Increasing demand for more effective and affordable healthcare solutions, together with a focus on execution and operational efficiency, enabled Varian Medical Systems to grow and achieve excellent financial results in fiscal year 2005. The year was marked by another major revolution in cancer care sparked by products for state-of-the-art radiation oncology and X-ray imaging. The company launched several new and enhanced products for advanced cancer treatments, bloodless neurosurgery, filmless X-ray imaging, and automatic inspection of cargo containers. We extended our global leadership in our traditional markets and pushed more deeply into promising new markets.

All in all, it was another successful year in which we positioned the company for continued growth.

PROFITABLE GROWTH
In fiscal year 2005, compared with the previous fiscal year:

• Net orders rose 14 percent, to $1.6 billion
• Year-end backlog rose 21 percent, to $1.2 billion
• Revenues increased 12 percent, to $1.4 billion
• Operating earnings climbed 19 percent, to $305 million
• Net earnings rose 23 percent, to $207 million
• Earnings per diluted share climbed 27 percent, to $1.50

All three of our business segments contributed positively to the growth in annual net orders, revenues, and operating earnings. Annual net orders increased 14 percent in Oncology Systems, 11 percent in X-Ray Products, and 20 percent in the “Other” segment that included the Ginzton Technology Center and BrachyTherapy products. Annual revenues rose 10 percent in Oncology Systems, 18 percent in X-Ray Products, and 23 percent in our “Other” segment.

Compared with the previous fiscal year, the company's gross margin rose by 1 percent to 43 percent of revenues with gains in every business segment. We credit this achievement to a bigger mix of new, more profitable products.

Despite spending roughly $5 million to implement the new Sarbanes-Oxley financial accounting requirements, we reduced selling, general, and administrative (SG&A) expenses as a percentage of revenues by about half a point, to 15 percent. In recognition of several promising potential technological developments for cancer care and imaging, we increased research and development investment by nearly 14 percent, keeping it flat as a percentage of revenues at 6 percent. With the help of our gross margin improvements and well-managed controls on SG&A, our operating earnings for fiscal year 2005 were up 19 percent from the previous fiscal year.

The company generated a record $252 million from operations. We ended the year with $382 million in cash and marketable securities after spending $227 million to repurchase nearly 6 million shares of the company's common stock, $44 million on capital expenditures including an expansion of our Las Vegas facilities, and approximately $14 million for the acquisition of Sigma Micro Informatique Conseil, a supplier of information-management software for radiation oncology and medical oncology in cancer clinics and hospitals in France and other European nations.

For fiscal year 2005, Varian Medical Systems delivered a 33 percent return on equity—an increase of 5 points from a 28 percent return on equity in fiscal year 2004.

MARKET LEADERSHIP
As the world's largest dedicated manufacturer of radiotherapy products for cancer care, we challenged ourselves in fiscal 2005 not just to provide better medical technology, but also to control the cost and increase the efficiency of treatments. Several highlights of the year stood out.

By combining new accessories for high-quality imaging with our machines for treatment delivery as well as enhanced software for planning and information management, we have enabled oncologists to see anatomical structures and target tumors precisely while making the entire process faster and more comfortable for the patient.

A new process, known as image-guided radiation therapy (IGRT), has been hailed as a technological breakthrough. We have led the field in the practical implementation of this technology with more than 275 orders and 110 shipments of automated, robotically controlled On-Board Imager™ devices for IGRT since their introduction in fiscal 2004.

Our IGRT products also facilitate 4D treatments by correcting for tumor
motion caused by respiration during treatment. This capability holds special importance for treatment of lung cancer, which today is the most common and one of the most lethal forms of cancer. Many institutions throughout the world are adopting this technology.

A second major initiative in fiscal 2005 was the deployment of our new Varian Trilogy™ accelerator, which delivers traditional radiation therapy, intensity-modulated radiation therapy (IMRT), IGRT, and stereotactic radiosurgery treatments. IMRT shapes the treatment field to conform to the irregular 3D shape of the tumor. Stereotactic radiosurgery, often called bloodless neurosurgery, excises tumors and neoplasms in a short, noninvasive outpatient treatment. A growing body of evidence suggests that stereotactic radiosurgery, combined with today's advanced diagnostic imaging techniques, makes it possible to stop the spread of early-stage metastatic cancer. With this capability, some fatal forms of cancer may be converted into controllable, chronic diseases.

Throughout the year, we continued to concentrate on the enhancement and tighter integration of all products needed for more advanced radiotherapy treatments. We developed a new version of our Eclipse™ software with additional features and functions designed to simplify and speed up treatment planning.

We also introduced the ARIA™ Oncology Information System for paperless and filmless cancer clinics that offer radiation therapy, chemotherapy, and/or surgery. ARIA combines rapid image-processing capabilities with a comprehensive database and network capability that integrates and supports devices, processes, and staff members involved in patient care. We see it as an important tool for providing clinicians with all the information they need to make critical treatment decisions.

The digital revolution has led to an explosion of new technology in medical equipment in the last few years. This rapid technological change is especially characteristic of cancer diagnosis and treatment systems. Sophisticated technology alone, however, cannot cure cancer. Our customers need training, on-site support, periodic software enhancements, patient education materials, telephone support, parts availability, and quality assurance tools. We are second to none in providing these capabilities. Revenues for service and support rose more than 20 percent in 2005, indicating our customers' growing appreciation for these critical services.

Our expertise in X-ray imaging gives Varian a huge advantage in this market. Our IGRT accessories are equipped with a Varian X-ray tube for diagnostic-quality images and our unique PaxScan® image detector for instantly capturing and digitizing X-ray images. The unmatched processing speed of the Varian PaxScan detector makes it possible to generate superior image detail in order to precisely locate and target tumors.

As a measure of our image detector’s unique capabilities, Varian has been supplying these products in increasing volumes to manufacturers of X-ray equipment for medical diagnostics, veterinary imaging, dental computed tomography (CT) scans, and non-destructive test and inspection of machined or cast metal parts.

The PaxScan product line, together with our high-power tubes for CT scans, significantly enhanced the growth rate of our X-Ray Product segment in fiscal year 2005. In anticipation of future growth for this segment, we announced plans to expand our X-Ray Products manufacturing plant in Salt Lake City.

MANAGEMENT SUCCESSION AND EMPLOYEES
Shortly after the fiscal year ended, I announced my intention to retire as Chief Executive Officer and to continue as Chairman of the Board of Directors of Varian Medical Systems effective February 17, 2006. In the last year or two, we have established a sound succession plan with a team of proven performers in senior management positions.

Upon my retirement, Tim Guertin, who was named President of the company and appointed to the Board of Directors earlier in fiscal year 2005, will become CEO. He will be continuing a 30-year career, having served Varian in many posts including several years as the President and strategic architect of our Oncology Systems business.

Dow Wilson joined Varian during the fiscal year, leaving a position as CEO of the GE Healthcare Information Technologies business to become President of our Oncology Systems business. While retaining direct responsibility for managing our Oncology Systems business, Dow was subsequently appointed Executive Vice President for the company.

Elisha Finney, who is well known to our investors as Varian’s Chief Financial Officer, was promoted during the year to Senior Vice President for the company. In addition to managing finance, investor relations, and regulatory affairs for the company, she has assumed responsibility for the company’s information systems function.

Our senior management team taps a deep pool of talented and committed managers and employees who have continued to build our company over the years through superb execution in virtually every aspect of our business. Thanks to this collection of people, who are among the leaders in their fields, Varian Medical Systems is a global powerhouse with a winning tradition and an excellent reputation for delivering when it counts.

WHAT’S NEXT?
Our successes in fiscal year 2005 have inspired us. Varian Medical Systems’ key goals for fiscal year 2006 are to:

• Accelerate the adoption of better, more advanced cancer treatments
  
• Expand our image detector business for filmless X-rays
  
• Strengthen our emerging businesses in neurosurgery, brachytherapy, and homeland security
  
• Extend our reach into new and emerging markets
  
• Strengthen our operations
  
• Deliver excellent financial results

The last several years at Varian Medical Systems have been the most exciting in my 37 years with the company. We have advanced technologies and launched many new products that are improving X-ray imaging and helping to cure cancer. With our leading technology, products, and talent, Varian Medical Systems has a tremendous opportunity to make modern healthcare more effective, more affordable, and more available for patients around the world, as exemplified by the stories in this annual report. Our potential to make a positive difference for patients as well as our stockholders, customers, and employees has never been greater.

We are looking forward to making fiscal year 2006 rewarding for all of us, and we thank you for your continued support.

Sincerely yours,

Richard M. Levy
Chairman and CEO
Varian Medical Systems