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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-K

(Mark One)

| |     |  |                                                                                      
| | --- |  | -------------------------------------------------------------------------------------
| | [X] |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2002

OR

| |       |  |                                                                                          
| | ----- |  | -----------------------------------------------------------------------------------------
| | [   ] |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from         to

Commission File Number 000-17157

NOVELLUS SYSTEMS, INC.

(Exact name of Registrant as specified in its charter)


|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|California                                                     |  | 77-0024666                             
|(State or other jurisdiction of incorporation of organization) |  | (I.R.S. Employer Identification Number)

4000 North First Street, San Jose, California 95134
(Address of principal executive offices including Zip code)

(408) 943-9700
(Registrants telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, no par value

(Title of Class)


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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrants knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [X]

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). YES [X]  NO [  ]

As of June 28, 2002 the aggregate market value of voting and non-voting stock
held by non-affiliates of the Registrant was approximately
$5,064,390,563, based
on the average of the high and low prices of the Common Stock as reported on
the NASDAQ National Market on such date. Shares of Common Stock held by
officers, directors and holders of more than 5% of the outstanding Common Stock
have been excluded from this calculation because such persons may be deemed to
be affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.

The number of shares of the Registrants Common Stock outstanding on February
26, 2003 was 149,575,876.

Documents Incorporated by Reference: Part III of this Form 10-K incorporates
information by reference from the Registrants Proxy Statement for its 2003
Annual Meeting of Shareholders.





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TABLE OF CONTENTS



|              |                                                                                               |  |  |  |  |  |  | 
|------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I       
|              | ITEM 1. BUSINESS                                                                             
|              | ITEM 2. PROPERTIES                                                                           
|              | ITEM 3. LEGAL PROCEEDINGS                                                                    
|              | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|PART II      
|              | ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED SHAREHOLDER MATTERS                
|              | ITEM 6. SELECTED FINANCIAL DATA                                                              
|              | ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|              | ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                          
|              | ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                          
|              | ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 
|PART III     
|              | ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                  
|              | ITEM 11. EXECUTIVE COMPENSATION                                                              
|              | ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT                      
|              | ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                      
|              | ITEM 14. CONTROLS AND PROCEDURES                                                             
|PART IV      
|              | ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K                    
|SIGNATURES   
|EXHIBIT 4.1  
|EXHIBIT 4.2  
|EXHIBIT 4.3  
|EXHIBIT 4.4  
|EXHIBIT 4.5  
|EXHIBIT 10.27
|EXHIBIT 10.28
|EXHIBIT 10.29
|EXHIBIT 10.30
|EXHIBIT 10.31
|EXHIBIT 10.32
|EXHIBIT 10.33
|EXHIBIT 10.34
|EXHIBIT 10.35
|EXHIBIT 10.36
|EXHIBIT 10.37
|EXHIBIT 10.38
|EXHIBIT 10.39
|EXHIBIT 12.1 
|EXHIBIT 21.1 
|EXHIBIT 23.1 
|EXHIBIT 99.1 
|EXHIBIT 99.2 
|EXHIBIT 99.3 



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NOVELLUS SYSTEMS, INC.

2002 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

|           |  |          |  |                                                                                       |      |    | 
|---------- |  | -------- |  | ------------------------------------------------------------------------------------- | ---- | -- | 
|           |  |          |  |                                                                                       | Page
|           |  |          |  |                                                                                       |     
|Part I     |  |          |  |                                                                                       |      |    | 
|           |  | Item 1:  |  | Business                                                                              |      | 8  | 
|           |  | Item 2:  |  | Properties                                                                            |      | 16 | 
|           |  | Item 3:  |  | Legal Proceedings                                                                     |      | 16 | 
|           |  | Item 4:  |  | Submission of Matters to a Vote of Security Holders                                   |      | 18 | 
|Part II    |  |          |  |                                                                                       |      |    | 
|           |  | Item 5:  |  | Market for Registrants Common Equity and Related Shareholder Matters                 |      | 18 | 
|           |  | Item 6:  |  | Selected Financial Data                                                               |      | 18 | 
|           |  | Item 7:  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |      | 20 | 
|           |  | Item 7A: |  | Quantitative and Qualitative Disclosures about Market Risk                            |      | 33 | 
|           |  | Item 8:  |  | Financial Statements and Supplementary Data                                           |      | 35 | 
|           |  | Item 9:  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure  |      | 65 | 
|Part III   |  |          |  |                                                                                       |      |    | 
|           |  | Item 10: |  | Directors and Executive Officers of the Registrant                                    |      | 65 | 
|           |  | Item 11: |  | Executive Compensation                                                                |      | 65 | 
|           |  | Item 12: |  | Security Ownership of Certain Beneficial Owners and Management                        |      | 65 | 
|           |  | Item 13: |  | Certain Relationships and Related Transactions                                        |      | 65 | 
|           |  | Item 14: |  | Controls and Procedures                                                               |      | 65 | 
|Part IV    |  |          |  |                                                                                       |      |    | 
|           |  | Item 15: |  | Exhibits, Financial Statement Schedules and Reports on Form 8-K                       |      | 67 | 
|Signatures |  |          |  |                                                                                       |      | 72 | 

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K and certain information incorporated herein by
reference contain forward-looking statements within the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. All
statements included or incorporated by reference in this Annual Report on Form
10-K, other than statements that are purely historical, are forward-looking
statements. Words such as anticipates, expects, intends, plans,
believes, seeks, estimates and similar expressions also identify
forward-looking statements. Forward-looking statements are not guarantees of
future performance and are subject to risks and uncertainties that could cause
actual results to differ materially from the results contemplated by the
forward-looking statements. Forward-looking statements in this Annual Report on
Form 10-K include, without limitation:



| |  | Statements about the growth of the semiconductor
industry; market size, share and demand; product
performance; our expectations, objectives,
anticipations, intentions and strategies regarding
the future; expected operating results, revenues and
earnings; and current and potential litigation, which
statements are subject to various uncertainties,
including, without limitation, those discussed in
Item 7. Managements Discussion and Analysis of
Financial Condition and Results of Operations  Risk
Factors;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | The statements under the heading Item 1. Business
concerning (1) the semiconductor industrys migration
to the use of copper and low-k dielectrics and (2)
the growing importance of the surface preparation and
CMP manufacturing steps, which statements are subject
to various risks and uncertainties, including, without
limitation, the failure of our expectations regarding
the future direction of the semiconductor industry
and our failure to combine the recently-acquired
product offerings of GaSonics International
Corporation and SpeedFam-IPEC, Inc. with our
offerings;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| 
| |  | The statements under the heading Item 1. Business 
Industry Background regarding our beliefs that (1) unit
demand for semiconductor devices will continue to increase; (2) the next
generation of chips will likely see line widths as small as 90 nanometer
and below; (3) there will be a
transition from aluminum to copper
conductive material; (4) there will be a transition from
silicon oxide films to low-k dielectric insulators;
and (5) there is a trend toward larger wafer sizes,
which statements are subject to various
risks and  uncertainties, including, without limitation, periodic downturns in the
semiconductor industry, slowdowns in the rate of
capital investment by semiconductor manufacturers, shifts
in demand from expensive, high-performance products
to lower priced, conventional products, and the failure of our expectations regarding the
future direction of the semiconductor industry;                                                                                                                                                                                                                                                                                         
| 
| |  | The statements under the heading Item 1. Business 
Strategy, concerning (1) our objective to increase our
market share in the interconnect manufacturing market and strengthen
our position as a leading supplier of semiconductor processing
equipment; (2) our emphasis on high-productivity systems;
(3) our focus on reducing customer costs; (4) our service
differentiation philosophy; (5) our goal to lead in our target
markets; (6) our goal to broaden our interconnect offerings;
(7) our focus on major semiconductor manufacturers; (8) our
intention to expand our market presence in Asia; and (9) our
intention to leverage our low manufacturing cost structure, which statements are subject to various
risks and uncertainties, including, without limitation, shifts
in demand from expensive, high-performance products
to lower priced, conventional products, resulting in reduced profit
for semiconductor manufacturers, the current and
other periodic downturns in the semiconductor
industry and the economy in general, slowdowns in the rate of capital investment
by semiconductor manufacturers and future product
developments, introductions by competitors,
increased competition in the

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|  |  | semiconductor equipment industry
and risks and uncertainties associated with international
operations, including economic downturns, trade balance issues,
political instability, banking issues, fluctuations in interest and
foreign currency exchange rates and slower economic development in Asia;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | The statements under the heading Item 1. Business 
Products of our beliefs regarding our products,
including (1) that Concept Two enables increased
production throughput and system capability; (2) that
Concept Three offers greater throughput in 300mm
wafer-manufacturing applications; (3) that Concept
Three SPEED offers minimal risk to our customers in
making the transition from 200mm to 300mm volume
chipmaking; (4) that Concept Two ALTUS is ideal for
meeting the requirements of high-volume, automated
200mm wafer fabs producing semiconductor devices at
0.18 micron and below; (5) that the INOVA 200mm
system will continue to gain market acceptance based
on barrier seed step coverage performance; (6) that
the 300 mm INOVA XT with Hollow Cathode Magnetron or HCM will continue to offer
superior barrier performance; (7) that our
Electrofill products are highly reliable and
cost-effective; (8) the increasing importance of
photoresist strip and clean processes; (9) that
IRIDIA offers the highest productivity of any 200 mm
dry-clean system currently on the market; (10) that
SIERRA yields significantly higher capital
productivity and significantly lower
cost-of-ownership advantages than competing dry-clean
systems; (11) that the opportunity to integrate and
optimize the planarization, deposition and surface
preparation steps gives us an important
advantage in extending copper/low-k processes to
advanced semiconductor devices; and (12) that
MOMENTUM allows for maximum manufacturing
flexibility, which statements are subject to various
risks and uncertainties, including, among others, the inaccuracy of
our assessment of the capabilities of our products, the
greater financial, marketing, technical or other
resources, broader product lines, greater customer
service capabilities and larger and more established
sales organizations and customer bases that some of
our competitors possess, future competition from new
market entrants,
our competitors improvement of the design and
performance of their products that may offer superior
price or performance features over our products, and difficulties in selecting, developing, manufacturing and
marketing our new products or enhancing our existing
products;
| 
| |  | The statements under the heading Item 1. Business 
Marketing, Sales and Service of our beliefs that (1) our strategy of supporting our
installed base through customer support and R&D
groups has accelerated penetration of certain key
accounts; (2) our marketing efforts are enhanced by
the technical expertise of our R&D personnel; and (3)
our customer service is enhanced by the design
simplicity of our systems, which statements are
subject to certain risks and uncertainties, including, without
limitation, that during periods of rapid growth, we
may not be able to hire, assimilate and retain a sufficient number of qualified
people and our failure to design simple, streamlined systems;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| 
| |  | The statement under the heading Item 1. Business 
Research and Development regarding our expectation that research and development
expenditures will continue to represent a substantial
percentage of sales, which statement is subject to
certain risks and uncertainties, including, among others, that we may
be unable to allocate substantial resources to research and
development;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| 
| |  | The statements under the heading Item 1. Business 
Manufacturing regarding (1) our belief that our
outsourcing strategy enables us to minimize our fixed
costs and capital expenditures while also                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

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|  |  | providing the flexibility to increase capacity as needed and allows us to
focus on product differentiation through system design and quality control;
(2) our belief that the use of manufacturing specialists for our subsystems
incorporate the most advanced technologies in robotics, gas panels and
microcomputers; (3) our goal to work with suppliers to achieve mutual cost
reduction through joint design efforts; and (4) our goal of reduced
dependence on limited suppliers for certain key parts, which statements are
subject to various risks and uncertainties, including, without limitation, the
possible occurrence of a disruption or termination of certain limited source
suppliers, our prolonged inability to obtain certain components, our
failure to work efficiently with suppliers, and our inability to
establish relationships with alternative suppliers of key parts;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | The statement under the heading Item 1. Business  Competition
regarding our belief as to our favorable competitiveness in our market
segments, which statement is subject to various risks and
uncertainties, including,
among others, the greater financial, marketing, technical or other
resources, broader product lines, greater customer service
capabilities and larger and more established sales organizations and
customer bases that some of our competitors possess, future
competition from new market entrants from overseas and domestic
sources, our competitors improvement of the design and performance of
their products that may offer superior price or performance features
as compared to our products, and our success in selecting, developing,
manufacturing and marketing our new products or enhancing our existing
products;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| 
| |  | The statements under the heading Item 1. Business  Patents and
Proprietary Rights regarding our beliefs and intentions (1) to pursue
the legal protection of our technology primarily through patent and
trade secret protection; (2) to file additional patent applications;
(3) to vigorously protect our intellectual property rights; (4) that
the outcomes of current litigation will not have a material impact on our
business; and (5) that in the future, litigation may be necessary to
enforce patents issued to us, to protect trade secrets or know-how
owned by us or to defend us against claimed infringement of the rights
of others and to determine the scope and validity of the proprietary
rights of others, which statements are subject to various
risks and uncertainties, including, without limitation, the absence of assurance
that patents will be issued from any of our pending applications or
that any claims allowed from existing or pending patents will be
sufficiently broad to protect our technology, the fact that litigation
could result in substantial cost and diversion of our effort and the
fact that adverse litigation determinations could result in a
loss of our proprietary rights, subject us to significant liabilities
to third parties, require us to seek licenses from third parties or
prevent us from manufacturing or selling our products;
| 
| |  | The statements under the heading Item 1. Business  Employees that
our success depends upon (1) our ability to recruit and retain
engineers and technicians, marketing, sales, service and other key
personnel and (2) the retention of a limited number of key employees
and other members of our senior management, which statements are
subject to risks and uncertainties, including, among others, our
inability to successfully retain or recruit key personnel and our
inability to effectively manage growth;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| 
| |  | The statement under the heading Item 1. Business  Environmental
Matters that neither compliance with federal, state and local
provisions regulating discharge of materials into the environment nor
remedial agreements or other environmental actions is expected to have
a material affect on our capital expenditures, financial condition,
results of operations or competitive position, which statement is
subject to various risks and uncertainties, including, among others, that we have
inaccurately assessed the compliance requirements of environmental
provisions;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| 
| |  | The statement under the heading Item 2. Properties of our belief
that our current properties will be sufficient to meet our
requirements for the foreseeable future is subject to various risks
and
uncertainties, including, without limitation, growth in net sales
placing unexpected strains on our resources and properties;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| 
| |  | The statements under the headings Item 3. Legal Proceedings and
Item 8. Financial Statements and Supplementary Data  Notes to
Consolidated Financial Statements  Note 11. Litigation of our beliefs
(1) that there are meritorious defenses in the Applied Materials,
Inc., Semitool, Inc., Plasma Physics Corporation, Solar Physics
Corporation and Linear Technology Corporation litigation matters, and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

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|  |  | (2)  regarding the impact and outcome of the Applied, Semitool, Plasma Physics,
Solar Physics and Linear Technology litigation matters, which statements are subject to various
uncertainties, including, without limitation, our inability to accurately
predict the determination of complex issues of fact and law;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | The statements under the heading Item 7. Managements Discussion and
Analysis of Financial Condition and Results of Operations  Results of
Operations regarding calculation of allowances, reserves, and other
estimates that are based on historical experience, the judgment of
management, and various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources, our
beliefs about critical accounting policies, and the significant
judgments and estimates used in the preparation of our consolidated
financial statements, which statements are subject to certain risks, including,
among others, the inaccuracy of our beliefs regarding critical accounting
policies and that actual product failure rates, material usage,
installation costs, customer reserves or other estimates may be
different from our estimates, requiring revisions to our
estimated allowance for doubtful accounts, additional inventory
write-downs, restructuring charges, litigation, warranty, and other
reserves;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| 
| |  | The statements under the heading Item 7. Managements Discussion and
Analysis of Financial Condition and Results of Operations  Results of
Operations of our strategies, beliefs, plans, expectations,
anticipations and hopes with respect to Net Sales, Gross Profit,
Selling, General and Administrative, Research and Development,
Acquired In-Process Research and Development, Restructuring and Other
Charges, Bad Debt (Recovery) Write-off, Other Income, net, Provision
for Income Taxes, Deferred Tax Assets, Foreign Currency Accounting and
Foreign Exchange Contracts including, without limitation, (1) our plan
to continue our R&D commitment to improvement of new and existing
technologies; (2) our belief that substantial investment in R&D is
required to remain competitive; (3) managements beliefs regarding the
realization of deferred tax assets; and (4) the belief that our
forward foreign exchange contracts do not subject us to speculative
risk that would otherwise result from changes in currency exchange
rates; and our strategies, beliefs, plans, expectations, anticipations
and hopes with respect to Liquidity and Capital Resources set forth
under Item 7. Managements Discussion and Analysis of Financial
Condition and Results of Operations  Liquidity and Capital
Resources, including, without limitation, (1) our beliefs regarding
the impact of the adoption of SFAS Nos. 143, 145 and 146; (2) our
intention to continue our participation in synthetic leases in 2003;
(3) our beliefs regarding our exposure in connection with the residual
value guarantees related to our synthetic leases; (4) our belief that
the fair market value of each of the properties subject to the
synthetic leases exceeds the purchase option price for each property;
(5) our beliefs regarding the impact to liquidity if we must purchase
the properties subject to the synthetic leases; (6) our expectations
regarding our actions if the lessor under the synthetic leases is deemed to be a
voting interest entity versus a variable interest entity; (7) our
belief that the additional taxes, losses and expenses associated with
our maximum loss exposure on the synthetic leases would be immaterial;
and (8) our belief that our current cash position, cash generated
through operations and equity offerings, and available borrowings will
be sufficient to meet our needs through at least the next twelve
months, which statements are subject to numerous risks and
uncertainties, including, without limitation, our inability to
allocate substantial resources to R&D programs, the inaccuracy of our
beliefs regarding taxes, foreign exchange contracts, the impact of
certain accounting standards and our synthetic leases, that the semiconductor
industry will continue to experience this or another periodic
downturn, which could have a material adverse effect on the
semiconductor industrys demand for semiconductor processing
equipment, including equipment we manufacture and market, and our success in
selecting, developing, manufacturing and marketing our new products,
or enhancing our existing products;
| 
| |  | The statement under the heading Item 7A. Quantitative and Qualitative
Disclosures About Market Risk  Interest Rate Risk that we believe
that an immediate change to interest rates to variable short-term
borrowings will not have a material effect on our results is subject
to the risk, among other risks, that we have inaccurately assessed
our future borrowing needs; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

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| |  | The statement in Item 8. Financial Statements and Supplementary Data
 Notes to Consolidated Financial Statements  Note 2. Significant
Accounting Policies  Concentration of Credit and Other Risks that we
do not believe that there is a significant risk of nonperformance by
counterparties on foreign exchange contracts is subject to the risk,
among other risks, that we may fail to continuously monitor our
positions and the credit ratings of counterparties.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The forward-looking statements in this Annual Report on Form 10-K are subject
to additional risks and uncertainties further discussed under Item 7.
Managements Discussion and Analysis of Financial Condition and Results of
Operations  Risk Factors and are based on information available to us on the
date hereof. We assume no obligation to update any forward-looking statements.
Readers are cautioned not to place undue reliance on forward-looking
statements, which speak only as of the date of this Annual Report on Form 10-K.
Readers should also consult the cautionary statements and risk factors listed
from time to time in our Reports on Forms 10-Q, 8-K, 10-K and in our Annual
Reports to Shareholders.

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PART I




ITEM 1. BUSINESS

Novellus Systems, Inc., a California corporation organized in
1984, develops, manufactures, sells and supports systems used in the
fabrication of integrated circuits. The customers for these products are
manufacturers of semiconductor integrated circuits, or chips, who either
incorporate the chips they manufacture in their own products or sell them to
other companies for use in electronic products.

Integrated circuits are generally built on a silicon wafer base and include a
large number of different components, such as transistors, capacitors and other
electronic devices that are connected by multiple layers of wiring or
interconnects. To build an integrated circuit, transistors are first created
on the surface of the silicon wafer. The wiring and insulating structures are
then added as multiple thin-film layers through a series of processes.
Typically, a first layer of dielectric, or insulating material is deposited on
top of the formed transistors. That layer is then etched to create patterns
that are subsequently filled with conductive metal (traditionally aluminum, but
increasingly, copper is used). In copper dual damascene, a chemical mechanical
planarization, or polishing, step follows to remove excess copper. The sequence
is then repeated to create the multiple layers of wiring needed to connect the
transistors and form the integrated circuit. Advanced chip designs require as
many as 500 steps involving these and other manufacturing processes.

Novellus operates in a single industry segment for the manufacture, marketing
and support of semiconductor fabrication equipment. Our product offerings are
centered on the advanced systems used to deposit the films of conducting and
insulating material, using chemical vapor deposition (CVD), physical vapor
deposition (PVD) and electroplating or ElectrofillTM, commonly known in the
industry as electrochemical deposition (ECD) processes, to form the layers of
wiring and insulation, known as the interconnect, in semiconductor devices.
Our High-Density Plasma CVD (HDP) and Plasma-Enhanced CVD (PECVD) systems employ a chemical
plasma to deposit all of the dielectric or insulating layers and some of the
metal or conductive layers on the surface of a semiconductor wafer. Our PVD
systems use direct-current power to deposit conductive metal layers by
sputtering metallic atoms from the surface of a target source. Our Electrofill
systems are used for depositing conductive layers of copper on wafers in an
electroplating or damascene process.

Building on our historical strength in deposition technologies, in 2001 we
expanded into the area of wafer surface preparation by acquiring
GaSonics International Corporation, a
manufacturer of systems used to clean and prepare a wafer surface after the
manufacturing steps that precede deposition. More recently, in December 2002
we completed the acquisition of SpeedFam-IPEC, Inc., a manufacturer of chemical
mechanical planarization (CMP) products. As the semiconductor industry
migrates to the use of copper and low-k (low-capacitance) dielectrics in
semiconductors, the manufacturing steps for surface preparation and CMP are
becoming increasingly important.

Our headquarters are located at 4000 North First Street, San Jose, California
95134. The telephone number is (408) 943-9700.

Additional information about Novellus is available on our web site at
www.novellus.com. Novellus makes available free of charge on
its web site its Annual Reports on Form 10-K, its Quarterly Reports
on Form 10-Q, its Current Reports on Form 8-K and amendments to those
Reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934, as amended, as soon as reasonably
practicable after we electronically file them with or furnish them to
the Securities and Exchange Commission, or the SEC. Information
contained on our web site is not part of this
Annual Report on Form 10-K or our other filings with the SEC.

Industry Background

Over the past twenty years, the semiconductor industry has grown rapidly as a
result of increasing demand for personal computers, the expansion of the
Internet and the telecommunications industry, and the emergence of new
applications in consumer electronics. More recently, growth has slowed, and
there are signs that the industry may be beginning to mature. While unit
demand for semiconductor devices continues to rise, the average selling prices
are declining. There is increasing pressure on chipmakers to reduce
manufacturing costs while increasing the value of their products at the same
time. The semiconductor industry has also been cyclical in nature over its
history, with periods of rapid expansion followed by periods of over-capacity.

Several technological trends characterize semiconductor manufacturing. Perhaps
the most prominent of these trends is increasing density. Moores Law, first
postulated in the mid-1960s and still accurate almost 40 years later, states
that the density of circuitry on an individual semiconductor chip doubles every
18 months. Todays advanced devices are being manufactured with line widths as
small as 0.13 micron and with up to eight layers of interconnect circuitry. By
increasing circuit density, manufacturers can pack more electronic components
on a chip and thereby provide higher performance and value. The next
generation of chips will likely see line widths as small as 90 nanometer (0.09
micron) and below, requiring even more sophisticated interconnect wiring to

keep pace.

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Another trend worth noting is the transition to copper wiring in place of
aluminum as the primary conductive material in semiconductor devices. Copper
has a lower electrical resistance value than aluminum, and this provides a
number of performance advantages. Because of the superior properties of
copper, a chip made with copper may need only half as many metal layers as one
made with aluminum. This provides a significant reduction in manufacturing
cost. In addition, copper wiring produces a significant improvement in device
performance and a significant reduction in power requirements as compared to
aluminum.

A similar transition is underway to low-k dielectric insulators, which are
replacing traditional silicon oxide films. Low-k dielectrics are better at
limiting the capacitance that occurs between metal lines in a device. This
quality is important to the goal of smaller line widths and increasing
component density. However, low-k materials are also less stable than silicon
oxide, and this poses a host of new challenges to the semiconductor industry in
pursuing its goals of increased circuit density and, at the same time, lower
cost of manufacture and higher performance and value of the manufactured
product.

Another important trend is the move to larger wafer sizes. Chipmakers are
migrating to larger, 300mm wafers because of the potential manufacturing cost
advantages these larger wafers provide (through the production of more
integrated circuits on each individual wafer) compared to the 200mm wafers that
have been the industry standard for approximately the past ten years.

These trends shape the equipment and process demands that our customers place
on us. Our customers generally measure the cost and performance of their
production equipment in terms of cost per wafer, a ratio  determined by
factoring in the costs for acquisition and installation of a system, operating costs, and net throughput rate. A system with higher net
throughput allows a manufacturer to recover the purchase price over a greater
number of wafers, thereby reducing the cost of ownership of the system on a
per-wafer basis. Yield and film qualities are also significant factors in
selecting processing equipment. The higher costs of larger and more complex
semiconductor wafers have made high yields extremely important to our
customers. To achieve higher yields and better film quality, systems must be
able to repeat a process consistently and reliably. This characteristic, known
as repeatability, is critical in achieving commercially acceptable yields.
Systems that operate at desired throughput rates without approaching critical
tolerance limits can achieve repeatability more easily.

Strategy

Our business objective at Novellus is to use our core expertise to increase our
market share in the interconnect manufacturing arena and strengthen our
position as a leading supplier of semiconductor processing equipment. The
following are the key elements of our strategy:

Emphasize High-Productivity Systems We established our current position in
the industry by emphasizing high productivity as the principal benefit that our
products and technologies deliver to customers. Our unique multi-chamber system
for continuous PECVD processing illustrates our commitment to productivity.
This multi-chamber design enables our PECVD systems to attain very high levels
of wafer throughput, yield and film quality. The simple architecture of our
systems also takes up less space in the fab and requires less downtime than
other system designs. We intend to retain our historical focus on productivity
by applying our multi-chamber and continuous processing architecture in product
enhancements and new product offerings.

Focus on Reducing Customer Costs Cost is an important component when
measuring overall productivity. To that end, we strive to provide products and
technologies that reduce our customers overall cost of ownership. We pursue
these advantages by offering chipmakers a number of process improvements and
process differentiators, as well as by providing highly reliable systems that
require less servicing than competing alternatives in the market.

Differentiate our Service Philosophy We do not view our customer service
operations as a profit center and source of revenue generation. Our philosophy
is to develop reliable products that do not break down as often or require as
much servicing as competing alternatives. In addition, we strive to provide
support that minimizes the downtime and service costs that our customers
experience.

Lead in our Target Markets Our goal is to command a leadership position in
each of our target market areas. Historically, we have aimed to be the leader
or the second or third largest provider in each of the subsets that comprise
the served available market for our deposition products: HDP, CVD, PECVD, PVD
and ECD. Due to our 2001 acquisition of GaSonics and subsequent internal
product development efforts, we are one of the leading providers of surface
preparation products. Our 2002 acquisition of SpeedFam-IPEC has enabled us to
become one of the industrys top suppliers of CMP products. We intend to
aggressively pursue a leadership position in CMP similar to those we have
achieved in other market segments.

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Broaden our Interconnect Offerings As semiconductor manufacturing technology
becomes more complex, the interconnect structures on a chip take on a greater
importance in the manufacturing process. We believe that by expanding beyond
our historical focus on deposition products we can add value in related
interconnect manufacturing process steps. The acquisitions of GaSonics and
SpeedFam-IPEC  which enabled Novellus to enter the surface preparation and
CMP product arenas, respectively  are examples of this strategy in action.

Focus on Major Semiconductor Manufacturers We have sold one or more systems
to each of the 2002 worlds top 20 semiconductor
manufacturing equipment capital spenders. Our sales objective is to work closely with our
customers as they expand existing facilities, retrofit older manufacturing
plants with new equipment, and build new fabrication facilities. We strive to
build customer loyalty and achieve a high level of repeat business by offering
high-reliability products, comprehensive field support, and a responsive parts
replacement and service program.

Expand Market Presence in Asia While we derive a significant percentage of
net sales from Asia, we believe that substantial additional growth potential
exists in the region over the long term. Japan, Taiwan and Korea continue to
represent a disproportionate share of the worlds capacity for semiconductor
manufacturing, and China is rapidly becoming a major manufacturing region for
the industry. Our local presence in Asia includes sales and support offices
throughout Japan. In addition, we maintain five offices in Korea, three in
China, two each in Taiwan, Malaysia and Singapore, and one office in India. We
plan to continue our efforts to better serve this region.

Leverage our Low Manufacturing Cost Structure We do all system design,
assembly and testing in-house, and outsource the manufacture of major
subassemblies. This strategy allows us to minimize our fixed costs and capital
expenditures and gives us the flexibility to increase capacity as needed.
Outsourcing also allows us to focus on product differentiation through system
design and quality control and helps to ensure that our subsystems incorporate
the latest third-party technologies in robotics, gas panels and microcomputers.
We work closely with our suppliers to achieve mutual cost reduction through
joint design projects.

Products

Deposition Products

Our historical strength is rooted in deposition products, where we have
consistently maintained a leadership position in the industry. We currently
offer products that address the needs of manufacturers across a number of
different deposition technologies  CVD, PVD and ECD.

Since the introduction of our Concept One dielectric platform in 1987, we have
offered a range of processing systems for dielectric and metal deposition. In
1991, we introduced the Concept Two platform  a modular, integrated
production system capable of depositing both dielectric and conductive metal
layers by combining one or more processing chambers with a common, automated
wafer handler. The Concept Two enables chipmakers to increase production
throughput and system capability, as required in 200mm wafer manufacturing
applications, by adding process modules without having to replace existing
equipment. In 1997, we introduced the Concept Three platform, which builds on
the foundation of its predecessor to offer greater throughput in 300mm
wafer-manufacturing applications.

HDP CVD Products

In the CVD process, manufacturers place wafers in a reaction chamber, introduce
a variety of pure and precisely metered gases into the chamber, and then add
some form of energy to activate a chemical reaction that deposits a film on the
wafer. The CVD process is the traditional method used to deposit dielectric
(insulating) films on wafers. Manufacturers also use CVD to deposit conductive
metal layers, particularly tungsten, as it is difficult to deposit
such layers on devices with very
small features using conventional PVD or other deposition technologies.

Concept Two
SPEED®Introduced in 1996, Concept Two SPEED was the
semiconductor industrys first high-density plasma system capable of
high-volume manufacturing, and today it is one of the top two leading systems
in the HDP CVD marketplace. Concept Two SPEED is a single-wafer processing
system for 200mm substrates. It is targeted for depositing dielectric material
in aluminum interconnect manufacturing processes, as well as for deposition of
pre-metal layers in copper manufacturing processes.

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Concept Three SPEED The Concept Three SPEED is designed for applying
dielectric material in 300mm wafer manufacturing processes. Because it is based
on our production-proven Concept Two products, Concept Three SPEED offers
minimal risk to our customers in making the transition from 200mm to 300mm
wafer size in their high-volume integrated circuit manufacturing processes.

CVD Products

Concept Two ALTUS In 1994, we introduced the Concept Two ALTUS, used to
deposit the tungsten plugs and vias that connect aluminum interconnect lines in
aluminum-based chips. The Concept Two ALTUS combines the modular architecture
of the Concept Two with an advanced tungsten CVD dual-process chamber. The
system is ideal for meeting the requirements of high-volume, automated 200mm
wafer fabs producing semiconductor devices at 0.18 micron and below.

Concept Three ALTUS The Concept Three ALTUS, introduced in 1997, brings the
same advantages to 300mm wafer tungsten deposition as our Concept Two ALTUS
predecessor provides for 200mm wafer applications.

PECVD Products

Concept Two SEQUEL
Express®Introduced in 1999, the Concept Two SEQUEL
Express is designed to deposit our CORAL®family of low-k dielectric films,
as well as other advanced films required for manufacturing 0.18
micron-and-smaller semiconductor devices. With a throughput in excess of 110
wafers per hour, Concept Two SEQUEL Express delivers up to 40 percent higher
capital productivity and 40 percent lower cost of ownership than competing
PECVD systems.

VECTOR® Introduced in 2000, VECTOR is a PECVD system for depositing
dielectric films on 300mm wafers. VECTOR delivers a fully integrated low-k
dielectric structure at 0.10-micron-and-smaller design rules. With
approximately two-thirds the footprint of the nearest competitor, 40 percent
fewer critical subassemblies and a throughput of 120 wafers per hour, VECTOR
delivers higher capital productivity than any other PECVD system currently on
the market.

PVD Products

PVD, also known as sputtering, is a process where ions of an inert gas such
as argon are electrically accelerated in a high vacuum toward a target of pure
metal, such as tantalum or copper. Upon impact, the argon ions sputter off the
target material, which is then deposited as a thin film on the silicon wafer.
PVD processes are used to create the barrier and seed layers in copper
damascene interconnect applications. We entered the PVD marketplace with the
acquisition of Varian Associates Thin Film Systems Division in 1998.

INOVA® The INOVA 200mm system was introduced in 1998 with a multi-chamber,
single-wafer processing design. The Hollow Cathode Magnetron or HCM ionized PVD source continues to gain
market acceptance based on barrier seed step coverage performance.

INOVA xT In 2000, we introduced the 300mm INOVA xT with HCM technology. The
product continues to offer superior barrier performance leading to low via
resistance and improved device reliability.

Electrofill Products

Our Electrofill products are used to produce the primary copper conductive
layers in advanced integrated circuits. Electrofill uses copper to fill a
structure created within the circuits insulating layers, in a manufacturing
process called copper damascene. Damascene manufacturing reverses the
manufacturing process used with aluminum, where the metal is deposited first,
then etched to create lines and vias, and finally filled with insulating layers
between the metal lines. Our highly reliable and cost-effective Electrofill
products employ liquid chemistries and electrolytic principles to deposit the
copper wiring into the dielectric structure.

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SABRE The SABRE copper Electrofill system, introduced in 1998, is one of the
most reliable and technologically advanced copper ECD system available on the
market. SABRE meets todays technology requirements for copper metal layers all
the way down to 90 nanometer (0.09 micron) line widths and beyond. It employs a
proprietary electrofilling cell that eliminates contamination of the back of
the wafer with copper. It features a unique plating cell design that improves
the repeatability of the copper fill. The simplicity of SABREs design is the
key to the systems high reliability and manufacturing availability. Coupled
with the INOVA PVD system, SABRE provides a complete system for depositing
advanced copper interconnects.

SABRE xT The second generation SABRE xT, introduced in 1999, is the
industrys leading ECD platform at both 200 mm and 300 mm wafer sizes. New
features on the xT that were not found on the original SABRE include
programmable electrical waveforms, advanced plating chemistries, an integrated
anneal module and closed-loop chemical monitoring.

Surface Preparation Products

Photoresist strip and clean processes represent an area of semiconductor
manufacturing that is becoming increasingly important with the industrys
migration to copper interconnects. Chipmakers use surface preparation products
to remove photoresist and other potential contaminants from a wafer before
proceeding with the next deposition step in the manufacturing process. We
entered this application arena by acquiring GaSonics in 2001, and today we are
one of the industrys leading suppliers of dry-clean surface preparation
products.

GAMMA 2100  The GAMMA 2100 200mm photoresist removal system uses a plasma
source to strip photoresist. The GAMMA architecture features a multi-station
sequential processing design with six strip stations, resulting in high wafer
throughput with a minimal number of critical subsystems.

GAMMA 2130 The GAMMA 2130 system is a front-end-of-line (FEOL) photoresist
strip system for 300mm wafers. Our multi-station sequential processing
architecture incorporates six stations within a single process chamber,
enabling a 30 percent higher throughput rate when compared to that of the
closest competitor.

PEP IRIDIA®  The PEP IRIDIA is an advanced cleaning system designed for
sub-0.18-micron 200mm wafer applications. The IRIDIAs modular architecture
allows manufacturers to configure the system for both front and
back-end-of-line cleaning applications down to 90 nanometer device geometries.
Targeted at critical steps in copper and low-k manufacturing processes, the
IRIDIA offers the highest productivity of any 200mm dry-clean system currently
on the market.

SIERRA® The SIERRA system is an advanced dry-clean system for 300mm wafer
manufacturing processes. It delivers photoresist and residue removal for
todays most advanced applications. The SIERRA system is designed specifically
to address the intricate cleaning challenges associated with the industrys
migration to copper metallization and low-k dielectrics. It yields
significantly higher capital productivity and significantly lower
cost-of-ownership advantages than competing dry-clean systems.

CMP Products

CMP systems polish the surface of a wafer after a deposition process to create
a flat topography before moving on to subsequent manufacturing steps. Because
copper is more difficult to polish and smooth than previous-generation aluminum
interconnects, and because low-k dielectrics are much more porous than their
predecessors, CMP has been elevated to the forefront of enabling technology
required in a copper damascene manufacturing process. In recognition of this
trend, in 2002, we completed the acquisition of SpeedFam-IPEC, a global
supplier of CMP systems used in the fabrication of advanced copper
interconnects. We believe that the opportunity to integrate the planarization,
deposition and surface preparation steps and optimize them for overall
performance gives us an important advantage in extending copper/low-k processes
to advanced semiconductor devices.

MOMENTUM  MOMENTUM is a high-throughput, dry-in/dry-out CMP system for all
200mm-wafer process applications. Designed with extendibility to accommodate
future reductions in line widths, the MOMENTUM has four independent
wafer-polishing platens that allow for maximum manufacturing flexibility. It
also employs a patented orbital polishing motion that minimizes surface dishing
and erosion and a slurry delivery system that results in more efficient
consumption of polishing chemicals.

MOMENTUM 300 Our MOMENTUM 300 is a highly flexible, dry-in/dry-out CMP system
that provides a transition for manufacturers moving from 200mm to 300mm wafer
processing. The system is unique in that it combines a number of advanced

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planarization and in-line inspection technologies to produce highly effective
throughput, yield management, superior process capabilities and low cost of
ownership.

Marketing, Sales and Service

We market products worldwide to manufacturers of semiconductor devices. In
North America, we sell our products through a direct sales force that operates
out of ten sales and support offices. In Europe, we sell our products
predominantly through our sales and support facilities in France and Scotland.
We also maintain sales and service support offices in the Netherlands,
Germany, Ireland and Italy. In Asia, we sell our products directly in China,
Japan, Korea, Malaysia, Singapore and Taiwan. Our Japanese operations, with
headquarters near Tokyo, include ten sales offices throughout Japan.

The ability to provide prompt and effective field support is critical to our
sales efforts, and we believe the support that we provide to our installed base
has accelerated the penetration of certain key accounts. We also believe that
our marketing efforts are enhanced by the technical expertise of our research
and development personnel, who provide customer process applications support
and participate in a number of industry forums such as conferences and
technical symposia.

Equally significant, we believe that the design simplicity of our systems
substantially enhances our ability to support our customers. In 1992, we became
the first semiconductor equipment manufacturer to extend our warranty up to 24
months from shipment, and in 1993 we began to include the cost of consumable
parts on some systems and preventative maintenance parts under warranty. We
offer maintenance contracts as an additional service to customers.

For the year ended December 31, 2002, Samsung Electronics, Intel Corporation,
Taiwan Semiconductor Manufacturing Company and International Business
Machines Corporation
accounted for 17%, 11%, 11% and 10% of our net sales, respectively. For the
year ended December 31, 2001, Intel Corporation accounted for 16% of our net
sales. For the year ended December 31, 2000, Intel Corporation and Taiwan
Semiconductor Manufacturing Company accounted for 14% and 10% of our net sales,
respectively. Historically, we have sold a significant proportion of systems in
any particular period to a limited number of customers. Sales to our ten
largest customers in 2002, 2001 and 2000 accounted for 79%, 61% and 71% of our
net sales, respectively. We expect that sales of our products to relatively few
customers  none of which has entered into a long-term agreement requiring it
to purchase our products  will continue to account for a high percentage of
our net sales in the foreseeable future.

Export sales  including sales by our Japanese subsidiary  for the year
ended December 31, 2002 were approximately $513.6 million, or 61% of net sales.
For the year ended December 31, 2001, export sales were $733.9 million, or 55%
of net sales, while export sales for the year ended December 31, 2000 were
approximately $834.5 million, or 63% of net sales.

Backlog

As of December 31, 2002, our
backlog was $304.4 million, with no
cancellations in the period subsequent to December 31, 2002 to
the date of this Annual Report on Form 10-K, compared to a backlog of $266.5
million as of December 31, 2001, with approximately $81.8 million
of cancellations subsequent to December 31, 2001. Our backlog includes only
those customer orders for which we have accepted purchase orders and assigned
shipment dates within twelve months. All orders are subject to cancellation or
rescheduling by customers, with limited or no penalties. Some products are
shipped in the same quarter in which the order was received. For this reason,
and because of possible changes in delivery schedules, cancellations of orders
and delays in shipments, our backlog as of any particular date is not
necessarily a reliable indicator of actual sales for any succeeding period.

Research and Development

The highly cyclical semiconductor manufacturing industry is subject to rapid
technological change and continual new product introductions and enhancements.
Our ability to remain competitive depends in large part on our success in
developing new and enhanced systems and introducing them at competitive prices
on a timely basis. For this reason, we devote a significant portion of our
personnel and financial resources to research and development programs.

Our current research and development efforts are directed at the development of
new systems and processes and the improvement of the capabilities of existing
systems. Research and development programs include advanced PVD systems,
advanced gap fill technology, primary conductor metals, low-k dielectric
materials, CMP systems, and additional advanced deposition and surface

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preparation technologies for the next generation of smaller-geometry
fabrication lines. All new systems under development are capable of processing
300mm wafers.

Expenditures for research and development during 2002, 2001 and 2000 were
$222.3 million, $272.0 million and $198.3 million, respectively. These
investments represented approximately 26%, 20% and 15% of our net sales in
2002, 2001 and 2000, respectively. We believe that research and development
expenditures will continue to represent a substantial percentage of our net
sales in the future.

Manufacturing

Our manufacturing activities consist primarily of assembling and testing
components and subassemblies that we acquire from third-party vendors and then
integrate into a finished system. We utilize an outsourcing strategy for the
manufacture of major subassemblies, and we perform all system design, assembly
and testing in-house. Our outsourcing strategy enables us to minimize fixed
costs and capital expenditures as well as provide the flexibility to increase
production capacity. This strategy also allows us to focus on product
differentiation through system design and quality control. We believe that our
use of outsourced product specialists enables our subsystems to incorporate the
latest and most advanced technologies in robotics, gas panels and
microcomputers without the need for in-house expertise. We strive to work as
closely as possible with all of our suppliers to achieve mutual cost reduction
through joint design efforts.

Although we make reasonable efforts to ensure that such parts are available
from multiple suppliers, certain key parts may only be obtained from a single
or limited source. These suppliers are in some cases thinly capitalized,
independent companies that generate significant portions of their business from
us and/or a small group of other companies in the semiconductor industry. We
seek to reduce our dependence on single or limited source suppliers. However,
disruptions in parts delivery or termination of certain of these suppliers may occur. Such
disruptions and terminations could have an adverse effect on our operations. A prolonged
inability to obtain certain parts could have a material adverse effect on our
business, financial condition or results of operations, and could result in our
inability to meet customer demands on time.

We manufacture our systems in clean room environments similar to those used by
semiconductor manufacturers for wafer fabrication. This helps to minimize the
amount of particulates and other contaminants in the final assembled system,
which in turn improves yields and reduces the level of contaminants for our
customers. Following assembly, we package our completed systems in plastic
shrink-wraps to maintain clean room standards during shipment.

Competition

Significant competitive factors in the semiconductor equipment market include
system performance and flexibility, cost, the size of each manufacturers
installed customer base, customer support capability and the breadth of a
companys product line. We believe that we compete favorably in all of the
market segments we serve because of the fundamental advantages associated with
our system performance and flexibility, low cost of ownership, high wafer
yields and customer support. However, we face substantial competition from both
established competitors and potential new entrants in each of these markets.
Installing and integrating capital equipment into a semiconductor production
line represents a substantial investment. For this reason, once a manufacturer
chooses a particular vendors capital equipment, experience has shown that the
manufacturer will generally rely upon that equipment for the useful life of the
specific application. As a result, all of todays semiconductor equipment
makers typically have difficulty in selling a product to a particular customer
to replace or substitute for a competitors product previously chosen or
qualified by that customer.

In the CVD, PECVD and PVD markets, our principal competitor is Applied
Materials, Inc., a major supplier of systems which has established
a substantial base of installed equipment among todays leading semiconductor
manufacturers. In the ECD market, our principal competitors are Semitool, which
has a large base of installed equipment, and Applied, which entered
the market in 1999. Our principal competitors in the surface preparation
product arena are Mattson Technologies and Axcelis Technologies. In the CMP
market, which we entered at the end of 2002, our major competitors are Applied
and Ebara.

Patents and Proprietary Rights

We intend to continue to pursue the legal protection of our technology
primarily through patent and trade secret protection. We currently hold over
300 patents. We have many pending patent applications, and we intend to file
additional patent applications as appropriate. There can be no assurance that
patents will be issued from any of these pending applications or future
filings, or that any

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claims allowed from existing patents or pending or future patent applications
will be sufficiently broad to protect our technology. While we intend to
vigorously protect our intellectual property rights, there can be no assurance
that any patents we hold will not be challenged, invalidated or circumvented,
or that the rights granted thereunder will provide competitive advantages to
us. See Item 3. Legal Proceedings for further
discussions.

We also rely on trade secrets and proprietary technology that we protect
through confidentiality agreements with employees, consultants, and other
parties. There can be no assurance that these parties will not breach these
agreements, that we will have adequate remedies for any breach, or that our
trade secrets will not otherwise become known to or independently developed by
others.

There has been substantial litigation regarding patent and other intellectual
property rights in semiconductor-related industries. We are currently involved
in such litigation. Except as set forth in Item
3. Legal Proceedings, we are not aware of any significant claim of infringement
by our products of any patent or proprietary rights of others; however, we
could become involved in additional litigation in the future. Although we do
not believe the outcome of the current litigation will have a material impact
on our business, financial condition or results of operations, no assurances
can be given that this litigation or future litigation will not have such an
impact. For further discussion see Item 3. Legal Proceedings.

In addition to the current litigation, our operationsincluding the further
commercialization of our productscould provoke additional claims of
infringement from third parties. In the future, litigation may be necessary to
enforce patents issued to us, to protect trade secrets or know-how that we own,
to defend ourselves against claimed infringement of the rights of others, or to
determine the scope and validity of the proprietary rights of others. Any such
litigation could result in substantial cost and diversion of our effort and
could have a material adverse effect on our financial condition or operating
results. In addition, adverse determinations in such litigation could result in
our loss of proprietary rights, subject us to significant liabilities to third
parties, require us to seek licenses from third parties, or prevent us from
manufacturing or selling our products. Any of these occurrences could have a
material adverse effect on our business, financial condition or results of
operations.

Employees

On December 31, 2002, we had 3,228 full-time and temporary employees. None of
our employees are represented by a labor union, and we have never experienced a
work stoppage, slowdown or strike. We consider our employee relations to be
good.

The success of our future operations depends in large part on our ability to
recruit and retain senior management, engineers, technicians, marketing, sales
and service professionals and other key personnel. Qualified people are in
great demand across each of these industry disciplines, and there can be no
assurance that we will be successful in retaining or recruiting key personnel.

Business Combinations

We acquired SpeedFam-IPEC on December 6, 2002 in a stock-for-stock acquisition
whereby each share of SpeedFam-IPEC common stock and options outstanding as of
the closing date were converted into 0.1818 of a share of Novellus common stock
or options on a fixed exchange ratio basis.

We acquired GaSonics in a stock-for-stock
acquisition on January 10, 2001, with all outstanding shares of GaSonics capital stock converted
into approximately 9,240,000 shares of Novellus common stock. In addition,
all outstanding options to purchase shares of GaSonics capital stock were
automatically converted into options to purchase approximately 1,400,000 shares
of Novellus common stock. For further
discussion of business combinations, see Note 7 to the
Consolidated Financial Statements.

Environmental Matters

Neither compliance with federal, state and local provisions regulating
discharge of materials into the environment, nor remedial agreements or other
actions relating to the environment, has had  or is expected to have  a
material effect on our capital expenditures, financial condition, results of
operations or competitive position.

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ITEM 2. PROPERTIES

Our operations are conducted primarily in 13 buildings with approximately
1,109,000 square feet of space. Eight buildings totaling approximately 559,000
square feet are located in the San Jose, California area, and four buildings
totaling approximately 442,000 square feet are located in the Portland, Oregon
area. In addition, we occupy one building of approximately 108,000 square feet
in Chandler, Arizona, which served as the corporate headquarters of
SpeedFam-IPEC prior to the December 2002 acquisition.

We lease buildings in San Jose under
agreements that expire in 2006. These leases have options to extend for three one-year renewal periods with
the lessors consent. These buildings house three manufacturing operations, a
research and development facility, an applications demonstration lab, various
administrative and customer support offices, and our headquarters.

Our properties in the Portland area consist of four buildings in the city of
Tualatin. These buildings are located on 58 acres of owned land. Under a long-term
ground lease, we lease a portion of the land consisting of 23 acres to the
lessor of the buildings which have been constructed thereon. One building
totaling approximately 65,000 square feet is owned by Novellus and provides
manufacturing, research and development, and customer support for the SABRE,
our Electrofill product. The remaining three buildings totaling approximately
377,000 square feet are leased under an agreement that expires in 2006 and
contains an option to extend for three one-year renewal periods with the
lessors consent. These buildings consist of manufacturing, research and
development, engineering and training facilities.

Our Chandler facility consists of one building leased under an operating lease
that expires in 2017. This building houses our CMP operations, including
manufacturing, research and development and engineering.

We lease several field office sites domestically totaling approximately 94,000
square feet of space. In addition, we own one building totaling approximately
41,000 square feet in the Chicago, Illinois area, which we acquired in
conjunction with the SpeedFam-IPEC acquisition in December 2002. We also
sublease, or have available for sublease, approximately 778,000 square feet of
space in and around the San Jose, California and Chandler, Arizona areas. We
lease several sites outside of the United States which we use as sales and
customer service centers. These sites total approximately 201,000 square feet of space.

Our European offices occupy approximately 38,000 square feet of space in
various countries throughout Europe, including France, Germany, Italy, Ireland,
the Netherlands and the United Kingdom. Our Asian offices occupy approximately
173,000 square feet of space in various countries throughout Asia, including
China, India, Japan, Korea, Malaysia, Singapore and Taiwan.

We believe that our current facilities are sufficient to meet our requirements
for the foreseeable future.




ITEM 3. LEGAL PROCEEDINGS

Applied Materials, Inc.

On June 13, 1997, we agreed to purchase the Thin Film Systems (TFS) business
of Varian Associates, Inc. On the same day, Applied Materials, Inc. sued Varian in the
United States District Court (the Court) for the Northern District of California for
alleged infringement by TFS of several of Applieds physical vapor deposition
(PVD) patents (the Applied Patents).

On June 23, 1997, we sued Applied in the United States District Court for the
Northern District of California, claiming infringement by Applied of several of
our PVD patents acquired from Varian in the TFS purchase. Applied has filed
counterclaims in this suit, alleging that we infringe Applieds patents. We
seek an injunction against future infringement by Applied, damages for past
infringement and treble damages for willful infringement.

On July 7, 1997, Applied amended its complaint in its suit against Varian to
add Novellus as a defendant. We have requested that the Court dismiss us as a
defendant in this suit. The Court has not yet ruled on the request or required
us to file an answer in this lawsuit.

The relief requested by Applied in both suits includes a permanent injunction
against future infringement, damages for alleged past infringement and treble
damages for alleged willful infringement.

We believe that we have meritorious claims against Applied. We also believe
that there are meritorious defenses to Applieds allegations, including the
defense that our operations and products (including TFS products and systems)
do not infringe the Applied Patents, and that the Applied Patents are invalid,
unenforceable or both. As a result of court rulings adverse to Appliedand
in light of

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certain indemnity obligations undertaken by Varian, which include
reimbursement of certain legal expenses and a portion of any losses incurred
from this litigation  we do not believe that Applieds claims will have a
material adverse effect on our business, financial condition or results of
operations.

Semitool, Inc.

On August 10, 1998, Semitool, Inc. sued Novellus for patent infringement in the
United States District Court for the Northern District of California. Semitool
alleges patent infringement concerning several patents related to our SABRE and
SABRE xT systems for depositing copper layers on semiconductor wafers. Semitool
seeks an injunction against the manufacturing and sale of the SABRE and SABRE
xT systems by Novellus, and damages for alleged past infringement. Semitool
also seeks treble damages for alleged willful infringement.

On March 17, 2000, the District Court granted our motion for summary judgment
and ruled that our SABRE and SABRE xT systems do not infringe Semitools
patents. On May 15, 2000, Semitool appealed this ruling to the United States
Court of Appeals for the Federal Circuit. On June 8, 2001, the Court of Appeals
affirmed the judgment of non-infringement. On September 6, 2001, Semitool then
filed a petition with the United States Supreme Court to review the judgment of
the Court of Appeals. The Supreme Court vacated the opinion of the Court of
Appeals and remanded the case to the Court of Appeals for further
consideration. On July 23, 2002, the Court of Appeals again affirmed the
District Courts judgment of non-infringement.

On June 11, 2001, Semitool again sued Novellus for patent infringement in the
United States District Court for the District of Oregon. In this second
lawsuit, Semitool alleges that our SABRE and SABRE xT systems infringe one of
Semitools patents. Semitool seeks an injunction against future infringement by
Novellus, damages for alleged past infringement and treble damages for alleged
willful infringement.

On November 13, 2001, we countersued Semitool for patent infringement in the
United States District Court for the District of Oregon. We allege that
Semitool infringes certain Novellus patents related to the SABRE and SABRE xT
systems. We seek an injunction against Semitool, damages for past infringement,
and treble damages for willful infringement by Semitool.

This litigation is in its early stages and therefore is inherently difficult
to assess. We believe that we have meritorious claims against Semitool, and
that this litigation will not have a material adverse impact on our business,
financial condition or results of operations. However, the outcome of patent
disputes is often affected by uncertainty in the resolution of complex issues
of fact and law. If Semitool were to prevail against us, the adverse effect on
our business, financial condition or results of operations could be material.

Plasma Physics Corporation and Solar Physics Corporation

On June 14, 2002, certain of our customers  including Agilent Technologies,
Inc., Micron Technology, Inc., Agere Systems, Inc., National Semiconductor
Corporation, Koninklijke Philips Electronics N.V., Texas Instruments, Inc., ST
Microelectronics, Inc., LSI Logic Corporation, International Business Machines
Corporation, Conexant Systems, Inc., Motorola, Inc., Advanced Micro Devices,
Inc. and Analog Devices Inc. were sued for patent infringement by Plasma
Physics Corporation and Solar Physics Corporation. We have not been sued by
Plasma Physics, Solar Physics, or any other party in connection with any
allegation of patent infringement by Plasma Physics or Solar Physics. Certain
defendants in the case have notified us that they believe that we have
indemnification obligations and liability relating to these lawsuits. We
believe that this matter will not have a material adverse impact on our
business, financial condition or results of operations. There can be no
assurance, however, that we will not be sued in the future in connection with
the allegations made by Plasma Physics and Solar Physics or that, if we are
sued, we will prevail in any such lawsuit. If a party were to file such a
lawsuit and prevail against us, the adverse impact on our business, financial
condition or results of operations could be material.

Linear Technology Corporation

On March 12, 2002, Linear Technology Corporation filed a complaint against
Novellus, among other parties, in the Superior Court of the State of California
for the County of Santa Clara. The complaint seeks damages (including punitive
damages) and injunctions for causes of actions involving alleged breach of
contract, fraud, unfair competition, breach of warranty and declaratory relief.
We filed a demurrer to Linears complaint.

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This litigation is in its early stages and is therefore inherently difficult to
assess. We believe that this litigation will not have a material adverse impact
on our business, financial condition or results of operations. However, the outcome of
patent disputes is often affected by uncertainty in the resolution of complex
issues of fact and law. If Linear were to prevail against us, the adverse
effect on our business, financial condition or results of operations could be
material.

Other Litigation

We are a defendant or plaintiff in
various actions that have arisen in the
normal course of business. We believe that the ultimate disposition of these
matters will not have a material adverse effect on our business, financial
condition or results of operations.




ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.




PART II




ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

Stock Information

Novellus common stock is traded on the NASDAQ Stock Market and is quoted on
the NASDAQ National Market under the symbol NVLS. The following table sets
forth the high and low prices of our common stock as reported by the NASDAQ
National Market for the periods indicated:

|               |  |      |       |     |  |   |       | 
|-------------- |  | ---- | ----- | --- |  | - | ----- | 
|2002           |  | High |       | Low
|               |  |      |       |    
|First Quarter  |  | $    | 54.48 |     |  | $ | 36.18 | 
|Second Quarter |  |      | 54.45 |     |  |   | 29.69 | 
|Third Quarter  |  |      | 34.56 |     |  |   | 19.61 | 
|Fourth Quarter |  |      | 38.09 |     |  |   | 19.40 | 

|               |  |      |       |     |  |   |       | 
|-------------- |  | ---- | ----- | --- |  | - | ----- | 
|2001           |  | High |       | Low
|               |  |      |       |    
|First Quarter  |  | $    | 49.50 |     |  | $ | 34.19 | 
|Second Quarter |  |      | 58.70 |     |  |   | 32.56 | 
|Third Quarter  |  |      | 57.20 |     |  |   | 25.84 | 
|Fourth Quarter |  |      | 45.70 |     |  |   | 25.37 | 

We have not paid cash dividends on our common stock since inception, and our
Board of Directors presently plans to reinvest our earnings in the
business. Accordingly, it is anticipated that no cash dividends will be paid to
holders of common stock in the foreseeable future. As of February 26, 2003,
there were 1,179 holders of record of our common stock.




ITEM 6. SELECTED FINANCIAL DATA

Set forth below is a summary of certain consolidated financial information with
respect to Novellus as of the dates and for the periods indicated. The
consolidated statements of operations data set forth below for the fiscal years
ended December 31, 2002, 2001, 2000, 1999 and 1998 and the consolidated balance
sheet data as of December 31, 2002, 2001, 2000, 1999 and 1998 have been derived
from our consolidated financial statements, which have been audited.
We acquired GaSonics on January 10, 2001, in a transaction accounted for as a
pooling-of-interests. The selected financial data includes the operating
results and financial data of Novellus and GaSonics for all periods.
We acquired SpeedFam-IPEC on December 6, 2002, in a transaction accounted for as a
purchase business combination. The selected financial data includes the
operating results and financial data of SpeedFam-IPEC from December 6, 2002.

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Selected Consolidated Financial Data
(in thousands, except per share data)

|                                                                                                                                |                                                                   |         |           |       |      |         |           |       |      |      |           |      |       |   |           |         |      |   |         |   |      |  |  | 
|------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------- | ------- | --------- | ----- | ---- | ------- | --------- | ----- | ---- | ---- | --------- | ---- | ----- | - | --------- | ------- | ---- | - | ------- | - | ---- |  |  | 
|Years ended December 31,                                                                                                        |                                                                   | 2002    |           | 2001  |      | 2000(1) |           | 1999  |      | 1998
|                                                                                                                                |                                                                   |         |           |       |      |         |           |       |      |     
|Consolidated Statements of Operations Data:                                                                                     |                                                                   |         |           |       |      |         |           |       |      |      |           |      |       |   |           |         |      |   |         |  
|Net sales                                                                                                                       |                                                                   | $       | 839,958   |       |      | $       | 1,339,322 |       |      | $    | 1,319,486 |      |       | $ | 657,021   |         |      | $ | 619,208 |  
|Gross profit                                                                                                                    |                                                                   |         | 378,523   |       |      |         | 691,351   |       |      |      | 730,893   |      |       |   | 351,839   |         |      |   | 330,774 |  
|Income before cumulative effect of change in
accounting principle                                                               |                                                                   |         | 22,920    |       |      |         | 144,470   |       |      |      | 239,168   |      |       |   | 68,707    |         |      |   | 47,115  |  
|Cumulative effect of change in accounting principle                                                                             |                                                                   |         |          |       |      |         |          |       |      |      | (89,788   | )    |       |   |          |         |      |   |        |  
|Net income                                                                                                                      |                                                                   | $       | 22,920    | (3,4) |      | $       | 144,470   | (2,3) |      | $    | 149,380   |      |       | $ | 68,707    |         |      | $ | 47,115  |  
|Per common share:                                                                                                               |                                                                   |         |           |       |      |         |           |       |      |      |           |      |       |   |           |         |      |   |         |  
|                                                                                                                                | Income before cumulative effect of change in
accounting principle |         |           |       |      |         |           |       |      |      |           |      |       |   |           |         |      |   |         |   |     
|                                                                                                                                |                                                                   | Basic   |           | $     | 0.16 |         |           | $     | 1.01 |      |           | $    | 1.76  |   |           | $       | 0.56 |   |         | $ | 0.43 | 
|                                                                                                                                |                                                                   | Diluted |           | $     | 0.15 |         |           | $     | 0.97 |      |           | $    | 1.66  |   |           | $       | 0.54 |   |         | $ | 0.42 | 
|                                                                                                                                | Cumulative effect of change in accounting
principle, net of tax   |         |           |       |      |         |           |       |      |      |           |      |       |   |           |         |      |   |         |   |     
|                                                                                                                                |                                                                   | Basic   |           |       |     |         |           |       |     |      |           | $    | (0.66 | ) |           |         |     |   |         |   |     | 
|                                                                                                                                |                                                                   | Diluted |           |       |     |         |           |       |     |      |           | $    | (0.62 | ) |           |         |     |   |         |   |     | 
|                                                                                                                                | Net income                                                        |         |           |       |      |         |           |       |      |      |           |      |       |   |           |         |      |   |         |   |     
|                                                                                                                                |                                                                   | Basic   |           | $     | 0.16 |         |           | $     | 1.01 |      |           | $    | 1.10  |   |           | $       | 0.56 |   |         | $ | 0.43 | 
|                                                                                                                                |                                                                   | Diluted |           | $     | 0.15 |         |           | $     | 0.97 |      |           | $    | 1.04  |   |           | $       | 0.54 |   |         | $ | 0.42 | 
|Shares used in basic per share calculations                                                                                     |                                                                   |         | 144,371   |       |      |         | 142,462   |       |      |      | 135,728   |      |       |   | 122,261   |         |      |   | 109,406 |  
|Shares used in diluted per share calculations                                                                                   |                                                                   |         | 148,748   |       |      |         | 148,924   |       |      |      | 143,654   |      |       |   | 127,826   |         |      |   | 112,437 |  
|                                                                                                                               
|Pro forma amounts with the change in accounting
principle related to revenue recognition applied
retroactively: (unaudited) (1) |                                                                   |         |           |       |      |         |           |       |      |      |           |      |       |   |           |         |      |   |         |  
|                                                                                                                                | Net
revenues                                                      |         |           |      |      |         |           |      |      |      |           |     |       |   | $         | 582,397 |      |   |         |  |     
|                                                                                                                                | Net income                                                        |         |           |      |      |         |           |      |      |      |           |     |       |   |           | 39,550  |      |   |         |  |     
|                                                                                                                                | Net income per share:                                             |         |           |       |      |         |           |       |      |      |           |      |       |   |           |         |      |   |         |   |     
|                                                                                                                                |                                                                   | Basic   |           |       |     |         |           |       |     |      |           |      |      |   |           | $       | 0.32 |   |         |   |     | 
|                                                                                                                                |                                                                   | Diluted |           |       |     |         |           |       |     |      |           |      |      |   |           | $       | 0.31 |   |         |   |     | 
|                                                                                                                               
|December 31,                                                                                                                    |                                                                   |         |           | 2002  |      | 2001    |           | 2000  |      | 1999 |           | 1998
|                                                                                                                                |                                                                   |         |           |       |      |         |           |       |      |     
|Consolidated Balance Sheet Data:                                                                                                |                                                                   |         |           |       |      |         |           |       |      |      |           |      |       |   |           |         |      |   |        
|Cash, cash equivalents and short-term investments                                                                               |                                                                   | $       | 1,019,652 |       |      | $       | 921,822   |       |      | $    | 1,219,664 |      |       | $ | 413,014   |         |      | $ | 163,156 |  
|Working capital                                                                                                                 |                                                                   |         | 1,252,324 |       |      |         | 1,395,902 |       |      |      | 1,410,836 |      |       |   | 646,063   |         |      |   | 344,908 |  
|Total assets                                                                                                                    |                                                                   |         | 2,493,994 |       |      |         | 3,031,124 |       |      |      | 2,205,474 |      |       |   | 1,000,352 |         |      |   | 649,155 |  
|Long-term obligations                                                                                                           |                                                                   |         |          |       |      |         |          |       |      |      |          |      |       |   |          |         |      |   | 65,223  |  
|Shareholders equity                                                                                                            |                                                                   |         | 2,055,688 |       |      |         | 1,871,994 |       |      |      | 1,641,475 |      |       |   | 837,537   |         |      |   | 450,873 |  

---

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | 
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | 
|(1) | We recorded a non-cash charge of $89.8 million, after reduction for income
taxes of $48.6 million, or $0.62 per diluted share, to reflect the cumulative
effect of a change in accounting principle as of January 1, 2000 related to the
adoption of the Securities and Exchange Commission Staff Accounting Bulletin
No. 101, Revenue Recognition in Financial Statements, or SAB No. 101. If the
change in accounting principle had been applied retroactively to 1999, net
sales would have been $582.4 million. Data was not available to calculate the
effect of applying such change for years prior to 1999.
Net income for the year ended December 31, 2000 also included a pre-tax charge
of $6.0 million for acquired in-process research and development associated
with GaSonics acquisition of Gamma Precision Technology.

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|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | We recorded pre-tax charges totaling $84.5 million for the year ended
December 31, 2001 associated with restructuring and acquisition activities,
other than temporary decline in value of an investment and write-off of a bad
debt.                                                                                                                                                                                                                                                                                                                                                        
|(3) | We adopted Statement of Financial Accounting Standards No. 142, Goodwill
and Other Intangible Assets, or SFAS No. 142, in the first quarter of 2002. As
a result of its adoption, we no longer amortize goodwill, which resulted in an
increase in net income of $3.6 million for the year ended December 31, 2002.
Retroactive application of SFAS No. 142 would have resulted in
an increase in net income for the year ended December 31, 2001 of $3.5 million, or
$0.02 per diluted share. Amortization of goodwill was not material in all years
shown prior to 2001.                 
|(4) | We recorded pre-tax charges totaling $32.5 million for the year ended
December 31, 2002 associated with restructuring and severance activities of
$6.5 million, write-off of debt issuance costs of $17.0 million and acquired
in-process research and development charge relating to the acquisition of
SpeedFam-IPEC of $9.0 million. Additionally, we recorded a pre-tax benefit of
$12.3 million for the year ended December 31, 2002 associated with the recovery
of a receivable previously written off of $7.7 million and a gain on the sale
of an equity investment of $4.6 million.




ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

We are a supplier of semiconductor manufacturing equipment used in the
fabrication of integrated circuits. Demand for our systems can vary
significantly from period to period as a result of various factors, including,
but not limited to, downturns in the semiconductor industry, supply and demand
for semiconductor devices and substantial competition in the semiconductor
industry among suppliers of similar products. For these and other reasons, our
results of operations for fiscal 2002, 2001 and 2000 may not necessarily be
indicative of future operating results.

As more fully described in Note 7 to the Consolidated Financial Statements, we
acquired GaSonics, a developer and supplier of semiconductor equipment used for
photoresist and residue removal, on January 10, 2001 in a pooling-of-interests
transaction. The consolidated financial statements for fiscal 2000 have been
restated to include the results of operations and cash flows of GaSonics.
Because of differing year-end periods, financial information relating to
Novellus fiscal year ended December 31, 2000 has been combined with financial
information relating to GaSonics fiscal year ended September 30, 2000.
GaSonics net income for the three months ended December 31, 2000 was not
combined with our net income, but rather was included as an adjustment to
shareholders equity. Revenue and net income of GaSonics for the three-month
period ended December 31, 2000, which are excluded from the accompanying
statements of operations, were $47.7 million and $0.9 million, respectively.
There were no transactions between GaSonics and Novellus prior to the
combination.

On December 6, 2002, we completed the acquisition of SpeedFam-IPEC, a global
supplier of CMP systems used in the fabrication of advanced copper
interconnects. Under the terms of the definitive agreement signed on August
12, 2002, we acquired all outstanding shares of SpeedFam-IPEC in a
stock-for-stock acquisition whereby each share of SpeedFam-IPEC common stock
outstanding as of the closing date was converted into 0.1818 of a share of
Novellus common stock on a fixed exchange ratio basis. In addition, we assumed
all $116.4 million of SpeedFam-IPECs 6.25% Convertible Subordinated Notes,
originally due in 2004. The notes were subsequently paid off in full in January
2003. The acquisition was accounted for as a purchase business combination and
qualifies as a tax-free reorganization under IRS regulations. The consolidated
financial statements for fiscal 2002 include the financial position, results of
operations and cash flows of SpeedFam-IPEC from December 6, 2002. For further
discussion, see Note 7 to the Consolidated Financial Statements.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires that we
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses and the related disclosure of contingent
assets and liabilities. On an ongoing basis, we evaluate our estimates,
including those related to revenue recognition, inventory valuation,
goodwill and other intangible assets, deferred
tax assets, warranty obligations and restructuring and impairment
charges. We base our estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the current circumstances, the results of which form the basis
for making judgments about the carrying values of assets and liabilities that
are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions. We believe the
following critical accounting policies affect our more significant judgments
and estimates used in the preparation of our consolidated financial statements.

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Revenue Recognition

We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 101,
or SAB 101, Revenue Recognition in Financial Statements and SAB 101: Revenue
Recognition in Financial Statements-Frequently Asked Questions and Answers
(SAB 101 FAQ). We recognize revenue when persuasive evidence of an
arrangement exists, delivery has occurred or services have been rendered, the
sellers price is fixed or determinable and collectibility is reasonably
assured.

Certain of our product sales are accounted for as multiple-element
arrangements. A multiple-element arrangement is a transaction which
may involve the delivery or performance of multiple products,
services, or rights to use assets, and performance may occur at
different points in time or over different periods of time. If we have met defined customer acceptance experience levels with
both the customer and the specific type of equipment, then we recognize
equipment revenue upon shipment and transfer of title, with the remainder
generally recognized at the later of completion of the installation services or
customer acceptance.

Installation services are not essential to the functionality of the delivered
equipment. We allocate revenue based on the residual method as a fair value has
been established for installation services. However, since the final payment is
not typically due until customer acceptance, we defer revenue for the final
payment, which is in excess of the fair value of the installation services. All
other equipment sales are recognized upon customer acceptance.

Revenue related to spare part sales is recognized upon shipment. Revenue
related to maintenance and service contracts is recognized ratably over the
duration of the contracts. Unearned maintenance and service contract revenue is
not significant and is included in other accrued liabilities.

Inventory Valuation

We assess the recoverability of all inventory, including raw materials,
work-in-process, finished goods and spare parts to determine whether
adjustments for impairment are required. Inventory that is obsolete or in
excess of our forecasted usage is written down to its estimated market value
based on assumptions about future demand and market conditions. If actual
demand is lower than our forecast, additional inventory write-downs may be
required.

Goodwill and Other Intangible Assets

Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible
Assets.
SFAS No. 142 requires that goodwill and identifiable intangible assets with
indefinite useful lives no longer be amortized, but instead be tested for
impairment at least annually. SFAS No. 142 also requires that intangible assets
with estimable useful lives be amortized over their respective estimated useful
lives to their estimated residual values and reviewed for impairment in
accordance with SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. Furthermore, SFAS
No. 142 includes provisions on the identification of intangible assets,
reclassification of certain intangible assets from previously reported goodwill, and
reassessment of the useful lives of existing intangible assets. Upon adoption,
we reassessed the useful lives and residual values of all acquired identifiable
intangible assets to identify any necessary amortization period adjustments and
to determine whether other intangible assets should be reclassified from
goodwill. Based on that assessment, no adjustments were made to the
amortization period or residual values of identifiable intangible assets.

Deferred Tax Assets

We record a valuation allowance to reduce our deferred tax assets to the amount
that is more likely than not to be realized. Our valuation allowance was
recorded as an increase to goodwill in connection with acquired net operating
loss carryforwards, which are not realizable until 2009 and beyond. We have
considered future taxable income and ongoing prudent and feasible tax planning
strategies in assessing the need for the valuation allowance. Should the
existing deferred tax asset, which is currently offset by the valuation
allowance, be realized, the benefit of such realization and the related
reversal of the valuation allowance would result in a reduction of goodwill.
If we determine that we would not be able to realize all or part of our net
deferred tax assets in the future, an adjustment to the deferred tax assets
would decrease income in the period such determination was made.

Warranty Obligations

Our warranty policy generally states that we will provide warranty coverage for
a predetermined amount of time on systems and modules for material and labor to
repair and service the equipment. We record the estimated cost of warranty
coverage to cost of sales

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upon system shipment. The estimated cost of warranty is determined by the
warranty term, as well as the average historical labor and material costs for a
specific product. Should actual product failure rates or material usage differ
from our estimates, revisions to the estimated warranty liability may be
required. These revisions could have a positive or negative impact
on gross profit. We review the actual product failure rates and material usage
rates on a quarterly basis and adjust our warranty liability as necessary.

Restructuring and Impairment Charges

We account for restructuring in accordance with Emerging Issues Task Force
(EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring), EITF Issue No. 95-3, Recognition of Liabilities in Connection with
a Purchase Business Combination and SAB No. 100,
Restructuring and Impairment Charges. Accordingly, restructuring accruals are
recorded when management initiates an exit plan that will cause us to incur
costs that have no future economic benefit. Also under the terms of EITF 94-3,
a liability for the restructuring charges is recognized in the period
management approves the restructuring plan. Additionally, certain restructuring
charges related to asset impairments are recorded in accordance with SFAS No.
144. The
restructuring accrual related to vacated properties is calculated net of
estimated sublease income we expect to receive once we sublet the properties
that have been vacated. Sublease income is estimated based on current market quotes for
similar properties. If we are unable to sublet these properties on a timely basis
or if we are forced to sublet them at lower rates due to changes in market
conditions, we would adjust the accrual accordingly.

Results of Operations
(dollars in thousands)

Net Sales

|          |  |                          |         |          |  |          |           |         |  |         |           |  |  |  |      |  |  |   |   | 
|--------- |  | ------------------------ | ------- | -------- |  | -------- | --------- | ------- |  | ------- | --------- |  |  |  | ---- |  |  | - | - | 
|          |  | Years ended December 31, |         |          |  |         
|          |  |                          |         | % Change |  | %
Change
|          |  | 2002                     |         | 2001     |  | 2000     |           | in 2002 |  | in 2001
|          |  |                          |         |          |  |          |           |         |  |        
|Net sales |  | $                        | 839,958 |          |  | $        | 1,339,322 |         |  | $       | 1,319,486 |  |  |  | -37% |  |  | 2 | %

We operate our business in the semiconductor equipment industry, which is
subject to cyclical conditions. These conditions have played a major role in
the fluctuations in our net sales. The decrease in net sales of 37% from 2001
was primarily due to a substantial reduction in customer capital spending in
response to weakened worldwide demand for semiconductor devices. The demand for
semiconductor manufacturing equipment has historically fluctuated with changes
in the supply of and demand for semiconductor devices and other factors,
including rapid technological advances in the semiconductor manufacturing
processes. The increase in net sales of 2% in 2001 from 2000 was attributable
to an increase in sales of our Electrofill and 300mm product lines, partially
offset by a decrease in sales of our 200mm products.

International sales were 61% of net sales in 2002, an increase from 55% in
2001. This increase was attributable to higher demand in the Asian
region, primarily related to higher demand in China, Taiwan and
Korea, and partially offset by lower demand in Southeast Asia and Japan.
The Asian region accounted for 54% and 48% of total net sales in 2002
and 2001, respectively. International sales in 2001 were down from 63% of total net sales in 2000. The
decrease in international sales as a percentage of net sales in 2001 was a
result of lower demand in China, Taiwan, Southeast Asia and Korea, partially
offset by higher demand in Japan.

Gross Profit

|               |  |                          |         |          |  |          |         |         |  |         |         |   |  |  |     |   |  |  |    |  
|-------------- |  | ------------------------ | ------- | -------- |  | -------- | ------- | ------- |  | ------- | ------- | - |  |  | --- | - |  |  | -- | -
|               |  | Years ended December 31, |         |          |  |         
|               |  |                          |         | % Change |  | %
Change
|               |  | 2002                     |         | 2001     |  | 2000     |         | in 2002 |  | in 2001
|               |  |                          |         |          |  |          |         |         |  |        
|Gross profit   |  | $                        | 378,523 |          |  | $        | 691,351 |         |  | $       | 730,893 |   |  |  | -45 | % |  |  | -5 | %
|% of net sales |  |                          | 45      | %        |  |          | 52      | %       |  |         | 55      | % |  |  |     |   |  |  |    |  

The decline in gross profit as a percentage of net sales in 2002 compared to
2001 and 2000 was primarily due to the reduced absorption of fixed overhead
costs resulting from lower production and shipments. During 1999 and 2000, and
through our acquisition of GaSonics in January 2001, we expanded our
manufacturing facilities to accommodate the unprecedented growth in demand for

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semiconductor manufacturing equipment. As a result of the industry downturn
and overall slowing economy that began in 2001 and continued through 2002,
orders for our equipment were not sufficient to fully absorb the fixed overhead
costs of these facilities in those periods. In 2001, we implemented a
restructuring plan to consolidate some of our facilities. The 2001 gross
profit was reduced by a $7.1 million charge associated with the write-off of
inventory related to two products which we discontinued in connection with our
restructuring plan. The gross profit was also impacted by a benefit of $4.4
million related to our decision not to pay our 2001 bonus and profit sharing
because we did not meet the minimum performance guidelines required for bonus
payment.

In addition, our gross profit is
impacted by our
treatment of certain product sales as multiple-element arrangements
in accordance with SAB 101, for which we
recognize all of a products cost upon shipment even though a
portion of a products revenue may be deferred until final
payment is due, which is typically upon customer acceptance.

Selling, General and Administrative

|                                    |  |                          |         |          |  |          |         |         |  |         |         |   |  |  |     |   |  |  |     |  
|----------------------------------- |  | ------------------------ | ------- | -------- |  | -------- | ------- | ------- |  | ------- | ------- | - |  |  | --- | - |  |  | --- | -
|                                    |  | Years ended December 31, |         |          | 
|                                    |  |                          |         | % Change |  | % Change
|                                    |  | 2002                     |         | 2001     |  | 2000     |         | in 2002 |  | in 2001
|                                    |  |                          |         |          |  |          |         |         |  |        
|Selling, general and administrative |  | $                        | 154,172 |          |  | $        | 198,567 |         |  | $       | 232,749 |   |  |  | -22 | % |  |  | -15 | %
|% of net sales                      |  |                          | 18      | %        |  |          | 15      | %       |  |         | 18      | % |  |  |     |   |  |  |     |  

Selling, general and administrative, or SG&A, expenses include compensation and
benefits for corporate, financial, marketing, and administrative personnel,
travel, utilities, communications expenses and professional fees. Also
included are expenses for rents, depreciation and amortization related to the
assets utilized by the functions noted above. The increase in SG&A expenses as
a percentage of net sales in 2002 over 2001 was primarily due to the
substantial reduction in net sales. The decrease in the absolute dollar amount
of these expenses reflects the impact of the cost reduction measures that we
implemented in the second half of 2001. These cost reduction measures include
executive and employee pay reductions and facilities consolidation. In
addition, we had workforce reductions in the first and fourth quarter of 2002.
The decrease in SG&A expense, both in absolute dollars and as a percentage of
net sales in 2001 over 2000, reflects the impact of the cost reduction measures
as well as our decision not to pay $13.1 million of bonus and profit sharing in
2001 as we did not meet the minimum performance guidelines required for bonus
payment.

Research and Development

|                         |  |                          |         |          |  |          |         |         |  |         |         |   |  |  |     |   |  |  |    |  
|------------------------ |  | ------------------------ | ------- | -------- |  | -------- | ------- | ------- |  | ------- | ------- | - |  |  | --- | - |  |  | -- | -
|                         |  | Years ended December 31, |         |          | 
|                         |  |                          |         | % Change |  | % Change
|                         |  | 2002                     |         | 2001     |  | 2000     |         | in 2002 |  | in 2001
|                         |  |                          |         |          |  |          |         |         |  |        
|Research and development |  | $                        | 222,344 |          |  | $        | 272,032 |         |  | $       | 198,310 |   |  |  | -18 | % |  |  | 37 | %
|% of net sales           |  |                          | 26      | %        |  |          | 20      | %       |  |         | 15      | % |  |  |     |   |  |  |    |  

Our significant investments in
research and development, or R&D, over the past
three years reflect our strong commitment to the continuous improvement of our
current product lines and the development of new products and technologies. We
plan to continue to focus our R&D investment on the continuous improvement of
our existing product lines as well as the development of new products and
technologies such as advanced PVD and CMP systems, advanced gap fill
technology, primary conductor metals, low-k dielectric materials, additional
advanced deposition and surface preparation technologies for the next
generation of smaller geometry fabrication lines and equipment to process
300mm wafers. R&D expenses include compensation and benefits for our research
and development personnel, project materials, chemicals and other direct
expenses incurred in product and technology development, repairs and
maintenance, rent, depreciation and amortization expenses associated with
patents and purchased technologies. The increase in R&D expenses as a
percentage of net sales in 2002 over 2001 was primarily due to the substantial
reduction in net sales. The 18% decrease in the absolute dollar amount of R&D
expenses from 2001 to 2002 was due to the decision to lower our investment
levels in R&D spending. The increase in R&D expenses from 2000 to 2001 resulted
from our continued commitment to invest in new products and technologies. This
increase was partially offset by our decision to cancel the payment of our 2001
bonus and profit sharing of $7.9 million as we did not meet the minimum
performance guidelines required for bonus payment.

Fiscal 2002 R&D expense as a
percentage of net sales increased from 2001 primarily because of the
substantial reduction in net sales in 2002. This increase in R&D expenses as a
percentage of net sales reflects our continued commitment to the development of
new products and technologies to provide competitive cost advantages for our
customers. Despite the downturn in the industry and weakened demand for
semiconductor equipment, we continue to believe that substantial investments in
R&D are critical to remaining competitive and positioning ourselves to meet
current and projected requirements of semiconductor fabrication processes.

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Acquired In-Process Research and Development

|                                             |  |                          |       |          |  |          |   |         |  |         |       |   |  |  |     |   |  |  |      |  
|-------------------------------------------- |  | ------------------------ | ----- | -------- |  | -------- | - | ------- |  | ------- | ----- | - |  |  | --- | - |  |  | ---- | -
|                                             |  | Years ended December 31, |       |          |  |         
|                                             |  |                          |       | % Change |  | % Change
|                                             |  | 2002                     |       | 2001     |  | 2000     |   | in 2002 |  | in 2001
|                                             |  |                          |       |          |  |          |   |         |  |        
|Acquired in-process research and development |  | $                        | 9,003 |          |  | $        |  |         |  | $       | 6,000 |   |  |  | 100 | % |  |  | -100 | %
|% of net sales                               |  |                          | 1     | %        |  |          |  |         |  |         | 0.5   | % |  |  |     |   |  |  |      |  

In connection with the acquisition of SpeedFam-IPEC in December 2002, we
recorded a $9.0 million charge to write-off certain acquired in-process
research and development, or IPR&D. Projects which qualify as IPR&D have not
yet reached technological feasibility and have no alternative future use.
Technological feasibility is defined as being equivalent to completion of a
beta-phase working prototype in which there is no significant remaining risk
relating to the development.

The value assigned to IPR&D was determined by considering the importance of
each project to the overall development plan, estimating costs to develop the
acquired IPR&D into commercially viable products, estimating the resulting net
cash flows from the projects when completed and discounting the net cash flows
to their present value. The revenue estimates used to value the purchased
IPR&D were based on estimates of relevant market sizes and growth factors,
expected trends in technology and the nature and expected timing of new
product introductions by SpeedFam-IPEC and its competitors.

The rates utilized to discount the net cash flows to their present value were
based on a weighted-average cost of capital determined by examining market
information for several comparable companies. The weighted-average
cost of capital was adjusted to reflect the difficulties and uncertainties in
completing each project and thereby achieving technological feasibility, the
percentage of completion of each project, anticipated market acceptance and
penetration, market growth rates and risks related to the impact of potential
changes in future target markets. Based on these factors, a discount rate of
25% was deemed appropriate for valuing the IPR&D. The estimates used in
valuing IPR&D were based upon assumptions believed to be reasonable but which
are inherently uncertain and unpredictable. As a result, actual results may
differ from estimates.

In fiscal 2000, GaSonics recorded a charge of $6.0 million for the write-off of
acquired in-process research and development associated with the acquisition of
Gamma Precision Technologies, Inc., or GPT, because certain of GPTs ongoing
research and development projects had not reached technological feasibility and
had no alternative future use. This included development, engineering and
testing activities associated with the introduction of GPTs new products and
technologies.

Restructuring and Other Charges

|                                |  |                          |       |          |  |          |        |         |  |         |   |   |  |  |     |   |  |  |     |  
|------------------------------- |  | ------------------------ | ----- | -------- |  | -------- | ------ | ------- |  | ------- | - | - |  |  | --- | - |  |  | --- | -
|                                |  | Years ended December 31, |       |          |  |          |        |        
|                                |  |                          |       | % Change |  | % Change
|                                |  | 2002                     |       | 2001     |  | 2000     |        | in 2002 |  | in 2001
|                                |  |                          |       |          |  |          |        |         |  |        
|Restructuring and other charges |  | $                        | 6,467 |          |  | $        | 61,106 |         |  | $       |  |   |  |  | -89 | % |  |  | 100 | %
|% of net sales                  |  |                          | 1     | %        |  |          | 5      | %       |  |         | 0 | % |  |  |     |   |  |  |     |  

Restructuring and other charges in 2002 consisted of $1.5 million related to
vacated facilities and $5.0 million of severance benefits for workforce
reductions. In 2001, we implemented a restructuring plan and recorded
restructuring and asset impairment charges of $47.9 million and acquisition
costs of $13.2 million related to the acquisition of GaSonics. The
restructuring and asset impairment charges included $33.8 million related to
vacated facilities, $9.5 million related to abandoned assets associated with
the discontinuation of certain projects and $4.6 million related to a write-off
of abandoned purchased technology. The discontinuation of two products
resulted in a $7.1 million inventory write-down in 2001, which is included in
cost of sales for that year.

The charge for vacated facilities relates to rent obligations after the
abandonment of certain facilities currently under long-term operating lease
agreements. When applicable, anticipated future sublease income related to the
vacated buildings has been offset against the charge for the remaining lease
payments. Additionally, certain fixed assets, including leasehold
improvements, associated with the abandoned facilities that had no future
economic benefit have been written off. Except for the future rent obligations
and the sublease of the vacated facilities, substantially all actions under the
2001 restructuring plan had been achieved as of December 31,
2001. Under the 2001 restructuring plan, $18.5 million remains
for future rent obligations, which are to be paid in cash over the next four
years. For further discussion, see Note 8 to the Consolidated Financial
Statements.

The restructuring saved us
approximately $38.8 million of expenses in fiscal 2002. Of the
$38.8 million in savings, $9.8 million relates to savings from vacated facilities
and $29.0 million relates to savings from workforce reductions.

The acquisition costs related to the acquisition of GaSonics included $9.4
million of professional fees and financial printing and $3.8 million of other
related costs. The acquisition costs also included charges related to the
cancellation of various contracts and the write-off of certain redundant
assets. All expenses related to this acquisition have been paid.

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Bad Debt (Recovery) Write-off

|                              |  |                          |        |          |  |          |       |         |  |         |   |   |  |   |     |   |  |  |     |  
|----------------------------- |  | ------------------------ | ------ | -------- |  | -------- | ----- | ------- |  | ------- | - | - |  | - | --- | - |  |  | --- | -
|                              |  | Years ended December 31, |        |          |  |         
|                              |  |                          |        | % Change |  | % Change
|                              |  | 2002                     |        | 2001     |  | 2000     |       | in 2002 |  | in 2001
|                              |  |                          |        |          |  |          |       |         |  |        
|Bad debt (recovery) write-off |  | $                        | (7,662 | )        |  | $        | 7,662 |         |  | $       |  |   |  | - | 200 | % |  |  | 100 | %
|% of net sales                |  |                          | -1     | %        |  |          | 1     | %       |  |         | 0 | % |  |   |     |   |  |  |     |  

In
September 2001, we
determined that an outstanding accounts receivable balance was at risk for
collection because the customer was facing financial difficulties, payment was overdue and overall industry conditions
continued to deteriorate. Accordingly, we recorded a write-off of $7.7 million.
However, in the first quarter of 2002, all amounts owed under this accounts
receivable balance were collected, resulting in a benefit to operations of $7.7
million.

Other Income, net

|                  |  |                          |        |          |  |          |        |         |  |         |        |   |  |  |     |   |  |  |   |  
|----------------- |  | ------------------------ | ------ | -------- |  | -------- | ------ | ------- |  | ------- | ------ | - |  |  | --- | - |  |  | - | -
|                  |  | Years ended December 31, |        |          |  |         
|                  |  |                          |        | % Change |  | % Change
|                  |  | 2002                     |        | 2001     |  | 2000     |        | in 2002 |  | in 2001
|                  |  |                          |        |          |  |          |        |         |  |        
|Other income, net |  | $                        | 28,721 |          |  | $        | 57,393 |         |  | $       | 56,330 |   |  |  | -50 | % |  |  | 2 | %
|% of net sales    |  |                          | 3      | %        |  |          | 4      | %       |  |         | 4      | % |  |  |     |   |  |  |   |  

Other income, net, includes interest income, interest expense and other
non-operating income and expenses. The decrease in other income, net, from 2001
to 2002 reflects a decrease in interest income primarily due to a continued
decline in interest rates and a decrease in interest-bearing investments after
we used $880.0 million of restricted investments to retire substantially all of
our Liquid Yield OptionTM Notes, or LYONs, in the third quarter of 2002.
Additionally, we recorded a non-cash charge of $17.0 million for the unamortized
issuance costs related to the retirement of the LYONs in the third quarter of
2002. The decrease in other income in 2002 was partially offset by a $4.6
million gain on the sale of an equity investment.

The increase in other income, net from 2000 to 2001 is attributable to higher
cash and short-term investment balances in the second half of the year as a
result of the $880.0 million cash obtained from the LYONs, partially offset by
an $8.6 million write-down of an equity investment due to an
other-than-temporary decline in fair value.

Provision for Income Taxes

The provision for income taxes reflects an effective tax rate of zero in 2002,
31.0% in 2001 and 31.7% in 2000. The decrease in the effective tax rate
compared with the prior years is due primarily to the relative benefit of tax
credits being higher due to decreased profitability in 2002.

Deferred Tax Assets

As of December 31, 2002, we had approximately $100.1 million of deferred tax
assets, net of a valuation allowance, related principally to acquired net
operating loss carryforwards and items that are not currently deductible.
Management believes the deferred tax assets will be realized due to anticipated
future income and potentially refundable taxes in available carryback periods.
We have a valuation allowance of $57.0 million principally related to acquired
net operating loss carryforwards, which are not realizable until 2009 and
beyond.

Foreign Currency Accounting

The local currency is the functional currency for all foreign operations.
Accordingly, translation gains or losses related to our foreign subsidiaries
are included as a component of accumulated other comprehensive income (loss).

Foreign Exchange Contracts

We conduct our business in various foreign currencies. Forward foreign
exchange contracts are used to hedge against the short-term impact of foreign
currency fluctuations on intercompany accounts payable denominated in U.S.
dollars recorded by our Japanese

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subsidiary. We also enter into forward foreign exchange contracts to buy and
sell foreign currencies to hedge our intercompany balances denominated in a
currency other than the U.S. dollar. In 2002 and 2001, these hedging contracts
were denominated primarily in the Japanese yen and the Taiwanese dollar. The
forward foreign exchange contracts we use are generally short-term in nature.
The effect of exchange rate changes on forward foreign exchange contracts is
expected to offset the effect of exchange rate changes on the underlying hedged
items. We believe these financial instruments do not subject us to
speculative risk that would otherwise result from changes in currency exchange
rates. Net foreign currency gains and losses have not been material to the
results of operations.

Related Parties

We lease an aircraft from NVLS I, LLC, a third-party entity wholly owned by Richard S. Hill,
our Chairman and Chief Executive Officer. Under the aircraft lease agreement,
we incurred lease expense of approximately $0.2 million through December 31, 2002.
The Board of Directors authorized us to commission an
accounting firm to conduct a study of lease rates for similar
aircraft. The results of this study confirmed that rates charged by
NVLS I, LLC are comparable to amounts charged by third-party commercial charter companies
for similar aircraft.

A member of our Board of Directors, D. James Guzy, is also a member of the
Board of Directors of Intel Corporation, which is one of our significant
customers. Intel Corporation represented approximately 11%, 16% and 14% of net
sales for the years ended December 31, 2002, 2001 and 2000,
respectively. Intel Corporation also accounted for 18% and 14% of our
accounts receivable as of December 31, 2002 and 2001,
respectively.

From time to time we have made secured relocation loans to our executive
officers, vice presidents and key personnel. As of December 31, 2002, we do not
have any outstanding loans to our executive officers as defined by the Securities
and Exchange Commission. However, we do have outstanding loans to certain
non-executive vice-presidents and key personnel. As of December 31, 2002, the
total outstanding balance of loans to non-executive vice presidents and key personnel
was approximately $5.7 million, of which $5.5 million are secured
by collateral
and $0.2 million are unsecured. All loans except relocation loans
bear interest.

Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board, or FASB, issued SFAS
No. 143, Accounting for Asset Retirement Obligations, which addresses
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. SFAS No.
143 is effective for fiscal years beginning after June 15, 2002. We do not
expect that the adoption of SFAS No. 143 will have a material effect on our
financial condition or results of operations.

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.
For most companies, SFAS No. 145 will require gains and losses on
extinguishments of debt to be classified as income or loss from continuing
operations, rather than as extraordinary items, as previously required under
SFAS No. 4, Reporting Gains and Losses from Extinguishment
of Debt, an amendment of APB Opinion No. 30. Extraordinary treatment will be required for certain
extinguishments, as provided in APB Opinion No. 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. The statement also amended
SFAS No. 13, Accounting for Leases, for certain sale-leaseback transactions and sublease accounting. We
are required to adopt the provisions of SFAS No. 145 effective January 1, 2003.
We do not expect the adoption of SFAS No. 145 to have a material effect on our
financial condition or results of operations.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. SFAS No. 146 addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullifies EITF Issue No. 94-3, and must be applied beginning on January
1, 2003. SFAS No. 146 requires that a liability for a cost associated with an
exit or disposal activity be recognized when the liability is incurred rather
than when the exit or disposal plan is approved. We do not expect the adoption
of SFAS No. 146 to have a material effect on our financial condition or results
of operations.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation, Transition and Disclosure. SFAS No. 148 provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. SFAS No. 148 also requires
that disclosures of the pro forma effect of using the fair value method of
accounting for stock-based employee compensation be displayed more prominently
and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the
pro forma effect in interim financial statements. SFAS No. 148 is effective for
financial statements for fiscal years ending after December 15, 2002. The
adoption of SFAS No. 148 has not had a material effect on our
financial condition or results of
operations.

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In November 2002, the FASB issued FASB Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, or FIN 45. FIN 45 will significantly
change current practice in the accounting for, and disclosure of, guarantees.
FIN 45 requires certain guarantees to be recorded at fair value, which is
different from the current practice of recording a liability only
when a loss is probable and reasonably estimable, as those terms are defined in
SFAS No. 5, Accounting for Contingencies. FIN 45 also requires a guarantor
to make significant new disclosures, even when the likelihood of making any
payments under the guarantee is remote, which is another change from
the current
practice. FIN 45 disclosure requirements are effective for financial
statements of interim or annual periods ending after December 15, 2002, while
the initial recognition and initial measurement provisions are applicable on a
prospective basis to guarantees issued or modified after December 31, 2002. We
are currently evaluating the impact of the adoption of FIN 45 on our results of
operations or financial condition.

In January 2003, the FASB issued FIN 46, Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51. FIN 46 requires certain variable
interest entities to be consolidated by the primary beneficiary of the entity
if the equity investors in the entity do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 is effective for all new variable interest
entities created or acquired after January 31, 2003. For variable interest
entities created or acquired prior to February 1, 2003, the provisions of FIN
46 must be applied for the first interim or annual period beginning after June
15, 2003. We are currently evaluating our synthetic leases and seeking
additional information from the lessor and its advisors with regard to whether the
lessor should be characterized as a variable interest entity. Consequently, we
have not yet concluded whether it is reasonably possible that we would be
required to record the specific assets and liabilities associated with our
synthetic leases in our financial statements for our third fiscal
quarter beginning on June 29, 2003. In the event the
leasing structures used in our synthetic leases qualify as variable
interest entities, we would seek to refinance with entities with whom we
would not be required to consolidate or  purchase the properties
by exercising our purchase option. For further discussion, see Note 10 to the
Consolidated Financial Statements.

Liquidity and Capital Resources

We have historically financed our operating and capital resource requirements
through cash flows from operations, sales of equity securities and borrowings.
Our primary source of funds as of December 31, 2002 consisted of $1,019.7
million of cash, cash equivalents and short-term investments. This amount
represents an increase of $97.9 million from the December 31, 2001 balance of
$921.8 million. The increase is primarily due to net cash provided by operating
activities, which is attributable to net income, as adjusted to exclude
non-cash charges and benefits and changes in working capital. The increase is
partially offset by our decision to participate in the synthetic leases. Our
participation in the synthetic lease transactions is further discussed below.

Net cash provided by operating activities for the year ended December 31, 2002
was $214.9 million. The primary sources of cash from operating
activities were net income, as adjusted to exclude non-cash charges and benefits and
changes in working capital requirements, including notable decreases in
accounts receivable, inventories and prepaid and other current assets. The
decrease in accounts receivable is attributable to the decrease in net sales
and improved cash collections. The decrease in inventories, as adjusted to
exclude inventories acquired from SpeedFam-IPEC, is due to a lower inventory
level as a result of certain inventory management programs initiated in 2002.
The decrease in prepaid and other current assets is primarily due to
a $69.0 million income tax refund received during the year.

Net cash provided by investing activities was $777.2 million for the year ended
December 31, 2002. The cash inflows from investing activities consist primarily
of $3.0 billion in proceeds from sales and maturities of available-for-sale
securities and restricted investments, partially offset by purchases of new
investments of $2.0 billion. Additionally, we acquired $43.5 million of net
cash upon the closing of the acquisition of SpeedFam-IPEC on December 6, 2002.
The cash inflows were partially offset by $26.8 million of capital expenditures
and $177.5 million of cash used for collateral in synthetic lease transactions.

We did not have any significant
property and equipment purchase commitments as of December 31,
2002.

For the year ended December 31, 2002, net cash used in financing activities was
$926.9 million, which was attributable to the $880.0 million retirement of
the LYONs, $78.2 million for repurchases of common stock, and $23.4 million for
repayment of borrowings under lines of credit. The cash used in financing activities
is partially offset by proceeds of $54.4 million from the issuance of common
stock under our employee stock option and stock purchase plans.

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The following is a table summarizing our significant commitments as of December
31, 2002, consisting of future minimum lease payments under all non-cancelable
operating leases, including synthetic leases, with initial or remaining terms
in excess of one year and debt payments related to the convertible debentures
assumed as part of our acquisition of SpeedFam-IPEC. These
convertible debentures were redeemed in January 2003. Amounts payable under
synthetic leases exclude any payments under residual value guarantees and
relate only to the net lease financing amounts. In addition, payments under
synthetic leases are subject to changes in the London Interbank Offer
Rate (LIBOR) and have been included using
interest rates on December 31, 2002 (in thousands):

|                  |  |             |         |           |  |   |         | 
|----------------- |  | ----------- | ------- | --------- |  | - | ------- | 
|                  |  | Convertible |         | Operating
|                  |  | debt        |         | leases   
|                  |  |             |         |          
|2003              |  | $           | 116,437 |           |  | $ | 27,132  | 
|2004              |  |             |        |           |  |   | 27,185  | 
|2005              |  |             |        |           |  |   | 26,540  | 
|2006              |  |             |        |           |  |   | 18,966  | 
|2007              |  |             |        |           |  |   | 5,933   | 
|Thereafter        |  |             |        |           |  |   | 45,499  | 
|                  |  |             |         |           |  |   |         | 
|Total
commitments |  | $           | 116,437 |           |  | $ | 151,255 | 
|                  |  |             |         |           |  |   |         | 

We lease nearly all of our facilities under operating leases, including
synthetic leases, which expire at various dates through 2017. A synthetic
lease is a form of operating lease wherein a third party lessor funds 100% of
the acquisition and construction costs relating to one or more properties to be
leased to a lessee. The lessor is the owner of the leased property and must
provide at least 3% of the required funds in the form of at-risk equity. The
lessor generally borrows the balance of the funds necessary to fund the
acquisition and construction. Under our synthetic lease agreements,
we are obligated to lend approximately 87% of the cost of the leased asset to
the lessor upon completion of construction. The leases with this requirement
are known as defeased or self-funded transactions. Additionally, our
synthetic leases require us to maintain collateral for the benefit of the
lessor.

The San Jose lease agreement covers 13 properties located in and around San
Jose, California, including manufacturing, research and development, and
administrative facilities, as well as our corporate headquarters. The lease
has a term of five years beginning in September 2001 and covers properties with
original values of approximately $293.2 million. The lease agreement requires
the lessor to provide 3.5% of at-risk equity throughout the term of the lease.
The remaining 96.5% of the lessors financing was in the form of debt, including
$257.0 million loaned to the lessor which is classified as notes receivable on
our balance sheet. We have also provided the lessor with $36.2 million in
collateral, which is classified within other assets on our balance
sheet.

Under the lease agreement, we have the right to purchase the properties at any
time prior to the expiration date of the lease for an amount that equals the
total lease financing amount of $293.2 million plus any current rent due and
payable. At the end of the lease term, we may renew the lease for up to three
additional years with the lessors consent, refinance the lease, purchase the
properties under a purchase option or arrange to sell the properties to a
third party. If we choose the sale option we will be obligated to the lessor
up to the amount of the residual value guarantee if the sale price
falls below the lease financing amount. The aggregate
residual value guarantee related to the San Jose properties is approximately
$258.2 million as of December 31, 2002, and represents an off-balance sheet
contingent liability for which we do not believe that we have any significant
exposures as discussed below.

Rent payments under the San Jose lease agreement are based on the net
outstanding lease balance, which includes the cost of the leased properties,
less the amount defeased by us, multiplied by either a fixed rate or LIBOR plus an applicable margin. As of December 31, 2002, the
net outstanding lease balance and the amount we have defeased were $293.2
million, and $257.0 million, respectively. Rent expense and interest income on
the lease balance includes $8.0 million of imputed
amounts at rates of 2% to 4% for the year ended December 31, 2002. Imputed
amounts result from the application of a deemed market rate of interest on loan
balances, including the lease receivable from the lessor, which is non-interest
bearing, and a portion of the collateral, which is interest bearing at lower
than the deemed market rate of interest. Our lease receivable from the lessor is
repayable in full only if we choose the sale option at the end of the lease
term and successfully sell the properties for amounts in excess of the cost.
Our collateral is available to the lessor upon default, with certain
exceptions.

On April 18, 2001, we entered into a synthetic lease agreement for the
development of a manufacturing, research and development and administrative
facility to be constructed on 23 acres of land we own in Tualatin,
Oregon. We have leased the land to the lessor under a long-term ground lease.
Construction was completed at the Tualatin site in May 2002. The construction
costs totaled $163.2 million and were fully financed by the lessor. The lease agreement requires the lessor
to maintain 3% of at-risk equity throughout the term of

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the lease. The lessor financed the balance of the construction costs with debt. Upon completion of
construction, we defeased $140.4 million of the lessors debt financing in the
form of a non-interest bearing loan to the lessor, which is included in notes
receivable on our balance sheet at December 31, 2002. We have also provided
$22.8 million in collateral held by the lessor to cover the remainder of the
lease financing, which is classified as other assets on our balance sheet.

We have the right to purchase the property at any time prior to the expiration
date of the lease for an amount that equals the total lease financing amount of
$163.2 million, plus any current rent due and payable. At the end of the
five-year lease term, we may renew the lease for up to three additional years
with the lessors consent, purchase the property under the purchase option for
an amount equal to the total lease financing amount or arrange to sell the
property to a third party. If we choose the sale option, we will be obligated
to the lessor up to the amount of the residual value guarantee if the
sale price falls below the lease financing amount.
The residual value guarantee related to the Tualatin property is approximately
$140.4 million as of December 31, 2002 and represents an off-balance sheet
contingent liability for which we do not believe that we have any significant
exposure as discussed below.

Rent payments under the Tualatin lease agreement are based on the net
outstanding lease balance, which includes the cost of the leased properties,
less the amount defeased by us, multiplied by either a fixed rate or LIBOR, plus an applicable margin. As of December 31, 2002, the
net outstanding lease balance and the amount we have defeased were $163.2
million and $140.4 million, respectively. Rent expense and interest income on
the lease balance includes $2.9 million of imputed
amounts at rates of 2% to 4% for the year ended December 31, 2002. Imputed
amounts result from the application of a deemed market rate of interest on loan
balances, including the lease receivable from the lessor, which is non-interest
bearing, and a portion of the collateral, which is interest bearing at lower
than the deemed market rate of interest. Our lease receivable from the lessor is repayable in
full only if we choose the sale option at the end of the lease term and
successfully sell the property for an amount in excess of the cost. Our
collateral is available to the lessor upon default, with certain exceptions.

If we purchase the San Jose and
Tualatin properties at the end of their respective lease
terms or earlier, the transactions would increase property and equipment by the
lower of the purchase option price or the then fair value of the purchased
properties. As of December 31, 2002, we believe that the fair market value for
each property exceeds the purchase option price for each property. We estimate
the cumulative fair value of all properties to be approximately $456.4 million
as of December 31, 2002. Upon purchase of the properties, our
note receivable
and collateral would be returned to us as cash or used to offset the purchase price of the
properties. As a result of the purchase, depreciation expense would increase by
approximately $30.0 million to $35.0 million per year, and rent expense and
interest income would each decrease by approximately $12.6 million per year,
based on current interest rates. If we purchased the properties at the end of
their respective lease terms or earlier, we believe there would be no material impact on our
liquidity, as the cash paid to purchase the properties would be offset by the
note receivable and collateral associated with our participation in these
leases.

The synthetic lease agreements contain certain restrictive covenants, which
include quick ratio and tangible net worth tests. We were in compliance with
these covenants as of December 31, 2002. If we had not complied with these
covenants, the lessor could have terminated the leases, resulting in an
acceleration of our purchase obligation, in which case, our residual
value guarantee
would have equaled 100% of the lease balances.

Our intention with respect to the properties we lease under synthetic leases is
dependent upon the treatment of our lessor under FIN 46. If the lessor is
deemed to be a voting interest entity, we would expect to continue the
synthetic lease arrangements and exercise our three one-year renewals subject
to obtaining the lessors consent. If our lessor is deemed to be a variable
interest entity and we are deemed to be the primary beneficiary, we would
seek to refinance with entities with whom we would not be required to
consolidated or purchase the properties by exercising our purchase option.

The maximum exposure to loss on our synthetic leases includes (i) residual
value guarantee payments as described above, (ii) certain tax indemnifications
in the event third parties are obligated for certain federal, state or
local taxes as a result of their participation in the transaction, and (iii)
indemnification for various losses, costs and expenses incurred by
third-party participants as a result of their ownership of the leased property
or participation in the transaction, and as a result of the environmental
condition of the property. The additional taxes, losses and expenses as
described in (ii) and (iii) are contingent upon the existence of certain
conditions that may arise in the future and, therefore, are not quantifiable at
this time. However, we do not expect these additional taxes, losses and
expenses to be material. In addition, as noted above, we have funded
advances to the lessor in the aggregate amounts of $257.0 million for the San Jose
facilities and $140.4 million for the Tualatin facilities, and
have deposited
with the lessor investment collateral in the amount of $36.2 million for the San Jose facilities and $22.8 million for the
Tualatin facilities as a source of payment for our obligations for the
residual value guarantee payments and other amounts owed under the leases.

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As of December 31, 2002, our subsidiaries had no outstanding obligation under
lines of credit with banks. The available lines of credit with these banks
total $36.7 million. These credit facilities bear interest at
various rates, expire on various dates through December 2003 and are used for general
corporate purposes. As of December 31, 2001, amounts outstanding under
these lines of credit were $26.2 million at an annual
weighted-average interest rate of 0.62%. There were no balances
outstanding under these lines of credit as of December 31, 2002.

On December 6, 2002, in connection with the acquisition of SpeedFam-IPEC, we
assumed SpeedFam-IPECs $115.0 million Convertible Subordinated Notes due in
2004. The notes accrue interest at a rate of 6.25%, which is payable
semi-annually in March and September and were adjusted to their fair value of
$116.4 million as of the acquisition date. The notes were subordinated to all
existing and future senior indebtedness and could be converted into 3.3096
shares of Novellus common stock at a conversion price of $302.15 per $1,000
principal amount. We had the right to redeem the Notes at various prices,
subject to specified conditions as set forth in the indenture.

We called the Notes on January 8, 2003 at a redemption price of $117.1 million,
which represents 101.786% of par value. We recognized approximately $0.6
million in expense in January 2003 as a result of the redemption of
the Notes. The $0.6 million expense represents the difference between the carrying value and the redemption price
of the Notes.

On July 26, 2001, we issued $880.0 million of Liquid Yield Option Notes
(LYONs) due July 26, 2031. The net proceeds after issuance costs (which were
being amortized over 30 years) from the LYONs offering were $862.4 million. The
LYONs are zero coupon, zero-yield subordinated debentures convertible into
shares of our common stock or redeemable for cash by the security holder,
subject to specified conditions as set forth in the indenture.

On July 26, 2002, the holders of the LYONs exercised their option to require us
to repurchase the LYONs for $1,000 in cash each on such date, or approximately
$880.0 million for substantially all of the outstanding LYONs. We used
restricted short-term investments, which had matured to $880.0 million, to
repurchase the LYONs. We recorded a charge of approximately $17.0 million in
other expenses for the remaining unamortized issuance costs related to the
LYONs.

We believe that our current cash position, cash generated through operations
and equity offerings, and available borrowings will be sufficient to meet our
needs through at least the next twelve months.

Risk Factors

Set forth below and elsewhere in this Annual Report on Form 10-K, including in
Item 7. Managements Discussion and Analysis, and in other documents we file
with the Securities and Exchange Commission are risks and uncertainties that
could cause actual results to differ materially from the results contemplated
by the forward-looking statements contained in this Annual Report.

Cyclical Downturns in the
Semiconductor Industry

Our business depends
predominantly on the capital expenditures of semiconductor manufacturers, which
in turn depend on current and anticipated market demand for integrated circuits
and the products that use them. The semiconductor industry has historically
been very cyclical and has experienced periodic downturns that have had a
material adverse effect on the demand for semiconductor processing equipment,
including equipment that we manufacture and market. During periods of reduced
and declining demand, we must be able to quickly and effectively align our
costs with prevailing market conditions, as well as motivate and retain key
employees. In particular, our inventory levels during periods of reduced demand
have at times reached and are now at higher-than-necessary levels relative to
the current levels of production demand. We cannot provide any assurance that
we may not be required to make inventory valuation adjustments in future
periods. During periods of rapid growth, we must be able to acquire and/or
develop sufficient manufacturing capacity to meet customer demand, and hire and
assimilate a sufficient number of qualified people. We cannot give assurances
that our net sales and operating results will not be adversely affected if the
current downturn in the semiconductor industry continues, or if other downturns
or slowdowns in the rate of capital investment in the semiconductor industry
occur in the future.

The Semiconductor Industry is
Intensely Competitive and Capital-Intensive

We
face substantial competition in the industry, both from potential new entrants
into the market and established competitors. Some of these companies may have
greater financial, marketing, technical or other resources than we do, as well
as broader product lines, greater customer service capabilities, or larger and
more established sales organizations and customer bases. Remaining competitive
in the market depends in part upon our ability to develop new and enhanced
systems, and to introduce them at competitive prices on a timely
basis.

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Our customers must incur substantial expenditures to install and integrate
capital equipment into their semiconductor production lines. Once a
manufacturer has selected another vendors capital equipment, the manufacturer
is generally reliant upon that equipment vendor for the specific production
line application in question. Accordingly, we may experience difficulty in
selling a product to a particular customer for a significant period of time
when that customer has selected a competitors product. In addition, sales of
our systems depend in significant part upon a prospective customers decision
to increase manufacturing capacity or expand current manufacturing
capacityboth of which typically involve a significant capital commitment. From
time to time, we have experienced delays in finalizing system sales following
initial system qualification. Due to these and other factors, our systems
typically have a lengthy sales cycle, during which we may expend substantial
funds and management effort.

Rapidly Changing
Technology

We devote a significant portion of our personnel
and financial resources to research and development programs, and we seek to
maintain close relationships with our customers in order to remain responsive
to their product needs. As is typical in the semiconductor capital equipment
market, we have experienced delays from time to time in the introduction of and
certain technical and manufacturing difficulties with certain of our products
and product enhancements. In addition, we may experience delays and technical
and manufacturing difficulties in future introductions or volume production of
our new systems or enhancements.

Our success in developing, introducing and selling new and enhanced systems
depends upon a variety of factors. These include product selection, timely and
efficient completion of product design and development, timely and efficient
implementation of manufacturing and assembly processes, product performance in
the field, and effective sales and marketing. There can be no assurance that we
will be successful in selecting, developing, manufacturing and marketing new
products, or in enhancing our existing products. In addition, we could incur
substantial unanticipated costs to ensure the functionality and reliability of
our future product introductions early in their product life cycles. If new
products have reliability or quality problems, reduced orders, or higher
manufacturing costs, then delays in collecting accounts receivable and
additional service and warranty expenses may result. Any of these events could
materially adversely affect our business, financial condition or results of
operations.

International Operations

Export sales currently account for a significant
portion of our net sales. This trend is expected to continue in the foreseeable
future. As a result, a significant portion of our sales is subject to certain
risks, including, but not limited to:



| |  | Tariffs and other trade barriers;                                                                                                                                                                                                                   
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Challenges in staffing and managing foreign subsidiary operations;                                                                                                                                                                                  
| 
| |  | Difficulties in managing foreign distributors;                                                                                                                                                                                                      
| 
| |  | Potentially adverse tax consequences;                                                                                                                                                                                                               
| 
| |  | Imposition of legislation and regulations relating to the import or
export of semiconductor products, either by the United States or other
countries;                                                                                               
| 
| |  | Periodic economic downturns;                                                                                                                                                                                                                        
| 
| |  | Political instability; and                                                                                                                                                                                                                          
| 
| |  | Fluctuations in interest and
foreign currency exchange rates, creating
the need to enter into forward foreign exchange contracts to hedge
against the short-term impact of foreign currency fluctuations,
specifically yen-denominated transactions.

There can be no assurance that any of these factors or the adoption of
restrictive policies will not have a material adverse effect on our business,
financial condition or results of operations. In addition, each region in the
global semiconductor equipment market exhibits unique market characteristics
that can cause capital equipment investment patterns to vary significantly from
period to period. We derive a substantial portion of our revenues from
customers in Asian countries. Any negative economic developments in these
countries could result in the cancellation or delay by Asian customers of
orders for our products, which could adversely affect our business, financial
condition or results of operations.

Variability of Quarterly Operating
Results

We have experienced and expect to
continue experiencing significant fluctuations in our quarterly operating
results. These fluctuations are due to a number of factors that include, but
are not limited to:



| |  | Building our systems according to forecast, and not using limited backlog information, which hinders our ability to plan
production and inventory levels;
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Failure to receive anticipated orders in time to permit shipment during that quarter;                                                                    
| 
| |  | Customers rescheduling or canceling shipments;                                                                                                           
| 
| |  | Manufacturing difficulties;                                                                                                                              
| 
| |  | Customers deferring orders of our existing products due to new product announcements by us and/or our competitors; and                                   

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| |  | Overall business conditions in the semiconductor equipment industry.
|- |  | --------------------------------------------------------------------

Variations in quarterly operating results or changes in analysts earnings
estimates may subject the price of our common stock to wide fluctuations and
possible rapid increases or declines in a short time period.

Acquisitions

We have madeand may in the future makeacquisitions of or
significant investments in businesses with complementary products, services
and/or technologies. Acquisitions involve numerous risks, including, but not
limited to:



| |  | Difficulties in integrating the operations, technologies, products and personnel of acquired companies;                                          
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Lack of synergies or the inability to realize expected synergies;                                                                                
| 
| |  | Difficulties in managing geographically dispersed operations;                                                                                    
| 
| |  | The potential loss of key employees, customers and strategic partners of acquired companies;                                                     
| 
| |  | Diversion of managements attention from normal daily operations of the business; and                                                            
| 
| |  | The impairment of acquired intangible assets as a result of technological advancements, or worse-than-expected performance
of acquired companies.

Acquisitions are inherently risky, and we cannot provide any assurance that our
previous or future acquisitions will be successful. The inability to
effectively manage the risks associated with previous or future acquisitions
could materially and adversely affect our business, financial
condition or results of operations.

A Large Portion of Net Sales is
Derived from Sales to a Few Customers

We
currently sell a significant proportion of our systems in any particular period
to a limited number of customers, and we expect that sales of our products to
relatively few customers will continue to account for a high percentage of our
net sales in the foreseeable future. In addition, we believe that sales to
certain of our customers will decrease in the near future as they complete
current purchasing requirements for new or expanded fabrication facilities.
Although the composition of the group comprising our largest customers varies
from year to year, the loss of a significant customer or any reduction in
orders from any significant customerincluding reductions due to customer
departures from recent buying patterns, as well as economic or competitive
conditions in the semiconductor industrycould adversely affect our business,
financial condition or results of operations.

Intellectual Property

We intend to continue pursuing the legal protection of
our proprietary technology primarily through patent and trade secret
protection. There can be no assurance that patents will be issued from any of
these pending applications, or that any claims allowed from existing or pending
patents will be sufficiently broad to protect our proprietary technology. There
is also no guarantee that any patents we hold will not be challenged,
invalidated or circumvented, or that the rights granted thereunder will provide
competitive advantages to us. We also cannot provide assurance that the
confidentiality agreements we enter into with employees, consultants and other
parties will not be breached.

We are currently involved in a number of legal disputes regarding patent and
other intellectual property rights. Except as set forth in Item 3. Legal
Proceedings in this document, we are not aware of any significant claim of
infringement by our products of any patent or proprietary rights of others.
Adverse outcomes in current or future legal disputes could result in our loss
of proprietary rights, subject the company to significant liabilities to third
parties, require us to seek licenses from third parties, or prevent us from
manufacturing or selling our products. Any of these circumstances could have a
material adverse effect on our business, financial condition or results of
operations.

Supply Shortages

We use numerous suppliers to obtain parts, components and
sub-assemblies for the manufacture and support of our products. Although we
make reasonable efforts to ensure that such parts are available from multiple
suppliers, certain key parts may only be obtained from a single or limited
source. These suppliers are in some cases thinly capitalized, independent
companies that generate significant portions of their business from us and/or a
small group of other companies in the semiconductor industry. We seek to reduce
our dependence on this limited group of sources. However, disruption or
termination of certain of these suppliers may occur. Such disruptions could
have an adverse effect on our operations. A prolonged inability to obtain
certain parts could have a material adverse effect on our business, financial condition or results of operations,
and could result in our inability to meet customer demands on time.

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

Our exposure to market risk for changes in interest rates
relates primarily to our investment portfolio and short-term debt obligations.
We do not use derivative financial instruments in our investment portfolio. We
place our investments with high credit quality issuers and, by policy, limit
the amount of credit exposure to any one issuer.

We mitigate default risk by investing in only the safest and highest credit
quality securities and by monitoring the credit rating of investment issuers.
The portfolio includes only marketable securities with active secondary or
resale markets to ensure portfolio liquidity. We have no material cash flow
exposure due to rate changes for cash equivalents and short-term investments.

The majority of our short-term obligations have fixed interest rates, including
the convertible bonds assumed in connection with the
SpeedFam-IPEC acquisition, all of which were subsequently redeemed in January
2003. Therefore, our results are only affected by the interest rate changes to
variable rate short-term borrowings. Due to the short-term nature of these
borrowings, an immediate change to interest rates is not expected to have a
material effect on our results.

The table below presents principal amounts and related weighted interest rates
by year of maturity for our investment portfolio and debt obligations and the
fair value of each as of December 31, 2002 and 2001. All of our
available-for-sale investments and debt securities mature within two years from
the original purchase or issuance date.

|             |                             |      |                     |           |   |       |   |        |            |  |   |           |   |  |              |           | 
|------------ | --------------------------- | ---- | ------------------- | --------- | - | ----- | - | ------ | ---------- |  | - | --------- | - |  | ------------ | --------- | 
|             |                             |      | Periods of Maturity |           |   |       |   |        |            |  |  
|             |                             |      |                     |           |   |       |   |        | Fair Value
|             |                             |      |                     |           |   |       |   |        |            |  |   |           |   |  | December 31,
|In thousands |                             | 2003 |                     | 2004      |   | Total |   | 2002  
|             |                             |      |                     |           |   |       |   |       
|Assets:      |                             |      |                     |           |   |       |   |        |            |  |   |           |   |  |              |          
|             | Cash equivalents            |      | $                   | 615,844   |   |       |   |       |            |  | $ | 615,844   |   |  | $            | 615,844   | 
|             | Average interest rate       |      |                     | 1.36      | % |       |   |       |            |  |   | 1.36      | % |  |              |           | 
|             | Short-term investments      |      | $                   | 385,793   |   |       | $ | 18,016 |            |  | $ | 403,809   |   |  | $            | 403,809   | 
|             | Average interest rate       |      |                     | 2.04      | % |       |   | 1.92   | %          |  |   | 2.03      | % |  |              |           | 
|             | Restricted investments      |      | $                   | 58,995    |   |       |   |       |            |  | $ | 58,995    |   |  | $            | 58,995    | 
|             | Average interest rate       |      |                     | 0.32      | % |       |   |       |            |  |   | 0.32      | % |  |              |           | 
|             | Total investment securities |      | $                   | 1,060,952 |   |       | $ | 18,016 |            |  | $ | 1,078,648 |   |  | $            | 1,078,648 | 
|             | Average interest rate       |      |                     | 1.55      | % |       |   | 1.92   | %          |  |   | 1.55      | % |  |              |           | 
|Liabilities: |                             |      |                     |           |   |       |   |        |            |  |   |           |   |  |              |          
|             | Convertible debentures      |      | $                   | 116,437   |   |       |   |       |            |  | $ | 116,437   |   |  | $            | 116,437   | 
|             | Average interest rate       |      |                     | 6.25      | % |       |   |       |            |  |   | 6.25      | % |  |              |           | 

|             |                             |      |                     |           |   |       |   |       |            |  |   |           |   |  |              |           | 
|------------ | --------------------------- | ---- | ------------------- | --------- | - | ----- | - | ----- | ---------- |  | - | --------- | - |  | ------------ | --------- | 
|             |                             |      | Periods of Maturity |           |   |       |   |       |            |  |  
|             |                             |      |                     |           |   |       |   |       | Fair Value
|             |                             |      |                     |           |   |       |   |       |            |  |   |           |   |  | December 31,
|In thousands |                             | 2002 |                     | 2003      |   | Total |   | 2001 
|             |                             |      |                     |           |   |       |   |      
|Assets:      |                             |      |                     |           |   |       |   |       |            |  |   |           |   |  |              |          
|             | Cash equivalents            |      | $                   | 550,640   |   |       |   |      |            |  | $ | 550,640   |   |  | $            | 550,640   | 
|             | Average interest rate       |      |                     | 1.96      | % |       |   |      |            |  |   | 1.96      | % |  |              |           | 
|             | Short-term investments      |      | $                   | 364,716   |   |       | $ | 6,466 |            |  | $ | 371,182   |   |  | $            | 371,182   | 
|             | Average interest rate       |      |                     | 3.28      | % |       |   | 4.84  | %          |  |   | 3.31      | % |  |              |           | 
|             | Restricted investments      |      | $                   | 961,643   |   |       |   |      |            |  | $ | 961,643   |   |  | $            | 961,643   | 
|             | Average interest rate       |      |                     | 3.34      | % |       |   |      |            |  |   | 3.34      | % |  |              |           | 
|             | Total investment securities |      | $                   | 1,876,999 |   |       | $ | 6,466 |            |  | $ | 1,883,465 |   |  | $            | 1,883,465 | 
|             | Average interest rate       |      |                     | 2.93      | % |       |   | 4.84  | %          |  |   | 2.94      | % |  |              |           | 
|Liabilities: |                             |      |                     |           |   |       |   |       |            |  |   |           |   |  |              |          
|             | Short-term borrowing        |      | $                   | 26,179    |   |       |   |      |            |  | $ | 26,179    |   |  | $            | 26,179    | 
|             | Average interest rate       |      |                     | 0.62      | % |       |   |      |            |  |   | 0.62      | % |  |              |           | 
|             | Convertible debentures      |      | $                   | 880,000   |   |       |   |      |            |  | $ | 880,000   |   |  | $            | 876,700   | 
|             | Average interest rate       |      |                     | 0.00      | % |       |   |      |            |  |   | 0.00      | % |  |              |           | 

We have operating lease agreements on several properties. The agreements are
for five years with interest rates that approximate the London Interbank Offer
Rate (LIBOR). Rent expense was approximately $17.8 million, $16.9 million and
$20.1 million for the years ended December 31, 2002, 2001 and 2000,
respectively, net of sublease income of $7.4 million, $7.2 million and $8.1
million, respectively. Rent expense may increase significantly with
changes in prevailing interest rates.

Excluded from the 2002 table above is
$456.4 million of collateralized investments
recorded within other assets and as a note receivable, related to our
participation in the synthetic leases. Of this amount, $15.2 million is
subject to interest rate risk since amounts payable as rent expense
are based on
LIBOR. The remaining balance of rent expense is either paid using a fixed rate
of interest or is non-

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interest bearing. Imputed amounts
result from the
application of a deemed market rate of interest on loan balances, including the
lease receivable from the lessor, which is non-interest bearing, and a portion
of the collateral, which is interest bearing at lower than the deemed market rate of
interest. Since interest is imputed for financial reporting and disclosure
purposes only, market risk is not associated with these instruments. For
further discussion, see Note 10 to the Consolidated Financial Statements.

Foreign Currency Risk

We transact business in various foreign countries. Our
primary foreign currency cash flows are in Asia and Europe. During 2002 and 2001,
we utilized foreign currency forward exchange contracts to hedge foreign
currency denominated balance sheet positions. Under this program, increases or
decreases in currency commitments and balance sheet positions, as translated
into U.S. dollars, were primarily offset by realized gains and losses on the
hedging instruments. The goal of the hedging program is to minimize the impact
of foreign currency fluctuations on our results of operations. We do not use foreign currency
forward exchange contracts for speculative or trading purposes.

All of our unsettled foreign currency contracts are marked-to-market, with
unrealized gains and losses included as a component of other income and
expense. The following table provides information as of December 31, 2002 and
2001 about our derivative financial instruments, which are comprised of foreign
currency forward exchange contracts. The information is provided in U.S. dollar
equivalent amounts, as presented in our consolidated financial statements. The
table below presents the notional amounts (at the contract exchange rates), the
weighted-average contractual foreign currency exchange rates, and the estimated
fair value of those contracts.

|                                               |                  |                 |         |               |   |                   |  |          |  |   |     |     |  
|---------------------------------------------- | ---------------- | --------------- | ------- | ------------- | - | ----------------- |  | -------- |  | - | --- | --- | -
|December 31, 2002                              |                  | Notional Amount |         | Average       |   | Estimated Fair   
|In thousands, except for average contract rate |                  | (Buy) Sell      |         | Contract Rate |   | Value-Gain (Loss)
|                                               |                  |                 |         |               |   |                  
|Foreign currency forward exchange contracts:   |                  |                 |         |               |   |                   |  |          |  |   |     |    
|                                               | Japanese yen     |                 | $       | 18,460        |   |                   |  | 118.33   |  |   | $   | 817 |  
|                                               | British pound    |                 |         | (4,140        | ) |                   |  | 0.64     |  |   |     | (8  | )
|                                               | Euro             |                 |         | (2,417        | ) |                   |  | 0.99     |  |   |     | 3   |  
|                                               | Singapore dollar |                 |         | (4,563        | ) |                   |  | 1.76     |  |   |     | (7  | )
|                                               | Taiwan dollar    |                 |         | (21,957       | ) |                   |  | 34.86    |  |   |     | 72  |  
|                                               | Korean won       |                 |         | (7,914        | ) |                   |  | 1,215.25 |  |   |     | 21  |  
|                                               | Chinese Yuan     |                 |         | (494          | ) |                   |  | 8.27     |  |   |     |    |  
|                                               |                  |                 |         |               |   |                   |  |          |  |   |     |     |  
|                                               |                  | $               | (23,024 | )             |   |                   |  |          |  | $ | 898 |    
|                                               |                  |                 |         |               |   |                   |  |          |  |   |     |     |  

|                                               |                  |                 |        |               |   |                   |  |          |  |   |       |       |  
|---------------------------------------------- | ---------------- | --------------- | ------ | ------------- | - | ----------------- |  | -------- |  | - | ----- | ----- | -
|December 31, 2001                              |                  | Notional Amount |        | Average       |   | Estimated Fair   
|In thousands, except for average contract rate |                  | (Buy) Sell      |        | Contract Rate |   | Value-Gain (Loss)
|                                               |                  |                 |        |               |   |                  
|Foreign currency forward exchange contracts:   |                  |                 |        |               |   |                   |  |          |  |   |       |      
|                                               | Japanese yen     |                 | $      | 72,930        |   |                   |  | 115.55   |  |   | $     | 8,626 |  
|                                               | British pound    |                 |        | (1,949        | ) |                   |  | 0.69     |  |   |       | (16   | )
|                                               | Euro             |                 |        | (660          | ) |                   |  | 1.14     |  |   |       | 4     |  
|                                               | Singapore dollar |                 |        | (1,970        | ) |                   |  | 1.85     |  |   |       | 22    |  
|                                               | Taiwan dollar    |                 |        | (10,598       | ) |                   |  | 35.00    |  |   |       | 182   |  
|                                               | Korean won       |                 |        | (2,839        | ) |                   |  | 1,322.00 |  |   |       | 140   |  
|                                               |                  |                 |        |               |   |                   |  |          |  |   |       |       |  
|                                               |                  | $               | 54,914 |               |   |                   |  |          |  | $ | 8,958 |      
|                                               |                  |                 |        |               |   |                   |  |          |  |   |       |       |  

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOVELLUS SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)

|                                                                                                   |       |                                              |                                                                     |                              |         |                          |           |      |         |      |           |   |         |       |      | 
|-------------------------------------------------------------------------------------------------- | ----- | -------------------------------------------- | ------------------------------------------------------------------- | ---------------------------- | ------- | ------------------------ | --------- | ---- | ------- | ---- | --------- | - | ------- | ----- | ---- | 
|                                                                                                   |       |                                              |                                                                     |                              |         | Years Ended December 31,
|                                                                                                   |       |                                              |                                                                     |                              |         |                         
|                                                                                                   |       |                                              |                                                                     |                              |         | 2002                     |           | 2001 |         | 2000
|                                                                                                   |       |                                              |                                                                     |                              |         |                          |           |      |         |     
|Net sales                                                                                          |       | $                                            | 839,958                                                             |                              |         | $                        | 1,339,322 |      |         | $    | 1,319,486 |  
|Cost of sales                                                                                      |       |                                              | 461,435                                                             |                              |         |                          | 647,971   |      |         |      | 588,593   |  
|                                                                                                   |       |                                              |                                                                     |                              |         |                          |           |      |         |      |           |  
|Gross profit                                                                                       |       |                                              | 378,523                                                             |                              |         |                          | 691,351   |      |         |      | 730,893   |  
|Operating expenses:                                                                                |       |                                              |                                                                     |                              |         |                          |           |      |         |      |           |  
|                                                                                                   |       | Selling, general and administrative          |                                                                     |                              | 154,172 |                          |           |      | 198,567 |      |           |   | 232,749 |      
|                                                                                                   |       | Research and development                     |                                                                     |                              | 222,344 |                          |           |      | 272,032 |      |           |   | 198,310 |      
|                                                                                                   |       | Acquired in-process research and development |                                                                     |                              | 9,003   |                          |           |      |        |      |           |   | 6,000   |      
|                                                                                                   |       | Restructuring and other charges              |                                                                     |                              | 6,467   |                          |           |      | 61,106  |      |           |   |        |      
|                                                                                                   |       | Bad debt (recovery) write-off                |                                                                     |                              | (7,662  | )                        |           |      | 7,662   |      |           |   |        |      
|                                                                                                   |       |                                              |                                                                     |                              |         |                          |           |      |         |      |           |  
|Total operating expenses                                                                           |       |                                              | 384,324                                                             |                              |         |                          | 539,367   |      |         |      | 437,059   |  
|Operating (loss) income, net                                                                       |       |                                              | (5,801                                                              | )                            |         |                          | 151,984   |      |         |      | 293,834   |  
|Other income (expense):                                                                            |       |                                              |                                                                     |                              |         |                          |           |      |         |      |           |  
|                                                                                                   |       | Interest income                              |                                                                     |                              | 41,851  |                          |           |      | 64,297  |      |           |   | 58,755  |      
|                                                                                                   |       | Interest expense                             |                                                                     |                              | (1,020  | )                        |           |      | (1,146  | )    |           |   | (2,425  | )    
|                                                                                                   |       | Other, net                                   |                                                                     |                              | (12,110 | )                        |           |      | (5,758  | )    |           |   |        |      
|                                                                                                   |       |                                              |                                                                     |                              |         |                          |           |      |         |      |           |  
|Other income, net                                                                                  |       |                                              | 28,721                                                              |                              |         |                          | 57,393    |      |         |      | 56,330    |  
|                                                                                                   |       |                                              |                                                                     |                              |         |                          |           |      |         |      |           |  
|Income before provision for income taxes and
cumulative effect of a change in accounting principle |       |                                              | 22,920                                                              |                              |         |                          | 209,377   |      |         |      | 350,164   |  
|Provision for income taxes                                                                         |       |                                              |                                                                    |                              |         |                          | 64,907    |      |         |      | 110,996   |  
|                                                                                                   |       |                                              |                                                                     |                              |         |                          |           |      |         |      |           |  
|Income before cumulative effect of a change in
accounting principle                                |       |                                              | 22,920                                                              |                              |         |                          | 144,470   |      |         |      | 239,168   |  
|Cumulative effect of a change in accounting principle, net of tax                                  |       |                                              |                                                                    |                              |         |                          |          |      |         |      | (89,788   | )
|                                                                                                   |       |                                              |                                                                     |                              |         |                          |           |      |         |      |           |  
|Net income                                                                                         |       | $                                            | 22,920                                                              |                              |         | $                        | 144,470   |      |         | $    | 149,380   |  
|                                                                                                   |       |                                              |                                                                     |                              |         |                          |           |      |         |      |           |  
|Net income per share:                                                                              |       |                                              |                                                                     |                              |         |                          |           |      |         |      |           |  
|                                                                                                   | Basic |                                              |                                                                     |                              |         |                          |           |      |         |      |           |   |        
|                                                                                                   |       |                                              | Income before cumulative effect of a change
in accounting principle |                              | $       | 0.16                     |           |      | $       | 1.01 |           |   | $       | 1.76  |     
|                                                                                                   |       |                                              | Cumulative effect of a change in accounting principle               |                              |         |                         |           |      |         |     |           |   |         | (0.66 | )   
|                                                                                                   |       |                                              |                                                                     |                              |         |                          |           |      |         |      |           |  
|                                                                                                   |       |                                              |                                                                     | Basic net income per share   |         | $                        | 0.16      |      |         | $    | 1.01      |   |         | $     | 1.10 | 
|                                                                                                   |       |                                              |                                                                     |                              |         |                          |           |      |         |      |           |  
|                                                                                                   |       | Diluted                                      |                                                                     |                              |         |                          |           |      |         |      |           |   |         |      
|                                                                                                   |       |                                              | Income before cumulative effect of a change
in accounting principle |                              | $       | 0.15                     |           |      | $       | 0.97 |           |   | $       | 1.66  |     
|                                                                                                   |       |                                              | Cumulative effect of a change in accounting principle               |                              |         |                         |           |      |         |     |           |   |         | (0.62 | )   
|                                                                                                   |       |                                              |                                                                     |                              |         |                          |           |      |         |      |           |  
|                                                                                                   |       |                                              |                                                                     | Diluted net income per share |         | $                        | 0.15      |      |         | $    | 0.97      |   |         | $     | 1.04 | 
|                                                                                                   |       |                                              |                                                                     |                              |         |                          |           |      |         |      |           |  
|Shares used in basic per share calculations                                                        |       |                                              | 144,371                                                             |                              |         |                          | 142,462   |      |         |      | 135,728   |  
|                                                                                                   |       |                                              |                                                                     |                              |         |                          |           |      |         |      |           |  
|Shares used in diluted per share calculations                                                      |       |                                              | 148,748                                                             |                              |         |                          | 148,924   |      |         |      | 143,654   |  
|                                                                                                   |       |                                              |                                                                     |                              |         |                          |           |      |         |      |           |  

See accompanying Notes to the Consolidated Financial Statements.

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NOVELLUS SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)

|                                           |                                      |                                                                                                                              |                           |                      |           |              |           |      |           |           |           | 
|------------------------------------------ | ------------------------------------ | ---------------------------------------------------------------------------------------------------------------------------- | ------------------------- | -------------------- | --------- | ------------ | --------- | ---- | --------- | --------- | --------- | 
|                                           |                                      |                                                                                                                              |                           |                      |           | December 31,
|                                           |                                      |                                                                                                                              |                           |                      |           |             
|                                           |                                      |                                                                                                                              |                           |                      |           | 2002         |           | 2001
|                                           |                                      |                                                                                                                              |                           |                      |           |              |           |     
|ASSETS                                     |                                      |                                                                                                                              |                           |                      |           |              |           |     
|Current assets:                            |                                      |                                                                                                                              |                           |                      |           |              |           |     
|                                           |                                      | Cash and cash equivalents                                                                                                    |                           | $                    | 615,844   |              |           | $    | 550,640   |          
|                                           |                                      | Short-term investments                                                                                                       |                           |                      | 403,808   |              |           |      | 371,182   |          
|                                           |                                      | Restricted short-term investments                                                                                            |                           |                      |          |              |           |      | 961,643   |          
|                                           |                                      | Accounts receivable, net of allowance for doubtful accounts
of $7,339 in 2002 and $14,390 in 2001                            |                           |                      | 192,862   |              |           |      | 222,857   |          
|                                           |                                      | Inventories                                                                                                                  |                           |                      | 257,358   |              |           |      | 244,712   |          
|                                           |                                      | Deferred tax assets, net                                                                                                     |                           |                      | 119,699   |              |           |      | 84,421    |          
|                                           |                                      | Prepaid and other current assets                                                                                             |                           |                      | 44,363    |              |           |      | 81,049    |          
|                                           |                                      |                                                                                                                              |                           |                      |           |              |           |      |           |          
|                                           |                                      |                                                                                                                              |                           | Total current assets |           |              | 1,633,934 |      |           |           | 2,516,504 | 
|Property and equipment, net                |                                      |                                                                                                                              | 179,926                   |                      |           |              | 177,601   |     
|Notes receivable                           |                                      |                                                                                                                              | 397,429                   |                      |           |              | 244,673   |     
|Goodwill                                   |                                      |                                                                                                                              | 163,136                   |                      |           |              | 21,262    |     
|Intangible and other assets                |                                      |                                                                                                                              | 119,569                   |                      |           |              | 71,084    |     
|                                           |                                      |                                                                                                                              |                           |                      |           |              |           |      |           |          
|Total assets                               |                                      | $                                                                                                                            | 2,493,994                 |                      |           | $            | 3,031,124 |     
|                                           |                                      |                                                                                                                              |                           |                      |           |              |           |      |           |          
|                                           | LIABILITIES AND SHAREHOLDERS EQUITY |                                                                                                                              |                           |                      |           |              |           |      |          
|Current liabilities:                       |                                      |                                                                                                                              |                           |                      |           |              |           |     
|                                           |                                      | Accounts payable                                                                                                             |                           | $                    | 71,218    |              |           | $    | 67,317    |          
|                                           |                                      | Accrued payroll and related expenses                                                                                         |                           |                      | 36,748    |              |           |      | 34,211    |          
|                                           |                                      | Accrued warranty                                                                                                             |                           |                      | 31,002    |              |           |      | 43,337    |          
|                                           |                                      | Other accrued liabilities                                                                                                    |                           |                      | 56,522    |              |           |      | 40,194    |          
|                                           |                                      | Income taxes payable                                                                                                         |                           |                      | 14,070    |              |           |      | 5,870     |          
|                                           |                                      | Deferred profit                                                                                                              |                           |                      | 55,613    |              |           |      | 40,835    |          
|                                           |                                      | Current obligations under lines of credit                                                                                    |                           |                      |          |              |           |      | 26,179    |          
|                                           |                                      | Convertible subordinated debentures                                                                                          |                           |                      | 116,437   |              |           |      | 862,659   |          
|                                           |                                      |                                                                                                                              |                           |                      |           |              |           |      |           |          
|                                           |                                      |                                                                                                                              | Total current liabilities |                      |           | 381,610      |           |      |           | 1,120,602 |          
|Deferred income tax liabilities            |                                      |                                                                                                                              | 19,502                    |                      |           |              | 21,462    |     
|Other liabilities                          |                                      |                                                                                                                              | 37,194                    |                      |           |              | 17,066    |     
|                                           |                                      |                                                                                                                              |                           |                      |           |              |           |      |           |          
|Total liabilities                          |                                      |                                                                                                                              | 438,306                   |                      |           |              | 1,159,130 |     
|                                           |                                      |                                                                                                                              |                           |                      |           |              |           |      |           |          
|Commitments and contingencies              |                                      |                                                                                                                              |                           |                      |           |              |           |     
|Shareholders equity:                      |                                      |                                                                                                                              |                           |                      |           |              |           |     
|                                           |                                      | Preferred stock, no par value; authorized shares - 10,000;
issued and outstanding shares -  none                             |                           |                      |          |              |           |      |          |          
|                                           |                                      | Common stock, no par value; authorized shares - 240,000; issued and
outstanding shares - 149,119 in 2002 and 143,606 in 2001 |                           |                      | 1,487,281 |              |           |      | 1,273,201 |          
|                                           |                                      | Retained earnings                                                                                                            |                           |                      | 570,153   |              |           |      | 597,267   |          
|                                           |                                      | Accumulated other comprehensive (loss) income                                                                                |                           |                      | (1,746    | )            |           |      | 1,526     |          
|                                           |                                      |                                                                                                                              |                           |                      |           |              |           |      |           |          
|Total shareholders equity                 |                                      |                                                                                                                              | 2,055,688                 |                      |           |              | 1,871,994 |     
|                                           |                                      |                                                                                                                              |                           |                      |           |              |           |      |           |          
|Total liabilities and shareholders equity |                                      | $                                                                                                                            | 2,493,994                 |                      |           | $            | 3,031,124 |     
|                                           |                                      |                                                                                                                              |                           |                      |           |              |           |      |           |          

See accompanying Notes to the Consolidated Financial Statements.

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NOVELLUS SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

|                                                               |                                                                                   |                                                                                                                         |                                                                           |                                      |         |                          |            |      |        |        |            |   |        |        |          |  
|-------------------------------------------------------------- | --------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------- | ------------------------------------ | ------- | ------------------------ | ---------- | ---- | ------ | ------ | ---------- | - | ------ | ------ | -------- | -
|                                                               |                                                                                   |                                                                                                                         |                                                                           |                                      |         | Years Ended December 31,
|                                                               |                                                                                   |                                                                                                                         |                                                                           |                                      |         |                         
|                                                               |                                                                                   |                                                                                                                         |                                                                           |                                      |         | 2002                     |            | 2001 |        | 2000  
|                                                               |                                                                                   |                                                                                                                         |                                                                           |                                      |         |                          |            |      |        |       
|Cash flows from operating activities:                          |                                                                                   |                                                                                                                         |                                                                           |                                      |         |                          |            |      |        |        |            |  
|Net income                                                     |                                                                                   | $                                                                                                                       | 22,920                                                                    |                                      |         | $                        | 144,470    |      |        | $      | 149,380    |  
|                                                               | Adjustments to reconcile net income to net cash
provided by operating activities: |                                                                                                                         |                                                                           |                                      |         |                          |            |      |        |        |            |   |       
|                                                               |                                                                                   |                                                                                                                         | Write-off of debt issuance costs                                          |                                      |         | 17,047                   |            |      |        |       |            |   |        |       |         
|                                                               |                                                                                   |                                                                                                                         | (Gain) loss on sale/impairment of equity investments                      |                                      |         | (4,602                   | )          |      |        | 8,556  |            |   |        |       |         
|                                                               |                                                                                   |                                                                                                                         | Non-cash portion of restructuring and other charges                       |                                      |         |                         |            |      |        | 25,501 |            |   |        |       |         
|                                                               |                                                                                   |                                                                                                                         | Bad debt (recovery) write-off                                             |                                      |         | (7,662                   | )          |      |        | 7,662  |            |   |        |       |         
|                                                               |                                                                                   |                                                                                                                         | Adjustment to conform fiscal year end of GaSonics                         |                                      |         |                         |            |      |        | 1,714  |            |   |        |       |         
|                                                               |                                                                                   |                                                                                                                         | Depreciation and amortization                                             |                                      |         | 44,310                   |            |      |        | 51,934 |            |   |        | 46,951 |         
|                                                               |                                                                                   |                                                                                                                         | Amortization of deferred compensation                                     |                                      |         | 1,626                    |            |      |        | 1,451  |            |   |        | 1,780  |         
|                                                               |                                                                                   |                                                                                                                         | Cumulative effect of a change in accounting principle, net of tax
benefit |                                      |         |                         |            |      |        |       |            |   |        | 89,788 |         
|                                                               |                                                                                   |                                                                                                                         | Acquired in-process research and development                              |                                      |         | 9,003                    |            |      |        |       |            |   |        | 6,000  |         
|                                                               |                                                                                   |                                                                                                                         | Income tax benefits from employee stock plans                             |                                      |         | 19,427                   |            |      |        | 25,037 |            |   |        | 40,247 |         
|                                                               |                                                                                   |                                                                                                                         | Changes in operating assets and liabilities:                              |                                      |         |                          |            |      |        |        |            |   |        |        |         
|                                                               |                                                                                   |                                                                                                                         |                                                                           | Accounts receivable                  |         |                          | 58,341     |      |        |        | 167,713    |   |        |        | (168,627 | )
|                                                               |                                                                                   |                                                                                                                         |                                                                           | Inventories                          |         |                          | 19,912     |      |        |        | (50,079    | ) |        |        | (85,287  | )
|                                                               |                                                                                   |                                                                                                                         |                                                                           | Prepaid and other current assets     |         |                          | 42,706     |      |        |        | (66,511    | ) |        |        | (5,755   | )
|                                                               |                                                                                   |                                                                                                                         |                                                                           | Deferred income taxes                |         |                          | 3,346      |      |        |        | 55,860     |   |        |        | (41,378  | )
|                                                               |                                                                                   |                                                                                                                         |                                                                           | Accounts payable                     |         |                          | (4,021     | )    |        |        | (55,706    | ) |        |        | 73,894   |  
|                                                               |                                                                                   |                                                                                                                         |                                                                           | Accrued payroll and related expenses |         |                          | (2,809     | )    |        |        | (36,000    | ) |        |        | 46,250   |  
|                                                               |                                                                                   |                                                                                                                         |                                                                           | Accrued warranty                     |         |                          | (13,599    | )    |        |        | (8,006     | ) |        |        | 29,008   |  
|                                                               |                                                                                   |                                                                                                                         |                                                                           | Other accrued liabilities            |         |                          | (11,995    | )    |        |        | 11,073     |   |        |        | 12,437   |  
|                                                               |                                                                                   |                                                                                                                         |                                                                           | Income taxes payable                 |         |                          | 6,186      |      |        |        | (54,502    | ) |        |        | 40,433   |  
|                                                               |                                                                                   |                                                                                                                         |                                                                           | Deferred profit                      |         |                          | 14,778     |      |        |        | (153,078   | ) |        |        | 55,777   |  
|                                                               |                                                                                   |                                                                                                                         |                                                                           |                                      |         |                          |            |      |        |        |            |  
|Net cash provided by operating activities                      |                                                                                   |                                                                                                                         | 214,914                                                                   |                                      |         |                          | 77,089     |      |        |        | 290,898    |  
|                                                               |                                                                                   |                                                                                                                         |                                                                           |                                      |         |                          |            |      |        |        |            |  
|Cash flows from investing activities:                          |                                                                                   |                                                                                                                         |                                                                           |                                      |         |                          |            |      |        |        |            |  
|Purchases of short-term investments                            |                                                                                   |                                                                                                                         | (2,028,463                                                                | )                                    |         |                          | (2,293,771 | )    |        |        | (1,268,238 | )
|Proceeds from sales and maturities of short-term investments   |                                                                                   |                                                                                                                         | 2,956,991                                                                 |                                      |         |                          | 1,599,183  |      |        |        | 842,386    |  
|Capital expenditures                                           |                                                                                   |                                                                                                                         | (26,776                                                                   | )                                    |         |                          | (79,965    | )    |        |        | (77,704    | )
|Decrease (increase) in intangible and other assets             |                                                                                   |                                                                                                                         | 9,407                                                                     |                                      |         |                          | (7,443     | )    |        |        | 3,092      |  
|Increase in synthetic lease collateral                         |                                                                                   |                                                                                                                         | (177,458                                                                  | )                                    |         |                          | (244,673   | )    |        |        |           |  
|Cash acquired from SpeedFam-IPEC acquisition, net              |                                                                                   |                                                                                                                         | 43,462                                                                    |                                      |         |                          |           |      |        |        |           |  
|Cash used in Gamma Precision Technology acquisition, net       |                                                                                   |                                                                                                                         |                                                                          |                                      |         |                          |           |      |        |        | (18,454    | )
|                                                               |                                                                                   |                                                                                                                         |                                                                           |                                      |         |                          |            |      |        |        |            |  
|Net cash provided by (used in) investing activities            |                                                                                   |                                                                                                                         | 777,163                                                                   |                                      |         |                          | (1,026,669 | )    |        |        | (518,918   | )
|                                                               |                                                                                   |                                                                                                                         |                                                                           |                                      |         |                          |            |      |        |        |            |  
|Cash flows from financing activities:                          |                                                                                   |                                                                                                                         |                                                                           |                                      |         |                          |            |      |        |        |            |  
|Proceeds (repayments) from convertible subordinated debentures |                                                                                   |                                                                                                                         | (879,750                                                                  | )                                    |         |                          | 862,400    |      |        |        |           |  
|Proceeds from employee stock compensation plans                |                                                                                   |                                                                                                                         | 54,434                                                                    |                                      |         |                          | 45,469     |      |        |        | 42,008     |  
|Proceeds (repayments) from lines of credit, net                |                                                                                   |                                                                                                                         | (23,380                                                                   | )                                    |         |                          | 4,577      |      |        |        | 5,249      |  
|Repurchases of common stock                                    |                                                                                   |                                                                                                                         | (78,177                                                                   | )                                    |         |                          | (1,641     | )    |        |        | (1,158     | )
|Proceeds from common stock offering, net                       |                                                                                   |                                                                                                                         |                                                                          |                                      |         |                          |           |      |        |        | 572,910    |  
|                                                               |                                                                                   |                                                                                                                         |                                                                           |                                      |         |                          |            |      |        |        |            |  
|Net cash provided by (used in) financing activities            |                                                                                   |                                                                                                                         | (926,873                                                                  | )                                    |         |                          | 910,805    |      |        |        | 619,009    |  
|                                                               |                                                                                   |                                                                                                                         |                                                                           |                                      |         |                          |            |      |        |        |            |  
|Net increase (decrease) in cash and cash equivalents           |                                                                                   |                                                                                                                         | 65,204                                                                    |                                      |         |                          | (38,775    | )    |        |        | 390,989    |  
|Cash and cash equivalents at the beginning of the year         |                                                                                   |                                                                                                                         | 550,640                                                                   |                                      |         |                          | 589,415    |      |        |        | 198,426    |  
|                                                               |                                                                                   |                                                                                                                         |                                                                           |                                      |         |                          |            |      |        |        |            |  
|Cash and cash equivalents at the end of the year               |                                                                                   | $                                                                                                                       | 615,844                                                                   |                                      |         | $                        | 550,640    |      |        | $      | 589,415    |  
|                                                               |                                                                                   |                                                                                                                         |                                                                           |                                      |         |                          |            |      |        |        |            |  
|Supplemental disclosures:                                      |                                                                                   |                                                                                                                         |                                                                           |                                      |         |                          |            |      |        |        |            |  
|                                                               | Cash
paid (received) during the year for:                                         |                                                                                                                         |                                                                           |                                      |         |                          |            |      |        |        |            |   |       
|                                                               |                                                                                   | Interest                                                                                                                |                                                                           | $                                    | 204     |                          |            | $    | 1,146  |        |            | $ | 2,425  |       
|                                                               |                                                                                   | Income taxes                                                                                                            |                                                                           | $                                    | (63,329 | )                        |            | $    | 63,201 |        |            | $ | 69,221 |       
|                                                               | Non-cash financing activities:                                                    |                                                                                                                         |                                                                           |                                      |         |                          |            |      |        |        |            |   |       
|                                                               |                                                                                   | Issuance of common stock and stock options related to SpeedFam-IPEC
acquisition, net of deferred compensation of $3,104 |                                                                           | $                                    | 166,736 |                          |            | $    |       |        |            | $ |       |       
|                                                               |                                                                                   | Subordinated debt assumed from SpeedFam-IPEC acquisition                                                                |                                                                           | $                                    | 116,437 |                          |            | $    |       |        |            | $ |       |       
|                                                               |                                                                                   | Issuance of GaSonics common stock related to GPT acquisition                                                           |                                                                           | $                                    |        |                          |            | $    |       |        |            | $ | 12,679 |       

See accompanying Notes to the Consolidated Financial Statements.

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##### Table of Contents



NOVELLUS SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
(in thousands)



|                             |                                                                                                              |                                                                  |                      |        |              |   |           |         |                               |   |                    |         |         |   |         |   |         |   |           |         |         |         | 
|---------------------------- | ------------------------------------------------------------------------------------------------------------ | ---------------------------------------------------------------- | -------------------- | ------ | ------------ | - | --------- | ------- | ----------------------------- | - | ------------------ | ------- | ------- | - | ------- | - | ------- | - | --------- | ------- | ------- | ------- | 
|                             |                                                                                                              |                                                                  |                      |        | Common Stock |   | Retained  |         | AccumulatedOtherComprehensive |   | TotalShareholders
|                             |                                                                                                              |                                                                  |                      |        | Shares       |   | Amount    |         | Earnings                      |   | (Loss) Income      |         | Equity 
|                             |                                                                                                              |                                                                  |                      |        |              |   |           |         |                               |   |                    |         |        
|Balance at December 31, 1999 |                                                                                                              |                                                                  | 126,543              |        |              | $ | 531,224   |         |                               | $ | 304,898            |         |         | $ | 1,415   |   |         | $ | 837,537   |        
|                             | Components of comprehensive income:                                                                          |                                                                  |                      |        |              |   |           |         |                               |   |                    |         |         |   |         |   |         |   |           |         |        
|                             |                                                                                                              | Net income                                                       |                      |        |             |   |           |         |                              |   |                    |         | 149,380 |   |         |   |        |   |           |         | 149,380 |        
|                             |                                                                                                              | Net change in unrealized losses on available-for-sale securities |                      |        |             |   |           |         |                              |   |                    |         |        |   |         |   | (10,191 | ) |           |         | (10,191 | )      
|                             |                                                                                                              | Foreign currency translation adjustments                         |                      |        |             |   |           |         |                              |   |                    |         |        |   |         |   | (3,717  | ) |           |         | (3,717  | )      
|                             |                                                                                                              |                                                                  |                      |        |              |   |           |         |                               |   |                    |         |         |   |         |   |         |   |           |        
|                             |                                                                                                              |                                                                  | Comprehensive income |        |              |   |           |         |                               |   |                    |         |         |   |         |   |         |   |           |         |         | 135,472 | 
|                             |                                                                                                              |                                                                  |                      |        |              |   |           |         |                               |   |                    |         |         |   |         |   |         |   |           |        
|                             | Proceeds from common stock offering, net                                                                     |                                                                  |                      | 10,089 |              |   |           | 572,910 |                               |   |                    |        |         |   |         |  |         |   |           | 572,910 |        
|                             | Issuance of common stock under employee compensation plans                                                   |                                                                  |                      | 3,441  |              |   |           | 42,008  |                               |   |                    |        |         |   |         |  |         |   |           | 42,008  |        
|                             | Issuance of restricted common stock                                                                          |                                                                  |                      | 219    |              |   |           |        |                               |   |                    |        |         |   |         |  |         |   |           |        |        
|                             | Acquisition of Gamma Precision Technology                                                                    |                                                                  |                      | 341    |              |   |           | 12,679  |                               |   |                    |        |         |   |         |  |         |   |           | 12,679  |        
|                             | Amortization of deferred compensation, net of
cancellations of restricted common stock                       |                                                                  |                      | (12    | )            |   |           | 1,780   |                               |   |                    |        |         |   |         |  |         |   |           | 1,780   |        
|                             | Income tax benefits realized from activity in employee stock plans                                           |                                                                  |                      |       |              |   |           | 40,247  |                               |   |                    |        |         |   |         |  |         |   |           | 40,247  |        
|                             | Repurchases of common stock                                                                                  |                                                                  |                      | (20    | )            |   |           | (130    | )                             |   |                    | (1,028  | )       |   |         |  |         |   |           | (1,158  | )      
|                             |                                                                                                              |                                                                  |                      |        |              |   |           |         |                               |   |                    |         |         |   |         |   |         |   |           |        
|Balance at December 31, 2000 |                                                                                                              |                                                                  | 140,601              |        |              |   | 1,200,718 |         |                               |   | 453,250            |         |         |   | (12,493 | ) |         |   | 1,641,475 |        
|                             | Components of comprehensive income:                                                                          |                                                                  |                      |        |              |   |           |         |                               |   |                    |         |         |   |         |   |         |   |           |         |        
|                             |                                                                                                              | Net income                                                       |                      |        |             |   |           |         |                              |   |                    |         | 144,470 |   |         |   |        |   |           |         | 144,470 |        
|                             |                                                                                                              | Net change in unrealized gains on available-for-sale securities  |                      |        |             |   |           |         |                              |   |                    |         |        |   |         |   | 7,988   |   |           |         | 7,988   |        
|                             |                                                                                                              | Foreign currency translation adjustments                         |                      |        |             |   |           |         |                              |   |                    |         |        |   |         |   | 127     |   |           |         | 127     |        
|                             |                                                                                                              | Other than temporary loss included in net income, net of tax     |                      |        |             |   |           |         |                              |   |                    |         |        |   |         |   | 5,904   |   |           |         | 5,904   |        
|                             |                                                                                                              |                                                                  |                      |        |              |   |           |         |                               |   |                    |         |         |   |         |   |         |   |           |        
|                             |                                                                                                              |                                                                  | Comprehensive income |        |              |   |           |         |                               |   |                    |         |         |   |         |   |         |   |           |         |         | 158,489 | 
|                             |                                                                                                              |                                                                  |                      |        |              |   |           |         |                               |   |                    |         |         |   |         |   |         |   |           |        
|                             | Issuance of common stock under employee compensation plans                                                   |                                                                  |                      | 2,954  |              |   |           | 45,469  |                               |   |                    |        |         |   |         |  |         |   |           | 45,469  |        
|                             | Adjustment to conform fiscal year end of GaSonics                                                            |                                                                  |                      | 57     |              |   |           | 851     |                               |   |                    | 863     |         |   |         |  |         |   |           | 1,714   |        
|                             | Issuance of restricted common stock                                                                          |                                                                  |                      | 31     |              |   |           |        |                               |   |                    |        |         |   |         |  |         |   |           |        |        
|                             | Amortization of deferred compensation                                                                        |                                                                  |                      |       |              |   |           | 1,451   |                               |   |                    |        |         |   |         |  |         |   |           | 1,451   |        
|                             | Income tax benefits realized from activity in employee stock plans                                           |                                                                  |                      |       |              |   |           | 25,037  |                               |   |                    |        |         |   |         |  |         |   |           | 25,037  |        
|                             | Repurchases of common stock                                                                                  |                                                                  |                      | (37    | )            |   |           | (325    | )                             |   |                    | (1,316  | )       |   |         |  |         |   |           | (1,641  | )      
|                             |                                                                                                              |                                                                  |                      |        |              |   |           |         |                               |   |                    |         |         |   |         |   |         |   |           |        
|Balance at December 31, 2001 |                                                                                                              |                                                                  | 143,606              |        |              |   | 1,273,201 |         |                               |   | 597,267            |         |         |   | 1,526   |   |         |   | 1,871,994 |        
|                             | Components of comprehensive income:                                                                          |                                                                  |                      |        |              |   |           |         |                               |   |                    |         |         |   |         |   |         |   |           |         |        
|                             |                                                                                                              | Net income                                                       |                      |        |             |   |           |         |                              |   |                    |         | 22,920  |   |         |   |        |   |           |         | 22,920  |        
|                             |                                                                                                              | Net change in unrealized losses on available-for-sale securities |                      |        |             |   |           |         |                              |   |                    |         |        |   |         |   | (350    | ) |           |         | (350    | )      
|                             |                                                                                                              | Foreign currency translation adjustments                         |                      |        |             |   |           |         |                              |   |                    |         |        |   |         |   | 714     |   |           |         | 714     |        
|                             |                                                                                                              | Gain on sale of an equity investment, net of tax                 |                      |        |             |   |           |         |                              |   |                    |         |        |   |         |   | (3,636  | ) |           |         | (3,636  | )      
|                             |                                                                                                              |                                                                  |                      |        |              |   |           |         |                               |   |                    |         |         |   |         |   |         |   |           |        
|                             |                                                                                                              |                                                                  | Comprehensive income |        |              |   |           |         |                               |   |                    |         |         |   |         |   |         |   |           |         |         | 19,648  | 
|                             |                                                                                                              |                                                                  |                      |        |              |   |           |         |                               |   |                    |         |         |   |         |   |         |   |           |        
|                             | Issuance of common stock under employee compensation plans                                                   |                                                                  |                      | 2,870  |              |   |           | 54,434  |                               |   |                    |        |         |   |         |  |         |   |           | 54,434  |        
|                             | Issuance of common stock and assumption of stock options in connection with the acquisition of
SpeedFam-IPEC |                                                                  |                      | 5,733  |              |   |           | 166,736 |                               |   |                    |        |         |   |         |  |         |   |           | 166,736 |        
|                             | Issuance of restricted common stock                                                                          |                                                                  |                      | 100    |              |   |           |        |                               |   |                    |        |         |   |         |  |         |   |           |        |        
|                             | Amortization of deferred compensation                                                                        |                                                                  |                      |       |              |   |           | 1,626   |                               |   |                    |        |         |   |         |  |         |   |           | 1,626   |        
|                             | Income tax benefits realized from activity in employee
stock plans                                           |                                                                  |                      |       |              |   |           | 19,427  |                               |   |                    |        |         |   |         |  |         |   |           | 19,427  |        
|                             | Repurchases of common stock                                                                                  |                                                                  |                      | (3,190 | )            |   |           | (28,143 | )                             |   |                    | (50,034 | )       |   |         |  |         |   |           | (78,177 | )      
|                             |                                                                                                              |                                                                  |                      |        |              |   |           |         |                               |   |                    |         |         |   |         |   |         |   |           |        
|Balance at December 31, 2002 |                                                                                                              |                                                                  | 149,119              |        |              | $ | 1,487,281 |         |                               | $ | 570,153            |         |         | $ | (1,746  | ) |         | $ | 2,055,688 |        
|                             |                                                                                                              |                                                                  |                      |        |              |   |           |         |                               |   |                    |         |         |   |         |   |         |   |           |        

See accompanying Notes to the Consolidated Financial Statements.

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NOVELLUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 DESCRIPTION OF THE BUSINESS

Novellus Systems, Inc. is a supplier of semiconductor manufacturing equipment
used in the fabrication of integrated circuits. We are focused on delivering
innovative interconnect products and technologies that meet the increasingly
complex and demanding needs of the worlds largest semiconductor manufacturers.
The semiconductor manufacturing equipment that we build, market and service
provides todays chipmakers with high productivity and low cost
of ownership.

As part of our growth strategy from time to time we
make acquisitions. On January 10, 2001, we acquired GaSonics International Corporation, a
developer and supplier of photoresist and residue removal technologies in a
pooling-of-interests transaction. Our consolidated financial statements for
fiscal 2000 have been restated to include the financial position, results of
operations and cash flows of GaSonics. Because of differing year ends,
financial information relating to our fiscal year ended December 31, 2000 has
been combined with financial information relating to GaSonics fiscal year
ended September 30, 2000. GaSonics net income for the three months ended
December 31, 2000 was not combined with our net income, but rather was included
as an adjustment to shareholders equity. Revenue and net income of GaSonics
for the three-month period ended December 31, 2000, which is excluded from the
accompanying consolidated statements of operations, were $47.7 million and $0.9
million, respectively. There were no transactions between GaSonics and Novellus
prior to the combination.

On December 6, 2002, we acquired SpeedFam-IPEC, Inc., a global supplier of
chemical mechanical planarization (CMP) systems used in the fabrication of
advanced copper interconnects. The acquisition was accounted for as a purchase
business combination and qualifies as a tax-free reorganization under IRS
regulations. Our consolidated financial statements for fiscal 2002 include the
financial position, results of operations and cash flows of SpeedFam-IPEC from
December 6, 2002.

NOTE 2 SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation -The accompanying consolidated financial statements
include our accounts and the accounts of our wholly-owned subsidiaries after
elimination of all significant intercompany account balances and transactions.
Certain prior year amounts in the consolidated financial statements and the
notes thereto have been reclassified to conform to the 2002 presentation.

Use of Estimates -The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses and the related disclosure of
contingent assets and liabilities. We evaluate our estimates on an ongoing
basis, including those related to revenue recognition, cash and investments,
allowance for doubtful accounts, inventory valuation, deferred tax assets,
property and equipment, goodwill and other intangible assets, warranty
obligations, restructuring and impairment charges, contingencies and litigation and stock-based
compensation. We base our estimates on historical experience and on various
other assumptions that are believed to be reasonable under the current
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent
from other sources. Our intent is to accurately state our assets
given facts known at the time of valuation. Our assumptions may prove
incorrect as facts change in the future. Actual results may differ from these estimates under
different assumptions or conditions.

Revenue Recognition - We recognize revenue in accordance with SEC Staff
Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, or
SAB 101, and SAB 101: Revenue Recognition in Financial Statements-Frequently
Asked Questions and Answers, or SAB 101 FAQ. We recognize revenue when
persuasive evidence of an arrangement exists, delivery has occurred or services
have been rendered, the sellers price is fixed or determinable and
collectibility is reasonably assured.

Certain of our product sales are accounted for as multiple-element
arrangements. A multiple-element arrangement is a transaction which
may involve the delivery or performance of multiple products,
services, or rights to use assets, and performance may occur at
different points in time or over different periods of time. If we have met defined customer acceptance experience levels with
both the customer and the specific type of equipment, then we recognize
equipment revenue upon shipment and transfer of title, with the remainder
generally recognized at the later of completion of the installation services or
customer acceptance.

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Installation services are not essential to the functionality of the delivered
equipment. We allocate revenue based on the residual method, as a fair value
has been established for installation services. However, since the final
payment is not typically due until customer acceptance, we defer revenue for
the final payment, which is in excess of the fair value of the installation
services. All other equipment sales are recognized upon customer acceptance.

Revenue related to spare part sales is recognized upon shipment. Revenue
related to maintenance and service contracts is recognized ratably over the
duration of the contracts. Unearned maintenance and service contract revenue is
not significant and is included in other accrued liabilities.

In accordance with guidance provided in SAB 101 and SAB 101 FAQ, Novellus
recorded a non-cash charge of $89.8 million, net of income tax of $48.6
million, or $0.62 per diluted share, to reflect the cumulative effect of the
change in accounting principle as of the beginning of fiscal year 2000. The
decrease to net income before the cumulative effect of the change in accounting
principle as a result of the adoption was $98.1 million or $0.68 per diluted
share for fiscal year 2000.

Cash, Cash Equivalents and Short-Term Investments -We consider all highly
liquid debt instruments with insignificant interest rate risk and original
maturities of ninety days or less to be cash equivalents. Investments with
original maturities greater than three months and that mature within one year
from the balance sheet date are considered to be short-term investments. Our
short-term investments are classified as available-for-sale and are reported at
fair value, with unrealized gains and losses, net of tax, recorded in
shareholders equity. The fair value of short-term investments is based on
quoted market prices. Realized gains and losses and declines in fair value
that are other than temporary are recorded in earnings when realized. The cost
of securities sold is based on the specific identification method.

Allowance for Doubtful Accounts -We evaluate our
allowance for doubtful accounts based on a combination of factors. In
circumstances where we are aware of a specific customers inability to meet its
financial obligations, we provide a specific allowance for bad debt against the
amount due to reduce the net recognized receivable to the amount we reasonably
believe will be collected. For all other customers, we recognize an allowance
for doubtful accounts based on a certain percentage of total revenues, which
is based on our historical experience over the past five years. If
circumstances change (e.g. higher than expected defaults or an unexpected
material adverse change in a major customers ability to meet its financial
obligations), we may amend our estimates of the recoverability of the
outstanding balance.

Inventories and Inventory Valuation- Inventories are stated at the lower of
cost (first-in, first-out) or market. We assess the recoverability of all
inventories, including raw materials, work-in-process, finished goods and spare
parts to determine whether adjustments for impairment are necessary. Inventory
that is obsolete or in excess of our forecasted usage is written down to our
estimated market value based on assumptions about future demand and market
conditions. Due to the fast moving technology used in our business
actual demand can differ materially from forecasted demand. If actual demand is lower than our forecast, additional inventory
write-downs may be required.

Deferred Tax Assets- We record a valuation allowance to reduce our deferred
tax assets to the amount that is more likely than not to be realized. Our
valuation allowance was recorded as an increase to goodwill in connection with
acquired net operating loss carryforwards, which are not realizable until 2009
and beyond. We have considered future taxable income and ongoing prudent and
feasible tax planning strategies in assessing the need for the valuation
allowance. Should the existing deferred tax asset, which is currently offset by
the valuation allowance, be realized, the benefit of such realization and the
related reversal of the valuation allowance would result in a reduction of
goodwill. If we determine that we would not be able to realize all or part of
our net deferred tax assets in the future, an adjustment to the deferred tax
assets would decrease income in the period such determination was made.

Property and Equipment -Property and equipment are stated at cost.
Depreciation and amortization are provided mainly on the straight-line method
over the following estimated useful lives:

|                        |  |                                                |  | 
|----------------------- |  | ---------------------------------------------- |  | 
|Machinery and equipment |  | 2  7 years                                   
|Furniture and fixtures  |  | 3  5 years                                   
|Buildings               |  | 30  40 years                                 
|Leasehold improvements  |  | Shorter of useful life or remaining lease term

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Goodwill and Other Intangible Assets- Effective January 1, 2002, we adopted
Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets, or SFAS No. 142. SFAS No. 142 requires that goodwill and
identifiable intangible assets with indefinite useful lives no longer be
amortized, but instead be tested for impairment at least annually. SFAS No. 142
also requires that intangible assets with estimable useful lives be amortized
over their respective estimated useful lives to their estimated residual
values, and reviewed for impairment in accordance with SFAS No. 121, as
superseded by SFAS No. 144. Furthermore, SFAS No. 142 includes provisions on
the identification of intangible assets, reclassification of certain
intangibles from previously reported goodwill, and reassessment of the useful
lives of existing intangible assets. Upon adoption, we reassessed the useful
lives and residual values of all acquired identifiable intangible assets to
identify any necessary amortization period adjustments and to determine whether
other intangible assets should be reclassified from goodwill. Based on that
assessment, no adjustments were made to the amortization period or residual
values of identifiable intangible assets.

We review our long-lived assets, including goodwill and intangible assets, for
impairment at least annually or whenever events or changes in circumstances
indicate that the carrying amount of these assets may not be recoverable. For
further discussion, see Note 6 to the Consolidated Financial Statements.

Warranty- Our warranty policy generally states that we will provide warranty
coverage for a predetermined amount of time on systems and modules for material
and labor to repair and service the equipment. We record the estimated cost of
warranty coverage to cost of sales upon system shipment. The estimated cost of
warranty is determined by the warranty term as well as the average historical
labor and material costs for a specific product. Should actual product failure
rates or material usage differ from our estimates, revisions to the estimated
warranty liability may be required. These revisions could have a
positive or negative impact on gross profit. We review the actual product
failure rates and material usage rates on a quarterly basis and adjust our
warranty liability as necessary.

Restructuring and Impairment
Charges- We account for restructuring in accordance with Emerging Issues
Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring), EITF Issue No. 95-3, Recognition of Liabilities
in Connection with a Purchase Business Combination and SAB No. 100, Restructuring and Impairment Charges. In accordance with
this guidance, restructuring accruals are recorded when management initiates an
exit plan that will cause us to incur costs that have no future economic
benefit. Also under the terms of EITF No. 94-3, a liability for the
restructuring charges are recognized in the period management approves the
restructuring plan. Additionally, certain restructuring charges related to
asset impairments are recorded in accordance with SFAS No. 144.

Contingencies and Litigation -We assess the probability of adverse judgments
in connection with current and threatened litigation. We would accrue the cost
of an adverse judgment if, in our estimation, the adverse outcome is probable
and we can reasonably estimate the ultimate cost. We have made no such accruals
as of December 31, 2002.

Foreign Currency Translation -For all of our foreign subsidiaries, the local
currency is the functional currency. Accordingly, translation gains or losses
related to these foreign subsidiaries are included as a component of
accumulated other comprehensive income (loss).

Forward Foreign Exchange Contracts -Forward foreign exchange contracts are
used to hedge against the short-term impact of foreign currency fluctuations on
intercompany accounts payable denominated in U.S. dollars recorded by our
Japanese subsidiary. We also enter into forward foreign exchange contracts to
buy and sell foreign currencies to hedge the parents intercompany balances
denominated in a currency other than the U.S. dollar. In 2002 and 2001, these
hedging contracts were denominated primarily in the Japanese yen and the
Taiwanese dollar. The forward foreign exchange contracts we use are generally
short-term in nature. The effect of exchange rate changes on forward exchange
contracts is expected to offset the effect of exchange rate changes on the
underlying hedged items. We believe these financial instruments do not subject
us to speculative risk that would otherwise result from changes in currency
exchange rates. All unsettled foreign currency contracts are marked-to-market,
with unrealized gains and losses included as a component of other income and
expense. Net foreign currency gains and losses have not been material to the
results of operations.

Advertising Expenses -We expense advertising costs as incurred. Advertising
expenses for 2002, 2001 and 2000 were $2.7 million, $4.7 million and $9.5
million, respectively.

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Employee Stock Plans -We account for stock-based employee compensation in
accordance with SFAS No. 123, Accounting for Stock-Based Compensation,
whereby stock-based employee compensation arrangements are accounted for under
the intrinsic value method prescribed by the Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees. We provide pro
forma disclosures of net income and earning per share as if the fair value
method prescribed by SFAS No. 123 had been applied in measuring employee
compensation expense. In December 2002, the FASB issued SFAS
No. 148, which provides alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation.
SFAS No. 148 also requires that disclosures of the pro forma effect of using
the fair value method of accounting for stock-based employee compensation be
displayed more prominently and in a tabular format. Additionally, SFAS No. 148
requires disclosure of the pro forma effect in interim financial statements
effective for the first quarter of 2003. SFAS No. 148s amendment of the
transition and annual disclosure requirements of SFAS No. 123 are effective for
fiscal years ending after December 15, 2002. For further discussion, see Note
14 to the Consolidated Financial Statements.

Concentration of Credit and Other Risks -We use financial instruments that
potentially subject us to concentrations of credit risk. Such instruments
include cash equivalents, short-term investments, accounts receivable and
financial instruments used in hedging activities. We invest our cash in cash
deposits, money market funds, commercial paper, certificates of deposit,
readily marketable debt securities, or medium-term notes. We place our
investments with highcredit quality financial institutions, which limits the
credit exposure from any one financial institution or instrument. To date, we
have not experienced significant losses on these investments. We sell a
significant portion of our systems to a limited number of customers. Sales to
our ten largest customers in 2002, 2001 and 2000 accounted for 79%, 61% and 71%
of net sales, respectively. One customer accounted for 18% and 14% of
receivables at December 31, 2002 and 2001, respectively. We expect that sales
of our products to relatively few customers, none of which has entered into a
long-term agreement requiring them to purchase our systems, will continue to
account for a high percentage of our net sales in the foreseeable future. If
the financial condition or operations of these customers deteriorate
substantially, our operating results could be adversely affected. We perform
ongoing credit evaluations of our customers financial condition and generally
require no collateral. We have an exposure to nonperformance by counterparties
on the foreign exchange contracts used in hedging activities. These
counterparties are large international financial institutions and to date, no
such counterparty has failed to meet its financial obligations to us. We do not
believe there is a significant risk of nonperformance by these counterparties
because we continuously monitor our positions and the credit ratings of such
counterparties and the amount of contracts we enter into with any one party.
However, there can be no assurance that there will be no significant
nonperformance by these counterparties and that this would not materially
adversely affect our business, financial condition, and results of operations.

Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board, or FASB, issued SFAS
No. 143, Accounting for Asset Retirement Obligations, which addresses
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. SFAS No.
143 is effective for fiscal years beginning after June 15, 2002. We do not
expect that the adoption of SFAS No. 143 will have a material effect on our
financial condition or results of operations.

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.
For most companies, SFAS No. 145 will require gains and losses on
extinguishments of debt to be classified as income or loss from continuing
operations, rather than as extraordinary items, as previously required under
SFAS No. 4, Reporting Gains and Losses for Extinguishment
of Debt, an amendment of APB Opinion No. 30. Extraordinary treatment will be required for certain
extinguishments as provided in APB Opinion No. 30,
Reporting the Results of Operations  Reporting the
Effects of Disposal of a Segment of Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions. SFAS No. 145 also amended
SFAS No. 13, Accounting for Leases for certain sale-leaseback transactions and sublease accounting. We
are required to adopt the provisions of SFAS No. 145 effective January 1, 2003.
We do not expect the adoption of SFAS No. 145 to have a material effect on our
financial condition or results of operations.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. SFAS No. 146 addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullifies EITF Issue No. 94-3, and must be applied beginning January 1,
2003. SFAS No. 146 requires that a liability for a cost associated with an exit
or disposal activity be recognized when the liability is incurred, rather than
when the exit or disposal plan is approved. We do not expect the adoption of
SFAS No. 146 to have a material effect on our financial condition or results of
operations.

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In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation, Transition and Disclosure. SFAS No. 148 provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. SFAS No. 148 also requires
that disclosures of the pro forma effect of using the fair value method of
accounting for stock-based employee compensation be displayed more prominently
and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the
pro forma effect in interim financial statements. SFAS No. 148 is effective for
financial statements for fiscal years ending after December 15, 2002. The
adoption of SFAS No. 148 does not have a material effect on our results of
operations or financial condition.

In November 2002, the FASB issued FASB
Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, or FIN 45. FIN 45 will significantly
change current practice in the accounting for and disclosure of guarantees.
FIN 45 requires certain guarantees to be recorded at fair value which is
different from the current practice of recording a liability only
when a loss is probable and reasonably estimable, as those terms are defined in
SFAS No. 5, Accounting for Contingencies. FIN 45 also requires a guarantor
to make significant new disclosures, even when the likelihood of making any
payments under the guarantee is remote, which is another change from
the current
practice. FIN 45 disclosure requirements are effective for financial
statements of interim or annual periods ending after December 15, 2002, while
the initial recognition and initial measurement provisions are applicable on a
prospective basis to guarantees issued or modified after December 31, 2002. We
are currently evaluating the impact of the adoption of FIN 45 on our results of
operations or financial condition.

In January 2003, the FASB issued FIN
46, Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51. FIN 46 requires certain variable
interest entities to be consolidated by the primary beneficiary of the entity
if the equity investors in the entity do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 is effective for all new variable interest
entities created or acquired after January 31, 2003. For variable interest
entities created or acquired prior to February 1, 2003, the provisions of FIN
46 must be applied for the first interim or annual period beginning after June
15, 2003. We are currently evaluating our synthetic leases and seeking
additional information from the lessor and its advisors as to whether the
lessor should be characterized as a variable interest entity. Consequently, we
have not yet concluded whether it is reasonably possible that we would be
required to record the specific assets and liabilities associated with our
synthetic leases in our financial statements for our third fiscal
quarter beginning on June 29, 2003. In the event the
leasing structures used in our synthetic leases qualify as variable
interest entities, we would seek to refinance with entities with whom we
would not be required to consolidate or  purchase the properties
by exercising our purchase option. For further discussion, see Note 10 to the
Consolidated Financial Statements.

NOTE 3 FINANCIAL INSTRUMENTS

Cash, Cash Equivalents and Short-term Investments

The following table presents the
estimated fair value of our short-term investments by investment grade (in thousands):

|                                 |                                               |                                                         |         |              |           |      |         |         |         | 
|-------------------------------- | --------------------------------------------- | ------------------------------------------------------- | ------- | ------------ | --------- | ---- | ------- | ------- | ------- | 
|                                 |                                               |                                                         |         | December 31,
|                                 |                                               |                                                         |         |             
|                                 |                                               |                                                         |         | 2002         |           | 2001
|                                 |                                               |                                                         |         |              |           |     
|Cash                             |                                               | $                                                       | 7,727   |              |           | $    | 23,456  |        
|Institutional money market funds |                                               |                                                         | 565,694 |              |           |      | 442,072 |        
|Commercial paper                 |                                               |                                                         | 42,423  |              |           |      | 81,912  |        
|Municipal securities             |                                               |                                                         |        |              |           |      | 3,200   |        
|                                 |                                               |                                                         |         |              |           |      |         |        
|                                 | Amounts included in cash and cash equivalents |                                                         |         | 615,844      |           |      |         | 550,640 |        
|US Government agencies           |                                               |                                                         | 314,545 |              |           |      | 220,365 |        
|Municipal securities             |                                               |                                                         | 27,532  |              |           |      | 23,668  |        
|Commercial paper                 |                                               |                                                         | 25,783  |              |           |      | 33,447  |        
|Corporate securities             |                                               |                                                         | 18,653  |              |           |      | 78,302  |        
|Tax-exempt auction rate notes    |                                               |                                                         | 14,700  |              |           |      | 15,400  |        
|Mutual Fund                      |                                               |                                                         | 2,595   |              |           |      |        |        
|                                 |                                               |                                                         |         |              |           |      |         |        
|                                 | Amounts included in short-term investments    |                                                         |         | 403,808      |           |      |         | 371,182 |        
|                                 |                                               |                                                         |         |              |           |      |         |        
|                                 |                                               | Total cash, cash equivalents and short-term investments |         | $            | 1,019,652 |      |         | $       | 921,822 | 
|                                 |                                               |                                                         |         |              |           |      |         |        

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Unrealized gains (losses) on all securities were not significant as of December
31, 2002 and 2001. All debt securities held at December 31, 2002 are due in
less than two years.

Fair Value of Other Financial Instruments

The carrying and estimated fair values of our other financial instruments are
as follows (in thousands):

|                                          |  |              |         |                |  |          |         |                |  |   |         |  |  |   |         | 
|----------------------------------------- |  | ------------ | ------- | -------------- |  | -------- | ------- | -------------- |  | - | ------- |  |  | - | ------- | 
|                                          |  | December 31,
|                                          |  |             
|                                          |  | 2002         |         | 2001          
|                                          |  |              |         |               
|                                          |  | Carrying     |         | Estimated Fair |  | Carrying |         | Estimated Fair
|                                          |  | Value        |         | Value          |  | Value    |         | Value         
|                                          |  |              |         |                |  |          |         |               
|Restricted investment - current           |  | $            |        |                |  | $        |        |                |  | $ | 961,643 |  |  | $ | 961,643 | 
|Restricted investment - noncurrent        |  |              | 58,995  |                |  |          | 58,995  |                |  |   | 34,293  |  |  |   | 34,293  | 
|Notes receivable                          |  |              | 397,429 |                |  |          | 397,429 |                |  |   | 244,673 |  |  |   | 244,673 | 
|Current obligations under lines of credit |  |              |        |                |  |          |        |                |  |   | 26,179  |  |  |   | 26,179  | 
|Convertible subordinated debentures       |  |              | 116,437 |                |  |          | 116,437 |                |  |   | 862,659 |  |  |   | 876,700 | 

The fair values of our restricted investments are based on quoted market prices
as of December 31, 2002 and 2001. The fair value of our obligations under lines
of credit is based on current rates offered to us for similar debt instruments
of the same remaining maturities.

Financial Instruments with Off-Balance Sheet Risk

As part of our asset and liability management, we enter into various types of
transactions that involve financial instruments with off-balance sheet risk. We
enter into foreign forward exchange contracts in order to manage foreign
exchange risk. The notional amounts, carrying amounts and estimated fair values
of our foreign currency forward exchange contracts are as follows (in
thousands):

|                                              |  |          |         |          |  |            |     |          |  |              |     |            |  |   |        |      |  |   |       |  |  |   |       | 
|--------------------------------------------- |  | -------- | ------- | -------- |  | ---------- | --- | -------- |  | ------------ | --- | ---------- |  | - | ------ | ---- |  | - | ----- |  |  | - | ----- | 
|                                              |  |          |         |          |  |            |     |          |  | December 31, |     |            |  |   |        |      |  |  
|                                              |  |         
|                                              |  |          |         |          |  | 2002       |     |          |  |              |     |            |  |   |        | 2001 |  |   |       | 
|                                              |  |          |         |         
|                                              |  | Notional |         | Carrying |  | Estimated  |     | Notional |  | Carrying     |     | Estimated 
|                                              |  | Amount   |         | Amount   |  | Fair Value |     | Amount   |  | Amount       |     | Fair Value
|                                              |  |          |         |          |  |            |     |          |  |              |     |           
|Sell foreign currency, primarily Japanese yen |  | $        | (23,024 | )        |  | $          | 898 |          |  | $            | 898 |            |  | $ | 54,914 |      |  | $ | 8,958 |  |  | $ | 8,958 | 

The fair value of our foreign forward
exchange contracts is calculated based
on quoted market prices or pricing models using current market rates as of
December 31, 2002 and 2001, respectively.

NOTE 4 BALANCE SHEET DETAILS

Inventories

|                          |                   |      |              |         |  |   |         |         | 
|------------------------- | ----------------- | ---- | ------------ | ------- |  | - | ------- | ------- | 
|                          |                   |      |              |         |  |   |         |        
|                          |                   |      | December 31,
|                          |                   |      |             
|(in thousands)            |                   | 2002 |              | 2001   
|                          |                   |      |              |         | 
|Purchased and spare parts |                   | $    | 205,341      |         |  | $ | 199,702 |        
|Work-in-process           |                   |      | 45,487       |         |  |   | 42,717  |        
|Finished goods            |                   |      | 6,530        |         |  |   | 2,293   |        
|                          |                   |      |              |         |  |   |         |        
|                          | Total inventories |      | $            | 257,358 |  |   | $       | 244,712 | 
|                          |                   |      |              |         |  |   |         |        

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Property and equipment, net

|                              |                              |              |         |         |  |  |         |         | 
|----------------------------- | ---------------------------- | ------------ | ------- | ------- |  |  | ------- | ------- | 
|                              |                              | December 31,
|                              |                              |             
|(in thousands)                |                              | 2002         |         | 2001   
|                              |                              |              |         |         | 
|Property and equipment:       |                              |              |         |         |  |  |         |        
|                              | Machinery and equipment      |              | $       | 290,273 |  |  | $       | 243,677 | 
|                              | Furniture and fixtures       |              |         | 19,725  |  |  |         | 15,256  | 
|                              | Leasehold improvements       |              |         | 87,740  |  |  |         | 79,264  | 
|                              | Land                         |              |         | 8,983   |  |  |         | 8,782   | 
|                              |                              |              |         |         |  |  |         |         | 
|                              |                              |              | 406,721 |         |  |  | 346,979 |        
|Less accumulated depreciation |                              |              | 226,795 |         |  |  | 169,378 |        
|                              |                              |              |         |         |  |  |         |         | 
|                              | Total property and equipment |              | $       | 179,926 |  |  | $       | 177,601 | 
|                              |                              |              |         |         |  |  |         |         | 

Accrued warranty

Changes in our accrued warranty
liability were as follows (in thousands):

|                             |                                                                         |              |        |          |  |   |        |          | 
|---------------------------- | ----------------------------------------------------------------------- | ------------ | ------ | -------- |  | - | ------ | -------- | 
|                             |                                                                         | December 31,
|                             |                                                                         |             
|                             |                                                                         | 2002         |        | 2001    
|                             |                                                                         |              |        |          | 
|Balance,
beginning of period |                                                                         | $            | 43,337 |          |  | $ | 51,343 |         
|                             | Warranties
issued                                                       |              |        | 42,723   |  |   |        | 64,457   | 
|                             | Settlements                                                             |              |        | (56,322) |  |   |        | (72,463) | 
|                             | SpeedFam-IPEC
balance at acquisition                                    |              |        | 1,264    |  |   |        |         | 
|                             | Changes
in liability for pre-existing warranties, including expirations |              |        |         |  |   |        |         | 
|                             |                                                                         |              |        |          |  |   |        |          | 
|Balance,
end of period       |                                                                         | $            | 31,002 |          |  | $ | 43,337 |         
|                             |                                                                         |              |        |          |  |   |        |          | 

NOTE 5 EARNINGS PER SHARE

Basic net income per share is computed by dividing net income by the
weighted-average number of common shares outstanding during the period. For
purposes of computing net income per share, the weighted-average number of
outstanding shares of common stock excludes shares of restricted stock subject
to repurchase.

Diluted net income per share is computed using the weighted-average number of
shares of common stock outstanding, including shares of restricted common stock
subject to repurchase and, when dilutive, potential shares from stock options
to purchase common stock using the treasury stock method and from convertible
securities on an as-if-converted basis.

The following table provides a reconciliation of the numerators and
denominators of the basic and diluted per share computations (in thousands,
except for per share amounts):

|                             |                                             |   |                          |         |      |   |      |         |  |   |      |         | 
|---------------------------- | ------------------------------------------- | - | ------------------------ | ------- | ---- | - | ---- | ------- |  | - | ---- | ------- | 
|                             |                                             |   | Years ended December 31,
|                             |                                             |   |                         
|                             |                                             |   | 2002                     |         | 2001 |   | 2000
|                             |                                             |   |                          |         |      |   |     
|Numerator:                   |                                             |   |                          |         |      |   |      |         |  |   |      |        
|                             | Net income                                  |   | $                        | 22,920  |      |   | $    | 144,470 |  |   | $    | 149,380 | 
|Denominator:                 |                                             |   |                          |         |      |   |      |         |  |   |      |        
|                             | Basic weighted-average shares outstanding   |   |                          | 144,371 |      |   |      | 142,462 |  |   |      | 135,728 | 
|                             | Employee stock options                      |   |                          | 4,179   |      |   |      | 6,342   |  |   |      | 7,719   | 
|                             | Restricted stock                            |   |                          | 198     |      |   |      | 120     |  |   |      | 207     | 
|                             |                                             |   |                          |         |      |   |      |         |  |   |      |         | 
|                             | Diluted weighted-average shares outstanding |   |                          | 148,748 |      |   |      | 148,924 |  |   |      | 143,654 | 
|                             |                                             |   |                          |         |      |   |      |         |  |   |      |         | 
|Basic net income per share   |                                             | $ | 0.16                     |         |      | $ | 1.01 |         |  | $ | 1.10 |        
|Diluted net income per share |                                             | $ | 0.15                     |         |      | $ | 0.97 |         |  | $ | 1.04 |        

Options to purchase 8,717,229, 3,596,000 and 519,000 shares of common stock at
weighted-average prices of $42.60, $46.77 and $55.35 per share were outstanding
during 2002, 2001 and 2000, respectively, but were not included in the
computation of diluted net income per common share because the exercise price
of the options was greater than the average market price of the common shares
and, therefore, the effect would be antidilutive.

NOTE 6 GOODWILL AND OTHER INTANGIBLE ASSETS

As described in Note 2, we adopted SFAS No. 142 effective January 1, 2002.
SFAS No. 142 requires that goodwill and identifiable intangible assets with
indefinite useful lives no longer be amortized, but instead be tested for
impairment at least annually. SFAS No. 142 provides a six-month transitional
period from the effective date of adoption to perform an assessment of whether
there is an indication of goodwill impairment at the reporting unit level. To
perform the impairment test, it is necessary to identify our reporting units
and determine the carrying value of each reporting unit by assigning the

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assets and liabilities to the reporting units as of the date of adoption. A reporting
unit is the same as, or one level below, an operating segment as defined by
SFAS No. 131, Disclosures About Segments of an Enterprise and Related
Information. We have only one reporting unit as we operate in one segment, the
manufacturing, marketing and servicing of semiconductor wafer fabrication
equipment. Additionally, all of the operating components of our operating segment
qualify for aggregation under SFAS No. 142, due to their identical customer
base and similarities in economic characteristics, nature of products and
services, and procurement, manufacturing and distribution processes and
therefore are considered one reporting unit. We completed the first step of
the transitional goodwill impairment test in the first quarter of fiscal 2002
and completed the annual goodwill impairment test in the fourth quarter of
fiscal 2002. The first step of the test identifies when impairment may have
occurred, while the second step of the test measures the amount of the
impairment, if any. The result of our impairment test did not indicate
impairment.

As of December 31, 2001, we had goodwill of approximately $20.1 million. As a
result of the acquisition of SpeedFam-IPEC in December 2002, we recorded
additional goodwill in the amount of $143.0 million, which
resulted in an  ending
balance of $163.1 million as of December 31, 2002. The following table
reconciles the reported net income and net income per share for fiscal years
2001 and 2000 to their respective pro forma balances, adjusted to exclude
goodwill amortization expense, net of tax. Fiscal 2002 results are presented
for comparative purposes (in thousands, except for net income per
share):

|                                    |                                            |   |                          |      |      |   |         |       |  |   |         |      | 
|----------------------------------- | ------------------------------------------ | - | ------------------------ | ---- | ---- | - | ------- | ----- |  | - | ------- | ---- | 
|                                    |                                            |   | Years ended December 31,
|                                    |                                            |   |                         
|                                    |                                            |   | 2002                     |      | 2001 |   | 2000   
|                                    |                                            |   |                          |      |      |   |        
|Reported net income                 |                                            | $ | 22,920                   |      |      | $ | 144,470 |       |  | $ | 149,380 |     
|                                    | Add back goodwill amortization, net of tax |   |                          |     |      |   |         | 2,232 |  |   |         | 736  | 
|                                    |                                            |   |                          |      |      |   |         |       |  |   |         |     
|Adjusted net income                 |                                            | $ | 22,920                   |      |      | $ | 146,702 |       |  | $ | 150,116 |     
|                                    |                                            |   |                          |      |      |   |         |       |  |   |         |     
|Basic and diluted income per share: |                                            |   |                          |      |      |   |         |       |  |   |         |     
|                                    | Reported basic net income per share        |   | $                        | 0.16 |      |   | $       | 1.01  |  |   | $       | 1.76 | 
|                                    | Add back goodwill amortization, net of tax |   |                          |     |      |   |         | 0.02  |  |   |         | 0.01 | 
|                                    |                                            |   |                          |      |      |   |         |       |  |   |         |     
|                                    | Adjusted basic income per share            |   | $                        | 0.16 |      |   | $       | 1.03  |  |   | $       | 1.77 | 
|                                    |                                            |   |                          |      |      |   |         |       |  |   |         |     
|                                    | Reported diluted net income per share      |   | $                        | 0.15 |      |   | $       | 0.97  |  |   | $       | 1.66 | 
|                                    | Add back goodwill amortization, net of tax |   |                          |     |      |   |         | 0.02  |  |   |         | 0.01 | 
|                                    |                                            |   |                          |      |      |   |         |       |  |   |         |     
|                                    | Adjusted diluted income per share          |   | $                        | 0.15 |      |   | $       | 0.99  |  |   | $       | 1.67 | 
|                                    |                                            |   |                          |      |      |   |         |       |  |   |         |     

Intangible assets consist primarily of purchased technology. Intangible assets
amounted to $25.6 million (net of accumulated amortization of
$2.4 million)
and $11.2 million (net of accumulated amortization of $1.0 million) as of
December 31, 2002 and 2001, respectively. The amortization expense for the
identifiable intangible assets is approximately $1.4 million,
$1.0 million and
$0.2 million for the years ended December 31, 2002, 2001 and 2000,
respectively. Our estimated amortization expense for the identifiable
intangible assets for each of the next five years will be
approximately $4.0 million per year. We have no identifiable intangible assets with indefinite lives.

NOTE 7 BUSINESS COMBINATIONS

Acquisition of SpeedFam-IPEC

On December 6, 2002, we acquired all of the outstanding stock of SpeedFam-IPEC in exchange for 0.1818 of a share of
Novellus common stock for each outstanding share of SpeedFam-IPEC common stock.
We assumed options to purchase SpeedFam-IPEC common stock based on the same
ratio. In addition, we assumed all $115.0 million of SpeedFam-IPECs 6.25%
Convertible Subordinated Notes due in 2004. The Notes were adjusted
to a fair
value of $116.4 million as of the acquisition date. The acquisition of SpeedFam-IPEC enables us to
increase our product portfolio. The acquisition was accounted for as a purchase
business combination and qualifies as a tax-free reorganization under IRS
regulations. The results of SpeedFam-IPECs operations

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have been included in the consolidated financial statements since December 6, 2002. The total
purchase price of approximately $174.4 million includes Novellus common stock
valued at $153.4 million, assumed options and warrants with a fair value of
$16.4 million and estimated direct transaction costs of $4.5 million. The fair
value of Novellus common stock was derived using an average market price per
share of $26.77, which was based on an average of the closing prices for a
range of five trading days around August 12, 2002, the announcement date of the
acquisition. The fair value of the stock options was determined using the
Black-Scholes option pricing model with the following assumptions: no dividend
yield, expected volatility of 85%, 3.3 years and a risk-free interest rate of
2.49%. The model assumed an expected life of 3.3 years for assumed options and
0.5 years for assumed warrants. The purchase price was allocated to the fair
market value of assets acquired and liabilities assumed as follows (in
thousands):

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|                                                  |                      |   |          |         | 
|------------------------------------------------- | -------------------- | - | -------- | ------- | 
|Cash and cash equivalents                         |                      | $ | 43,463   |        
|Accounts receivable                               |                      |   | 22,622   |        
|Inventories                                       |                      |   | 33,972   |        
|Deferred tax assets, current                      |                      |   | 38,625   |        
|Deferred
tax assets, non-current                  |                      |   | 6,915    |        
|Property, plant and equipment                     |                      |   | 24,125   |        
|Prepaid and other assets                          |                      |   | 6,777    |        
|Intangible assets  developed and core technology |                      |   | 17,380   |        
|In-process research and development (IPR&D)       |                      |   | 9,003    |        
|Goodwill                                          |                      |   | 142,996  |        
|Accounts payable and accrued liabilities          |                      |   | (25,424  | )      
|Restructuring accrual                             |                      |   | (28,528  | )      
|Long-term debt                                    |                      |   | (116,437 | )      
|Other long-term liabilities                       |                      |   | (4,217   | )      
|Deferred compensation on unvested stock options   |                      |   | 3,104    |        
|                                                  |                      |   |          |        
|                                                  | Total purchase price |   | $        | 174,376 | 
|                                                  |                      |   |          |        

Intangible Assets - As of the closing of our acquisition of SpeedFam-IPEC on December 6, 2002,
$17.4 million of the total purchase price was allocated to intangible assets
subject to amortization, including developed and core technologies. Developed
technologies, which comprise products that have reached technological
feasibility, include products in most of SpeedFam-IPECs product lines,
principally the SpeedFam-IPEC MOMENTUMTM family of products. Core technologies
represent a combination of SpeedFam-IPEC processes and trade secrets developed
through years of experience in design and development of CMP technologies. We
are amortizing the developed and core technologies on a straight-line basis
over an average estimated life of six years.

The allocated intangible assets as of December 6, 2002 decreased $27.7 million
from the preliminary allocation of $45.1 million as of
June 29, 2002, as noted in our Registration Statement on Form S-4/A filed with the Securities and Exchange Commission
(SEC) on November 1, 2002. The decrease was due to a change in the revenue
estimates and projected cash flows of SpeedFam-IPEC.

Goodwill - The potential value of the combined companies products and technologies
contributed to a purchase price that resulted in goodwill. Goodwill represents
the excess of the purchase price of an acquired business over the fair value of
the underlying net tangible and intangible assets. Goodwill is not deductible
for tax purposes and is not subject to amortization, however, it is to be
tested for impairment at least annually in accordance with SFAS No. 142.
Approximately $143.0 million of the total purchase price was allocated to
goodwill upon the closing of our acquisition of SpeedFam-IPEC on December 6,
2002.

The increase in the allocated goodwill as of December 6, 2002 from the
preliminary allocation of $55.1 million as of June 29,
2002, as noted in our Registration Statement on Form S-4/A filed with the SEC on November 1, 2002, was due to several
factors. These factors include estimated restructuring charges of $28.5
million for certain activities of SpeedFam-IPEC which we will discontinue, a
$27.7 million decrease in the estimated fair value of amortizable intangible
assets and a $9.4 million decrease in the estimated fair value of IPR&D costs.
The increase in goodwill was also attributed to a higher purchase consideration
due to an increase in the number of shares of common stock and stock options assumed, and
the decrease in net assets of SpeedFam-IPEC due to its operating loss for the
period from June 29, 2002 to December 6, 2002.

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In-process Research and
Development - Of the total purchase price as of December 6, 2002, approximately $9.0 million
was allocated to IPR&D and was immediately written off as an acquired IPR&D
charge in fiscal 2002. Projects which qualify as IPR&D have not yet reached
technological feasibility and have no alternative future use. Technological
feasibility is defined as being equivalent to completion of a beta-phase
working prototype in which there is no significant remaining risk relating to
the development.

The value assigned to IPR&D was determined by considering the importance of
each project to the overall development plan, estimating costs to develop the
acquired IPR&D into commercially viable products, estimating the resulting net
cash flows from the projects when completed and discounting the net cash flows
to their present value. The revenue estimates used to value the purchased
IPR&D were based on estimates of relevant market sizes and growth factors,
expected trends in technology and the nature and expected timing of new
product introductions by SpeedFam-IPEC and its competitors.

The rates utilized to discount the net cash flows to their present value were
based on a weighted-average cost of capital determined by examining market
information for several comparable companies. The weighted-average
cost of capital was adjusted to reflect the difficulties and uncertainties in
completing each project and thereby achieving technological feasibility, the
percentage of completion of each project, anticipated market acceptance and
penetration, market growth rates and risks related to the impact of potential
changes in future target markets. Based on these factors, a discount rate of
25% was deemed appropriate for valuing the IPR&D. The estimates used in
valuing IPR&D were based upon assumptions believed to be reasonable but which
are inherently uncertain and unpredictable. As a result, actual results may
differ from estimates.

The allocated IPR&D as of December 6, 2002 decreased $9.4 million from the
preliminary allocation of $18.4 million as of June 29,
2002, as noted in our Registration Statement on Form S-4/A filed with the SEC on November 1, 2002. The decrease was due to
a change in the revenue estimates and projected cash flows of SpeedFam-IPEC.

Restructuring accrual - The restructuring accrual of $28.5 million consists of facility-related costs
of $27.0 million, severance-related costs for involuntary terminations of $0.3
million and other costs associated with exiting certain activities of
SpeedFam-IPEC of $1.2 million. The facility-related accrual was calculated net
of estimated sublease income we expect to receive once we sublet the facilities
that have been vacated. Sublease income is estimated based on current market
quotes for similar properties. If we are unable to sublet these properties on
a timely basis or are forced to sublet them at lower rates due to changes in
the market conditions, we may have to adjust the purchase price allocation.
For further discussion, see Note 8 to the Consolidated Financial Statements.

Deferred Compensation - The intrinsic value of unvested SpeedFam-IPEC options of approximately $3.1
million as of December 6, 2002 has been allocated to deferred compensation in
the purchase price allocation. The deferred compensation will be amortized
over the remaining vesting period of the options, which was approximately four
years as of December 6, 2002. Stock options assumed in conjunction with the
acquisition had exercise prices ranging from $11.22  $324.53, with a
weighted-average exercise price of $42.85 and a weighted-average remaining
contractual life of five years. Approximately 755,000 of the approximately
1,145,000 shares of stock options assumed were fully vested.

Pro Forma Results - The following table represents the unaudited pro forma consolidated results of
operations, assuming the acquisition of SpeedFam-IPEC was consummated as of the
beginning of the periods presented. The pro forma information excludes $9.0
million of acquired IPR&D. The unaudited pro forma information has been
prepared for comparative purposes only and is not indicative of what operating
results would have been if the acquisition had taken place at the beginning of
fiscal 2001 or of future operating results. Due to different fiscal period
ends, the combined operating results below consist of historical

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results of Novellus for the years ended December 31, 2002 and 2001 and
historical results of SpeedFam-IPEC for the twelve months ended December 1,
2002 and 2001.

|                                      |  |                          |         |   |  |   |           | 
|------------------------------------- |  | ------------------------ | ------- | - |  | - | --------- | 
|                                      |  | (unaudited)             
|                                      |  | Years ended December 31,
|                                      |  |                         
|(in thousands, except per share data) |  |                          | 2002    |   |  |   | 2001      | 
|                                      |  |                          |         |  
|Net sales                             |  | $                        | 944,142 |   |  | $ | 1,516,381 | 
|Net (loss) income                     |  |                          | (9,526  | ) |  |   | 55,115    | 
|Net (loss) income per share           |  | $                        | (0.06   | ) |  | $ | 0.36      | 

Acquisition of GaSonics

On January 10, 2001, we acquired GaSonics. The transaction, accounted for as a
pooling of interest, involved our acquisition of all outstanding shares of
GaSonics in a stock-for-stock acquisition in exchange for approximately
9,240,000 shares of Novellus common stock. In addition, all outstanding
options to purchase shares of GaSonics capital stock were automatically
converted into options to purchase approximately 1,400,000 shares of Novellus
common stock. Acquisition related costs of approximately $13.2 million were
recorded in the first quarter of fiscal 2001 and were included in restructuring
and other charges within our consolidated statement of operations.

The following is a reconciliation of the amounts of net sales and net income
previously reported for the year ended December 31, 2000 with
restated amounts (in thousands):

|                              |            |  |          |           |          |  |             |         |          |  |            |         |   |  |   |           | 
|----------------------------- | ---------- |  | -------- | --------- | -------- |  | ----------- | ------- | -------- |  | ---------- | ------- | - |  | - | --------- | 
|                              |            |  |          |           |          |  |             |         |          |  | Conforming |         |   |  |  
|                              |            |  | Novellus |           | GaSonics |  | Adjustments |         | Combined
|                              |            |  |          |           |          |  |             |         |         
|Year ended December 31, 2000: |            |  |          |           |          |  |             |         |          |  |            |         |   |  |   |          
|                              | Revenue    |  | $        | 1,173,731 |          |  | $           | 155,833 |          |  | $          | (10,078 | ) |  | $ | 1,319,486 | 
|                              | Net income |  |          | 151,065   |          |  |             | 14,381  |          |  |            | (16,066 | ) |  |   | 149,380   | 

Conforming adjustments consist of an adjustment to the provision for income
taxes for the realization of deferred tax assets in fiscal 2000 and
adjustments related to adoption of SAB 101 and SAB 101 FAQ as of the beginning
of GaSonics fiscal year 2000.

Acquisition of Gamma Precision Technology

On September 13, 2000, GaSonics completed its acquisition of Gamma Precision
Technology (GPT), a global supplier of products and services used in the
fabrication of advanced integrated circuits. GaSonics issued 340,900 shares of
common stock (as adjusted for the acquisition exchange ratio of 0.52 of a
Novellus share for each share of GaSonics) and paid approximately $21.5 million
in cash in exchange for all outstanding GPT common stock, preferred stock,
warrants and vested options. In connection with the acquisition, GaSonics
recorded a $6.0 million charge to operating expenses relating to the write-off
of in-process research and development, as certain products had not reached
technological feasibility and, in managements opinion, had no probable
alternative future use. In addition, GaSonics assumed all unvested options.
The total cost of the acquisition, including transaction costs, was
approximately $34.9 million.

NOTE 8 RESTRUCTURING AND OTHER CHARGES

The components of restructuring and other charges are as follows (in thousands):

|                                            |  |            |        |            |  |           |         |         |  |       |        |             |  |   |         |   |  |              |         |   |  |   |        |  
|------------------------------------------- |  | ---------- | ------ | ---------- |  | --------- | ------- | ------- |  | ----- | ------ | ----------- |  | - | ------- | - |  | ------------ | ------- | - |  | - | ------ | -
|                                            |  |            |        |            |  | Asset     |         |         |  |       |        | Acquisition |  |   |         |   |  | Discontinued
|                                            |  | Facilities |        | Impairment |  | Severance |         | Expense |  | Total |        | Inventory  
|                                            |  |            |        |            |  |           |         |         |  |       |        |            
|Restructuring charges for 2001              |  | $          | 33,818 |            |  | $         | 14,127  |         |  | $     |       |             |  | $ | 13,161  |   |  | $            | 61,106  |   |  | $ | 7,102  |  
|Cash payments                               |  |            | (952   | )          |  |           | (1,745  | )       |  |       |       |             |  |   | (13,161 | ) |  |              | (15,858 | ) |  |   |       |  
|Non-cash charges                            |  |            | (6,017 | )          |  |           | (12,382 | )       |  |       |       |             |  |   |        |   |  |              | (18,399 | ) |  |   | (7,102 | )
|                                            |  |            |        |            |  |           |         |         |  |       |        |             |  |   |         |   |  |              |         |   |  |   |        |  
|Balance at December 31, 2001                |  |            | 26,849 |            |  |           |        |         |  |       |       |             |  |   |        |   |  |              | 26,849  |   |  |   |       |  
|Restructuring charges for 2002              |  |            | 1,478  |            |  |           |        |         |  |       | 4,989  |             |  |   |        |   |  |              | 6,467   |   |  |   |       |  
|SpeedFam-IPEC related
restructuring charges |  |            | 27,024 |            |  |           |        |         |  |       | 251    |             |  |   | 1,253   |   |  |              | 28,528  |   |  |   |       |  
|Cash payments                               |  |            | (9,783 | )          |  |           |        |         |  |       | (4,989 | )           |  |   |        |   |  |              | (14,772 | ) |  |   |       |  
|                                            |  |            |        |            |  |           |         |         |  |       |        |             |  |   |         |   |  |              |         |   |  |   |        |  
|Balance at December 31, 2002                |  | $          | 45,568 |            |  | $         |        |         |  | $     | 251    |             |  | $ | 1,253   |   |  | $            | 47,072  |   |  | $ |       |  
|                                            |  |            |        |            |  |           |         |         |  |       |        |             |  |   |         |   |  |              |         |   |  |   |        |  

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In September 2001, we implemented a restructuring plan that was driven by the
decline in sales orders due to the contraction of the semiconductor capital
equipment market from calendar year 2000 levels and the need to improve our
cost structure by consolidating excess facilities. As a result, we recorded
restructuring and asset impairment charges totaling $55.0 million, of which
$47.9 million is included in operating expense and $7.1 million is included in
cost of sales. The restructuring charges consist of $33.8 million related to
vacated facilities, $14.1 million of asset impairment charges and $7.1 million
of discontinued inventory write-downs. Of the $14.1 million asset impairment
charge, $9.5 million related to abandoned assets associated with the
discontinuation of certain projects and $4.6 million related to the write-off
of purchased technology.

The restructuring charges in 2002 include approximately $28.5 million incurred
in connection with exiting activities of SpeedFam-IPEC that were
recognized as liabilities assumed in the purchase business
combination. These activities relate primarily to facility-related charges of $27.0 million, severance-related charges of $0.3
million and other costs associated with exiting activities of SpeedFam-IPEC of
$1.2 million.

Facilities The 2001 vacated facilities charge of $33.8 million relates to
rent obligations after the abandonment of five corporate facilities in
California, primarily San Jose, and eleven field offices located in Arizona,
California, Florida, Washington, the Netherlands, Germany, Israel, Singapore
and Japan, which are currently under long-term operating lease agreements. The
abandoned corporate facilities are redundant facilities from the GaSonics
acquisition. The closure of the field offices was due to a slowdown in the
semiconductor capital equipment market. As of December 31, 2001, we estimated
anticipated future sublease income of $4.5 million relating to the vacated
facilities and offset the amount against the remaining lease payments. During
the fourth quarter of 2002, an additional charge of $1.5 million was recorded
due to a decrease in our future sublease income estimate. As of December 31,
2002, the estimated future sublease income was $3.0 million. Actual future cash
requirements may differ materially from the accrual at December 31, 2002,
particularly if actual sublease income is significantly different from current
estimates.

The facility-related charges of
$27.0 million in 2002 are attributable to the closure
and/or subletting of excess SpeedFam-IPEC office space, primarily in the U.S.
and Asia. The majority of the facility-related charges consisted of remaining
rent obligations and restoration costs offset by estimated sublease income of
approximately $44.1 million. The estimated costs of abandoning these leased
facilities, including estimated sublease income, were based primarily on market
information analyses provided by a commercial real estate brokerage firm
retained by us. Net cash payments through December 31, 2002 related to
abandoned SpeedFam-IPEC facilities amounted to $0.4 million. Actual future cash
requirements could differ materially from the accrual at December 31, 2002,
particularly if actual sublease income is significantly different from the
current estimate. As of December 31, 2002,
$26.6 million of SpeedFam-IPECs
remaining facility-related liability is expected to be paid by the end of fiscal 2017.

Asset Impairment In 2001, we abandoned assets and wrote off purchased
technology of $14.1 million. The charge for abandoned assets of $9.5 million
relates to the write-off of evaluation tools of $6.1 million, with the
remaining balance pertaining to the write-off of certain assets related to two
abandoned product lines and certain previous generation lab equipment. These
items have been written off due to the fact that we do not expect future cash
flows from them. The write-off of purchased technology of $4.6 million relates
to technology purchased from a third party vendor for use in certain research
and development projects. The purchased technology has been written off as
these research and development projects have been cancelled and there is no
future economic benefit pertaining to the purchased technology. The results of
operations relating to these product lines were not material to our
consolidated results of operations.

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Severance In the first and fourth quarters of 2002, we reduced our workforce
by approximately 13.1% and 8.0% in response to market conditions, and
accordingly recorded charges of $3.3 million and
$1.7 million, respectively, primarily for the cost
of severance compensation. These employee reductions affected
approximately 500
people across all business functions, operating units and major geographic
regions. As of December 31, 2002, significantly all severance benefits related
to these reductions in workforce had been paid.

SpeedFam-IPECs severance-related
charges of $0.3 million were attributable to
workforce reductions in the U.S. and various international locations
across many business functions and job classes. The charges include severance,
payroll taxes and COBRA benefits. None of these severance-related
charges had been paid as of December 31, 2002.

Acquisition Costs In addition to the restructuring charges, we also incurred
acquisition costs of $13.2 million related to the acquisition of GaSonics in
the first quarter of fiscal 2001. These costs included professional fees,
financial printing and other related costs. Additionally, these costs included
charges related to the cancellation of various contracts and the write-off of
certain redundant assets. At December 31, 2001, all expenses related to these
accruals had been paid.

Other costs of $1.2 million
recorded in 2002 primarily relate to fees and other exit costs
associated with the closing of SpeedFamIPEC foreign entities. These costs include legal and
other professional fees.

Discontinued Inventory The charge for discontinued inventory of $7.1 million
in 2001 relates to the abandonment of two product lines. One product line was
not a part of our core business strategy and the other, a PECVD product, has
been replaced by a next-generation product. The results of operations relating
to these product lines were not material to our consolidated results of
operations.

The restructuring saved us approximately $38.8 million in fiscal 2002. Of the
$38.8 million savings, $9.8 million relates to savings from vacated facilities
and $29.0 million relates to savings from workforce reductions.

As of December 31, 2002,
significantly all actions under the 2001 restructuring plan
have been achieved, except for future rent obligations of $18.5 million, which are to be paid in cash over the next four
years.

NOTE 9 CONVERTIBLE SUBORDINATED DEBENTURES

On December 6, 2002, in connection with the acquisition of SpeedFam-IPEC, we
assumed SpeedFam-IPECs $115.0 million Convertible Subordinated Notes due in
2004. The notes were adjusted to their fair value of $116.4 million as of the
acquisition date and accrued interest at a rate of 6.25%, which is payable
semi-annually in March and September. The notes were subordinated to all
existing and future senior indebtedness and could be converted into 3.3096
shares of Novellus common stock at a conversion price of $302.15 per $1,000
principal amount. We exercised our right to redeem the notes on January 8,
2003 at a redemption price of $117.1 million. The redemption price represents
101.786% of par value. In January 2003, we
recognized approximately $0.6 million in expense for the
difference between the fair value as of the acquisition date and the
redemption price.

On July 26, 2001, we issued
$880.0 million of Liquid Yield Option Notes  (LYONs) due July 26, 2031. The net proceeds after issuance costs (which were
being amortized over 30 years) from the LYONs offering were $862.4 million. The
LYONs are zero coupon, zero-yield subordinated debentures convertible into
shares of Novellus common stock or redeemable for cash by the security holder,
subject to specified conditions as set forth in the indenture.

On July 26, 2002, the holders of the LYONs exercised their option to require us
to repurchase the LYONs for $1,000 in cash each on such date, or approximately
$880.0 million for substantially all of the outstanding LYONs. We used restricted
short-term investments, which had matured to $880.0 million, to repurchase the
LYONs. We recorded a charge of approximately $17.0 million in other expense for
the remaining unamortized issuance costs related to the LYONs.

NOTE 10 COMMITMENTS

We lease nearly all of our facilities under operating leases, including
synthetic leases, which expire at various dates through 2017. A synthetic
lease is a form of operating lease wherein a third party lessor funds 100% of
the acquisition and

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construction costs relating to one or more properties to be
leased to a lessee. The lessor is the owner of the leased property and must
provide at least 3% of the required funds in the form of at-risk equity. The
lessor generally borrows the balance of the funds necessary to fund the
acquisition and construction. Under our synthetic lease agreements,
we are obligated to lend approximately 87% of the cost of the leased asset to
the lessor upon completion of construction. The leases with this requirement
are known as defeased or self-funded transactions. Additionally, our synthetic
leases require us to maintain collateral for the benefit of the lessor.

San Jose, California

The San Jose lease agreement covers 13 properties located in and around San
Jose, California, including manufacturing, research and development, and
administrative facilities, as well as our corporate headquarters. The lease
has a term of five years beginning in September 2001 and covers properties with
original values of approximately $293.2 million. The lease agreement requires
the lessor to provide 3.5% of at-risk equity throughout the term of the lease.
The remaining 96.5% of the lessors financing was in the form of debt, including
$257.0 million loaned to the lessor which is classified as notes receivable on
our balance sheet. We have also provided the lessor with $36.2 million in
collateral, which is classified within other assets on our
consolidated balance
sheet.

Under the lease agreement, we have the right to purchase the properties at any
time prior to the expiration date of the lease for an amount that equals the
total lease financing amount of $293.2 million plus any current rent due and
payable. At the end of the lease term, we may renew the lease for up to three
additional years with the lessors consent, refinance the lease, purchase the
properties under a purchase option or arrange to sell the properties to a
third party. If we choose the sale option, we will be obligated to
the lessor up to the amount of the residual value guarantee if the sale price falls
below the lease financing amount. The aggregate
residual value guarantee related to the San Jose properties is approximately
$258.2 million as of December 31, 2002, and represents an off-balance sheet
contingent liability for which we do not believe that we have any significant
exposure as discussed below.

Rent payments under the San Jose lease agreement are based on the net
outstanding lease balance, which includes the cost of the leased properties,
less the amount defeased by us, multiplied by either a fixed rate or the London Interbank
Offer Rate (LIBOR) plus an applicable margin. As of December 31, 2002, the
net outstanding lease balance and the amount we have defeased were $293.2
million, and $257.0 million, respectively. Rent expense and interest income on
the lease balance includes $8.0 million of imputed
amounts at rates of 2% to 4% for the year ended December 31, 2002. Imputed
amounts result from the application of a deemed market rate of interest on loan
balances, including the lease receivable from the lessor, which is non-interest
bearing, and a portion of the collateral, which is interest bearing at lower
than the deemed market rate of interest. Our lease receivable from the lessor is
repayable in full only if we choose the sale option at the end of the lease
term and successfully sell the properties for amounts in excess of the cost.
Our collateral is available to the lessor upon default, with certain
exceptions.

Tualatin, Oregon

On April 18, 2001, we entered into a synthetic lease agreement for the
development of a manufacturing, research and development, and administrative
facility to be constructed on 23 acres of land we own in Tualatin,
Oregon. We have leased the land to the lessor under a long-term ground lease.
Construction was completed at the Tualatin site in May 2002. The construction
costs totaled $163.2 million and were fully financed by the lessor. The lease
agreement requires the lessor to maintain 3% of at-risk equity throughout the
term of the lease. The lessor financed the balance of the construction costs
with debt. Upon completion of construction, we defeased $140.4 million of the
lessors debt financing in the form of a non-interest bearing loan to the
lessor, which is included in notes receivable on our balance sheet at December
31, 2002. We have also provided $22.8 million in collateral held by the lessor
to cover the remainder of the lease financing, which is classified as other
assets on our consolidated balance sheet.

We have the right to purchase the property at any time prior to the expiration
date of the lease for an amount that equals the total lease financing amount of
$163.2 million, plus any current rent due and payable. At the end of the
five-year lease term, we may renew the lease for up to three additional years
with the lessors consent, purchase the property under the purchase option for
an amount equal to the total lease financing amount or arrange to sell the
property to a third party. If we choose the sale option, we will be obligated
to the lessor up to the amount of the residual value guarantee if the
sale price falls below the lease financing amount.
The residual value guarantee related to the Tualatin property is approximately
$140.4 million as of December 31, 2002 and represents an off-balance sheet
contingent liability for which we do not believe that we have any significant
exposure as discussed below.

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Rent payments under the Tualatin lease agreement are based on the net
outstanding lease balance, which includes the cost of the leased properties,
less the amount defeased by us, multiplied by either a fixed rate or LIBOR, plus an applicable margin. As of December 31, 2002, the
net outstanding lease balance and the amount we have defeased were $163.2
million and $140.4 million, respectively. Rent expense and
interest income on the lease balance includes $2.9 million of imputed
amounts at rates of 2% to 4% for the year ended December 31, 2002. Imputed
amounts result from the application of a deemed market rate of interest on loan
balances, including the lease receivable from the lessor, which is non-interest
bearing, and a portion of the collateral, which is interest bearing at lower
than the deemed market rate of interest. Our lease receivable from the lessor is repayable in
full only if we choose the sale option at the end of the lease term and
successfully sell the property for an amount in excess of the cost. Our
collateral is available to the lessor upon default, with certain exceptions.

Summary information about our synthetic lease arrangements is as follows as of
December 31, 2002 (currency amounts in thousands):

|             |  |            |    |             |  |               |         |           |  |            |         |                |  |   |        |  |  |   |        |  |  |   |         | 
|------------ |  | ---------- | -- | ----------- |  | ------------- | ------- | --------- |  | ---------- | ------- | -------------- |  | - | ------ |  |  | - | ------ |  |  | - | ------- | 
|Property     |  | Number of  |    | Total Lease |  | Novellus      |         | Net Lease |  | Collateral |         | Residual Value
|Location     |  | Properties |    | Financing   |  | Participation |         | Financing |  | Value      |         | Guarantee     
|             |  |            |    |             |  |               |         |           |  |            |         |               
|San Jose, CA |  |            | 13 |             |  | $             | 293,183 |           |  | $          | 257,042 |                |  | $ | 36,141 |  |  | $ | 36,141 |  |  | $ | 258,220 | 
|Tualatin, OR |  |            | 1  |             |  |               | 163,241 |           |  |            | 140,387 |                |  |   | 22,854 |  |  |   | 22,854 |  |  |   | 140,387 | 
|             |  |            |    |             |  |               |         |           |  |            |         |                |  |   |        |  |  |   |        |  |  |   |         | 
|             |  |            | 14 |             |  | $             | 456,424 |           |  | $          | 397,429 |                |  | $ | 58,995 |  |  | $ | 58,995 |  |  | $ | 398,607 | 
|             |  |            |    |             |  |               |         |           |  |            |         |                |  |   |        |  |  |   |        |  |  |   |         | 

If we purchase the San Jose and
Tualatin properties at the end of their respective lease terms or
earlier, the transactions would increase property and equipment by
the lower of the purchase option price or the then fair value of the
purchased properties. As of December 31, 2002, we believe that
the fair market value for each property exceeds the purchase option
price for each property. We estimate the cumulative fair value of
all properties to be approximately $456.4 million as of
December 31, 2002. Upon purchase of the facilities, our note
receivable and collateral would be returned to us as cash or used to offset the
purchase price of the properties. As a result of the purchase,
depreciation expense would increase by approximately
$30.0 million to $35.0 million per year, and rent expense
and interest income would each decrease by approximately
$12.6 million per year, based on current interest rates.

Under the FASBs new rule, FIN 46, if the lessee under a synthetic lease is the
primary beneficiary of a variable interest entity which leases property to the
lessee, the lessee would be required to consolidate the variable interest
entity. We are currently evaluating our synthetic leases and seeking
additional information from the lessor and its advisors as to whether the
lessor should be characterized as a variable interest entity. Consequently, we
have not yet concluded whether it is reasonably possible that we would be
required to record the specific assets and liabilities associated with our
synthetic leases in our financial statements for our third fiscal
quarter beginning June 29, 2003. In the event the
leasing structures used in synthetic leases qualify as variable
interest entities, we would seek to refinance with entities with whom we
would not be required to consolidate or purchase the properties
by exercising our purchase option.

The following table summarizes our future minimum lease payments under all
non-cancelable operating leases, including synthetic leases, and future
sublease income under non-cancelable subleases. Amounts payable under the
synthetic leases exclude any payments under residual value guarantees and
relate only to the net lease financing amounts. In addition, payments under
the synthetic leases are subject to changes in LIBOR and have been included in
the table using interest rates as of December 31, 2002 (in thousands):

|                             |  |   |         | 
|---------------------------- |  | - | ------- | 
|2003                         |  | $ | 27,132  | 
|2004                         |  |   | 27,185  | 
|2005                         |  |   | 26,540  | 
|2006                         |  |   | 18,966  | 
|2007                         |  |   | 5,933   | 
|Thereafter                   |  |   | 45,499  | 
|                             |  |   |         | 
|                             |  |   | 151,255 | 
|Less: future sublease income |  |   | 43,097  | 
|                             |  |   |         | 
|Total minimum lease payments |  | $ | 108,158 | 
|                             |  |   |         | 

Rent expense was approximately $17.8 million, $16.9 million and $20.1 million
for the years ended December 31, 2002, 2001 and 2000, respectively, net of
sublease income of $7.4 million, $7.2 million and $8.1 million, respectively.

Restrictive Covenants

The synthetic lease agreements contain certain restrictive covenants, which
include quick ratio and tangible net worth tests. We were in
compliance with these covenants at December 31, 2002. If we had not complied with
these covenants, the lessor could have terminated the leases, resulting in an
acceleration of our

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purchase obligation, in which case our
residual value guarantee would equal 100% of the lease balances.

Lines of Credit

Our subsidiaries, Novellus Systems, Japan and Novellus Systems, Korea,
have available lines of credit with various banks for a total of $36.7 million.
These credit facilities bear interest at various rates, expire at various dates
through December 2003 and are used for general corporate purposes. As of
December 31, 2001, amounts outstanding under these lines of credit were $26.2
million, at an annual weighted-average interest rate of 0.62%. There were no
outstanding balances under these lines of credit as of December 31, 2002.

NOTE 11 LITIGATION

Applied Materials, Inc.

On June 13, 1997, we agreed to purchase the Thin Film
Systems (TFS) business of Varian Associates, Inc. On the same day, Applied Materials,
Inc. sued Varian in the United States District Court for the Northern District
of California for alleged patent infringement concerning several of its
physical vapor deposition (PVD) patents (the Applied Patents).

On June 23, 1997, we sued Applied in the United States District Court for the
Northern District of California, claiming infringement by Applied of several of
our PVD patents acquired from Varian in the TFS purchase. Applied has filed
counterclaims in this suit, alleging that we infringed the Applied Patents. We
are seeking an injunction against future infringement by Applied, damages for
past infringement and treble damages for alleged willful infringement.

On July 7, 1997, Applied amended its complaint in its suit against Varian to
add Novellus as a defendant. We have requested that the Court dismiss us as a
defendant in this suit. The Court has not yet ruled on the request or required
us to file an answer in this lawsuit.

The relief requested by Applied in both suits includes a permanent injunction
against future infringement, damages for alleged past infringement and treble
damages for alleged willful infringement.

We believe that we have meritorious claims against Applied. We also believe
that there are meritorious defenses to Applieds allegations, including the
defense that our operations and products (including TFS products and systems)
do not infringe the Applied Patents, and that the Applied Patents are invalid,
unenforceable or both. As a result of court rulings adverse to Applied, and in
light of certain indemnity obligations undertaken by Varian, which include
reimbursement of certain legal expenses and a portion of any losses incurred
from this litigation, we do not believe that Applieds claims will have a
material adverse effect on our business, financial condition or results of
operations.

Semitool, Inc.

On August 10, 1998, Semitool, Inc. sued us for patent
infringement in the United States District Court for the Northern District of
California. Semitool alleges patent infringement concerning several patents
related to our SABRE and SABRE xT systems for depositing copper layers on
semiconductor wafers. Semitool seeks an injunction against the manufacture and
sale of the SABRE and SABRE xT systems by us, and damages for alleged past
infringement. Semitool also seeks treble damages for alleged willful
infringement.

On March 17, 2000, the District Court granted us a motion for summary judgment
of non-infringement and ruled that our SABRE and SABRE xT systems do not
infringe Semitools patents. On May 15, 2000, Semitool appealed this ruling to
the United States Court of Appeals for the Federal Circuit. On June 8, 2001,
the Court of Appeals affirmed the judgment of non-infringement. On September 6,
2001, Semitool then filed a petition with the United States Supreme Court to
review the judgment of the Court of Appeals. The Supreme Court vacated the
Court of Appeals opinion and remanded the case to the Court of Appeals for
further consideration. On July 23, 2002, the Court of Appeals again affirmed
the District Courts judgment of non-infringement.

On June 11, 2001, Semitool again sued us for patent infringement in the United
States District Court for the District of Oregon. In this second lawsuit,
Semitool alleges that we infringed one of Semitools patents related to our
SABRE and SABRE xT systems. Semitool seeks an injunction against future
infringement by us, damages for past infringement, and treble damages for
alleged willful infringement.

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On November 13, 2001, we countersued Semitool for patent infringement in the
United States District Court for the District of Oregon. We alleged that
Semitool infringed certain patents related to the SABRE and SABRE xT systems.
We seek an injunction against Semitool, damages for past infringement, and
treble damages for willful infringement by Semitool.

This litigation is in its early stages, and therefore is inherently difficult
to assess. We believe that we have meritorious claims against Semitool, and
that this litigation will not have a material adverse impact on our business,
financial condition or results of operations. However, the outcome of patent
disputes is often affected by uncertainty in the resolution of complex issues
of fact and law. If Semitool were to prevail against us, the adverse effect on
our business, financial condition or results of operations could be material.

Plasma Physics Corporation and
Solar Physics Corporation

On June 14, 2002,
certain of our customers, including Agilent Technologies, Inc., Micron
Technology, Inc., Agere Systems, Inc., National Semiconductor Corporation,
Koninklijke Philips Electronics N.V., Texas Instruments, Inc., ST
Microelectronics, Inc., LSI Logic Corporation, International Business Machines
Corporation, Conexant Systems, Inc., Motorola, Inc., Advanced Micro Devices,
Inc. and Analog Devices Inc., were sued for patent infringement by Plasma
Physics Corporation and Solar Physics Corporation. We have not been sued by
Plasma Physics, Solar Physics, or any other party in connection with any
allegation of patent infringement by Plasma Physics or Solar Physics. Certain
defendants in the case have notified us that they believe that we have
indemnification obligations and liability relating to these lawsuits. We
believe that this matter will not have a material adverse impact on our
financial condition or results of operations. There can be no assurance,
however, that we will not be sued in the future in connection with the
allegations of patent infringement made by Plasma Physics and Solar Physics or
that, if we are sued, we will prevail in any such lawsuit. If a party were to
file such a lawsuit and prevail against us the adverse impact on our business,
financial condition or results of operations could be material.

Linear Technology Corporation

On March 12, 2002, Linear Technology
Corporation filed a complaint against Novellus, among other parties, in the
Superior Court of the State of California for the County of Santa Clara. The
complaint seeks damages (including punitive damages) and injunctions for causes
of actions involving alleged breach of contract, fraud, unfair competition,
breach of warranty and declaratory relief. We filed a demurrer to Linears
complaint.

This litigation is in its early stages and therefore inherently difficult to
assess. We believe that this litigation will not have a material adverse impact
on our financial condition or results of operations. However, the outcome of
patent disputes is often affected by uncertainty in the resolution of complex
issues of fact and law. If Linear were to prevail against us, the adverse
effect on our business, financial condition or results of operations could be
material.

Other Litigation

We are a defendant or plaintiff in various actions that arose in the normal
course of business. We believe that the ultimate disposition of these matters
will not have a material adverse effect on our business, financial condition or
results of operations.

NOTE 12 INCOME TAXES

Significant components of the provision for income taxes attributable to income
before income taxes and cumulative effect of a change in accounting principle
are as follows (in thousands):

|        |          |  |         |                          |   |      |        |         |   |  |        |         |   | 
|------- | -------- |  | ------- | ------------------------ | - | ---- | ------ | ------- | - |  | ------ | ------- | - | 
|        |          |  |         | Years ended December 31,
|        |          |  |         |                         
|        |          |  |         | 2002                     |   | 2001 |        | 2000   
|        |          |  |         |                          |   |      |        |        
|Federal |          |  |         |                          |   |      |        |         |   | 
|        | Current  |  | $       | (41,842                  | ) |      | $      | (40,645 | ) |  | $      | 92,781  |  
|        | Deferred |  |         | 19,346                   |   |      |        | 72,765  |   |  |        | (37,681 | )
|        |          |  |         |                          |   |      |        |         |   |  |        |         |  
|        |          |  | (22,496 | )                        |   |      | 32,120 |         |   |  | 55,100 |        

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|                                                                                                   |          |                                  |        |        |   |  |        |       |        |  |        |        |         |  |  | 
|-------------------------------------------------------------------------------------------------- | -------- | -------------------------------- | ------ | ------ | - |  | ------ | ----- | ------ |  | ------ | ------ | ------- |  |  | 
|State                                                                                              |          |                                  |        |        |   |  |        |       |        |  |        |       
|                                                                                                   | Current  |                                  |        | 377    |   |  |        | 864   |        |  |        | 9,552  |        
|                                                                                                   | Deferred |                                  |        | (8,853 | ) |  |        | 70    |        |  |        | (3,697 | )      
|                                                                                                   |          |                                  |        |        |   |  |        |       |        |  |        |        |        
|                                                                                                   |          |                                  | (8,476 | )      |   |  | 934    |       |        |  | 5,855  |       
|Foreign                                                                                            |          |                                  |        |        |   |  |        |       |        |  |        |       
|                                                                                                   | Current  |                                  |        | 11,544 |   |  |        | 6,816 |        |  |        | 9,794  |        
|Income tax benefits attributable to
employee stock plan activity
allocated to shareholders equity |          |                                  | 19,428 |        |   |  | 25,037 |       |        |  | 40,247 |       
|                                                                                                   |          |                                  |        |        |   |  |        |       |        |  |        |        |        
|                                                                                                   |          | Total provision for income taxes |        | $      |  |  |        | $     | 64,907 |  |        | $      | 110,996 | 
|                                                                                                   |          |                                  |        |        |   |  |        |       |        |  |        |        |         | 

Pre-tax income from foreign operations was approximately $18.0 million, $15.0
million and $31.0 million in 2002, 2001 and 2000, respectively.

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of our deferred tax assets and liabilities are as follows (in thousands):

|                          |                                                 |                                                 |   |              |         |      |   |         |         | 
|------------------------- | ----------------------------------------------- | ----------------------------------------------- | - | ------------ | ------- | ---- | - | ------- | ------- | 
|                          |                                                 |                                                 |   | December 31,
|                          |                                                 |                                                 |   |             
|                          |                                                 |                                                 |   | 2002         |         | 2001
|                          |                                                 |                                                 |   |              |         |     
|Deferred tax assets:      |                                                 |                                                 |   |              |         |      |   |        
|                          | Financial valuation accounts                    |                                                 | $ | 42,716       |         |      | $ | 16,542  |        
|                          | Expenses not currently deductible               |                                                 |   | 27,869       |         |      |   | 41,402  |        
|                          | Capitalized in-process research and development |                                                 |   | 29,826       |         |      |   | 27,282  |        
|                          | Deferred profit                                 |                                                 |   | 25,527       |         |      |   | 22,729  |        
|                          | Net Operating Loss carryforwards                |                                                 |   | 71,374       |         |      |   |        |        
|                          | Credits                                         |                                                 |   | 29,188       |         |      |   |        |        
|                          | Other                                           |                                                 |   |             |         |      |   | 9,590   |        
|                          |                                                 |                                                 |   |              |         |      |   |         |        
|                          |                                                 | Total deferred tax assets                       |   |              | 226,500 |      |   |         | 117,545 | 
|                          | Valuation allowance                             |                                                 |   | (57,028      | )       |      |   | (7,628  | )      
|                          |                                                 |                                                 |   |              |         |      |   |         |        
|                          |                                                 | Deferred tax assets, net of valuation allowance |   |              | 169,472 |      |   |         | 109,917 | 
|Deferred tax liabilities: |                                                 |                                                 |   |              |         |      |   |        
|                          | Depreciation                                    |                                                 |   | (69,246      | )       |      |   | (44,823 | )      
|                          | Other                                           |                                                 |   | (29          | )       |      |   |        |        
|                          |                                                 |                                                 |   |              |         |      |   |         |        
|                          |                                                 | Total net deferred tax assets                   |   | $            | 100,197 |      |   | $       | 65,094  | 
|                          |                                                 |                                                 |   |              |         |      |   |         |        

The net increase in the valuation allowance was $49.4 million during the year
ended December 31, 2002. This includes an increase of $52.5 million related to
the acquired deferred tax assets of SpeedFam-IPEC, which will be credited to
goodwill when realized. It also includes a decrease of $3.1 million related to
the amortization deduction realized on in-process technology purchased in a
prior year.

At December 31, 2002, we had federal and state tax credit carryforwards of
approximately $11.8 million and $17.4 million, respectively. The federal tax
credit carryforwards expire in years 2006 through 2022. Of the state tax
credit carryforwards, $15.4 million carry forward indefinitely
and $2.0 million
expire in 2009 and 2010.

The provision for income taxes differs from the provision calculated by
applying the federal statutory tax rate to income before income taxes, and
cumulative effect of a change in accounting principle, because of the following
(in thousands):

|                                  |                                  |   |                          |   |      |   |        |        |  |   |         |         | 
|--------------------------------- | -------------------------------- | - | ------------------------ | - | ---- | - | ------ | ------ |  | - | ------- | ------- | 
|                                  |                                  |   | Years ended December 31,
|                                  |                                  |   |                         
|                                  |                                  |   | 2002                     |   | 2001 |   | 2000  
|                                  |                                  |   |                          |   |      |   |       
|Expected provision at 35%         |                                  | $ | 8,022                    |   |      | $ | 73,282 |        |  | $ | 122,557 |        
|State tax, net of federal benefit |                                  |   | (3,975                   | ) |      |   | 2,886  |        |  |   | 8,307   |        
|Research and development credits  |                                  |   | (5,144                   | ) |      |   | (6,783 | )      |  |   | (6,490  | )      
|Export sales incentive            |                                  |   | (1,199                   | ) |      |   | (7,328 | )      |  |   | (13,663 | )      
|Valuation allowance decrease      |                                  |   | (3,100                   | ) |      |   | (3,100 | )      |  |   | (3,100  | )      
|Write-off of acquired IPR&D       |                                  |   | 3,151                    |   |      |   |       |        |  |   |        |        
|Other                             |                                  |   | 2,245                    |   |      |   | 5,950  |        |  |   | 3,385   |        
|                                  |                                  |   |                          |   |      |   |        |        |  |   |         |        
|                                  | Total provision for income taxes |   | $                        |  |      |   | $      | 64,907 |  |   | $       | 110,996 | 
|                                  |                                  |   |                          |   |      |   |        |        |  |   |         |        

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NOTE 13 SHAREHOLDERS EQUITY

Other Comprehensive (Loss) Income

The components of accumulated other comprehensive (loss) income, net of related
taxes are as follows (in thousands):

|                                                                    |                                               |   |              |        |      |   |        |       | 
|------------------------------------------------------------------- | --------------------------------------------- | - | ------------ | ------ | ---- | - | ------ | ----- | 
|                                                                    |                                               |   | December 31,
|                                                                    |                                               |   |             
|                                                                    |                                               |   | 2002         |        | 2001
|                                                                    |                                               |   |              |        |     
|Foreign currency translation adjustments                            |                                               | $ | (1,461       | )      |      | $ | (2,175 | )    
|Unrealized gain (loss) on available-for-sale securities, net of tax |                                               |   | (285         | )      |      |   | 3,701  |      
|                                                                    |                                               |   |              |        |      |   |        |      
|                                                                    | Accumulated other comprehensive (loss) income |   | $            | (1,746 | )    |   | $      | 1,526 | 
|                                                                    |                                               |   |              |        |      |   |        |      

Common Stock Repurchase Program

Through December 1998, the Board of Directors approved plans to repurchase up
to 10,460,000 shares of common stock for issuance in future employee benefit
and compensation plans and other requirements. In October 2000, GaSonics and
Novellus announced that their respective Boards of Directors had rescinded the
authorization for the purchase of common stock under the common stock purchase
program, through which time a total of 4,873,000 shares were repurchased.

On September 19, 2001, we announced that our Board of Directors authorized a
stock repurchase program of up to $500 million over the next two years. As of
December 31, 2002, 3,190,000 shares, or $78.2 million of common stock, has been
repurchased under this program.

NOTE 14 EMPLOYEE BENEFIT PLANS

Employee Stock Option Plans

We grant options to employees under several stock option plans. Under the 1992
Stock Option Plan, which expired in fiscal 2002, options to purchase up to 33.3
million shares of Novellus common stock were made available for grant at not
less than fair market value. In May 2001, our shareholders approved the 2001
Stock Incentive Plan, the terms of which reserve 6,360,000 shares of common
stock for future issuance. In December 2001, the Board of Directors approved
the reservation of 6,000,000 shares of common stock for future issuance under
the 2001 Non-Qualified Option Plan. In fiscal 2002, an additional 4,500,000
shares of common stock were reserved for future issuance under the 2001
Non-Qualified Option Plan. Options generally vest ratably over a four-year
period on the anniversary of the date of grant or as determined by the Board of
Directors. Stock options expire ten years after the date of grant. In addition,
we also award restricted stock to our employees from our 1992 Stock Option Plan
and our 2001 Stock Incentive Plan. We awarded a total of 252,100 shares of
common stock under our 1992 Stock Option Plan, of which 132,100 shares of common
stock remain outstanding as of December 31, 2002. We awarded a total of
100,000 shares of common stock under our 2001 Stock Incentive Plan, of which
95,000 shares of common stock remain outstanding as of December 31, 2002.

Pursuant to the terms of the SpeedFam-IPEC acquisition agreement, we
assumed SpeedFam-IPECs 1991 Employee Incentive Stock Option Plan, 1992 Stock
Option Plan, 1995 Stock Plan, 2001 Nonstatutory Stock Option Plan and
Stand-Alone Nonstatutory Stock Option Agreement. These plans accounted for
approximately 1,675,000 shares of common stock, of which 530,000 had
not been granted as of the acquisition date of December 6, 2002. These shares have been included in the stock option rollforward
table presented below.

We have adopted the disclosure-only provisions of SFAS 123, and accordingly, no
expense has been recognized for options granted to employees under the Plan.
We amortize deferred stock-based compensation on the graded
vesting method over the vesting periods of the applicable stock purchase rights
and stock options, generally four years. The graded vesting method provides
for vesting of portions of the overall awards at interim dates and results in
greater vesting in earlier years than the straight-line method. Had compensation expense been determined
based on the fair value at the grant date for

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awards, consistent with the
provisions of SFAS 123, our pro forma net income (loss) and net income (loss)
per share would be as follows (in thousands, except per share data):

|                                                                                                     |  |                          |         |      |  |      |         |   |  |   |         |  
|---------------------------------------------------------------------------------------------------- |  | ------------------------ | ------- | ---- |  | ---- | ------- | - |  | - | ------- | -
|                                                                                                     |  | Years ended December 31,
|                                                                                                     |  |                         
|                                                                                                     |  | 2002                     |         | 2001 |  | 2000
|                                                                                                     |  |                          |         |      |  |     
|Net income as reported                                                                               |  | $                        | 22,920  |      |  | $    | 144,470 |   |  | $ | 154,064 |  
|Add back:                                                                                            |  |                          |         |      |  |      |         |   |  |   |         |  
|Intrinsic value method
expense          included in
reported net income,          net of related tax |  |                          | 1,178   |      |  |      | 1,175   |   |  |   | 1,216   |  
|Less:                                                                                                |  |                          |         |      |  |      |         |   |  |   |         |  
|Fair value method expense,
net of          related tax                                               |  |                          | (70,232 | )    |  |      | (68,478 | ) |  |   | (41,869 | )
|                                                                                                     |  |                          |         |      |  |      |         |   |  |   |         |  
|Pro-forma
net (loss) income                                                                          |  | $                        | (46,134 | )    |  | $    | 77,167  |   |  | $ | 113,411 |  
|                                                                                                     |  |                          |         |      |  |      |         |   |  |   |         |  
|Pro-forma
basic net (loss) income per share                                                          |  | $                        | (0.32   | )    |  | $    | 0.53    |   |  | $ | 0.88    |  
|Pro-forma
diluted net (loss) income per share                                                        |  | $                        | (0.32   | )    |  | $    | 0.49    |   |  | $ | 0.82    |  

The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model, with the following weighted-average
assumptions for grants made in 2002, 2001 and 2000:

|                        |  |           |      |           |  |           |  |  |      |  |  | 
|----------------------- |  | --------- | ---- | --------- |  | --------- |  |  | ---- |  |  | 
|                        |  | 2002      |      | 2001      |  | 2000     
|                        |  |           |      |           |  |          
|Dividend
yield          |  | None      |      | None      |  | None     
|Expected volatility     |  |           | 0.85 |           |  | 0.85      |  |  | 0.83
|Risk free interest rate |  |           | 3.1% |           |  | 4.1%      |  |  | 6.2%
|Expected lives          |  | 3.1 years |      | 3.3 years |  | 3.3 years

The weighted-average fair value of options granted during the year was $17.67,
$22.85 and $21.50 for 2002, 2001 and 2000, respectively. The effects of applying SFAS 123 on pro forma disclosures are not likely to be
representative of the effects on pro forma disclosures of future years.

The pro forma net income and earnings per share listed above include expense
related to our Employee Stock Purchase Plans. The fair value of issuance under
the employee stock purchase plans is estimated on the date of issuance using
the Black-Scholes option-pricing model, with the following weighted-average assumptions for
issuance made in 2002, 2001 and 2000:

|                        |  |          |      |          |  |          |  |  |      |  |  | 
|----------------------- |  | -------- | ---- | -------- |  | -------- |  |  | ---- |  |  | 
|                        |  | 2002     |      | 2001     |  | 2000    
|                        |  |          |      |          |  |         
|Dividend yield          |  | None     |      | None     |  | None    
|Expected volatility     |  |          | 0.72 |          |  | 0.81     |  |  | 1.03
|Risk free interest rate |  |          | 2.0% |          |  | 4.2%     |  |  | 6.4%
|Expected lives          |  | 1/2 year |      | 1/2 year |  | 1/2 year

The weighted average fair value of purchase rights granted during the year was
$12.88, $16.76 and $21.66 for 2002, 2001 and 2000, respectively.

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Information with respect to stock option activity is as follows (in thousands,
except per share data):

|                              |                                     |  |                     |        |           |  |                |        |           |   |       |       | 
|----------------------------- | ----------------------------------- |  | ------------------- | ------ | --------- |  | -------------- | ------ | --------- | - | ----- | ----- | 
|                              |                                     |  | Options
Outstanding
|                              |                                     | 
|                              |                                     |  | Shares              |        |           |  |                |        | Weighted-
|                              |                                     |  | available           |        | Number of |  | average       
|                              |                                     |  | for grant           |        | shares    |  | exercise price
|                              |                                     |  |                     |        |           |  |               
|Balances at December 31, 1999 |                                     |  | 1,855               |        |           |  | 17,222         |        |           | $ | 16.11 |      
|                              | Additional authorization            |  |                     | 6,195  |           |  |                |       |           |   |       |      | 
|                              | Options granted                     |  |                     | (5,022 | )         |  |                | 5,022  |           |   | $     | 37.44 | 
|                              | Options exercised                   |  |                     |       |           |  |                | (3,155 | )         |   | $     | 10.32 | 
|                              | Options canceled                    |  |                     | 1,095  |           |  |                | (1,095 | )         |   | $     | 26.23 | 
|                              |                                     |  |                     |        |           |  |                |        |           |   |       |      
|Balances at December 31, 2000 |                                     |  | 4,123               |        |           |  | 17,994         |        |           | $ | 22.47 |      
|                              | Additional authorization            |  |                     | 12,122 |           |  |                |       |           |   |       |      | 
|                              | Options granted                     |  |                     | (7,614 | )         |  |                | 7,614  |           |   | $     | 39.85 | 
|                              | Options exercised                   |  |                     |       |           |  |                | (2,506 | )         |   | $     | 14.04 | 
|                              | Options canceled                    |  |                     | 543    |           |  |                | (543   | )         |   | $     | 32.64 | 
|                              |                                     |  |                     |        |           |  |                |        |           |   |       |      
|Balances at December 31, 2001 |                                     |  | 9,174               |        |           |  | 22,559         |        |           | $ | 29.04 |      
|                              | Additional authorization            |  |                     | 4,500  |           |  |                |       |           |   |       |      | 
|                              | Assumption of SpeedFam-IPEC options |  |                     | 530    |           |  |                | 1,145  |           |   | $     | 42.85 | 
|                              | Options granted                     |  |                     | (6,292 | )         |  |                | 6,292  |           |   | $     | 33.34 | 
|                              | Options exercised                   |  |                     |       |           |  |                | (2,485 | )         |   | $     | 15.23 | 
|                              | Options expired                     |  |                     | (513   | )         |  |                |       |           |   | $     | 35.71 | 
|                              | Options canceled                    |  |                     | 1,455  |           |  |                | (1,455 | )         |   | $     | 36.58 | 
|                              |                                     |  |                     |        |           |  |                |        |           |   |       |      
|Balances at December 31, 2002 |                                     |  | 8,854               |        |           |  | 26,056         |        |           | $ | 31.16 |      
|                              |                                     |  |                     |        |           |  |                |        |           |   |       |      

The following table summarizes information about stock options outstanding as
of December 31, 2002 (share data in thousands):

|                         |  |                     |                     |         |                  |                |                  |                   |                |                |                  |  |  |  |        |  |  |   |       |  | 
|------------------------ |  | ------------------- | ------------------- | ------- | ---------------- | -------------- | ---------------- | ----------------- | -------------- | -------------- | ---------------- |  |  |  | ------ |  |  | - | ----- |  | 
|Options Outstanding      |  | Options Exercisable
|                         |  |                    
|                         |  |                     |                     |         |                  |                | Weighted-Average |                   |                |                |                  |  |  |  |        |  |  |   |      
|                         |  |                     | Options Outstanding |         | Remaining        |                |                  |                   |                |                | Options          |  |  |  |       
|                         |  |                     | at December 31,     |         | Contractual Life |                | Weighted-Average |                   | Exercisable at |                | Weighted-Average
|Range of Exercise Prices |  | 2002                |                     | (years) |                  | Exercise Price |                  | December 31, 2002 |                | Exercise Price
|                         |  |                     |                     |         |                  |                |                  |                   |                |               
|$4.69 - $25.08           |  |                     | 5,493               |         |                  |                | 5.48             |                   |                | $              | 14.69            |  |  |  | 4,779  |  |  | $ | 14.07 | 
|$25.10 - $28.00          |  |                     | 3,736               |         |                  |                | 7.32             |                   |                | $              | 25.93            |  |  |  | 2,499  |  |  | $ | 25.85 | 
|$28.16 - $30.25          |  |                     | 7,276               |         |                  |                | 9.16             |                   |                | $              | 29.63            |  |  |  | 1,370  |  |  | $ | 30.21 | 
|$30.65 - $38.70          |  |                     | 6,001               |         |                  |                | 8.97             |                   |                | $              | 38.12            |  |  |  | 1,378  |  |  | $ | 38.35 | 
|$38.87 - $324.53         |  |                     | 3,550               |         |                  |                | 7.63             |                   |                | $              | 53.52            |  |  |  | 1,390  |  |  | $ | 59.71 | 
|                         |  |                     |                     |         |                  |                |                  |                   |                |                |                  |  |  |  |        |  |  |   |       | 
|$4.69 - $324.53          |  |                     | 26,056              |         |                  |                | 7.87             |                   |                | $              | 31.16            |  |  |  | 11,416 |  |  | $ | 27.07 | 
|                         |  |                     |                     |         |                  |                |                  |                   |                |                |                  |  |  |  |        |  |  |   |       | 

The range of option exercise prices for options outstanding at December 31,
2002 is wide, primarily due to the impact of assumed options of acquired
companies that had experienced significant price fluctuations.

Employee Stock Purchase Plans

In December 1988 and May 1992, we adopted qualified Employee Stock Purchase
Plans, referred to herein as the Purchase Plans, under Sections 421 and 423 of the
Internal Revenue Code, and reserved 1,200,000 and 900,000 shares of common
stock for issuance under the respective Purchase Plans. In April 1998, the
Board of Directors approved amendments to the Purchase Plans, which were
subsequently ratified by shareholders, increasing the number of shares
available for issuance thereunder from 2,100,000 shares to 2,850,000 shares. In
April 1999, the Board of Directors approved amendments to the Purchase Plans,
which were subsequently ratified by shareholders, increasing the number of
shares available for issuance thereunder from 2,850,000 shares to 3,900,000
shares. Under the Purchase Plans, qualified employees are entitled to purchase
shares at 85% of the fair market value on specified dates. There were
approximately 366,000, 309,000 and 237,000 shares issued under the Purchase
Plans in 2002, 2001 and 2000, respectively. In fiscal 2002, an additional
1,000,000 shares of

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common stock were reserved for future issuance under the
Purchase Plans. As of December 31, 2002, approximately 1,051,000 shares were
reserved for future issuance under the Purchase Plans.

Prior to our acquisition with GaSonics, GaSonics adopted the 1994 Employee
Stock Purchase Plan, or the GaSonics Plan. Participants in this plan were able
to purchase shares at 85% of the lower of the fair value of the common stock on
the participants entry date into the offering period or the fair market value
on the semi-annual purchase date. As of December 31, 2000, 379,000 shares were
reserved for future issuance under the GaSonics Plan. There were approximately
49,000 and 89,000 shares issued under the GaSonics Plan in 2000 and 1999,
respectively. Upon our acquisition of GaSonics in January 2001, the GaSonics
Plan was liquidated.

Employee Savings and Retirement Plan

We maintain a 401(k) retirement savings plan for our full-time employees.
Participants in the 401(k) plan may contribute up to 20% of their annual
salary, limited by the maximum dollar amount allowed by the Internal Revenue
Code. In January 2000, we announced that we would contribute a percentage of each participating
employees salary deferral contributions, up to a maximum of $2,000, or 50% of
the first 6% of an employees annual compensation. Our matching contributions
are invested in Novellus common stock and become fully vested at the end of the
employees third year of service beginning on January 1, 2000. We recorded $3.6
million, $4.7 million and $3.3 million of expense in connection with matching
contributions under the 401(k) plan for the years ended December 31, 2002, 2001 and
2000, respectively.

Before our acquisition of GaSonics, GaSonics maintained a 401(k) benefit plan
that covered all employees who met certain requirements. The GaSonics 401(k)
Plan included a deferred compensation arrangement that permitted participants
to make elective contributions. Contributions made by GaSonics employees were
at the discretion of the GaSonics Board of Directors and were not material in
2000 and 1999. Upon consummation of the GaSonics acquisition in January 2001,
GaSonics 401(k) plan was terminated.

NOTE 15 GEOGRAPHIC INFORMATION REPORTING AND MAJOR CUSTOMERS

We operate primarily in one segment, the manufacturing, marketing and servicing
of semiconductor wafer fabrication equipment for thin film deposition, surface
preparation and CMP systems. In accordance with SFAS No. 131, our chief
operating decision-maker is the Chairman of the Board of Directors and Chief
Executive Officer, who reviews operating results to make decisions about
allocating resources and assessing performance for the entire company. All
material operating units qualify for aggregation under SFAS No. 131, due to
their identical customer base and similarities in economic characteristics,
nature of products and services, and procurement, manufacturing and
distribution processes. Since we operate in one segment and in one group of
similar products and services, all financial segment and product line
information required by SFAS No. 131 can be found in the consolidated financial
statements.

For the year ended December 31, 2002, four customers accounted for 17%, 11%,
11% and 10% of our net sales, respectively. One customer accounted for 16% of
our net sales for the year ended December 31, 2001. For the year ended
December 31, 2000, two customers accounted for 14% and 10% of our net sales,
respectively.

For geographical reporting, revenues are attributed to the geographic location
in which the customer is located. Long-lived property, plant and equipment,
goodwill and other intangible assets are attributed to the geographic location
in which they are located.

The following is a summary of operations in geographic areas (in thousands):

|                                       |                 |               |           |           |  |              |        |              |  |              |         |         |  |   |         |         |   |   |           |           | 
|-------------------------------------- | --------------- | ------------- | --------- | --------- |  | ------------ | ------ | ------------ |  | ------------ | ------- | ------- |  | - | ------- | ------- | - | - | --------- | --------- | 
|2002                                   |                 | North America |           | Europe    |  | Asian
Region |        | Eliminations |  | Consolidated
|                                       |                 |               |           |           |  |              |        |              |  |             
|Sales to unaffiliated customers        |                 | $             | 719,957   |           |  | $            | 8,031  |              |  | $            | 111,970 |         |  | $ |        |         |   | $ | 839,958   |          
|Transfers between geographic locations |                 |               | 14,349    |           |  |              | 13,898 |              |  |              | 33,665  |         |  |   | (61,912 | )       |   |   |          |          
|                                       |                 |               |           |           |  |              |        |              |  |              |         |         |  |   |         |         |   |   |           |          
|                                       | Total net sales |               |           | 734,306   |  |              |        | 21,929       |  |              |         | 145,635 |  |   |         | (61,912 | ) |   |           | 839,958   | 
|                                       |                 |               |           |           |  |              |        |              |  |              |         |         |  |   |         |         |   |   |           |          
|Operating (loss) income                |                 | $             | (47,548   | )         |  | $            | 37,017 |              |  | $            | 4,730   |         |  | $ |        |         |   | $ | (5,801    | )        
|                                       |                 |               |           |           |  |              |        |              |  |              |         |         |  |   |         |         |   |   |           |          
|Long-lived assets                      |                 |               | 175,095   |           |  |              | 3,815  |              |  |              | 1,016   |         |  |   |        |         |   |   | 179,926   |          
|All other identifiable assets          |                 |               | 2,190,365 |           |  |              | 15,717 |              |  |              | 107,986 |         |  |   |        |         |   |   | 2,314,068 |          
|                                       |                 |               |           |           |  |              |        |              |  |              |         |         |  |   |         |         |   |   |           |          
|                                       | Total assets    |               | $         | 2,365,460 |  |              | $      | 19,532       |  |              | $       | 109,002 |  |   | $       |        |   |   | $         | 2,493,994 | 
|                                       |                 |               |           |           |  |              |        |              |  |              |         |         |  |   |         |         |   |   |           |          

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|                                       |                 |               |           |           |  |              |        |              |  |              |         |         |  |   |          |          |   |   |           |           | 
|-------------------------------------- | --------------- | ------------- | --------- | --------- |  | ------------ | ------ | ------------ |  | ------------ | ------- | ------- |  | - | -------- | -------- | - | - | --------- | --------- | 
|2001                                   |                 | North America |           | Europe    |  | Asian
Region |        | Eliminations |  | Consolidated
|                                       |                 |               |           |           |  |              |        |              |  |             
|Sales to unaffiliated customers        |                 | $             | 1,165,923 |           |  | $            | 7,425  |              |  | $            | 165,974 |         |  | $ |         |          |   | $ | 1,339,322 |          
|Transfers between geographic locations |                 |               | 84,257    |           |  |              | 16,185 |              |  |              | 33,347  |         |  |   | (133,789 | )        |   |   |          |          
|                                       |                 |               |           |           |  |              |        |              |  |              |         |         |  |   |          |          |   |   |           |          
|                                       | Total net sales |               |           | 1,250,180 |  |              |        | 23,610       |  |              |         | 199,321 |  |   |          | (133,789 | ) |   |           | 1,339,322 | 
|                                       |                 |               |           |           |  |              |        |              |  |              |         |         |  |   |          |          |   |   |           |          
|Operating Income                       |                 | $             | 135,137   |           |  | $            | 2,170  |              |  | $            | 14,677  |         |  | $ |         |          |   | $ | 151,984   |          
|                                       |                 |               |           |           |  |              |        |              |  |              |         |         |  |   |          |          |   |   |           |          
|Long-lived assets                      |                 |               | 172,494   |           |  |              | 608    |              |  |              | 4,499   |         |  |   |         |          |   |   | 177,601   |          
|All other identifiable assets          |                 |               | 2,758,827 |           |  |              | 5,475  |              |  |              | 89,221  |         |  |   |         |          |   |   | 2,853,523 |          
|                                       |                 |               |           |           |  |              |        |              |  |              |         |         |  |   |          |          |   |   |           |          
|                                       | Total assets    |               | $         | 2,931,321 |  |              | $      | 6,083        |  |              | $       | 93,720  |  |   | $        |         |   |   | $         | 3,031,124 | 
|                                       |                 |               |           |           |  |              |        |              |  |              |         |         |  |   |          |          |   |   |           |          
|                                      
|2000                                   |                 | North America |           | Europe    |  | Asian
Region |        | Eliminations |  | Consolidated
|                                       |                 |               |           |           |  |              |        |              |  |             
|Sales to unaffiliated customers        |                 | $             | 1,047,387 |           |  | $            | 9,726  |              |  | $            | 262,373 |         |  | $ |         |          |   | $ | 1,319,486 |          
|Transfers between geographic locations |                 |               | 158,258   |           |  |              | 13,387 |              |  |              | 33,994  |         |  |   | (205,639 | )        |   |   |          |          
|                                       |                 |               |           |           |  |              |        |              |  |              |         |         |  |   |          |          |   |   |           |          
|                                       | Total net sales |               |           | 1,205,645 |  |              |        | 23,113       |  |              |         | 296,367 |  |   |          | (205,639 | ) |   |           | 1,319,486 | 
|Operating income                       |                 | $             | 261,560   |           |  | $            | 1,827  |              |  | $            | 30,173  |         |  | $ | 274      |          |   | $ | 293,834   |          
|                                       |                 |               |           |           |  |              |        |              |  |              |         |         |  |   |          |          |   |   |           |          
|Long-lived assets                      |                 |               | 137,972   |           |  |              | 327    |              |  |              | 10,083  |         |  |   |         |          |   |   | 148,382   |          
|All other identifiable assets          |                 |               | 1,894,053 |           |  |              | 6,200  |              |  |              | 158,314 |         |  |   | (1,475   | )        |   |   | 2,057,092 |          
|                                       |                 |               |           |           |  |              |        |              |  |              |         |         |  |   |          |          |   |   |           |          
|                                       | Total assets    |               | $         | 2,032,025 |  |              | $      | 6,527        |  |              | $       | 168,397 |  |   | $        | (1,475   | ) |   | $         | 2,205,474 | 
|                                       |                 |               |           |           |  |              |        |              |  |              |         |         |  |   |          |          |   |   |           |          

Revenue for each geographic area is recognized from the locations within a
designated geographic region in accordance with SAB 101. Transfers and
commission arrangements between geographic areas are at prices sufficient to
recover a reasonable profit.

NOTE 16 BAD DEBT WRITE-OFF (RECOVERY)

In September 2001, we determined that, due to the financial difficulties facing
one of our customers, an outstanding accounts receivable balance was at risk
for collection. Accordingly, we recorded a write-off of $7.7 million. In the
first quarter of 2002, all amounts under this accounts receivable balance were
paid, resulting in a recovery of $7.7 million.

NOTE 17 RELATED PARTY TRANSACTIONS

Beginning in March 2002, we lease an
aircraft from NVLS I, LLC, a third-party entity
wholly-owned by Richard S. Hill, our Chairman and Chief Executive Officer.
Under the aircraft lease agreement, we incurred lease expense of approximately
$0.2 million, for the year ended December 31, 2002.

A member of our Board of Directors, D. James Guzy, is also a member of the
Board of Directors of Intel Corporation, one of our significant customers.
Intel Corporation represented approximately 11%, 16% and 14% of net sales for
the years ended December 31, 2002, 2001 and 2000, respectively. Intel
Corporation also accounted for 18% and 14% of our accounts receivable as of
December 31, 2002 and 2001, respectively.

From time to time we have made secured relocation loans to our executive
officers, vice presidents and key personnel. As of
December 31, 2002, we do not
have any outstanding loans to our executive officers as defined by the Securities
and Exchange Commission. However, we do have outstanding loans to
non-executive vice presidents and key personnel. As of

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December 31, 2002 and
2001, the total outstanding balance of loans to certain vice-presidents and key
personnel was approximately $5.7 million and $4.9 million,
respectively. Of the $5.7 million of loans outstanding at
December 31, 2002, $5.5 million were secured by collateral.

NOTE 18 QUARTERLY FINANCIAL DATA (UNAUDITED)

|                                              |  |         |         |         |  |                              |         |            |  |   |         |   |  |   |         | 
|--------------------------------------------- |  | ------- | ------- | ------- |  | ---------------------------- | ------- | ---------- |  | - | ------- | - |  | - | ------- | 
|                                              |  |         |         |         |  | Year ended December 31, 2002 |         |            |  |  
|                                              |  |        
|                                              |  | First   |         | Second  |  | Third                        |         | Fourth    
|(In
thousands, except per share data)         |  | Quarter |         | Quarter |  | Quarter                      |         | Quarter   
|                                              |  |         |         |         |  |                              |         |            |  |   |        
|Net sales                                     |  | $       | 169,679 |         |  | $                            | 222,147 |            |  | $ | 230,495 |   |  | $ | 217,637 | 
|Gross profit                                  |  | $       | 71,350  |         |  | $                            | 101,564 |            |  | $ | 109,382 |   |  | $ | 96,048  | 
|Net income                                    |  | $       | 3,836   |         |  | $                            | 12,013  |            |  | $ | 4,083   |   |  | $ | 2,988   | 
|Basic net income per share                    |  | $       | 0.03    |         |  | $                            | 0.08    |            |  | $ | 0.03    |   |  | $ | 0.02    | 
|Diluted net income per share                  |  | $       | 0.03    |         |  | $                            | 0.08    |            |  | $ | 0.03    |   |  | $ | 0.02    | 
|Shares used in basic per share calculations   |  |         | 144,255 |         |  |                              | 145,120 |            |  |   | 143,691 |   |  |   | 144,416 | 
|Shares used in diluted per share calculations |  |         | 150,624 |         |  |                              | 151,053 |            |  |   | 146,094 |   |  |   | 147,219 | 
|                                             
|                                              |  |         |         |         |  | Year ended December 31, 2001 |         |            |  |  
|                                              |  |        
|                                              |  | First   |         | Second  |  | Third                        |         | Fourth    
|(In
thousands, except per share data)         |  | Quarter |         | Quarter |  | Quarter                      |         | Quarter(1)
|                                              |  |         |         |         |  |                              |         |            |  |   |        
|Net sales                                     |  | $       | 458,705 |         |  | $                            | 376,899 |            |  | $ | 303,687 |   |  | $ | 200,031 | 
|Gross profit                                  |  | $       | 254,985 |         |  | $                            | 199,624 |            |  | $ | 140,138 |   |  | $ | 96,604  | 
|Net income (loss)                             |  | $       | 82,102  |         |  | $                            | 59,221  |            |  | $ | (14,019 | ) |  | $ | 17,166  | 
|Basic net income (loss) per share             |  | $       | 0.58    |         |  | $                            | 0.42    |            |  | $ | (0.10   | ) |  | $ | 0.12    | 
|Diluted net income (loss) per share           |  | $       | 0.55    |         |  | $                            | 0.40    |            |  | $ | (0.10   | ) |  | $ | 0.12    | 
|Shares used in basic per share calculations   |  |         | 141,009 |         |  |                              | 142,267 |            |  |   | 143,218 |   |  |   | 143,354 | 
|Shares used in diluted per share calculations |  |         | 148,108 |         |  |                              | 149,643 |            |  |   | 143,218 |   |  |   | 148,459 | 



---

|(1) |  | Net income for the fourth quarter of 2001 includes the benefit of a
pre-tax $25.4 million, or $0.12 per diluted share, for the reversal of bonus and
profit sharing expense recorded in the first three quarters of 2001.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Shareholders

Novellus Systems, Inc.

We have audited the accompanying consolidated balance sheets of Novellus
Systems, Inc. as of December 31, 2002 and 2001, and the related consolidated
statements of operations, shareholders equity, and cash flows for each of the
three years in the period ended December 31, 2002. Our audits also included the
financial statement schedule listed in the index at Item 15(a)(2). The
consolidated financial statements give retroactive effect to the acquisition of
GaSonics International Corporation by Novellus Systems, Inc. on January 10, 2001, which has
been accounted for using the pooling of interests method as described in the
notes to the consolidated financial statements. These financial statements and
schedule are the responsibility of the Companys management. Our responsibility
is to express an opinion on these financial statements and schedule based on
our audits. We did not audit the 2000 financial statements of GaSonics
International Corporation, which statements reflect total net sales constituting 11% of the related consolidated totals. Those statements were audited by other
auditors whose report has been furnished to us, and our opinion, insofar as it
relates to the data included for GaSonics International Corporation, is based solely on the
report of the other auditors.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits and the report of other auditors provide a reasonable basis for our
opinion.

In our opinion, based on our audits and the report of the other auditors, the
financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Novellus Systems, Inc. as of
December 31, 2002 and 2001 and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December 31,
2002, in conformity with accounting principles generally accepted in the United
States. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.

As discussed in Note 1 to the Consolidated Financial Statements, in 2000,
Novellus changed its method of accounting for revenue recognition in accordance
with guidance provided in SEC Staff Accounting Bulletin No. 101 (SAB 101),
Revenue Recognition in Financial Statements. As discussed
in Note 6 to the consolidated financial statements, in 2002,
Novellus changed its method of accounting for goodwill and other
intangible assets in accordance with guidance provided in Statement
of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets.

| |  |                      
| |  | ---------------------
| |  | /s/ ERNST & YOUNG LLP

San Jose, California
January 20, 2003

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable.




PART III




ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this item is included under Proposal No. 1:
Election of Directors, Other Information - Executive Officers and
Compliance with Section 16(a) of the Exchange Act in our Proxy Statement, to
be filed in connection with our 2003 Annual Meeting of Shareholders, and is
incorporated herein by reference.




ITEM 11. EXECUTIVE COMPENSATION

The information required by this item is included under Other Information -
Executive Compensation in our Proxy Statement, to be filed in connection with
our 2003 Annual Meeting of Shareholders, and is incorporated herein by
reference.




ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this item is included under Other Information -
Security Ownership of Certain Beneficial Owners and Management in our Proxy
Statement, to be filed in connection with our 2003 Annual Meeting of
Shareholders, and is incorporated herein by reference.




ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this item is included under Other Information -
Certain Transactions in our Proxy Statement, to be filed in connection with
our 2003 Annual Meeting of Shareholders, and is incorporated herein by
reference.




ITEM 14. CONTROLS AND PROCEDURES

Annual Evaluation of Our Disclosure Controls and Internal Controls

Within the 90 days prior to the date of this Annual Report on Form 10-K, we
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures and our internal controls and procedures for financial
reporting. This controls evaluation was done under the supervision and with the
participation of management, including our Chief Executive Officer and Chief
Financial Officer. Rules adopted by the Securities and Exchange Commission, or
the SEC, require that in this section of the Annual Report on Form 10-K, we
present the conclusions of the CEO and the CFO about the effectiveness of our
disclosure controls and internal controls based on and as of the date of the
controls evaluation.

CEO and CFO Certifications

Appearing immediately following the Signatures section of this Annual Report on
Form 10-K there are certifications of the Chief Executive Officer and the
Chief Financial Officer. The certifications are required in accordance
with Section 302 of the Sarbanes-Oxley Act of 2002. This section of the Annual
Report is the information concerning the controls evaluation referred to in the

65



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Section 302 certifications and this information should be read in conjunction
with the Section 302 certifications for a more complete understanding of the
topics presented.

Disclosure Controls and Internal Controls

Disclosure controls are procedures that are designed with the objective of
ensuring that information required to be disclosed in our reports filed under
the Securities Exchange Act of 1934, or the Exchange Act, such as this Annual
Report, is recorded, processed, summarized and reported within the time periods
specified in the SECs rules and forms. Disclosure controls are also designed
with the objective of ensuring that such information is accumulated and
communicated to our management, including the Chief Executive Officer and Chief
Financial Officer, as appropriate to allow timely decisions regarding required
disclosure. Internal controls are procedures which are designed with the
objective of providing reasonable assurance that our transactions are properly
authorized, our assets are safeguarded against unauthorized or improper use and
our transactions are properly recorded and reported, all to permit the
preparation of our financial statements in conformity with generally accepted
accounting principles.

Limitations on the Effectiveness of Controls

The companys management, including the Chief Executive Officer and the Chief
Financial Officer, does not expect that our disclosure controls or our internal
controls will prevent all error and all fraud. A control system, no matter how
well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met. Further, the
design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within the Company have been detected. These
inherent limitations include the realities that judgments in decision-making
can be faulty, and that breakdowns can occur because of simple error or
mistake. Additionally, controls can be circumvented by the individual acts of
some persons, by collusion of two or more people, or by management override of
the control. The design of any system of controls also is based in part upon
certain assumptions about the likelihood of future events, and there can be no
assurance that any design will succeed in achieving its stated goals under all
potential future conditions; over time, control may become inadequate because
of changes in conditions, or the degree of compliance with the policies or
procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur
and not be detected.

Scope of the Controls Evaluation

The evaluation of our disclosure controls and our internal controls by our
Chief Executive Officer and our Chief Financial Officer included a
review of controls implemented by the Company and the effect of the controls on the information generated for use in this
Annual Report on Form 10-K. In the course of the controls evaluation, we sought
to identify data errors, controls problems or acts of fraud and to confirm that
appropriate corrective action, including process improvements, were being
undertaken. This type of evaluation will be done on a quarterly basis so that
the conclusions concerning controls effectiveness can be reported in our
Quarterly Reports on Form 10-Q and our Annual Report on Form 10-K. Our internal
controls are also evaluated on an ongoing basis by our outsourced internal
audit department, by other personnel in our finance department and by our
independent auditors in connection with their audit and review activities. The
overall goals of these various evaluation activities are to monitor our
disclosure controls and our internal controls and to make modifications as
necessary; our intent in this regard is that the disclosure controls and the
internal controls will be maintained as dynamic systems that change (including
with improvements and corrections) as conditions warrant.

Among other matters, we sought in our evaluation to determine whether there
were any significant deficiencies or material
weaknesses in our internal controls, or whether we had identified any acts of fraud
involving personnel who have a significant role in our internal
controls. This information was important both for the controls evaluation
generally and because Items 5 and 6 in the Section 302 certifications of the
Chief Executive Officer and the Chief Financial Officer require that the Chief
Executive Officer and the Chief Financial Officer disclose that information to
our Boards Audit Committee and to our independent auditors and to report on
related matters in this section of the Annual Report on Form 10-K. In the
professional auditing literature, significant deficiencies are referred to as
reportable conditions. These are control issues that could have a
significant adverse effect on the ability to record, process, summarize and
report financial data in the financial statements. A material weakness is
defined in the auditing literature as a particularly serious reportable
condition where the internal control does not reduce to a relatively low level
the risk that misstatements caused by error or fraud may occur in amounts that
would be material in relation to the financial statements and not be detected
within a timely period by employees in the normal course of performing their
assigned

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functions. We also sought to deal with other controls matters in the
controls evaluation and, in each case if a problem was identified, we
considered what revision, improvement and/or correction to make in
accordance with
our ongoing procedures.
In accordance with SEC requirements, the Chief Executive Officer and the Chief
Financial Officer note that, since the date of the controls evaluation to the
date of this Annual Report, there have been no significant changes in internal
controls or in other factors that could significantly affect internal controls,
including any corrective actions with regard to significant deficiencies and
material weaknesses.

Conclusions

Based upon the controls evaluation, our Chief Executive Officer and our Chief
Financial Officer have concluded that, subject to the limitations noted above,
our disclosure controls are effective to ensure that material information
relating to the Company is made known to management, including the Chief
Executive Officer and the Chief Financial Officer, particularly during the
period when our periodic reports are being prepared, and that our internal
controls are effective to provide reasonable assurance that our financial
statements are fairly presented in conformity with generally accepted
accounting principles.




PART IV




ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)              The following documents are filed as part of this report:

|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1)    |  | Financial Statements and Report of Ernst & Young LLP, Independent Auditors
Consolidated Statements of Operations - Years Ended December 31, 2002, 2001, and 2000.
Consolidated Balance Sheets at December 31, 2002 and 2001.
Consolidated Statements of Cash Flows - Years Ended December 31, 2002, 2001, and 2000.
Consolidated Statement of Shareholders Equity - Years Ended December 31, 2002, 2001 and
2000.
Notes to Consolidated Financial Statements.
Report of Ernst & Young LLP, Independent Auditors.
|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|(2)    |  | Financial Statement Schedules
The following financial statement schedule is filed as part of this Report on Form 10-K
and should be read in conjunction with the financial statements:
Schedule II - Valuation and Qualifying Accounts.
All other schedules are omitted because they are not required or the required information
is included in the financial statements or notes thereto.                                                                                                                      
|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|(3)    |  | Exhibits (numbered in accordance with Item 601 of Regulation S-K)                                                                                                                                                                                                                                                                                                                                                                                                                                                
|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|2.1(1) |  | Agreement and Plan of Reorganization by and among Novellus Systems, Inc., NHL
Acquisition-Sub, Inc. and SpeedFam-IPEC, Inc. dated August 11, 2002.                                                                                                                                                                                                                                                                                                                                                               
|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|3.1(2) |  | Amended and Restated Articles of Incorporation of Novellus.                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|3.2(3) |  | Form of Bylaws of Novellus, as amended.                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|4.1    |  | Indenture between Integrated Process Equipment Corp. and State Street Bank and Trust
Company of California, N.A. dated September 15, 1997, as guaranteed by Novellus.                                                                                                                                                                                                                                                                                                                                            
|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|4.2    |  | First Supplemental Indenture by and among Integrated Process Equipment Corp.,
SpeedFam-IPEC, Inc. and State Street Bank and Trust Company of
California, N.A. dated April 6, 1999, as guaranteed by Novellus.                                                                                                                                                                                                                                                                                                    
|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|4.3    |  | Registration Rights Agreement between Integrated Process Equipment
Corp. and the Initial Purchasers dated September 15,
1997, as guaranteed by Novellus.                                                                                                                                                                                                                                                                                                                                                         
|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|4.4    |  | Specimen of 6 1/4% Convertible Subordinated Note due 2004 in the amount of $115,000,000
issued by Integrated Process Equipment Corp. on September 17,
1997, as guaranteed by Novellus.                                                                                                                                                                                                                                                                                                                           
|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|4.5    |  | Second Supplemental Indenture by and among SpeedFam-IPEC Corporation f/k/a Integrated
Process Equipment Corp., SpeedFam-IPEC, Inc., Novellus Systems, Inc. and State Street Bank and Trust
Company of California, N.A. dated December 6, 2002.                                                                                                                                                                                                                                                                   

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|           |  |                                                                                                                                                                                                                                                    
|---------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|8.1(4)     |  | Written opinion regarding tax matters associated with the Liquid Yield Option Notes
issued by Shearman & Sterling dated September 25, 2001.                                                                                                       
|           |  |                                                                                                                                                                                                                                                    
|10.3(5)    |  | Assignment and Assumption of Lessees Interest in Lease (Units 8 and 9, Palo Alto) and
Covenants, Conditions and Restrictions on Leasehold Interests (Units 1-12, Palo Alto) by
and between Varian Associates, Inc. and Novellus dated May 7, 1997.
|           |  |                                                                                                                                                                                                                                                    
|10.4(6)    |  | Sublease (Portion of Unit 9, Palo Alto) by and between Varian Associates, Inc. and
Novellus dated May 7, 1997.                                                                                                                                     
|           |  |                                                                                                                                                                                                                                                    
|10.5(7)    |  | Environmental Agreement by and between Varian Associates, Inc. and Novellus dated May 7,
1997.                                                                                                                                                     
|           |  |                                                                                                                                                                                                                                                    
|10.8(8)    |  | Settlement Agreement by and between Applied Materials, Inc. and Novellus dated May 4,
1997. Confidential treatment has been granted with respect to portions of this Exhibit.                                                                      
|           |  |                                                                                                                                                                                                                                                    
|*10.9(9)   |  | Novellus 1992 Stock Option Plan, together with forms of agreements thereunder.                                                                                                                                                                    
|           |  |                                                                                                                                                                                                                                                    
|*10.10(10) |  | Form of Restated Stock Purchase Agreement between Novellus and Jeff Benzing, Wilbert van
den Hoek and certain other employees of Novellus dated December 16, 1999.                                                                                 
|           |  |                                                                                                                                                                                                                                                    
|*10.11(11) |  | Novellus 1992 Employee Stock Purchase Plan.                                                                                                                                                                                                       
|           |  |                                                                                                                                                                                                                                                    
|*10.12(12) |  | Form of Directors and Officers Indemnification Agreement.                                                                                                                                                                                          
|           |  |                                                                                                                                                                                                                                                    
|*10.13(13) |  | Employment Agreement between Novellus and Peter Hanley dated June 15, 1992.                                                                                                                                                                        
|           |  |                                                                                                                                                                                                                                                    
|*10.14(14) |  | Offer Letter Agreement between Novellus and Richard S. Hill dated November 1, 1993.                                                                                                                                                                
|           |  |                                                                                                                                                                                                                                                    
|*10.15(15) |  | Employment Agreement between Novellus and Richard S. Hill dated October 1, 1998.                                                                                                                                                                   
|           |  |                                                                                                                                                                                                                                                    
|*10.16(16) |  | Amendment to Employment Agreement between Novellus and Richard S. Hill dated December 16,
1999.                                                                                                                                                    
|           |  |                                                                                                                                                                                                                                                    
|*10.17(16) |  | Restricted Stock Purchase Agreement between Novellus and Richard S. Hill dated December
16, 1999.                                                                                                                                                  
|           |  |                                                                                                                                                                                                                                                    
|*10.18(17) |  | Employment Agreement between Novellus and Asuri Raghavan dated January 12, 2001.                                                                                                                                                                   
|           |  |                                                                                                                                                                                                                                                    
|*10.19(18) |  | GaSonics International Corporation Amended and Restated 1994 Stock
Option/Stock Issuance Plan, together with forms of
agreements thereunder, as assumed by Novellus.                                                                               
|           |  |                                                                                                                                                                                                                                                    
|*10.20(19) |  | Gamma Precision Technology, Inc. 1998 Stock Option Plan, together with forms of
agreements thereunder, as assumed by Novellus.                                                                                                                     
|           |  |                                                                                                                                                                                                                                                    
|*10.21(20) |  | GaSonics International Corporation Supplemental Stock Option Plan, as assumed by Novellus.                                                                                                                                                         
|           |  |                                                                                                                                                                                                                                                    
|*10.22(21) |  | Form of Light Industrial Lease between Teachers Insurance and Annuity Association of
America and GaSonics, Inc. for office space at 2730 Junction Avenue, San Jose, California.                                                                    
|           |  |                                                                                                                                                                                                                                                    
|10.23(22)  |  | Participation Agreement among Novellus Systems, Inc., ABN AMRO
Leasing, Inc., the participants named therein and ABN
AMRO Bank N.V. dated April 18, 2001.                                                                                          
|           |  |                                                                                                                                                                                                                                                    
|10.24(23)  |  | Novellus Systems, Inc. 2001 Stock Incentive Plan dated May 11, 2001, together with forms
of agreement thereunder.                                                                                                                                  
|           |  |                                                                                                                                                                                                                                                    
|10.25(24)  |  | Participation Agreement among Novellus Systems, Inc., ABN AMRO Leasing, Inc.,
Novellus Investment I, LLC and ABN AMRO Bank N.V. dated September 21, 2001.                                                                                          
|           |  |                                                                                                                                                                                                                                                    
|10.26(25)  |  | Amended and Restated
Ground Lease Agreement between Novellus Systems, Inc. and ABN AMRO
Leasing, Inc. dated September 21, 2001.                                                                                                                    
|           |  |                                                                                                                                                                                                                                                    
|*10.27     |  | Employment Agreement between SpeedFam International, Inc. and Richard J. Faubert dated
October 8, 1998.                                                                                                                                            
|           |  |                                                                                                                                                                                                                                                    
|*10.28     |  | Letter Agreement between Novellus and Robert Smith dated
September 24, 2002.                                                                                                                                                                       
|           |  |                                                                                                                                                                                                                                                    
|*10.29     |  | Separation Agreement between Novellus and Asuri Raghavan dated
February 5, 2003.                                                                                                                                                                   
|           |  |                                                                                                                                                                                                                                                    
|*10.30     |  | SpeedFam-IPEC, Inc. Amended and Restated 1995 Stock Plan, as assumed by Novellus.                                                                                                                                                                  

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|       |  |                                                                                                                                                                                                                                                        
|------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|*10.31 |  | SpeedFam-IPEC, Inc. 2001 Nonstatutory Stock Option Plan, together with forms of
agreements thereunder, as assumed by Novellus.                                                                                                                         
|       |  |                                                                                                                                                                                                                                                        
|*10.32 |  | Integrated Process Equipment Corporation 1992 Stock Option Plan, as assumed by Novellus.                                                                                                                                                               
|       |  |                                                                                                                                                                                                                                                        
|*10.33 |  | SpeedFam International, Inc. Amended and Restated 1991 Employee Incentive Stock Option
Plan, as assumed by Novellus.                                                                                                                                   
|       |  |                                                                                                                                                                                                                                                        
|*10.34 |  | SpeedFam-IPEC, Inc. Stand-Alone Stock Option Agreement dated June 14, 2001 between
SpeedFam-IPEC, Inc. and Peter Simone, as assumed by Novellus.                                                                                                       
|       |  |                                                                                                                                                                                                                                                        
|10.35  |  | Lease Agreement between Seldin Properties and Integrated Process
Equipment Corp. dated
December 26, 1996.                                                                                                                                              
|       |  |                                                                                                                                                                                                                                                        
|10.36  |  | Purchase and Sale Agreement between Glen Una Management Company, Inc. and SpeedFam-IPEC,
Inc. dated May 31, 2002.                                                                                                                                      
|       |  |                                                                                                                                                                                                                                                        
|10.37  |  | Lease Agreement between Phoenix Industrial Investment Partners, L.P. and SpeedFam-IPEC,
Inc. dated June 21, 2002.                                                                                                                                      
|       |  |                                                                                                                                                                                                                                                        
|10.38  |  | First Amendment to Lease Agreement between Phoenix Industrial Investment Partners, L.P.
and SpeedFam-IPEC, Inc. dated January 21, 2003.                                                                                                                
|       |  |                                                                                                                                                                                                                                                        
|10.39  |  | Lease Guaranty between Novellus and Phoenix Industrial Investment
Partners, L.P. dated January 21, 2003.                                                                                                                                               
|       |  |                                                                                                                                                                                                                                                        
|12.1   |  | Ratio of Earnings to Fixed Charges.                                                                                                                                                                                                                    
|       |  |                                                                                                                                                                                                                                                        
|21.1   |  | Subsidiaries of Novellus.                                                                                                                                                                                                                              
|       |  |                                                                                                                                                                                                                                                        
|23.1   |  | Consent of Ernst & Young LLP, Independent Auditors.                                                                                                                                                                                                    
|       |  |                                                                                                                                                                                                                                                        
|24.1   |  | Power of Attorney (see page 72).                                                                                                                                                                                                                       
|       |  |                                                                                                                                                                                                                                                        
|99.1   |  | Certification of Richard S. Hill, Chairman of the Board of Directors and Chief Executive
Officer of Novellus Systems, Inc. dated March 5, 2003 in accordance with 18 U.S.C.
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|       |  |                                                                                                                                                                                                                                                        
|99.2   |  | Certification of Kevin S. Royal, Vice President and Chief Financial Officer of Novellus
Systems, Inc. dated March 5, 2003 in accordance with 18 U.S.C. 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                     
|       |  |                                                                                                                                                                                                                                                        
|99.3   |  | Statement Regarding Consent of Arthur Andersen LLP, Independent Public
Accountants.                                                                                                                                                                    
|       |  |                                                                                                                                                                                                                                                        
|      

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|(1)  |  | Incorporated by reference to the
exhibit with the corresponding exhibit number in Novellus Report on
Form 8-K filed with the Securities and Exchange Commission on August 14,
2002.                   
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(2)  |  | Incorporated by reference to the
exhibit with the corresponding exhibit number in Novellus Report on Form
10-K filed with the Securities and Exchange Commission on March 30, 2000.                   
|    
|(3)  |  | Incorporated by reference to exhibit with the corresponding exhibit
number in Novellus Report on Form 10-K filed with the Securities and
Exchange Commission on March 21, 2002.                       
|    
|(4)  |  | Incorporated by reference to the exhibit with the corresponding exhibit
number in Novellus Registration Statement on Form S-3 filed with the
Securities and Exchange Commission on September 25, 2001.
|    
|(5)  |  | Incorporated by reference to Exhibit 2.3 to Novellus Report on Form 8-K
filed with the Securities and Exchange Commission on July 7, 1997.                                                            
|    
|(6)  |  | Incorporated by reference to Exhibit 2.4 to Novellus Report on Form 8-K
filed with the Securities and Exchange Commission on July 7, 1997.                                                            
|    
|(7)  |  | Incorporated by reference to Exhibit 2.6 to Novellus Report on Form 8-K
filed with the Securities and Exchange Commission on July 7, 1997.                                                            
|    
|(8)  |  | Incorporated by reference to Exhibit 10.1 to Novellus Report on Form
10-Q filed with the Securities and Exchange Commission on August 11, 1997.                                                       
|    
|(9)  |  | Incorporated by reference to Exhibit 10.30 filed with Novellus Report on
Form 10-K filed with the Securities and Exchange Commission on February
26, 1993.                                            
|    
|(10) |  | Incorporated by reference to
Exhibit 10.21 to Novellus Report on Form 10-K filed
with the Securities and Exchange Commission on March 30, 2000.                                                       
|    
|(11) |  | Incorporated by reference to Exhibit 10.31 filed with Novellus Report on
Form 10-K filed with the Securities and Exchange Commission on February
26, 1993.                                            
|    
|(12) |  | Incorporated by reference to Exhibit 10.1 filed with Novellus Report on
Form 10-Q filed with the Securities and Exchange Commission on August 13,
2002.                                               
|    
|(13) |  | Incorporated by reference to Exhibit 10.34 filed with Novellus Report on
Form 10-K filed with the Securities and Exchange Commission on February
26, 1993.                                            
|    
|(14) |  | Incorporated by reference to Exhibit 10.41 filed with Novellus Report on
Form 10-K filed with the Securities and Exchange Commission on February
18, 1994.                                            
|    
|(15) |  | Incorporated by reference to Exhibit 10.27 to Novellus Report on Form
10-K filed with the Securities and Exchange Commission on March 10, 1999.                                                       
|    
|(16) |  | Incorporated by reference to Exhibit 10.27 to Novellus Report on Form
10-K filed with the Securities and Exchange Commission on March 30, 2000.                                                       
|    
|(17) |  | Incorporated by reference to
Exhibit 10.30 to Novellus Report on Form 10-K filed with the Securities and Exchange
Commission on March 23, 2001.                                                       
|    
|(18) |  | Incorporated by reference to Exhibit 10.31 to Novellus Report on Form
10-K filed with the Securities and Exchange Commission on March 23, 2001.                                                       

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|(19) |  | Incorporated by reference to Exhibit 10.32 to Novellus Report on Form
10-K filed with the Securities and Exchange Commission on March 23, 2001.  
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(20) |  | Incorporated by reference to Exhibit 10.33 to Novellus Report on Form
10-K filed with the Securities and Exchange Commission on March 23, 2001.  
|    
|(21) |  | Incorporated by reference to Exhibit 10.34 to Novellus Report on Form
10-K filed with the Securities and Exchange Commission on March 23, 2001.  
|    
|(22) |  | Incorporated by reference to Exhibit 10.6 to Novellus Report on Form
10-Q filed with the Securities and Exchange Commission on May 15, 2001.     
|    
|(23) |  | Incorporated by reference to Exhibit 10.7 to Novellus Report on Form
10-Q filed with the Securities and Exchange Commission on May 15, 2001.     
|    
|(24) |  | Incorporated by reference to Exhibit 10.1 to Novellus Report on Form
10-Q filed with the Securities and Exchange Commission on November 13,
2001.
|    
|(25) |  | Incorporated by reference to Exhibit 10.2 to Novellus Report on Form
10-Q filed with the Securities and Exchange Commission on
November 13,
2001.



---

|* |  | Management contracts or compensatory plans or arrangements.
|- |  | -----------------------------------------------------------



|(b) |  | Reports on Form 8-K:                                                                                        
|--- |  | ------------------------------------------------------------------------------------------------------------
|   
|    |  | On December 9, 2002, Novellus filed a report on Form 8-K relating to the
acquisition of SpeedFam- IPEC, Inc.

71



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##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this Report on Form 10-K
to be signed on its behalf by the undersigned, thereunto duly authorized, in
the City of San Jose, State of California on this
5th day of March, 2003.

NOVELLUS SYSTEMS, INC.

|    |  |                                                                               
|--- |  | ------------------------------------------------------------------------------
|By: |  | /s/ Richard S. Hill                                                           
|    |  | Richard S. Hill
Chairman of the Board of Directors
and Chief Executive Officer

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Richard S. Hill and Kevin S. Royal, and each of
them, his attorneys-in-fact, each with the power of substitution, for him in
any and all capacities, to sign any amendments to this Annual Report on Form
10-K and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorneys-in-fact, or his
substitute or substitutes, may do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this
Annual Report on Form 10-K has been signed by the following persons on behalf
of the Registrant in the capacities and on the date indicated.

|                                      |  |                                                                                                           |  |              
|------------------------------------- |  | --------------------------------------------------------------------------------------------------------- |  | -------------
|Signature                             |  | Title                                                                                                     |  | Date         
|                                      |  |                                                                                                           |  |              
|/s/ Richard S. Hill
Richard S. Hill   |  | Chairman of the Board of Directors
and Chief Executive Officer
(Principal Executive Officer)              |  | March 5, 2003
|                                     
|/s/ Kevin S. Royal
Kevin S. Royal     |  | Vice President and
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer) |  | March 5, 2003
|                                     
|/s/ D. James Guzy
D. James Guzy       |  | Director                                                                                                  |  | March 5, 2003
|                                     
|/s/ J. David Litster
J. David Litster |  | Director                                                                                                  |  | March 5, 2003
|                                     
|/s/ Yoshio Nishi
Yoshio Nishi         |  | Director                                                                                                  |  | March 5, 2003
|                                     
|/s/ Glen Possley
Glen Possley         |  | Director                                                                                                  |  | March 5, 2003

72



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##### Table of Contents



|                                        |  |          |  |              
|--------------------------------------- |  | -------- |  | -------------
|                                        |  |          |  |              
|                                       
|/s/ William R. Spivey
William R. Spivey |  | Director |  | March 5, 2003
|                                       
|/s/ Ann D. Rhoads
Ann D. Rhoads         |  | Director |  | March 5, 2003
|                                       
|/s/ Delbert Whitaker
Delbert Whitaker   |  | Director |  | March 5, 2003

73



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##### Table of Contents



CERTIFICATION

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Richard S. Hill, certify that:



|1. |  | I have reviewed this annual report on Form 10-K of Novellus Systems,
Inc.;                                                                                                                                                                                                                                              
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;                   
|  
|4. |  | The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:                                                                                               



| | a) |  | designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the Evaluation Date); and                                                                                                  
|
| | c) |  | presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                        



|5. |  | The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent functions):
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrants
ability to record, process, summarize and report financial data and
have identified for the registrants auditors any material weaknesses
in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrants
internal controls; and                                                                                                                                        



|6. |  | The registrants other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                    |  |                                                                                                   
|------------------- |  | --------------------------------------------------------------------------------------------------
|Date: March 5, 2003 |  | /s/ Richard S. Hill
Richard S. Hill
Chairman of the Board of Directors and
Chief Executive Officer

74



---



##### Table of Contents



CERTIFICATION

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Kevin S. Royal, certify that:



|1. |  | I have reviewed this annual report on Form 10-K of Novellus Systems,
Inc.;                                                                                                                                                                                                                                              
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;                   
|  
|4. |  | The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:                                                                                               



| | a) |  | designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the Evaluation Date); and                                                                                                  
|
| | c) |  | presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                        



|5. |  | The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent functions):
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrants
ability to record, process, summarize and report financial data and
have identified for the registrants auditors any material weaknesses
in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrants
internal controls; and                                                                                                                                        



|6. |  | The registrants other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                    |  |                                                                             
|------------------- |  | ----------------------------------------------------------------------------
|Date: March 5, 2003 |  | /s/ Kevin S. Royal
Kevin S. Royal
Vice President and Chief Financial Officer

75



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##### Table of Contents



SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)

|                                |  |            |        |            |  |            |       |            |  |           |      |   |  |     |        |            |  |   |        | 
|------------------------------- |  | ---------- | ------ | ---------- |  | ---------- | ----- | ---------- |  | --------- | ---- | - |  | --- | ------ | ---------- |  | - | ------ | 
|                                |  | Balance at |        |            |  |            |       |            |  |           |      |   |  |     |        | Balance at
|                                |  | Beginning  |        | Charged to |  |            |       |            |  |           |      |   |  | End
|Description                     |  | of Period  |        | Expense    |  | Write-offs |       | Recoveries |  | of Period
|                                |  |            |        |            |  |            |       |            |  |          
|Year Ended December 31, 2000    |  |            |        |            |  |            |       |            |  |           |      |   |  |     |        |            |  |   |        | 
|Allowance for Doubtful Accounts |  | $          | 4,375  |            |  |            | 1,335 |            |  |           | (318 | ) |  |     |       |            |  | $ | 5,392  | 
|Year Ended December 31, 2001    |  |            |        |            |  |            |       |            |  |           |      |   |  |     |        |            |  |   |        | 
|Allowance for Doubtful Accounts |  | $          | 5,392  |            |  |            | 9,209 |            |  |           | (211 | ) |  |     |       |            |  | $ | 14,390 | 
|Year Ended December 31, 2002    |  |            |        |            |  |            |       |            |  |           |      |   |  |     |        |            |  |   |        | 
|Allowance for Doubtful Accounts |  | $          | 14,390 |            |  |            | 1,042 |            |  |           | (431 | ) |  |     | (7,662 | )          |  | $ | 7,339  | 

76



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##### Table of Contents



EXHIBIT INDEX

|           |  |                                                                                                                                                                                                                                                     
|---------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|           |  |                                                                                                                                                                                                                                                     
|2.1(1)     |  | Agreement and Plan of Reorganization by and among Novellus Systems, Inc., NHL
Acquisition-Sub, Inc. and SpeedFam-IPEC, Inc. dated August 11, 2002.                                                                                                  
|           |  |                                                                                                                                                                                                                                                     
|3.1(2)     |  | Amended and Restated Articles of Incorporation of Novellus.                                                                                                                                                                                         
|           |  |                                                                                                                                                                                                                                                     
|3.2(3)     |  | Form of Bylaws of Novellus, as amended.                                                                                                                                                                                                             
|           |  |                                                                                                                                                                                                                                                     
|4.1        |  | Indenture between Integrated Process Equipment Corp. and State Street Bank and Trust
Company of California, N.A. dated September 15, 1997, as
guaranteed by Novellus.                                                                               
|           |  |                                                                                                                                                                                                                                                     
|4.2        |  | First Supplemental Indenture by and among Integrated Process Equipment Corp.,
SpeedFam-IPEC, Inc. and State Street Bank and Trust Company of
California, N.A. dated April 6, 1999, as guaranteed by Novellus.                                       
|           |  |                                                                                                                                                                                                                                                     
|4.3        |  | Registration Rights Agreement between Integrated Process Equipment
Corp. and the Initial Purchasers dated September 15,
1997, as guaranteed by Novellus.                                                                                            
|           |  |                                                                                                                                                                                                                                                     
|4.4        |  | Specimen of 6 1/4% Convertible Subordinated Note due 2004 in the amount of $115,000,000
issued by Integrated Process Equipment Corp. on September 17, 1997, as guaranteed by Novellus.                                                              
|           |  |                                                                                                                                                                                                                                                     
|4.5        |  | Second Supplemental Indenture by and among SpeedFam-IPEC Corporation f/k/a Integrated
Process Equipment Corp., SpeedFam-IPEC, Inc., Novellus Systems, Inc. and State Street Bank and Trust
Company of California, N.A. dated as of December 6, 2002.
|           |  |                                                                                                                                                                                                                                                     
|8.1(4)     |  | Written opinion regarding tax matters associated with the Liquid Yield Option Notes
issued by Shearman & Sterling dated September 25, 2001.                                                                                                        
|           |  |                                                                                                                                                                                                                                                     
|10.3(5)    |  | Assignment and Assumption of Lessees Interest in Lease (Units 8 and 9, Palo Alto) and
Covenants, Conditions and Restrictions on Leasehold Interests (Units 1-12, Palo Alto) by
and between Varian Associates, Inc. and Novellus dated May 7, 1997. 
|           |  |                                                                                                                                                                                                                                                     
|10.4(6)    |  | Sublease (Portion of Unit 9, Palo Alto) by and between Varian Associates, Inc. and
Novellus dated May 7, 1997.                                                                                                                                      
|           |  |                                                                                                                                                                                                                                                     
|10.5(7)    |  | Environmental Agreement by and between Varian Associates, Inc. and Novellus dated May 7,
1997.                                                                                                                                                      
|           |  |                                                                                                                                                                                                                                                     
|10.8(8)    |  | Settlement Agreement by and between Applied Materials, Inc. and Novellus dated May 4,
1997. Confidential treatment has been granted with respect to portions of this Exhibit.                                                                       
|           |  |                                                                                                                                                                                                                                                     
|*10.9(9)   |  | Novellus 1992 Stock Option Plan, together with forms of agreements thereunder.                                                                                                                                                                     
|           |  |                                                                                                                                                                                                                                                     
|*10.10(10) |  | Form of Restated Stock Purchase Agreement between Novellus and Jeff Benzing, Wilbert van
den Hoek and certain other employees of Novellus dated December 16, 1999.                                                                                  
|           |  |                                                                                                                                                                                                                                                     
|*10.11(11) |  | Novellus 1992 Employee Stock Purchase Plan.                                                                                                                                                                                                        
|           |  |                                                                                                                                                                                                                                                     
|*10.12(12) |  | Form of Directors and Officers Indemnification Agreement.                                                                                                                                                                                           
|           |  |                                                                                                                                                                                                                                                     
|*10.13(13) |  | Employment Agreement between Novellus and Peter Hanley dated June 15, 1992.                                                                                                                                                                         
|           |  |                                                                                                                                                                                                                                                     
|*10.14(14) |  | Offer Letter Agreement between Novellus and Richard S. Hill dated November 1, 1993.                                                                                                                                                                 
|           |  |                                                                                                                                                                                                                                                     
|*10.15(15) |  | Employment Agreement between Novellus and Richard S. Hill dated October 1, 1998.                                                                                                                                                                    
|           |  |                                                                                                                                                                                                                                                     
|*10.16(16) |  | Amendment to Employment Agreement between Novellus and Richard S. Hill dated December 16,
1999.                                                                                                                                                     
|           |  |                                                                                                                                                                                                                                                     
|*10.17(16) |  | Restricted Stock Purchase Agreement between Novellus and Richard S. Hill dated December
16, 1999.                                                                                                                                                   
|           |  |                                                                                                                                                                                                                                                     
|*10.18(17) |  | Employment Agreement between Novellus and Asuri Raghavan dated January 12, 2001.                                                                                                                                                                    
|           |  |                                                                                                                                                                                                                                                     
|*10.19(18) |  | GaSonics International Corporation Amended and Restated 1994 Stock
Option/Stock Issuance Plan, together with forms of
agreements thereunder, as assumed by Novellus.                                                                                





---



##### Table of Contents



|           |  |                                                                                                                                                                                                                                                        
|---------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|*10.20(19) |  | Gamma Precision Technology, Inc. 1998 Stock Option Plan, together with forms of
agreements thereunder, as assumed by Novellus.                                                                                                                         
|           |  |                                                                                                                                                                                                                                                        
|*10.21(20) |  | GaSonics International Corporation Supplemental Stock Option Plan, as assumed by Novellus.                                                                                                                                                             
|           |  |                                                                                                                                                                                                                                                        
|*10.22(21) |  | Form of Light Industrial Lease between Teachers Insurance and Annuity Association of
America and GaSonics, Inc. for office space at 2730 Junction Avenue, San Jose, California.                                                                        
|           |  |                                                                                                                                                                                                                                                        
|10.23(22)  |  | Participation Agreement among Novellus Systems, Inc., ABN AMRO
Leasing, Inc., the participant named therein and ABN
AMRO Bank N.V. dated April 18, 2001.                                                                                               
|           |  |                                                                                                                                                                                                                                                        
|10.24(23)  |  | Novellus Systems, Inc. 2001 Stock Incentive Plan dated May 11, 2001, together with forms
of agreement thereunder.                                                                                                                                      
|           |  |                                                                                                                                                                                                                                                        
|10.25(24)  |  | Participation Agreement among Novellus Systems, Inc., ABN AMRO Leasing, Inc.,
Novellus Investment I, LLC and ABN AMRO Bank N.V. dated September 21, 2001.                                                                                              
|           |  |                                                                                                                                                                                                                                                        
|10.26(25)  |  | Amended and Restated Grand Lease Agreement between Novellus Systems,
Inc. and ABN AMRO Leasing, Inc. dated September 21, 2001.                                                                                                                         
|           |  |                                                                                                                                                                                                                                                        
|*10.27     |  | Employment Agreement between SpeedFam International, Inc. and Richard J. Faubert dated
October 8, 1998.                                                                                                                                                
|           |  |                                                                                                                                                                                                                                                        
|*10.28     |  | Letter Agreement between Novellus and Robert Smith dated
September 24, 2002.                                                                                                                                                                           
|           |  |                                                                                                                                                                                                                                                        
|*10.29     |  | Separation Agreement between Novellus and Asuri Raghavan dated
February 5, 2003.                                                                                                                                                                       
|           |  |                                                                                                                                                                                                                                                        
|*10.30     |  | SpeedFam-IPEC, Inc. Amended and Restated 1995 Stock Plan, as assumed by Novellus.                                                                                                                                                                      
|           |  |                                                                                                                                                                                                                                                        
|*10.31     |  | SpeedFam-IPEC, Inc. 2001 Nonstatutory Stock Option Plan, together with forms of
agreements thereunder, as assumed by Novellus.                                                                                                                         
|           |  |                                                                                                                                                                                                                                                        
|*10.32     |  | Integrated Process Equipment Corporation 1992 Stock Option Plan, as assumed by Novellus.                                                                                                                                                               
|           |  |                                                                                                                                                                                                                                                        
|*10.33     |  | SpeedFam International, Inc. Amended and Restated 1991 Employee Incentive Stock Option
Plan, as assumed by Novellus.                                                                                                                                   
|           |  |                                                                                                                                                                                                                                                        
|*10.34     |  | SpeedFam-IPEC, Inc. Stand-Alone Stock Option Agreement dated June 14, 2001 between
SpeedFam-IPEC, Inc. and Peter Simone, as assumed by Novellus.                                                                                                       
|           |  |                                                                                                                                                                                                                                                        
|10.35      |  | Lease Agreement between Seldin Properties and Integrated Process
Equipment Corp. dated
December 26, 1996.                                                                                                                                              
|           |  |                                                                                                                                                                                                                                                        
|10.36      |  | Purchase and Sale Agreement between Glen Una Management Company, Inc. and SpeedFam-IPEC,
Inc. dated May 31, 2003.                                                                                                                                      
|           |  |                                                                                                                                                                                                                                                        
|10.37      |  | Lease Agreement between Phoenix Industrial Investment Partners, L.P. and SpeedFam-IPEC,
Inc. dated June 21, 2002.                                                                                                                                      
|           |  |                                                                                                                                                                                                                                                        
|10.38      |  | First Amendment to Lease Agreement between Phoenix Industrial Investment Partners, L.P.
and SpeedFam-IPEC, Inc. dated January 21, 2003.                                                                                                                
|           |  |                                                                                                                                                                                                                                                        
|10.39      |  | Lease Guaranty between Novellus and Phoenix Industrial Investment
Partners, L.P. dated January 21, 2002.                                                                                                                                               
|           |  |                                                                                                                                                                                                                                                        
|12.1       |  | Ratio of Earnings to Fixed Charges.                                                                                                                                                                                                                    
|           |  |                                                                                                                                                                                                                                                        
|21.1       |  | Subsidiaries of Novellus.                                                                                                                                                                                                                              
|           |  |                                                                                                                                                                                                                                                        
|23.1       |  | Consent of Ernst & Young LLP, Independent Auditors.                                                                                                                                                                                                    
|           |  |                                                                                                                                                                                                                                                        
|24.1       |  | Power of Attorney (see page 72).                                                                                                                                                                                                                       
|           |  |                                                                                                                                                                                                                                                        
|99.1       |  | Certification of Richard S. Hill, Chairman of the Board of Directors and Chief Executive
Officer of Novellus Systems, Inc. dated March 5, 2003 in accordance with 18 U.S.C.
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|           |  |                                                                                                                                                                                                                                                        
|99.2       |  | Certification of Kevin S. Royal, Vice President and Chief Financial Officer of Novellus
Systems, Inc. dated March 5, 2003 in accordance with 18 U.S.C. 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                     
|           |  |                                                                                                                                                                                                                                                        





---



##### Table of Contents



|     |  |                                                                                    
|---- |  | -----------------------------------------------------------------------------------
|99.3 |  | Statement Regarding Consent of Arthur Andersen LLP, Independent Public
Accountants.
|     |  |                                                                                    



|(1)  |  | Incorporated by reference to the
exhibit with the corresponding exhibit number in Novellus Report on
Form 8-K filed with the Securities and Exchange Commission on August 14,
2002.                   
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(2)  |  | Incorporated by reference to  the
exhibit with the corresponding exhibit number in Novellus Report on Form
10-K filed with the Securities and Exchange Commission on March 30, 2000.                  
|    
|(3)  |  | Incorporated by reference to exhibit with the corresponding exhibit
number in Novellus Report on Form 10-K filed with the Securities and
Exchange Commission on March 21, 2002.                       
|    
|(4)  |  | Incorporated by reference to the exhibit with the corresponding exhibit
number in Novellus Registration Statement on Form S-3 filed with the
Securities and Exchange Commission on September 25, 2001.
|    
|(5)  |  | Incorporated by reference to Exhibit 2.3 to Novellus Report on Form 8-K
filed with the Securities and Exchange Commission on July 7, 1997.                                                            
|    
|(6)  |  | Incorporated by reference to Exhibit 2.4 to Novellus Report on Form 8-K
filed with the Securities and Exchange Commission on July 7, 1997.                                                            
|    
|(7)  |  | Incorporated by reference to Exhibit 2.6 to Novellus Report on Form 8-K
filed with the Securities and Exchange Commission on July 7, 1997.                                                            
|    
|(8)  |  | Incorporated by reference to Exhibit 10.1 to Novellus Report on Form
10-Q filed with the Securities and Exchange Commission on August 11, 1997.                                                       
|    
|(9)  |  | Incorporated by reference to Exhibit 10.30 filed with Novellus Report on
Form 10-K filed with the Securities and Exchange Commission on February
26, 1993.                                            
|    
|(10) |  | Incorporated by reference to
Exhibit 10.21 to Novellus Report on Form 10-K filed
with the Securities and Exchange Commission on March 30, 2000.                                                       
|    
|(11) |  | Incorporated by reference to Exhibit 10.31 filed with Novellus Report on
Form 10-K filed with the Securities and Exchange Commission on February
26, 1993.                                            
|    
|(12) |  | Incorporated by reference to Exhibit 10.1 filed with Novellus Report on
Form 10-Q filed with the Securities and Exchange Commission on August 13,
2002.                                               
|    
|(13) |  | Incorporated by reference to Exhibit 10.34 filed with Novellus Report on
Form 10-K filed with the Securities and Exchange Commission on February
26, 1993.                                            
|    
|(14) |  | Incorporated by reference to Exhibit 10.41 filed with Novellus Report on
Form 10-K filed with the Securities and Exchange Commission on February
18, 1994.                                            
|    
|(15) |  | Incorporated by reference to Exhibit 10.27 to Novellus Report on Form
10-K filed with the Securities and Exchange Commission on March 10, 1999.                                                       
|    
|(16) |  | Incorporated by reference to Exhibit 10.27 to Novellus Report on Form
10-K filed with the Securities and Exchange Commission on March 30, 2000.                                                       
|    
|(17) |  | Incorporated by reference to
Exhibit 10.30 to Novellus Report on Form 10-K filed with the Securities and Exchange
Commission on March 23, 2001.                                                       
|    
|(18) |  | Incorporated by reference to Exhibit 10.31 to Novellus Report on Form
10-K filed with the Securities and Exchange Commission on March 23, 2001.                                                       





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##### Table of Contents





|(19) |  | Incorporated by reference to Exhibit 10.32 to Novellus Report on Form
10-K filed with the Securities and Exchange Commission on March 23, 2001.  
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(20) |  | Incorporated by reference to Exhibit 10.33 to Novellus Report on Form
10-K filed with the Securities and Exchange Commission on March 23, 2001.  
|    
|(21) |  | Incorporated by reference to Exhibit 10.34 to Novellus Report on Form
10-K filed with the Securities and Exchange Commission on March 23, 2001.  
|    
|(22) |  | Incorporated by reference to Exhibit 10.6 to Novellus Report on Form
10-Q filed with the Securities and Exchange Commission on May 15, 2001.     
|    
|(23) |  | Incorporated by reference to Exhibit 10.7 to Novellus Report on Form
10-Q filed with the Securities and Exchange Commission on May 15, 2001.     
|    
|(24) |  | Incorporated by reference to Exhibit 10.1 to Novellus Report on Form
10-Q filed with the Securities and Exchange Commission on November 13,
2001.
|    
|(25) |  | Incorporated by reference to Exhibit 10.2 to Novellus Report on Form
10-Q filed with the Securities and Exchange Commission on
November 13,
2001.



---

|* |  | Management contracts or compensatory plans or arrangements.
|- |  | -----------------------------------------------------------