduce its dependence on these limited sources, disruption or
termination of certain of these sources could occur and such disruptions could
have at least a temporary adverse effect on SEB's operations. Moreover, a
prolonged inability to obtain certain components could have a material adverse
effect on SEB's business, financial condition and results of operations and
could result in damage to customer relationships.
Quality efforts at SEB begin with product development. SEB uses 3D, computer-
aided design, finite element analysis and other computer-based modeling methods
to prove new designs. A SEB implanter design is thoroughly tested and proven
throughout all stages of development before the first production system is
built. Concurrent engineering programs ensure that new designs are quickly and
successfully integrated into manufacturing.
COMPETITION
The semiconductor manufacturing equipment market is highly competitive and is
characterized by a small number of large players and over 250 small domestic
and foreign participants. The larger companies include Applied Materials, Lam
Research, Eaton, Novellus Systems, Tokyo Electron, Nikon, Canon and ASML. SEB
faces significant competitive factors in the ion implantation market. Within
this segment, as reported for calendar 1997 by Dataquest, SEB, Eaton, Applied
Materials, Nissin and Ulvac had 35%, 45%, 13%, 4% and 3%, respectively, of the
market share for ion implantation equipment.
Significant competitive factors in the ion implantation market include
relationships, price/cost of ownership, technological performance, distribution
and financial viability. Other significant competitive factors in the
semiconductor equipment market include system performance and flexibility,
cost, the size of each manufacturer, its installed customer base, capability
for customer support and breadth of product line. SEB believes it competes
favorably in each of these categories. For example, its gradual transition from
joint ventures and distributor agreements to direct selling and service has
given SEB the ability to serve customers on a global basis through the
management of information critical to consistent, timely delivery of services
and products. Management believes that to remain competitive it will require
significant financial resources to offer a broad range of products, to maintain
customer service and support centers worldwide and to invest in product and
process research and development.
Certain of SEB's existing and potential competitors have substantially
greater financial resources and more extensive engineering, manufacturing,
marketing and customer service and support organizations. SEB expects its
competitors to continue to improve the design and performance of their current
products and processes and to introduce new products and processes with
enhanced price and performance characteristics. If SEB's competitors enter into
strategic relationships with leading semiconductor manufacturers covering ion
implantation products similar to those sold by SEB, its ability to sell its
products to those manufacturers could be adversely affected.
In addition, a substantial investment is required by customers to install and
integrate capital equipment into a semiconductor production line. As a result,
once a semiconductor manufacturer has selected a particular vendor's capital
equipment, SEB believes that the manufacturer will be generally reliant upon
that equipment for the specific production line application. Accordingly, SEB
may experience difficulty in selling a product line to a particular customer
for a significant period of time if that customer selects a competitor's
product. Increased competitive pressure could lead to lower prices for SEB's
products, thereby materially and adversely affecting SEB's business, financial
condition and results of operations. There can be no assurance that SEB will be
able to compete successfully in the future.
PATENT AND OTHER PROPRIETARY RIGHTS
As a leader in the manufacture and sale of ion implantation equipment, SEB
has pursued a policy of seeking patent, copyright, trademark and trade secret
protection in the United States and other countries for
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developments, improvements and inventions originating within its organization
that are incorporated in SEB's products or that fall within its fields of
interest. As of October 2, 1998, SEB owned approximately 119 patents in the
United States and approximately 219 patents throughout the world, and had
approximately 84 patent applications on file with various patent agencies
worldwide. SEB intends to file additional patent applications as appropriate.
SEB relies on a combination of copyright, trade secret and other laws, and
contractual restrictions on disclosure, copying and transferring title to
protect its rights. SEB has trademarks, both registered and unregistered, that
are maintained and enforced to provide customer recognition for its products in
the marketplace. SEB also has agreements with third parties that provide for
licensing of patented or proprietary technology. These agreements include
royalty-bearing licenses and technology cross-licenses. The loss of certain of
such licenses could have a material adverse effect on SEB's business. In
particular, the current royalty bearing license agreements with Applied
Materials and TEL for gas-assisted wafer heat transfer patents have produced
approximately $5.9 million in royalties in fiscal year 1998 and over $40
million in royalties since 1992. The principal patent covered by these licenses
will expire on July 14, 2004.
SEB's competitors, like companies in many high-technology businesses,
routinely review the products of others for possible conflict with their own
patent rights. There has also been substantial litigation regarding patent and
other intellectual property rights in semiconductor related industries. SEB is
currently involved in such litigation and there can be no assurances as to the
results of such litigation. There can be no assurance that SEB or its licensers
or suppliers will not be subject to additional claims of patent infringement or
that any claim will not require that SEB pay substantial damages or delete
certain features from its products or both.
THE HEALTH CARE SYSTEMS BUSINESS
OVERVIEW
HCS is a world leader in the design and production of equipment for treating
cancer with radiation, as well as high-quality, cost-effective x-ray tubes for
both equipment manufacturers and replacement tube and imaging subsystems
suppliers.
In serving the market for advanced medical systems (primarily for cancer
care), HCS continues to broaden its offerings to address the unrelenting demand
for cost containment and enhanced efficacy which are driving this sector. Its
oncology systems line encompasses a fully integrated system of products
embracing not only linear accelerators but sophisticated ancillary products and
services to extend its capabilities and efficiency. These ancillary offerings
now account for more than half of all oncology systems sales.
In addition to developing leading-edge medical hardware, HCS also develops
clinical software products and devices that enhance productivity and quality.
These developments, while particularly valuable in helping U.S. hospitals and
clinics cope with the challenges of managed care, are finding use in markets
around the world as health care providers search for new ways to reduce costs,
improve efficiency and bring improved levels of care to more patients.
In the x-ray tube sector, HCS provides a broad selection of diagnostic tubes
capable of delivering more scans with excellent resolution and imaging more
patients than its competitors. HCS is also developing a solid state system for
digital imaging in collaboration with imaging system manufacturers in several
related markets.
CANCER-CARE MARKET
Approximately 50% of all cancer patients in the U.S. receive radiation
therapy at some point during the course of their disease. An important
advantage of radiation therapy is that the radiation acts with some selectivity
on cancer cells. The absorption of radiation by a cell affects its genetic
structure and inhibits the replication of the cell, leading to its gradual
death. Cancerous cells are fast replicating and thereby are disproportionately
damaged by the radiation absorbed.
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Currently, the most common type of radiotherapy uses x-rays delivered by
external beams and is administered using linear accelerators ("LINACS"). LINACS
are conventionally used for multiple, or "fractionated," treatments of a tumor
in up to 30 radiation sessions, or, as used more recently in the brain, to
deliver a single high dose of radiation in a procedure referred to as
stereotactic radiosurgery ("SRS"). In addition to external radiation therapy,
radioactive seeds, wires or ribbons are sometimes inserted into a tumor
("interstitially") or into a body cavity ("intracavitary"). These modalities,
known as "brachytherapy," do not require the radiation to pass through
surrounding healthy tissue.
PRODUCTS
HCS's products can be broadly classified into two principal categories:
oncology systems, and x-ray tubes and imaging subsystems.
Oncology Systems
HCS oncology systems designs, manufactures, sells and services hardware and
software products for radiation treatment of cancer, including linear
accelerators, simulators and computer systems for planning cancer treatments,
high dose rate brachytherapy systems and data management systems for radiation
oncology centers. HCS oncology systems offers an integrated system of products
embracing both linear accelerators and sophisticated ancillary products and
services to extend its capabilities and efficiency.
Linear accelerators are primarily used in cancer therapy. HCS's CLINAC series
of medical linear accelerators, marketed to hospitals and clinics worldwide,
generates therapeutic x-rays and radiation beams for cancer treatment.
VariSource, HCS's high dose rate brachytherapy system, treats tumors internally
by delivering radiation to the tumor by means of a radioactive source on the
end of a wire in a catheter. It is a cost-effective and efficacious adjunct to
linear accelerator-based therapy.
Linear accelerators are also used for industrial radiographic applications.
HCS's Linatron linear accelerators are used for nondestructive examination of
objects, such as cargo or luggage and to x-ray heavy metallic structures for
quality control.
HCS also manufactures and markets related radiotherapy products such as
imaging systems, information management systems, multi-leaf collimators,
simulators and radiosurgery products. HCS has received United States Food and
Drug Administration ("FDA") approval of new oncology products including a
three-dimensional cancer treatment planning system, and an advanced multileaf
collimator used to more precisely direct electron beams for cancer treatment.
HCS continually works with physicians and technicians to develop the latest
technology and treatments.
In addition to pursuing growth opportunities in existing markets, HCS is
pursuing the vast potential in combining advances in focused energy with the
latest breakthroughs in biotechnology. HCS is also evaluating the application
of radiation to treat diseases other than cancer. Such efforts are designed to
yield a whole new range of products and technologies that allow HCS to take
full advantage of its reputation for technology innovation leadership in the
health care field.
X-Ray Tubes and Imaging Subsystems
HCS is a world leader in the design and manufacture of subsystems for
diagnostic radiology, including x-ray-generating tubes and imaging subsystems,
for the estimated worldwide $7 billion diagnostic imaging market. Its tubes are
a key component of x-ray imaging subsystems, including both new system
configurations and replacement tubes for the installed base. HCS conducts an
active research and development program to address new technology and
applications in both the medical and industrial x-ray tube markets. HCS's
extensive scientific and engineering expertise in glass and metal center
section tubes is considered to be state-of-the-art.
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HCS manufactures tubes for four primary medical x-ray imaging applications:
CT scanner; radiographic/fluoroscopic; special procedures; and mammography. HCS
x-ray tube products have over time substantially increased the heat storage
capacity of CT tubes. These high heat unit tubes were developed in response to
customers who needed rapid, continuous scanning to accommodate continuous CT
scanning techniques over large regions of the patient, and to reduce
examination times. Innovative design and process improvements have increased
tube life such that HCS's current tubes last twice as long as tubes did 5 years
ago, resulting in significant savings for customers.
HCS mammography tubes produce high quality images at low doses. Today, almost
half the mammography systems and nearly a quarter of the CT scanner systems
worldwide employ HCS tubes. HCS also offers a complete line of industrial x-ray
tubes. The industrial product line consists of analytical x-ray tubes used for
x-ray fluorescence and diffraction as well as tubes used for non-destructive
imaging and gauging.
HCS also designs, manufactures and markets imaging products. A new imaging
product line was launched in September 1996. Amorphous silicon imaging
technologies developed by HCS can be broadly applied as an alternative to image
intensifiers or film, representing over $1 billion of industry sales. The new
products are expected to increase the efficiency of diagnostic x-ray imaging
while decreasing costs. An amorphous silicon imaging subsystems is compact and
weighs only about 10 pounds, replacing a 100-lb. image intensifier used in
fluoroscopic imaging and the TV camera connected to it. It is expected that
imaging equipment based on amorphous silicon semiconductors may be more stable
and reliable, have far fewer adjustments, and suffer less degradation over
time.
MARKETING AND SALES
HCS sells its products throughout the world through a direct sales force in
North America, Asia, Europe and Latin America.
HCS sells its oncology system products primarily to hospitals, clinics,
private and governmental institutions and health care agencies and doctors'
offices. Total sales for oncology systems and services were $408 million, $343
million and $324 million for fiscal years 1998, 1997 and 1996, respectively.
HCS sells approximately 80% of its x-ray tube products to original equipment
manufacturers and 20% to replacement tube distributors. HCS has supplied tubes
to such industry leaders as Toshiba, Elscint, Hitachi and Shimadzu.
HCS believes that in the foreseeable future there will be a continuous world-
wide growth in the markets for oncology systems and related services because of
the improvement of health care services in developing countries and Eastern
Europe and the necessity to meet increasingly stricter regulations with respect
to radiation dosage and other safety features and environmental hazards in many
jurisdictions. With the transition from conventional to digital x-ray systems,
the demand for products and services related to networking, archiving and
electronic distribution of digital x-ray images will grow in industrialized
countries. HCS also believes there will be continuous growth in the markets for
information technology.
HCS's marketing strategy is to offer to its customers a complete package of
products and services in the fields of cancer-care and radiotherapy, including
equipment, accessories and related services such as consulting and after-sales
services. HCS's marketing efforts include the development of relationships with
current and prospective customers, participation in annual professional
meetings for clinicians and hospitals, advertisement in trade journals, direct
mail and telephone marketing. HCS's growth strategy is to add products in its
existing markets and expand its international market share.
CUSTOMER SUPPORT AND SERVICES
HCS maintains service support centers in Milpitas, California; Buc, France;
and Tokyo, Japan; as well as field service forces throughout the world for its
oncology systems. HCS's network of service engineers and
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customer support specialists provide installation, warranty, repair, training
and support services. HCS generates service revenue by providing service to
customers on a time and materials basis and through comprehensive service
contracts and sale of parts.
HCS warrants most of its oncology systems for hardware parts and labor for 12
months. Under the terms of the warranty, the customer is assured of service and
parts so that the equipment will operate in accordance with specifications. HCS
warrants that software will perform in accordance with specifications at the
delivery date and up to 3 months thereafter if the customer gives notice of any
nonconformance. HCS offers a variety of post-warranty service agreements that
permit customers to contract for the level of equipment maintenance they
require. In addition, HCS has begun to offer specific software support
agreements, reflecting the growing use in HCS's products of software that can
be updated. Service is provided at rates competitive with those offered by
HCS's competitors.
Systems under warranty or service contract receive periodic maintenance by
HCS service engineers, who also install new system capabilities or software
upgrades and respond to customer service requests. These services may be
purchased from HCS's service organization by customers who do not have a
service contract with HCS.
Oncology system customers receive installation, technical training, clinical
in-service and documentation support appropriate for the product type.
Customers receive both emergency and routine maintenance from a worldwide
network of field engineers. These individuals are generally home-based
engineers who are available to handle service requests 24-hours a day to
satisfy HCS's customer requirements. Most of these engineers are employees of
HCS, but many are also employees of dealers and/or agents of HCS. Customers can
access HCS's extensive service network by calling any of HCS's service centers
located throughout North America, Europe, Asia and Latin America.
HCS believes that its customer service and support are an integral part of
its competitive strategy. Service capability, availability and responsiveness
play an important role in marketing and selling medical equipment and systems,
particularly as the technological complexity of the products increases.
Nevertheless, many hospitals use their own biomedical engineering departments
and/or independent service organizations to service equipment after the
warranty period expires. Therefore, HCS cannot depend on conversion of all
maintenance to service contracts after the warranty period. However, after-
warranty service does provide an on-going source of revenue for HCS.
HCS provides technical advice and consultation for x-ray tube products to
major OEM customers from offices in Tokyo, Japan, Houten, The Netherlands and
Salt Lake City, Utah. HCS applications specialists and engineers make
recommendations to meet the customer's technical requirements within the
customer's budgetary constraints. HCS often develops specifications for a
unique product, which will be designed and manufactured to meet a specific
customer's requirements. HCS also maintains a technical customer support group
in Charleston, South Carolina to meet the technical support requirements of
independent tube installers using HCS's x-ray tube products.
COMPETITION
The health care equipment markets are characterized by rapidly evolving
technology, intense competition and pricing pressure. HCS competes with
companies worldwide, some of which have greater financial, marketing and
management resources than HCS. These competitors could develop technologies and
products that are more effective than those currently used or produced by HCS
or that could render HCS's products obsolete or noncompetitive. Smaller
competitors of HCS could be acquired by companies with greater financial
strength enabling them to compete more aggressively. Certain distributors of
HCS could also be acquired by competitors thereby disrupting certain
distribution arrangements of HCS. Management believes, however, HCS competes
favorably with its competitors on the basis of its continued commitment to
global distribution and customer service, value-added manufacturing,
technological leadership and new product innovation. HCS
17
<PAGE>
believes that the key to success in its markets is to provide technologically
superior products that deliver cost-effective, high quality clinical diagnosis
and that meet or exceed customer quality and service expectations. HCS's
ability to compete successfully depends on its ability to commercialize new
products ahead of its competitors. In its sales of oncology systems, HCS
competes with Siemens, Nucletron, Elekta, Mitsubishi, and certain government
facilities. In addition, HCS competes with independent service organizations in
its service and maintenance business and with a variety of companies in its
software systems and accessories business.
The market place for x-ray tube products is extremely competitive. All of the
major diagnostic imaging systems companies, which are the primary customers of
HCS's x-ray tube business, manufacture x-ray tubes for use in their own
products. HCS must compete with these in-house x-ray tube manufacturing
operations that are naturally favored by their parent company. As a result, HCS
must have a competitive advantage in one or more significant areas which may
include lower product cost, better product quality, or technological
superiority. HCS sells a significant volume of its x-ray tube products to
companies such as Toshiba Medical Systems, Hitachi Medical Systems, Shimadzu
Medical Systems, Philips Medical Systems and General Electric Medical Systems,
all of which have in-house x-ray tube production capability. In addition, HCS
competes against other stand-alone x-ray tube manufacturers such as Comet,
located in Switzerland and IAE, located in Italy. These companies compete with
HCS for both the OEM business of major diagnostic imaging equipment
manufacturers as well as independent servicers of x-ray tube equipment.
MANUFACTURING AND SUPPLIES
Oncology systems manufactures its accelerator systems in Palo Alto,
California, and its treatment simulator systems, accelerator subsystems and
brachytherapy systems in Crawley, England. In addition, oncology systems
manufactures certain of its ancillary products in Baden, Switzerland and
Helsinki, Finland. X-ray tube products are manufactured at HCS's manufacturing
facilities in Salt Lake City, Utah, Arlington Heights, Illinois, and
Charleston, South Carolina. These facilities employ state-of-the-art
manufacturing techniques, and several have been honored by the press,
governments, and trade organizations for their commitment to quality
improvement. They are registered to ISO 9001 (or ISO 9002, in the case of the
Charleston facility), the most rigorous of the international quality standards.
Production processes at HCS facilities include machining, fabrication,
subassembly, system assembly and final testing. HCS has invested in various
automated and semi-automated equipment for the fabrication and machining of
parts and assemblies incorporated in its products. HCS may from time to time
further invest in such equipment when cost justified. HCS's quality assurance
program includes various quality control measures from inspection of raw
material, purchased parts and assemblies through on-line inspection.
HCS's manufacturing activities consist primarily of assembling and testing
components and subassemblies, which are acquired from third-party suppliers and
then integrated into a finished system by HCS. HCS utilizes an outsourcing
strategy for the manufacture of major subassemblies and performs system design,
assembly and testing in-house. HCS believes outsourcing enables it to minimize
its fixed costs and capital expenditures while also providing it with the
flexibility to increase production capacity. HCS purchases material and
components from various suppliers that are either standard products or built to
HCS specifications. Certain components used in existing products of HCS, as
well as products under development, are frequently purchased from single
sources.
BACKLOG
Backlog for the Health Care Systems business amounted to $352 million at the
end of fiscal 1998 of which $237 million is expected to be filled within fiscal
year 1999. Backlog for fiscal year 1997 amounted to $344 million of which $179
million was filled in fiscal year 1998. HCS includes in backlog only orders for
products scheduled to be shipped within two years. Orders may be revised or
canceled, either pursuant to their terms or as a result of negotiations;
consequently, it is impossible to predict accurately the amount of backlog
orders that will result in sales.
18
<PAGE>
PRODUCT LIABILITY
HCS's business exposes it to potential product liability claims which are
inherent in the manufacture and sale of medical devices, and as such HCS may
face substantial liability to patients for damages resulting from the faulty
design or manufacture of products. Because these products involve the delivery
of radiation to the human body or are involved in diagnostic imaging of the
human body, the possibility for significant injury and/or death exists with any
of HCS's products. Therefore, the design, manufacture, sale or service of the
medical products manufactured by HCS involve the risk of product liability
claims and expose HCS to substantial liability to patients for damages
resulting from the faulty design, manufacture or servicing of such products.
Although HCS maintains limited product liability insurance coverage in an
amount that it deems sufficient for its business, there can be no assurance
that such coverage will ultimately prove to be adequate or that such coverage
will continue to remain available on acceptable terms, if at all.
On December 5, 1997, HCS purchased General Electric's Radiotherapy Service
Business (the "RS Business"). In connection with that transaction, HCS agreed
to assume liability for certain product defects and personal injury matters
which might arise with respect to RS Business products, and obtained insurance
for these matters. The insurance provides that in each annual period HCS is
responsible for the first $5,000,000 of expenses or liabilities related to any
such claims. HCS has been notified of three potential claims related to these
RS Business products for which HCS may have an indemnity obligation.
GOVERNMENT REGULATION
Domestic Regulation
HCS's products are regulated by the FDA. The FDA regulates the design,
development, testing, manufacturing, packaging, labeling, distribution and
marketing of medical devices under the U.S. Food, Drug and Cosmetic Act (the
"FDC Act") and regulations promulgated by the FDA. The State of California
(through its Department of Health Services), where HCS maintains one of its
manufacturing facilities, as well as other states, also regulates the
manufacture of medical devices.
In general, these laws require that manufacturers adhere to certain standards
designed to ensure the safety and effectiveness of medical devices. Under the
FDC Act, each medical device manufacturer must comply with requirements
applicable to manufacturing practices, clinical investigations involving
humans, sale and marketing of medical devices, post-market surveillance,
repairs, replacements and refunds, recalls and other matters. The FDA is
authorized to obtain and inspect devices and their labeling and advertising,
and to inspect the facilities in which they are manufactured.
The FDC Act also requires compliance with specific manufacturing and quality
assurance standards, including regulations promulgated by the FDA with respect
to good manufacturing practices. FDA regulations require that each manufacturer
establish a quality assurance program by which the manufacturer monitors the
manufacturing process and maintains records that show compliance with FDA
regulations and the manufacturer's written specifications and procedures
relating to the devices. Compliance is necessary to receive FDA clearance to
market new products and is necessary for a manufacturer to be able to continue
to market cleared product offerings. Recently, the FDA promulgated new design
process regulations that revise the good manufacturing practices applicable to
medical device manufacturers. Among other things, these new regulations require
that manufacturers establish performance requirements before production, insure
that device components are compatible, select adequate packing materials, and,
if appropriate, do risk analyses. The regulations took effect on June 1, 1997,
but include a twelve-month transition period during which enforcement action
with respect to design control requirements was not taken.
The FDA makes announced and unannounced inspections of medical device
manufacturers and may issue reports of observations where the manufacturer has
failed to comply with applicable regulations and/or procedures. Failure to
comply with applicable regulatory requirements can, among other things, result
in
19
<PAGE>
warning letters, civil penalties, injunctions, suspensions or losses of
regulatory clearances, product recalls, seizure or administrative detention of
products, operating restrictions through consent decrees or otherwise, and
criminal prosecution.
There has been a trend in recent years, both in the United States and abroad,
toward more stringent regulation and enforcement of requirements applicable to
medical device manufacturers. The continuing trend of more stringent regulatory
oversight in product clearance and enforcement activities may cause medical
device manufacturers to experience longer approval cycles, more uncertainty,
greater risk and higher expenses.
The FDA requires that a new medical device or a new indication for use of or
other significant change in an existing medical device obtain either 510(k)
premarket notification clearance or an approved Pre-Market Approval Application
("PMAA") before orders can be obtained and the product distributed in the
United States. The 510(k) clearance process is applicable when the new product
being submitted is substantially equivalent to an existing commercially
available product. The process of obtaining 510(k) clearance may take at least
three months from the date of filing of the application and generally requires
the submission of supporting data, which can be extensive and extend the
process for a considerable period of time. Under the PMAA process, the
applicant must generally conduct at least one clinical investigation and submit
extensive supporting data and clinical information in the PMAA, which typically
takes from one to two years, but sometimes longer for the FDA to review.
Generally, HCS has not been required to resort to the PMAA process for approval
of its products.
Software deemed to be a medical device, such as HCS's treatment planning
software, is reviewed by the FDA in connection with the agency's clearance of
the pre-market notification for the related device. Computer health information
system or stand-alone software may also be subject to FDA regulations. A draft
policy issued by the FDA in 1989 has been the applicable guidance for the
regulation of computer products intended to affect the diagnosis or treatment
of patients. The 1989 draft policy exempts certain software from regulation on
the basis of "competent human intervention" occurring with the use of the
software before any impact on human health would occur. The FDA is considering
a revised policy, which is expected to eliminate this exemption and to base the
level of regulation on the level of risk imposed by the product. It is not
clear what impact such regulatory policies, if adopted, will have on clinical
information systems or other medical software offered by HCS.
HCS believes that it is in material compliance with all applicable federal,
state and most foreign regulations regarding the manufacture and sale of its
products. Such regulations and their enforcement are, however, constantly
undergoing change, and HCS cannot predict what effect, if any, such change may
have on its business. Approvals may be withdrawn for failure to comply with
regulatory standards or due to the occurrence of unforeseen problems. Failure
to comply with FDA regulations could result in warning letters, product
approval delays or other sanctions being imposed, including restrictions on the
marketing or the recall of HCS's products, injunction or civil penalties.
Delays in the receipt of or failure to receive necessary regulatory approvals
or the loss of existing approvals could have a material adverse effect on HCS.
HCS believes that its products substantially comply with all applicable
electrical safety and environmental standards, such as those of Underwriters
Laboratories and IEC 601.
HCS is also subject to FDA and FTC restrictions on advertising and numerous
foreign, federal, state and local laws relating to such matters as safe working
conditions and manufacturing practices. Changes in existing requirements,
adoption of new requirements or failure to comply with applicable requirements
could have a material adverse effect on HCS.
The manufacture and sale of medical products manufactured by HCS involve the
risk of product liability claims and exposes HCS to substantial liability to
patients for damages resulting from the faulty design or manufacture of
products. Because these products involve the delivery of radiation to the human
body or are involved in diagnostic imaging of the human body, the possibility
for significant injury and/or death exists with any of HCS's products.
Therefore, the design, manufacture, sale or service of the medical products
20
<PAGE>
manufactured by HCS involve the risk of product liability claims and exposes
HCS to substantial liability to patients for damages resulting from the faulty
design, manufacture or servicing of such products.
Medicare and Medicaid Reimbursement
The Federal government regulates reimbursement for diagnostic examinations
furnished to Medicare beneficiaries, including related physician services and
capital equipment acquisition costs. For example, Medicare reimbursement for
operating costs for radiation treatment performed on hospital inpatients
generally is set under the Medicare prospective payment system ("PPS")
diagnosis-related group ("DRG") regulations. Under PPS, Medicare pays hospitals
a fixed amount for services provided to an inpatient based on his or her DRG,
rather than reimbursing for the actual costs incurred by the hospital. Patients
are assigned to a DRG based on their principal and secondary diagnoses,
procedures performed during the hospital stay, age, gender and discharge
status.
For capital costs for inpatient services, prior to October 1, 1991, Medicare
reimbursed hospitals an amount based on 85 percent of the actual reasonable
costs they had incurred. On October 1, 1991, Medicare began to phase in over a
ten-year period a prospective payment system for capital costs which
incorporates an add-on to the DRG-based payment to cover capital costs and
which replaces the reasonable cost-based methodology. The Balanced Budget Act
of 1997 ("BBA"), enacted in law August 5, 1997, further reduces capital
payments to hospitals by 2.1 percent between October 1, 1997 and September 30,
2002.
For certain hospital outpatient services, including radiation treatment
reimbursement, currently is based on the lesser of the hospital's costs or
charges, or a blended amount, 42 percent of which is based on the hospital's
reasonable costs and 58 percent of which is based on the fee schedule amount
that Medicare reimburses for such services when furnished in a physician's
office. The BBA requires capital outpatient reimbursement to shift from a cost
basis to a prospective payment system by 1999. Because the Health Care
Financing Administration ("HCFA") has not yet proposed regulations to implement
the outpatient PPS, it is unclear what impact such a change will have on
payment for radiation treatment. Until January 2000, capital acquisition costs
for services furnished to hospital outpatients will be reimbursed on the basis
of 90 percent of the reasonable costs actually incurred by the hospital.
Until January 1, 1992, Medicare generally reimbursed physicians on the basis
of their reasonable charges or, for certain physicians, including radiologists,
on the basis of a "charge-based" fee schedule. On January 1, 1992, Medicare
began to phase in over a five-year period a new system that reimburses all
physicians, based on the lower of their actual charges or a fee schedule amount
based on a "resource-based relative value scale." Relative value units
representing practice expenses, such as equipment costs, currently account for
approximately 42 percent of a physician's Medicare fee schedule payment for a
particular service. Under the BBA, HCFA is required to implement by January 1,
1999, a revised methodology for calculating practice expense relative value
units from the current historical basis to a resource basis. HCFA already has
proposed to establish two separate practice expense values for each physician
service--one for when a service is furnished in a facility setting and another
for when the service is performed in a physician's office. Typically, for a
service that could be provided in either setting, the practice expense value
would be higher when the service is performed in a physician's office as it
would cover a physician's costs such as for equipment, supplies, and overhead.
At this time, HCFA has yet to issue regulations setting new practice expense
values. Certain revisions that HCFA might make in these values could have a
positive or negative effect on physician reimbursement for oncology system
services provided in a facility and a positive or negative effect on physician
reimbursement for oncology system services provided in a physician's office.
Reimbursement for services rendered to Medicaid beneficiaries is determined
pursuant to each state's Medicaid plan which is established by state law and
regulations, subject to requirements of federal law and regulations. The BBA
has revised the Medicaid program to allow states even more control over
coverage and payment issues. In addition, the HCFA already has granted many
states waivers to allow for greater control of the Medicaid program at the
state level. The impact on HCS of this greater state control on Medicaid
payment for diagnostic services is uncertain.
21
<PAGE>
The sale of medical devices, the referral of patients for diagnostic
examinations utilizing such devices, and the submission of claims to third
party payers (including Medicare and Medicaid) seeking reimbursement for such
services, are subject to various federal and state laws pertaining to health
care "fraud and abuse," including physician self-referral prohibitions, anti-
kickback laws, and false claims laws. Subject to certain enumerated exceptions,
the federal physician self-referral law, also known as Stark II, prohibits a
physician from referring Medicare or Medicaid patients to an entity in which
the physician (or a family member) has an ownership interest or compensation
relationship if the referral is for a "designated health service," which is
defined explicitly to include radiology services. Although final regulations
implementing Stark II have not yet been issued by the United States Department
of Health and Human Services, proposed regulations were issued in January 1998.
Under the proposed regulations, the definition of radiology services subject to
the Stark II restriction would expressly exclude screening mammography services
(i.e., mammography services furnished to asymptomatic patients), but not
diagnostic mammography (i.e., mammography services furnished to symptomatic
patients). The Stark II law, as well as physician self-referral restrictions
that exist in a number of states and which apply regardless of whether Medicare
or Medicaid patients are involved, may result in lower utilization of certain
diagnostic procedures, which may affect the demand for HCS's products. Anti-
kickback laws make it illegal to solicit, offer, receive, or pay any
remuneration in exchange for, or to induce, the referral of business, including
the purchase of medical devices from a particular manufacturer or the referral
of patients to a particular supplier of diagnostic services utilizing such
devices. False claims laws prohibit anyone from knowingly and willfully
presenting, or causing to be presented, claims for payment to third party
payers (including Medicare and Medicaid) that are false or fraudulent, for
services not provided as claimed, or for medically unnecessary services.
Violations of fraud and abuse laws are prosecuted by the Office of the
Inspector General and are punishable by criminal and/or civil sanctions
including, in some instances, imprisonment and exclusion from participation in
federal health care programs such as Medicare and Medicaid.
The current administration and the Congress from time to time consider
various Medicare and other health care reform proposals that could
significantly affect both private and public reimbursement for health care
services. Some of these proposals, if enacted into law, could reduce
reimbursement for or the incentive to use diagnostic devices and procedures and
thus could adversely affect the demand for diagnostic devices, including HCS's
products.
Foreign Regulation
Sales of medical devices outside the United States are subject to regulatory
requirements that vary from country to country. Specifically, certain foreign
regulatory bodies have adopted various regulations governing product standards,
packaging requirements, labeling requirements, import restrictions, tariff
regulations, duties and tax requirements. The European Union has adopted a new
Medical Device Directive, which was implemented in all countries of the
European Union in July 1998. HCS is required to obtain ISO 9001 certification
necessary to enable it to affix the required CE mark to its products. The CE
mark is an international symbol of adherence to certain quality assurance
standards and compliance with applicable European medical device directives
which, once affixed, enables a product to be sold in member countries of the
European Union. Several Asian countries are reviewing the possibility of
adopting similar regulatory schemes. In addition, several countries are
reviewing proposed regulations that would require manufacturers to dispose of
their products at the end of their useful life. There can be no assurance that
HCS will not be required to incur significant costs in obtaining or maintaining
its non-U.S. regulatory approvals. Delays in receipt of or failure to receive
such approvals, the loss of previously obtained approvals, or failure to comply
with existing or future regulatory requirements would have a material adverse
effect on HCS's business, financial condition and results of operation.
PATENT AND OTHER PROPRIETARY RIGHTS
As a leader in the manufacture and sale of oncology systems and x-ray tubes,
HCS has pursued a policy of seeking patent, copyright, trademark and trade
secret protection in the United States and other countries for developments,
improvements, and inventions originating within its organization that are
incorporated in HCS's
22
<PAGE>
products or that fall within its fields of interest. As of October 2, 1998, HCS
owned approximately 58 patents in the United States and approximately 77
patents throughout the world, and had approximately 101 patent applications on
file with various patent agencies worldwide. HCS intends to file additional
patent applications as appropriate.
HCS relies on a combination of copyright, trade secret and other laws, and
contractual restrictions on disclosure, copying and transferring title to
protect its proprietary rights. HCS has trademarks, both registered and
unregistered, that are maintained and enforced to provide customer recognition
for its products in the marketplace. HCS also has agreements with third parties
that provide for licensing of patented or proprietary technology. These
agreements include royalty-bearing licenses and technology cross-licenses.
While HCS places considerable importance on its licensed technology, HCS does
not believe that the loss of any license would have a material adverse effect
on HCS's business.
HCS's competitors, like companies in many high technology businesses,
routinely review the products of others for possible conflict with their own
patent rights. Although HCS has from time to time received notices of claims
from others alleging patent infringement, HCS believes that there are no
pending patent infringement claims that might have a material adverse effect on
the business of HCS.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth the names and ages of the Registrant's
executive officers, together with positions and offices held within the last
five years by such executive officers. Officers are appointed to serve until
the meeting of the Board of Directors following the next Annual Meeting of
Stockholders and until their successors have been elected and have qualified.
Ages are as of December 15, 1998.
<TABLE>
<CAPTION>
NAME AGE POSITION (BUSINESS EXPERIENCE) TERM
---- --- ------------------------------ ----
<S> <C> <C> <C>
J. Tracy
O'Rourke
(Director) 63 Chairman of the Board and Chief Executive Officer 1990-Present
Richard A.
Aurelio 54 Executive Vice President 1992-Present
Allen J.
Lauer 61 Executive Vice President 1990-Present
Richard M.
Levy 60 Executive Vice President 1990-Present
Elisha W.
Finney 37 Treasurer 1998-Present
Assistant Treasurer 1995-1998
Risk Manager 1988-1998
Timothy E.
Guertin 49 Corporate Vice President 1992-Present
President, Oncology Systems 1990-Present
Robert A.
Lemos 57 Vice President, Finance and Chief Financial Officer 1986-Present
Treasurer 1995-1998
Joseph B.
Phair 51 Secretary 1991-Present
Vice President and General Counsel 1990-Present
Wayne P.
Somrak 53 Vice President 1991-Present
Controller 1995-Present,
1985-1994
Treasurer 1995
</TABLE>
There is no family relationship between any of the executive officers.
23
<PAGE>
ITEM 2. PROPERTIES
The Company's executive offices and principal research and manufacturing
facilities are located in Palo Alto, California, on 45 acres of land held under
leaseholds which expire in the years 2012 through 2058. These facilities are
owned by the Company, and provide floor space totaling 641,316 square feet. The
following is a summary of the Company's properties at October 2, 1998:
<TABLE>
<CAPTION>
NUMBER OF
LAND (ACRES) BUILDINGS (000'S SQ. FT.) BUILDINGS
------------ --------------------------- ------------
OWNED LEASED OWNED LEASED OWNED LEASED
----- ------ ------------- ------------- ----- ------
<S> <C> <C> <C> <C> <C> <C>
United States............. 100 50 1,594 513 19 45
International............. 34 10 411 391 8 84
--- --- ------------- ----------- --- ---
134 60 2,005 904 27 129
=== === ============= =========== === ===
</TABLE>
Utilization of facilities by segment is shown in the following table:
<TABLE>
<CAPTION>
BUILDINGS (000'S SQ. FT.)
-------------------------------------------
MANUFACTURING,
ADMINISTRATIVE AND
RESEARCH & DEVELOPMENT
-------------------------
NON- MARKETING
U.S. U.S. TOTAL AND SERVICE TOTAL
-------- ------- -------- ----------- -----
<S> <C> <C> <C> <C> <C>
Health Care Systems.................. 560 43 603 223 826
Instruments.......................... 543 188 731 436 1,167
Semiconductor Equipment.............. 373 72 445 116 561
-------- ------ -------- --- -----
Total Operations................... 1,476 303 1,779 775 2,554
======== ====== ======== === =====
Other Operations..................... 355
-----
Total.............................. 2,909
=====
</TABLE>
Other Operations includes manufacturing support.
The capacity of these facilities is sufficient to meet current demand. The
Company owns substantially all of the machinery and equipment in use in its
plants. It is the Company's policy to maintain its plants and equipment in
excellent condition and at a high level of efficiency.
Manufacturing sites by geographical location are as follows:
<TABLE>
<S> <C>
Health Care Systems.. California, Illinois, South Carolina, Utah,
England, Finland, France, Switzerland
Instruments..... California, Colorado, Massachusetts, Arizona,
Australia, Italy, The Netherlands
Semiconductor
Equipment...... Massachusetts, Japan, Korea
</TABLE>
Company-owned and staffed sales offices throughout the world are located in
North and South America: Argentina, Brazil, Venezuela, Canada, Mexico, United
States; Europe: Austria, Belgium, Denmark, France, Italy, the Netherlands,
Spain, Sweden, Switzerland, Finland, England, Scotland, Germany, Israel, India,
Russia; and Pacific Basin: Australia, People's Republic of China, Hong Kong,
Japan, Korea, Singapore, Taiwan and Thailand.
ITEM 3. LEGAL PROCEEDINGS
Information required by this Item is provided under the heading
"Contingencies" of the Notes to the Consolidated Financial Statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
24
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The information required by this Item is provided in the quarterly financial
table, "Common Stock Prices (Unaudited)," located on page F-23 of this
document and under the heading "Long-Term Debt," in the Notes to the
Consolidated Financial Statements.
The Company's common stock is listed on the New York Stock Exchange and the
Pacific Exchange under the trading symbol VAR.
There were 5,992 holders of record of the Company's common stock on December
15, 1998.
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
FISCAL YEARS
--------------------------------------------
1998 1997* 1996 1995 1994
-------- -------- -------- -------- --------
(DOLLARS IN MILLION EXCEPT PER SHARE
AMOUNTS)
SUMMARY OF OPERATIONS:
<S> <C> <C> <C> <C> <C>
Sales.............................. $1,422.1 $1,425.8 $1,599.4 $1,575.7 $1,313.4
-------- -------- -------- -------- --------
Earnings from Continuing Operations
before Taxes...................... $ 112.7 $ 177.8 $ 189.2 $ 165.3 $ 109.1
Taxes on earnings................ 38.9 62.2 67.1 59.5 41.5
-------- -------- -------- -------- --------
Earnings from Continuing
Operations........................ $ 73.8 $ 115.6 $ 122.1 $ 105.8 $ 67.6
Earnings from Discontinued
Operations,
Net of Taxes.................... -- -- -- 33.5 11.8
-------- -------- -------- -------- --------
Net Earnings....................... 73.8 115.6 122.1 139.3 79.4
======== ======== ======== ======== ========
Net Earnings Per Share--Basic
Net Earnings Continuing
Operations........................ $ 2.47 $ 3.79 $ 3.93 $ 3.14 $ 1.97
Net Earnings Discontinued
Operations........................ -- -- -- 1.00 0.34
-------- -------- -------- -------- --------
Net Earnings Per Share--Basic...... $ 2.47 $ 3.79 $ 3.93 $ 4.14 $ 2.31
======== ======== ======== ======== ========
Net Earnings Per Share--Diluted
Net Earnings Continuing
Operations........................ $ 2.43 $ 3.67 $ 3.81 $ 3.02 $ 1.90
Net Earnings Discontinued
Operations........................ -- -- -- 0.95 0.33
-------- -------- -------- -------- --------
Net Earnings Per Share--Diluted.... $ 2.43 $ 3.67 $ 3.81 $ 3.97 $ 2.23
======== ======== ======== ======== ========
Dividends Declared Per Share....... $ 0.390 $ 0.350 $ 0.310 $ 0.270 $ 0.230
======== ======== ======== ======== ========
<CAPTION>
FINANCIAL POSITION AT YEAR END:
<S> <C> <C> <C> <C> <C>
Total assets....................... $1,218.3 $1,104.3 $1,018.9 $1,003.8 $ 962.4
Long-term debt (excluding current
portion).......................... $ 111.1 $ 73.2 $ 60.3 $ 60.3 $ 60.4
</TABLE>
* Fiscal year 1997 results include a $51.0 million pre-tax gain ($33.2 million
after-tax or $1.06 per diluted share) on the sale of the Thin Film Systems
business.
This selected financial data should be read in conjunction with the related
consolidated financial statements and notes thereto included in Item 14.
25
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
Fiscal Year
The Company's fiscal years reported are the 52- or 53-week periods which
ended on the Friday nearest September 30. Fiscal year 1998 comprises the 53-
week period ended on October 2, 1998. Fiscal years 1997 and 1996 comprise the
52-week periods ended on September 26, 1997 and September 27, 1996,
respectively.
Fiscal Year 1998 Compared to Fiscal Year 1997
Sales. The Company's sales of $1.422 billion in fiscal year 1998 were flat
with fiscal year 1997 sales of $1.426 billion, but increased 6% over fiscal
year 1997 after adjusting for the sale of the Company's former Thin Film
Systems (TFS) business in June 1997. Fourth quarter fiscal year 1998 sales
declined 10% to $364 million from the fourth quarter of fiscal year 1997, but
were 7% higher than sales in the third quarter of fiscal year 1998.
The Company's Health Care Systems business (HCS) sales of $540 million in
fiscal year 1998 were 14% higher than its sales of $472 million in fiscal year
1997. Fourth fiscal quarter sales were significant in both years, accounting
for $179 million of HCS's sales in fiscal year 1998 and $158 million of its
sales in fiscal year 1997, amounting to 33% of total sales in each fiscal year.
Oncology systems sales were $408 million, or 76% of HCS's sales in fiscal year
1998, compared to $343 million, or 73% of its sales, in fiscal year 1997. X-ray
tubes and imaging subsystems sales were $131 million, or 24% of HCS's sales, in
fiscal year 1998, compared to $130 million, or 28% of its sales, in fiscal year
1997. Oncology systems sales accounted for almost all of the increase in HCS's
sales in fiscal year 1998. The 19% increase in sales of oncology systems
between fiscal year 1997 and fiscal year 1998 reflects both an increase in
volume of products and services sold and the acquisition from General Electric
Company of its radiotherapy service business in December 1997. X-ray tubes and
imaging subsystem sales also increased 2% between fiscal year 1997 and fiscal
year 1998. International sales were $267 million, or 49% of HCS's total sales,
in fiscal year 1998, compared to $236 million, or 50% of its total sales in
fiscal year 1997. Geographically, fiscal year 1998 sales to customers in
Europe, the Far East and the rest of the world were $156 million, $69 million
and $42 million, respectively. In fiscal 1997, sales to customers in Europe,
the Far East and the rest of the world were $102 million, $98 million and $36
million.
The Company's Instruments business (IB) sales of $543 million in fiscal year
1998 were 3% greater than its sales of $527 million in fiscal year 1997. Fiscal
year 1998 sales were driven largely by IB's analytical instruments and NMR
instruments lines. The effect of the stronger U.S. dollar and a softening Asian
market slowed sales growth during fiscal year 1998. International sales were
$261million in fiscal year 1998, compared to $253 million in fiscal year 1997,
both 48% of total sales in each year. Geographically, fiscal year 1998 sales to
customers in Europe, the Far East and the rest of the world were $161 million,
$58 million and $42 million, respectively. In fiscal 1997, sales to customers
in Europe, the Far East and the rest of the world were $140 million, $70
million and $43 million.
The Company's Semiconductor Equipment business (SEB) sales of $338 million in
fiscal year 1998 were 20% lower than its sales of $424 million in fiscal year
1997. Adjusted for sales attributable to the TFS business, SEB's sales were 2%
lower in fiscal year 1998 than in fiscal year 1997. Fourth quarter sales of $42
million in fiscal year 1998 were 61% lower than the $107 million of fourth
quarter sales in fiscal year 1997. International sales were $239 million, or
71% of SEB's total sales, in fiscal year 1998, compared to $231 million, or 54%
of its total sales, in fiscal year 1997. Geographically, SEB sales to customers
in the Far East were $165 million in fiscal 1998 as compared to $174 million in
fiscal 1997. Sales to customers in Europe were $74 million and $57 million in
fiscal year 1998 and fiscal year 1997, respectively. Starting in the first half
of fiscal year 1998, the semiconductor industry began to experience a
significant worldwide slowdown in equipment demand, brought about by depressed
device pricing, excess capacity and the Asian financial crisis.
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The slowdown in product demand and extreme volatility in product pricing has
caused the semiconductor industry to reduce significantly or delay purchases of
semiconductor manufacturing equipment and construction of new fabrication
facilities. This slowdown and volatility is expected to continue throughout
fiscal year 1999. These conditions have adversely affected and will continue to
adversely affect SEB's results of operations.
Gross Profit. Total Company gross profit of $526 million for fiscal year 1998
remained essentially unchanged from fiscal year 1997 gross profit of $523
million and represented 37% of its sales in both fiscal years. HCS's gross
profit of $191 million in fiscal year 1998 was 35% of its sales, compared to
$161 million, or 34% of its sales, in fiscal year 1997. The increase in HCS's
gross profit as a percentage of its sales from fiscal year 1997 to fiscal year
1998 was primarily attributable to the increase in oncology systems sales
relative to the fixed components of overhead and, to a lesser extent, a shift
in oncology systems sales to a higher mix of ancillary products that earn a
higher margin. IB's gross profit of $216 million in fiscal year 1998 was 40% of
its sales, compared to $207 million, or 39% of its sales, in fiscal year 1997.
The increase in IB's gross profit as a percentage of its sales from fiscal year
1997 to fiscal year 1998 was primarily attributable to improved operating
efficiencies. SEB's gross profit of $115 million in fiscal year 1998 was 34% of
its sales, compared to $157 million, or 37% of its sales, in fiscal year 1997.
The decrease in SEB's gross profit as a percentage of its sales from fiscal
year 1997 to fiscal year 1998 was primarily attributable to competitive pricing
pressures encountered during the industry slowdown in the second half of fiscal
year 1998, and costs associated with excess capacity.
Research and Development. For the Company overall, research and development
expenses declined $4 million in fiscal year 1998 to $107 million, or 8% of its
sales, compared to 7% of its sales in fiscal year 1997. HCS's research and
development expenses increased primarily due to investments in new digital
radiographic imaging products, new oncology administrative and imaging
software, improvements in oncology systems multileaf collimator products and
new x-ray tube platforms. IB's research and development decreased reflecting
the shift away from outside consultants and the Ginzton Research Center to in-
house employees. SEB's research and development expenses also decreased;
however, after adjusting for research and development expenses attributable to
the TFS business in fiscal year 1997 of $13 million, SEB's research and
development expenses increased over fiscal year 1997.
Sale of Business. In June 1997, the Company completed the sale of its TFS
business. Total proceeds received from the sale of the TFS business were $146
million in cash. The gain on the sale was $33 million, net of income taxes of
$18 million. A $52 million reserve was recorded to cover, among other items,
purchase price disputes, retained liabilities, transaction costs, employee
terminations, facilities separation costs, indemnification obligations,
litigation expenses and other contingencies.
Earnings before Taxes. The Company's fiscal year 1998 pretax earnings were
$113 million, compared to $178 million in fiscal year 1997, which included the
$51 million gain on sale of the TFS business.
Net Earnings. In fiscal year 1998, the Company earned $73.8 million compared
to $115.6 million in fiscal year 1997. Diluted earnings per share of $2.43
declined from the diluted earnings per share of $3.67 in fiscal year 1997.
Fiscal year 1997 earnings included a $33 million after-tax gain ($1.06 per
diluted share) on the sale of the TFS business, as well as a $4.0 million
($0.14 per diluted share) operating loss from that business. Diluted earnings
per share for fiscal year 1997 were $2.75 after adjusting for the sale of the
TFS business.
Fiscal Year 1997 Compared to Fiscal Year 1996
Sales. The Company's sales of $1.426 billion in fiscal year 1997 were 11%
lower than fiscal year 1996 (5% lower on a TFS-adjusted basis).
HCS's sales of $472 million in fiscal year 1997 were 2% higher than its sales
of $464 million in fiscal year 1996. Oncology systems sales were $343 million,
or 73% of HCS's sales, in fiscal year 1997, compared to $324 million, or 70% of
its sales, in fiscal year 1996. X-ray tubes and imaging subsystems sales were
27
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$129 million, or 27% of HCS's sales, in fiscal year 1997, compared to $140
million, or 30% of its sales, in fiscal year 1996. International sales were
$236 million, or 50% of HCS's total sales, in fiscal year 1997, compared to
$238 million, or 51% of its total sales in fiscal year 1996. Geographically,
fiscal year 1997 sales to customers in Europe, the Far East and the rest of the
world were $102 million, $98 million and $36 million, respectively. In fiscal
1996, sales to customers in Europe, the Far East and the rest of the world were
$99 million, $104 million and $35 million.
IB's sales of $527 million in fiscal year 1997 were 10% higher than its sales
of $481 million in fiscal year 1996. All of IB's product lines contributed to
the higher sales in fiscal year 1997. International sales were $253 million, or
48% of IB's total sales, in fiscal year 1997, compared to $250 million, or 52%
of its total sales in fiscal year 1997. Geographically, fiscal year 1997 sales
to customers in Europe, the Far East and the rest of the world were $140
million, $70 million and $43 million, respectively. In fiscal 1996, sales to
customers in Europe, the Far East and the rest of the world were $142 million,
$62 million and $46 million.
SEB's sales of $424 million in fiscal year 1997 were 35% lower than its sales
of $650 million in fiscal year 1996. Adjusted for sales attributable to the TFS
business, SEB's sales were 27% lower in fiscal year 1997 than in fiscal year
1996. Beginning in the latter half of fiscal year 1996, the semiconductor
equipment industry began to experience a slowdown. The slowdown was a product
of excess capacity and sharply decreasing device prices within the DRAM market
segment. This slowdown lasted through the first half of fiscal year 1997, when
industry conditions began to improve slightly as a result of strengthening
demand from logic and microprocessor device manufacturers, primarily located in
Taiwan. International sales by SEB were $231 million, or 54% of SEB's sales, in
fiscal year 1997, compared to $430 million, or 66% of its sales, in fiscal year
1996. Geographically, SEB sales to customers in the Far East were $174 million
in fiscal 1997 as compared to $349 million in fiscal 1996. Sales to customers
in Europe were $57 million and $81 million in fiscal year 1997 and fiscal year
1996, respectively.
Gross Profit. Total Company gross profit of $523 million in fiscal year 1997
declined 13% from the $604 million recorded in fiscal year 1996 due to the
lower sales. HCS's gross profit of $161 million in fiscal year 1997 was 34% of
its sales, compared to $162 million, or 35% of HCS's sales, in fiscal year
1996. The decrease in gross profit as a percentage of its sales from fiscal
year 1996 to fiscal year 1997 was primarily attributable to the strengthening
of the U.S. dollar relative to other international currencies. IB's gross
profit of $207 million in fiscal year 1997 was 39% of its sales, compared to
$192 million, or 40% of its sales, in fiscal year 1996. The increase in gross
profit was attributable primarily to improved sales volume and relatively
constant fixed costs. SEB's gross profit of $157 million in fiscal year 1997
and $252 million in fiscal year 1996 represented 37% and 39% of its sales in
fiscal year 1997 and fiscal year 1996, respectively.
Research and Development. For the Company overall, research and development
expenses in fiscal year 1997 remained level with fiscal year 1996 at $111
million, or 8% of its sales, compared to 7% of its sales in fiscal year 1996.
HCS's research and development expenses increased in fiscal year 1997 due to
increased spending on new software products, particularly its imaging products
and increased spending on new x-ray tube developments. The imaging business
continued to address technical and manufacturing issues for amorphous silicon
solid state detectors. IB's research and development expenses increased
slightly due to consulting costs. SEB's research and development expenses
decreased primarily due to the sale of the TFS business.
Earnings Before Taxes. The Company's pre-tax earnings in fiscal year 1997
were $178 million, compared to $189 million in fiscal year 1996. Fiscal year
1997 pretax earnings included the $51 million gain on the sale of the TFS
business.
Net Earnings. In fiscal year 1997, the Company earned $116 million compared
to $122 million in fiscal year 1996. Included in 1997 net earnings is the $33
million after tax gain ($1.06 per diluted share) on the sale of the TFS
business. Diluted earnings per share of $3.67 in fiscal year 1997 were down
from $3.81 in fiscal year 1996.
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RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting and Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income." SFAS No.130 establishes standards for reporting and
display of comprehensive income and its components in a full set of general-
purpose financial statements. It is effective for the Company's 1999 fiscal
year. The Company has not yet determined the impact of its implementation on
the Company's consolidated financial statements.
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of an
Enterprise and Related Information." SFAS No.131 changes current practice under
SFAS No.14 by establishing a new framework on which to base segment reporting
(referred to as the "management" approach) and also requires interim reporting
of segment information. It is effective for the Company's 1999 fiscal year. The
impact of implementation of SFAS No. 131 on the reporting of the Company's
segment information has not yet been determined.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No.1