##### Table of Contents

---

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



---



FORM 10-Q



---



(Mark One)

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



For the quarterly period ended December 30, 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



---



VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.

(Exact name of Registrant as Specified in its Charter)



---



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



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



(978) 282-2000

(Registrants telephone number, including area code)



---



Indicate by
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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.
(Check one):



|                           |  |                    |  |                       
|-------------------------- |  | ------------------ |  | ----------------------
|Large accelerated filer  x |  | Accelerated filer ̈ |  | Non-accelerated filer ̈



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



Shares of common stock outstanding at February 6, 2006 : 38,268,782.



An index of exhibits filed with this Form 10-Q is located on page 33.



---



---

##### Table of Contents

VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.



INDEX



|                              |  |                                                                                                                           |  |           
|----------------------------- |  | ------------------------------------------------------------------------------------------------------------------------- |  | ----------
|Item Number                   |  |                                                                                                                           |  | PageNumber
|PART I. FINANCIAL INFORMATION |  |                                                                                                                          
|                              |  |                                                                                                                          
|Item 1.                       |  | Consolidated Financial Statements                                                                                         |  |           
|                              |  |                                                                                                                          
|                              |  | Unaudited Consolidated Balance Sheets at December 30, 2005 and September 30, 2005                                         |  | 1         
|                              |  | Unaudited Consolidated Statements of Income for the three month periods ended December 30, 2005 and December 31, 2004     |  | 2         
|                              |  | Unaudited Consolidated Statements of Cash Flows for the three month periods ended December 30, 2005 and December 31, 2004 |  | 3         
|                              |  | Notes to the Consolidated Financial Statements (Unaudited)                                                                |  | 4         
|                              |  |                                                                                                                          
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations .                                   |  | 18        
|                              |  |                                                                                                                          
|Item 3.                       |  | Quantitative and Qualitative Disclosures About Market Risk                                                                |  | 31        
|                              |  |                                                                                                                          
|Item 4.                       |  | Controls and Procedures                                                                                                   |  | 32        
|                              | 
|PART II. OTHER INFORMATION    |  |                                                                                                                          
|                              |  |                                                                                                                          
|Item 1.                       |  | Legal Proceedings                                                                                                         |  | 33        
|                              |  |                                                                                                                          
|Item 2.                       |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                               |  | 33        
|                              |  |                                                                                                                          
|Item 6.                       |  | Exhibits                                                                                                                  |  | 33        
|                              |  |                                                                                                                          
|                              |  | Signatures.                                                                                                               |  | 34        



---

##### Table of Contents

PART 1. FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS



VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.

UNAUDITED CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                                                                              |  |                                           |         |   |                    |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------- | ------- | - | ------------------ | - | ------- | -
|                                                                                                                                                                                                              |  | December 30, 2005                         |         |   | September 30, 2005 |  
|                                                                                                                                                                                                              |  | (Amounts in thousands, except share data) |        
|ASSETS                                                                                                                                                                                                        |  |                                           |         |   |                    |   |         |  
|                                                                                                                                                                                                              |  |                                          
|Current assets                                                                                                                                                                                                |  |                                           |         |   |                    |   |         |  
|Cash and cash equivalents                                                                                                                                                                                     |  | $                                         | 191,525 |   |                    | $ | 193,426 |  
|Short-term investments                                                                                                                                                                                        |  |                                           | 285,789 |   |                    |   | 280,646 |  
|Accounts receivable, net                                                                                                                                                                                      |  |                                           | 145,787 |   |                    |   | 123,612 |  
|Inventories                                                                                                                                                                                                   |  |                                           | 117,618 |   |                    |   | 127,374 |  
|Deferred income taxes                                                                                                                                                                                         |  |                                           | 31,893  |   |                    |   | 30,865  |  
|Other current assets                                                                                                                                                                                          |  |                                           | 16,440  |   |                    |   | 32,796  |  
|                                                                                                                                                                                                              |  |                                           |         |   |                    |   |         |  
|Total current assets                                                                                                                                                                                          |  |                                           | 789,052 |   |                    |   | 788,719 |  
|                                                                                                                                                                                                              |  |                                          
|Property, plant and equipment, net                                                                                                                                                                            |  |                                           | 57,235  |   |                    |   | 58,435  |  
|Goodwill                                                                                                                                                                                                      |  |                                           | 12,280  |   |                    |   | 12,280  |  
|Other assets                                                                                                                                                                                                  |  |                                           | 3,508   |   |                    |   | 3,385   |  
|                                                                                                                                                                                                              |  |                                           |         |   |                    |   |         |  
|Total assets                                                                                                                                                                                                  |  | $                                         | 862,075 |   |                    | $ | 862,819 |  
|                                                                                                                                                                                                              |  |                                           |         |   |                    |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                          |  |                                           |         |   |                    |   |         |  
|                                                                                                                                                                                                              |  |                                          
|Current liabilities                                                                                                                                                                                           |  |                                           |         |   |                    |   |         |  
|Notes payable and current portion of long-term debt                                                                                                                                                           |  | $                                         | 435     |   |                    | $ | 426     |  
|Accounts payable                                                                                                                                                                                              |  |                                           | 41,566  |   |                    |   | 33,272  |  
|Accrued expenses                                                                                                                                                                                              |  |                                           | 45,155  |   |                    |   | 59,280  |  
|Product warranty                                                                                                                                                                                              |  |                                           | 9,033   |   |                    |   | 8,585   |  
|Deferred revenue                                                                                                                                                                                              |  |                                           | 41,370  |   |                    |   | 52,118  |  
|                                                                                                                                                                                                              |  |                                           |         |   |                    |   |         |  
|Total current liabilities                                                                                                                                                                                     |  |                                           | 137,559 |   |                    |   | 153,681 |  
|                                                                                                                                                                                                              |  |                                          
|Long-term accrued expenses                                                                                                                                                                                    |  |                                           | 10,884  |   |                    |   | 10,849  |  
|Deferred income taxes                                                                                                                                                                                         |  |                                           | 5,477   |   |                    |   | 5,477   |  
|Long-term debt                                                                                                                                                                                                |  |                                           | 3,623   |   |                    |   | 3,736   |  
|                                                                                                                                                                                                              |  |                                           |         |   |                    |   |         |  
|Total liabilities                                                                                                                                                                                             |  |                                           | 157,543 |   |                    |   | 173,743 |  
|                                                                                                                                                                                                              |  |                                           |         |   |                    |   |         |  
|Commitments, contingencies and guarantees (Note 12)                                                                                                                                                           |  |                                           |         |   |                    |   |         |  
|                                                                                                                                                                                                              |  |                                          
|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; 38,098,943 shares issued and 37,568,094 shares outstanding at December 30,
2005; 38,013,838 shares issued and outstanding at September 30, 2005 |  |                                           | 381     |   |                    |   | 380     |  
|Capital in excess of par value                                                                                                                                                                                |  |                                           | 387,564 |   |                    |   | 382,445 |  
|Retained earnings                                                                                                                                                                                             |  |                                           | 338,608 |   |                    |   | 316,330 |  
|Less: Cost of 530,849 shares of common stock held in treasury at December 30, 2005                                                                                                                            |  |                                           | (20,040 | ) |                    |   |        |  
|Deferred compensation                                                                                                                                                                                         |  |                                           |        |   |                    |   | (9,366  | )
|Accumulated other comprehensive loss                                                                                                                                                                          |  |                                           | (1,981  | ) |                    |   | (713    | )
|                                                                                                                                                                                                              |  |                                           |         |   |                    |   |         |  
|Total stockholders equity                                                                                                                                                                                    |  |                                           | 704,532 |   |                    |   | 689,076 |  
|                                                                                                                                                                                                              |  |                                           |         |   |                    |   |         |  
|Total liabilities and stockholders equity                                                                                                                                                                    |  | $                                         | 862,075 |   |                    | $ | 862,819 |  
|                                                                                                                                                                                                              |  |                                           |         |   |                    |   |         |  



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



1



---

##### Table of Contents

VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF INCOME



|                                              |  |                                               |         |   |                   |   |         |  
|--------------------------------------------- |  | --------------------------------------------- | ------- | - | ----------------- | - | ------- | -
|                                              |  | Fiscal Three Months Ended                     |        
|                                              |  | December 30, 2005                             |         |   | December 31, 2004 |  
|                                              |  | (Amounts in thousands, except per share data) |        
|Revenue                                       |  |                                               |         |   |                   |   |         |  
|Product                                       |  | $                                             | 138,726 |   |                   | $ | 107,088 |  
|Service                                       |  |                                               | 20,561  |   |                   |   | 19,395  |  
|Royalty and license                           |  |                                               | 1,629   |   |                   |   | 21,942  |  
|                                              |  |                                               |         |   |                   |   |         |  
|Total revenue                                 |  |                                               | 160,916 |   |                   |   | 148,425 |  
|                                              |  |                                               |         |   |                   |   |         |  
|Cost of revenue                               |  |                                               |         |   |                   |   |         |  
|Product                                       |  |                                               | 86,599  |   |                   |   | 58,904  |  
|Service                                       |  |                                               | 10,763  |   |                   |   | 13,380  |  
|                                              |  |                                               |         |   |                   |   |         |  
|Total cost of revenue                         |  |                                               | 97,362  |   |                   |   | 72,284  |  
|                                              |  |                                               |         |   |                   |   |         |  
|Gross profit                                  |  |                                               | 63,554  |   |                   |   | 76,141  |  
|                                              |  |                                               |         |   |                   |   |         |  
|Operating expenses                            |  |                                               |         |   |                   |   |         |  
|Research and development                      |  |                                               | 21,587  |   |                   |   | 18,653  |  
|Marketing, general and administrative         |  |                                               | 28,380  |   |                   |   | 27,380  |  
|                                              |  |                                               |         |   |                   |   |         |  
|Total operating expenses                      |  |                                               | 49,967  |   |                   |   | 46,033  |  
|                                              |  |                                               |         |   |                   |   |         |  
|Operating income                              |  |                                               | 13,587  |   |                   |   | 30,108  |  
|Interest income                               |  |                                               | 5,480   |   |                   |   | 7,827   |  
|Interest expense                              |  |                                               | (49     | ) |                   |   | (222    | )
|Other (expense) income, net                   |  |                                               | (41     | ) |                   |   | 2,819   |  
|                                              |  |                                               |         |   |                   |   |         |  
|Income before income taxes                    |  |                                               | 18,977  |   |                   |   | 40,532  |  
|(Benefit from) provision for income taxes     |  |                                               | (3,301  | ) |                   |   | 12,565  |  
|                                              |  |                                               |         |   |                   |   |         |  
|Net income                                    |  | $                                             | 22,278  |   |                   | $ | 27,967  |  
|                                              |  |                                               |         |   |                   |   |         |  
|Weighted average shares outstanding - basic   |  |                                               | 37,565  |   |                   |   | 36,456  |  
|Weighted average shares outstanding - diluted |  |                                               | 38,048  |   |                   |   | 37,222  |  
|Net income per share - basic                  |  | $                                             | 0.59    |   |                   | $ | 0.77    |  
|Net income per share - diluted                |  | $                                             | 0.59    |   |                   | $ | 0.75    |  



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



2



---

##### Table of Contents

VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                                                                                                 |  |                           |         |   |                  |   |         |  
|-------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                 |  | Fiscal Three Months Ended |        
|                                                                                                                                 |  | December 30,2005          |         |   | December 31,2004 |  
|                                                                                                                                 |  | (Amounts in thousands)    |        
|Cash flows from operating activities:                                                                                            |  |                           |         |   |                  |   |         |  
|Net income                                                                                                                       |  | $                         | 22,278  |   |                  | $ | 27,967  |  
|Adjustments to reconcile net income to net cash provided by operating activities:                                                |  |                           |         |   |                  |   |         |  
|Depreciation and amortization                                                                                                    |  |                           | 3,296   |   |                  |   | 3,098   |  
|Amortization of investment premiums                                                                                              |  |                           | 277     |   |                  |   | 346     |  
|Tax benefit from stock-based compensation                                                                                        |  |                           | 2,062   |   |                  |   | 468     |  
|Deferred income taxes                                                                                                            |  |                           | (1,028  | ) |                  |   | (38     | )
|Stock-based compensation                                                                                                         |  |                           | 3,964   |   |                  |   | 2,725   |  
|Excess tax benefits from stock-based compensation                                                                                |  |                           | (1,044  | ) |                  |   |        |  
|Changes in assets and liabilities:                                                                                               |  |                           |         |   |                  |   |         |  
|Accounts receivable                                                                                                              |  |                           | (22,736 | ) |                  |   | 4,539   |  
|Inventories                                                                                                                      |  |                           | 10,240  |   |                  |   | (17,068 | )
|Other current assets                                                                                                             |  |                           | 16,356  |   |                  |   | 22,286  |  
|Accounts payable                                                                                                                 |  |                           | 8,319   |   |                  |   | 12,349  |  
|Accrued expenses                                                                                                                 |  |                           | (15,262 | ) |                  |   | (5,017  | )
|Product warranty                                                                                                                 |  |                           | 470     |   |                  |   | 196     |  
|Deferred revenue                                                                                                                 |  |                           | (10,749 | ) |                  |   | 1,564   |  
|Other                                                                                                                            |  |                           | (271    | ) |                  |   | (551    | )
|                                                                                                                                 |  |                           |         |   |                  |   |         |  
|Net cash provided by operating activities                                                                                        |  |                           | 16,172  |   |                  |   | 52,864  |  
|                                                                                                                                 |  |                           |         |   |                  |   |         |  
|Cash flows from investing activities:                                                                                            |  |                           |         |   |                  |   |         |  
|Purchase of property, plant and equipment                                                                                        |  |                           | (2,501  | ) |                  |   | (3,336  | )
|Proceeds from sales and maturities of short-term investments                                                                     |  |                           | 76,330  |   |                  |   | 6,337   |  
|Purchase of short-term investments                                                                                               |  |                           | (81,734 | ) |                  |   | (56,270 | )
|                                                                                                                                 |  |                           |         |   |                  |   |         |  
|Net cash used in investing activities                                                                                            |  |                           | (7,905  | ) |                  |   | (53,269 | )
|                                                                                                                                 |  |                           |         |   |                  |   |         |  
|Cash flows from financing activities:                                                                                            |  |                           |         |   |                  |   |         |  
|Proceeds from the issuance of common stock upon exercise of options and issuance of stock under the employee stock purchase
plan |  |                           | 8,411   |   |                  |   | 1,953   |  
|Excess tax benefits from stock-based compensation                                                                                |  |                           | 1,044   |   |                  |   |        |  
|Repurchase of common stock                                                                                                       |  |                           | (20,040 | ) |                  |   |        |  
|Repayment of long-term debt                                                                                                      |  |                           | (104    | ) |                  |   | (98     | )
|                                                                                                                                 |  |                           |         |   |                  |   |         |  
|Net cash (used in) provided by financing activities                                                                              |  |                           | (10,689 | ) |                  |   | 1,855   |  
|                                                                                                                                 |  |                           |         |   |                  |   |         |  
|Effects of exchange rates on cash                                                                                                |  |                           | 521     |   |                  |   | 586     |  
|                                                                                                                                 |  |                           |         |   |                  |   |         |  
|Net (decrease) increase in cash and cash equivalents                                                                             |  |                           | (1,901  | ) |                  |   | 2,036   |  
|Cash and cash equivalents at beginning of period                                                                                 |  |                           | 193,426 |   |                  |   | 218,578 |  
|                                                                                                                                 |  |                           |         |   |                  |   |         |  
|Cash and cash equivalents at end of period                                                                                       |  | $                         | 191,525 |   |                  | $ | 220,614 |  
|                                                                                                                                 |  |                           |         |   |                  |   |         |  



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



3



---

##### Table of Contents

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 the 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 accounting principles generally accepted 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 13, 2005 for the fiscal year ended September 30, 2005. 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 month period ended
December 30, 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. Stock-Based Compensation



Effective October 1, 2005, Varian Semiconductor adopted on a modified prospective basis
the provisions of the Financial Accounting Standards Boards (FASB) Statement of Financial Accounting Standard (SFAS) No. 123(R), Share-Based Payment, (SFAS No. 123(R)) which requires
the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee stock options, restricted stock awards and employee stock purchases related to Varian Semiconductors
Employee Stock Purchase Plan (ESPP) based on estimated fair values. Accordingly, stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized as expense over the employees
requisite service period. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB 107) relating to SFAS No. 123(R). Varian Semiconductor has applied the provisions of SAB 107 in its adoption of SFAS
No. 123(R).



Impact of the adoption of SFAS No. 123(R)



Varian Semiconductor adopted SFAS No. 123(R) using the modified
prospective transition method, which requires the application of the accounting standard as of October 1, 2005, the first day of Varian Semiconductors fiscal year 2006. Under this transition method, stock-based compensation expense
recognized during the quarter ended December 30, 2005 includes: (a) ESPP awards with the offering period commencing on July 1, 2005, based on the grant-date fair value estimated in accordance with the original provisions of SFAS
No. 123, (b) stock options and restricted stock awards granted prior to, but not yet vested as of September 30, 2005, based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. 123, and
(c) stock options and restricted stock awards granted, subsequent to September 30, 2005, based on the grant-date fair value, in accordance with the provisions of SFAS No. 123(R). Under the modified prospective transition method,
results for prior periods are not restated.



4



---

##### Table of Contents

VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



The estimated fair value of Varian Semiconductors stock-based awards, less expected forfeitures, is amortized
over the awards vesting period on a straight-line basis. The effect of recording stock-based compensation for the three month period ended December 30, 2005 was as follows:



|                                                           |  |                                                 |        |  
|---------------------------------------------------------- |  | ----------------------------------------------- | ------ | -
|                                                           |  | Fiscal Three Months EndedDecember 30, 2005      |       
|                                                           |  | (Amounts in thousands except per share amounts) |       
|Stock-based compensation expense by type of award:         |  |                                                 |        |  
|Stock options                                              |  | $                                               | 3,021  |  
|Restricted stock                                           |  |                                                 | 781    |  
|Employee Stock Purchase Plan                               |  |                                                 | 250    |  
|Less: Amounts capitalized as inventory                     |  |                                                 | (88    | )
|                                                           |  |                                                 |        |  
|Total stock-based compensation                             |  |                                                 | 3,964  |  
|Less: Tax effect on stock-based compensation               |  |                                                 | (1,189 | )
|                                                           |  |                                                 |        |  
|Net effect on income                                       |  | $                                               | 2,775  |  
|                                                           |  |                                                 |        |  
|Effect on earnings per share                               |  |                                                 |        |  
|Basic                                                      |  | $                                               | 0.07   |  
|Diluted                                                    |  | $                                               | 0.07   |  
|Effect of stock-based compensation on income by line item: |  |                                                 |        |  
|Cost of product revenue                                    |  | $                                               | 219    |  
|Cost of service revenue                                    |  |                                                 | 228    |  
|Research and development expense                           |  |                                                 | 1,019  |  
|Marketing, general and administrative expense              |  |                                                 | 2,498  |  
|Provision for income taxes                                 |  |                                                 | (1,189 | )
|                                                           |  |                                                 |        |  
|Total cost related to stock-based compensation             |  | $                                               | 2,775  |  
|                                                           |  |                                                 |        |  



Prior to the adoption of SFAS
No. 123(R)



Prior to October 1, 2005, Varian Semiconductor
accounted for its stock plans under the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (APB No. 25) and FASB Interpretation No. 44, Accounting for
Certain Transactions Involving Stock Compensation - an Interpretation of APB Opinion No. 25 (FIN No. 44) and provided the required pro forma disclosures of SFAS No. 123, Accounting for Stock-Based
Compensation as amended by SFAS No. 148, Accounting for Stock-Based Compensation -Transition and Disclosure.



5



---

##### Table of Contents

VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



The pro-forma information for the three months ended December 31, 2004 was as follows:



|                                                                                      |  |                                                  |        |  
|------------------------------------------------------------------------------------- |  | ------------------------------------------------ | ------ | -
|                                                                                      |  | Fiscal Three Months Ended December 31, 2004      |       
|                                                                                      |  | (Amounts in thousands, except per share amounts) |       
|Net income as reported                                                                |  | $                                                | 27,967 |  
|Add: Compensation expense included in net income, net of related tax benefit          |  |                                                  | 1,880  |  
|Less: Total stock-based employee compensation                                         |  |                                                  |        |  
|expense determined under fair value method for all awards, net of related tax benefit |  |                                                  | (5,111 | )
|                                                                                      |  |                                                  |        |  
|Pro forma net income                                                                  |  | $                                                | 24,736 |  
|                                                                                      |  |                                                  |        |  
|Net income per share:                                                                 |  |                                                  |        |  
|Basic, pro forma                                                                      |  | $                                                | 0.68   |  
|Basic, as reported                                                                    |  | $                                                | 0.77   |  
|                                                                                      | 
|Diluted, pro forma                                                                    |  | $                                                | 0.66   |  
|Diluted, as reported                                                                  |  | $                                                | 0.75   |  
|                                                                                      | 
|Effect of stock-based compensation on income by line item:                            |  |                                                  |        |  
|Cost of product revenue                                                               |  | $                                                |       |  
|Cost of service revenue                                                               |  |                                                  |       |  
|Research and development expense                                                      |  |                                                  |       |  
|Marketing, general and administrative expense                                         |  |                                                  | 2,725  |  
|Provision for income taxes                                                            |  |                                                  | (845   | )
|                                                                                      |  |                                                  |        |  
|Total cost related to stock-based compensation                                        |  | $                                                | 1,880  |  
|                                                                                      |  |                                                  |        |  



The $5.1 million in stock-based
compensation for the three month period ended December 31, 2004 included $2.1 million resulting from the amendment to the definition of retirement in the 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).



The fair value of Varian Semiconductors stock-based awards granted during the three month period ended December 31, 2004 was estimated using the following weighted-average assumptions:



|                                     |  |         |   |  |      |  
|------------------------------------ |  | ------- | - |  | ---- | -
|                                     |  | Options |   |  | ESPP |  
|Three months ended December 31, 2004 |  |         |   |  |      |  
|Expected life (in years)             |  | 4.0     |   |  | 0.5  |  
|Expected volatility                  |  | 69.4    | % |  | 46.5 | %
|Risk-free interest rate              |  | 3.3     | % |  | 1.6  | %
|Expected dividend yield              |  | 0.0     | % |  | 0.0  | %



Omnibus Stock Plan



The Amended and Restated Omnibus Stock Plan (the Plan) provides for the grant
of non-qualified share-based awards to eligible employees, consultants and non-employee directors of Varian Semiconductor. As of December 30, 2005, there were a total of 1,377,007 shares reserved for future issuance under the Plan.



6



---

##### Table of Contents

VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



Stock Options



Share-based awards granted under the plan vest over a period determined by the Compensation Committee of the Board of Directors. Options granted prior to
November 8, 2002 have a life no longer than ten years after the date of grant. Options granted on or after November 8, 2002 have a life no longer than seven years after the date of the grant. Options granted before October 15, 2004
generally vested as to 33% one year from the grant date, and the remaining 67% vest in eight equal quarterly installments so that all options are vested at the end of three years. Options granted after October 15, 2004 generally vest as to 25%
one year from date of grant, and the remaining 75% vest in twelve equal quarterly installments so that all options are vested at the end of four years.



The fair value of the Varian Semiconductors stock options issued prior to the adoption of SFAS No. 123(R) was estimated using a Black-Scholes option valuation
model. This model requires the input of subjective assumptions, including expected stock price volatility and the estimated life of each award. The fair value of these stock options was estimated assuming no expected dividends and estimates of
expected life, volatility and risk-free interest rate at the time of grant. Prior to the adoption of SFAS No. 123(R), Varian Semiconductor used historical volatility as a basis for calculating expected volatility.



The following table summarizes the stock option activity as
of and for the fiscal quarter ended December 30, 2005:



|                                  |  |           |   |  |                                 |       |                                             |     |                           |   |       
|--------------------------------- |  | --------- | - |  | ------------------------------- | ----- | ------------------------------------------- | --- | ------------------------- | - | ------
|                                  |  | Shares    |   |  | Weighted-Average Exercise Price |       | Weighted-Average Remaining Contractual Term |     | Aggregate Intrinsic Value
|                                  |  |           |   |  |                                 |       | (In years)                                  |     | (In thousands)           
|Outstanding at September 30, 2005 |  | 4,411,524 |   |  | $                               | 33.19 |                                             |     |                           |   |       
|Granted                           |  |          |   |  |                                 |      |                                             |     |                           |   |       
|Exercised                         |  | (276,642  | ) |  |                                 | 24.32 |                                             |     |                           |   |       
|Forfeited/expired/cancelled       |  | (26,452   | ) |  |                                 | 46.17 |                                             |     |                           |   |       
|                                  |  |           |   |  |                                 |       |                                             |     |                           |   |       
|Outstanding at December 30, 2005  |  | 4,108,430 |   |  | $                               | 33.74 |                                             | 5.4 |                           | $ | 45,925
|                                  |  |           |   |  |                                 |       |                                             |     |                           |   |       
|Exercisable at December 30, 2005  |  | 2,529,492 |   |  | $                               | 33.08 |                                             | 4.9 |                           | $ | 31,510
|                                  |  |           |   |  |                                 |       |                                             |     |                           |   |       



As of December 30, 2005, the
unrecognized compensation cost related to non-vested stock options was $22.6 million. This unrecognized balance will be recognized over an estimated weighted average amortization period of 2.4 years.



The total intrinsic value of options exercised during the quarter ended December 30,
2005 was $5.7 million, with intrinsic value defined as the difference between the market price on the date of exercise and the grant date price.



7



---

##### Table of Contents

VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



The following table summarizes significant ranges of outstanding and exercisable options as of December 30,
2005:



|                         |  |                     |  |                                            |  |                                |       |                           |   |                               |  |                                 |  |                           |       |  |   |       
|------------------------ |  | ------------------- |  | ------------------------------------------ |  | ------------------------------ | ----- | ------------------------- | - | ----------------------------- |  | ------------------------------- |  | ------------------------- | ----- |  | - | ------
|                         |  | Options Outstanding |  | Options Exercisable                       
|Range of Exercise Prices |  | NumberOutstanding   |  | Weighted Average Remaining ContractualLife |  | Weighted Average ExercisePrice |       | Aggregate Intrinsic Value |   | Number Vested and Exercisable |  | Weighted Average Exercise Price |  | Aggregate Intrinsic Value
|$9.85-$20.50             |  | 452,946             |  | 3.5                                        |  | $                              | 15.87 |                           | $ | 12,710                        |  | 452,946                         |  | $                         | 15.87 |  | $ | 12,710
|$20.87-$30.00            |  | 857,207             |  | 5.1                                        |  | $                              | 26.37 |                           | $ | 15,056                        |  | 720,075                         |  | $                         | 26.41 |  | $ | 12,617
|$30.56-$35.19            |  | 935,063             |  | 5.4                                        |  | $                              | 33.93 |                           | $ | 9,351                         |  | 398,823                         |  | $                         | 33.64 |  | $ | 4,105 
|$35.31-$43.92            |  | 1,272,499           |  | 6.6                                        |  | $                              | 37.01 |                           | $ | 8,808                         |  | 373,930                         |  | $                         | 38.37 |  | $ | 2,078 
|$44.00-$69.00            |  | 590,715             |  | 4.8                                        |  | $                              | 50.81 |                           |   |                              |  | 583,718                         |  | $                         | 50.89 |  |   |      
|                         |  |                     |  |                                            |  |                                |       |                           |   |                               |  |                                 |  |                           |       |  |   |       
|                         |  | 4,108,430           |  | 5.4                                        |  | $                              | 33.74 |                           | $ | 45,925                        |  | 2,529,492                       |  | $                         | 33.08 |  | $ | 31,510
|                         |  |                     |  |                                            |  |                                |       |                           |   |                               |  |                                 |  |                           |       |  |   |       



The aggregate intrinsic value in the
preceding table represents the total intrinsic value, based on Varian Semiconductors closing stock price of $43.93 as of December 30, 2005, that would have been received by the option holders had all option holders exercised their options
as of that date. The total number of in-the-money options exercisable as of December 30, 2005 was 1.9 million.



Restricted Stock



Varian Semiconductor issues restricted common stock at $0.01 per share and generally 25% vests one year from the date of grant and the remaining 75% vests in twelve equal quarterly installments. Stock compensation
expense associated with restricted common stock is charged for the difference between the market value on the date of grant and the issuance price, less estimated forfeitures, and is amortized over the awards vesting period on a straight-line
basis.



The following table summarizes the restricted common stock activity as
of and for the fiscal quarter ended December 30, 2005:



|                                |  |         |   |  |                                        |      
|------------------------------- |  | ------- | - |  | -------------------------------------- | -----
|                                |  | Shares  |   |  | Weighted-Average Grant Date Fair Value
|Nonvested at September 30, 2005 |  | 257,911 |   |  | $                                      | 39.45
|Granted                         |  | 56,137  |   |  |                                        | 42.55
|Vested                          |  | (11,850 | ) |  |                                        | 32.94
|Forfeited/expired/cancelled     |  | (286    | ) |  |                                        | 42.99
|                                |  |         |   |  |                                        |      
|Nonvested at December 30, 2005  |  | 301,912 |   |  | $                                      | 40.28
|                                |  |         |   |  |                                        |      



As of September 30, 2005, Varian
Semiconductor had unrecognized compensation cost related to non-vested restricted stock of $9.4 million before estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised in subsequent periods if
actual forfeitures differ from those estimates. Varian Semiconductor applied the estimated forfeiture rate to the previously recorded stock compensation expense on unvested restricted stock and determined that the cumulative effect of a change in
accounting principle was immaterial.



As of December 30, 2005, the
unrecognized compensation cost related to non-vested restricted stock was $10.9 million. This unrecognized balance will be recognized over an estimated weighted average amortization period of 3.5 years.



Employee Stock Purchase Plan



Employees of Varian Semiconductor who elect to participate in the ESPP are able to purchase
common stock at the lower of 85% of the fair market value of Varian Semiconductors common stock on the first or last day of the applicable offering period. Typically, each offering period lasts six months. As of December 30, 2005, there
were a total of 400,000 shares of common stock reserved for issuance under the ESPP, of which 328,180 shares have been issued through December 30, 2005.



8



---

##### Table of Contents

VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



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 unvested restricted stock. Options to purchase common shares with exercise prices that
exceeded the market value of the underlying common stock are excluded from the computation of diluted earnings per share. For purposes of the diluted net income per share calculation, the additional shares issuable upon exercise of stock options are
determined using the treasury stock method which, as required by SFAS 123(R), includes as assumed proceeds share-based compensation expense and the tax effect of such compensation.



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



|                                             |  |                                              |        |                  |   |       
|-------------------------------------------- |  | -------------------------------------------- | ------ | ---------------- | - | ------
|                                             |  | Fiscal Three Months Ended                   
|                                             |  | December 30,2005                             |        | December 31,2004
|                                             |  | (Amounts in thousands,except per share data)
|Numerator:                                   |  |                                              |        |                  |   |       
|Net income                                   |  | $                                            | 22,278 |                  | $ | 27,967
|                                             |  |                                              |        |                  |   |       
|Denominator:                                 |  |                                              |        |                  |   |       
|Denominator for basic net income per share:  |  |                                              |        |                  |   |       
|Weighted average shares outstanding          |  |                                              | 37,565 |                  |   | 36,456
|Effect of dilutive securities:               |  |                                              |        |                  |   |       
|Stock options and restricted stock           |  |                                              | 483    |                  |   | 766   
|                                             |  |                                              |        |                  |   |       
|Denominator for diluted net income per share |  |                                              | 38,048 |                  |   | 37,222
|                                             |  |                                              |        |                  |   |       
|Net income per share - basic                 |  | $                                            | 0.59   |                  | $ | 0.77  
|Net income per share - diluted               |  | $                                            | 0.59   |                  | $ | 0.75  



For the three month periods ended
December 30, 2005 and December 31, 2004, 1.8 million and 1.1 million potentially dilutive shares, respectively, were excluded from the computation of diluted earnings per share.



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 date of purchase to be cash and cash equivalents. The carrying amounts of cash and cash equivalents approximate estimated fair value because of the short-term maturities of those
financial instruments. Cash equivalents at December 30, 2005 and September 30, 2005 were $172.7 million and $182.1 million, respectively.



Short-term investments consist primarily of certificates of deposit and corporate bonds with ratings AA or better. All short-term investments have been classified as
available-for-sale and are carried at fair market value, which approximates cost, due to the short period of time to maturity and the relative risk of the investments. Varian Semiconductor has the intent and ability, if necessary, to liquidate any
of its investments in order to meet its liquidity needs for 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 December 30, 2005, a net unrealized loss on short-term investments of $2.1 million
was recorded as accumulated other comprehensive loss. As of September 30, 2005, a net unrealized loss on short-term investments of $1.9 million was recorded as accumulated other comprehensive loss.



9



---

##### Table of Contents

VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



Short-term investments by security type at December 30, 2005 were as follows:



|                                    |  |      |         |                        |   |                       |  |   |                     |   |  |   |        
|----------------------------------- |  | ---- | ------- | ---------------------- | - | --------------------- |  | - | ------------------- | - |  | - | -------
|                                    |  | Cost |         | GrossUnrealizedGains   |   | GrossUnrealizedLosses |  |   | EstimatedFair Value
|                                    |  |      |         | (Amounts in thousands) |   |                       | 
|Bank certificates of deposit        |  | $    | 24,545  |                        | $ |                      |  | $ |                    |   |  | $ | 24,545 
|U.S. Treasury and agency securities |  |      | 124,409 |                        |   | 186                   |  |   | (1,528              | ) |  |   | 123,067
|Corporate bonds                     |  |      | 138,909 |                        |   | 127                   |  |   | (859                | ) |  |   | 138,177
|                                    |  |      |         |                        |   |                       |  |   |                     |   |  |   |        
|                                    |  | $    | 287,863 |                        | $ | 313                   |  | $ | (2,387              | ) |  | $ | 285,789
|                                    |  |      |         |                        |   |                       |  |   |                     |   |  |   |        



Short-term investments by security
type at September 30, 2005 were as follows:



|                                    |  |                        |         |                      |   |                       |  |   |                     |   |  |   |        
|----------------------------------- |  | ---------------------- | ------- | -------------------- | - | --------------------- |  | - | ------------------- | - |  | - | -------
|                                    |  | Cost                   |         | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | EstimatedFair Value
|                                    |  | (Amounts in thousands)
|Bank certificates of deposit        |  | $                      | 24,343  |                      | $ |                      |  | $ |                    |   |  | $ | 24,343 
|U.S. Treasury and agency securities |  |                        | 132,174 |                      |   | 1,651                 |  |   | (2,963              | ) |  |   | 130,862
|Corporate bonds                     |  |                        | 126,056 |                      |   | 127                   |  |   | (742                | ) |  |   | 125,441
|                                    |  |                        |         |                      |   |                       |  |   |                     |   |  |   |        
|                                    |  | $                      | 282,573 |                      | $ | 1,778                 |  | $ | (3,705              | ) |  | $ | 280,646
|                                    |  |                        |         |                      |   |                       |  |   |                     |   |  |   |        



The short-term investment maturities
are as follows:



|                                    |  |                        |         |                   |   |        
|----------------------------------- |  | ---------------------- | ------- | ----------------- | - | -------
|                                    |  | December 30,2005       |         | September 30,2005
|                                    |  | (Amounts in thousands)
|Maturing within 1 year              |  | $                      | 167,769 |                   | $ | 163,228
|Maturing between 1 year and 5 years |  |                        | 118,020 |                   |   | 117,418
|                                    |  |                        |         |                   |   |        
|Total                               |  | $                      | 285,789 |                   | $ | 280,646
|                                    |  |                        |         |                   |   |        



Note 5. Accounts Receivable



Accounts receivable consist of the following:



|                                |  |                        |         |   |                   |   |         |  
|------------------------------- |  | ---------------------- | ------- | - | ----------------- | - | ------- | -
|                                |  | December 30,2005       |         |   | September 30,2005 |  
|                                |  | (Amounts in thousands) |        
|Billed receivables              |  | $                      | 146,691 |   |                   | $ | 124,504 |  
|Allowance for doubtful accounts |  |                        | (904    | ) |                   |   | (892    | )
|                                |  |                        |         |   |                   |   |         |  
|Accounts receivable, net        |  | $                      | 145,787 |   |                   | $ | 123,612 |  
|                                |  |                        |         |   |                   |   |         |  



Substantially all of Varian
Semiconductors accounts receivable balance relates to trade receivables. Trade accounts receivable are recorded at the invoiced amounts and do not bear interest.



10



---

##### Table of Contents

VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



Note 6. Inventories



The components of inventories are as follows:



|                        |  |                        |         |                   |   |        
|----------------------- |  | ---------------------- | ------- | ----------------- | - | -------
|                        |  | December 30,2005       |         | September 30,2005
|                        |  | (Amounts in thousands)
|Raw materials and parts |  | $                      | 55,285  |                   | $ | 55,789 
|Work in process         |  |                        | 29,232  |                   |   | 21,102 
|Finished goods          |  |                        | 33,101  |                   |   | 50,483 
|                        |  |                        |         |                   |   |        
|Total inventories       |  | $                      | 117,618 |                   | $ | 127,374
|                        |  |                        |         |                   |   |        



Note 7. Accrued Expenses



The components of accrued expenses are
as follows:



|                               |  |                        |        |                   |   |       
|------------------------------ |  | ---------------------- | ------ | ----------------- | - | ------
|                               |  | December 30,2005       |        | September 30,2005
|                               |  | (Amounts in thousands)
|Income taxes payable           |  | $                      | 9,171  |                   | $ | 19,300
|Accrued incentive compensation |  |                        | 5,414  |                   |   | 12,519
|Accrued employee benefits      |  |                        | 9,205  |                   |   | 8,975 
|Accrued payroll                |  |                        | 5,851  |                   |   | 4,323 
|Accrued retirement benefits    |  |                        | 7,363  |                   |   | 5,890 
|Estimated loss contingencies   |  |                        | 2,839  |                   |   | 2,899 
|Restructuring                  |  |                        |       |                   |   | 208   
|Other                          |  |                        | 5,312  |                   |   | 5,166 
|                               |  |                        |        |                   |   |       
|Total accrued expenses         |  | $                      | 45,155 |                   | $ | 59,280
|                               |  |                        |        |                   |   |       



Note 8. 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 twenty-four 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 90 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.



11



---

##### Table of Contents

VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



Product warranty activity for the first three months of fiscal year 2006 was as follows:



|                                                 |  |                            |        |  
|------------------------------------------------ |  | -------------------------- | ------ | -
|                                                 |  | Product Warranty Liability |       
|                                                 |  | (Amounts in thousands)     |       
|Balance as of September 30, 2005                 |  | $                          | 8,585  |  
|Accruals for warranties issued during the period |  |                            | 3,259  |  
|Increase to pre-existing warranties              |  |                            | 3      |  
|Fulfillments during the period                   |  |                            | (2,814 | )
|                                                 |  |                            |        |  
|Balance as of December 30, 2005                  |  | $                          | 9,033  |  
|                                                 |  |                            |        |  



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



|                                                 |  |                           |        |  
|------------------------------------------------ |  | ------------------------- | ------ | -
|                                                 |  | Product WarrantyLiability |       
|                                                 |  | (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    |  
|Fulfillments made during the period              |  |                           | (2,077 | )
|                                                 |  |                           |        |  
|Balance as of December 31, 2004                  |  | $                         | 8,090  |  
|                                                 |  |                           |        |  



Note 9. Deferred Revenue



The components of deferred revenue are
as follows:



|                                                            |  |                        |        |                   |   |       
|----------------------------------------------------------- |  | ---------------------- | ------ | ----------------- | - | ------
|                                                            |  | December 30,2005       |        | September 30,2005
|                                                            |  | (Amounts in thousands)
|Fully deferred systems, installation and acceptance revenue |  | $                      | 23,366 |                   | $ | 31,752
|Extended warranties                                         |  |                        | 10,845 |                   |   | 10,509
|Maintenance and service contracts                           |  |                        | 6,113  |                   |   | 8,488 
|Other deferred revenue                                      |  |                        | 1,046  |                   |   | 1,369 
|                                                            |  |                        |        |                   |   |       
|Total deferred revenue                                      |  | $                      | 41,370 |                   | $ | 52,118
|                                                            |  |                        |        |                   |   |       



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.



Note 11. Retirement Plans



On October 5, 2004, Varian Semiconductors Board of Directors amended the definition of retirement for purposes of Varian Semiconductors Omnibus Stock
Plan. On December 8, 2004, Varian Semiconductor entered into a Retirement Agreement and General Release with the then-President and Chief Operating Officer of Varian Semiconductor, who retired effective as of December 31, 2004. As a
result, approximately $3.5 million was expensed in the first quarter of fiscal 2005, of which $2.5 million was a non-cash charge.



12



---

##### Table of Contents

VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



Note 12. 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.



Varian Semiconductor has indemnification agreements with its officers and
directors and certain of its customers. 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 December 30, 2005.



Varian Semiconductor enters into purchase order commitments in the normal course of business. As of December 30, 2005, Varian Semiconductor has approximately $46.0
million of purchase order commitments with various vendors.



Environmental
Remediation



Pursuant to the agreements entered into when Varian
Semiconductor, Varian Medical Systems, Inc. (VMS) and Varian Inc. (VI) spun off from Varian Associates, Inc. (VAI) in 1999, Varian Semiconductor, VMS and VI indemnify each other for one-third of environmental
investigation and remediation costs at certain sites, as adjusted for any insurance proceeds and tax benefits expected to be realized upon payment of these costs. These sites consist of locations where VAI is alleged to have shipped manufacturing
waste for recycling or disposal and current or former VAI facilities. For certain of these sites and facilities, various uncertainties make it difficult to assess the likelihood and scope of further investigation or remediation activities or to
estimate the future costs of such activities if undertaken. Varian Semiconductor has accrued $1.3 million in estimated environmental investigation and remediation costs for these sites and facilities as of December 30, 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 $4.4 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 December 30, 2005, Varian Semiconductors environmental liability, based upon future environmental-related costs estimated by VMS, the surviving entity
from the 1999 VAI spin off, as of that date and included in current and long-term accrued expenses, totaled $5.7 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. 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.



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 December 30, 2005.



Legal
Proceedings



In the first quarter of fiscal year 2005, Varian
Semiconductor settled a lawsuit against and recorded a payment from Applied Materials, Inc. (Applied Materials) for past due royalties of $18.9 million and interest of $5.7 million.



Varian Semiconductor had maintained a provision of $2.7 million in current liabilities to
cover any residual indemnification obligations related to a separate lawsuit with Applied Materials. The statute of limitations on the indemnification obligations expired during the first quarter of fiscal year 2005, and Varian Semiconductor
believed it had no further liability with respect to the settlement. As a result, the remaining estimated loss contingency was reversed during the first quarter of fiscal year 2005, and was included as a component of other income, net, for the first
quarter of fiscal year 2005.



13



---

##### Table of Contents

VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



Varian Semiconductor has agreed to indemnify VMS and VI for any costs, liabilities or expenses relating to Varian
Semiconductors legal proceedings. Under the distribution related agreements, Varian Semiconductor has agreed to reimburse VMS for one-third of the costs, liabilities, and expenses, adjusted for any related tax benefits recognized or realized
by VMS, with respect to certain legal proceedings relating to discontinued operations of VMS. Varian Semiconductor 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 would 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 13. 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. Prior to any restructuring announcements, the restructuring is approved by the appropriate level of management necessary to commit to the specific actions of the reduction in force.



During fiscal year 2005, Varian Semiconductor recognized approximately $0.9 million in
restructuring costs. The restructuring costs related to reductions in headcount and facilities in Europe. The restructuring reserve balance of $0.2 million as of September 30, 2005, was paid during the first quarter of fiscal year 2006.



Below is a table summarizing the restructuring reserve activity in the first
three months of fiscal year 2006:



|                                 |  |                         |      |  
|-------------------------------- |  | ----------------------- | ---- | -
|                                 |  | Reduction in Work Force |     
|                                 |  | (Amounts in thousands)  |     
|Balance as of September 30, 2005 |  | $                       | 208  |  
|Reversal of charges              |  |                         | (15  | )
|Cash payments                    |  |                         | (193 | )
|                                 |  |                         |      |  
|Balance as of December 30, 2005  |  | $                       |     |  
|                                 |  |                         |      |  



Note 14. 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 has a policy of hedging its balance sheet 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



14



---

##### Table of Contents

VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



accumulated in other comprehensive income (OCI). Any measured ineffectiveness is included immediately in other income and expense in the
consolidated statements of income. There has been no amount of ineffectiveness recognized during the three month period ended December 30, 2005. OCI associated with hedges of sales denominated in foreign currencies is reclassified to revenue
upon recognition in income of the underlying hedged exposure.



The following
table summarizes OCI activity associated with hedges of foreign currency denominated sales during the first three months of fiscal year 2006:



|                                                   |  |                        |        |  
|-------------------------------------------------- |  | ---------------------- | ------ | -
|                                                   |  | Amount of Income       |       
|                                                   |  | (Amounts in thousands) |       
|Balance as of September 30, 2005                   |  | $                      | 1,214  |  
|Effective portion of cash flow hedging instruments |  |                        | 916    |  
|Reclassified to revenue                            |  |                        | (2,037 | )
|                                                   |  |                        |        |  
|Balance as of December 30, 2005                    |  | $                      | 93     |  
|                                                   |  |                        |        |  



Note 15. Comprehensive Income



The following table reconciles net income to comprehensive income for the
first three months of fiscal years 2006 and 2005:



|                                                   |  |                           |        |   |                  |   |        |  
|-------------------------------------------------- |  | ------------------------- | ------ | - | ---------------- | - | ------ | -
|                                                   |  | Fiscal Three Months Ended |       
|                                                   |  | December 30,2005          |        |   | December 31,2004 |  
|                                                   |  | (Amounts in thousands)    |       
|Net income                                         |  | $                         | 22,278 |   |                  | $ | 27,967 |  
|Other comprehensive loss:                          |  |                           |        |   |                  |   |        |  
|Effective portion of cash flow hedging instruments |  |                           | (1,121 | ) |                  |   | (134   | )
|Unrealized loss on short-term investments          |  |                           | (147   | ) |                  |   | (733   | )
|                                                   |  |                           |        |   |                  |   |        |  
|Comprehensive income                               |  | $                         | 21,010 |   |                  | $ | 27,100 |  
|                                                   |  |                           |        |   |                  |   |        |  



Note 16. Share Repurchase Program



In October 2004, Varian Semiconductor announced that its Board of
Directors had authorized the repurchase of up to 3.5 million shares of Varian Semiconductors common stock on the open market. The first purchases under this plan were made during the first quarter of fiscal year 2006. Varian Semiconductor
plans to continue to execute authorized repurchases. Share repurchases under this authorization during the first quarter of fiscal year 2006 were as follows:



|                                             |  |                           |         |                  |  
|-------------------------------------------- |  | ------------------------- | ------- | ---------------- | -
|                                             |  | Fiscal Three Months Ended
|                                             |  | December 30,2005          |         | December 31,2004
|                                             |  | (Dollars in thousands)   
|Number of shares of common stock repurchased |  |                           | 530,849 |                  | 
|Total cost of repurchase                     |  | $                         | 20,040  |                  | 



Note 17. 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 SFAS
No. 131, Disclosures about Segments of an Enterprise and Related Information, can be found in the consolidated financial statements.



15



---

##### Table of Contents

VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



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. In the first quarter of fiscal year 2006, revenue from three customers accounted for 14%, 14% and 13%, respectively, of Varian Semiconductors total revenue. In the first quarter of
fiscal year 2005, revenue from three customers, including the non-recurring royalty revenue of $18.9 million received from Applied Materials, accounted for 14%, 12% and 11% of Varian Semiconductors total revenue.



As of December 30, 2005, two customers represented 21% and 10%, respectively, of the
total accounts receivable balance. As of September 30, 2005, two customers accounted for 16% and 9% of the total accounts receivable balance.



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



|                                          |  |                        |        |        |   |        |  |        |        |       |   |        |  |              |        |  |   |        |  |   |        
|----------------------------------------- |  | ---------------------- | ------ | ------ | - | ------ |  | ------ | ------ | ----- | - | ------ |  | ------------ | ------ |  | - | ------ |  | - | -------
|                                          |  | NorthAmerica           |        | Europe |   | Japan  |  | Taiwan |        | Korea |   | Other  |  | Consolidated
|                                          |  | (Amounts in thousands)
|Revenue - Three months ended:             |  |                        |        |        |   |        |  |        |        |       |   |        |  |              |        |  |   |        |  |   |        
|December 30, 2005                         |  | $                      | 30,492 |        | $ | 16,787 |  | $      | 28,394 |       | $ | 24,501 |  | $            | 47,012 |  | $ | 13,730 |  | $ | 160,916
|December 31, 2004                         |  |                        | 57,432 |        |   | 16,195 |  |        | 10,922 |       |   | 18,326 |  |              | 33,413 |  |   | 12,137 |  |   | 148,425
|                                          |  |                        |        |        |   |        | 
|Property, plant and equipment, net as of: |  |                        |        |        |   |        |  |        |        |       |   |        |  |              |        |  |   |        |  |   |        
|December 30, 2005                         |  | $                      | 51,543 |        | $ | 300    |  | $      | 426    |       | $ | 405    |  | $            | 4,204  |  | $ | 357    |  | $ | 57,235 
|September 30, 2005                        |  |                        | 52,704 |        |   | 323    |  |        | 470    |       |   | 424    |  |              | 4,175  |  |   | 339    |  |   | 58,435 



The $18.9 million in non-recurring
royalty revenue received from Applied Materials in the first three months of fiscal year 2005 is included in the North America revenue in the table above.



Note 18. Income Tax Benefit



In the normal course of business, Varian Semiconductor and its subsidiaries are examined by various tax authorities, including the U.S. Internal Revenue Service
(IRS). The IRS conducted an examination for the tax years 1999 through 2003 as part of its routine examinations of Varian Semiconductors income tax returns. The IRS completed fieldwork for this examination of Varian Semiconductor
in the fourth quarter of fiscal year 2005 and submitted its report to the Joint Committee for final approval. Varian Semiconductor was notified of Joint Committee approval in the first quarter of fiscal year 2006. In the first quarter of fiscal year
2006, Varian Semiconductor recognized an income tax benefit of $9.0 million related to the favorable conclusion of this multi-year examination. Additionally, Varian Semiconductor reduced other current assets by $8.0 million upon the receipt of an
$8.0 million refund from the IRS. Included in interest income is $1.3 million of interest income related to the final resolution of the audit.



Note 19. Recent Accounting Pronouncements



In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections. This statement replaces APB Opinion No. 20, Accounting
Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and reporting of a change in accounting principle. This statement applies to all voluntary
changes in accounting principles. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition
provisions, those provisions should be followed. SFAS No. 154 requires retrospective application to prior periods financial statements of voluntary changes in accounting principles. SFAS No. 154 is effective for accounting changes and
corrections of errors made during Varian Semiconductors fiscal year 2007, beginning on September 30, 2006. Varian Semiconductor does not believe the adoption of SFAS No. 154 will have a material impact on its financial statements.



Note 20. Subsequent Events



On February 1, 2006, Varian Semiconductor announced that its Board of Directors
approved a three-for-two split of common stock to be effected in the form of a stock dividend. This split will be effective February 28, 2006 for shareholders of record on February 13, 2006. Cash will be paid in lieu of fractional shares.



The pro forma effect on the December 30, 2005 balance sheet is
approximately a $190 thousand reclassification from capital in excess of par to common stock. Common shares outstanding, giving retroactive effect to the stock split at December 30, 2005 and September 30, 2005, would have been
56.4 million and 57.0 million shares, respectively.



16



---

##### Table of Contents

VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



Pro forma earnings per share, giving retroactive effect to the stock split, were as
follows:



|                                                           |  |                           |      |                  |   |     
|---------------------------------------------------------- |  | ------------------------- | ---- | ---------------- | - | ----
|                                                           |  | Fiscal Three Months Ended
|                                                           |  | December 30,2005          |      | December 31,2004
|Basic earnings per share - as reported (pre-stock split)   |  | $                         | 0.59 |                  | $ | 0.77
|Basic earnings per share - pro forma (post-stock split)    |  |                           | 0.40 |                  |   | 0.51
|                                                           |  |                          
|Diluted earnings per share - as reported (pre-stock split) |  |                           | 0.59 |                  |   | 0.75
|Diluted earnings per share - pro forma (post-stock split)  |  |                           | 0.39 |                  |   | 0.50



17



---

##### Table of Contents

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 September 30, 2005, filed with the Securities and Exchange Commission (SEC) on December 13, 2005.



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 September 30, 2005, filed with the SEC on December 13,
2005.



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 world. Varian Semiconductors
VIIStaTMion implanter products are designed to leverage single wafer processing technology for the full range of
semiconductor implant applications. Varian Semiconductor has shipped over 3,400 systems worldwide.



Varian Semiconductor provides support, training, and after-market products and services that help its customers obtain high utilization and productivity, reduce operating costs, and extend capital productivity of
investments through multiple product generations. In fiscal year 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 years 2001 and
2002, 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. Demand for semiconductor industry products continued and Varian Semiconductors fiscal
year 2004 revenue increased 46% over fiscal year 2003. For fiscal year 2005, Varian Semiconductors revenue increased 13% over fiscal year 2004 as customers migrated to single wafer systems, which favor Varian Semiconductors product
offerings.



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 accounting principles generally accepted in the United States
(U.S.) (GAAP). 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 disclosures 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,
deferred revenue, post-retirement benefits, contingencies, and foreign 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 geographic and macroeconomic 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 in the section titled Risk Factors.



18



---

##### Table of Contents

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,
upgrades 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 system installation services. Revenue related to maintenance and service contracts is recognized ratably over the duration of the contracts. Extended warranty revenue is deferred 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.



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 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.



Allowance for Doubtful Accounts



Varian
Semiconductor maintains allowances for doubtful accounts for estimated losses resulting from the inability 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 number of days the balance is past



19



---

##### Table of Contents

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.



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 the commitments exceeds expected production demand. These assumptions include, but are not limited to, future manufacturing schedules, customer demand, supplier lead time and
technological and market obsolescence. 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 inventory previously written down is subsequently sold, gross profit would improve by the amount of the specific
write-down reversed in the period 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 period the excess purchase
order commitments are reduced.



Varian Semiconductor occasionally supplies
evaluation tools to potential new customers, usually for a period of three months to one year. While the tool is at the customers semiconductor manufacturing factory (fab), Varian Semiconductor and the customer work closely
together through complex processes to qualify the tool for that particular customers requirements. These qualification costs are included in marketing, general and administrative expenses in the period incurred. During the evaluation period,
Varian Semiconductor generally reduces the carrying value of the evaluation tool ratably over a period of four years. This cost is recorded as a component of marketing, general and administrative expenses. Customer evaluations are normally
successful and upon receipt of the customer purchase order and when all four revenue recognition criteria are met, Varian Semiconductor recognizes the revenue from the evaluation tool and remaining tool cost through cost of product revenue.



Valuation Allowance on Deferred Tax Assets and Income Tax Provision



The Financial Accounting Standards Board (FASB) Statement of
Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes, 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 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 in the statement of income in the period in which such determination
was made. It is 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 U.S. Internal Revenue Service (IRS). The IRS conducted an examination for the tax years 1999 through 2003 as
part of its routine examinations of Varian Semiconductors income tax returns. Fieldwork for the examination was completed in the fourth quarter of fiscal year 2005 and submitted to the Congressional Joint Committee on Taxation (Joint
Committee) for final approval. Varian Semiconductor was notified of Joint Committee approval in the first quarter of fiscal year 2006. In the first quarter of fiscal year 2006, Varian Semiconductor recognized an income tax benefit of $9.0
million related to the favorable conclusion of this multi-year examination by the IRS. In addition, the company recorded $1.3 million of interest income related to various income tax refunds that were released by the IRS at the conclusion of this
examination.



20



---

##### Table of Contents

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 incurred in correcting a product failure 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 future costs, the lower limit of an estimated range is accrued on a non-discounted basis. All other liabilities, where Varian
Semiconductor has generally sufficient knowledge to estimate the scope of costs and future activities, are accrued on a discounted basis. Should new information become available and/or different assumptions are applied in the estimation of
environmental liabilities, revisions to the accrued environmental liability would be required.



Results of Operations



Revenue



The following table sets forth revenue by category for the three month
periods ended December 30, 2005 and December 31, 2004:



|                      |  |                           |         |                   |   |         |  |   |                |   |  |       |  
|--------------------- |  | ------------------------- | ------- | ----------------- | - | ------- |  | - | -------------- | - |  | ----- | -
|                      |  | Fiscal Three Months Ended |        
|                      |  | December 30, 2005         |         | December 31, 2004 |   | Change  |  |   | Percent Change |  
|                      |  |                           |        
|                      |  | (Amounts in thousands)    |        
|Revenue               |  |                           |         |                   |   |         |  |   |                |   |  |       |  
|Product               |  | $                         | 138,726 |                   | $ | 107,088 |  | $ | 31,638         |   |  | 29.5  | %
|Service               |  |                           | 20,561  |                   |   | 19,395  |  |   | 1,166          |   |  | 6.0   | %
|Royalty and license   |  |                           | 1,629   |                   |   | 21,942  |  |   | (20,313        | ) |  | -92.6 | %
|                      |  |                           |         |                   |   |         |  |   |                |   |  |       |  
|Revenue               |  | $                         | 160,916 |                   | $ | 148,425 |  | $ | 12,491         |   |  | 8.4   | %
|                      |  |                           |         |                   |   |         |  |   |                |   |  |       |  
|Revenue by territory: |  |                           |         |                   |   |         |  |   |                |   |  |       |  
|Asia Pacific          |  | $                         | 113,637 |                   | $ | 74,798  |  | $ | 38,839         |   |  | 51.9  | %
|North America*        |  |                           | 30,492  |                   |   | 57,432  |  |   | (26,940        | ) |  | -46.9 | %
|Europe                |  |                           | 16,787  |                   |   | 16,195  |  |   | 592            |   |  | 3.7   | %
|                      |  |                           |         |                   |   |         |  |   |                |   |  |       |  
|Revenue               |  | $                         | 160,916 |                   | $ | 148,425 |  | $ | 12,491         |   |  | 8.4   | %
|                      |  |                           |         |                   |   |         |  |   |                |   |  |       |  

---

|* | North America revenue in fiscal year 2005 included $18.9 million in past due royalties from Applied Materials.
|- | --------------------------------------------------------------------------------------------------------------



Product



During the first quarter of fiscal year 2006, product revenue increased $31.6 million, or 29.5% to $138.7 million from $107.1 million in the
first quarter of fiscal year 2005. The increase in product revenue was primarily due to increased high current tool sales, particularly to memory and foundry manufacturers. On a unit basis, the number of high current tools recorded in revenue
increased 150% compared to the first quarter of fiscal year 2005. The increase in tool revenues was slightly offset by a decrease in upgrades revenue.



21



---

##### Table of Contents

Service



Service revenue during the first quarter of fiscal year 2006 was $20.6 million, compared to $19.4 million for the same period a year ago. Generally, installation revenue
is influenced by shipment volume of systems, product mix, customer mix, and timing of customer acceptances.



Royalty and license



Royalty revenue
during the first quarter of fiscal year 2006 was $1.6 million, compared to $21.9 million for the same period a year ago. During the first quarter of fiscal year 2005, Varian Semiconductor received $18.9 million for past due royalties from Applied
Materials, Inc. (Applied Materials) pursuant to an arbitration panel ruling. 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. Also in the first quarter of fiscal year 2005, Varian Semiconductor received its final quarterly cash payment of $1.25 million
pursuant to the terms of a Settlement and License Agreement between Varian Semiconductor and Lam Research Corporation (Lam).



Customers



During the first quarter of fiscal year 2006, revenue from three customers accounted for 14%, 14% and 13%, 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 first quarter of fiscal year 2005, revenue from three customers, including the non-recurring royalty revenue of
$18.9 million from Applied Materials, accounted for 14%, 12% and 11% of Varian Semiconductors total revenue.



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 reporting period (see also Risk Factors and Critical Accounting Policies - Revenue Recognition).



Cost of Product Revenue.Cost of product revenue was $86.6 million and gross product
margin was 38% for the first quarter of fiscal year 2006, compared to cost of product revenue of $58.9 million and gross margin of 45% for the first quarter of fiscal year 2005. Cost of product revenue for the first quarter of fiscal year 2006
included $0.2 million of equity-based compensation costs recorded upon the adoption of SFAS No. 123(R), Share-Based Payment (SFAS No. 123 (R)) as of October 1, 2005. The primary drivers of the decrease in gross
margin, quarter over quarter, were increased costs associated with new account penetration initiatives, fluctuations in inventory charges associated with product transitions and legacy parts demand, and lower levels of upgrades sales. New account
penetration initiatives primarily relate to the sale of high current tools to new customers, new regions (where local infrastructure is not already in place) and/or new customer fabs and strategic pricing decisions relative to new customer
purchases. The gross margin in the first quarter of fiscal year 2005 was favorably impacted by $1.7 million from the sale of certain inventory for which the carrying value had been reduced in previous periods, whereas the gross margin for the first
quarter of fiscal 2006 included $1.0 million in inventory related product transition costs. Upgrades sales traditionally have higher margins than sales of other products, therefore, lower volume of upgrade sales negatively impacts gross margin.



Cost of Service Revenue.Cost of service revenue was $10.8 million and
gross margin was 48% for the first quarter of fiscal year 2006, compared to a cost of service revenue of $13.4 million and gross margin of 31% for the first quarter of fiscal year 2005. Cost of service revenue for the first quarter of fiscal year
2006 included $0.2 million of equity-based compensation costs recorded upon the adoption of SFAS No. 123(R) as of October 1, 2005. The decrease in cost of service was the result of reduced installation costs. The reduction in installation
costs as a percent of revenue is a result of maturing products, improved installation labor efficiency (which reduces the time to install completion), and a higher percentage of installations being performed by local Varian Semiconductor technicians
(as opposed to U.S.-based technicians).



Research and Development.
Research and development expenses were $21.6 million for the first quarter of fiscal year 2006, compared to $18.7 million for the first quarter of fiscal year 2005. $1.0 million of the increase in the first quarter of fiscal year 2006 is a result of
equity-based compensation costs recorded upon the adoption of SFAS No. 123(R) as of October 1, 2005. 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. 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 $28.4 million for the first quarter of fiscal year 2006, compared to $27.4 million in the first quarter of fiscal year 2005. $2.5 million of the increase in the first quarter of fiscal year 2006 is a result
of equity-based compensation costs recorded upon the adoption of SFAS 123(R) as of October 1, 2005. Additionally, the first quarter of fiscal year 2005 included a $3.5 million charge associated with the



22



---

##### Table of Contents

retirement of the President and Chief Operating Officer of Varian Semiconductor effective as of December 31, 2004. Exclusive of the equity-based
compensation costs in the first quarter of fiscal year 2006 and the retirement costs in the first quarter of fiscal year 2005, the increases are primarily related to costs to demonstrate the capabilities of Varian Semiconductors latest
generation of products, both at the customer fab and Varian Semiconductors factory.



Interest Income and Interest Expense. During the first quarter of fiscal year 2006, Varian Semiconductor earned $5.4 million in net interest income, compared to $7.6 million in net interest income for the first
quarter of fiscal year 2005. Interest income for the first quarter of fiscal year 2006 included $1.3 million related to the release of tax refunds by the IRS upon the conclusion of a multi-year tax examination. Interest income in the first quarter
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 and license). Higher cash and investment balances and rates, along with an increased
portfolio of investments compared to the total cash and investments balance has led to higher interest income from investments.



Other Income (Expense), Net. Other income (expense), net, was less than $0.1 million in expense for the first quarter of fiscal year 2006, compared to other income
of $2.8 million for the first quarter of fiscal year 2005. In the first quarter 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 related to the Applied Materials settlement (see also Royalty and license). The statute of limitations on the indemnification obligations expired during the
first quarter of fiscal year 2005 (See Note 12. Commitments, Contingencies and Guarantees in the Notes to the Unaudited Interim Consolidated Financial Statements).



Provision for (benefit from) Income Taxes. Varian Semiconductors effective income tax rate was a benefit of 17%, including the
tax benefit discussed in the following paragraph, for the first three months of fiscal year 2006 and a provision of 31% for the same period in fiscal year 2005. Exclusive of the benefit received, the tax rate was a provision of 30% for the first
three months of fiscal year 2006. The decrease in the effective rate, exclusive of the benefit received, 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 IRS. The IRS conducted an examination for the tax years 1999 through 2003 as part of its routine examinations of Varian
Semiconductors income tax returns. The IRS completed fieldwork for this examination of Varian Semiconductor in the fourth quarter of fiscal year 2005 and submitted its report to the Joint Committee for final approval. Varian Semiconductor was
notified of Joint Committee approval in the first quarter of fiscal year 2006. Related to the conclusion of this examination, Varian Semiconductor recorded a net tax benefit of $9.0 million in the first quarter of fiscal year 2006.



In October 2004, the American Jobs Creation Act of 2004 (AJCA) was signed into
law. The AJCA phases out the benefits from the extraterritorial exclusion in fiscal years 2005 and 2006, and provides a new deduction for income from domestic production activities. This deduction became effective for Varian Semiconductor in the
first quarter of fiscal year 2006. The AJCA also creates a temporary incentive for U.S. companies to repatriate accumulated foreign earnings by providing an elective 85% dividends received deduction for certain dividends from controlled foreign
corporations. Varian Semiconductor completed its evaluation of the foreign repatriation provisions and decided not to repatriate foreign earnings under these provisions as it would not be beneficial to Varian Semiconductor.



Net Income. As a result of the foregoing factors, in the first quarter of fiscal year
2006, Varian Semiconductor recorded net income of $22.3 million, compared to net income of $28.0 million for the same period of fiscal year 2005. The net income per diluted share was $0.59 for the first quarter of fiscal year 2006, compared to net
income per diluted share of $0.75 for the first quarter of fiscal year 2005.



Liquidity and Capital Resources



Varian Semiconductor
generated $16.2 million of cash from operations during the first three months of fiscal year 2006, compared to $52.9 million of cash generated from operations during the first three months of fiscal year 2005. Cash provided by operations in the
first three months of fiscal year 2006 was primarily a result of net income of $22.3 million, decreases in other current assets of $16.4 million and inventories of $10.2 million, and an increase in accounts payable of $8.3 million. These changes
were partially offset by a $22.7 million increase in accounts receivable, a $15.3 million decrease in accrued expenses, and a $10.7 million decrease in deferred revenue. The decrease in other current assets is related to the receipt of refunds from
the IRS associated with the conclusion of a multi-year tax examination and the high number of completed



23



---

##### Table of Contents

installations during the quarter, which reduced the amount of inventory related to installations, which is included in other current assets. The increase in
accounts payable is related to an increase in the manufacturing schedule for the second quarter as opposed to the first quarters plan. The increase in accounts receivable is related to the timing of revenue recognition within the quarter. Cash
provided by operations in the first three months of fiscal year 2005 was primarily a result of net income of $28.0 million, an increase in accounts payable of $12.3 million, and decreases in other current assets and accounts receivable of $22.3
million and $4.5 million, respectively. These changes were partially offset by a $17.1 million increase in inventories and a $5.0 million decrease in accrued expenses.



Varian Semiconductor used $81.7 million of cash and cash equivalents for the purchase of short-term investments during the first three
months of fiscal year 2006, and $2.5 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 $76.3 million during the period. In the first three months of fiscal year 2005, Varian Semiconductor used $56.3 million of cash and cash equivalents for the purchase of short-term investments, and $3.3 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 $6.3 million during the first three months of fiscal year 2005.



During the first three months of fiscal year 2006, Varian Semiconductor used $10.7 million of
cash for financing activities, primarily due to $20.0 million for the repurchase of treasury stock, offset by $8.4 million received from the issuance of common stock upon the exercise of stock options and the issuance of common stock under the
Employee Stock Purchase Plan. During the first three months of fiscal year 2005, Varian Semiconductor generated $1.9 million of cash from financing activities, primarily due to $2.0 million from the issuance of common stock upon the exercise of
stock options and related to 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. In the first quarter of fiscal year 2006, Varian Semiconductor repurchased 530,849 shares at a weighted-average price of $37.75 per share. No shares were repurchased prior to
the first quarter of fiscal year 2006.



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
$477.3 million at December 30, 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 course of business, may have a material impact on liquidity. The following commitments as of December 30, 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 complete picture of Varian Semiconductors financial position and liquidity.



24



---

##### Table of Contents

|                           |  |                        |        |                  |   |           |  |           |     |  |   |   
|-------------------------- |  | ---------------------- | ------ | ---------------- | - | --------- |  | --------- | --- |  | - | --
|                           |  | Payments Due by Period
|                           |  | Total                  |        | Less than 1 Year |   | 1-3 Years |  | 3-5 Years
|                           |  |                        |       
|                           |  | (Amounts in thousands)
|Operating leases           |  | $                      | 2,071  |                  | $ | 1,573     |  | $         | 478 |  | $ | 20
|Purchase order commitments |  |                        | 45,997 |                  |   | 45,989    |  |           | 8   |  |   |  
|                           |  |                        |        |                  |   |           |  |           |     |  |   |   
|Total commitments          |  | $                      | 48,068 |                  | $ | 47,562    |  | $         | 486 |  | $ | 20
|                           |  |                        |        |                  |   |           |  |           |     |  |   |   



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 12. Commitments, Contingencies and Guarantees in the Notes to the Unaudited Interim Consolidated Financial Statements).
During fiscal years 2005, 2004 and 2003, Varian Semiconductor was charged $1.2 million, $1.6 million and $1.4 million, respectively, by VMS in settlement of obligations related to operations prior to April 2, 1999. During the first quarter of
fiscal year 2006, Varian Semiconductor was charged by VMS $0.2 million in settlement of these obligations. During the first quarter of fiscal year 2005, Varian Semiconductor was charged by VMS $0.3 million in settlement of these obligations.



Recent Accounting Pronouncements



In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error
Corrections. This statement replaces APB Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and
reporting of a change in accounting principle. This statement applies to all voluntary changes in accounting principles. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not
include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. SFAS No. 154 requires retrospective application to prior periods financial statements of voluntary
changes in accounting principles. SFAS No. 154 is effective for accounting changes and corrections of errors made during Varian Semiconductors fiscal year 2007, beginning on September 30, 2006. Varian Semiconductor does not believe the
adoption of SFAS No. 154 will have a material impact on its financial statements.



Risk Factors



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



The semiconductor industry historically has been cyclical in nature and has experienced periodic downturns. The industry may experience 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 construction of new fab facilities. Even though Varian Semiconductors revenues may fluctuate
significantly from period to period, in order to remain competitive, Varian Semiconductor continues to invest in research and development and to maintain its worldwide customer service and support capabilities. 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 needs 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 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 be adversely affected.



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 sold significant percentages of its systems to its major customers, some of which include Elpida Memory, Inc., Hynix Semiconductor, Inc., Infineon Technologies AG, International Business
Machines Corporation, Intel Corporation, Micron Technology, Inc., Samsung Electronics Company Limited, Sony Corporation, STMicroelectronics, Texas Instruments, Inc., Taiwan Semiconductor Manufacturing Corporation, Limited and United Microelectronics
Corporation. During some quarters, some of these customers have individually accounted for more than 10% 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



25



---

##### Table of Contents

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 may 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 products sold, costs to manufacture and customize systems
and inventory management. In addition, a number of other factors may 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;
| | - |  | ---------------------------------------



| |  |  | a technological change that Varian Semiconductor is unable to address with its products;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | a failure to achieve continued market acceptance of Varian Semiconductors key products;
| | - |  | ----------------------------------------------------------------------------------------



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



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



| |  |  | strategic technology investment decisions;
| | - |  | ------------------------------------------



| |  |  | 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 fluctuation 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.



Varian
Semiconductor customarily sells a relatively small number of systems within any period. 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. Generally, Varian Semiconductor recognizes all or a portion of the revenue from a product 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. Please refer to the full revenue recognition policy in the Critical



26



---

##### Table of Contents

Accounting Policies and Significant Judgments and Accounting Estimates section of this report. 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 at more advanced nodes. Varian Semiconductor derives virtually all of its revenue from sales and servicing of 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. 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.



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 accounts for a substantial portion of Varian Semiconductors revenue. Because Varian Semiconductor relies on sales to customers in Asia Pacific for a significant 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 Pacific is affected by demand in each country. In addition, international sales are subject to risks, including, but not limited
to:



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



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



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



| |  |  | natural disasters or public health crises;
| | - |  | ------------------------------------------



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



| |  |  | foreign trade disputes; and
| | - |  | ---------------------------



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



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 be issued 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.
| | - |  | ---------------------------------------------------------------------------------------------------------



27



---

##### Table of Contents

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



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



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



28



---

##### Table of Contents

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 (CERCLA), at eight sites where VAI is alleged to have shipped manufacturing waste for recycling or disposal. VAI is also in various stages of
environmental investigation and/or remediation under the direction of, or in consultation with foreign, federal, state and local agencies at certain current or former VAI facilities. 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 estimated environmental investigation and remediation costs for
these sites and facilities. 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 sufficient accruals to
cover Varian Semiconductors portion of these costs.



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 accruals and subsequent 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 may 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.



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 may cause delays in shipments of products to Varian Semiconductors customers
and may result in cancellation of orders or loss of customers and could seriously harm Varian Semiconductors business.



29



---

##### Table of Contents

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 could 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.



Varian Semiconductors financial results may be adversely impacted by higher than expected tax rates or exposure to additional income tax liabilities.



As a global company, Varian Semiconductors effective tax rate is highly dependent upon
the geographic composition of worldwide earnings and tax regulations governing each region. Varian Semiconductor is subject to income taxes in both the U.S. and various foreign jurisdictions, and significant judgment is required to determine
worldwide tax liabilities. Varian Semiconductors effective tax rate could be adversely affected by changes in the distribution of earnings between countries with differing statutory tax rates, in the valuation of deferred tax assets, in tax
laws or by material audit assessments, which could affect profitability. For example, recent U.S. legislation governing taxation of extraterritorial income repealed certain export subsidies that were prohibited by the World Trade Organization and
enacted different tax provisions. These new tax provisions are not expected to fully offset the loss of the repealed tax provisions and, as a result, Varian Semiconductors U.S. tax liability may increase. In addition, Varian
Semiconductors effective tax rate has benefited from the research and development (R & D) tax credit which expired on December 31, 2005. If the R & D credit is not extended, Varian Semiconductors tax
liability may increase. Further, the carrying value of deferred tax assets, which are predominantly in the U.S., is dependent on Varian Semiconductors ability to generate future taxable income in the U.S. In addition, the amount of income
taxes paid is subject to ongoing audits in various jurisdictions, and a material assessment by a governing tax authority could affect profitability.



Changes in accounting standards for stock-based compensation may adversely affect Varian Semiconductors operating results, stock price, and competitiveness in
the employee marketplace.



The adoption of SFAS No. 123(R)
requires Varian Semiconductor to expense all stock-based compensation provided to employees beginning with fiscal year 2006. The environment for skilled employees that are knowledgeable about Varian Semiconductors products and services is a
competitive one, and Varian Semiconductor believes that stock-based compensation is an important part of the overall compensation offered to attract and retain such employees. SFAS No. 123(R) will decrease Varian Semiconductors
earnings based on its measure of the value of stock-based compensation. There is some risk that the design of Varian Semiconductors compensation plans could not balance profitability with employee retention objectives. Moreover, as Varian
Semiconductor is adopting these rules before many of its peer companies, there may be, for some period of time, an appearance that Varian Semiconductors earnings are lower than those of comparable companies that have not yet adopted
SFAS No. 123(R), which could have a negative effect on Varian Semiconductors stock price.



30



---

##### Table of Contents

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 impact Varian
Semiconductors financial results. However, a 10% change in the exchange rate of the U.S. dollar against other major currencies would not have a material effect on Varian Semiconductors results of operations. Historically, Varian
Semiconductors primary exposures have resulted from non-U.S. dollar-denominated sales and purchases in Asia Pacific 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 exceeds one year in original maturity.



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 gain for the first quarter of fiscal year 2006 was $14,000.



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



|                                          |  |                   |        |                    |          |            |   |                |  |               |        |            |          |  |   |       
|----------------------------------------- |  | ----------------- | ------ | ------------------ | -------- | ---------- | - | -------------- |  | ------------- | ------ | ---------- | -------- |  | - | ------
|                                          |  | December 30, 2005 |        | September 30, 2005
|                                          |  | Notional Value    |        | Contract Rate      |          | Fair Value |   | Notional Value |  | Contract Rate |        | Fair Value
|                                          |  |                   |        |                    |         
|Foreign currency purchase contracts:      |  |                   |        |                    |          |            |   |                |  |               |        |            |          |  |   |       
|Euro                                      |  | $                 | 2,482  |                    | 0.85     |            | $ | 2,487          |  | $             | 1,002  |            | 0.80     |  | $ | 967   
|New Taiwan Dollar                         |  |                   | 777    |                    | 33.46    |            |   | 784            |  |               | 638    |            | 32.60    |  |   | 625   
|Japanese Yen                              |  |                   | 75     |                    | 115.86   |            |   | 74             |  |               |       |            |         |  |   |      
|British Pound                             |  |                   | 54     |                    | 0.58     |            |   | 54             |  |               |       |            |         |  |   |      
|Korean Won                                |  |                   |       |                    |         |            |   |               |  |               | 8,839  |            | 1,034.63 |  |   | 8,699 
|                                          |  |                   |        |                    |          |            |   |                |  |               |        |            |          |  |   |       
|Total foreign currency purchase contracts |  | $                 | 3,388  |                    |          |            | $ | 3,399          |  | $             | 10,479 |            |          |  | $ | 10,291
|                                          |  |                   |        |                    |          |            |   |                |  |               |        |            |          |  |   |       
|Foreign currency sell contracts:          |  |                   |        |                    |          |            |   |                |  |               |        |            |          |  |   |       
|Japanese Yen                              |  | $                 | 35,279 |                    | 118.23   |            | $ | 35,671         |  | $             | 21,268 |            | 110.89   |  | $ | 20,868
|Korean Won                                |  |                   | 3,969  |                    | 1,025.68 |            |   | 3,974          |  |               | 10,637 |            | 1,051.30 |  |   | 10,417
|New Taiwan Dollar                         |  |                   | 506    |                    | 33.00    |            |   | 504            |  |               | 410    |            | 33.21    |  |   | 409   
|Israeli Shekel                            |  |                   | 284    |                    | 4.67     |            |   | 288            |  |               | 860    |            | 4.50     |  |   | 840   
|British Pound                             |  |                   |       |                    |         |            |   |               |  |               | 395    |            | 0.55     |  |   | 381   
|Euro                                      |  |                   |       |                    |         |            |   |               |  |               | 89     |            | 0.83     |  |   | 89    
|                                          |  |                   |        |                    |          |            |   |                |  |               |        |            |          |  |   |       
|Total foreign currency sell contracts     |  | $                 | 40,038 |                    |          |            | $ | 40,437         |  | $             | 33,659 |            |          |  | $ | 33,004
|                                          |  |                   |        |                    |          |            |   |                |  |               |        |            |          |  |   |       
|Total contracts                           |  | $                 | 43,426 |                    |          |            | $ | 43,836         |  | $             | 44,138 |            |          |  | $ | 43,295
|                                          |  |                   |        |                    |          |            |   |                |  |               |        |            |          |  |   |       



Varian Semiconductor uses derivative
instruments to protect its foreign operations from fluctuations in earnings and cash flows caused by volatility in currency exchange rates. Varian Semiconductor hedges its current exposures and a portion of its anticipated foreign currency exposures
with hedging instruments having terms of up to twelve months.



Varian
Semiconductors international sales, except for those in Japan, are primarily denominated in the U.S. dollar. For foreign currency-denominated sales, however, the volatility of the foreign currency markets represents risk to Varian
Semiconductor. Upon forecasting the exposure, Varian Semiconductor enters into hedges with forward sales contracts whose critical terms are designed to match those of the underlying exposure. These hedges are evaluated for effectiveness at least
quarterly using the change in value of the forward contracts to the change in value of the underlying transaction, with the effective portion of the hedge accumulated in other comprehensive income. Any measured ineffectiveness is included
immediately in other income and expense in the consolidated statements of operations. There were four forward foreign exchange sell contracts designated as hedges of anticipated product sales in Japanese Yen outstanding at December 30, 2005
totaling an equivalent of $18.8 million. In addition, there were two forward foreign exchange purchase contracts totaling an equivalent of $9.5 million offsetting 2 of the forward sell contracts.



There were approximately $0.1 million in net unrealized gains on these forward Yen contracts
as of December 30, 2005. There were approximately $1.2 million in net unrealized gains on these forward Yen revenue contracts as of September 30, 2005. The fair value of forward exchange contracts generally reflects the estimated amounts
that Varian Semiconductor would receive or pay to terminate the contracts at the reporting date. The notional amounts of forward exchange contracts are not a measure of Varian Semiconductors exposure.



31



---

##### Table of Contents

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 U.S.
Treasury, government agency and investment-grade corporate and municipal securities, as well as short-term time deposits with investment grade financial institutions. Cash equivalents at December 30, 2005 and September 30, 2005 were $172.7
million and $182.1 million, respectively. At December 30, 2005 and September 30, 2005, Varian Semiconductors short-term investments were $285.8 million and $280.6 million, respectively, and consisted primarily of U.S. Treasury,
government agency and corporate bonds and certificates of deposit with ratings of AA or better.



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 December 30, 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 December 30, 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 December 30, 2005 that has materially affected, or is reasonably
likely to materially affect, the internal control over financial reporting.



32



---

##### Table of Contents

PART II. OTHER INFORMATION



ITEM 1. LEGAL PROCEEDINGS



Information
required by this Item is provided in Note 12. 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



The following table provides information about purchases by Varian Semiconductor Equipment Associates, Inc. (Varian Semiconductor) during the quarter ended December 30, 2005 of equity securities that
are registered by Varian Semiconductor pursuant to Section 12 of the Securities Exchange Act of 1934:



ISSUER PURCHASES OF EQUITY SECURITIES



|                                |  |                                                     |  |                                            |       |                                                                                                     |         |                                                                                                                            |          
|------------------------------- |  | --------------------------------------------------- |  | ------------------------------------------ | ----- | --------------------------------------------------------------------------------------------------- | ------- | -------------------------------------------------------------------------------------------------------------------------- | ---------
|Period                          |  | (a) Total Number of Shares (or Units) Purchased (1) |  | (b) Average Price Paid per Share (or Unit) |       | (c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs
(2) |         | (d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be PurchasedUnder the Plans or Programs
|October 1  October 28, 2005    |  | 0                                                   |  | $                                          | 0     |                                                                                                     | 0       |                                                                                                                            | 3,500,000
|October 29  November 25, 2005  |  | 530,849                                             |  | $                                          | 37.75 |                                                                                                     | 530,849 |                                                                                                                            | 2,969,151
|November 26  December 30, 2005 |  | 0                                                   |  | $                                          | 0     |                                                                                                     | 0       |                                                                                                                            | 2,969,151
|Total:                          |  | 530,849                                             |  | $                                          | 37.75 |                                                                                                     | 530,849 |                                                                                                                            | 2,969,151

---

|(1) | Varian Semiconductor repurchased an aggregate of 530,849 shares of its common stock pursuant to the repurchase program that was publicly announced on October 22, 2004 (the
Program).
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Varian Semiconductors board of directors approved the repurchase of up to an aggregate of 3,500,000 shares of common stock pursuant to the Program. The Program does not have a
fixed expiration date.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



ITEM 6. EXHIBITS



|         |  |                                                                                                                                                       
|-------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibits |  |                                                                                                                                                       
|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.



33



---

##### Table of Contents

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: February 8, 2006



34