VSEA Varian Semiconductor (MM)

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

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

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

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

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VARIAN SEMICONDUCTOR EQUIPMENT ASSOCIATES, INC.

During the three months ended December 28, 2007, Varian Semiconductor did not award any restricted stock units. The number of restricted stock units outstanding as of December 28, 2007 was 34,704.

As of December 28, 2007, the unrecognized compensation cost related to unvested stock options was $25.1 million before estimated forfeitures. This unrecognized balance will be recognized over an estimated weighted average amortization period of 3.0 years.

As of December 28, 2007, the unrecognized compensation cost related to unvested restricted stock was $30.1 million before estimated forfeitures. This unrecognized balance will be recognized over an estimated weighted average amortization period of 2.9 years.

The total intrinsic value of options exercised during the three month period ended December 28, 2007 was $1.6 million. The total intrinsic value of options exercised during the three month period ended December 29, 2006 was $10.4 million. Intrinsic value is defined as the difference between the market price on the date of exercise and the grant date price.

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The total fair value of restricted stock grants that vested during the three month period ended December 28, 2007 was $6.8 million. The total fair value of restricted stock grants that vested during the three month period ended December 29, 2006 was $1.8 million.

Employee Stock Purchase Plan

Employees of Varian Semiconductor who elect to participate in the Employee Stock Purchase Plan (“ESPP”), are able to purchase common stock at the lower of 85% of the fair market value of Varian Semiconductor’s common stock on the first or last day of the applicable offering period. Typically, each offering period lasts six months. As of December 28, 2007, there were a total of 1,046,541 shares of common stock reserved for issuance under the ESPP. The fair value of shares issued under the ESPP was estimated on the commencement date of each offering period using the Black-Scholes option-pricing model with the following assumptions:

Note 3. Computation of Net Income Per Share

Basic net income per share is calculated based on net income and the weighted average number of shares of common stock outstanding during the reporting period. Diluted net income per share includes additional dilution from stock issuable pursuant to the exercise of stock options outstanding and unvested restricted stock. Options to purchase common shares with exercise prices that exceeded the market value of the underlying common stock are excluded from the computation of diluted earnings per share, as these options are anti-dilutive. For purposes of the diluted net income per share calculation, the additional shares issuable upon exercise of stock options are determined using the treasury stock method which, as required by SFAS No. 123(R), includes as assumed proceeds share-based compensation expense and the tax effect of such compensation.

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

For the three month periods ended December 28, 2007 and December 29, 2006, 0.6 million and 0.9 million potentially dilutive shares, respectively, were excluded from the computation of diluted earnings per share.

Note 4. Accounts Receivable

Accounts receivable consist of the following:

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Note 7. Long-Term Accrued Expenses and Other Long-Term Liabilities

There was $60.2 million in long-term accrued expenses and other long-term liabilities at December 28, 2007. Included in this amount was $34.9 million for long-term tax liabilities. In addition, post-employment liabilities, environmental and other costs not expected to be expended within the next year are included in long-term accrued expenses and other long-term liabilities. The current portion is recorded within accrued expenses.

$53.9 million in long-term accrued expenses and other long-term liabilities at September 28, 2007 are comprised of accruals of $28.5 million for long-term tax liabilities. In addition, post-employment liabilities, environmental and other costs not expected to be expended within the next year are included in long-term accrued expenses and other long-term liabilities. The current portion is recorded within accrued expenses.

Note 8. Product Warranties

Varian Semiconductor warrants that its products will be free from defects in materials and workmanship and will conform to its standard published specifications in effect at the time of delivery for a period of three to twenty-four months from the date the customer accepts the products. Additionally, Varian Semiconductor warrants that maintenance services will be performed in a workmanlike manner consistent with generally accepted industry standards for a period of 90 days from the completion of any agreed-upon services. Varian Semiconductor provides for the estimated cost of product warranties, the amount of which is based primarily upon historical information, at the time product revenue is recognized. Varian Semiconductor’s warranty obligation is affected by a number of factors, including product failure rates, utilization levels, material usage, service delivery costs incurred in correcting a product failure, and supplier warranties on parts delivered to Varian Semiconductor. Should these factors or other factors affecting warranty costs differ from Varian Semiconductor’s estimates, revisions to the estimated warranty liability would be required.

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Product warranty activity for the first three months of fiscal years 2008 and 2007 was as follows:

Note 10. Commitments, Contingencies and Guarantees

As permitted under Delaware law, Varian Semiconductor has agreements whereby it indemnifies its officers and directors for certain events or occurrences while the officer or director is, or was, serving in such capacity at the request of Varian Semiconductor. The term of the indemnification period is for the officer’s or director’s lifetime. The maximum potential amount of future payments Varian Semiconductor could be required to make under these indemnification agreements is unlimited; however, Varian Semiconductor has a Director and Officer insurance policy that limits its exposure and enables Varian Semiconductor to recover a portion of any future amounts paid. As a result of Varian Semiconductor’s insurance policy coverage, management believes the estimated fair value of these indemnification agreements is minimal. Accordingly, Varian Semiconductor has not recorded any liabilities for these agreements as of December 28, 2007.

Varian Semiconductor enters into indemnification agreements in the normal course of business. Pursuant to these agreements, Varian Semiconductor indemnifies, holds harmless, and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally Varian Semiconductor customers, in connection with any patent, or any copyright or other intellectual property infringement claim by any third party with respect to Varian Semiconductor products. The term of these indemnification agreements is generally perpetual any time after execution of the agreement. The maximum potential amount of future payments Varian Semiconductor could be required to make under these indemnification agreements may be unlimited. Management believes the estimated fair value of these agreements is minimal. Accordingly, Varian Semiconductor has not recorded any liabilities for these agreements as of December 28, 2007.

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Varian Semiconductor also indemnifies certain customers with respect to damages, losses and liabilities they may suffer or incur relating to personal injury, personal property damage, product liability, and environmental claims relating to the use of Varian Semiconductor’s products and services or resulting from the acts or omissions of Varian Semiconductor, its employees, officers, authorized agents or subcontractors. Varian Semiconductor has general and umbrella insurance policies that limit its exposure under these indemnification obligations and guarantees. As a result of Varian Semiconductor’s insurance policy coverage, Varian Semiconductor believes the estimated fair value of these indemnification agreements is minimal. Accordingly, Varian Semiconductor has not recorded any liabilities for these agreements as of December 28, 2007.

Prior to the spin–off of Varian Semiconductor from Varian Associates, Inc. (“VAI”), Varian Semiconductor’s business was operated as the Semiconductor Equipment Business (“SEB”) of VAI. On April 2, 1999, VAI contributed its SEB to Varian Semiconductor, its Instruments Business to Varian, Inc. (“VI”), and changed its name to Varian Medical Systems, Inc. (“VMS”). In connection with the spin-off from VAI, Varian Semiconductor, VMS and VI entered into certain agreements which include a Distribution Agreement, an Employee Benefits Allocation Agreement, an Intellectual Property Agreement, a Tax Sharing Agreement, and a Transition Services Agreement (collectively, the “Distribution Related Agreements”) whereby Varian Semiconductor agreed to indemnify VMS and VI for any costs, liabilities or expenses relating to Varian Semiconductor’s legal proceedings. Under the Distribution Related Agreements, Varian Semiconductor has agreed to reimburse VMS for one-third of the costs, liabilities, and expenses, adjusted for any related tax benefits recognized or realized by VMS, with respect to certain legal proceedings relating to discontinued operations of VMS. Varian Semiconductor believes the estimated fair value of the indemnification agreements is minimal, except as already recorded on the financial statements.

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

Varian Semiconductor also enters into purchase order commitments in the normal course of business. As of December 28, 2007, Varian Semiconductor had approximately $70.7 million of purchase order commitments with various suppliers.

Environmental Remediation

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

For certain of these sites and facilities, various uncertainties make it difficult to assess the likelihood and scope of further investigation or remediation activities or to estimate the future costs of such activities if undertaken. Varian Semiconductor has accrued $1.1 million in estimated environmental investigation and remediation costs for these sites and facilities as of December 28, 2007. 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 $4.1 million as of December 28, 2007, 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 $1.1 million as of December 28, 2007 previously described.

As of December 28, 2007, Varian Semiconductor’s environmental liability, based upon future environmental-related costs estimated by VMS as of that date and included in current and long-term accrued expenses, totaled $5.2 million, of which $0.6 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.

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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. 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.

Legal Proceedings

From time to time, in the ordinary course of business, Varian Semiconductor is a party to legal disputes related to employment and contract matters and could incur an uninsured liability in one or more of them. While it is not possible to predict or determine the outcomes of the disputes, Varian Semiconductor believes the outcomes of such disputes will not have a material adverse effect on its consolidated financial position, results of operations or cash flows.

Note 11. Derivative Financial Instruments

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

Varian Semiconductor’s international sales are primarily denominated in U.S. dollars. For foreign currency denominated sales, however, the volatility of the foreign currency markets represents risk to Varian Semiconductor. Upon forecasting the exposure, Varian Semiconductor enters into hedges with forward sales contracts for which critical terms are designed to match those of the underlying exposure. These hedges are evaluated for effectiveness at least quarterly by comparing the change in value of the forward contracts to the change in value of the underlying transaction, with the effective portion of the hedge accumulated in other comprehensive income (“OCI”). Any measured ineffectiveness is included immediately in other income and expense in the consolidated statements of income. There was an immaterial amount of ineffectiveness recognized during the three month period ended December 28, 2007. OCI associated with hedges of sales denominated in foreign currencies is reclassified to revenue upon recognition in income of the underlying hedged exposure. The unrealized loss included in OCI associated with hedges of foreign currency denominated sales during the quarter ended December 28, 2007 was $0.1 million.

Note 12. Comprehensive Income

The following table reconciles net income to comprehensive income for the first quarter of fiscal years 2008 and 2007:

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Note 13. Share Repurchase Program

The Board of Directors voted to increase the amount of funds that may be expended in repurchasing Varian Semiconductor’s common stock to a total of $700 million as of November 13, 2007. The program does not have a fixed expiration date.

Share repurchases under this program during the first quarter of fiscal years 2008 and 2007 were as follows:

Varian Semiconductor has repurchased an aggregate of 18,426,625 shares of its common stock through December 28, 2007 pursuant to this repurchase program since its inception in October 2004. As of December 28, 2007, there was a total of $100 million remaining under this repurchase program.

Note 14. Operating Segments and Geographic Information

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

Varian Semiconductor expects that sales of its products to relatively few customers will continue to account for a high percentage of its revenue in the foreseeable future. In the first quarter of fiscal year 2008, revenue from three customers accounted for 16%, 15% and 14%, respectively, of Varian Semiconductor’s total revenue. In the first quarter of fiscal year 2007, revenue from two customers accounted for 14% and 11%, respectively, of Varian Semiconductor’s total revenue.

As of December 28, 2007, three customers represented 13%, 12% and 12%, respectively, of the total accounts receivable balance. As of September 28, 2007, one customer accounted for 15% of the total accounts receivable balance.

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

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Note 15. Income Taxes

Varian Semiconductor’s effective tax rate is based on its current profitability outlook and its expectations of earnings from operations in the U.S. and other tax jurisdictions throughout the world.

In fiscal 2007 Varian Semiconductor implemented a plan to realign the legal entities within its worldwide affiliated group. The objective of this realignment was to make its legal structure more consistent with the geographic mix of its customers and suppliers. In effecting this realignment, Varian Semiconductor has established operations in Switzerland that will provide operational and financial services to all of its international locations.

For the quarter ended December 28, 2007, Varian Semiconductor’s income tax expense of $20.0 million included a discrete net benefit of $1.2 million related to a Swiss net operating loss and other discrete items. Varian Semiconductor’s effective income tax rate was 31% for the first quarter of fiscal year 2008. The discrete income tax benefit received in the first quarter of fiscal year 2008 reduced the effective tax rate by approximately 2 percentage points. For the quarter ended December 29, 2006, Varian Semiconductor’s income tax expense included a discrete net benefit of $2.1 million related to the reinstatement of the research and development tax credit retroactive to January 1, 2006. Varian Semiconductor’s effective income tax rate was 29% for the first quarter of fiscal year 2007. The discrete income tax benefit recorded in the first quarter of fiscal year 2007 reduced the effective tax rate by approximately 4 percentage points.

Varian Semiconductor adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN 48”) on September 29, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” This interpretation prescribes the recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. Upon adoption of FIN 48, Varian Semiconductor increased the liability for net unrecognized tax benefits by $1.7 million, and accounted for the increase as a cumulative effect of change in accounting principle that resulted in a reduction in retained earnings of $1.7 million at September 29, 2007. Varian Semiconductor also reclassified $4.0 million of current income taxes payable to long term income taxes payable and $1.3 million of long-term income taxes payable to non-current deferred tax assets.

As of September 29, 2007, the total gross unrecognized tax benefits related to various federal, state and foreign income tax matters was $40.8 million. Of this amount, the amount that would impact the effective tax rate, if recognized, was $38.5 million. The difference between the total amount of unrecognized tax benefits and the amount that would impact the effective tax rate consists of items that are offset by deferred tax assets of $2.3 million, of which $0.9 million relates to state tax credits which are fully offset by a valuation allowance. The increase in the reserve for the quarter ended December 28, 2007 was $2.2 million. Varian Semiconductor anticipates a ratable increase in unrecognized tax benefits during the remainder of the fiscal year ending October 3, 2008. Varian Semiconductor will reexamine the tax provision and the effect of estimated unrecognized tax benefits on its financial position at the end of each reporting period.

In the normal course of business, Varian Semiconductor and its subsidiaries are examined by various federal, state and foreign tax authorities, including the Internal Revenue Service. Varian Semiconductor is subject to audit by the Internal Revenue Service and various state and foreign authorities for the fiscal years ended 2003 through 2007. The Internal Revenue Service is currently examining certain refund claims filed by Varian Semiconductor for fiscal years ended 2000 through 2004. The favorable resolution of these claims could result in a benefit to the tax provision in the range of $0 to $5.8 million. It is reasonably possible that agreement on these claims may be reached within the next twelve months. Final agreement could reduce the amount of unrecognized tax benefits by approximately $5.8 million.

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As of September 29, 2007, Varian Semiconductor had accrued $1.7 million of interest and penalties related to unrecognized tax benefits. As of December 28, 2007, the total amount of accrued interest and penalties was $1.9 million. Varian Semiconductor includes interest and penalties related to unrecognized tax benefits within its provision for income taxes.

Note 16. Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This statement defines fair value, establishes a framework for measuring fair value in accordance with GAAP, and expands disclosures about fair value measurements. This statement applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this statement does not require any new fair value measurements. However, for some entities, the application of this statement will change current practice. This statement will be effective for Varian Semiconductor’s fiscal year 2009. Varian Semiconductor is in the process of evaluating the impact of this statement on its financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities Including an amendment of FASB Statement No. 115.” This statement permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The decision to measure items at fair value can be made on an instrument-by-instrument basis, but once the decision is made, it is permanent. This statement will be effective for Varian Semiconductor’s fiscal year 2009. Varian Semiconductor is in the process of evaluating the impact of this statement on its financial statements.