Prepared by R.R. Donnelley Financial -- Form 10-Q

This Quarterly Report on Form 10-Q contains “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that could cause actual results of Varian, Inc. (the “Company”) to differ materially from management’s current expectations. Those risks and uncertainties include, without limitation: new product development and commercialization; continued growth in Scientific Instruments sales and the impact on these sales of the timing of shipments and the recognition of revenues on NMR systems; renewed demand for vacuum products and contract electronics manufacturing; demand for and acceptance of the Company’s products; competitive products and pricing; economic conditions in the Company’s product and geographic markets; foreign currency fluctuations that could adversely impact revenue growth and earnings; sustained or improved market investment in capital equipment; and other risks detailed from time to time in the Company’s filings with the Securities and Exchange Commission.

	Quarter Ended				Six Months Ended
	Mar. 29, 2002		Mar. 30, 2001		Mar. 29, 2002		Mar. 30, 2001
Sales	$	190,331	$	189,559	$	374,571	$	371,912
Cost of sales		120,131		117,076		234,670		231,102

Gross profit		70,200		72,483		139,901		140,810

Operating expenses
Sales and marketing		31,976		33,453		62,924		64,455
Research and development		9,601		9,256		18,619		17,100
General and administrative		8,678		10,625		18,491		22,100
Purchased in-process research and development		890		—		890		—

Total operating expenses		51,145		53,334		100,924		103,655

Operating earnings		19,055		19,149		38,977		37,155
Interest expense, net		455		113		799		577

Earnings before income taxes and cumulative effect of change in accounting principle		18,600		19,036		38,178		36,578
Income tax expense		7,017		7,424		14,065		14,265

Earnings before cumulative effect of change in accounting principle		11,583		11,612		24,113		22,313
Cumulative effect of change in accounting principle, net of tax of $4,767		—		—		—		(7,455	)

Net earnings	$	11,583	$	11,612	$	24,113	$	14,858

Net earnings per share:
Basic
Before cumulative effect of change in accounting principle	$	0.35	$	0.35	$	0.72	$	0.68
Cumulative effect of change in accounting principle, net of tax		—		—		—		(0.23	)

After cumulative effect of change in accounting principle	$	0.35	$	0.35	$	0.72	$	0.45

Diluted
Before cumulative effect of change in accounting principle	$	0.33	$	0.34	$	0.69	$	0.65
Cumulative effect of change in accounting principle, net of tax		—		—		—		(0.22	)

After cumulative effect of change in accounting principle	$	0.33	$	0.34	$	0.69	$	0.43

Shares used in per share calculations:
Basic		33,452		32,946		33,375		32,903

Diluted		34,922		34,475		34,750		34,468

	Mar. 29, 2002			Sept. 28, 2001
ASSETS

Current assets
Cash and cash equivalents	$	28,767		$	59,879
Accounts receivable, net		152,726			158,280
Inventories		121,389			119,498
Deferred taxes		26,664			26,303
Other current assets		12,680			11,084

Total current assets		342,226			375,044
Property, plant and equipment, net		101,524			90,528
Goodwill		116,888			85,906
Intangible assets, net		13,114			4,019
Other assets		4,085			3,760

Total assets	$	577,837		$	559,257


LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities
Current portion of long-term debt	$	5,342		$	6,424
Accounts payable		47,816			48,728
Deferred profit		21,453			21,705
Accrued liabilities		117,705			124,754

Total current liabilities		192,316			201,611
Long-term debt		38,641			39,656
Deferred taxes		6,533			2,801
Other liabilities		9,376			9,918

Total liabilities		246,866			253,986

Contingencies (Note 10)

Stockholders’ equity
Preferred stock—par value $.01, authorized—1,000,000 shares; issued—none		—			—
Common stock—par value $.01, authorized—99,000,000 shares; issued and outstanding—33,518,997 shares at Mar. 29, 2002 and 33,223,815 shares at Sept. 28, 2001		240,757			236,660
Retained earnings		116,905			92,792
Other comprehensive loss		(26,691	)		(24,181	)

Total stockholders’ equity		330,971			305,271

Total liabilities and stockholders’ equity	$	557,837		$	559,257

	Six Months Ended
	Mar. 29, 2002			Mar. 30, 2001
Cash flows from operating activities
Net earnings	$	24,113		$	14,858
Adjustments to reconcile net earnings to net cash provided by operating activities:
Cumulative effect of change in accounting principle, net of tax		—			7,455
Depreciation and amortization		9,730			10,153
Loss (gain) on disposition of property, plant and equipment		66			(81	)
Purchased in-process research and development		890			—
Deferred taxes		—			(2,161	)
Changes in assets and liabilities, excluding effects of acquisitions:
Accounts receivable, net		5,353			8,804
Inventories		238			(14,920	)
Other current assets		352			(1,617	)
Accounts payable		(1,997	)		(3,574	)
Deferred profit		(252	)		6,113
Accrued liabilities		(9,403	)		10,365
Other liabilities		(321	)		(797	)
Other assets		413			839

Net cash provided by operating activities		29,182			35,437

Cash flows from investing activities
Proceeds from sale of property, plant and equipment		312			545
Purchase of property, plant and equipment		(10,399	)		(12,107	)
Purchase of businesses, net of cash acquired		(48,871	)		(16,061	)

Net cash used in investing activities		(58,958	)		(27,623	)

Cash flows from financing activities
Net (payment) issuance of debt		(2,837	)		8,095
Issuance of common stock		4,097			2,368
Net transfers to Varian Medical Systems, Inc.		(2,201	)		(1,190	)

Net cash (used in) provided by financing activities		(941	)		9,273

Effects of exchange rate changes on cash		(395	)		(901	)

Net (decrease) increase in cash and cash equivalents		(31,112	)		16,186
Cash and cash equivalents at beginning of period		59,879			39,708

Cash and cash equivalents at end of period	$	28,767		$	55,894

Supplemental cash flow information
Income taxes paid	$	9,798		$	11,510
Interest paid	$	1,474		$	1,707

These interim consolidated financial statements of Varian, Inc. and its subsidiary companies (collectively, the “Company”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The September 28, 2001 balance sheet data was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles. These interim consolidated financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company’s Form 10-K for the year ended September 28, 2001 filed with the SEC. In the opinion of the Company’s management, the interim consolidated financial statements include all normal recurring adjustments necessary to present fairly the information required to be set forth therein. The results of operations for the fiscal quarter and six months ended March 29, 2002 are not necessarily indicative of the results to be expected for a full year or for any other periods.

The Company is a major supplier of scientific instruments and consumable laboratory supplies, vacuum technology products and services, and electronics manufacturing services. These businesses primarily serve life science, health care, semiconductor processing, communications, industrial, and academic customers. Until April 2, 1999, the business of the Company was operated as the Instruments Business (“IB”) of Varian Associates, Inc. (“VAI”). On that date, VAI distributed to the holders of its common stock one share of common stock of the Company for each share of VAI (the “Distribution”).

As discussed in Note 2 to the financial statements included in the Company’s Form 10-K for the fiscal year ended September 28, 2001, the Company adopted the provisions of SEC Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (“SAB 101”), in the fourth quarter of fiscal year 2001, retroactive to the beginning of fiscal year 2001. As a result, in the fourth quarter of fiscal year 2001, the Company restated its sales and related cost of sales for the first three quarters of fiscal year 2001 and recorded a non-cash charge for the cumulative effect of a change in accounting principle in the amount of $7.5 million after taxes in the first quarter of fiscal year 2001. The results of operations for fiscal year 2001 presented in the unaudited consolidated condensed financial statements included in this Form 10-Q reflect the adoption of SAB 101.

The Company accounts for foreign exchange forward contracts pursuant to the requirements of Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards No. (“FAS”) 133, “Accounting for Derivative Instruments and Hedging Activities,” which was amended by FAS 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities.” FAS 133 and FAS 138 require derivatives to be measured at fair value and to be recorded as assets or liabilities on the balance sheet. The accounting for gains or losses resulting from changes in the fair values of those derivatives is dependent upon the type of the derivative and whether it qualifies for “hedge” accounting. The Company estimates the fair value of its forward contracts based on changes in forward rates.

The Company enters into foreign exchange forward contracts to minimize the short-term impact of foreign currency fluctuations on assets and liabilities denominated in currencies other than the local functional currencies. These contracts are not designated as “hedges” and do not qualify for hedge accounting under FAS 133. The Company records these contracts at fair value with the related gains and losses recorded in general and administrative expenses. The gains and losses on these contracts are substantially offset by transaction losses and gains on the underlying balances being hedged.

The Company also enters into foreign exchange forward contracts to minimize the impact of foreign currency fluctuations on forecasted transactions. These contracts are designated as cash flow hedges under FAS 133. For such hedging transactions, the Company formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives are highly effective in offsetting changes in the cash flows of the hedged items. Effectiveness is calculated by comparing the cumulative change in fair value of the underlying transaction being hedged to the cumulative change in fair value of the derivative based on changes in forward rates. If a derivative qualifies as a cash flow hedge, changes in the fair value of the derivative, to the extent effective, are recorded in other comprehensive loss in stockholders’ equity. The Company could experience ineffectiveness on any specific hedge transaction if the underlying transaction is cancelled or if the underlying transaction’s delivery date is re-scheduled. For cash flow hedges of forecasted sale transactions, gains and losses are deferred in other comprehensive loss and are then recorded to sales in the period in which the underlying sale transaction is recorded. At March 29, 2002, forward contracts to sell Japanese yen having an aggregate notional value of $8.6 million were designated as cash flow hedges of forecasted sale transactions. A gain of $0.3 million (net of tax) was recorded for these forward contracts in other comprehensive loss as of March 29, 2002. There was no ineffectiveness from these contracts during the fiscal quarter and the six months ended March 29, 2002.

In July 2001, the FASB issued FAS 141, “Business Combinations,” and FAS 142, “Goodwill and Other Intangible Assets.” FAS 141 eliminates pooling-of-interests accounting prospectively. It also provides guidance on purchase accounting related to the recognition of intangible assets. FAS 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. FAS 141 and FAS 142 are effective for all business combinations completed after June 30, 2001. Under FAS 142, goodwill must be tested for impairment annually and whenever events or circumstances occur indicating that goodwill might be impaired. Upon adoption of FAS 142, amortization of goodwill recorded for business combinations consummated prior to July 1, 2001 must cease, and intangible assets acquired prior to July 1, 2001 that do not meet the new criteria for recognition as intangibles must be reclassified to goodwill.

The Company elected to early adopt the provisions of FAS 142 on the first day of fiscal year 2002 (September 29, 2001). In accordance with FAS 142, the Company ceased amortizing goodwill with a net carrying value totaling $85.9 million as of that date, including certain intangible assets previously classified as purchased intangible assets. In connection with the adoption of FAS 142, the Company performed a transitional impairment test and determined that there was no impairment of goodwill.

	Quarter ended				Six months ended
	Mar. 29, 2002		Mar. 30, 2001		Mar. 29, 2002		Mar. 30, 2001⁽¹⁾
(in thousands, except per share amounts)
Net earnings
As previously reported	$	11,583	$	11,612	$	24,113	$	22,313
Add back: Goodwill amortization, net of tax		—		753		—		1,267

As adjusted	$	11,583	$	12,365	$	24,113	$	23,580

Net earnings per basic share
As previously reported	$	0.35	$	0.35	$	0.72	$	0.68
Add back: Goodwill amortization, net of tax		—		0.03		—		0.04

As adjusted	$	0.35	$	0.38	$	0.72	$	0.72

Net earnings per diluted share
As previously reported	$	0.33	$	0.34	$	0.69	$	0.65
Add back: Goodwill amortization, net of tax		—		0.02		—		0.03

As adjusted	$	0.33	$	0.36	$	0.69	$	0.68

The amounts allocated to existing technology and other identified intangible assets have a weighted average useful life of approximately 9.5 years. These intangible assets are being amortized using the straight-line method over their respective estimated useful lives. The amount allocated to purchased in-process research and development relates to several new consumables products that were in the research and development phase at the time of the acquisition. The percentage of completion for these products ranged from 49% to 73%. An external appraisal was performed which used the income approach, the royalty savings approach and the cost approach to determine the fair value of ANSYS’ significant identifiable intangible assets, including the portion of the purchase price attributed to in-process research and development. Risk-adjusted discount rates ranging from 15% to 29% were applied to cash flow projections to determine the present value of the different intangible assets including the in-process research and development.

All of the above acquisitions have become part of the Company’s Scientific Instruments segment and were accounted for using the purchase method of accounting. Accordingly, the Company’s unaudited consolidated condensed statements of earnings for the fiscal quarter and six months ended March 29, 2002 include the results of operations of the acquired companies since the effective dates of their respective purchases. There were no significant differences between the accounting policies of the Company and any of the acquired companies. Pro forma sales, earnings from operations, net earnings, and net earnings per share have not been presented because the effects of these acquisitions were not material on either an individual or an aggregated basis.

For the fiscal quarters ended March 29, 2002, and March 30, 2001, options to purchase 636,942 and 667,531 shares, respectively, were excluded from the calculation of diluted earnings per share as their effect would be anti-dilutive. For the six months ended March 29, 2002, and March 30, 2001, options to purchase 659,529 and 468,644 shares, respectively, were excluded from the calculation of diluted earnings per share as their effect would be anti-dilutive.

	Quarter Ended				Six Months Ended
	Mar. 29, 2002		Mar. 30, 2001		Mar. 29, 2002		Mar. 30, 2001
(in thousands, except per share amounts)
Basic
Before cumulative effect of change in accounting principle	$	11,583	$	11,612	$	24,113	$	22,313
Cumulative effect of change in accounting principle, net of tax		—		—		—		(7,455	)

After cumulative effect of change in accounting principle	$	11,583	$	11,612	$	24,113	$	14,858

Weighted average shares outstanding		33,452		32,946		33,375		32,903

Before cumulative effect of change in accounting principle	$	0.35	$	0.35	$	0.72	$	0.68
Cumulative effect of change in accounting principle, net of tax		—		—		—		(0.23	)

After cumulative effect of change in accounting principle	$	0.35	$	0.35	$	0.72	$	0.45

Diluted
Before cumulative effect of change in accounting principle	$	11,583	$	11,612	$	24,113	$	22,313
Cumulative effect of change in accounting principle, net of tax		—		—		—		(7,455	)

After cumulative effect of change in accounting principle	$	11,583	$	11,612	$	24,113	$	14,858

Weighted average shares outstanding		33,452		32,946		33,375		32,903
Net effect of dilutive stock options		1,470		1,529		1,375		1,565

Total shares		34,922		34,475		34,750		34,468

Before cumulative effect of change in accounting principle	$	0.33	$	0.34	$	0.69	$	0.65
Cumulative effect of change in accounting principle, net of tax		—		—		—		(0.22	)

After cumulative effect of change in accounting principle	$	0.33	$	0.34	$	069	$	0.43

During the fiscal quarter ended March 29, 2002, the Company established a three-year unsecured revolving bank credit facility (the “Revolver”) in the amount of $50.0 million for working capital purposes. No amounts were outstanding under this credit facility as of March 29, 2002. Borrowings under the Revolver bear interest at rates of LIBOR plus 1.25% to 2.0% depending on certain financial ratios of the Company at the time of borrowing. The Revolver contains certain customary covenants that limit future borrowings of the Company and require the maintenance by the Company of certain levels of financial performance.

As of March 29, 2002, the Company also had $38.9 million in uncommitted and unsecured credit facilities for working capital purposes with interest rates for these facilities established at the time of borrowing. No amount was outstanding under these credit facilities as of March 29, 2002. All of these credit facilities contain certain conditions and events of default customary for such facilities, for which the Company was in compliance.

Environmental Matters. The Company’s operations are subject to various foreign, federal, state, and local laws regulating the discharge of materials into the environment or otherwise relating to the protection of the environment. These regulations increase the costs and potential liabilities of the Company’s operations. However, the Company does not currently anticipate that its compliance with these regulations will have a material effect upon the Company’s capital expenditures, earnings, or competitive position.

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

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. As of March 29, 2002, it was nonetheless estimated that the Company’s share of the future exposure for environmental-related investigation and remediation costs for these sites and facilities ranged in the aggregate from $1.6 million to $4.8 million (without discounting to present value). The time frame over which these costs are expected to be incurred varies with each site and facility, ranging up to approximately 30 years as of March 29, 2002. No amount in the foregoing range of estimated future costs is believed to be more probable of being incurred than any other amount in such range, and the Company therefore accrued $1.6 million as of March 29, 2002.

As to other sites and facilities, sufficient knowledge has been gained to be able to better estimate the scope and costs of future environmental activities. As of March 29, 2002, it was estimated that the Company’s share of the future exposure for environmental-related investigation and remediation costs for these sites and facilities ranged in the aggregate from $6.9 million to $15.3 million (without discounting to present value). The time frame over which these costs are expected to be incurred varies with each site and facility, ranging up to approximately 30 years as of March 29, 2002. As to each of these sites and facilities, it was determined that a particular amount within the range of estimated costs was a better estimate of the future environmental liability than any other amount within the range, and that the amount and timing of these future costs were reliably determinable. Together, these amounts totaled $8.5 million at March 29, 2002. The Company therefore accrued $5.8 million as of March 29, 2002, which represents the best estimate of its share of these future costs discounted at 4%, net of inflation. This accrual is in addition to the $1.6 million described in the preceding paragraph.

Lawsuits for recovery of environmental investigation and remediation costs already incurred, and to be incurred in the future, were filed by VAI against various insurance companies and other third parties. Following settlements with or judgments against insurance companies, VMS is still pursuing a lawsuit against a third party for the benefit of itself, VSEA, and the Company. One insurance company has agreed to pay a portion of certain of VAI’s (now VMS’) future environmental-related expenditures for which the Company has an indemnity obligation, and the Company therefore has a $1.4 million receivable in Other Assets as of March 29, 2002 for the

The Company’s management believes that its reserves for the foregoing and certain other environmental-related matters are adequate, but as the scope of its obligation becomes more clearly defined, these reserves may be modified, and related charges or credits against earnings 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 the Company’s financial statements, the likelihood of such occurrence is considered remote. Based on information currently available and its best assessment of the ultimate amount and timing of environmental-related events, management believes that the costs of these environmental-related matters are not reasonably likely to have a material adverse effect on the Company’s financial position or results of operations.

Legal Proceedings. Under the terms of the Distribution, the Company agreed to defend and indemnify VSEA and VMS for costs, liabilities, and expenses with respect to legal proceedings relating to the Instruments Business of VAI, and agreed to reimburse VMS for one-third of certain costs and expenses (after adjusting for any insurance proceeds and tax benefits recognized or realized by VMS for such costs and expenses) that are paid after April 2, 1999 and arise from actual or potential claims or legal proceedings relating to discontinued, former, or corporate operations of VAI. From time to time, the Company is involved in its own legal actions and could incur an uninsured liability in one or more of them. While the ultimate outcome of all of the foregoing legal matters is not determinable, management believes that these matters are not reasonably likely to have a material adverse effect on the Company’s financial position or results of operations.

The Company’s operations are grouped into three business segments: Scientific Instruments, Vacuum Technologies, and Electronics Manufacturing. The Scientific Instruments segment designs, develops, manufactures, sells, and services equipment and consumable laboratory supplies for a broad range of life science and chemical analysis applications requiring identification, quantification, and analysis of the composition or structure of liquids, solids, or gases. The Vacuum Technologies segment designs, develops, manufactures, sells, and services high-vacuum pumps, leak detection equipment, and related products and services used to create, control, measure or test vacuum environments in a broad range of life science, industrial and scientific applications requiring ultra-clean or high-vacuum environments. The Electronics Manufacturing segment provides contract manufacturing services, including design, support, manufacturing and post-manufacturing services, of advanced electronics assemblies and subsystems for a wide range of customers, in particular small-and medium-sized companies with low-to-medium volume, high-mix requirements.

	Quarter Ended				Quarter Ended
	Mar. 29, 2002		Mar. 30, 2001		Mar. 29, 2002			Mar. 30, 2001
	Sales		Sales		Pretax Earnings			Pretax Earnings
(in millions)
Scientific Instruments	$	119.1	$	105.5	$	12.2		$	10.9
Vacuum Technologies		27.3		40.9		4.2			8.6
Electronics Manufacturing		44.0		43.2		4.0			2.1

Total industry segments		190.4		189.6		20.4			21.6
General corporate		—		—		(1.3	)		(2.4	)
Interest expense, net		—		—		(0.5	)		(0.1	)

Total	$	190.4	$	189.6	$	18.6		$	19.1


	Six Months Ended				Six Months Ended
	Mar. 29, 2002		Mar. 30, 2001		Mar. 29, 2002			Mar. 30, 2001
	Sales		Sales		Pretax Earnings			Pretax Earnings
(in millions)
Scientific Instruments	$	236.0	$	203.2	$	27.1		$	19.5
Vacuum Technologies		53.7		82.5		8.0			17.7
Electronics Manufacturing		84.9		86.2		7.1			4.9

Total industry segments		374.6		371.9		42.2			42.1
General corporate		—		—		(3.2	)		(4.9	)
Interest expense, net		—		—		(0.8	)		(0.6	)

Total	$	374.6	$	371.9	$	38.2		$	36.6

In August 2001, the FASB issued FAS 143, “Accounting for Asset Retirement Obligations,” which is effective for fiscal years beginning after June 15, 2002. FAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. FAS 143 applies to all entities. The Company does not expect the adoption of FAS 143 to have a significant impact on its financial position or results of operations.

In October 2001, the FASB issued FAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which supersedes FAS 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,” and portions of Accounting Principles Board Opinion No. (“APB”) 30, “Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.” While FAS 144 carries forward many of the provisions of FAS 121 and APB 30, some of the key differences in the new standard are that goodwill is excluded from its scope, assets to be abandoned will be viewed as held for use and amortized over

In April 2002, the FASB issued FAS 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections,” which is effective for transactions occurring after May 15, 2002. FAS 145 rescinds FAS 4 and FAS 64, which addressed the accounting for gains and losses from extinguishment of debt. FAS 44 set forth industry-specific transitional guidance that did not apply to the Company. FAS 145 amends FAS 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. FAS 145 also makes technical corrections to certain existing pronouncements that are not substantive in nature. The Company does not expect the adoption of FAS 145 to have a significant impact on its financial position or results of operations.

Until April 2, 1999, the business of Varian, Inc. (the “Company”) was operated as the Instruments Business (“IB”) of Varian Associates, Inc. (“VAI”). IB included the business units that designed, developed, manufactured, sold, and serviced scientific instruments and vacuum technologies, and a business unit that provided contract electronics manufacturing services. VAI contributed IB to the Company; then on April 2, 1999, VAI distributed to the holders of record of VAI common stock on March 24, 1999 one share of common stock of the Company for each share of VAI common stock outstanding on April 2, 1999 (the “Distribution”). At the same time, VAI contributed its Semiconductor Equipment business to Varian Semiconductor Equipment Associates, Inc. (“VSEA”) and distributed to the holders of record of VAI common stock on March 24, 1999 one share of common stock of VSEA for each share of VAI common stock outstanding on April 2, 1999. VAI retained its Health Care Systems business and changed its name to Varian Medical Systems, Inc. (“VMS”), effective as of April 3, 1999. These transactions were accomplished under the terms of an Amended and Restated Distribution Agreement dated as of January 14, 1999 by and among the Company, VAI, and VSEA (the “Distribution Agreement”). For purposes of providing an orderly transition and to define certain ongoing relationships between and among the Company, VMS and VSEA after the Distribution, the Company, VMS and VSEA 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.

In the fourth quarter of fiscal year 2001, the Company adopted the provisions of SEC Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (“SAB 101”) retroactive to the beginning of fiscal year 2001. As a result, in the fourth quarter of fiscal year 2001, the Company restated its sales and related cost of sales for the first three quarters of fiscal year 2001 and recorded a non-cash charge for the cumulative effect of a change in accounting principle in the amount of $7.5 million after taxes in the first quarter of fiscal year 2001. The results of operations for the second quarter of fiscal year 2001 presented in the financial statements included in this Form 10-Q reflect the adoption of SAB 101.

Geographically, sales in North America of $117.6 million, Europe of $46.6 million and the rest of the world of $26.2 million in the second quarter of fiscal year 2002 represented increases (decreases) of 5.5%, 2.4%, and (19.8%), respectively, as compared to the second quarter of fiscal year 2001. The increase in North America primarily resulted from an increase in Scientific Instruments’ North America sales. This increase was partially offset by the sales decline in Vacuum Technologies due to weak demand from semiconductor equipment and other industrial capital equipment manufacturers. The increase in Europe was primarily driven by growth in Scientific Instruments sales. The decrease in the rest of the world was primarily due to large system sales by Scientific Instruments into the Pacific Rim in the prior year period, and the decline of Scientific Instruments sales into Latin America and of Vacuum Technologies sales into the Pacific Rim in the current year period.

decrease in gross profit percentage was due to the sale of several high-field nuclear magnetic resonance (“NMR”) systems in the Scientific Instruments segment. High-field systems tend to have lower gross margins but these lower margins are typically offset by lower operating expense ratios. In addition, the gross profit percentage for Vacuum Technologies was negatively impacted by market weakness in the semiconductor equipment and industrial sectors due to the general economic slowdown.

Sales and Marketing. Sales and marketing expenses were $32.0 million (representing 16.8% of sales) in the second quarter of fiscal year 2002, compared to $33.5 million (representing 17.6% of sales) in the second quarter of fiscal year 2001. The decline as a percentage of sales relates primarily to increased sales of Scientific Instruments, particularly high-field NMR systems which typically generate lower operating expense ratios. The decline is also attributable to cost reduction programs undertaken since the first quarter of fiscal year 2001 to further reduce sales and marketing costs.

Research and Development. Research and development expenses were $9.6 million (representing 5.0% of sales) in the second quarter of fiscal year 2002, compared to $9.3 million (representing 4.9% of sales) in the second quarter of fiscal year 2001. Research and development expenses increased from the prior year quarter primarily because the Company continued to increase its focus on new product development for life science and health care research applications within the Scientific Instruments segment.

General and Administrative. General and administrative expenses were $8.7 million (representing 4.6% of sales) in the second quarter of fiscal year 2002, compared to $10.6 million (representing 5.6% of sales) in the second quarter of fiscal year 2001. The decrease as a percentage of sales resulted primarily from the Company’s adoption at the beginning of fiscal year 2002 of FAS 142, which eliminated the amortization of goodwill and certain other related intangible assets. Had the provisions of FAS 142 been applicable in the fiscal year 2001 period, general and administrative expenses would have been lower by $0.9 million. The decrease is also attributable to cost reduction programs undertaken since the first quarter of fiscal year 2001 to further reduce general and administrative costs.

Purchased In-Process Research and Development. In connection with the acquisition of ANSYS Technologies, Inc. (“ANSYS”) in February 2002, the Company capitalized approximately $31.6 million in goodwill and identified intangible assets. In addition, the Company recorded a one-time charge of $0.9 million for purchased in-process research and development in the quarter ended March 29, 2002. At the time of the acquisition, research and development of several consumables products were in process. The percentage of completion for these products ranged from 49% to 73%. The percentage of completion for each project was determined using estimates of effort, value added, and degree of difficulty of the portion of each project completed as of the acquisition date, as compared to the remaining research and development needed to bring each project to technical feasibility. An external appraisal was performed which used the income approach to determine the portion of the purchase price attributed to the in-process research and development.

Net Interest Expense. Net interest expense was $0.5 million (representing 0.2% of sales) for the second quarter of fiscal year 2002, compared to $0.1 million (representing 0.1% of sales) for the second quarter of fiscal year 2001. The increase in net interest expense resulted primarily from decreased interest income due to a lower level of invested cash as a result of the acquisition of ANSYS as well as lower interest rates on invested cash.

Taxes on Earnings. The effective income tax rate was 37.7% (36.0% without the purchased in-process research and development charge) for the second quarter of fiscal year 2002, compared to 39.0% for the second quarter of fiscal year 2001. The fiscal year 2002 period rate was lower than the fiscal year 2001 period rate due mainly to reductions in foreign tax rates in jurisdictions where the Company has significant manufacturing operations.

Segments. Scientific Instruments sales of $119.1 million in the second quarter of fiscal year 2002 increased 13.0% over second quarter of fiscal year 2001 sales of $105.5 million. The revenue growth was primarily driven by increased sales of NMR products and certain products selling into life science applications. Earnings from operations in the second quarter of fiscal year 2002 were $12.2 million or 10.2% of sales. Excluding the purchased in-process research and development charge, earnings from operations of $13.1 million (11.0% of sales) increased from $10.9 million (10.4% of sales) in the second quarter of fiscal year 2001, primarily as a result of increased sales of products targeted toward life science applications. In addition, the Company’s adoption of FAS 142 had a positive impact on this segment’s operating profit; had the provisions of FAS 142 been applicable in the fiscal year 2001 period, operating profits would have been $11.7 million (11.1% of sales).

Vacuum Technologies sales of $27.3 million in the second quarter of fiscal year 2002 decreased 33.3% from second quarter of fiscal year 2001 sales of $40.9 million. The revenue decrease compared to the prior year period was caused primarily by weak demand from semiconductor equipment and other industrial capital equipment manufacturers. While sales decreased from the prior year period, second quarter fiscal year 2002 sales increased $0.9 million or 3.1% sequentially over the first quarter of fiscal year 2002, reversing a declining trend over the last four quarters. This increase was attributable to higher sales into life science and other research applications and, to a lesser degree, improved sales to semiconductor equipment manufacturers. Earnings from operations in the second quarter of fiscal year 2002 of $4.2 million (15.3% of sales) were down from the $8.6 million (21.0% of sales) in the second quarter of fiscal year 2001. The decreased earnings were primarily the result of lower sales in the fiscal year 2002 quarter.

Electronics Manufacturing sales in the second quarter of fiscal year 2002 of $44.0 million increased 1.6% from second quarter of fiscal year 2001 sales of $43.2 million and 7.2% sequentially from first quarter of fiscal year 2002 sales of $40.9 million. These increases were primarily the result of increased sales to health care equipment manufacturers who became new customers during fiscal year 2001. Earnings from operations in the second quarter of fiscal year 2002 of $4.0 million (8.9% of sales) increased from $2.1 million (4.9% of sales) in the second quarter of fiscal year 2001. The lower earnings in the second quarter of fiscal year 2001 were primarily the result of the costs of integrating an acquisition and start-up costs relating to new customers.

In the fourth quarter of fiscal year 2001, the Company adopted the provisions of SAB 101 retroactive to the beginning of fiscal year 2001. As a result, in the fourth quarter of fiscal year 2001, the Company restated its sales and related cost of sales for the first three quarters of fiscal year 2001 and recorded a non-cash charge for the cumulative effect of a change in accounting principle in the amount of $7.5 million after taxes in the first quarter of fiscal year 2001. The results of operations for the first half of fiscal year 2001 presented in the financial statements included in this Form 10-Q reflect the adoption of SAB 101.

equipment and other industrial capital equipment manufacturers. The decline was predominantly offset by an increase in Scientific Instruments’ North America sales. The increase in Europe was primarily driven by growth in Scientific Instruments sales. The decrease in the rest of the world was primarily due to large system sales by Scientific Instruments into the Pacific Rim in the prior year period and the decline of Vacuum Technologies sales and Scientific Instruments sales into the Pacific Rim in the current year period.

Gross Profit. Gross profit was $139.9 million (representing 37.3% of sales) in the first half of fiscal year 2002, compared to $140.8 million (representing 37.9% of sales) in the first half of fiscal year 2001. The slight decrease in gross profit percentage was driven primarily by a lower gross profit percentage for Vacuum Technologies which was negatively impacted by market weakness in the semiconductor equipment and industrial sectors due to the general economic slowdown.

Sales and Marketing. Sales and marketing expenses were $62.9 million (representing 16.8% of sales) in the first half of fiscal year 2002, compared to $64.5 million (representing 17.3% of sales) in the first half of fiscal year 2001. The decline as a percentage of sales relates primarily to increased sales of Scientific Instruments, particularly high-field NMR systems which typically generate lower operating expense ratios. The decline is also attributable to cost reduction programs undertaken since the first half of fiscal year 2001 to further reduce sales and marketing costs.

Research and Development. Research and development expenses were $18.6 million (representing 5.0% of sales) in the first half of fiscal year 2002, compared to $17.1 million (representing 4.6% of sales) in the first half of fiscal year 2001. Research and development expenses increased from the first half of fiscal year 2001 primarily because the Company continued to increase its focus on new product development for life science and health care research applications within the Scientific Instruments segment.

General and Administrative. General and administrative expenses were $18.5 million (representing 4.9% of sales) in the first half of fiscal year 2002, compared to $22.1 million (representing 5.9% of sales) in the first half of fiscal year 2001. The decrease as a percentage of sales resulted primarily from the Company’s adoption at the beginning of fiscal year 2002 of FAS 142, which eliminated the amortization of goodwill and certain other related intangible assets. Had the provisions of FAS 142 been applicable in the first half of fiscal year 2001, general and administrative expenses would have been lower by $1.6 million. The decrease is also attributable to cost reduction programs undertaken since the first half of fiscal year 2001 to further reduce general and administrative costs.

Net Earnings. Net earnings were $24.1 million ($0.69 net earnings per diluted share) in the first half of fiscal year 2002 ($25.0 million or $0.72 net earnings per diluted share prior to the purchased in-process research and development charge), compared to net earnings of $22.3 million ($0.65 net earnings per diluted share) in the first half of fiscal year 2001 prior to the cumulative effect of a change in accounting principle (SAB 101). Excluding the impact of the purchased in-process research and development charge in 2002 and the adoption of SAB 101 in 2001, the improvement in net earnings resulted primarily from lower operating expenses and the lower income tax rate.

Segments. Scientific Instruments sales of $236.0 million in the first half of fiscal year 2002 increased 16.2% over first half of fiscal year 2001 sales of $203.2 million. The revenue growth was primarily driven by increased sales of NMR products and certain products selling into life science applications. Earnings from operations in the first half of fiscal year 2002 were $27.1 million (11.5% of sales). Excluding the purchased in-process research and development charge, earnings from operations of $28.0 million (11.9% of sales) increased from $19.5 million (9.6% of sales) in the first half of fiscal year 2001, primarily as a result of increased sales of products targeted toward life science applications and revenues from after-market products and services. In addition, the Company’s adoption of FAS 142 had a positive impact on this segment’s operating profit; had the provisions of FAS 142 been applicable in the first half of fiscal year 2001, operating profits would have been $20.9 million (10.3% of sales).

Vacuum Technologies sales of $53.7 million in the first half of fiscal year 2002 decreased 34.9% from first half of fiscal year 2001 sales of $82.5 million. The revenue decrease was caused primarily by weak demand from semiconductor equipment and other industrial capital equipment manufacturers. Earnings from operations in the first half of fiscal year 2002 of $8.0 million (14.9% of sales) were down from the $17.7 million (21.5% of sales) in the first half of fiscal year 2001. The lower earnings were primarily the result of lower sales in the first half of fiscal year 2002.

Electronics Manufacturing sales in the first half of fiscal year 2002 of $84.9 million decreased 1.5% from first half of fiscal year 2001 sales of $86.2 million. Sales declined as a result of order delays after September 11. Earnings from operations in the first half of fiscal year 2002 of $7.1 million (8.3% of sales) increased from $4.9 million (5.6% of sales) in the first half of fiscal year 2001. The lower earnings in the first half of fiscal year 2001 were primarily the result of the costs of integrating an acquisition and start-up costs relating to new customers.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to exercise certain judgments in selecting and applying accounting policies and methods. The following is a summary of what management considers to be the Company’s most critical accounting policies—those that are most important to the portrayal of its financial condition and results of operations and that require management’s most difficult, subjective or complex judgments—the effects of those accounting policies applied, the judgments made in their application, and the likelihood of materially different reported results if different assumptions or conditions were to prevail.

Revenue Recognition. The Company derives revenues from three sources: system sales, part sales and service contracts. Generally, the Company recognizes revenue when persuasive evidence of an arrangement exists, the product is delivered, title and risk of loss has passed to the customer, and collection of the resulting receivable is probable. The Company’s sales are typically not subject to rights of return and sales returns have not historically been significant. System sales of existing products that involve installation services are accounted for as multiple element arrangements, where the larger of the contractual billing hold back or the fair value of the installation service is deferred when the product is shipped and recognized when the installation is complete. In

all cases, the fair value of undelivered elements, such as accessories, is deferred until those items are delivered to the customer. For certain other system sales involving unique customer acceptance terms, or new specifications or technology with customer acceptance provisions, all revenue is generally deferred until customer acceptance. Revenue related to part sales is recognized when the parts have been shipped and title and risk of loss have passed to the customer. Revenue related to service contracts is recognized ratably over the duration of the contracts. Unearned maintenance and service contract revenue is included in accrued liabilities. Management determines when and how much revenue may be recognized on a particular transaction in a particular period based on its best estimate of the fair value of undelivered elements and its judgment of when the Company’s performance obligations have been met. These judgments and estimates impact reported revenues.

Allowances for Doubtful Accounts Receivable. The Company sells its products and extends trade credit to a large number of customers. These customers are dispersed across many different industries and geographies and no single customer accounts for 10% or more of the Company’s total revenues. The Company performs ongoing credit evaluations of its customers and generally does not require collateral from them. Although bad debt write-offs have historically not been significant, allowances are established for amounts that are considered to be uncollectible. These allowances represent management’s best estimates and are based on management’s judgment after considering a number of factors including third-party credit reports, actual payment history, customer-specific financial information and broader market and economic trends and conditions. In the event that actual uncollectible amounts differ from these best estimates, changes in allowances for doubtful accounts might become necessary.

Inventory Valuation. Inventories are stated at the lower of cost or market, with cost being computed on an average cost basis. Provisions are made to write down potentially excess, obsolete or slow moving inventories to their net realizable value. These provisions are based on management’s best estimates after considering historical demand, projected future demand (including current backlog), inventory purchase commitments, industry and market trends and conditions and other factors. In the event that excess, obsolete or slow moving inventories differ from these best estimates, changes to inventory reserves might become necessary.

Product Warranty. The Company’s products are generally subject to warranties, and liabilities are therefore established for the estimated future costs of repair or replacement in cost of sales at the time the related sale is recognized. These liabilities are adjusted based on management’s best estimates of future warranty costs after considering historical and projected product failure rates and product repair costs. In the event that actual experience differs from these best estimates, changes in the Company’s warranty liabilities might become necessary.

Environmental Liabilities. As discussed more fully below under the heading “Environmental Matters,” under the terms of the Distribution, the Company and VSEA each agreed to indemnify VMS for one-third of certain environmental investigation and remediation costs (after adjusting for any insurance proceeds and tax benefits recognized or realized by VMS for such costs). The liabilities recorded by the Company relating to these matters are based on management’s best estimates after considering currently available information regarding the cost and timing of remediation efforts, pending legal matters, insurance recoveries and other environmental-related events. As additional information becomes available, these amounts are adjusted accordingly. Should the cost or timing of remediation efforts, pending legal matters, insurance recoveries or other environmental-related events (including any which may be currently unidentified) differ from the Company’s current expectations and best estimates, changes to the Company’s environmental liability balance might become necessary.

The Company’s liquidity is affected by many other factors, some based on the normal ongoing operations of the business and others related to the uncertainties of the industry and global economies. Although the Company’s cash requirements will fluctuate based on the timing and extent of these factors, management believes that cash generated from operations, together with the Company’s borrowing capability, will be sufficient to satisfy commitments for capital expenditures and other cash requirements for the next 12 months.

	Six Months Ending Sept. 27,		Fiscal Years												Total
	2002		2003		2004		2005		2006		2007		Thereafter		Total
(in thousands)
Long-term debt (including current portion)	$	3,541	$	4,241	$	3,701	$	2,500	$	2,500	$	2,500	$	25,000	$	43,983
Operating leases		3,478		5,942		4,237		3,699		2,658		1,927		28,063		50,004

Total contractual cash obligations	$	7,019	$	10,183	$	7,938	$	6,199	$	5,158	$	4,427	$	53,063	$	93,987

The Company’s operations are subject to various foreign, federal, state, and local laws regulating the discharge of materials into the environment or otherwise relating to the protection of the environment. These regulations increase the costs and potential liabilities of the Company’s operations. However, the Company does not currently anticipate that its compliance with these regulations will have a material effect upon the Company’s capital expenditures, earnings, or competitive position.

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 the Company’s financial statements, the likelihood of such occurrence is considered remote. Based on information currently available and its best assessment of the ultimate amount and timing of environmental-related events, management believes that the costs of these environmental-related matters are not reasonably likely to have a material adverse effect on the Company’s financial position or results of operations.

Under the terms of the Distribution, the Company agreed to defend and indemnify VSEA and VMS for costs, liabilities, and expenses with respect to legal proceedings relating to the Instruments Business of VAI, and agreed to reimburse VMS for one-third of certain costs and expenses (after adjusting for any insurance proceeds and tax benefits recognized or realized by VMS for such costs and expenses) that are paid after April 2, 1999 and arise from actual or potential claims or legal proceedings relating to discontinued, former, or corporate operations of VAI. From time to time, the Company is involved in its own legal actions and could incur an uninsured liability in one or more of them. While the ultimate outcome of all of the foregoing legal matters is not determinable, management believes that these matters are not reasonably likely to have a material adverse effect on the Company’s financial position or results of operations.

On January 1, 1999, 11 of the 15 member countries of the European Union established fixed conversion rates between their existing currencies (legal currencies) and one new common currency—the Euro. The Euro then began trading on currency exchanges and began to be used in certain business transactions. The transition period for the introduction of the Euro occurs through June 2002. Beginning January 1, 2002, new Euro-denominated bills and coins were issued. Simultaneously, legacy currencies began to be withdrawn from circulation with the completion of the withdrawal scheduled for no later than July 1, 2002. Because of the Company’s significant sales and operating profits generated in the European Union, the Company has completed a program to identify and address risks arising from the conversion to the Euro currency. That program included converting information technology systems to handle the new currency, evaluating the competitive impact of one common currency due to, among other things, increased cross-border price transparency, evaluating the Company’s exposure to currency exchange risks during and following the transition period to the Euro, and determining the impact on the Company’s processes for preparing and maintaining accounting and taxation records. Management believes that it has taken appropriate steps to prepare for the Euro conversion and to mitigate its effects on the Company’s business, and that the Euro conversion is not likely to have a material adverse effect on the Company’s business or financial condition.

In August 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. (“FAS”) 143, “Accounting for Asset Retirement Obligations,” which is effective for fiscal years beginning after June 15, 2002. FAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. FAS 143 applies to all entities. The Company does not expect the adoption of FAS 143 to have a significant impact on its financial position or results of operations.

Foreign Currency Exchange Risk. The Company typically hedges its currency exposures associated with certain assets and liabilities denominated in non-functional currencies and with certain forecasted foreign currency cash flows. As a result, the effect of an immediate 10% change in exchange rates would not be material to the Company’s financial condition or results of operations. The gains or losses from the change in exchange rates would be substantially offset by losses or gains from the related foreign exchange forward contracts. The Company’s foreign exchange forward contracts generally range from one to 12 months in original maturity.

At March 29, 2002, forward contracts to sell Japanese yen having an aggregate notional value of $8.6 million were designated as cash flow hedges of forecasted sale transactions. These contracts were deemed to be highly effective and, as a result, a gain of $0.3 million (net of tax) on these contracts is included in other comprehensive loss in stockholders’ equity. A summary of all forward exchange contracts that were outstanding as of March 29, 2002 follows:

The Company has no material exposure to market risk for changes in interest rates. The Company invests any excess cash primarily in short-term U.S. Treasury securities and money market funds, and changes in interest rates would not be material to the Company’s financial condition or results of operations. The Company primarily enters into debt obligations to support general corporate purposes, including working capital requirements, capital expenditures, and acquisitions. At March 29, 2002, the Company’s debt obligations had fixed interest rates.

Delaware		77-0501995
(State or Other Jurisdiction of Incorporation or Organization		(IRS Employer Identification Number)

3120 Hansen Way, Palo Alto, California		94304-1030
(Address of Principal Executive Offices)		(Zip Code)

Part I.	Financial Information	3
Item 1.	Financial Statements	3
	Unaudited Consolidated Condensed Statements of Earnings	3
	Unaudited Consolidated Condensed Balance Sheets	4
	Unaudited Consolidated Condensed Statements of Cash Flows	5
	Notes to the Unaudited Consolidated Condensed Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosure about Market Risk	25

Part II.	Other Information	26
Item 4.	Submission of Matters to a Vote of Security Holders	26

	Mar. 29, 2002		Sept. 28, 2001
(In thousands)
INVENTORIES

Raw materials and parts	$	62,860	$	63,193
Work in process		13,044		12,175
Finished goods		45,485		44,130

	$	121,389	$	119,498

	Notional Value Sold		Notional Value Purchased
(in thousands)
Euro	$	—	$	23,344
Australian dollar		—		24,983
Japanese yen		14,410		—
British pound		6,415		—
Canadian dollar		6,958		—

Total	$	27,783	$	48,327

	Notional Value Sold		Notional Value Purchased
(in thousands)
Euro	$	—	$	23,344
Australian dollar		—		24,983
Japanese yen		14,410		—
British pound		6,415		—
Canadian dollar		6,958		—

Total	$	27,783	$	48,327

(in millions)
Current assets	$	5.6
Property, plant and equipment, net		9.6
Other assets		0.7
Goodwill		23.8
Existing technology and other identified intangibles		7.8

Total assets acquired		47.5
Liabilities assumed		(3.2	)

Net assets acquired		44.3
Purchased in-process research and development		0.9

Total consideration	$	45.2

VARIAN, INC. (Registrant)

By		/s/ G. Edward McClammy
		G. Edward McClammy Vice President, Chief Financial Officer and Treasurer (Duly Authorized Officer and Principal Financial Officer)