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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



For the quarterly period ended July 1, 2005



OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------



For the transition period from
                     to



Commission File Number: 0-25395



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VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.

(Exact name of Registrant as
Specified in its Charter)



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|                                                              |  |                                 
|------------------------------------------------------------- |  | --------------------------------
|Delaware                                                      |  | 77-0501994                      
|State or other jurisdiction of Incorporation or organization: |  | IRS Employer Identification No.:



|                                         |  |           
|---------------------------------------- |  | ----------
|35 Dory Road, Gloucester, Massachusetts  |  | 01930     
|(Address of principal executive offices) |  | (Zip code)



(978) 282-2000

(Registrants telephone number, including area code)



---



Indicate by checkmark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No ̈



Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No ̈



Shares of common stock outstanding at August 1, 2005: 37,199,150.



An index of exhibits filed with this Form 10-Q is located on page 31.



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##### Table of Contents

VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.



INDEX



|                              |  |                                                                                                                      |  |           
|----------------------------- |  | -------------------------------------------------------------------------------------------------------------------- |  | ----------
|ItemNumber                    |  |                                                                                                                      |  | PageNumber
|PART I. FINANCIAL INFORMATION |  |                                                                                                                     
|                              |  |                                                                                                                     
|Item 1.                       |  | Consolidated Financial Statements                                                                                    |  | 1         
|                              |  |                                                                                                                     
|                              |  | Unaudited Consolidated Balance Sheets at July 1, 2005 and October 1, 2004                                            |  | 1         
|                              |  | Unaudited Consolidated Statements of Income for the three and nine month periods ended July 1, 2005 and July 2, 2004 |  | 2         
|                              |  | Unaudited Consolidated Statements of Cash Flows for the nine month periods ended July 1, 2005 and July 2, 2004       |  | 3         
|                              |  | Notes to the Consolidated Financial Statements (Unaudited)                                                           |  | 4         
|                              |  |                                                                                                                     
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations .                              |  | 17        
|                              |  |                                                                                                                     
|Item 3.                       |  | Quantitative and Qualitative Disclosures About Market Risk                                                           |  | 33        
|                              |  |                                                                                                                     
|Item 4.                       |  | Controls and Procedures                                                                                              |  | 34        
|                              | 
|PART II. OTHER INFORMATION    |  |                                                                                                                     
|                              |  |                                                                                                                     
|Item 1.                       |  | Legal Proceedings                                                                                                    |  | 35        
|                              |  |                                                                                                                     
|Item 2.                       |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                          |  | 35        
|                              |  |                                                                                                                     
|Item 3.                       |  | Defaults Upon Senior Securities                                                                                      |  | 35        
|                              |  |                                                                                                                     
|Item 4.                       |  | Submission of Matters to a Vote of Security Holders                                                                  |  | 35        
|                              |  |                                                                                                                     
|Item 5.                       |  | Other Information                                                                                                    |  | 35        
|                              |  |                                                                                                                     
|Item 6.                       |  | Exhibits                                                                                                             |  | 36        
|                              |  |                                                                                                                     
|                              |  | Signatures                                                                                                           |  | 37        



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##### Table of Contents

PART 1. FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS



VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.



UNAUDITED CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                                        |  |                                          |         |   |                |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------- | ------- | - | -------------- | - | ------- | -
|                                                                                                                                                                        |  | July 1,2005                              |         |   | October 1,2004 |  
|                                                                                                                                                                        |  | (Amounts in thousands,except share data) |        
|ASSETS                                                                                                                                                                  |  |                                          |         |   |                |   |         |  
|Current assets                                                                                                                                                          |  |                                          |         |   |                |   |         |  
|Cash and cash equivalents                                                                                                                                               |  | $                                        | 189,272 |   |                | $ | 218,578 |  
|Short-term investments                                                                                                                                                  |  |                                          | 247,121 |   |                |   | 173,891 |  
|Accounts receivable, net                                                                                                                                                |  |                                          | 134,140 |   |                |   | 123,749 |  
|Inventories                                                                                                                                                             |  |                                          | 140,280 |   |                |   | 104,900 |  
|Deferred income taxes                                                                                                                                                   |  |                                          | 28,177  |   |                |   | 27,691  |  
|Other current assets                                                                                                                                                    |  |                                          | 23,084  |   |                |   | 32,938  |  
|                                                                                                                                                                        |  |                                          |         |   |                |   |         |  
|Total current assets                                                                                                                                                    |  |                                          | 762,074 |   |                |   | 681,747 |  
|                                                                                                                                                                        |  |                                         
|Property, plant and equipment, net                                                                                                                                      |  |                                          | 60,418  |   |                |   | 52,344  |  
|Goodwill                                                                                                                                                                |  |                                          | 12,280  |   |                |   | 12,280  |  
|Other assets                                                                                                                                                            |  |                                          | 3,041   |   |                |   | 3,125   |  
|                                                                                                                                                                        |  |                                          |         |   |                |   |         |  
|Total assets                                                                                                                                                            |  | $                                        | 837,813 |   |                | $ | 749,496 |  
|                                                                                                                                                                        |  |                                          |         |   |                |   |         |  
|                                                                                                                                                                        |  |                                         
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                    |  |                                          |         |   |                |   |         |  
|                                                                                                                                                                        |  |                                         
|Current liabilities                                                                                                                                                     |  |                                          |         |   |                |   |         |  
|Notes payable and current portion of long-term debt                                                                                                                     |  | $                                        | 416     |   |                | $ | 4,016   |  
|Accounts payable                                                                                                                                                        |  |                                          | 38,241  |   |                |   | 34,134  |  
|Accrued expenses                                                                                                                                                        |  |                                          | 53,019  |   |                |   | 53,234  |  
|Product warranty                                                                                                                                                        |  |                                          | 8,722   |   |                |   | 7,841   |  
|Deferred revenue                                                                                                                                                        |  |                                          | 64,482  |   |                |   | 54,509  |  
|                                                                                                                                                                        |  |                                          |         |   |                |   |         |  
|Total current liabilities                                                                                                                                               |  |                                          | 164,880 |   |                |   | 153,734 |  
|                                                                                                                                                                        |  |                                         
|Long-term accrued expenses                                                                                                                                              |  |                                          | 10,622  |   |                |   | 10,905  |  
|Deferred income taxes                                                                                                                                                   |  |                                          | 6,216   |   |                |   | 4,615   |  
|Long-term debt                                                                                                                                                          |  |                                          | 3,846   |   |                |   | 4,162   |  
|                                                                                                                                                                        |  |                                          |         |   |                |   |         |  
|Total liabilities                                                                                                                                                       |  |                                          | 185,564 |   |                |   | 173,416 |  
|                                                                                                                                                                        |  |                                          |         |   |                |   |         |  
|Commitments, contingencies and guarantees (Note 14)                                                                                                                     |  |                                          |         |   |                |   |         |  
|                                                                                                                                                                        |  |                                         
|Stockholders equity                                                                                                                                                    |  |                                          |         |   |                |   |         |  
|Preferred stock, $0.01 par value; 5,000,000 shares authorized; none issued or outstanding                                                                               |  |                                          |        |   |                |   |        |  
|Common stock, $0.01 par value; 150,000,000 shares authorized; 37,070,263 and 36,408,995 shares issued and outstanding at July 1, 2005 and
October 1, 2004, respectively |  |                                          | 371     |   |                |   | 364     |  
|Capital in excess of par value                                                                                                                                          |  |                                          | 352,511 |   |                |   | 331,701 |  
|Retained earnings                                                                                                                                                       |  |                                          | 302,698 |   |                |   | 244,320 |  
|Deferred compensation                                                                                                                                                   |  |                                          | (3,066  | ) |                |   | (149    | )
|Accumulated other comprehensive loss                                                                                                                                    |  |                                          | (265    | ) |                |   | (156    | )
|                                                                                                                                                                        |  |                                          |         |   |                |   |         |  
|Total stockholders equity                                                                                                                                              |  |                                          | 652,249 |   |                |   | 576,080 |  
|                                                                                                                                                                        |  |                                          |         |   |                |   |         |  
|Total liabilities and stockholders equity                                                                                                                              |  | $                                        | 837,813 |   |                | $ | 749,496 |  
|                                                                                                                                                                        |  |                                          |         |   |                |   |         |  



The accompanying notes
to the unaudited consolidated financial statements are an integral part of these statements.



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VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.



UNAUDITED CONSOLIDATED STATEMENTS OF INCOME



|                                            |  |                                               |         |   |                          |   |         |              |  |   |              |   |  |   |         |  
|------------------------------------------- |  | --------------------------------------------- | ------- | - | ------------------------ | - | ------- | ------------ |  | - | ------------ | - |  | - | ------- | -
|                                            |  | Fiscal Three Months Ended                     |         |   | Fiscal Nine Months Ended |  
|                                            |  | July 1, 2005                                  |         |   | July 2, 2004             |   |         | July 1, 2005 |  |   | July 2, 2004 |  
|                                            |  | (Amounts in thousands, except per share data) |        
|Revenue                                     |  |                                               |         |   |                          |   |         |              |  |   |              |   |  |   |         |  
|Product                                     |  | $                                             | 144,227 |   |                          | $ | 127,059 |              |  | $ | 367,359      |   |  | $ | 322,866 |  
|Service                                     |  |                                               | 19,902  |   |                          |   | 16,727  |              |  |   | 60,584       |   |  |   | 46,297  |  
|Royalty                                     |  |                                               | 2,561   |   |                          |   | 2,349   |              |  |   | 26,269       |   |  |   | 6,141   |  
|                                            |  |                                               |         |   |                          |   |         |              |  |   |              |   |  |   |         |  
|Total revenue                               |  |                                               | 166,690 |   |                          |   | 146,135 |              |  |   | 454,212      |   |  |   | 375,304 |  
|                                            |  |                                               |         |   |                          |   |         |              |  |   |              |   |  |   |         |  
|Cost of revenue                             |  |                                               |         |   |                          |   |         |              |  |   |              |   |  |   |         |  
|Product                                     |  |                                               | 84,176  |   |                          |   | 68,372  |              |  |   | 211,950      |   |  |   | 178,877 |  
|Service                                     |  |                                               | 12,057  |   |                          |   | 10,813  |              |  |   | 37,398       |   |  |   | 29,400  |  
|                                            |  |                                               |         |   |                          |   |         |              |  |   |              |   |  |   |         |  
|Total cost of revenue                       |  |                                               | 96,233  |   |                          |   | 79,185  |              |  |   | 249,348      |   |  |   | 208,277 |  
|                                            |  |                                               |         |   |                          |   |         |              |  |   |              |   |  |   |         |  
|Gross profit                                |  |                                               | 70,457  |   |                          |   | 66,950  |              |  |   | 204,864      |   |  |   | 167,027 |  
|                                            |  |                                               |         |   |                          |   |         |              |  |   |              |   |  |   |         |  
|Operating expenses                          |  |                                               |         |   |                          |   |         |              |  |   |              |   |  |   |         |  
|Research and development                    |  |                                               | 19,351  |   |                          |   | 17,497  |              |  |   | 57,081       |   |  |   | 50,720  |  
|Marketing, general and administrative       |  |                                               | 26,243  |   |                          |   | 21,737  |              |  |   | 77,953       |   |  |   | 62,556  |  
|Restructuring                               |  |                                               |        |   |                          |   |        |              |  |   | 914          |   |  |   |        |  
|                                            |  |                                               |         |   |                          |   |         |              |  |   |              |   |  |   |         |  
|Total operating expenses                    |  |                                               | 45,594  |   |                          |   | 39,234  |              |  |   | 135,948      |   |  |   | 113,276 |  
|                                            |  |                                               |         |   |                          |   |         |              |  |   |              |   |  |   |         |  
|Operating income                            |  |                                               | 24,863  |   |                          |   | 27,716  |              |  |   | 68,916       |   |  |   | 53,751  |  
|Interest income                             |  |                                               | 3,026   |   |                          |   | 1,285   |              |  |   | 13,430       |   |  |   | 3,463   |  
|Interest expense                            |  |                                               | (100    | ) |                          |   | (275    | )            |  |   | (495         | ) |  |   | (693    | )
|Other income (expense), net                 |  |                                               | 17      |   |                          |   | (386    | )            |  |   | 2,754        |   |  |   | (498    | )
|                                            |  |                                               |         |   |                          |   |         |              |  |   |              |   |  |   |         |  
|Income before income taxes                  |  |                                               | 27,806  |   |                          |   | 28,340  |              |  |   | 84,605       |   |  |   | 56,023  |  
|Provision for income taxes                  |  |                                               | 8,506   |   |                          |   | 9,069   |              |  |   | 26,227       |   |  |   | 17,927  |  
|                                            |  |                                               |         |   |                          |   |         |              |  |   |              |   |  |   |         |  
|Net income                                  |  | $                                             | 19,300  |   |                          | $ | 19,271  |              |  | $ | 58,378       |   |  | $ | 38,096  |  
|                                            |  |                                               |         |   |                          |   |         |              |  |   |              |   |  |   |         |  
|Weighted average shares outstandingbasic   |  |                                               | 36,798  |   |                          |   | 36,314  |              |  |   | 36,619       |   |  |   | 35,984  |  
|Weighted average shares outstandingdiluted |  |                                               | 37,597  |   |                          |   | 37,054  |              |  |   | 37,376       |   |  |   | 36,963  |  
|Net income per sharebasic                  |  | $                                             | 0.52    |   |                          | $ | 0.53    |              |  | $ | 1.59         |   |  | $ | 1.06    |  
|Net income per sharediluted                |  | $                                             | 0.51    |   |                          | $ | 0.52    |              |  | $ | 1.56         |   |  | $ | 1.03    |  





The accompanying notes to the unaudited consolidated financial statements are an integral part of these statements.



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VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.



UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                                                  |  |                          |          |   |              |   |          |  
|--------------------------------------------------------------------------------- |  | ------------------------ | -------- | - | ------------ | - | -------- | -
|                                                                                  |  | Fiscal Nine Months Ended |         
|                                                                                  |  | July 1, 2005             |          |   | July 2, 2004 |  
|                                                                                  |  | (Amounts in thousands)   |         
|Cash flows from operating activities:                                             |  |                          |          |   |              |   |          |  
|Net income                                                                        |  | $                        | 58,378   |   |              | $ | 38,096   |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                          |          |   |              |   |          |  
|Depreciation and amortization                                                     |  |                          | 9,513    |   |              |   | 9,723    |  
|Tax benefit from stock options exercised and employee stock purchase plan         |  |                          | 3,424    |   |              |   | 13,668   |  
|Deferred income taxes                                                             |  |                          | 1,115    |   |              |   | (235     | )
|Amortization of investment premiums                                               |  |                          | 1,343    |   |              |   | 770      |  
|Stock-based compensation                                                          |  |                          | 3,581    |   |              |   |         |  
|Changes in assets and liabilities:                                                |  |                          |          |   |              |   |          |  
|Accounts receivable                                                               |  |                          | (10,255  | ) |              |   | (37,345  | )
|Inventories                                                                       |  |                          | (42,415  | ) |              |   | (39,339  | )
|Other current assets                                                              |  |                          | 9,854    |   |              |   | 3,732    |  
|Accounts payable                                                                  |  |                          | 3,995    |   |              |   | 13,389   |  
|Accrued expenses                                                                  |  |                          | 112      |   |              |   | 4,814    |  
|Product warranty                                                                  |  |                          | 887      |   |              |   | (480     | )
|Deferred revenue                                                                  |  |                          | 9,860    |   |              |   | 25,278   |  
|Other                                                                             |  |                          | (142     | ) |              |   | 214      |  
|                                                                                  |  |                          |          |   |              |   |          |  
|Net cash provided by operating activities                                         |  |                          | 49,250   |   |              |   | 32,285   |  
|                                                                                  |  |                          |          |   |              |   |          |  
|Cash flows from investing activities:                                             |  |                          |          |   |              |   |          |  
|Purchase of property, plant and equipment                                         |  |                          | (10,633  | ) |              |   | (7,131   | )
|Proceeds from sales and maturities of short-term investments                      |  |                          | 96,853   |   |              |   | 23,126   |  
|Purchase of short-term investments                                                |  |                          | (172,218 | ) |              |   | (150,472 | )
|                                                                                  |  |                          |          |   |              |   |          |  
|Net cash used in investing activities                                             |  |                          | (85,998  | ) |              |   | (134,477 | )
|                                                                                  |  |                          |          |   |              |   |          |  
|Cash flows from financing activities:                                             |  |                          |          |   |              |   |          |  
|Proceeds from the issuance of common stock                                        |  |                          | 11,047   |   |              |   | 25,275   |  
|Repayment of notes payable                                                        |  |                          | (3,768   | ) |              |   | (1,654   | )
|Repayment of long-term debt                                                       |  |                          | (316     | ) |              |   | (289     | )
|                                                                                  |  |                          |          |   |              |   |          |  
|Net cash provided by financing activities                                         |  |                          | 6,963    |   |              |   | 23,332   |  
|                                                                                  |  |                          |          |   |              |   |          |  
|Effects of exchange rates on cash                                                 |  |                          | 479      |   |              |   | (2       | )
|                                                                                  |  |                          |          |   |              |   |          |  
|Net decrease in cash and cash equivalents                                         |  |                          | (29,306  | ) |              |   | (78,862  | )
|Cash and cash equivalents at beginning of period                                  |  |                          | 218,578  |   |              |   | 310,481  |  
|                                                                                  |  |                          |          |   |              |   |          |  
|Cash and cash equivalents at end of period                                        |  | $                        | 189,272  |   |              | $ | 231,619  |  
|                                                                                  |  |                          |          |   |              |   |          |  



The accompanying notes
to the unaudited consolidated financial statements are an integral part of these statements.



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VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.



NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



Note 1. Description of Business and Basis of Presentation



Varian Semiconductor Equipment Associates, Inc. (Varian
Semiconductor) designs, manufactures, markets and services semiconductor processing equipment used in the fabrication of integrated circuits to customers located both in the United States (U.S.) and in international markets. Varian
Semiconductor faces risk factors similar to all companies in the semiconductor manufacturing equipment market including, but not limited to, competition, market downturn, technological change, international operations and related foreign currency
risks and ability to recruit and retain key employees.



These
unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the SEC). Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles in the U.S. have been condensed or omitted pursuant to such rules and regulations. These unaudited interim consolidated financial statements should be read in
conjunction with the financial statements and the notes thereto included in the annual report on Form 10-K filed by Varian Semiconductor with the SEC on December 14, 2004 for the fiscal year ended October 1, 2004. In the opinion of management, the
unaudited interim consolidated financial statements include all adjustments, consisting of only normal recurring adjustments, necessary to present fairly the information required to be set forth therein. The results of operations for the three and
nine month periods ended July 1, 2005 are not necessarily indicative of the results to be expected for a full year or for any other period.



Reclassifications



Certain items in the prior years consolidated financial statements have been reclassified to conform to the current presentation of the financial
statements.



Note 2. Accounting for Stock-Based Compensation



Varian Semiconductor accounts for stock compensation plans in accordance
with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. If Varian Semiconductor had elected to recognize compensation cost based on the fair value of all stock awards at grant date as
prescribed by Financial Accounting Standards Board (FASB) Statement No. 123, Accounting for Stock-Based Compensation, the net income and net income per basic and diluted share for the three and nine month periods ended July
1, 2005 and July 2, 2004 would have been reduced to the pro forma amounts shown below:



|                                                                                                                                    |  |                                                 |        |   |                         |   |        |             |  |   |             |   |  |   |        |  
|----------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------- | ------ | - | ----------------------- | - | ------ | ----------- |  | - | ----------- | - |  | - | ------ | -
|                                                                                                                                    |  | Fiscal Three MonthsEnded                        |        |   | Fiscal Nine MonthsEnded |  
|                                                                                                                                    |  | July 1,2005                                     |        |   | July 2,2004             |   |        | July 1,2005 |  |   | July 2,2004 |  
|                                                                                                                                    |  | (Amounts in thousands, except per shareamounts) |       
|Net income as reported                                                                                                              |  | $                                               | 19,300 |   |                         | $ | 19,271 |             |  |   | $58,378     |   |  | $ | 38,096 |  
|Add: Compensation expense included in net income                                                                                    |  |                                                 | 477    |   |                         |   | 10     |             |  |   | 2,487       |   |  |   | 10     |  
|Less: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax
benefit |  |                                                 | (2,416 | ) |                         |   | (2,067 | )           |  |   | (10,268     | ) |  |   | (7,633 | )
|                                                                                                                                    |  |                                                 |        |   |                         |   |        |             |  |   |             |   |  |   |        |  
|Pro forma net income                                                                                                                |  | $                                               | 17,361 |   |                         | $ | 17,214 |             |  |   | $50,597     |   |  | $ | 30,473 |  
|                                                                                                                                    |  |                                                 |        |   |                         |   |        |             |  |   |             |   |  |   |        |  
|Net income per sharebasic, as reported                                                                                             |  | $                                               | 0.52   |   |                         | $ | 0.53   |             |  | $ | 1.59        |   |  | $ | 1.06   |  
|Net income per sharediluted, as reported                                                                                           |  | $                                               | 0.51   |   |                         | $ | 0.52   |             |  | $ | 1.56        |   |  | $ | 1.03   |  
|                                                                                                                                    |  |                                                 |        |  
|Pro forma net income per share:                                                                                                     |  |                                                 |        |   |                         |   |        |             |  |   |             |   |  |   |        |  
|Basic                                                                                                                               |  | $                                               | 0.47   |   |                         | $ | 0.47   |             |  | $ | 1.38        |   |  | $ | 0.85   |  
|Diluted                                                                                                                             |  | $                                               | 0.46   |   |                         | $ | 0.46   |             |  | $ | 1.35        |   |  | $ | 0.82   |  



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VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.



NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



The $10.3 million in stock based compensation for the nine month period ended July 1, 2005 includes
$2.1 million resulting from the amendment to the definition of retirement in the Amended and Restated Omnibus Stock Plan by Varian Semiconductors Board of Directors on October 5, 2004 and the Retirement Agreement entered into on December 8,
2004 (see Note 11. Retirement Plans).



Note 3. Computation of Net Income Per
Share



Basic net income per share is calculated based on
net income and the weighted average number of shares of common stock outstanding during the reporting period. Diluted net income per share includes additional dilution from stock issuable pursuant to the exercise of stock options outstanding and
restricted stock. For purposes of the diluted net income per share calculation, the additional shares issuable upon exercise of stock options and restricted stock are determined using the treasury stock method.



A reconciliation of the numerator and denominator used in the net income per
share calculations is presented as follows:



|                                             |  |                                               |        |                          |   |             |  |             |        |  |   |       
|-------------------------------------------- |  | --------------------------------------------- | ------ | ------------------------ | - | ----------- |  | ----------- | ------ |  | - | ------
|                                             |  | Fiscal Three Months Ended                     |        | Fiscal Nine Months Ended
|                                             |  | July 1,2005                                   |        | July 2,2004              |   | July 1,2005 |  | July 2,2004
|                                             |  | (amounts in thousands, except per share data)
|Numerator:                                   |  |                                               |        |                          |   |             |  |             |        |  |   |       
|Net income                                   |  | $                                             | 19,300 |                          | $ | 19,271      |  | $           | 58,378 |  | $ | 38,096
|                                             |  |                                               |        |                          |   |             |  |             |        |  |   |       
|Denominator:                                 |  |                                               |        |                          |   |             |  |             |        |  |   |       
|Denominator for basic net income per share:  |  |                                               |        |                          |   |             |  |             |        |  |   |       
|Weighted average shares outstanding          |  |                                               | 36,798 |                          |   | 36,314      |  |             | 36,619 |  |   | 35,984
|Effect of dilutive securities:               |  |                                               |        |                          |   |             |  |             |        |  |   |       
|Stock options and restricted stock           |  |                                               | 799    |                          |   | 740         |  |             | 757    |  |   | 979   
|                                             |  |                                               |        |                          |   |             |  |             |        |  |   |       
|Denominator for diluted net income per share |  |                                               | 37,597 |                          |   | 37,054      |  |             | 37,376 |  |   | 36,963
|                                             |  |                                               |        |                          |   |             |  |             |        |  |   |       
|Net income per sharebasic                   |  | $                                             | 0.52   |                          | $ | 0.53        |  | $           | 1.59   |  | $ | 1.06  
|Net income per sharediluted                 |  | $                                             | 0.51   |                          | $ | 0.52        |  | $           | 1.56   |  | $ | 1.03  



For the three and nine
month periods ended July 1, 2005, options to purchase 883,930 and 885,443 common shares at a weighted average exercise price of $48.22 and $48.33, respectively (exercise prices that exceeded the market value of the underlying common stock) were
excluded from the computation of diluted earnings per share. For the three and nine month periods ended July 2, 2004, options to purchase 906,738 and 821,733 common shares at a weighted average exercise price of $48.51 and $49.36, respectively
(exercise prices that exceeded the market value of the underlying common stock) were excluded from the computation of diluted earnings per share.



As of July 1, 2005, Varian Semiconductor had outstanding options to purchase an aggregate of 5,168,924 shares of its common stock at a weighted average
price of $31.29. Of these options, options to purchase an aggregate of 3,099,487 shares of its common stock at a weighted average price of $29.54 were exercisable.



Note 4. Cash, Cash Equivalents and Short-term Investments



Varian Semiconductor considers currency on hand, demand deposits, and all highly liquid investments with a remaining
maturity of three months or less at the time of acquisition to be cash and cash equivalents. The



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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



carrying amounts of cash and cash equivalents approximate estimated fair value because of the short-term maturities of those financial instruments. Cash
equivalents at July 1, 2005 and October 1, 2004 were $182.5 million and $212.8 million, respectively. Short-term investments consist primarily of U.S. Treasury, government agency and corporate bonds and certificates of deposit with ratings AA or
better with remaining maturity greater than three months at the time of acquisition. Varian Semiconductor manages its cash equivalents and short-term investments as a single portfolio of highly marketable securities that is intended to be available
to meet Varian Semiconductors current cash requirements.



Varian Semiconductor has the intent and ability, if necessary, to liquidate any of its investments in order to meet its liquidity needs in the next 12 months. Accordingly, those investments with contractual maturities greater than one year
from the date of acquisition have been classified as short-term.



As of July 1, 2005, a net unrealized loss on short-term investments of $1.4 million had been recorded as accumulated other comprehensive loss. As of October 1, 2004, a net unrealized loss on short-term investments of $0.2 million was
recorded as accumulated other comprehensive loss.



Short-term
investments by security type at July 1, 2005 were as follows:



|                                    |  |                        |         |                      |   |                       |  |   |                     |   |  |   |        
|----------------------------------- |  | ---------------------- | ------- | -------------------- | - | --------------------- |  | - | ------------------- | - |  | - | -------
|                                    |  | Cost                   |         | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | EstimatedFair Value
|                                    |  | (Amounts in thousands)
|Bank certificates of deposit        |  | $                      | 24,154  |                      | $ |                      |  | $ |                    |   |  | $ | 24,154 
|U.S. Treasury and agency securities |  |                        | 139,022 |                      |   | 120                   |  |   | (1,154              | ) |  |   | 137,988
|Corporate bonds                     |  |                        | 85,344  |                      |   | 68                    |  |   | (433                | ) |  |   | 84,979 
|                                    |  |                        |         |                      |   |                       |  |   |                     |   |  |   |        
|                                    |  | $                      | 248,520 |                      | $ | 188                   |  | $ | (1,587              | ) |  | $ | 247,121
|                                    |  |                        |         |                      |   |                       |  |   |                     |   |  |   |        



Short-term investments
by security type at October 1, 2004 were as follows:



|                                    |  |                        |         |                      |   |                       |  |   |                     |   |  |   |        
|----------------------------------- |  | ---------------------- | ------- | -------------------- | - | --------------------- |  | - | ------------------- | - |  | - | -------
|                                    |  | Cost                   |         | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | EstimatedFair Value
|                                    |  | (Amounts in thousands)
|Bank certificates of deposit        |  | $                      | 24,753  |                      | $ |                      |  | $ |                    |   |  | $ | 24,753 
|U.S. Treasury and agency securities |  |                        | 103,944 |                      |   | 184                   |  |   | (320                | ) |  |   | 103,808
|Corporate bonds                     |  |                        | 45,350  |                      |   | 59                    |  |   | (79                 | ) |  |   | 45,330 
|                                    |  |                        |         |                      |   |                       |  |   |                     |   |  |   |        
|                                    |  | $                      | 174,047 |                      | $ | 243                   |  | $ | (399                | ) |  | $ | 173,891
|                                    |  |                        |         |                      |   |                       |  |   |                     |   |  |   |        



The short-term
investment maturities are as follows:



|                                    |  |                        |         |                |   |        
|----------------------------------- |  | ---------------------- | ------- | -------------- | - | -------
|                                    |  | July 1,2005            |         | October 1,2004
|                                    |  | (Amounts in thousands)
|Maturing within 1 year              |  | $                      | 139,689 |                | $ | 92,603 
|Maturing between 1 year and 5 years |  |                        | 107,432 |                |   | 81,288 
|                                    |  |                        |         |                |   |        
|Total                               |  | $                      | 247,121 |                | $ | 173,891
|                                    |  |                        |         |                |   |        



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VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.



NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



Note 5. Accounts Receivable



Accounts receivable consist of the following:



|                                |  |                        |         |   |                |   |         |  
|------------------------------- |  | ---------------------- | ------- | - | -------------- | - | ------- | -
|                                |  | July 1,2005            |         |   | October 1,2004 |  
|                                |  | (Amounts in thousands) |        
|Billed receivables              |  | $                      | 135,031 |   |                | $ | 125,137 |  
|Allowance for doubtful accounts |  |                        | (891    | ) |                |   | (1,388  | )
|                                |  |                        |         |   |                |   |         |  
|Accounts receivable, net        |  | $                      | 134,140 |   |                | $ | 123,749 |  
|                                |  |                        |         |   |                |   |         |  



Substantially all of
Varian Semiconductors accounts receivable balance relates to trade receivables. Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is Varian Semiconductors best
estimate of the amount of probable credit losses in its existing accounts receivable. Varian Semiconductor maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments for
products and services. Accounts with known financial issues are first reviewed and specific estimates are recorded. The remaining accounts receivable balances are then grouped in categories by the amount of days the balance is past due and the
estimated loss is calculated as a percentage of the total category based upon past history. Account balances are charged off against the allowance when it is probable the receivable will not be recovered.



Note 6. Inventories



The components of inventories are as follows:



|                        |  |                        |         |                |   |        
|----------------------- |  | ---------------------- | ------- | -------------- | - | -------
|                        |  | July 1,2005            |         | October 1,2004
|                        |  | (Amounts in thousands)
|Raw materials and parts |  | $                      | 60,966  |                | $ | 34,874 
|Work in process         |  |                        | 29,211  |                |   | 33,674 
|Finished goods          |  |                        | 50,103  |                |   | 36,352 
|                        |  |                        |         |                |   |        
|Total inventories       |  | $                      | 140,280 |                | $ | 104,900
|                        |  |                        |         |                |   |        



Note 7. Accrued Expenses



The components of accrued expenses are as follows:



|                              |  |                        |        |                |   |       
|----------------------------- |  | ---------------------- | ------ | -------------- | - | ------
|                              |  | July 1,2005            |        | October 1,2004
|                              |  | (Amounts in thousands)
|Payroll and employee benefits |  | $                      | 28,343 |                | $ | 25,575
|Estimated loss contingencies  |  |                        | 2,958  |                |   | 5,100 
|Restructuring                 |  |                        | 521    |                |   | 87    
|Income taxes payable          |  |                        | 15,801 |                |   | 16,562
|Other                         |  |                        | 5,396  |                |   | 5,910 
|                              |  |                        |        |                |   |       
|Total accrued expenses        |  | $                      | 53,019 |                | $ | 53,234
|                              |  |                        |        |                |   |       



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VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.



NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



Note 8. Deferred Revenue



The components of deferred revenue are as follows:



|                                            |  |                        |        |                |   |       
|------------------------------------------- |  | ---------------------- | ------ | -------------- | - | ------
|                                            |  | July 1,2005            |        | October 1,2004
|                                            |  | (Amounts in thousands)
|Fully deferred tools and acceptance revenue |  | $                      | 44,391 |                | $ | 35,828
|Extended warranties                         |  |                        | 10,399 |                |   | 7,906 
|Maintenance and service contracts           |  |                        | 7,686  |                |   | 6,569 
|Other deferred revenue                      |  |                        | 2,006  |                |   | 4,206 
|                                            |  |                        |        |                |   |       
|Total deferred revenue                      |  | $                      | 64,482 |                | $ | 54,509
|                                            |  |                        |        |                |   |       



Note 9. Product Warranties



Varian Semiconductor warrants that its products will be
free from defects in materials and workmanship and will conform to its standard published specifications in effect at the time of delivery for a period of three to twelve months from the date the customer accepts the products. Additionally, Varian
Semiconductor warrants that maintenance services will be performed in a workmanlike manner consistent with generally accepted industry standards for a period of ninety days from the completion of any agreed-upon services. Varian Semiconductor
provides for the estimated cost of product warranties, the amount of which is based primarily upon historical information, at the time product revenue is recognized. Varian Semiconductors warranty obligation is affected by a number of factors,
including product failure rates, utilization levels, material usage, service delivery costs incurred in correcting a product failure, and supplier warranties on parts delivered to Varian Semiconductor. Should these factors or other factors affecting
warranty costs differ from Varian Semiconductors estimates, revisions to the estimated warranty liability would be required.



Product warranty activity for the first nine months of fiscal year 2005 was as follows:



|                                                 |  |                        |        |  
|------------------------------------------------ |  | ---------------------- | ------ | -
|                                                 |  | Amount of Liability    |       
|                                                 |  | (Amounts in thousands) |       
|Balance as of October 1, 2004                    |  | $                      | 7,841  |  
|Accruals for warranties issued during the period |  |                        | 1,834  |  
|Increase to pre-existing warranties, net         |  |                        | 492    |  
|Settlements made during the period               |  |                        | (2,077 | )
|                                                 |  |                        |        |  
|Balance as of December 31, 2004                  |  |                        | 8,090  |  
|Accruals for warranties issued during the period |  |                        | 2,551  |  
|Increase to pre-existing warranties, net         |  |                        | 401    |  
|Settlements made during the period               |  |                        | (2,803 | )
|                                                 |  |                        |        |  
|Balance as of April 1, 2005                      |  |                        | 8,239  |  
|Accruals for warranties issued during the period |  |                        | 3,211  |  
|Increase to pre-existing warranties, net         |  |                        | 28     |  
|Settlements made during the period               |  |                        | (2,756 | )
|                                                 |  |                        |        |  
|Balance as of July 1, 2005                       |  | $                      | 8,722  |  
|                                                 |  |                        |        |  



Note 10. Long-Term Accrued Expenses



Long-term accrued expenses are comprised of accruals for
post-employment liabilities and environmental costs not expected to be expended within the next year. The current portion is recorded within accrued expenses.



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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



Note 11. Retirement Plans



On October 5, 2004, Varian Semiconductors Board of Directors amended the definition of retirement to mean (i) for
non-employee directors, the voluntary cessation of service as a director after completion of at least three years of service as a director, (ii) for employees, other than executive officers as provided in clause (iii) below, the voluntary
resignation from employment after completion of at least ten years of service as an employee and the attainment of age 55, and (iii) for executive officers, the voluntary resignation from employment after the attainment of a combined age and years
of service as an employee of at least 65, a minimum age of 55, and completion of at least five years of service as an employee.



On December 8, 2004, Varian Semiconductor entered into a Retirement Agreement and General Release (the Retirement Agreement) with Ernest L.
Godshalk, III pursuant to which Mr. Godshalk resigned from his position as a director and as President and Chief Operating Officer of Varian Semiconductor effective as of December 31, 2004 (the Retirement Date) due to retirement. As a
result, approximately $3.5 million was due to Mr. Godshalk, and expensed in the first quarter of fiscal 2005, of which $2.5 million was a non-cash charge. For more information, please see Item 9B of Part II of the Annual Report on Form 10-K for the
year ended October 1, 2004.



Note 12. Recent Accounting Pronouncements



On October 22, 2004, the President signed the American
Jobs Creation Act of 2004 (the Jobs Act). The Jobs Act creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends received deduction for certain dividends from
controlled corporations. Varian Semiconductor may elect to apply this provision to qualifying earnings repatriations in either fiscal year 2005 or 2006. The maximum possible amount that the company is currently considering eligible for repatriation
is $14 million. Varian Semiconductor continues to evaluate the effects of the repatriation provision. At this time, the potential range of income tax effects of such repatriation cannot be reasonably estimated.



In December 2004, the FASB issued FASB Staff Position (FSP) No.
109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004 (FSP 109-2). FSP 109-2 provides guidance under FASB Statement No. 109, Accounting
for Income Taxes, (FASB No. 109) with respect to recording the potential impact of the repatriation provisions of the Jobs Act on enterprises income tax expense and deferred tax liability. The Jobs Act was enacted in October
2004. FSP No. 109-2 states that an enterprise is allowed time beyond the financial reporting period of enactment to evaluate the effect of the Jobs Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying FASB
No. 109.



Under the guidance in FSP No. 109-1,
Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004, issued in December 2004, the deduction will be treated as a
special deduction as described in FASB No. 109. As such, the special deduction has no effect on deferred tax assets and liabilities existing at the enactment date. Rather, the impact of this deduction will be reported in the period in
which the deduction is claimed on Varian Semiconductors tax return. This provision will become effective for Varian Semiconductor in fiscal year 2006.



The Jobs Act also provides for a two-year phase-out of the existing extra-territorial income exclusion (the ETI) for foreign sales. This
provision is effective for transactions entered into after December 31, 2004. Varian Semiconductor expects the net effect of the phase-out of the ETI to result in an increase in the effective tax rate for fiscal year 2005 of less than one percentage
point, based on current earnings levels.



In November 2004, the
FASB issued Statement No. 151, Inventory Costsan Amendment of ARB No. 43, Chapter 4 (FASB No. 151). FASB No. 151 amends Accounting Research Bulletin (ARB) No. 43, Chapter 4, to clarify that abnormal amounts
of idle facility expense, freight, handling costs, and wasted materials



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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



(spoilage) should be recognized as current-period charges. In addition, this statement requires that allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production facilities. The provisions of this statement are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Varian Semiconductor does not believe that the
adoption of FASB No. 151 will have a material impact on its financial statements.



In December 2004, the FASB issued Statement No. 123 (revised 2004), Share-Based Payment (FASB No. 123(R)). FASB No. 123(R) will require Varian Semiconductor to measure all stock-based
compensation awards using a fair value method and record such expense in its consolidated financial statements. In addition, the adoption of FASB No. 123(R) will require additional accounting related to the income tax effects and additional
disclosure regarding the cash flow effects resulting from share-based payment arrangements. In April 2005, the SEC extended the effective date for FASB No. 123(R) to fiscal years (rather than interim periods) beginning after June 15, 2005.
Therefore, FASB No. 123(R) will be effective as of October 1, 2005 for Varian Semiconductor. The adoption of FASB No. 123(R) will have a material impact on Varian Semiconductors consolidated financial position, results of operations and cash
flows. Varian Semiconductor is in the process of evaluating the impact of implementing FASB No. 123(R).



In March 2005, the SEC issued Staff Accounting Bulletin (SAB) No. 107 (SAB 107), which expresses the staffs views on issues
related to the implementation of FASB No. 123(R). The guidance offered in SAB 107 will be taken into consideration by Varian Semiconductor during the implementation of FASB No. 123(R).



Note 13. Operating Segments and Geographic Information



Varian Semiconductor has determined that it operates in one business segment: the manufacturing, marketing and servicing of
semiconductor processing equipment for ion implantation systems. Since Varian Semiconductor operates in one segment, all financial segment information required by FASB Statement No. 131, Disclosures about Segments of an Enterprise and Related
Information, can be found in the consolidated financial statements.



During the third quarter of fiscal year 2005, revenue from two customers accounted for 31.6% and 11.7%, respectively, of Varian Semiconductors total revenue. Varian Semiconductor expects that sales of its
products to relatively few customers will continue to account for a high percentage of its revenue in the foreseeable future. During the third quarter of fiscal year 2004, revenue from one customer accounted for 10.8% of Varian Semiconductors
total revenue. During the first nine months of fiscal year 2005, revenue from two customers accounted for 22.3% and 11.1%, respectively, of Varian Semiconductors total revenue. During the first nine months of fiscal year 2004, revenue from one
customer accounted for 15.2% of Varian Semiconductors total revenue.



As of July 1, 2005, two customers represented 28.8% and 16.2% of the total accounts receivable balance. As of October 1, 2004, two customers accounted for 14.5% and 12.2% of the total accounts receivable balance.



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VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.



NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



The following table summarizes revenue based on final geographic destination and long-lived assets by
geography:



|                                          |  |                        |         |        |   |        |  |       |        |           |   |         |  |              |        |  |   |        |  |   |        
|----------------------------------------- |  | ---------------------- | ------- | ------ | - | ------ |  | ----- | ------ | --------- | - | ------- |  | ------------ | ------ |  | - | ------ |  | - | -------
|                                          |  | NorthAmerica           |         | Europe |   | Taiwan |  | Korea |        | Singapore |   | Other   |  | Consolidated
|                                          |  | (Amounts in thousands)
|RevenueThree months ended:               |  |                        |         |        |   |        |  |       |        |           |   |         |  |              |        |  |   |        |  |   |        
|July 1, 2005                              |  | $                      | 25,216  |        | $ | 15,322 |  | $     | 38,736 |           | $ | 65,893  |  | $            | 3,351  |  | $ | 18,172 |  | $ | 166,690
|July 2, 2004                              |  |                        | 24,489  |        |   | 21,695 |  |       | 26,327 |           |   | 32,585  |  |              | 15,498 |  |   | 25,541 |  |   | 146,135
|                                          |  |                        |         |        |   |        | 
|RevenueNine months ended:                |  |                        |         |        |   |        |  |       |        |           |   |         |  |              |        |  |   |        |  |   |        
|July 1, 2005                              |  | $                      | 108,942 |        | $ | 45,726 |  | $     | 75,846 |           | $ | 146,618 |  | $            | 20,033 |  | $ | 57,047 |  | $ | 454,212
|July 2, 2004                              |  |                        | 72,579  |        |   | 50,102 |  |       | 70,800 |           |   | 84,990  |  |              | 35,855 |  |   | 60,978 |  |   | 375,304
|                                          |  |                        |         |        |   |        | 
|Property, plant and equipment, net as of: |  |                        |         |        |   |        |  |       |        |           |   |         |  |              |        |  |   |        |  |   |        
|July 1, 2005                              |  | $                      | 54,707  |        | $ | 338    |  | $     | 431    |           | $ | 4,214   |  | $            | 43     |  | $ | 685    |  | $ | 60,418 
|October 1, 2004                           |  |                        | 46,807  |        |   | 426    |  |       | 353    |           |   | 4,041   |  |              | 49     |  |   | 668    |  |   | 52,344 



The $18.9 million in
non-recurring royalty revenue received from Applied Materials, Inc. (Applied Materials) in the first quarter of fiscal year 2005 is included in the North America nine month revenue in the table above.



Note 14. Commitments, Contingencies and Guarantees



Varian Semiconductor is currently a defendant in a number of legal actions
and could incur an uninsured liability in one or more of them. In the opinion of management, the outcome of such litigation will not have a material adverse effect on the consolidated financial position, results of operations or cash flows of Varian
Semiconductor.



As permitted under Delaware law, Varian
Semiconductor has agreements whereby it indemnifies its officers and directors for certain events or occurrences while the officer or director is, or was, serving in such capacity at the request of Varian Semiconductor. The term of the
indemnification period is for the officers or directors lifetime. The maximum potential amount of future payments Varian Semiconductor could be required to make under these indemnification agreements is unlimited. However, Varian
Semiconductor has a Director and Officer insurance policy that limits its exposure and enables Varian Semiconductor to recover a portion of any future amounts paid. As a result of Varian Semiconductors insurance policy coverage, management
believes the estimated fair value of these indemnification agreements is minimal. Accordingly, Varian Semiconductor has not recorded any liabilities for these agreements as of July 1, 2005.



Varian Semiconductor enters into indemnification agreements in the normal
course of business. Pursuant to these agreements, Varian Semiconductor indemnifies, holds harmless, and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally Varian Semiconductors
customers, in connection with any patent, copyright or other intellectual property infringement claim by any third party with respect to Varian Semiconductors products. The term of these indemnification agreements is generally perpetual any
time after execution of the agreement. The maximum potential amount of future payments Varian Semiconductor could be required to make under these indemnification agreements is unlimited. Management believes the estimated fair value of these
agreements is minimal. Accordingly, Varian Semiconductor has not recorded any liabilities for these agreements as of July 1, 2005.



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VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.



NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



Varian Semiconductor also indemnifies certain customers with respect to damages, losses and
liabilities they may suffer or incur relating to personal injury, personal property damage, product liability, and environmental claims relating to the use of Varian Semiconductors products and services or resulting from the acts or omissions
of Varian Semiconductor, its employees, officers, authorized agents or subcontractors. Varian Semiconductor has general and umbrella insurance policies that limit its exposure under these indemnification obligations and guarantees. As a result of
its insurance policy coverage, Varian Semiconductor believes the estimated fair value of these indemnification agreements is minimal. Accordingly, Varian Semiconductor has not recorded any liabilities for these agreements as of July 1, 2005.



Varian Semiconductor enters into purchase order commitments in
the normal course of business. As of July 1, 2005, Varian Semiconductor has approximately $31.6 million of purchase order commitments with various vendors.



Environmental Remediation



Prior to the spin-off of Varian Semiconductor from Varian Associates, Inc. (VAI) on April 2, 1999, Varian Semiconductors business was
operated as the Semiconductor Equipment Business (SEB) of VAI. On April 2, 1999, VAI contributed its SEB to Varian Semiconductor, its Instruments Business (IB) to Varian, Inc. (VI), and changed its name to Varian
Medical Systems, Inc. (VMS). These transactions were accomplished under the terms of several agreements by and among Varian Semiconductor, VI and VMS which include a Distribution Agreement, an Employee Benefits Allocation Agreement, an
Intellectual Property Agreement, a Tax Sharing Agreement, and a Transition Services Agreement (collectively, the Distribution Related Agreements). VAI has been named by the U.S. Environmental Protection Agency or third parties as a
potentially responsible party under the Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended, at eight sites where VAI is alleged to have shipped manufacturing waste for recycling or disposal. VAI is also involved
in various stages of environmental investigation and/or remediation under the direction of, or in consultation with, foreign, federal, state and/or local agencies at certain current or former VAI facilities (including facilities disposed of in
connection with VAIs sale of its Electron Devices business during fiscal year 1995, and the sale of its Thin Film Systems business during fiscal year 1997). The Distribution Related Agreements provide that each of VMS, Varian Semiconductor and
VI will indemnify the others for one-third of these environmental investigation and remediation costs, as adjusted for any insurance proceeds and tax benefits expected to be realized upon payment of these costs.



For certain of these sites and facilities, various uncertainties make it
difficult to assess the likelihood and scope of further investigation or remediation activities or to estimate the future costs of such activities if undertaken. Varian Semiconductor has accrued $1.3 million in estimated environmental investigation
and remediation costs for these sites and facilities as of July 1, 2005. As to other sites and facilities, sufficient knowledge has been gained to be able to reasonably estimate the scope and costs of future environmental activities. As such, Varian
Semiconductor has accrued $4.5 million, which represents future costs discounted at 7%, net of inflation, to cover Varian Semiconductors portion of these costs. This reserve is in addition to the $1.3 million previously described.



As of July 1, 2005, Varian Semiconductors environmental liability,
based upon future environmental-related costs estimated by VMS as of that date and included in current and long-term accrued expenses, totaled $5.8 million, of which $1.1 million is classified as current.



The amounts set forth in the foregoing paragraph are only estimates of
anticipated future environmental-related costs, and the amounts actually spent in the years indicated may be greater or less than such estimates.



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VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.



NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



The aggregate range of cost estimates reflects various uncertainties inherent in many environmental investigation and remediation activities and the large
number of sites where VMS is undertaking such investigation and remediation activities. VMS believes that most of these cost ranges will narrow as investigation and remediation activities progress. Varian Semiconductor believes that its reserves are
adequate, but as the scope of the obligations becomes more clearly defined, these reserves may be modified and related charges against income may be made.



Although any ultimate liability arising from environmental-related matters described herein could result in significant expenditures that, if aggregated
and assumed to occur within a single fiscal year would be material to Varian Semiconductors financial statements, the likelihood of such occurrence is considered remote. Based on information currently available to management and its best
assessment of the ultimate amount and timing of environmental-related events, Varian Semiconductors management believes that the costs of these environmental-related matters are not reasonably likely to have a material adverse effect on the
consolidated financial statements of Varian Semiconductor.



Varian Semiconductor evaluates its liability for environmental-related investigation and remediation in light of the liability and financial wherewithal of potentially responsible parties and insurance companies where Varian Semiconductor
believes that it has rights to contribution, indemnity and/or reimbursement. Claims for recovery of environmental investigation and remediation costs already incurred, and to be incurred in the future, have been asserted against various insurance
companies and other third parties. In 1992, VAI filed a lawsuit against 36 insurance companies with respect to most of the above-referenced sites and facilities. VAI received certain cash settlements with respect to these lawsuits in prior years.
VMS has also reached an agreement with an insurance company under which the insurance company agreed to pay a portion of Varian Semiconductors past and future environmental-related expenditures. Varian Semiconductor therefore has a receivable
of $1.1 million in other assets at July 1, 2005, as its portion of the insurance recoveries. Although VMS intends to aggressively pursue additional insurance recoveries, Varian Semiconductor has not reduced any liability in anticipation of recovery
with respect to claims made against third parties.



As part of
the purchase of Varian Semiconductors facility located in Newburyport, Massachusetts, Varian Semiconductor has indemnified the lender for any violation of any local, state and federal laws pertaining to environmental regulations, contamination
or clean-up. Varian Semiconductor believes the estimated fair value of this indemnification is minimal. Accordingly, Varian Semiconductor has not recorded any liabilities for this agreement as of July 1, 2005.



Legal Proceedings



In September 2000, Varian Semiconductor and Applied Materials settled patent infringement and antitrust litigation. After
recording a payment to Applied Materials and legal expenses, Varian Semiconductor recorded a gain of $16.0 million ($10.8 million after taxes) relating to this litigation settlement. Varian Semiconductor maintained a provision of $2.7 million in
current liabilities to cover any residual indemnification obligations described above. After evaluating all of the facts associated with this transaction, and consultation with counsel, management believes that Varian Semiconductor has no further
liability with respect to the settlement. The statute of limitations on the indemnification obligations expired during the first quarter of fiscal year 2005. As a result, the remaining estimated loss contingency was reversed during the first quarter
of fiscal year 2005, and is included as a component of other income, net for the first quarter and the first nine months of fiscal year 2005.



Varian Semiconductor has agreed to indemnify VMS and VI for any costs, liabilities or expenses relating to Varian Semiconductors legal proceedings,
including the Applied Materials matter. Under the Distribution Related Agreements, Varian Semiconductor has agreed to reimburse VMS for one-third of the costs, liabilities,



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VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.



NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



and expenses, adjusted for any related tax benefits recognized or realized by VMS, with respect to certain legal proceedings relating to discontinued
operations of VMS. Varian Semiconductor believes the estimated fair value of the indemnification agreements is minimal, except as already recorded on the financial statements.



Varian Semiconductors operations are subject to various foreign, federal, state and/or local laws relating to the
protection of the environment. These include laws regarding discharges into soil, water and air, and the generation, handling, storage, transportation and disposal of waste and hazardous substances. In addition, several countries are reviewing
proposed regulations that would require manufacturers to dispose of their products at the end of a products useful life. These laws have the effect of increasing costs and potential liabilities associated with the conduct of certain
operations.



Varian Semiconductor is currently the plaintiff in
several legal disputes related to breach of contract and certain patents that Varian Semiconductor believes the defendants have infringed. While Varian Semiconductor believes favorable judgments will be rendered with respect to such claims, the
timing and amount, if any, of these judgments is uncertain.



Note 15.
Restructurings



Varian Semiconductors business is
cyclical and depends upon the capital expenditures of semiconductor manufacturers, which in turn depend on the current and anticipated market demand for integrated circuits and products utilizing integrated circuits. The semiconductor industry has
historically experienced periodic downturns and in response, Varian Semiconductor has occasionally recorded restructuring charges in connection with cost reduction initiatives implemented in response to the industry downturns. Restructuring charges
typically consist of severance, benefits and outplacement services offered to terminated employees and sometimes include charges for remaining lease payments on facilities that are closed.



No restructuring costs were recognized during fiscal year 2004 or the first
three months of fiscal year 2005. In the second quarter of fiscal year 2005, $0.9 million of restructuring expense was recognized related to downsizing in Europe. These restructuring costs related to reductions in headcount and in facilities. During
fiscal year 2003, Varian Semiconductor recognized approximately $1.4 million in restructuring costs. The 2003 restructuring costs related to a reduction in headcount of approximately 55 employees and were severance-related. The majority of the
remaining restructuring reserve balance as of July 1, 2005 is expected to be paid during fiscal year 2005.



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VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.



NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



Below is a table summarizing the restructuring reserve activity in the first nine months of fiscal
year 2005:



|                                 |  |                        |        |   |                  |   |      |       |  |   |        |  
|-------------------------------- |  | ---------------------- | ------ | - | ---------------- | - | ---- | ----- |  | - | ------ | -
|                                 |  | Reduction inWork Force |        |   | FacilityClosures |   |      | Total | 
|                                 |  | (Amounts in thousands) |       
|Balance as of September 27, 2002 |  | $                      | 2,167  |   |                  | $ | 602  |       |  | $ | 2,769  |  
|New charges                      |  |                        | 1,390  |   |                  |   | 45   |       |  |   | 1,435  |  
|Cash payments                    |  |                        | (3,293 | ) |                  |   | (529 | )     |  |   | (3,822 | )
|                                 |  |                        |        |   |                  |   |      |       |  |   |        |  
|Balance as of October 3, 2003    |  |                        | 264    |   |                  |   | 118  |       |  |   | 382    |  
|Cash payments                    |  |                        | (264   | ) |                  |   | (31  | )     |  |   | (295   | )
|                                 |  |                        |        |   |                  |   |      |       |  |   |        |  
|Balance as of October 1, 2004    |  |                        |       |   |                  |   | 87   |       |  |   | 87     |  
|Cash Payments                    |  |                        |       |   |                  |   | (46  | )     |  |   | (46    | )
|Other Adjustments                |  |                        |       |   |                  |   |     |       |  |   |       |  
|                                 |  |                        |        |   |                  |   |      |       |  |   |        |  
|Balance as of December 31, 2004  |  |                        |       |   |                  |   | 41   |       |  |   | 41     |  
|New charges                      |  |                        | 640    |   |                  |   | 274  |       |  |   | 914    |  
|Cash payments                    |  |                        | (109   | ) |                  |   | (82  | )     |  |   | (191   | )
|                                 |  |                        |        |   |                  |   |      |       |  |   |        |  
|Balance as of April 1, 2005      |  |                        | 531    |   |                  |   | 233  |       |  |   | 764    |  
|Cash payments                    |  |                        | (140   | ) |                  |   | (103 | )     |  |   | (243   | )
|                                 |  |                        |        |   |                  |   |      |       |  |   |        |  
|Balance as of July 1, 2005       |  | $                      | 391    |   |                  | $ | 130  |       |  | $ | 521    |  
|                                 |  |                        |        |   |                  |   |      |       |  |   |        |  



Note 16. Derivative Financial
Instruments



Varian Semiconductor uses derivative
instruments to protect its interests from fluctuations in earnings and cash flows caused by volatility in currency exchange rates. Varian Semiconductor continued its policy of hedging its current balance sheet re-measurement and certain foreign
currency sales exposures with hedging instruments having terms of up to twelve months.



Varian Semiconductors international sales are primarily denominated in U.S. dollars. For foreign currency denominated sales, however, the volatility of the foreign currency markets represents risk to Varian
Semiconductor. Upon forecasting the exposure, Varian Semiconductor enters into hedges with forward sales contracts whose critical terms are designed to match those of the underlying exposure. These hedges are evaluated for effectiveness at least
quarterly by comparing the change in value of the forward contracts to the change in value of the underlying transaction, with the effective portion of the hedge accumulated in other comprehensive income (OCI). Any measured
ineffectiveness is included immediately in marketing, general and administrative expenses in the consolidated statements of operations. There has been no amount of ineffectiveness recognized during the three and nine month periods ended July 1,
2005. OCI associated with hedges of sales denominated in foreign currencies are reclassified to revenue upon recognition in income of the underlying hedged exposure.



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VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.



NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



The following table summarizes OCI activity associated with hedges of foreign currency denominated
sales during the year:



|                                                   |  |                        |       |  
|-------------------------------------------------- |  | ---------------------- | ----- | -
|                                                   |  | Amount of Income       |      
|                                                   |  | (Amounts in thousands) |      
|Balance as of October 1, 2004                      |  | $                      |      |  
|Effective portion of cash flow hedging instruments |  |                        | (352  | )
|Reclassified to revenue                            |  |                        | 218   |  
|                                                   |  |                        |       |  
|Balance as of December 31, 2004                    |  |                        | (134  | )
|Effective portion of cash flow hedging instruments |  |                        | 111   |  
|Reclassified to revenue                            |  |                        | 23    |  
|                                                   |  |                        |       |  
|Balance as of April 1, 2005                        |  |                        |      |  
|Effective portion of cash flow hedging instruments |  |                        | 1,134 |  
|Reclassified to revenue                            |  |                        |      |  
|                                                   |  |                        |       |  
|Balance as of July 1, 2005                         |  | $                      | 1,134 |  
|                                                   |  |                        |       |  



Note 17. Comprehensive Income



The following table reconciles net income to
comprehensive income for the third quarter and first nine months of fiscal years 2005 and 2004:



|                                                   |  |                           |        |              |                          |        |              |  |   |              |   |  |   |        |  
|-------------------------------------------------- |  | ------------------------- | ------ | ------------ | ------------------------ | ------ | ------------ |  | - | ------------ | - |  | - | ------ | -
|                                                   |  | Fiscal Three Months Ended |        |              | Fiscal Nine Months Ended |       
|                                                   |  | July 1, 2005              |        | July 2, 2004 |                          |        | July 1, 2005 |  |   | July 2, 2004 |  
|                                                   |  | (Amounts in thousands)    |       
|Net income                                         |  | $                         | 19,300 |              | $                        | 19,271 |              |  | $ | 58,378       |   |  | $ | 38,096 |  
|Other comprehensive income (loss):                 |  |                           |        |              |                          |        |              |  |   |              |   |  |   |        |  
|Effective portion of cash flow hedging instruments |  |                           | 1,134  |              |                          | (264   | )            |  |   | 893          |   |  |   | (264   | )
|Reclassified to revenue                            |  |                           |       |              |                          |       |              |  |   | 241          |   |  |   |       |  
|Unrealized gain (loss) on short-term investments   |  |                           | 528    |              |                          | (590   | )            |  |   | (1,243       | ) |  |   | (506   | )
|                                                   |  |                           |        |              |                          |        |              |  |   |              |   |  |   |        |  
|Comprehensive income                               |  | $                         | 20,962 |              | $                        | 18,417 |              |  | $ | 58,269       |   |  | $ | 37,326 |  
|                                                   |  |                           |        |              |                          |        |              |  |   |              |   |  |   |        |  



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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



This Form 10-Q contains certain forward-looking statements. For purposes of the safe harbor provisions under The Private Securities Litigation Reform Act
of 1995, any statements using the terms believes, anticipates, expects, plans or similar expressions are forward-looking statements. The forward-looking statements involve risks and uncertainties that
could cause actual results to differ materially from those projected. There are a number of important factors that could cause Varian Semiconductor Equipment Associates, Inc. (Varian Semiconductor)s actual results to differ
materially from those indicated by forward-looking statements made in this report and presented by management from time to time. Some of the important risks and uncertainties that may cause Varian Semiconductors financial results to differ are
described under the heading Risk Factors in this report and in the annual report on Form 10-K for the fiscal year ended October 1, 2004, filed with the Securities and Exchange Commission (SEC) on December 14, 2004.



The following information should be read in conjunction with
the unaudited interim consolidated financial statements and notes thereto included in Item 1. Consolidated Financial Statements of this quarterly report and the audited consolidated financial statements and notes thereto and the section
titled Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations in Varian Semiconductors annual report on Form 10-K for the fiscal year ended October 1, 2004, filed with the SEC on December
14, 2004.



Overview



Varian Semiconductor is the leading supplier of ion implantation equipment
used in the fabrication of semiconductor chips. Varian Semiconductor designs, manufactures, markets and services semiconductor processing equipment for virtually all of the major semiconductor manufacturers in the United States (U.S.),
Europe and Asia Pacific. The VIISta® ion implanter
products are designed to leverage single-wafer processing technology for the full range of semiconductor implant applications.



Varian Semiconductor provides support, training, and after-market products and services that help its customers to obtain high utilization and
productivity, reduce operating costs, and extend capital productivity of customer investments through multiple product generations. In 2005, Varian Semiconductor was ranked number one in customer satisfaction in VLSI Research Inc.s customer
survey for all large suppliers of wafer processing equipment, an honor received in eight of the past nine years.



Varian Semiconductors business is cyclical and depends upon the capital expenditures of semiconductor manufacturers, which in turn depends on the
current and anticipated market demand for integrated circuits and products utilizing integrated circuits. In fiscal 2001 and fiscal 2002, the semiconductor equipment manufacturers experienced a significant contraction in the demand for products due
to the slowdown in economies worldwide, specifically the slowdown in technology sectors that utilize integrated circuits. In fiscal year 2003, Varian Semiconductor experienced an increase in business activity owing to a generally strengthening
economy and increased demand for semiconductors. During fiscal year 2004 and the first nine months of fiscal year 2005, demand was strong for products in the semiconductor industry. However, visibility is still limited and thus, it is not known
whether or not the industry will continue in its current pattern.



Critical
Accounting Policies and Significant Judgments and Accounting Estimates



Varian Semiconductors discussion and analysis of its financial condition and results of operations are based upon Varian Semiconductors consolidated financial statements, which have been prepared in
accordance with generally accepted accounting principles (GAAP) in the U.S. The preparation of these consolidated financial statements requires Varian Semiconductor to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On a continual basis, Varian Semiconductor evaluates its estimates, including those related to inventories, accounts receivable, intangible
assets, income taxes, warranty obligations, post-retirement benefits, contingencies, and



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functional currencies. Varian Semiconductor operates in a highly cyclical and competitive industry that is influenced by a variety of diverse factors
including, but not limited to, technological advances, product life cycles, customer and supplier lead times, and macroeconomic and geographic economic trends. Estimating product demand beyond a relatively short forecasting horizon is difficult and
prone to forecasting error due to the cyclical nature and inherent lack of visibility in the industry. Varian Semiconductor bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions
or conditions. See also the factors discussed below under the section titled Risk Factors.



Varian Semiconductor believes that the following sets forth the critical accounting policies used by Varian Semiconductor in the preparation of its
consolidated financial statements.



Revenue Recognition



Product revenue includes established products, new products and spare parts.



Varian Semiconductor recognizes revenue from product sales
upon shipment provided title and risk of loss has passed to the customer, evidence of an arrangement exists, fees are contractually fixed or determinable, collectibility is reasonably assured through historical collection results and regular credit
evaluations, and there are no uncertainties regarding customer acceptance.



For established and new products, a portion of the total purchase price is typically not due until installation occurs and the customer accepts the product. For established products, the lesser of the amount allocated
to the equipment or the contractual amount due upon delivery is recorded as product revenue upon delivery. The amount deferred is recognized as revenue upon customer acceptance. For new products, revenue allocated to the equipment is recognized upon
customer acceptance. Revenue related to spare parts and upgrade sales is recognized upon the later of delivery or when the title and risk of loss passes to the customer.



Products are classified as established products if post-delivery acceptance provisions and the installation process have
been determined to be routine (due to the fact that the acceptance provisions are generally a replication of pre-shipment procedures) and there is a demonstrated history of achieving predetermined installation cost targets. The majority of products
are designed and manufactured to meet contractual customer specifications. To ensure customer specifications are satisfied, the systems are tested at Varian Semiconductors manufacturing facility prior to shipment. To the extent that
customers conditions cannot be replicated in Varian Semiconductors facilities or if there is not a demonstrated history of meeting newer customer specifications, then the product is treated as new for revenue recognition purposes. Varian
Semiconductor has predetermined criteria for changing the classification of a new product to an established product. A new product must achieve a set number of acceptances and a set target for installation cost. Once the criteria have been achieved
for a new product, the product is considered established.



Service revenue includes revenue from maintenance and service contracts, extended warranties, paid service and installation services. Revenue related to maintenance and service contracts is recognized ratably over the duration of the
contracts. Extended warranties are deferred as deferred revenue and recognized ratably over the applicable warranty term. Revenue related to paid service is recorded when earned and revenue related to installation is recorded upon fulfillment of the
service obligation and customer acceptance. It takes approximately three to six weeks for Varian Semiconductor technicians to complete the installation of Varian Semiconductor products and perform tests agreed to with customers. Certain customers
formally document their acceptance of Varian Semiconductors products at this time. Other customers elect to perform additional internal testing prior to formal acceptance, and this process generally takes eight to twelve weeks. Royalty and
license revenue is recognized when contractual obligations are met, and in the case of royalties, upon receipt of a royalty report from the customer, evidence of an arrangement exists, fees are fixed or determinable and collection is reasonably
assured.



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When fees are not fixed or determinable, revenue is recorded when payments become due.



Varian Semiconductors transactions frequently include the sale of
systems and services under multiple element arrangements. Revenue under these arrangements is allocated to all elements, except systems, based upon the fair market value of those elements. The amount allocated to installation is based upon hourly
rates at the estimated time to complete the service. The fair value of all other elements is based upon the price charged when these amounts are sold separately and unaccompanied by other elements. The amount of revenue allocated to systems is done
on a residual method basis. Under this method, the total value of the arrangement is allocated first to the undelivered elements based on their fair values, with the remainder being allocated to systems revenue.



Inventory and Purchase Order Commitments



Varian Semiconductor values its inventory at the lower of cost or market.
The determination of lower of cost or market requires that Varian Semiconductor make significant assumptions about future demand for products and the transition to new product offerings from legacy products. Estimating product demand beyond a
relatively short forecasting horizon is difficult and prone to forecasting error due to the cyclical nature and inherent lack of visibility in the industry. Varian Semiconductor also provides for losses on those open purchase order commitments in
which Varian Semiconductors estimated obligation to receive inventory under these commitments exceeds expected production and field service demand. These assumptions include, but are not limited to, future manufacturing schedules, customer
demand, supplier lead time and technological and market obsolescence. Once inventory is written down and a new cost basis has been established, it is not written back up if demand increases. If market conditions are less favorable than those
projected by management, additional inventory provisions may be required. If market conditions are more favorable than those projected by management, and specific products previously written down are subsequently sold, gross profit would improve by
the amount of the specific write down reversed in the quarter the inventory is sold. In the case of purchase order commitments, more favorable market conditions or successful negotiations with suppliers will result in a reduction of provisions in
the quarter the excess purchase order commitments are reduced.



Allowance
for Doubtful Accounts



Varian Semiconductor maintains
allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments for products and services. Accounts with known financial issues are first reviewed and specific estimates are recorded. The
remaining accounts receivable balances are then grouped in categories by the amount of days the balance is past due and the estimated loss is calculated as a percentage of the total category based upon past history. If the financial conditions of
Varian Semiconductors customers were to deteriorate resulting in their inability to make payments, additional allowances may be required. If accounts previously identified as a risk and reserved for subsequently stabilize and are deemed to no
longer be at risk for collection, or categories past due decrease, the allowance for doubtful accounts may be reduced. As a result, a reduction to bad debt expense would be recognized in the period the determination was made.



Valuation Allowance on Deferred Tax Assets and Income Tax Provision



Financial Accounting Standards Board (FASB) Statement No. 109,
Accounting for Income Taxes, (FASB No. 109) requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that a portion of the deferred tax asset will not be realized. On a quarterly
basis, Varian Semiconductor evaluates both the positive and negative evidence bearing upon the realizability of its deferred tax assets. Varian Semiconductor considers future taxable income, ongoing prudent and feasible tax planning strategies, and
the ability to utilize tax losses and credits in assessing the need for a valuation allowance. A valuation allowance related to certain state tax credit carryforwards has been recorded. Management has concluded that it is more likely than not that
these credits will not be utilized since historically the annual amount of state credits generated



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exceeds the amount of credits that can be used. Should Varian Semiconductor determine that it is not able to realize all or part of its other deferred tax
assets in the future, a valuation allowance would be required resulting in an expense recorded within the provision for income taxes line in the Statement of Income in the period in which such determination was made. It is reasonably possible that
the amount of the deferred tax asset considered realizable could be reduced in the near term if future taxable income is reduced. Varian Semiconductors effective tax rate is affected by levels of taxable income in domestic and foreign tax
jurisdictions, U.S. tax credits generated and utilized for research and development expenditures, U.S. foreign income exclusion, investment tax credits and other tax incentives specific to domestic and foreign operations. In the normal course of
business, Varian Semiconductor and its subsidiaries are examined by various tax authorities, including the Internal Revenue Service (IRS). The IRS has conducted an examination for the tax years 1999 through 2003 as part of its routine
examinations of Varian Semiconductors income tax returns. Fieldwork was completed late in the third quarter of fiscal year 2005, and Varian Semiconductor is currently reviewing the audit findings. If agreed, the results of the examination are
subject to review by the Congressional Joint Committee on Taxation. Varian Semiconductor estimates that this review will be completed in the first or second quarter of fiscal year 2006. The ultimate resolution of the examination may impact Varian
Semiconductors financial statements, the result of which could be material to Varian Semiconductors earnings and effective tax rate. Any additional impact on Varian Semiconductors liability for income taxes associated with this
examination cannot presently be determined. However, Varian Semiconductor believes its accrued income tax liabilities are adequate.



Product Warranties



Varian Semiconductor provides for the estimated cost of product warranties, the amount of which is based primarily upon historical information, at the
time product revenue is recognized. While Varian Semiconductor engages in extensive product quality programs and processes including actively monitoring and evaluating the quality of its component supplies, Varian Semiconductors warranty
obligation is affected by product failure rates, utilization levels, material usage, service delivery costs incurred in correcting a product failure, and supplier warranties on parts delivered to Varian Semiconductor. Should actual product failure
rates, utilization levels, material usage, service delivery costs or supplier warranties on parts differ from Varian Semiconductors estimates, revisions to the estimated warranty liability would be required.



Environmental Liabilities



Liabilities are recorded when environmental assessments and/or remedial
efforts are probable and the costs can be reasonably estimated. Generally, the timing of these accruals coincides with completion of a feasibility study or Varian Semiconductors commitment to a formal plan of action. In situations where the
various uncertainties make it difficult to assess the likelihood and scope of further investigation or remediation activities or to estimate then future costs, the lower limit of an estimated range is accrued on a non-discounted basis. All other
liabilities, which are usually where Varian Semiconductor has generally sufficient knowledge to be able to better estimate the scope of costs and future activities, are accrued on a discounted basis. Should new information become available and/or
different assumptions be applied in the estimation of environmental liabilities, revisions to the accrued environmental liability would be required.



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Results of Operations



Revenue



The following table sets forth revenue by category for the three and nine month periods ended July 1, 2005 and July 2, 2004:



|                    |  |                           |         |             |                          |         |  |               |        |  |             |   |             |   |         |  |                |         |  |   |        |  |     |  
|------------------- |  | ------------------------- | ------- | ----------- | ------------------------ | ------- |  | ------------- | ------ |  | ----------- | - | ----------- | - | ------- |  | -------------- | ------- |  | - | ------ |  | --- | -
|                    |  | Fiscal Three Months Ended |         |             | Fiscal Nine Months Ended |        
|                    |  | July 1,2005               |         | July 2,2004 |                          | Change  |  | PercentChange |        |  | July 1,2005 |   | July 2,2004 |   | Change  |  | Percent Change |        
|                    |  | (Amounts in thousands)    |         |             | (Amounts in thousands)   |        
|Revenue             |  |                           |         |             |                          |         |  |              
|Product             |  | $                         | 144,227 |             | $                        | 127,059 |  | $             | 17,168 |  | 14          | % |             | $ | 367,359 |  | $              | 322,866 |  | $ | 44,493 |  | 14  | %
|Service             |  |                           | 19,902  |             |                          | 16,727  |  |               | 3,175  |  | 19          | % |             |   | 60,584  |  |                | 46,297  |  |   | 14,287 |  | 31  | %
|Royalty and license |  |                           | 2,561   |             |                          | 2,349   |  |               | 212    |  | 9           | % |             |   | 26,269  |  |                | 6,141   |  |   | 20,128 |  | 328 | %
|                    |  |                           |         |             |                          |         |  |               |        |  |             |   |             |   |         |  |                |         |  |   |        |  |     |  
|Revenue             |  | $                         | 166,690 |             | $                        | 146,135 |  | $             | 20,555 |  | 14          | % |             | $ | 454,212 |  | $              | 375,304 |  | $ | 78,908 |  | 21  | %
|                    |  |                           |         |             |                          |         |  |               |        |  |             |   |             |   |         |  |                |         |  |   |        |  |     |  



Product



During the third quarter of fiscal year 2005, product revenue increased
$17.1 million, or 13.5% to $144.2 million from $127.1 million in the third quarter of fiscal year 2004. Product revenue for the nine months ended July 1, 2005 increased $44.5 million, or 13.8%, to $367.4 million compared to $322.9 million for the
same period a year ago. The increase in revenue on both a quarterly and year-to-date basis is primarily due to increased levels of capital spending by Varian Semiconductors customers, particularly memory manufacturers, resulting in increased
product volume. Additionally, the mix of products was more heavily weighted towards VIISta products as opposed to legacy products, which have higher average selling prices.



Service



Service revenue during the third quarter of fiscal year 2005 was $19.9 million, compared to $16.7 million for the same period a year ago. Service revenue for the first nine months of fiscal year 2005 was $60.6
million, compared to $46.3 million for the same period of fiscal year 2004. The increase is a result of increased volume of system shipments, which resulted in higher installation revenue in the third quarter and first nine months of fiscal
year 2005.



Royalty



As a result of an arbitration panel ruling in the second phase of the
arbitration between Varian Semiconductor and Applied Materials, Inc. (Applied Materials), Varian Semiconductor received $24.6 million during the first quarter of fiscal year 2005 for past due royalties and interest. Of the $24.6 million,
$18.9 million was included in royalty revenue and $5.7 million in interest income in the first quarter of fiscal year 2005. Applied Materials is also required to make quarterly unit-based royalty payments to Varian Semiconductor on future sales of
certain products found to be within the scope of the patent license agreement (the Agreement) through expiration of the Agreement in March 2007.



Pursuant to the terms of a Settlement and License Agreement between Varian Semiconductor and Lam Research Corporation (Lam), Lam made its last
quarterly cash payment of $1.25 million in December 2004.



Customers



During the third quarter of fiscal year 2005, revenue
from two customers accounted for 31.6% and 11.7%, respectively, of Varian Semiconductors total revenue. Varian Semiconductor expects that sales of its products to relatively few customers will continue to account for a high percentage of its
revenue in the foreseeable future. During the third quarter of fiscal year 2004, revenue from one customer accounted for 10.8% of Varian Semiconductors total revenue. During the first nine months of fiscal year 2005, revenue from two customers
accounted for 22.3% and 11.1%, respectively, of Varian Semiconductors total revenue. During the first nine months of fiscal year 2004, revenue from one customer accounted for 15.2% of Varian Semiconductors total revenue.



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Fluctuations in the timing and mix of product shipments, customer requirements for systems, and the
completion of the installation of the product will continue to have a significant impact on the timing and amount of revenue in any given period (see also Risk Factors and Critical Accounting PoliciesRevenue
Recognition).



Cost of Product Revenue.Cost of
product revenue was $84.2 million and gross margin was 41.6% for the third quarter of fiscal year 2005, compared to cost of product revenue of $68.4 million and gross margin of 46.2% for the third quarter of fiscal year 2004. The two primary drivers
of the decrease in gross margin, quarter over quarter, were lower levels of parts and upgrades sales which traditionally have higher margins than sales of other products and product transition costs for which a $2.0 million obsolescence charge was
recorded. For the first nine months of fiscal year 2005, the cost of product revenue was $212.0 million and gross margin was 42.3%, compared to the cost of product revenue of $178.9 million and gross margin of 44.6% for the first nine months of
fiscal year 2004. The year-to-date decrease in gross margin is a result of higher levels of investment in field parts to support Varian Semiconductors growing customer base. Additionally, parts and upgrades revenues are a lower percentage of
product revenue in fiscal year 2005 than in fiscal year 2004.



Cost of Service Revenue.Cost of service revenue was $12.1 million and gross margin was 39.4% for the third quarter of fiscal year 2005, compared to a cost of service revenue of $10.8 million and gross margin of 35.4% for the third
quarter of fiscal year 2004. For the first nine months of fiscal year 2005, the cost of service revenue was $37.4 million and gross margin was 38.3%, compared to the cost of service revenue of $29.4 million and gross margin of 36.5% for the first
nine months of fiscal year 2004. The increase in service gross margin was primarily due to the timing and mix of completed installations.



Research and Development. Research and development expenses were $19.4 million for the third quarter of fiscal year 2005, compared to $17.5 million
for the third quarter of fiscal year 2004. For the first nine months of fiscal year 2005, research and development expenses were $57.1 million, compared to $50.7 million for the same period in fiscal year 2004. The increase in research and
development spending is attributable to Varian Semiconductors rapid product development cycle and continuing efforts to improve productivity and technical development of its products. The quarterly and nine month increases were a result of
increased labor and material spending associated with the development of new products, particularly high current implanters. In addition to developing new high current products, Varian Semiconductor continues to focus on maintaining its leadership
position in the market for medium current implanters.



Marketing, General and Administrative. Marketing, general and administrative expenses were $26.2 million for the third quarter of fiscal year 2005, compared to $21.7 million in the third quarter of fiscal year 2004. For the first
nine months of fiscal year 2005, marketing, general and administrative expenses were $78.0 million, compared to $62.6 million for the same period in fiscal year 2004. On a quarterly and year-to date basis, the increases are related to costs to
demonstrate the capabilities of Varian Semiconductors latest generation of products and variable compensation plans. Additionally, the first quarter of fiscal year 2005 included a $3.5 million charge associated with the retirement of the
President and Chief Operating Officer of Varian Semiconductor effective as of December 31, 2004. For more information, please see Item 9B of Part II of Varian Semiconductors Annual Report on Form 10-K for the year ended October 1, 2004.



Restructuring.In the second quarter of fiscal year
2005, $0.9 million of restructuring expense was recognized related to downsizing in Europe. These restructuring costs related to reductions in headcount and in facilities.



Interest Income and Interest Expense. During the third quarter of fiscal year 2005, Varian Semiconductor earned $2.9
million in net interest income, compared to $1.0 million for the third quarter of fiscal year 2004. For the first nine months of fiscal year 2005, Varian Semiconductor earned $12.9 million in interest income, compared to $2.8 million earned in the
first nine months of fiscal year 2004. Interest income in the first nine months of fiscal year 2005 included $5.7 million related to past due royalties from Applied Materials as a result of an arbitration ruling (see also Royalty). The
remaining increase is due to higher cash balances and rates, along with an increased portfolio of investments compared to the total cash and investments balance.



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Other Income (Expense), Net. Other income (expense), net, was less than $0.1 million in income for
the third quarter of fiscal year 2005, compared to other expenses of $0.3 million for the third quarter of fiscal year 2004. For the nine month period ended July 1, 2005, other income, net was $2.8 million. This is compared to other expenses of $0.5
million for the nine month period ended July 2, 2004. In the first nine months of fiscal year 2005, other income included $2.7 million for the reduction of an estimated loss contingency that had been established to cover any residual indemnification
obligations related to patent infringement and antitrust litigation. After evaluating all of the facts associated with this transaction, and consultation with counsel, management believed that Varian Semiconductor had no further liability with
respect to the settlement. The statute of limitations on the indemnification obligations expired during the first quarter of fiscal year 2005 (See Note 14. Commitments, Contingencies and Guarantees in the Notes to the Unaudited Interim Consolidated
Financial Statements).



Provision for Income Taxes.
Varian Semiconductors effective income tax rate was 31% for the nine month period ended July 1, 2005 and 32% for the same period ended July 2, 2004. The decrease in the effective rate is due to the increased benefit we expect to receive from
higher levels of research and development spending and foreign sales. The rate is lower than the U.S. federal statutory rate principally due to credits and lower-taxed foreign income. Future tax rates may vary from the historic rates depending on
the worldwide composition of earnings and the continuing availability of income tax credits as well as the potential resolution of tax contingencies. In the normal course of business, Varian Semiconductor and its subsidiaries are examined by various
tax authorities, including the Internal Revenue Service (IRS). The IRS has conducted an examination for the tax years 1999 through 2003 as part of its routine examinations of Varian Semiconductors income tax returns. Fieldwork was
completed late in the third quarter of fiscal year 2005, and Varian Semiconductor is currently reviewing the audit findings. If agreed, the results of the examination are subject to review by the Congressional Joint Committee on Taxation. Varian
Semiconductor estimates that this review will be completed in the first or second quarter of fiscal year 2006. The ultimate resolution of the examination may result in an adjustment to Varian Semiconductors financial statements that could be
material to Varian Semiconductors earnings and effective tax rate. Any additional impact on Varian Semiconductors liability for income taxes associated with this examination cannot presently be determined. However, Varian Semiconductor
believes its accrued income tax liabilities are adequate.



On
October 22, 2004, the President signed the American Jobs Creation Act of 2004 (the Jobs Act). The Jobs Act creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends
received deduction for certain dividends from controlled corporations. Varian Semiconductor may elect to apply this provision to qualifying earnings repatriations in either fiscal year 2005 or 2006. The maximum possible amount that the company is
currently considering as eligible for repatriation is $14 million. Varian Semiconductor continues to evaluate the effects of the repatriation provision. At this time, the potential range of income tax effects of such repatriation cannot be
reasonably estimated.



The Jobs Act also provides for a
two-year phase-out of the existing extra-territorial income exclusion (the ETI) for foreign sales. This provision is effective for transactions entered into after December 31, 2004. Varian Semiconductor expects the net effect of the
phase-out of the ETI to result in an increase in the effective tax rate for fiscal year 2005 of less than one percentage point, based on current earnings levels. In addition, the Jobs Act provides a deduction for income from qualified domestic
production activities, which will be phased in from 2005 through 2010. This provision will become effective for Varian Semiconductor in fiscal year 2006.



Net Income. As a result of the foregoing factors, in the third quarter of fiscal year 2005, Varian Semiconductor recorded net income of $19.3
million, compared to net income of $19.3 million for the same period of fiscal year 2004. The net income per diluted share was $0.51 for the third quarter of fiscal year 2005, compared to net income per diluted share of $0.52 for the third quarter
of fiscal year 2004. For the first nine months of fiscal year 2005, net income was $58.4 million, compared to net income of $38.1 million for the first nine months of fiscal year 2004. For the first nine months of fiscal year 2005, the net income
per diluted share was $1.56, compared to net income per diluted share of $1.03 for the same period of fiscal year 2004.



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Liquidity and Capital Resources



Varian Semiconductor generated $49.3 million of cash from operations during the first nine months of fiscal year 2005,
compared to $32.3 million of cash generated from operations during the first nine months of fiscal year 2004. Cash provided by operations in the first nine months of fiscal year 2005 was primarily a result of net income of $58.4 million, an increase
in deferred revenue of $9.9 million and a decrease in other current assets of $9.9 million. These increases were partially offset by a $42.4 million increase in inventories and a $10.3 million increase in accounts receivable. The increase in
inventories and a related increase in accounts payable of $4.0 million is attributable to increased customer orders for the fourth quarter of fiscal year 2005. The increase in accounts receivable is primarily related to a higher number of shipments
later in the fiscal year during fiscal year 2005 as compared to the same period in fiscal year 2004. The decrease in other current assets and accrued expenses is primarily related to the receipt of tax refunds, the provision for taxes on income and
the remittance of estimated income tax payments. Cash provided by operations in the first nine months of fiscal year 2004 was primarily a result of net income of $38.1 million and increases in deferred revenue of $25.3 million and accounts payable
of $13.4 million, and tax benefits from stock option exercises of $13.7 million. These changes were partially offset by increases in inventories of $39.3 million and accounts receivable of $37.3 million.



Varian Semiconductor used $172.2 million of cash and cash equivalents for the
purchase of short-term investments during the first nine months of fiscal year 2005, and $10.6 million of cash and cash equivalents for the purchase of property, plant and equipment during the same period. These outflows were partially offset by
proceeds from sales and maturities of short-term investments of $96.9 million during the period. In the first nine months of fiscal year 2004, Varian Semiconductor used $150.5 million of cash and cash equivalents for the purchase of short-term
investments, and $7.1 million of cash and cash equivalents for the purchase of property, plant and equipment. These were partially offset by proceeds from sales and maturities of short-term investments of $23.1 million during the first nine months
of fiscal year 2004.



During the first nine months of fiscal
year 2005, Varian Semiconductor generated $7.0 million of cash from financing activities, primarily due to $11.0 million from the issuance of common stock, offset by $4.1 million in repayments on short- and long-term borrowings. During the first
nine months of fiscal year 2004, Varian Semiconductor generated $23.3 million of cash from financing activities, primarily due to $25.3 million from the issuance of common stock upon the exercise of stock options and under the Employee Stock
Purchase Plan, partially offset by repayments on short- and long-term borrowings.



During the first quarter of fiscal year 2005, Varian Semiconductors Board of Directors authorized the repurchase of up to 3.5 million shares of Varian Semiconductors common stock from time to time on the
open market. Varian Semiconductor has not repurchased any stock to date.



Varian Semiconductors liquidity is affected by many factors, some based on the normal operations of the business and others related to the uncertainties of the industry and global economies. Varian Semiconductor
believes that cash, cash equivalents and short-term investments of $436.4 million at July 1, 2005 will be sufficient to satisfy working capital requirements, commitments for capital expenditures and other purchase commitments, environmental
contingencies and cash requirements for the foreseeable future.



Off-Balance
Sheet Arrangements



Varian Semiconductor does not have any
relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance-sheet
arrangements or other contractually narrow or limited purposes. As such, Varian Semiconductor is not exposed to any financing, liquidity, market or credit risk that could arise if Varian Semiconductor had engaged in such relationships.



Contractual Obligations



Under GAAP, certain obligations and commitments are not required to be
included in the consolidated balance sheets and statements of income. These obligations and commitments, while entered into in the normal



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course of business, may have a material impact on liquidity. The following commitments as of July 1, 2005 have not been included in the consolidated balance
sheets and statements of income included under Item 1. Consolidated Financial Statements; however, they have been disclosed in the following table in order to provide a more accurate picture of Varian Semiconductors financial position and
liquidity.



|                           |  |                        |                  |                        |          |        |  |   |    
|-------------------------- |  | ---------------------- | ---------------- | ---------------------- | -------- | ------ |  | - | ---
|                           |  | Total                  |                  | Payments Due by Period
|                           |  |                        | Less than 1 Year |                        | 1-3Years
|                           |  | (Amounts in thousands)
|Operating leases           |  | $                      | 2,416            |                        | $        | 1,721  |  | $ | 695
|Purchase order commitments |  |                        | 31,648           |                        |          | 31,648 |  |   |   
|                           |  |                        |                  |                        |          |        |  |   |    
|Total commitments          |  | $                      | 34,064           |                        | $        | 33,369 |  | $ | 695
|                           |  |                        |                  |                        |          |        |  |   |    



Transactions with Affiliates and
Related Parties



Operations prior to April 2, 1999 had
been part of the former Varian Associates, Inc. (VAI), now known as Varian Medical Systems, Inc. (VMS) (See Note 14. Commitments, Contingencies and Guarantees in the Notes to the Unaudited Interim Consolidated Financial
Statements). On April 2, 1999, VAI contributed its Semiconductor Equipment Business (SEB) to Varian Semiconductor, then distributed to the holders of record of VAI common stock one share of common stock of Varian Semiconductor for each
share of VAI common stock owned on March 24, 1999. At the same time, VAI contributed its Instruments Business (IB) to Varian, Inc. (VI) and distributed to the holders of record of VAI common stock one share of common stock of
IB for each share of VAI common stock owned on March 24, 1999. VAI retained its Health Care Systems business and changed its name to VMS effective as of April 2, 1999. These transactions were accomplished under the terms of a Distribution Agreement
by and among Varian Semiconductor, VAI, hereafter referred to as VMS for periods following the spin-off and VI (the Distribution Agreement). For purposes of providing an orderly transition and to define certain ongoing relationships
between and among Varian Semiconductor, VMS and VI after the spin-off Varian Semiconductor, VMS and VI also entered into certain other agreements which include an Employee Benefits Allocation Agreement, an Intellectual Property Agreement, a Tax
Sharing Agreement and a Transition Services Agreement (collectively, the Distribution Related Agreements).



The Distribution Related Agreements provide that from and after the spin-off, VMS, VI, and Varian Semiconductor will indemnify each and their respective
subsidiaries, directors, officers, employees and agents against all losses arising in connection with shared liabilities (including certain environmental and legal liabilities). All shared liabilities will be managed and administered by VMS and
expenses and losses, net of proceeds and other receivables, will be borne one-third each by VMS, VI, and Varian Semiconductor. The Distribution Related Agreements also provide that Varian Semiconductor shall assume all of its liabilities, other than
shared liabilities (including accounts payable, accrued payroll and pension liabilities) in accordance with their terms. During fiscal years 2004, 2003 and 2002, Varian Semiconductor was charged $1.6 million, $1.4 million, and $4.0 million,
respectively, by VMS in settlement of these obligations. During the first nine months of fiscal year 2005, Varian Semiconductor was charged by VMS $1.0 million in settlement of these obligations. During the first nine months of fiscal year 2004,
Varian Semiconductor was charged by VMS $1.3 million in settlement of these obligations.



Recent Accounting Pronouncements



On October 22, 2004, the President signed the Jobs Act. The Jobs Act creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends received deduction
for certain dividends from controlled corporations. Varian Semiconductor may elect to apply this provision to qualifying earnings repatriations in either fiscal year 2005 or 2006. The maximum possible amount that the company is currently considering
eligible for repatriation is $14 million. Varian Semiconductor continues to evaluate the effects of the repatriation provision. At this time, the potential range of income tax effects of such repatriation cannot be reasonably estimated.



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In December 2004, the FASB issued FASB Staff Position (FSP) No. 109-2, Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004 (FSP 109-2). FSP 109-2 provides guidance under FASB No. 109 with respect to recording the potential impact of the
repatriation provisions of the Jobs Act on enterprises income tax expense and deferred tax liability. The Jobs Act was enacted in October 2004. FSP No. 109-2 states that an enterprise is allowed time beyond the financial reporting period of
enactment to evaluate the effect of the Jobs Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying FASB No. 109. At this time, the range of earnings that may be repatriated and the potential range of income
tax effects of such repatriation cannot be reasonably estimated.



Under the guidance in FSP No. 109-1, Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004, issued in
December 2004, the deduction will be treated as a special deduction as described in FASB No. 109. As such, the special deduction has no effect on deferred tax assets and liabilities existing at the enactment date. Rather, the impact of
this deduction will be reported in the period in which the deduction is claimed on Varian Semiconductors tax return. This provision will become effective for Varian Semiconductor in fiscal year 2006.



The Jobs Act also provides for a two-year phase-out of the existing
extra-territorial income exclusion (the ETI) for foreign sales. This provision is effective for transactions entered into after July 1, 2005. Varian Semiconductor expects the net effect of the phase-out of the ETI to result in an
increase in the effective tax rate for fiscal year 2005 of less than one percentage point, based on current earnings levels.



In November 2004, the FASB issued Statement No. 151, Inventory Costsan Amendment of ARB No. 43, Chapter 4 (FASB No. 151).
FASB No. 151 amends Accounting Research Bulletin (ARB) No. 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges.
In addition, this statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of this statement are effective for inventory costs incurred
during fiscal years beginning after June 15, 2005. Varian Semiconductor does not believe that the adoption of FASB No. 151 will have a material impact on its financial statements.



In December 2004, the FASB issued Statement No. 123 (revised 2004), Share-Based Payment (FASB No.
123(R)). FASB No. 123(R) will require Varian Semiconductor to measure all stock-based compensation awards using a fair value method and record such expense in its consolidated financial statements. In addition, the adoption of FASB No.
123(R) will require additional accounting related to the income tax effects and additional disclosure regarding the cash flow effects resulting from share-based payment arrangements. FASB No. 123(R), as issued, would have been effective beginning in
Varian Semiconductors fourth quarter of fiscal year 2005. In April 2005, the SEC extended the effective date to fiscal years (rather than interim periods) beginning after June 15, 2005. Therefore, FASB No. 123(R) will be effective as of
October 1, 2005 for Varian Semiconductor. The adoption of FASB No. 123(R) could have a material impact on Varian Semiconductors consolidated financial position, results of operations and cash flows. Varian Semiconductor is in the process of
evaluating the impact of implementing FASB No. 123(R).



In
March 2005, the SEC issued Staff Accounting Bulletin (SAB) No. 107 (SAB 107), which expresses the staffs views on issues related to the implementation of FASB No. 123(R). The guidance offered in SAB 107 will be taken
into account by Varian Semiconductor during the implementation of FASB No. 123(R).



Risk Factors



The semiconductor
industry is cyclical, and a slowdown in demand for Varian Semiconductors semiconductor manufacturing equipment could negatively affect financial results.



The semiconductor industry historically has been cyclical in nature and has experienced periodic downturns. The industry is
currently experiencing volatility in product pricing and in product demand. Volatility may result in significant reductions and delays in the purchase of semiconductor manufacturing equipment and the



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construction of new fabrication facilities. Even though Varian Semiconductors revenues fluctuate significantly from period to period, in order to
remain competitive, Varian Semiconductor continues to invest in research and development to maintain its worldwide customer service and support capability. These investments in the business may adversely affect Varian Semiconductors financial
results.



Varian Semiconductor faces intense competition in the
semiconductor equipment industry.



Significant competitive
factors in semiconductor equipment manufacturing include the strength of customer relationships, pricing, technological performance and timing, distribution capabilities and financial viability. Varian Semiconductor believes that in order to remain
competitive in this industry, it will need to devote significant financial resources to research and development, to offer and market a broad range of products, and maintain and enhance customer service and support centers worldwide. The
semiconductor equipment industry is increasingly dominated by large manufacturers who have resources to support customers worldwide, and some of Varian Semiconductors competitors have substantially greater financial resources and more
extensive engineering, manufacturing, marketing, service and support than does Varian Semiconductor. With fewer resources, Varian Semiconductor may not be able to match the product offerings or customer service and technical support offered by its
competitors. In addition, there are several smaller companies that provide innovative technology that may have performance advantages over Varian Semiconductors systems. If these manufacturers continue to improve their product performance and
pricing, enter into strategic relationships, expand their current targeted geographic territory or consolidate with large equipment manufacturers, sales of Varian Semiconductors products may suffer.



Varian Semiconductor derives a substantial portion of its revenues from a small number of
customers, and its business may be harmed by the loss of any one significant customer.



Varian Semiconductor has historically sold at least half of its systems in any particular period to its major customers, some of which include Hynix Semiconductor, Inc., International Business Machines Corporation,
Infineon Technologies AG, Intel Corporation, Micron Technology, Inc., Samsung Electronics Corporation Limited, Sony Corporation, STMicroelectronics, Texas Instruments, Inc., Taiwan Semiconductor Machines Corporation and United Microelectronics
Corporation. During some quarters, some of these customers have individually accounted for more than ten percent of Varian Semiconductors total revenue. Varian Semiconductor expects that sales of its products to relatively few customers will
continue to account for a high percentage of its revenue in the foreseeable future. Furthermore, Varian Semiconductor may have difficulty attracting additional large customers because its sales depend, in large part, upon the decision of a
prospective customer to increase manufacturing capacity in an existing fabrication facility or to transfer a manufacturing process to a new fabrication facility, both of which typically involve a significant capital commitment. Once a semiconductor
manufacturer has selected a particular suppliers capital equipment, the manufacturer generally relies upon that equipment for the specific production line application and frequently will attempt to consolidate its other capital equipment
requirements with the same supplier. Consequently, Varian Semiconductor may experience difficulty in selling to a prospective customer if that customer initially selects a competitors capital equipment.



Varian Semiconductors quarterly results of operations are likely to fluctuate, and
as a result, Varian Semiconductor may fail to meet the expectations of its investors and securities analysts, which may cause the price of its common stock to decline.



Varian Semiconductor has experienced and expects to continue to experience significant fluctuations in its quarterly
financial results. From time to time, customers may accelerate, postpone, or cancel shipments, or production difficulties could delay shipments. A cancellation, delay in shipment or delay in customer acceptance of the product upon installation in
any quarter may cause revenue in such quarter to fall significantly below expectations, which could cause the market price of Varian Semiconductors common stock to decline. Varian Semiconductors financial results also fluctuate based on
gross profit realized on sales. Gross profit as a percentage of revenue may vary based on a variety of factors, including the mix and average selling prices of



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products sold, costs to manufacture and customize systems and inventory management. In addition, a number of other factors could impact Varian
Semiconductors quarterly financial results, including, but not limited to the following:



| |  |  | changing global economic conditions and worldwide political instability;
| | - |  | ------------------------------------------------------------------------



| |  |  | general conditions in the semiconductor equipment industry;
| | - |  | -----------------------------------------------------------



| |  |  | unexpected procurement or manufacturing difficulties;
| | - |  | -----------------------------------------------------



| |  |  | pricing of key components;
| | - |  | --------------------------



| |  |  | fluctuations in foreign exchange rates;
| | - |  | ---------------------------------------



| |  |  | ability to develop, introduce and market new, enhanced and competitive products in a timely manner;
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | introduction of new products by Varian Semiconductors competitors;
| | - |  | -------------------------------------------------------------------



| |  |  | legal or technical challenges to Varian Semiconductors products and technology; and
| | - |  | ------------------------------------------------------------------------------------



| |  |  | adverse weather conditions at its manufacturing facilities or customers facilities.
| | - |  | -----------------------------------------------------------------------------------



Because Varian Semiconductors operating expenses are based on anticipated capacity levels and a high percentage of
Varian Semiconductors expenses are relatively fixed, a variation in the timing of recognition of revenue and the level of gross profit from a single transaction could cause financial results to vary significantly from quarter to quarter.



It is difficult for Varian Semiconductor to predict the quarter in which it
will be recognizing revenue from large product orders.



During a quarter, Varian Semiconductor customarily sells a relatively small number of ion implantation systems. Consequently, Varian Semiconductors revenue and financial results could be negatively impacted for a particular quarter if
anticipated orders from even a few customers are not received in time to permit shipment and/or there are delays in customer acceptance of the product upon installation. Varian Semiconductor recognizes all or a portion of the revenue from a product
at the time the product is shipped and title and risk of loss has passed to the customer. As a result, it is often difficult to determine the timing of product revenue recognition. In addition, Varian Semiconductors product order backlog at
the beginning of each quarter may not include all systems needed to achieve expected revenues for that quarter. Because Varian Semiconductor may build systems according to forecast, the absence of a significant backlog for an extended period of time
could adversely affect financial results.



Varian Semiconductors
future business depends, in part, on its ability to successfully introduce and manage the transition to new products, and Varian Semiconductor may not succeed in accomplishing these goals.



Varian Semiconductor believes that its future success will depend on its
ability to develop, manufacture and successfully introduce new systems and product lines with improved capabilities and to continue enhancing existing products; in particular, products that respond to the trend toward single wafer processing and
300mm wafer processing. Varian Semiconductor derives virtually all of its revenue from sales and servicing of ion implantation systems and related products and services. Varian Semiconductor must accurately forecast the demand for new products while
managing the transition from older products. In addition, Varian Semiconductor may be unable to complete the development or meet the technical specifications of new systems or enhancements or to manufacture and ship these systems or enhancements in
volume and on time, which may harm its reputation and business. In the past, Varian Semiconductor has experienced some delays in manufacturing and shipping systems and enhancements. If any of Varian Semiconductors new products have reliability
or quality problems, Varian Semiconductor may incur additional warranty and service expenses, experience a decline in product orders or incur higher manufacturing costs to correct such problems, all of which could adversely affect financial results.



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Varian Semiconductor is subject to the risks of operating internationally and it derives a substantial portion of its
revenues from outside the U.S.



International revenue
accounted for approximately 80%, 61%, and 61% of Varian Semiconductors revenue in fiscal years 2004, 2003, and 2002, respectively; and specifically, revenue in Asia has accounted for a substantial portion of this revenue. Sales to Asia
accounted for approximately 68%, 46%, and 44% of revenue in fiscal years 2004, 2003 and 2002, respectively. Because Varian Semiconductor relies on sales to customers in Asia for a substantial portion of its revenue, its business is very likely to be
adversely impacted by economic downturns and instability in that region. Varian Semiconductors business in Asia is affected by demand in each country. In addition, international sales are subject to risks, including, but not limited to:



| |  |  | fluctuations in foreign exchange rates;
| | - |  | ---------------------------------------



| |  |  | changes in legal and regulatory requirements;
| | - |  | ---------------------------------------------



| |  |  | political and economic instability and acts of terrorism;
| | - |  | ---------------------------------------------------------



| |  |  | difficulties in accounts receivable collection;
| | - |  | -----------------------------------------------



| |  |  | any public health crisis such as Severe Acute Respiratory Syndrome, or SARS;
| | - |  | ----------------------------------------------------------------------------



| |  |  | difficulties in staffing cultural diversity and managing international operations; and
| | - |  | --------------------------------------------------------------------------------------



| |  |  | foreign trade disputes.
| | - |  | -----------------------



If Varian Semiconductor is unable to protect its proprietary rights adequately, it may lose its ability to compete effectively in the semiconductor equipment industry.



Varian Semiconductor relies on obtaining and maintaining patent, copyright
and trade secret protection for significant new technologies, products and processes and obtaining key licenses because of the length of time and expense associated with bringing new products through the development process to market. Varian
Semiconductor intends to continue to file applications as appropriate for patents covering new products and manufacturing processes. However, Varian Semiconductor cannot provide assurance of the following:



| |  |  | that patents will issue from any pending or future patent applications owned by, or licensed to, Varian Semiconductor;
| | - |  | ----------------------------------------------------------------------------------------------------------------------



| |  |  | that the claims allowed under any issued patents will be sufficiently broad to protect Varian Semiconductors technology position against competitors;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | that any issued patents owned by or licensed to Varian Semiconductor will not be challenged, invalidated or circumvented; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | that the rights granted under Varian Semiconductors patents will provide it with competitive advantages.
| | - |  | ---------------------------------------------------------------------------------------------------------



Varian Semiconductor also has agreements with third parties for licensing of
patented or proprietary technology. These agreements include royalty-bearing licenses and technology cross-licenses.



In addition, Varian Semiconductor maintains and enforces its trademarks to increase customer recognition of its products. If its trademarks are used by
unauthorized third parties, its business may be harmed. Varian Semiconductor also relies on contractual restrictions on disclosure, copying and transferring title, including confidentiality agreements with vendors, strategic partners, co-developers,
employees, consultants and other third parties to protect its proprietary rights. If these contractual agreements are breached, Varian Semiconductor may not have adequate remedies for any such breaches. Varian Semiconductor also cannot provide
assurance that its trade secrets will not otherwise become known to or be independently developed by others.



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Patent claims may be expensive to pursue, defend or settle and may substantially divert Varian Semiconductors
resources and the attention of management.



Varian
Semiconductor could incur substantial costs and diversion of management resources in defending patent suits brought against it or in asserting its patent rights against others. If the outcome of any such litigation is unfavorable to Varian
Semiconductor, its business may be harmed. Varian Semiconductor may not be aware of pending or issued patents held by third parties that relate to its products or technologies. In the event that a claim is asserted against Varian Semiconductor, it
may need to acquire a license to or contest the validity of a competitors patent. Varian Semiconductor cannot be certain that it could acquire such a license on commercially acceptable terms, if at all, or that it would prevail in such a
proceeding. From time to time Varian Semiconductor has received notices from and has issued notices to such third parties alleging infringement of patent and other intellectual property rights relating to its products. If Varian Semiconductor is
subject to future claims of patent infringement, it may be required to make substantial settlement or damages payments and may have to devote substantial resources to reengineering its products.



Varian Semiconductor depends on limited groups of suppliers or single source suppliers,
the loss of which could impair its ability to manufacture products and systems.



Varian Semiconductor obtains some of the components and subassemblies included in its products from a limited group of suppliers, or in some cases a single source supplier. The loss of any supplier, including any
single source supplier, would require obtaining one or more replacement suppliers and may also require devoting significant resources to product development to incorporate new parts from other sources into Varian Semiconductors products. The
need to change suppliers or to alternate between suppliers might cause delays in delivery or significantly increase Varian Semiconductors costs. Although Varian Semiconductor has insurance to protect against loss due to business interruption
from these and other sources, Varian Semiconductor cannot provide assurance that such coverage will be adequate or that it will remain available on commercially acceptable terms. Although Varian Semiconductor seeks to reduce its dependence on these
limited source suppliers, disruption or loss of these sources could negatively impact its business and damage customer relationships.



Varian Semiconductors indemnification obligations under the Distribution Related Agreements could be substantial, and Varian Semiconductor may not be fully
indemnified in accordance with the Distribution Related Agreements for the expenses it incurs.



Under the terms of the Distribution Related Agreements, each of VMS, VI and Varian Semiconductor has agreed to indemnify the other parties (and certain
related persons) from and after the spin-off with respect to certain indebtedness, liabilities and obligations which could be significant. The availability of such indemnities will depend upon the future financial strength of the companies. There is
a risk that one or more of these companies will not be able to satisfy their indemnification obligations. In addition, the Distribution Related Agreements generally provide that if a court prohibits a company from satisfying its indemnification
obligations, then such obligations will be shared equally by the other companies.



Failure to comply with present or future environmental regulations could subject Varian Semiconductor to penalties and environmental remediation costs.



Varian Semiconductor is subject to a variety of foreign, federal, state and local laws regulating the discharge of materials
into the environment and the protection of the environment. These regulations include discharges into the soil, water and air and the generation, handling, storage and transportation and disposal of waste and hazardous substances. These laws
increase the costs and potential liabilities associated with the conduct of Varian Semiconductors operations.



VAI has been named by the U.S. Environmental Protection Agency and third parties as a potentially responsible party under the Comprehensive Environmental
Response Compensation and Liability Act of 1980, as amended, at eight sites where VAI is alleged to have shipped manufacturing waste for recycling or disposal. VAI is also in various stages of environmental investigation and or remediation under the
direction of, or in consultation with foreign, federal, state and local agencies at certain current or former VAI facilities (including



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facilities disposed of in connection with VAIs sale of its Electron Devices business during fiscal year 1995, and the sale of its TFS business during
fiscal year 1997). The Distribution Related Agreements provides that each of VMS, Varian Semiconductor and VI will indemnify the others for one-third of these environmental investigation and remediation costs, as adjusted for any insurance proceeds
and tax benefits expected to be realized upon payment of these costs.



For certain of these sites and facilities, various uncertainties make it difficult to assess the likelihood and scope of further investigation or remediation activities or to estimate the future costs of such activities if undertaken.
Varian Semiconductor has accrued $1.4 million in estimated environmental investigation and remediation costs for these sites and facilities as of October 1, 2004. As to other sites and facilities, sufficient knowledge has been gained to be able to
reasonably estimate the scope and costs of future environmental activities. As such, Varian Semiconductor has accrued $4.6 million, which represents future costs discounted at 7%, net of inflation, to cover Varian Semiconductors portion of
these costs. This reserve is in addition to the $1.4 million previously described.



These accrued amounts are only estimates of anticipated future environmental-related costs, and the amounts actually spent may be greater than such estimates. Accordingly, Varian Semiconductor may need to make
additional payments to cover its indemnification obligations that would exceed current estimates. In addition, Varian Semiconductors present and past facilities have been in operation for many years, and over that time in the course of those
operations, such facilities have used substances which are or might be considered hazardous. Varian Semiconductor also may have generated and disposed of wastes which are or might be considered hazardous. Therefore, it is possible that additional
environmental issues may arise in the future that Varian Semiconductor cannot now predict.



Varian Semiconductors ability to manage potential growth or decline, integration of potential acquisitions, and potential disposition of product lines and technologies creates risks.



The cyclical nature of the semiconductor industry may cause Varian
Semiconductor to experience rapid growth or decline in demand for products and services. As a result, Varian Semiconductor may face significant challenges in maintaining adequate financial and business controls, management processes, information
systems and procedures on a timely basis and training, managing and appropriately sizing the work force. Current conditions in the semiconductor equipment industry challenge management to control spending on operating activities. There can be no
assurance that Varian Semiconductor will be able to perform such actions successfully.



An important element of Varian Semiconductors management strategy is to review acquisition prospects that would complement existing products, augment market coverage and distribution ability, or enhance
technological capabilities. In the future, Varian Semiconductor may make acquisitions of complementary companies, products or technologies, or may reduce or dispose of certain product lines or technologies that no longer fit Varian
Semiconductors long-term strategies. Managing an acquired business, disposing of product technologies or reducing personnel entails numerous operational and financial risks, including difficulties in assimilating acquired operations and new
personnel or separating existing business or product groups, diversion of managements attention to other business concerns, amortization of acquired intangible assets, the incurrence of debt and contingent liabilities and potential loss of key
employees or customers of acquired or disposed operations, among others. Varian Semiconductors success will depend, to a significant extent, on the ability of its executive officers and other members of its senior management to identify and
respond to these challenges effectively. In addition, any acquisitions could result in dilutive issuances of equity securities. There can be no assurance that Varian Semiconductor will be able to achieve and manage successfully any such growth,
decline, integration of potential acquisitions, disposition of product lines or technologies, or reduction in personnel, or that management, personnel or systems will be adequate to support continued operations. Any such inabilities or inadequacies
would have a material adverse effect on Varian Semiconductors business, operating results, financial condition, cash flows and/or the price of Varian Semiconductor common stock.



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Varian Semiconductor manufactures its products at one primary manufacturing facility and is thus subject to risk of
disruption.



Varian Semiconductor has one primary
manufacturing facility, located in Gloucester, Massachusetts, and its operations are subject to disruption for a variety of reasons, including, but not limited to natural disasters, work stoppages, operational facility constraints and terrorism.
Such disruption could cause delays in shipments of products to Varian Semiconductors customers and could result in cancellation of orders or loss of customers and could seriously harm Varian Semiconductors business.



If Varian Semiconductor loses key employees or is unable to attract and retain key
employees, it may be unable to pursue business opportunities.



Varian Semiconductors future success depends to a significant extent on the continued service of key managerial, technical and engineering personnel. Competition for such personnel is intense, particularly in the labor markets around
Varian Semiconductors facilities in Massachusetts. The available pool of qualified candidates is limited, and Varian Semiconductor may not be able to retain its key personnel or to attract, train, assimilate or retain other highly qualified
engineers and technical and managerial personnel in the future. The loss of these persons or Varian Semiconductors inability to hire, train or retrain qualified personnel could harm Varian Semiconductors business and results of
operations.



Varian Semiconductor has anti-takeover defenses that could
delay or prevent an acquisition and could adversely affect the price of its common stock.



Provisions of Varian Semiconductors certificate of incorporation and by-laws and of Delaware law could delay, defer or prevent an acquisition or change in control of Varian Semiconductor or otherwise adversely
affect the price of its common stock. For example, Varian Semiconductors Board of Directors is classified into three classes, and stockholders do not have the right to call special meetings of stockholders. Varian Semiconductors
certificate of incorporation also permits its Board of Directors to issue shares of preferred stock without stockholder approval. In addition to delaying or preventing an acquisition, the issuance of a substantial number of preferred shares could
adversely affect the price of the common stock. Varian Semiconductor has also adopted a stockholders rights plan which may significantly dilute the equity interests of a person seeking to acquire control of Varian Semiconductor without the approval
of the Board of Directors.



Varian Semiconductor does not anticipate paying
dividends on its common stock in the future.



Varian
Semiconductor has not paid and does not anticipate paying dividends on its common stock. Varian Semiconductors Board of Directors has discretion to make decisions to pay dividends to common stockholders in the future. The decision will depend
on a number of factors, including results of operations, financial conditions and contractual restrictions, that the Board, in its opinion, deems relevant.



Compliance with Internal Controls Evaluation and Attestation Requirements.



Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, Varian Semiconductor will be required, beginning in fiscal 2005,
to perform an evaluation of its internal controls over financial reporting and have its independent registered public accounting firm publicly attest to such evaluation. Varian Semiconductor has prepared an internal plan of action for compliance,
which includes a timeline and scheduled activities, although as of the date of this filing, Varian Semiconductor has not yet prepared the evaluation. Compliance with these requirements is expected to be expensive and time-consuming. If Varian
Semiconductor fails to timely complete this evaluation, or if its independent registered public accounting firm cannot timely attest to its evaluation, Varian Semiconductor could be subject to regulatory scrutiny and a loss of public confidence in
its internal controls. In addition, any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm Varian Semiconductors operating results or cause Varian Semiconductor to fail to
meet its reporting obligations, resulting in an adverse opinion from its independent registered public accounting firm.



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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK



Foreign Currency Exchange Risk



As a multinational company, Varian Semiconductor faces exposure to adverse movements in foreign currency exchange rates. This exposure may change over time as Varian Semiconductors business practices evolve and could have a material
adverse impact on Varian Semiconductors financial results. Historically, Varian Semiconductors primary exposures have resulted from non-U.S. dollar denominated sales in Asia and Europe. Varian Semiconductor does not enter into forward
exchange contracts for trading purposes. Varian Semiconductors forward exchange contracts generally range from one to nine months in original maturity. No forward exchange contract has an original maturity greater than one year.



Varian Semiconductor hedges currency exposures that are associated with
certain of its assets and liabilities denominated in various non-U.S. dollar currencies. The aggregate exchange loss was immaterial for the first nine months of fiscal year 2005.



Forward exchange contracts outstanding are summarized as follows (amounts in thousands):



|                                          |  |               |        |                 |          |           |   |               |  |              |        |           |          |  |   |       
|----------------------------------------- |  | ------------- | ------ | --------------- | -------- | --------- | - | ------------- |  | ------------ | ------ | --------- | -------- |  | - | ------
|                                          |  | July 1, 2005  |        | October 1, 2004
|                                          |  | NotionalValue |        | ContractRate    |          | FairValue |   | NotionalValue |  | ContractRate |        | FairValue
|Foreign currency purchase contracts:      |  |               |        |                 |          |           |   |               |  |              |        |           |          |  |   |       
|Korean Won                                |  | $             | 3,542  |                 | 1,016.87 |           | $ | 3,480         |  | $            | 2,520  |           | 1,148.68 |  | $ | 2,520 
|Euro                                      |  |               | 1,672  |                 | 0.82     |           |   | 1,652         |  |              |       |           |         |  |   |      
|New Taiwan Dollar                         |  |               | 1,082  |                 | 31.15    |           |   | 1,064         |  |              | 1,633  |           | 33.81    |  |   | 1,626 
|British Pound                             |  |               |       |                 |         |           |   |              |  |              | 125    |           | 0.56     |  |   | 126   
|Japanese Yen                              |  |               |       |                 |         |           |   |              |  |              | 826    |           | 109.44   |  |   | 820   
|                                          |  |               |        |                 |          |           |   |               |  |              |        |           |          |  |   |       
|Total foreign currency purchase contracts |  | $             | 6,296  |                 |          |           | $ | 6,196         |  | $            | 5,104  |           |          |  | $ | 5,092 
|                                          |  |               |        |                 |          |           |   |               |  |              |        |           |          |  |   |       
|Foreign currency sell contracts:          |  |               |        |                 |          |           |   |               |  |              |        |           |          |  |   |       
|Japanese Yen                              |  | $             | 10,082 |                 | 108.08   |           | $ | 9,822         |  | $            |       |           |         |  | $ |      
|Korean Won                                |  |               | 8,741  |                 | 1,014.20 |           |   | 8,565         |  |              | 6,467  |           | 1,155.45 |  |   | 6,504 
|New Taiwan Dollar                         |  |               | 595    |                 | 31.44    |           |   | 590           |  |              | 477    |           | 33.96    |  |   | 477   
|Israeli Shekel                            |  |               | 542    |                 | 4.42     |           |   | 522           |  |              |       |           |         |  |   |      
|Euro                                      |  |               |       |                 |         |           |   |              |  |              | 745    |           | 0.82     |  |   | 760   
|                                          |  |               |        |                 |          |           |   |               |  |              |        |           |          |  |   |       
|Total foreign currency sell contracts     |  |               | 19,960 |                 |          |           |   | 19,499        |  |              | 7,689  |           |          |  |   | 7,741 
|                                          |  |               |        |                 |          |           |   |               |  |              |        |           |          |  |   |       
|Total contracts                           |  | $             | 26,256 |                 |          |           | $ | 25,695        |  | $            | 12,793 |           |          |  | $ | 12,833
|                                          |  |               |        |                 |          |           |   |               |  |              |        |           |          |  |   |       



Varian Semiconductor
also hedges currency exposures that are associated with certain of its product sales denominated in Japanese Yen. In accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging
Activities, these forward foreign exchange contracts are designated as hedges of anticipated product sales, and accordingly the gains and losses resulting from the impact of currency rate movements on these contracts are not recognized in
income until the underlying hedged transactions are recognized. Upon recognition, such gains and losses are recorded in revenue as an adjustment to the carrying amount of the underlying transactions in the period in which these transactions are
recognized. Should the hedged anticipated product sales not occur within two months of the expiration of the forward foreign exchange contract, any unrealized gain or loss would be recorded in other (loss) income. There were five forward foreign
exchange contracts designated as hedges of anticipated product sales in Japanese Yen outstanding at July 1, 2005 totaling $32.7 million. There were no forward foreign exchange purchase contracts offsetting these sell contracts outstanding at July 1,
2005.



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Interest Rate Risk



Although payments under certain of Varian Semiconductors overseas borrowing facilities are tied to market indices, Varian Semiconductor is not
exposed to material interest rate risk from these borrowing facilities. Varian Semiconductor has no material cash flow exposure due to rate changes for cash equivalents and short-term investments. Varian Semiconductor maintains cash investments
primarily in commercial paper, investment-grade money market funds and municipal securities, as well as short-term time deposits with investment grade financial institutions. Cash equivalents at July 1, 2005 and October 1, 2004 were $182.5 million
and $212.8 million, respectively. At July 1, 2005 and October 1, 2004, Varian Semiconductors short-term investments were $247.1 million and $173.9 million, respectively and consisted primarily of U.S. Treasury and government agency securities,
certificates of deposit and corporate bonds with ratings of AA or better that are available-for-sale with maturities of less than five years.



Commodity Price Risk



Varian Semiconductor is not exposed to material commodity price risk.



ITEM 4. CONTROLS AND PROCEDURES



The management of Varian Semiconductor, with the participation of the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the disclosure controls and procedures of Varian Semiconductor as of July 1, 2005. The
term disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act), means controls and other procedures of a company that are designed
to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SECs rules and forms.
Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and
communicated to the companys management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no
matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the
evaluation of Varian Semiconductors disclosure controls and procedures as of July 1, 2005, the Chief Executive Officer and Chief Financial Officer concluded that, as of such date, Varian Semiconductors disclosure controls and procedures
were effective at the reasonable assurance level.



No change in
Varian Semiconductors internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended July 1, 2005 that has materially affected, or is reasonably likely to
materially affect, the internal control over financial reporting.



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PART II. OTHER INFORMATION



ITEM 1. LEGAL PROCEEDINGS



Information required by this Item is provided in Note 14. Commitments, Contingencies and Guarantees to the Unaudited Interim Consolidated Financial Statements under Part I, Item 1 and is incorporated herein by reference.



ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS



None



ITEM 3. DEFAULTS UPON SENIOR SECURITIES



None



ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



None.



ITEM 5. OTHER INFORMATION



In
connection with the expatriate assignment of Yong-Kil Kim to Korea as Varian Semiconductors Executive Vice President and General Manager, Asian Operations, Varian Semiconductor and Mr. Kim executed a VSEA Expatriate Assignment Offer Letter,
2005 effective August 2, 2005.



The offer letter provides that
Mr. Kim will receive an annual base salary of $265,000 and be eligible for, among other things, (i) an annual goods and services allowance of $10,000, (ii) a monthly foreign service allowance of $3,000, (iii) funding by Varian Semiconductor of
school tuition for Mr. Kims children, at a maximum rate of $20,000 annually per child under 19 years of age, and (iv) participation in Varian Semiconductors benefit plans. In addition, the United States federal income tax expense to Mr.
Kim from Varian Semiconductors source income will be equivalent to the United States federal income tax expense Mr. Kim would have paid had his services been performed entirely in the United States. Varian Semiconductor will pay any
incremental tax liability incurred by Mr. Kim either in the United States or in Korea.



The foregoing description of the offer letter is qualified in its entirety by reference to the actual offer letter, which is attached as Exhibit 10.1 to this Quarterly Report on Form 10-Q and is incorporated herein by
reference.



On August 3, 2005, Varian Semiconductors
Compensation Committee approved an amendment of the letter agreement dated as of October 14, 2004, between Varian Semiconductor and Gary E. Dickerson. The amendment provides that, in lieu of options to acquire 62,500 shares of Varian
Semiconductors common stock, Mr. Dickerson has been granted 19,231 shares of restricted stock on March 18, 2005, and will be granted 10,714 shares of restricted stock on August 12, 2005.



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ITEM 6. EXHIBITS



Exhibits



|     |  |                                                                                                                                                       
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------
|10.1 |  | VSEA Expatriate Assignment Offer Letter, 2005, executed by Varian Semiconductor and Yong-Kil Kim.                                                     
|     | 
|10.2 |  | Letter agreement with Gary E. Dickerson.                                                                                                              
|     | 
|31.1 |  | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                               
|     | 
|31.2 |  | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                               
|     | 
|32.1 |  | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|     | 
|32.2 |  | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.



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SIGNATURES



Pursuant to the
requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC. RegistrantBy:

/s/    ROBERT J.
HALLIDAYRobert J. HallidayExecutive Vice President, Treasurer and Chief Financial Officer (Principal Financial Officer and Duly Authorized
Officer)




Date: August 5, 2005



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