VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES INC - 10-Q Quarterly Report

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

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

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

Varian Semiconductor designs, manufactures, markets and services semiconductor processing equipment used in the fabrication of integrated circuits.

These unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These unaudited interim consolidated financial statements should be read in conjunction with the financial statements and the notes thereto included in the annual report on Form 10-K filed by Varian Semiconductor Equipment Associates, Inc. (“Varian Semiconductor”) with the Securities and Exchange Commission for the fiscal year ended September 27, 2002. In the opinion of Varian Semiconductor, the unaudited interim consolidated financial statements include all adjustments, consisting of only normal recurring adjustments, necessary to present fairly the information required to be set forth therein. The results of operations for the three and six month periods ended March 28, 2003 are not necessarily indicative of the results to be expected for a full year or for any other period.

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

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

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

For the three and six month periods ended March 28, 2003, options to purchase 2,554,133 and 2,510,143 common shares at a weighted average exercise prices of $34.72 and $35.04, respectively, were excluded from the computation due to their exercise price exceeding the market value of the underlying common stock. All potential common shares were excluded from the computation of diluted loss per share for the three-month period ended March 29, 2002 as their effect was anti-dilutive. For the six-month period ended March 29, 2002, options to purchase 714,005 common shares at a weighted average exercise price of $50.51, were excluded from the computation due to their exercise price exceeding the market value of the underlying common stock.

As of March 28, 2003, Varian Semiconductor had outstanding options to purchase an aggregate of 5,548,504 shares of its common stock at a weighted average price of $23.60. Of these options, options to purchase an aggregate of 4,151,773 shares at a weighted average price of $21.40 were fully vested and exercisable.

Varian Semiconductor considers currency on hand, demand deposits, and all highly liquid investments with an original purchase maturity of three months or less to be cash and cash equivalents. The carrying amounts of cash and cash equivalents approximate estimated fair value because of the short maturities of those financial instruments. Cash equivalents at March 28, 2003 and September 27, 2002 were $316.5 million and $305.2 million, respectively. Short-term investments consist primarily of certificates of deposit that are less than nine months in maturity. All short-term investments have been classified as held-to-maturity 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.

In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” to be effective for all fiscal years beginning after December 15, 2001. As part of the adoption of SFAS No. 142 on September 28, 2002, Varian Semiconductor will no longer amortize goodwill, eliminating annual goodwill amortization of approximately $1.6 million, and will test for impairment of goodwill at least on an annual basis and whenever events and changes in circumstances suggest that the carrying amount may not be recoverable. Varian Semiconductor completed its evaluation of the carrying amount of goodwill during the first quarter of fiscal year 2003 and concluded that no impairment existed as of that date. At March 28, 2003 and September 27, 2002, Varian Semiconductor had unamortized goodwill of approximately $12.3 million (net of accumulated amortization of $7.0 million).

Had Varian Semiconductor adopted SFAS No. 142 as of September 29, 2001, net income and net income per share would have been as follows:

As of March 28, 2003 and September 27, 2002, Varian Semiconductor’s subsidiary in Japan had two credit facilities available with two different financial institutions. Maximum available borrowings on each of the two loans were as follows: (Y)590,000,000 ($4.9 million at March 28, 2003) and (Y)1,000,000,000 ($8.3 million at March 28, 2003). The loans are unsecured and contain no restrictive covenants, although each loan is guaranteed by Varian Semiconductor. Interest rates for the (Y)590,000,000 credit facility are the Tokyo interbank offered rate + 1.75% (approximately 1.81% at March 28, 2003 and 1.84% at September 27, 2002). The interest rate for the other credit facility is based on the short-term prime rate + 0.25% (approximately 1.63% at March 28, 2003 and 1.38% at September 27, 2002). The loans mature every 30 to 90 days and are normally rolled over into new 30 to 90 day loans upon maturity. As of September 27, 2002, Varian Semiconductor had a third credit facility that was terminated during the first quarter of fiscal year 2003. Total outstanding borrowings at March 28, 2003 were (Y)590,000,000, or $4.9 million, and at September 27, 2002 were (Y)690,000,000, or $5.6 million.

Varian Semiconductor also has borrowing capacity in Europe, Korea and Taiwan. In June 2002, Varian Semiconductor’s subsidiary in Europe renewed a credit facility which includes overdraft protection of Euro 2.5 million ($2.7 million at March 28, 2003). Interest accrues at the Euro base rate + 1.5% (approximately 4.8% at March 28, 2003). In April 2002, Varian Semiconductor’s subsidiary in Korea closed on a $3.0 million credit facility. Any outstanding borrowings accrue interest at the local base rate + 1.6% (approximately 6.4% at March 28, 2003) and are payable on demand. In July 2001, Varian Semiconductor’s subsidiary in Taiwan closed on a $1.0 million credit facility. Any outstanding borrowings accrue interest at the local base rate + 1.3% (approximately 3.0% at March 28, 2003) and are payable on demand. All three credit facilities are unsecured and contain no restrictive covenants, although each loan is guaranteed by Varian Semiconductor. There were no outstanding borrowings as of March 28, 2003 or September 27, 2002 on any of these three loans.

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

Product warranty activity for the first half of fiscal year 2003 was as follows:

In February 2003, Varian Semiconductor purchased its previously leased facility located in Newburyport, Massachusetts. The purchase price consisted of cash payments totaling $3.4 million, the assumption of the seller’s outstanding loan of $5.1 million and the transfer of other prepaid assets of $0.8 million. The loan has a fixed interest rate of 9.05% with monthly payments of principal and interest until the loan matures in January 2013. The loan may be prepaid in full, but not in part, at any time after November 5, 2006. Prepayment would require Varian Semiconductor to pay a prepayment penalty equal to the greater of two percent of the outstanding principal balance or the excess of the present value of all future loan payments over the outstanding principal balance of the loan. The loan is secured by the property. The loan payments are as follows:

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment of FASB Statement No. 123,” to provide alternative methods of transition to the fair value method of accounting for stock-based employee compensation, and also amends the disclosure provision of SFAS No. 123 to require disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. Varian Semiconductor adopted SFAS No. 148 in the second quarter of fiscal year 2003.

If Varian Semiconductor had elected to recognize compensation cost based on the fair value of all stock awards at grant date as prescribed by SFAS No. 123, the net income (loss) and net income (loss) per basic and diluted share for three and six month periods ended March 28, 2003 and March 29, 2002 would have been reduced to the pro forma amounts shown below:

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue (“EITF”) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)” (“EITF 94-3”). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. EITF 94-3 allowed for an exit cost liability to be recognized at the date of an entity’s commitment to an exit plan. SFAS No. 146 also requires that liabilities recorded in connection with exit plans be initially measured at fair value. SFAS No. 146 will be effective for exit or disposal activities that are initiated after December 31, 2002. Varian Semiconductor adopted SFAS No. 146 in the second quarter of fiscal year 2003.

In November 2002, the FASB issued Interpretation (“FIN”) No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN No. 45 clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and initial measurement provisions of FIN No. 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements of FIN No. 45 are applicable for financial statements of interim or annual periods ending after December 15, 2002. The adoption of FIN No. 45 did not have a material effect on our consolidated financial statements. Varian Semiconductor adopted FIN No. 45 in the first quarter of fiscal year 2003 and has included the new disclosure requirements in the Notes to the Consolidated Financial Statements (see Note 9. Product Warranties and Note 14. Commitments and Contingencies).

In November 2002, the EITF issued No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” EITF No. 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. EITF No. 00-21 establishes three principles: revenue arrangements with multiple deliverables should be divided into separate units of accounting, arrangement consideration should be allocated among the separate units of accounting based on their relative fair values, and revenue recognition criteria should be considered separately for separate units of accounting. EITF No. 00-21 is effective for all revenue arrangements entered into in fiscal periods beginning after June 15, 2003, with early adoption permitted.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure,” which amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition to the fair value method of accounting for stock-based employee compensation, and also amends the disclosure provision of SFAS No. 123 to require disclosure in the summary of significant accounting policies the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. The disclosure provision is required for all companies with stock-based employee compensation, regardless of whether the company utilizes the fair value method of accounting described in SFAS No. 123 or the intrinsic value method described in APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS No. 148’s amendment of the transition and annual disclosure provisions of SFAS No. 123 are effective for fiscal years ending after December 15, 2002. The disclosure requirements for interim financial statements containing condensed consolidated financial statements are effective for interim periods beginning after December 15, 2002. Varian Semiconductor currently uses the intrinsic value method of accounting for stock-based employee compensation described by APB Opinion No. 25. Varian Semiconductor adopted SFAS No. 148 in the second quarter of fiscal year 2003 and has included the new disclosure requirements in the Notes to the Consolidated Financial Statements (see Note 11. Stockholders’ Equity and Employee Stock Plans).

Varian Semiconductor does not expect the adoption of the above mentioned pronouncements to have a material impact on Varian Semiconductor’s consolidated financial statements.

Varian Semiconductor operates in one business segment: the manufacturing, marketing and servicing of ion implantation systems. Since Varian Semiconductor operates in one segment, all financial segment information required by SFAS No. 131 can be found in the consolidated financial statements.

During the second quarter of fiscal year 2003, revenue from three customers accounted for 26%, 16% and 14% 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 second quarter of fiscal year 2002, revenue from three customers accounted for 24%, 23% and 11% of Varian Semiconductor’s total revenue. During the first six months of fiscal year 2003, revenue from two customers accounted for 20% and 13% of Varian Semiconductor’s total revenue. During the first six months of fiscal year 2002, Lam Research Corporation (“Lam”) accounted for 20% of total revenue and three other customers, each representing 10% or greater of total revenue, accounted for an additional 37% of total revenue. (See also Note 15. Settlement and License Agreement.)

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

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

As permitted under Delaware law, we have agreements whereby we indemnify our officers and directors for certain events or occurrences while the officer or director is, or was serving, at our request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have a Director and Officer insurance policy that limits our exposure and enables us to recover a portion of any future amounts paid. As a result of our insurance policy coverage, we believe the estimated fair value of these indemnification agreements is minimal. Accordingly, we have not recorded any liabilities for these agreements as of March 28, 2003.

We enter into indemnification agreements in our course of business. Pursuant to these agreements, we indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally our customers, in connection with any patent, or any copyright or other intellectual property infringement claim by any third party with respect to our products. The term of these indemnification agreements is generally perpetual any time after execution of the agreement. The maximum potential amount of future payments we could be required to make under these indemnification agreements is not capped. We believe the estimated fair value of these agreements is minimal. Accordingly, we have not recorded any liabilities for these agreements as of March 28, 2003.

Varian Semiconductor also indemnifies certain customers with respect to damages, losses and liabilities they may suffer or incur relating to personal injury, personal property damage, product liability, and environmental claims relating to the use of Varian Semiconductor’s products and services or resulting from the acts or omissions of Varian Semiconductor, its employees, officers, authorized agents or subcontractors. Varian Semiconductor has general and umbrella insurance policies that limit our exposure under these indemnification obligations and guarantees. As a result of our insurance policy coverage, we believe the estimated fair value of these indemnification agreements is minimal. Accordingly, we have not recorded any liabilities for these agreements as of March 28, 2003.

Prior to the spin-off of Varian Semiconductor from Varian Associates, Inc. (“VAI”) on April 2, 1999, Varian Semiconductor’s business was operated as the Semiconductor Equipment Business (“SEB”) of VAI. On April 2, 1999, VAI contributed its Semiconductor Equipment Business (“SEB”) to Varian Semiconductor, its Instruments Business (“IB”) to Varian, Inc. (“VI”), and changed its name to Varian Medical Systems, Inc. (“VMS”). These transactions were accomplished under the terms of a distribution agreement by and among Varian Semiconductor, VI and VMS (collectively, the “Distribution Related Agreements”). VAI has been named by the United States Environmental Protection Agency or third parties as a potentially responsible party under CERCLA, at eight sites where VAI is alleged to have shipped manufacturing waste for recycling or disposal. VAI is also involved in various stages of environmental investigation and/or remediation under the direction of, or in consultation with, foreign, federal, state and/or local agencies at certain current or former VAI facilities (including facilities disposed of in connection with VAI’s sale of its Electron Devices business during fiscal year 1995, and the sale of its Thin Film Systems (“TFS”) business during fiscal year 1997). The Distribution Agreement provides that each of VMS, Varian Semiconductor and VI will indemnify the others for one-third of these environmental investigation and remediation costs, as adjusted for any insurance proceeds and tax benefits expected to be realized upon payment of these costs.

For certain of these sites and facilities, various uncertainties make it difficult to assess the likelihood and scope of further investigation or remediation activities or to estimate the future costs of such activities if undertaken. Varian Semiconductor has accrued $1.8 million in estimated environmental investigation and remediation costs for these sites and facilities as of March 28, 2003. 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 $4.9 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 $1.8 million previously described.

As of March 28, 2003, Varian Semiconductor’s reserve for its portion of environmental liabilities, based upon future environmental related costs estimated by VMS as of that date and included in current and long-term accrued expenses, totaled $6.7 million, of which $1.2 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.

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

Varian Semiconductor evaluates its liability for environmental related investigation and remediation in light of the liability and financial wherewithal of potentially responsible parties and insurance companies where Varian Semiconductor believes that it has rights to contribution, indemnity and/or reimbursement. Claims for recovery of environmental investigation and remediation costs already incurred, and to be incurred in the future, have been asserted against various insurance companies and other third parties. In 1992, VAI filed a lawsuit against 36 insurance companies with respect to most of the above-referenced sites and facilities. VAI received certain cash settlements with respect to these lawsuits in prior years. VMS has also reached an agreement with an insurance company under which the insurance company agreed to pay a portion of Varian Semiconductor’s past and future environmental related expenditures. Varian Semiconductor therefore has a receivable of $1.3 million in other assets at March 28, 2003, as its portion of the insurance recoveries. Although VMS intends to aggressively pursue additional insurance recoveries, Varian Semiconductor has not reduced any liability in anticipation of recovery with respect to claims made against third parties.

As part of the purchase of Varian Semiconductor’s facility located in Newburyport, Massachusetts, the Company has indemnified the lender for any violation of any local, state and federal laws pertaining to environmental regulations, contamination or clean-up.

In September 2000, Varian Semiconductor and Applied Materials settled a patent infringement and antitrust litigation. After recording a payment to Applied Materials and legal expenses, Varian Semiconductor recorded a gain of $16.0 million ($10.8 million after taxes) relating to this litigation settlement. Varian Semiconductor maintains a provision to cover any residual indemnification obligations described above. Included in current liabilities and classified as an estimated loss contingency was $2.7 million as of March 28, 2003 and September 27, 2002.

Varian Semiconductor has agreed to indemnify VMS and VI for any costs, liabilities or expenses relating to Varian Semiconductor’s legal proceedings, including the Applied Materials matters. Under the Distribution Related Agreements, Varian Semiconductor has agreed to reimburse VMS for one-third of the costs, liabilities, and expenses, adjusted for any related tax benefits recognized or realized by VMS, with respect to certain legal proceedings relating to discontinued operations of VMS. We believe the estimated fair value of the indemnification agreements is minimal, except as already recorded on the financial statements.

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

Varian Semiconductor is currently the plaintiff in several legal disputes related to breach of contract and certain patents that the Company 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.

On December 19, 2001, Varian Semiconductor and Lam resolved the patent infringement litigation between the two parties, which was originally filed in October 1993, by Varian Semiconductor granting Lam a license under certain patents. Additionally, all claims and counterclaims have been dismissed in accordance with the agreement. The lawsuit involved Varian Semiconductor’s assertion that Lam infringed three Varian patents that relate to the use of low pressure gas to assist in the heating and cooling of semiconductor

wafers during various manufacturing processes, and Lam’s denial that the patents are valid or infringed. Under the agreement, Varian Semiconductor has granted a license to Lam for the patents in return for the payment of $20.0 million, with $5.0 million paid immediately in exchange for prior use of the patents. The remaining $15.0 million is to be paid in 12 quarterly installments through December 2004 and is in exchange for future use of the patents. As further payment for past royalties, Lam issued to Varian Semiconductor a warrant to purchase 2,000,000 shares of Lam common stock for $21.30 per share, exercisable at any time prior to December 31, 2005. The fair value of the warrant was $22.8 million upon receipt on December 19, 2001, based on an independent third party valuation, and has been recognized as royalty and license revenue. In addition, the $5.0 million cash payment was recognized as royalty and license revenue during fiscal year 2002 and the remaining $15.0 million in cash payments to be received will be recognized as royalty and license revenue when due. Under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” the warrant was treated as a derivative and was measured at fair value at each balance sheet date. During fiscal year 2002, a gain was recorded in other income in the amount of $5.1 million to reflect the change in fair value of the warrant. On April 1, 2002, Varian Semiconductor completed the sale of the Lam warrant to an unrelated third party for $28.0 million in cash.

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 2002, Varian Semiconductor recognized $5.4 million in restructuring costs, of which $2.2 million was recognized in the first quarter and $3.2 million was recognized in the fourth quarter. The majority of the restructuring charges relate to termination costs for a total reduction in force of 296 employees in fiscal year 2002. There were also charges associated with closing an office and relocating another office. During the second quarter of fiscal 2003, Varian Semiconductor recognized approximately $0.2 million in restructuring costs related to a select reduction in headcount. The restructuring costs were severance related and were paid during the second quarter of fiscal year 2003. The majority of the restructuring reserve balance of $0.5 million as of March 28, 2003 is expected to be utilized by June 2003.

Below is a table summarizing the restructuring reserve activity in fiscal year 2002 and the first six months of fiscal 2003:

The restructuring reserve of $0.5 million is included in accrued expenses on the balance sheet.

Varian Semiconductor has an agreement with two banks to sell specific receivables, subject to recourse provisions. There were no receivables sold under these arrangements during the first six months of fiscal year 2003. During the first six months of fiscal year 2002 approximately $4.9 million of receivables were sold under these arrangements. As of March 28, 2003 there were no receivables sold to the bank outstanding. As of September 27, 2002, approximately $4.5 million of receivables sold to the bank remained outstanding. Varian Semiconductor has not recorded any asset or liability in connection with these agreements. Varian Semiconductor does not believe it is materially at risk for any losses as a result of this agreement.

Varian Semiconductor uses derivative instruments to protect its interests from fluctuations in earnings and cash flows caused by volatility in currency exchange rates. Varian Semiconductor continued its policy of hedging its current exposures and in the second quarter of fiscal year 2003 began to hedge a portion of its anticipated foreign currency exposures with hedging instruments having terms of up to twelve months.

Varian Semiconductor’s international sales are primarily denominated in United States dollars. For foreign currency denominated sales, however, the volatility of the foreign currency markets represents risk to Varian Semiconductor. Upon forecasting the exposure, Varian Semiconductor enters into hedges with forward sales contracts whose critical terms are designed to match those of the underlying exposure. These hedges are evaluated for effectiveness at least quarterly using the change in value of the forward contracts to the change in value of the underlying transaction, with the effective portion of the hedge accumulated in Other Comprehensive Income (“OCI”). Any measured ineffectiveness is included immediately in marketing, general and administrative expenses in the consolidated statements of operations. There has been no amount of ineffectiveness recognized during the period. OCI associated with hedges of sales denominated in foreign currencies are reclassified to revenue upon recognition in income of the underlying hedged exposure. All amounts reported in OCI at March 28, 2003 are anticipated to be reclassified to revenue within six months. OCI activity during the year (in thousands):

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

This Form 10-Q contains certain forward-looking statements. For purposes of the safe harbor provisions under The Private Securities Litigation Reform Act of 1995, any statements using the terms “believes”, “anticipates”, “expects”, “plans” or similar expressions, are forward-looking statements. The forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected. There are a number of important factors that could cause Varian Semiconductor’s actual results to differ materially from those indicated by forward-looking statements made in this report and presented by management from time to time. Some of the important risks and uncertainties that may cause Varian Semiconductor’s financial results to differ are under the heading “Risk Factors” in this report and in the annual report on Form 10-K for the fiscal year ended September 27, 2002, filed with the Securities and Exchange Commission on December 13, 2002.

The following information should be read in conjunction with the unaudited interim consolidated financial statements and notes thereto included in “Item 1.—Consolidated Financial Statements” of this quarterly report and the audited combined financial statements and notes thereto and the section titled “Item 7.—Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Varian Semiconductor’s annual report on Form 10-K for the fiscal year ended September 27, 2002 filed with the Securities and Exchange Commission on December 13, 2002.

Critical Accounting Policies and Significant Judgments and Accounting Estimates

Varian Semiconductor’s discussion and analysis of its financial condition and results of operations are based upon Varian Semiconductor’s consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States. The preparation of these consolidated financial statements requires Varian Semiconductor to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On a continual basis, Varian Semiconductor evaluates its estimates, including those related to inventories, accounts receivable, intangible assets, income taxes, warranty obligations, post-retirement benefits, contingencies, and functional currencies. Varian Semiconductor operates in a highly cyclical and competitive industry that is influenced by a variety of diverse factors including, but not limited to, technological advances, product life cycles, customer and supplier lead times, and macroeconomic and geographic economic trends. Estimating product demand beyond a relatively short forecasting horizon is difficult and prone to forecasting error due to the cyclical nature and inherent lack of visibility in the industry. Varian Semiconductor bases its estimates on historical experience, and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. See also the factors discussed below under the section titled “Risk Factors.”

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

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 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, commercially inconsequential and perfunctory (due to the fact that the acceptance provisions are generally a replication of pre-shipment procedures) and there is an established history of installations. The majority of products are designed and manufactured to meet contractual customer specifications. To ensure customer specifications are satisfied, the systems are tested at Varian Semiconductor’s manufacturing facility prior to shipment. To the extent that customers’ conditions can not be replicated in

Varian Semiconductor’s facilities or if there is not a demonstrated history of meeting newer customer specifications, then the product is treated as new for revenue recognition purposes.

Service revenue includes revenue from maintenance and service contracts, paid service and installation services. Revenue related to maintenance and service contracts is recognized ratably over the duration of the contracts. Revenue related to paid service is recorded when earned and revenue related to installation is recorded upon fulfillment of the service obligation. Royalty and license revenue is recognized when contractual obligations are met, evidence of an arrangement exists, fees are fixed or determinable and collection is reasonably assured.

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

Varian Semiconductor’s transactions frequently include the sale of systems and services under multiple element arrangements. Revenue under these arrangements is allocated to all elements, except systems, based upon the fair market value of those elements. The amount allocated to installation is based upon hourly rates at the estimated time to complete the service. The fair value of all other elements is based upon the price charged when these amounts are sold separately and unaccompanied by other elements. The amount of revenue allocated to systems is done on a residual method basis. Under this method, the total value of the arrangement is allocated first to the undelivered elements based on their fair values, with the remainder being allocated to systems revenue. Installation is not essential to the functionality of the system, as these services do not alter the equipment’s capabilities.

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. Varian Semiconductor also reserves against those open purchase order commitments in which Varian Semiconductor’s estimated obligation to receive inventory under these commitments exceeds expected production demand. These assumptions include, but are not limited to, future manufacturing schedules, customer demand, supplier lead time and technological and market obsolescence. If market conditions are less favorable than those projected by management, additional inventory provisions may be required. If market conditions are more favorable than those projected by management and specific products previously reserved against are subsequently sold, gross profit would improve by the amount of the specific reserve in the quarter the product is sold.

Varian Semiconductor maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments for products and services. Accounts with known financial issues are first reviewed and specific estimates are recorded. The remaining accounts receivable balances are then grouped in categories by the amount of days the balance is past due and the estimated loss is calculated as a percentage of the total category based upon past history. If the financial condition 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.

As required by Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes,” Varian Semiconductor evaluates the positive and negative evidence bearing upon the realizability of its deferred tax assets. Varian Semiconductor has considered taxable income that can be carried back, future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance and has concluded that no valuation allowance is required at this time. An adjustment to deferred tax assets would be charged to income in the period such determination was made, if Varian Semiconductor determined that it would not be able to realize all or part of its deferred tax assets in the future.

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

supplier warranties on parts differ from Varian Semiconductor’s estimates, revisions to the estimated warranty liability would be required.

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

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

Varian Semiconductor’s business is highly cyclical and depends upon the capital expenditures of semiconductor manufacturers, which in turn depend on the current and anticipated market demand for integrated circuits and products utilizing integrated circuits. In the last two years, semiconductor equipment manufacturers have experienced a significant contraction in the demand for products due to the slowdown in economies worldwide, specifically the slowdown in technology sectors which utilize integrated circuits.

Revenue. The following table sets forth revenue by category for the three and six month periods ended March 28, 2003 and March 29, 2002.

During the second quarter and first six months of fiscal year 2003, the increase in product revenue was the result of an increase in demand for ion implanters, particularly the VIISta 810HP, Varian Semiconductor’s latest medium current machine, that was first shipped during the second quarter of fiscal year 2002. Demand for product parts also increased as warranties covering machines expired.

Service revenue during the second quarter of fiscal year 2003 decreased primarily due to decreased machine acceptances compared to the same period a year ago. Service revenue for the six months ended March 28, 2003 increased due to increased machine acceptances in the first quarter of fiscal year 2003, which was partially offset by the decrease in machine acceptances during the second quarter of fiscal year 2003.

Pursuant to the terms of a Settlement and License Agreement between Varian Semiconductor and Lam Research Corporation (“Lam”), Varian Semiconductor received, during the first quarter of fiscal year 2002, a warrant to purchase 2,000,000 shares of Lam common stock at $21.30 per share and a $5.0 million cash payment in exchange for prior use of certain Varian Semiconductor patents. Total royalty and license revenue recognized from Lam during the first quarter of fiscal year 2002 includes the warrant, which was valued at $22.8 million, and the $5.0 million cash payment received. Lam continues to make quarterly cash payments of $1.25 million, which are included in the royalty revenue in the first and second quarters of fiscal year 2003. Lam is required to make quarterly cash payments of $1.25 million through December 2004 for future use of the patents. Quarterly cash payments are recognized as royalty and license revenue in the period they become due.

The following table reflects revenue by continent for the three and six month periods ended March 28, 2003 and March 29, 2002, including the Lam royalty and license revenue of $27.8 million recognized during the first quarter of fiscal year 2002.

Product revenue increased across all regions for the second quarter of fiscal year 2003 compared to the second quarter of fiscal year 2002, as a result of increased demand for new machines to be utilized in manufacturing advanced devices, particularly the VIISta 810HP.

Revenue for the third quarter of fiscal year 2003 is currently estimated to decrease from the $111.2 million recognized in the second quarter of fiscal year 2003 due to continued softening of capital expenditure spending. At this time, demand beyond the third quarter remains difficult to forecast, as visibility is limited by the cyclical nature of the industry. Fluctuations in the timing and mix of product shipments, customer requirements for systems, and the completion of the installation of the product have a significant impact on revenue (see also “Risk Factors” and “Critical Accounting Policies—Revenue Recognition”).

Cost of Product and Service Revenue. Cost of product revenue was $60.2 million and gross margin was 36% for the second quarter of fiscal year 2003, as compared to the cost of product revenue of $32.1 million and gross margin of 33% for the second quarter of fiscal year 2002. Gross margin in the second quarter of fiscal year 2003 increased as a result of higher factory utilization and improved inventory management, including a reduction in inventory reserves totaling $1.2 million, partially offset by continued pricing pressure in the industry. Cost of product revenue was $97.7 million and gross margin was 37% for the first half of fiscal year 2003, as compared to the cost of product revenue of $61.6 million and gross margin of 25% for the first half of fiscal year 2002. The increase in gross margin for the six month period ended March 28, 2003 was primarily the result of the sale of specific inventories previously reserved, favorable factory operations and improved supply chain management, which required Varian Semiconductor to reduce the associated supply chain and inventory-related reserves by approximately $4.2 million. During the first six months of fiscal year 2002, Varian Semiconductor recorded approximately $8.4 million of supply chain and inventory-related charges as a result of reduced business projections. Varian Semiconductor has historically, and may in the future, sustain inventory-related charges resulting from changes in customers’ purchase commitments due to Varian Semiconductor’s manufacturing lead times. Cost of service revenue was $9.3 million and gross margin was 38% for the second quarter of fiscal year 2003, as compared to a cost of service revenue of $10.6 million and gross margin of 38% for the second quarter of fiscal year 2002. Cost of service revenue was $20.1 million and gross margin was 42% for the six-month period ended March 28, 2003, as compared with $18.8 million and gross margin of 40% for the six-month period ended March 29, 2002. The increase in gross margin of 2% for cost of service revenue for the six month period ended March 28, 2003, was primarily a result of improvements in the system installation process resulting in reduced field costs. Overall gross margin is expected to increase in the third quarter of fiscal year 2003 as compared to the second quarter of fiscal year 2003. The anticipated increase in margin is expected to reflect benefits from both tight inventory management and the final portion of revenue recognized upon system acceptance.

Research and Development. Research and development expenses were $14.4 million for the second quarter of fiscal year 2003, as compared to $12.6 million for the second quarter of fiscal year 2002. For the six month period ended March 28, 2003, research and development expenses were $28.0 million, as compared to $25.5 million for the same period a year ago. The increase was a result of increased labor and material spending associated with new products. Varian Semiconductor continues to be committed to investment in product development, particularly the ongoing shift to 300mm implanters, factory automation, and the transition to advanced

technology nodes. Research and development expenses are expected to increase in the third quarter of fiscal 2003 as Varian Semiconductor intends to continue to increase its investment in research and development.

Marketing, General and Administrative. Marketing, general and administrative expenses were $19.8 million for the second quarter of fiscal year 2003, as compared to $18.4 million in the same period in 2002. For the first six months of fiscal 2003, marketing, general and administrative expenses were $38.7 million as compared to $37.4 million in the first six months of fiscal 2002. The increase was the result of additional marketing expenses in the second quarter of fiscal 2003, including demonstration tool costs.

Restructuring Costs. During the second quarter of fiscal 2003, Varian Semiconductor recognized approximately $0.2 million in restructuring costs related to reductions in headcount. The restructuring costs were severance-related and were paid during the second quarter of fiscal year 2003. Varian Semiconductor recognized $2.2 million in restructuring costs during the first quarter of fiscal year 2002. The restructuring costs were primarily severance-related with $2.0 million and $0.2 million paid during the first and second quarter of fiscal year 2002, respectively.

Interest Income. During the second quarter of fiscal year 2003, Varian Semiconductor earned $1.0 million in interest income as compared with $1.3 million for the second quarter of fiscal year 2002. During the six-month period ended March 28, 2003, Varian Semiconductor earned $2.2 million in interest income as compared with $2.9 million for the same period a year ago. Despite increased cash and investment balances, interest income decreased compared to the prior year’s due to lower short-term interest rates.

Other (Loss) Income. During the second quarter and six month period ended March 28, 2003, Varian Semiconductor recorded a loss of $0.2 million and $0.1 million, respectively. During the second quarter and six month period ended March 29, 2002, Varian Semiconductor recorded a gain of $4.7 million and $5.1 million, respectively, in other income to reflect the fair value accounting of the Lam warrant. Varian Semiconductor received a warrant to purchase shares of Lam common stock on December 19, 2001 (See also Note 15. Settlement and License Agreement). The warrant was treated as a derivative and was measured at fair value. A $0.4 million gain was recorded in other income during the first quarter of fiscal year 2002 to reflect fair value accounting for the warrant.

Provision for (Benefit from) Income Taxes. Varian Semiconductor’s effective income tax rate was 33% in the second quarter of fiscal year 2003 with a benefit from income taxes of $0.5 million in the second quarter of fiscal year 2002. Varian Semiconductor’s effective income tax rate was 33% in the six-month period ended March 28, 2003, as compared with 34% in the first six months of fiscal year 2002. Future effective tax rates may vary from the historic rates depending on the worldwide allocation of earnings and the continuing availability of the extraterritorial income exclusion.

Net Income (Loss). As a result of the foregoing factors, in the second quarter of fiscal year 2003, Varian Semiconductor recorded net income of $5.5 million as compared to net loss of $41 thousand for the second quarter of fiscal year 2002. The net income per diluted share was $0.16 for the second quarter of fiscal year 2003 as compared to net loss per diluted share of $0.00 for the second quarter of fiscal year 2002. For the six month period ended March 28, 2003, Varian Semiconductor recorded net income of $8.3 million and $0.24 per diluted share, as compared with net income of $5.0 million and $0.14 per diluted share in the same period of fiscal year 2002. Net income and net income per share are currently estimated to decrease from the second quarter of fiscal year 2003 due to continued softening of capital expenditure spending.

Varian Semiconductor generated $37.5 million of cash from operations during the first six months of fiscal year 2003 as compared to $12.3 million during the first six months of fiscal year 2002. Cash provided by operations in the first six months of fiscal year 2003 was derived primarily from the decreases in accounts receivable of $25.7 million and inventory of $23.0 million and net income of $8.3 million. These decreases were partially offset by a decrease in deferred revenue of $27.7 million. In the first six months of fiscal year 2002, cash provided by operations was primarily a result of a decrease in accounts receivable of $39.4 million and a decrease in inventory of $20.0 million. The increase to cash during the first six months of fiscal year 2002 was partially offset by non-cash considerations of $22.8 million in royalty and license income, and a decrease in deferred revenue of $31.4 million.

Varian Semiconductor used $21.5 million for the purchase of short-term investments during the first six months of fiscal year 2003. In February 2003, Varian Semiconductor purchased its facility located in Newburyport, Massachusetts for approximately $9.3 million, using approximately $3.4 million of cash. Varian Semiconductor had previously leased the facility from the seller. As part of this purchase, Varian Semiconductor assumed the seller’s outstanding loan on the property of approximately $5.1 million. Overall, Varian Semiconductor used $6.9 million and $5.7 million of cash for investing activities and for the purchase of property, plant and equipment, during the six-month period ended March 28, 2003 and the six month period ended March 29, 2002, respectively.

During the six-month period ended March 28, 2003, Varian Semiconductor generated $4.5 million of cash from financing activities, primarily due to the issuance of stock upon the exercise of stock options and the Employee Stock Purchase Plan, offset by repayments on short-term borrowings. During the first six months of fiscal year 2002, $2.6 million of cash was used by financing activities, primarily due to repayments of short-term borrowings of $4.7 million. This was partially offset by $2.1 million from the issuance of stock upon the exercise of stock options. As noted above and further described below, as part of the purchase of the Newburyport facility, the loan on the property of approximately $5.1 million was assumed by Varian Semiconductor.

Under GAAP, certain obligations and commitments are not required to be included in the consolidated balance sheets and statements of operations. 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 March 28, 2003 have not been included in the consolidated balance sheets and statements of operations included under Item 1. Consolidated Financial Statements, however, they have been disclosed in the following table in order to provide a more accurate picture of Varian Semiconductor’s financial position and liquidity. 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.

balance or the excess of the present value of all future loan payments over the outstanding principal balance of the loan. The loan is secured by the property. The loan payments are as follows:

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 and short-term investments of $343.1 million at March 28, 2003 will be sufficient to satisfy working capital requirements, commitments for capital expenditures and other purchase commitments and cash requirements for the foreseeable future.

The unaudited interim consolidated financial statements of Varian Semiconductor reflect the financial position, results of operations and cash flows of Varian Semiconductor as of and for the three months and six months ended March 28, 2003 and March 29, 2002.

Operations prior to April 2, 1999 had been part of the former Varian Associates, Inc. (“VAI”). (See also Note 12 in the Notes to the Consolidated Financial Statements.) On April 2, 1999, VAI contributed its Semiconductor Equipment Business (“SEB”) to Varian Semiconductor, then distributed to the holders of record of VAI common stock one share of common stock of Varian Semiconductor for each share of VAI common stock owned on March 24, 1999. At the same time, VAI contributed its Instruments Business (“IB”) to Varian, Inc. (“VI”) and distributed to the holders of record of VAI common stock one share of common stock of IB for each share of VAI common stock owned on March 24, 1999. VAI retained its Health Care Systems business and changed its name to Varian Medical Systems, Inc. (“VMS”) effective as of April 2, 1999. These transactions were accomplished under the terms of a Distribution Agreement by and among Varian Semiconductor, VAI, hereafter referred to as VMS for periods following the spin-off and VI (the “Distribution Agreement”). For purposes of providing an orderly transition and to define certain ongoing relationships between and among Varian Semiconductor, VMS and VI after the spin-off Varian Semiconductor, VMS and VI also entered into certain other agreements which include an Employee Benefits Allocation Agreement, an Intellectual Property Agreement, a Tax Sharing Agreement and a Transition Services Agreement (collectively, the “Distribution Related Agreements”).

The Distribution Related Agreements provide that, from and after the spin-off, VMS, VI, and Varian Semiconductor will indemnify each and their respective subsidiaries, directors, officers, employees and agents against all losses arising in connection with shared liabilities (including certain environmental and legal liabilities). All shared liabilities will be managed and administered by VMS and expenses and losses, net of proceeds and other receivables, will be borne one-third each by VMS, VI, and Varian Semiconductor. The Distribution Related Agreements also provide that Varian Semiconductor shall assume all of its liabilities, other than shared liabilities (including accounts payable, accrued payroll, and pension liabilities) in accordance with their terms. During the first six months of fiscal years 2003 and 2002, Varian Semiconductor was charged by VMS $0.8 million and $2.8 million, respectively, in settlement of these obligations.

In June 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue (“EITF”) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)” (“EITF 94-3”). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. EITF 94-3 allowed for an exit cost liability to be recognized at the date of an entity’s commitment to an exit plan. SFAS No. 146 also requires that

liabilities recorded in connection with exit plans be initially measured at fair value. SFAS No. 146 will be effective for exit or disposal activities that are initiated after December 31, 2002. Varian Semiconductor adopted SFAS No. 146 in the second quarter of fiscal year 2003.

Varian Semiconductor does not expect the adoption of the above mentioned pronouncements to have a material impact on Varian Semiconductor’s consolidated financial statements.

The semiconductor industry is cyclical, and a slowdown in demand for Varian Semiconductor’s semiconductor manufacturing equipment has negatively affected financial results.

The semiconductor industry has been cyclical in nature and has historically experienced periodic downturns. The industry is currently experiencing extreme volatility in product pricing and a slowdown in product demand. Volatility and slowdowns have resulted in significant reductions and delays in the purchase of semiconductor manufacturing equipment and the construction of new fabrication facilities which has significantly harmed Varian Semiconductor’s financial results. Even though Varian Semiconductor’s revenues have declined, in order to remain competitive, Varian Semiconductor continues to invest in research and development and to maintain its worldwide customer service and support capability. These developments have adversely affected Varian Semiconductor’s financial results and could continue to adversely affect financial results. If the downturn in the semiconductor industry continues, the decrease in demand for Varian Semiconductor’s products will continue to adversely affect its financial results.

Varian Semiconductor faces intense competition in the semiconductor equipment industry.

Significant competitive factors in semiconductor equipment manufacturing include the strength of customer relationships, pricing, technological performance and timing, distribution capabilities and financial viability. Varian Semiconductor believes that in order to

remain competitive in this industry, it will need to devote significant financial resources to product and process research and development, to offering and marketing a broad range of products, and to maintaining and enhancing customer service and support centers worldwide. The semiconductor equipment industry is becoming increasingly dominated by large manufacturers who have resources to support customers worldwide, and some of Varian Semiconductor’s competitors have substantially greater financial resources and more extensive engineering, manufacturing, marketing, service and support than 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, some smaller equipment manufacturers provide innovative technology which may have performance advantages over Varian Semiconductor’s systems. If these manufacturers continue to improve their product performance and pricing, enter into strategic relationships or consolidate with large equipment manufacturers, sales of Varian Semiconductor’s products may suffer.

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

Varian Semiconductor has historically sold at least half of its systems in any particular quarter to its ten largest customers, some of which include AMD, IBM, Infineon, Intel, Micron, Samsung, Texas Instruments, TSMC and UMC. Some of these customers have individually accounted for more than ten percent of Varian Semiconductor’s total revenue. Varian Semiconductor expects that sales of its products to relatively few customers will continue to account for a high percentage of its revenue in the foreseeable future. Furthermore, Varian Semiconductor may have difficulty attracting additional large customers because its sales depend, in large part, upon the decision of a prospective customer to increase manufacturing capacity in an existing fabrication facility or to transfer a manufacturing process to a new fabrication facility, both of which typically involve a significant capital commitment. Once a semiconductor manufacturer has selected a particular supplier’s capital equipment, the manufacturer generally relies upon that equipment for the specific production line application and frequently will attempt to consolidate its other capital equipment requirements with the same supplier. Consequently, Varian Semiconductor may experience difficulty in selling to a prospective customer if that customer initially selects a competitor’s capital equipment.

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

Varian Semiconductor has experienced and expects to continue to experience significant fluctuations in its quarterly financial results. From time to time, customers may accelerate, postpone, or cancel shipments, or production difficulties could delay shipments. A cancellation, delay in shipment or delay in customer acceptance of the product upon installation in any quarter may cause revenue in such quarter to fall significantly below expectations, which could cause the market price of Varian Semiconductor’s common stock to decline. Varian Semiconductor’s financial results also fluctuate based on gross profit realized on sales. Gross profit as a percentage of revenue may vary based on a variety of factors, including the mix and average selling prices of products sold and costs to manufacture and customize systems. In addition, a number of other factors could impact Varian Semiconductor’s quarterly financial results, including, but not limited to the following:

Because Varian Semiconductor’s operating expenses are based on anticipated capacity levels, and a high percentage of Varian

Semiconductor’s expenses are relatively fixed, a variation in the timing of recognition of revenue and the level of gross profit from a single transaction could cause financial results to vary significantly from quarter to quarter.

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

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

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

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

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

International revenue has accounted for 61%, 71%, and 73% of Varian Semiconductor’s revenue in fiscal years 2002, 2001, and 2000, respectively, and specifically, revenue in Asia has accounted for a substantial portion of this revenue. Sales to Asia accounted for 44%, 50%, and 53% of revenue in fiscal years 2002, 2001, and 2000, respectively. Because Varian Semiconductor relies on sales to customers in Asia for a substantial portion of its revenue, its business is very likely to be adversely impacted by economic downturns and instability in that region. Varian Semiconductor’s business in Asia is affected by demand in each country. In addition, international sales are subject to risks, including, but not limited to:

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:

Varian Semiconductor also has agreements with third parties for licensing of patented or proprietary technology. These agreements include royalty bearing licenses and technology cross-licenses. Varian Semiconductor’s loss of licensing agreements with Applied Materials, Tokyo Electron Limited and Lam, could have a material adverse effect on its business.

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

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

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

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

Varian Semiconductor obtains some of its components and subassemblies included in its products from a limited group of 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 its products. The need to change suppliers or to alternate between suppliers might cause delays in delivery or significantly increase Varian Semiconductor’s costs. Although Varian Semiconductor has nominal insurance to protect against loss due to business interruption from these and other sources, Varian Semiconductor cannot provide assurance that such coverage will be adequate or that it will remain available on commercially acceptable terms. Although Varian Semiconductor seeks to reduce its dependence on these limited source suppliers, disruption or loss of these sources could negatively impact its business and damage customer relationships.

Varian Semiconductor’s indemnification obligations under the Distribution Agreement could be substantial, and Varian Semiconductor may not be fully indemnified in accordance with this agreement for the expenses it incurs.

Under the terms of the Distribution Agreement, each of VMS, 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 Agreement generally provides that if a court prohibits a company from satisfying its indemnification obligations, then such obligations will be shared equally by the other companies.

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

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

VAI has been named by the U.S. Environmental Protection Agency and third parties as a potentially responsible party under the Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended (“CERCLA”), at eight sites where VAI is alleged to have shipped manufacturing waste for recycling or disposal. VAI is also in various stages of environmental investigation and or remediation under the direction of, or in consultation with foreign, federal, state and local agencies at certain current or former VAI facilities (including facilities disposed of in connection with VAI’s sale of its Electron Devices business during fiscal year 1995, and the sale of its TFS business during fiscal year 1997). The Distribution Agreement provides that each of VMS, Varian Semiconductor and VI will indemnify the others for one-third of these environmental investigation and remediation costs, as adjusted for any insurance proceeds and tax benefits expected to be realized upon payment of these costs.

For certain of these sites and facilities, various uncertainties make it difficult to assess the likelihood and scope of further investigation or remediation activities or to estimate the future costs of such activities if undertaken. Varian Semiconductor has accrued $1.8 million in estimated environmental investigation and remediation costs for these sites and facilities as of September 27, 2002. 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 $5.1 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 $1.8 million previously described. Varian Semiconductor’s portion of total expenditures for environmental investigation and remediation amounted to $0.5 million in fiscal year 2002, $0.8 million in fiscal year 2001, and $1.2 million in fiscal year 2000.

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

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

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

An important element of Varian Semiconductor’s management strategy is to review acquisition prospects that would complement existing products, augment market coverage and distribution ability, or enhance technological capabilities. In the future, Varian Semiconductor may make acquisitions of complementary companies, products or technologies, or may reduce or dispose of certain product lines or technologies, which no longer fit Varian Semiconductor’s long-term strategies. Managing an acquired business,

disposing of product technologies or reducing personnel entail numerous operational and financial risks, including difficulties in assimilating acquired operations and new personnel or separating existing business or product groups, diversion of management’s attention to other business concerns, amortization of acquired intangible assets, the incurrence of debt and contingent liabilities and potential loss of key employees or customers of acquired or disposed operations, among others. Varian Semiconductor’s success will depend, to a significant extent, on the ability of its executive officers and other members of its senior management to identify and respond to these challenges effectively. In addition, any acquisitions could result in dilutive issuances of equity securities. There can be no assurance that Varian Semiconductor will be able to achieve and manage successfully any such growth, decline, integration of potential acquisitions, disposition of product lines or technologies, or reduction in personnel or that management, personnel or systems will be adequate to support continued operations. Any such inabilities or inadequacies would have a material adverse effect on Varian Semiconductor’s business, operating results, financial condition, cash flows and/or the price of Varian Semiconductor common stock.

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

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

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

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

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

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

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

Varian Semiconductor has not paid and does not anticipate paying dividends on its common stock. Varian Semiconductor’s Board of Directors will have discretion to make decisions to pay dividends to common stockholders in the future. 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.

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

Varian Semiconductor hedges currency exposures that are associated with certain of its assets and liabilities denominated in various non-U.S dollar denominated currencies. The aggregate exchange loss was immaterial for the second quarter and first half of fiscal year 2003.

Forward exchange contracts outstanding as of March 28, 2003 are summarized as follows (amounts in thousands):

Varian Semiconductor also hedges currency exposures that are associated with certain of its product sales denominated in Japanese Yen. In accordance with Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” these forward foreign exchange contracts are designated as hedges of anticipated product sales, and accordingly, the gains and losses resulting from the impact of currency rate movements on these contracts are not recognized in income until the underlying hedged transactions are recognized. Upon recognition, such gains and losses are recorded in revenue as an adjustment to the carrying amount of the underlying transactions in the period in which these transactions are recognized. Should the hedged anticipated product sales not occur within two months of the expiration of the forward foreign exchange contract, any unrealized gain or loss would be recorded in other (loss) income. There were no forward foreign exchange contracts designated as hedges of anticipated product sales in Japanese Yen outstanding at March 28, 2003.

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 securities, and investment quality municipal securities as well as short-term time deposits with investment-grade financial institutions. Cash equivalents at March 28, 2003 and September 27, 2002 were $316.5 million and $305.2 million, respectively. At March 28, 2003, Varian Semiconductor’s short-term investments were $21.5 million and consist of certificates of deposit that are less than nine months. Short-term investments at March 28, 2003 were $21.5 million. There were no short-term investments at September 27, 2002.

During the second quarter of fiscal year 2003, revenue from three customers accounted for 26%, 16% and 14% 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 second quarter of fiscal year 2002, revenue from three customers accounted for 24%, 23% and 11% of Varian Semiconductor’s total revenue. During the first six months of fiscal year 2003, revenue from two customers accounted for 20% and 13% of Varian Semiconductor’s total revenue. During the first six months of fiscal year 2002, Lam accounted for 20% of total revenue and three other customers, each representing 10% or greater of total revenue, accounted for an additional 37% of total revenue. (See also Note 15. Settlement and License Agreement.)

As of March 28, 2003, two customers, each representing 10% or greater of the total accounts receivable balance, accounted for 47% of the total accounts receivable balance. As of March 29, 2002, two customers, each representing 10% or greater of the total accounts receivable balance, accounted for 38% of the total accounts receivable balance.

(a) Evaluation of disclosure controls and procedures. Based on their evaluation of the Company’s disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) as of a date within 90 days of the filing date of this Quarterly Report on Form 10-Q, the Company’s chief executive officer and chief financial officer have concluded that the Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed by the 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 and are operating in an effective manner.

(b) Changes in internal controls. There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their most recent evaluation.

Information required by this Item is provided in Note 14. Commitments and Contingencies to the Unaudited Interim Consolidated Financial Statements.

The following items were submitted to a vote of the stockholders at the 2003 Annual Meeting of Stockholders of Varian Semiconductor held on January 28, 2003: (1) the election of two nominees as Class I Directors, each to a three year term expiring at the 2006 Annual Meeting of Stockholders; (2) the approval of an amendment of Varian Semiconductor’s Employee Stock Purchase Plan to increase the number of shares of Common Stock available for issuance under the plan by 250,000 shares; and (3) the ratification of PricewaterhouseCoopers LLP as Varian Semiconductor’s independent accountants for the fiscal year ending October 3, 2003. The number of shares of common stock eligible to vote as of the record date of December 9, 2002 was 34,039,026 shares. Each of these matters were approved by the requisite vote of the stockholders. Set forth below is the number of votes cast for, against, or withheld, as well as the number of abstentions as to each matter, including a separate tabulation with respect to each nominee for director.

Proposal 1—To elect two Class I Directors each to a three year term expiring at the 2006 Annual Meeting of Stockholders.

Proposal 2—To approve the amendment of Varian Semiconductor’s Employee Stock Purchase Plan to increase the number of shares of Common Stock available for issuance under the plan by 250,000 shares.

Proposal 3—To ratify and approve the selection by the Board of Directors of PricewaterhouseCoopers LLP as Varian Semiconductor’s independent accountants for the fiscal year ending October 3, 2003.

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.

By:

/s/ ROBERT J. HALLIDAY

Robert J. Halliday

Vice President and Chief Financial Officer

(Principal Financial Officer and Duly Authorized Officer)

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)

ITEM NUMBER		PAGE NUMBER
PART I.	FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements
	Consolidated Balance Sheets at March 28, 2003 and September 27, 2002	1
	Consolidated Statements of Operations for the three and six month periods ended March 28, 2003 and March 29, 2002	2
	Consolidated Statements of Cash Flows for the six month periods ended March 28, 2003 and March 29, 2002	3
	Notes to the Consolidated Financial Statements	4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	14
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	27
Item 4.	Controls and Procedures	28

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	29
Item 2.	Changes in Securities and Use of Proceeds	29
Item 3.	Defaults Upon Senior Securities	29
Item 4.	Submission of Matters to a Vote of Security Holders	29
Item 5.	Other Information	29
Item 6.	Exhibits and Reports on Form 8-K	30

Signatures.		31

	March 28, 2003		September 27, 2002
	(Amounts in thousands, except share data)
ASSETS
Current assets
Cash and cash equivalents	$	321,595	$	307,840
Short-term investments		21,548		—
Accounts receivable, net		61,144		85,793
Inventories		60,632		81,779
Deferred income taxes		42,153		42,311
Other current assets		9,171		9,530

Total current assets		516,243		527,253
Property, plant and equipment, net		49,397		46,718
Goodwill, net		12,280		12,280
Other assets		3,093		3,254

Total assets	$	581,013	$	589,505


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Notes payable and other short-term borrowings	$	5,433	$	5,779
Accounts payable		21,523		21,398
Accrued expenses		46,283		48,560
Product warranty		9,205		8,656
Deferred revenue		32,984		60,269

Total current liabilities		115,428		144,662
Long-term accrued expenses		5,649		5,674
Deferred income taxes		2,933		2,933
Long-term debt		4,732		—

Total liabilities		128,742		153,269


Commitments and contingencies (Note 14)

Stockholders’ equity
Preferred stock, $0.01 par value; 5,000,000 shares authorized, none issued		—		—
Common stock, $0.01 par value; 150,000,000 shares authorized, 34,164,803 issued and outstanding at March 28, 2003, and 33,821,277 issued and outstanding at September 27, 2002		342		338
Capital in excess of par value		271,163		263,470
Retained earnings		180,733		172,428
Other comprehensive income		33		—

Total stockholders’ equity		452,271		436,236

Total liabilities and stockholders’ equity.	$	581,013	$	589,505

	Fiscal Three Months Ended						Fiscal Six Months Ended
	March 28, 2003			March 29, 2002			March 28, 2003			March 29, 2002
	(Amounts in thousands, except per share data)
Revenue
Product	$	94,144		$	47,868		$	156,084		$	82,006
Service.		15,083			17,176			34,403			31,208
Royalty		1,972			2,174			4,421			31,784

Total revenue		111,199			67,218			194,908			144,998

Cost of revenue
Product		60,152			32,088			97,696			61,608
Service.		9,346			10,626			20,066			18,803

Total cost of revenue		69,498			42,714			117,762			80,411

Gross profit		41,701			24,504			77,146			64,587


Operating expenses
Research and development		14,410			12,632			27,979			25,482
Marketing, general and administrative		19,773			18,417			38,704			37,365
Restructuring		158			—			158			2,200

Total operating expenses		34,341			31,049			66,841			65,047

Operating income (loss)		7,360			(6,545	)		10,305			(460	)
Interest income, net		991			1,316			2,227			2,936
Other (loss) income, net		(193	)		4,709			(135	)		5,149

Income (loss) before income taxes.		8,158			(520	)		12,397			7,625
Provision for (benefit from) income taxes.		2,694			(479	)		4,092			2,616

Net income (loss)	$	5,464		$	(41	)	$	8,305		$	5,009

Weighted average shares outstanding—basic		34,141			32,858			34,028			32,773
Weighted average shares outstanding—diluted		34,998			32,858			34,874			34,580
Net income per share—basic.	$	0.16		$	0.00		$	0.24		$	0.15
Net income per share—diluted	$	0.16		$	0.00		$	0.24		$	0.14

	Fiscal Six Months Ended
	March 28, 2003			March 29, 2002
	(Amounts in thousands)
Cash flows from operating activities:
Net income	$	8,305		$	5,009
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		7,053			7,316
Non-cash consideration for royalty and license revenue		—			(22,800	)
Unrealized gain on investment		—			(5,149	)
Tax benefit from exercise of stock options		2,391			3,990
Deferred income taxes		158			(2,121	)
Changes in assets and liabilities:
Accounts receivable		25,698			39,395
Inventories		23,008			19,992
Other current assets		359			1,015
Accounts payable		150			(2,312	)
Accrued expenses		(2,381	)		7,525
Product warranty		424			(7,467	)
Deferred revenue		(27,658	)		(31,430	)
Other		(40	)		(644	)

Net cash provided by operating activities.		37,467			12,319

Cash flows from investing activities:
Purchase of property, plant and equipment		(6,883	)		(5,727	)
Purchase of available-for-sale securities		(21,500	)		—

Net cash used in investing activities		(28,383	)		(5,727	)

Cash flows from financing activities:
Proceeds from the issuance of common stock		5,306			2,158
Repayment of long-term borrowing		(27	)		—
Change in notes payable and short-term borrowing		(783	)		(4,746	)

Net cash provided by (used in) financing activities		4,496			(2,588	)

Effects of exchange rate changes on cash		175			(571	)

Net increase in cash and cash equivalents		13,755			3,433
Cash and cash equivalents at beginning of period		307,840			278,641

Cash and cash equivalents at end of period	$	321,595		$	282,074

Non-cash purchase of property and plant in exchange for debt	$	5,099		$	—

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	Fiscal Three Months Ended					Fiscal Six Months Ended
	March 28, 2003		March 29, 2002			March 28, 2003		March 29, 2002
	(Amounts in thousands, except per share data)
Numerator:
Net income (loss)	$	5,464	$	(41	)	$	8,305	$	5,009

Denominator:
Denominator for basic income per share—
Weighted average shares outstanding		34,141		32,858			34,028		32,773
Effect of dilutive securities:
Stock options		857		—			846		1,807

Denominator for diluted income per share		34,998		32,858			34,874		34,580

Net income per share—basic.	$	0.16	$	0.00		$	0.24	$	0.15
Net income per share—diluted.	$	0.16	$	0.00		$	0.24	$	0.14

	Three Months Ended March 29, 2002			Six Months Ended March 29, 2002
	(Amounts in thousands except per share amounts)
Net (loss) income as reported	$	(41	)	$	5,009
Add back: Goodwill amortization expense, net of tax effect		270			540

Adjusted net income	$	229		$	5,549

Basic net income per share, as reported	$	0.00		$	0.15
Add back: Goodwill amortization expense, net of tax effect		0.01			0.02

Adjusted basic net income per share	$	0.01		$	0.17

Diluted net income per share, as reported	$	0.00		$	0.14
Add back: Goodwill amortization expense, net of tax effect		0.01			0.02

Adjusted diluted net income per share	$	0.01		$	0.16

		Amount of Liability
		(Amounts in thousands)
Balance as of September 27, 2002		$8,656
Accruals for warranties issued during the period		6,131
(Decrease) increase to pre-existing warranties		(246)
Settlements made during the period		(5,336)

Balance as of March 28, 2003		$9,205

	Payments Due by Period
	Total		Less than 1 Year		1 – 3 Years		4 – 5 Years		After 5 Years
	(Amounts in thousands)
Mortgage loan and interest	$	7,700	$	800	$	2,400	$	1,600	$	2,900

	Fiscal Three Months Ended March 28, 2003			Fiscal Three Months Ended March 29, 2002			Fiscal Six Months Ended March 28, 2003			Fiscal Six Months Ended March 29, 2002
	(Amounts in thousands except per share amounts)
Net income (loss) as reported	$	5,464		$	(41	)	$	8,305		$	5,009
Add: Compensation expense included in net income (loss)		—			—			—			—
Less: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax benefit		(3,896	)		(4,406	)		(7,732	)		(8,412	)

Pro forma net (loss) income	$	1,568		$	(4,447	)	$	573		$	(3,403	)

Net income per share—basic—as reported	$	0.16		$	0.00		$	0.24		$	0.15
Net income per share—diluted—as reported	$	0.16		$	0.00		$	0.24		$	0.14
Pro forma net income (loss) per share:
Basic	$	0.05		$	(0.14	)	$	0.02		$	(0.10	)
Diluted	$	0.04		$	(0.14	)	$	0.02		$	(0.10	)

	North America		Europe		Japan		Taiwan		Korea		Other		Consolidated
	(Amounts in thousands)
Revenue—Three months ended:
March 28, 2003	$	47,613	$	11,606	$	4,472	$	5,800	$	30,232	$	11,476	$	111,199
March 29, 2002		29,825		6,625		6,882		3,335		18,304		2,247		67,218

Revenue—Six months ended:
March 28, 2003	$	88,270	$	23,278	$	12,142	$	14,902	$	41,781	$	14,535	$	194,908
March 29, 2002		82,852		20,642		10,260		6,809		21,491		2,944		144,998

Long-lived assets as of:
March 28, 2003	$	42,549	$	981	$	1,222	$	410	$	4,185	$	50	$	49,397
September 27, 2002		38,993		1,290		1,671		385		4,319		60		46,718

	Reduction in Work Force			Facility Closures			Other			Total
	(Amounts in thousands)
Balance as of September 28, 2001	$	—		$	—		$	—		$	—
New charges		4,594			602			209			5,405
Non-cash items		—			—			(114	)		(114	)
Cash payments		(2,427	)		—			—			(2,427	)

Balance as of September 27, 2002		2,167			602			95			2,864
New charges		158			—			—			158
Cash payments		(1,996	)		(463	)		(95	)		(2,554	)

Balance as of March 28, 2003	$	329		$	139		$	—		$	468

Balance, September 27, 2002	$	—
Effective portion of cash flow hedging instruments		33
Reclassified to revenue		—

Balance, March 28, 2003	$	33

	Three Months Ended					Six Months Ended
	March 28, 2003		March 29, 2002			March 28, 2003		March 29, 2002
	(Amounts in thousands)
Net income (loss)	$	5,464	$	(41	)	$	8,305	$	5,009
Other comprehensive income (loss):
Effective portion of cash flow hedging instruments		33		(11	)		33		(11	)

Comprehensive income (loss)	$	5,497	$	(52	)	$	8,338	$	4,998

	Notional Value		Contract Rate	Fair Value
Foreign currency purchase contracts:
Japanese Yen	$	4,988	118.22	$	4,916
New Taiwan Dollar		207	34.84		207

Total foreign currency purchase contracts	$	5,195		$	5,123

Foreign currency sell contracts:
Japanese Yen		4,175	118.33		4,118
Korean Won		2,324	1,201.02		2,234
Euro.		166	0.9303		167
Israeli Shekel		440	4.8878		456

Total foreign currency sell contracts		7,105			6,975

Total contracts	$	12,300		$	12,098

	For	Withheld
Ernest L. Godshalk III	26,989,814	320,629
Angus A. MacNaughton	25,477,726	1,832,717