##### Table of Contents



UNITED STATES SECURITIES AND
    EXCHANGE COMMISSIONWashington, D.C.
    20549
  Form 10-K
  FOR ANNUAL AND TRANSITION
    REPORTS PURSUANT TO SECTIONS 13 OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934
  (Mark One)þ

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended
    December 31, 2005ORo

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934For 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

(I.R.S. Employerincorporation of
    organization)

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)
  þ o
  o þ
  þ o
  Regulation S-K Form 10-K Form 10-K. þ
  Rule 12b-2
  þ o o
  Rule 12b-2 o þ
      DOCUMENTS
    INCORPORATED BY REFERENCE
  Form 10-K Form 10-K.




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##### 



NOVELLUS
    SYSTEMS, INC.
   2005 ANNUAL REPORT ON
    FORM 10-K
  TABLE OF CONTENTS
  
  PagePART IItem 1:

Business


2Item 1A:

Risk Factors


10Item 1B:

Unresolved Staff
    Comments


16Item 2:

Properties


17Item 3:

Legal
    Proceedings


18Item 4:

Submission of
    Matters to a Vote of Security Holders


18PART IIItem 5:

Market for
    Registrants Common Equity, Related Shareholder Matters and
    Issuer Purchases of Equity Securities


19Item 6:

Selected Financial
    Data


20Item 7:

Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations


21Item 7A:

Quantitative and
    Qualitative Disclosures about Market Risk


38Item 8:

Financial
    Statements and Supplementary Data


41Item 9:

Changes in and
    Disagreements with Accountants on Accounting and Financial
    Disclosure


76Item 9A:

Controls and
    Procedures


76Item 9B:

Other
    Information


79PART IIIItem 10:

Directors and
    Executive Officers of the Registrant


79Item 11:

Executive
    Compensation


79Item 12:

Security Ownership
    of Certain Beneficial Owners and Management and Related
    Stockholder Matters


79Item 13:

Certain
    Relationships and Related Transactions


79Item 14:

Principal
    Accounting Fees and Services


79PART IVItem 15:

Exhibits and
    Financial Statement Schedules


80Signatures


84EXHIBIT 21.1EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2




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PART I  Form 10-K.
  Item 1.
    Business  The
    Company
    tm
  tm
  200-year-old
  (408) 943-9700.
  www.novellus.com. Form 10-K, Form 10-Q, Form 8-K, Form 10-K
 2




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Semiconductor
    Industry Background
              Semiconductor
    Business Strategy
    Emphasize High-Productivity Systems
 3




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Be Recognized for our Technology in our Served Available
    Markets
  Focus on Reducing Customer Costs
  Broaden our Interconnect Offerings
  Differentiate our Service Philosophy
  Expand Market Presence in Asia
  Leverage our Low-Cost Manufacturing
    Structure
  Semiconductor
    Manufacturing Products
  Deposition
    Technologies
    ® ® tm
 4




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##### Table of Contents



CVD
    Products
    HDP
    CVD Products
  Concept Two
    SPEED ®
  Concept Three
    SPEED ®
  SPEED®
    NExTtm
  W-CVD
    Products
  Concept Two
    ALTUS ® tm
  Concept Three
    ALTUS ®
  ALTUS tm
  PECVD
    Products
  Concept Two SEQUEL
    Express tm ® micron-and-smaller
  VECTOR ®  nanometer-and-smaller
 5




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SOLA tm
  PVD
    Products
    INOVA ® ®
  INOVA
    xT tm
  INOVA
    NExT tm
  ECD
    Products
    SABRE ®
  SABRE
    xT tm
  SABRE
    NExT tm
  Surface
    Preparation Technologies
   6




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GAMMA tm 2100
  GAMMA 2130
  CMP
    Technologies
    MOMENTUM tm through-the-pad
  tm through-the-pad cost-of-ownership.
  Industrial
    Applications Group
      Marketing,
    Sales and Service
   7




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Customers
      Backlog
  Form 10-K.
  Research
    and Development
       8




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Manufacturing
        Competition
      Patents
    and Proprietary Rights
   9




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Employees
      Business
    Combinations
    Environmental
    Matters
    Item 1A.
    Risk
    Factors  Form 10-K Form 10-K.
  Cyclical
    downturns in the semiconductor industry negatively impact demand
    for our equipment.
   10




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and/or
  The
    competitive and capital-intensive nature of the semiconductor
    industry increases the difficulty of maintaining and capturing
    market share.
    Rapid
    technological change in the semiconductor industry requires
    substantial research and development expenditures and
    responsiveness to customer needs.
     11




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We are
    exposed to the risks of global operations.
    
    Tariffs and other trade barriers;
    Challenges in staffing and managing foreign operations and
    providing prompt and effective field support to our customers
    outside of the United States;
    Difficulties in managing foreign distributors;
    Potentially adverse tax consequences, including withholding tax
    rules that may limit the repatriation of our earnings, and
    higher effective income tax rates in foreign countries where we
    conduct business;
    Governmental controls, either by the United States or other
    countries, that restrict our business overseas or the import or
    export of semiconductor products, or increase the cost of our
    operations;
    Longer payment cycles and difficulties in collecting accounts
    receivables outside of the United States;
    Inadequate protection or enforcement of our intellectual
    property and other legal rights in foreign jurisdictions;
    Global or regional economic downturns;
    Geo-political instability, natural disasters, acts of war or
    terrorism; 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 currency
    fluctuations, specifically transactions denominated in Japanese
    yen. Exchange rate volatility may also increase the cost of our
    exported products for international customers and inhibit demand.   12




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Our
    quarterly operating results and stock price are
    unpredictable.
    
    Building our systems according to forecast, instead of limited
    backlog information, which hinders our ability to plan
    production and inventory levels;
    Variability in manufacturing yields;
    Failure to receive anticipated orders in time to permit shipment
    during the quarter;
    Timing and cancellation of customer orders and shipments,
    including deferring orders of our existing products due to new
    product announcements by us
    and/or our
    competitors;
    Changing demand for and sales of lower-margin products relative
    to higher-margin products;
    Competitive pricing pressures;
    The effect of revenue recognized upon acceptance with little or
    no associated costs; and
    Fluctuation in warranty costs.  Changes
    in tax rates or liabilities could negatively impact our future
    results.
    
    Changes in the regulatory environment;
    Changes in accounting and tax standards or practices; and
    Overall business conditions in the semiconductor equipment
    industry.  We
    face risks associated with acquisitions.
  and/or
  
    Difficulties in integrating the operations, technologies,
    products and personnel of acquired companies;
    Lack of synergies or the inability to realize expected synergies
    and cost-savings;
    Revenue and expense levels of acquired entities differing from
    those anticipated at the time of the acquisitions;
    Difficulties in managing geographically dispersed operations;
    The potential loss of key employees, customers and strategic
    partners of acquired companies;
    Claims by terminated employees, shareholders of acquired
    companies or other third parties related to the transaction;
    The issuance of dilutive securities, assumption or incurrence of
    additional debt obligations or expenses, or use of substantial
    portions of our cash;
    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. 13




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We are
    exposed to risks associated with our diversification
    strategy.
    We
    face risks related to concentration of net sales.
    We
    face risks related to intellectual property.
       14




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The
    loss of key employees could harm our business and
    operations.
    Supply
    shortages could affect our ability to meet customer
    demands.
  and/or
  We are
    exposed to risks associated with outsourcing
    activities.
    If our
    outside audit firm does not maintain its
    independence, we may be unable to meet our
    regulatory reporting obligations.
      Corporate
    governance and financial reporting compliance requirements may
    lead to increased costs and difficulty in attracting qualified
    executive officers and directors.
   15




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We are
    exposed to risks related to our indemnification of third
    parties.
    We
    face risks related to changes in accounting standards for stock
    option plans.
    We are
    exposed to risks associated with our investment
    activities.
  start-up
  Item 1B.
    Unresolved
    Staff Comments   16




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Item 2.
    Properties    # of



Operating





SquareBuildings

Location

Segment

Use

Ownership

Footage9


San Jose, CA

Semiconductor Group

Corporate Headquarters,
    Manufacturing, Research and Development, Engineering,
    Applications Demonstration Lab, Customer Support, Administration
    and Warehousing

Owned

642,0004


Tualatin, OR

Semiconductor Group

Manufacturing, Research and
    Development, Engineering, Customer Support, Administration and
    Warehousing

Owned

442,0002


Chandler, AZ

Semiconductor Group

Manufacturing, Research and
    Development, Engineering, Customer Support, Administration and
    Warehousing

Leased

148,0001


Des Plaines, IL

Industrial Applications Group

Manufacturing, Research and
    Development, Owned Engineering, Customer Support, Administration
    and Warehousing

Owned

41,0001


Plainville, MA

Industrial Applications Group

Research and Development,
    Engineering, Customer Support, and Warehousing

Owned

25,0001


Leicestershire, UK

Industrial Applications Group

Manufacturing, Customer Support,
    Administration and Warehousing

Owned

9,0001


Rendsburg, Germany

Industrial Applications Group

Manufacturing, Research and
    Development, Engineering, Customer Support, Administration and
    Warehousing

Owned

189,0001


Neuchâtel, Switzerland

Industrial Applications Group

Manufacturing, Research and
    Development, Customer Support and Administration

Owned

126,0001


La Chaux-de-Fonds, Switzerland

Industrial Applications Group

Manufacturing

Leased

13,000Total

Owned

1,474,000 Sq. Ft.Leased

161,000 Sq. Ft.        17




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##### Table of Contents



Item 3.
    Legal
    Proceedings  Linear
    Technology Corporation
    Plasma
    Physics Corporation and Solar Physics Corporation
    Matter
    Other
    Litigation
    Item 4.
    Submission
    of Matters to a Vote of Security Holders   18




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PART II  Item 5.
    Market
    for Registrants Common Equity, Related Shareholder Matters
    and Issuer Purchases of Equity Securities  Stock
    Information
    2005High


LowFirst Quarter

$
30.18


$
24.66Second Quarter


27.33



23.43Third Quarter


29.13



24.57Fourth Quarter


26.02



21.36   2004High


LowFirst Quarter

$
44.44


$
29.15Second Quarter


34.64



28.48Third Quarter


31.44



23.13Fourth Quarter


29.55



24.15       (1)
  TotalNumber of


ApproximateShares


Dollar ValuePurchased


of Sharesas Part of


that May yetTotal





Publicly


be PurchasedNumber of


Average Price


Announced


Under theShares


Paid per


Plans or


Plans orPeriod

Purchased(2)


Share


Programs


ProgramsOctober 2, 2005 to
    November 5, 2005


5,147,612


$
21.53



5,147,612


$
896.2 millionNovember 6, 2005 to
    December 3, 2005


390,200


$
23.46



390,200


$
887.0 millionDecember 4, 2005 to
    December 31, 2005


991,459


$
24.07



991,459


$
863.2 millionTotal


6,529,271


$
22.03



6,529,271


$
863.2 million     (1)
    
    On February 24, 2004, we announced that our Board of
    Directors had approved a stock repurchase plan that authorized
    the repurchase of up to $500.0 million of our outstanding
    common stock through February 13, 2007. On
    September 20, 2004 we announced that our Board of Directors
    had authorized an additional $1.0 billion for repurchase of
    our outstanding common stock through September 14, 2009. We
    may repurchase shares from time to time in the open market,
    through block trades or otherwise. The repurchases may be
    commenced or suspended at any time or from time to time without
    prior notice depending on prevailing market conditions and other
    factors.(2)
    
    All shares were purchased pursuant to the publicly announced
    plan. 19




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Item 6.
    Selected
    Financial Data    Selected
    Consolidated Financial Data
  Years Ended
    December 31,2005


2004


2003


2002


2001(In thousands, except per share
    data)Consolidated Statements of
    Operations Data:Net sales

$
1,340,471


$
1,357,288


$
925,070


$
839,958


$
1,339,322Gross profit


599,126
(1,2)


665,130
(3)


380,000
(6)


378,523



691,351Income (loss) before cumulative
    effect of change in accounting principle


110,107



156,690



(5,034
)


22,920



144,470Cumulative effect of change in
    accounting principle










(62,780
)(5)






Net income (loss)

$
110,107
(2)

$
156,690
(4)

$
(67,814
)(6)

$
22,920
(7,8)

$
144,470
(7,9)Per common share:Income (loss) before cumulative
    effect of change in accounting principleBasic

$
0.80


$
1.07


$
(0.03
)

$
0.16


$
1.01Diluted

$
0.80


$
1.06


$
(0.03
)

$
0.15


$
0.97Cumulative effect of change in
    accounting principle, net of taxBasic

$



$



$
(0.42
)

$



$
Diluted

$



$



$
(0.42
)

$



$
Net income (loss) Basic

$
0.80


$
1.07


$
(0.45
)

$
0.16


$
1.01Diluted

$
0.80


$
1.06


$
(0.45
)

$
0.15


$
0.97Shares used in basic per share
    calculations


137,447



145,956



150,680



144,371



142,462Shares used in diluted per share
    calculations


138,423



147,937



150,680



148,748



148,924   December 31,

2005


2004


2003


2002


2001Consolidated Balance Sheet
    Data:Cash, cash equivalents and
    marketable securities

$
649,240


$
587,762


$
1,006,013


$
1,019,652


$
921,822Working capital

$
1,019,168


$
1,045,294


$
1,350,906


$
1,252,324


$
1,395,902Total assets

$
2,290,249


$
2,401,832


$
2,338,900


$
2,493,994


$
3,031,124Long-term debt obligations

$
124,858


$
161,103


$



$



$
Shareholders equity

$
1,779,283


$
1,861,834


$
2,071,860


$
2,055,688


$
1,871,994     (1)
    
    In 2005, we recorded a credit to cost of sales of approximately
    $15.1 million related to the sale of inventories previously
    written down.(2)
    
    In 2005, we recorded net restructuring and other charges of
    $9.2 million and inventory write-downs due to restructuring
    of $5.3 million.(3)
    
    In 2004, we recorded a credit to cost of sales of approximately
    $9.0 million related to the sale of inventories previously
    written down. 20




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(4)
    
    In 2004, we recorded net restructuring and other charges of
    $1.5 million, acquired in-process research and development
    write-offs of $6.1 million, net recovery from legal
    settlements of $2.6 million and the reversal of previously
    accrued royalty payments of $8.1 million.(5)
    
    As a result of the early adoption of Financial Accounting
    Standards Board Interpretation No. 46, Consolidation
    of Variable Interest Entities, an Interpretation of ARB
    No. 51, we recorded a non-cash charge of
    $62.8 million, net of tax, for the year ended
    December 31, 2003, as a cumulative effect of a change in
    accounting principle from the consolidation of properties
    previously accounted for as synthetic leases.(6)
    
    We recorded $59.8 million of pre-tax charges for the year
    ended December 31, 2003 as a result of a restructuring plan
    to align our cost structure with business conditions. The
    charges consisted of an inventory write-down of
    $44.0 million (included in gross profit), asset write-offs
    of $7.9 million, facilities charges of $4.1 million,
    and severance of $3.8 million. In addition, we recorded a
    charge for litigation settlements of $2.7 million.(7)
    
    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.(8)
    
    We recorded $32.5 million of pre-tax charges 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 an 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
    previously written-off receivable of $7.7 million and a
    gain on the sale of an equity investment of $4.6 million.(9)
    
    We recorded $84.5 million of pre-tax charges for the year
    ended December 31, 2001. These charges include
    $55.0 million related to restructuring and asset
    impairment, $13.2 million of costs related to the GaSonics
    International Corporation acquisition, $8.6 million for an
    other than temporary decline in the value of an investment, and
    $7.7 million of a bad debt write-off.  Item 7.
    Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations  Cautionary
    Note Regarding Forward-Looking Statements
  Form 10-K Form 10-K,
  Form 10-K
  
    Statements about the growth of the semiconductor industry;
    market size, share and demand (particularly demand for corporate
    and consumer electronic devices); 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 1A. Risk Factors; 21




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
    The statements under the heading Item 1.
    Business  Semiconductor Industry
    Background regarding our beliefs that (1) unit demand
    for semiconductor devices will continue to increase;
    (2) there is a trend toward increasing density of the
    integrated circuit; (3) there is a trend toward copper
    conductive material and away from aluminum wiring;
    (4) there is a trend toward low-k dielectric insulators and
    away from traditional silicon oxide insulating films; 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; the inaccuracy of our
    expectations regarding the future direction of the semiconductor
    industry; and our inability to develop, improve and market
    products that respond to industry trends;
    The statements under the heading Item 1.
    Business  Semiconductor Business Strategy,
    concerning (1) our emphasis on high-productivity systems;
    (2) our goal to be recognized for our technology in each of
    our served available markets; (3) our focus on reducing
    customer costs; (4) our service differentiation philosophy;
    (5) our intent to broaden our interconnect offerings;
    (6) our strategy to expand our market presence in, and our
    belief in future growth potential of, Asia; and (7) our
    plan to leverage our low cost manufacturing structure, which
    statements are subject to various risks and uncertainties,
    including, without limitation, difficulties implementing our
    growth strategy and leveraging our resources to increase market
    share; increased competition in our served available markets;
    shifts in demand from expensive, high-performance products to
    lower priced, conventional products, resulting in reduced profit
    for semiconductor manufacturers; increases in the costs of
    material, labor or conducting a global business, or inability to
    enhance our systems productivity, which may preclude us
    from containing costs to customers; the current and other
    periodic downturns in the semiconductor industry and the global
    or domestic economy; political or economic instability in Asia,
    and fluctuations in interest and foreign currency exchange rates;
    The statements under the heading Item 1.
    Business  Semiconductor Manufacturing
    Products of our beliefs in the performance and
    effectiveness our products, including (1) that Concept
    Three SPEED offers minimal risk to our customers in making the
    transition from 200mm to 300mm volume chip making; (2) that
    ALTUS DirectFill lowers the overall cost of ownership by 50% or
    more when compared to existing processes; (3) that Concept
    Two SEQUEL Express delivers up to 40% higher capital
    productivity and 40% lower cost of ownership than competing
    PECVD systems; (4) that VECTOR has approximately 2/3 of the
    footprint of the nearest competition and 33% fewer critical
    subsystems; (5) that the INOVA 200mm system will continue
    to gain market acceptance; (6) the increasing importance of
    photoresist strip and clean processes as a result of the
    industrys migration to copper interconnects; (7) that
    the GAMMA 2130 system offers a 30% higher throughput rate than
    the closest competitor; (8) that we have an important
    advantage in extending copper/low-k processes to advanced
    semiconductor devices based on our understanding of interactions
    between planarization, deposition and surface preparation, which
    statements are subject to various risks and uncertainties,
    including, among others, the inaccuracy of our assessment of our
    products capabilities; technical difficulties which
    preclude our products from performing as expected;
    competitors greater financial, marketing, technical,
    customer service or other resources, broader product lines, and
    larger and more established sales organizations and customer
    bases; future competition from new market entrants;
    competitors design and performance product improvements
    that may offer superior price or performance features over our
    products; difficulties integrating, developing and
    commercializing SpeedFam-IPEC CMP systems; 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 and (2) our
    marketing efforts are enhanced by the technical expertise of our
    R&D personnel, 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 customer support and
    R&D personnel;
    The statement under the heading Item 1.
    Business  Research and Development
    regarding our belief that research and development expenditures
    will continue to represent a substantial percentage of sales,
    which 22




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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
    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 development efforts;
    and (4) our efforts to reduce our 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; a prolonged inability to
    obtain certain components imperative to our operations; 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 ability to compete favorably 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 intentions (1) to file additional patent
    applications; (2) to vigorously protect our intellectual
    property rights; and our beliefs (3) that the outcomes of
    current litigation will not have a material impact on our
    business, financial condition or results of operations; and
    (4) 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 possibility that patents will
    not be issued from any of our pending applications or that
    claims allowed from existing or pending patents will not 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 statement under the heading Item 1.
    Business  Environmental Matters that
    federal, state and local provisions regulating discharge of
    materials into the environment and remedial agreements or other
    environmental actions are not expected to have a material affect
    on our capital expenditures, financial condition, results of
    operations or competitive position, which statement is subject
    to certain risks and uncertainties, including, among others,
    that we have inaccurately assessed the environmental impact of
    our activities or the compliance requirements of environmental
    provisions and agreements;
    The statement under the heading Item 2.
    Properties of our belief that upon completion of our
    current facility consolidation initiative, our remaining
    properties will be sufficient to meet our requirements for the
    foreseeable future, which statement is subject to various risks
    and uncertainties, due to, without limitation, growth in our
    business placing unexpected strains on our resources and
    properties and international expansion beyond the capacities of
    our current properties;
    The statements under the headings Item 3. Legal
    Proceedings of our belief that the ultimate disposition of
    the Linear Technology Corporation, Plasma Physics Corporation,
    Solar Physics Corporation and other litigation matters will not
    have a material adverse effect on the impact on our business,
    financial condition, or results of operations, which statements
    are subject to various risks and uncertainties, including,
    without limitation, inherent uncertainty surrounding the
    litigation process and our inability to accurately predict the
    determination of complex issues of fact and law; 23




---



##### Table of Contents




    The statement in Item 7. Managements Discussion
    and Analysis of Financial Condition and Results of
    Operations  Overview of Our Business and
    Industry that our close relationships with our customers
    and substantial investments in research and development position
    us for future growth, which statement is subject to numerous
    risks and uncertainties, including, without limitation, our
    inability to maintain our customer accounts, realize marketable
    products from our investments or attain market acceptance for
    new product introductions;
    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
    and anticipations including, without limitation,
    (1) expansion of our market presence in Asia;
    (2) increase in gross margins during 2006;
    (3) continuation of our R&D commitment to improvement
    of new products and enhancement of our current product lines;
    (4) significant investment in R&D in order to remain
    competitive; (5) managements expectation that our
    effective tax rate in 2006 will increase because of further
    decreases in federal export sales incentives and the expiration
    of the federal research and development credit; and
    (6) managements belief that adequate accruals have
    been provided for any potential adjustments that may result from
    examinations by the IRS and foreign taxing authorities, which
    statements are subject to numerous risks and uncertainties,
    including, without limitation, 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 in Asia; ineffectiveness of installation and warranty
    improvement plans initiated in 2005; technical and operational
    difficulties with our products that result in continued
    increases in warranty costs; our inability to allocate
    substantial resources to R&D programs; the inaccuracy of our
    beliefs regarding taxes; and unanticipated changes in tax
    regulations;
    The statements under the heading Item 7.
    Managements Discussion and Analysis of Financial Condition
    and Results of Operations  Critical Accounting
    Policies regarding the calculation of allowances,
    reserves, and other estimates that are based on historical
    experience, 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, and the significant judgments of management that
    underlie the preparation of our consolidated financial
    statements including, without limitation, (1) realization
    of the majority of deferred tax assets due to anticipated future
    income; (2) the positive or negative impact on gross profit
    of possible revisions to estimated warranty liability; and
    (3) the lack of speculative risk in connection with our
    forward foreign exchange contracts, which statements are subject
    to certain risks and uncertainties, including, among others, the
    inaccuracy of our calculations, estimates, assumptions and
    judgments, regarding critical accounting policies; that actual
    and future product failure rates, material usage, installation
    costs, customer reserves or other estimates may differ from our
    historical experience, requiring revisions to our estimated
    doubtful account allowances, additional inventory write-downs,
    restructuring charges, litigation, warranty, and other reserves;
    the insufficiency of anticipated future income, whether due to a
    downturn in the semiconductor industry or increases in expenses;
    and the accuracy of our estimates and beliefs regarding warranty
    liability and foreign exchange contracts;
    The statement in Item 7. Managements Discussion
    and Analysis of Financial Condition and Results of
    Operations  Liquidity and Capital
    Resources of our expectation 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
    statement is subject to numerous risks and uncertainties,
    including, without limitation, inability to timely and
    effectively develop, manufacture and market our new products, or
    enhance our existing products, a downturn in our sales or
    defaults on payments by customers, which may adversely affect
    our cash flow;
    The statement in Item 7. Managements Discussion
    and Analysis of Financial Condition and Results of
    Operations  Off-Balance Sheet Arrangements
    that it is not probable that we will be required to pay any
    amounts under standby letters of credit arrangements or
    guarantee arrangements on behalf of our consolidated
    subsidiaries, which statement is subject to certain risks and
    uncertainties, including, without limitation, the inaccuracy of
    our assessment of our obligations under credit and guarantee
    arrangements; 24




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##### Table of Contents




    The statement in Item 7. Managements Discussion
    and Analysis of Financial Condition and Results of
    Operations  Purchase Commitments that we
    made adequate provision for potential exposure related to
    inventory on order which may go unused, which statement is
    subject to certain risks and uncertainties, including, without
    limitation, an unanticipated decline in demand that would
    increase our inventory-related exposure;
    The statements in Item 7. Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations  Recent Accounting
    Pronouncements regarding impact upon our results of
    operation and financial position as a result of adopting EITF
    No. 03-1,
    amended FASB Statement No. 115, FASB Statement No. 151
    and FASB Statement No. 123(R), which statements are subject
    to various risks, due to the uncertainty of the impact of
    certain accounting standards and the level of share-based
    payments granted in the future;
    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, which statement is subject to certain risks and
    uncertainties, including, without limitation, that we have
    inaccurately assessed our future borrowing needs;
    The statement under the heading Item 7A. Quantitative
    and Qualitative Disclosures About Market
    Risk  Foreign Currency Risk that we do not
    anticipate using options to hedge anticipated and uncommitted
    transactions to minimize the impact of foreign currency
    fluctuations on our results of operations, which statement is
    subject to certain risks and uncertainties, including, without
    limitation, unanticipated fluctuations in interest and foreign
    currency exchange rates;
    The statement in Item 8. Financial Statements and
    Supplementary Data  Notes to Consolidated
    Financial Statements  Note 2. Significant
    Accounting Policies  Concentration and Other
    Risks regarding our belief that there is not a significant
    risk of nonperformance by counterparties on foreign exchange
    contracts, which statement is subject to certain risks and
    uncertainties, including, without limitation, our failure to
    continuously monitor or accurately evaluate our positions and
    the credit ratings of counterparties;
    Our statement in Item 8. Financial Statements and
    Supplementary Data  Notes to Consolidated
    Financial Statements  Note 3. Financial
    Instruments that management has the ability to liquidate
    short-term investments to fund operations within the next twelve
    months, which statement is subject to certain risks and
    uncertainties, including, without limitation, that we have
    inadequately assessed the liquidity value of our short-term
    investments and our ability to take advantage of interest rate
    re-set periods;
    Our statement in Item 8. Financial Statements and
    Supplementary Data  Notes to Consolidated
    Financial Statements  Note 6. Goodwill and
    Other Intangible Assets of our future estimated
    amortization expense for the identifiable intangible assets,
    which statement is subject to certain risks and uncertainties,
    including, without limitation, the accuracy of our accounting
    judgments and estimates underlying the amortization expense
    amount;
    Our statements in Item 8. Financial Statements and
    Supplementary Data  Notes to Consolidated
    Financial Statements  Note 7. Business
    Combination of our intention to report changes related to
    the amounts recorded in connection with the Voumard acquisition,
    our anticipation that significant intangible assets will not be
    recorded as a result of the acquisition, and our expectation
    that the final purchase price allocation will not differ
    significantly from the preliminary allocation, which statements
    are subject to certain risks and uncertainties, including,
    without limitation, the inaccuracy of our estimates of
    Voumards assets and the costs of the acquisition;
    Our statement in Item 8.  Financial
    Statements and Supplementary Data  Notes to
    Consolidated Financial Statements  Note 9.
    Long-term Debt that as of December 31, 2005 we have
    an aggregate amount of $27.8 million available for future
    borrowing, which statement is subject to certain risks and
    uncertainties, including, without limitation, an inaccurate
    assessment of available borrowed funds or future needs for
    funds, and the continued viability of our long-term borrowing
    arrangements. 25




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##### Table of Contents



Introduction
    
    Overview of Our Business and Industry;
    Results of Operations;
    Critical Accounting Policies;
    Liquidity and Capital Resources;
    Off-Balance Sheet Arrangements;
    Contractual Obligations;
    Related Parties; and
    Recent Accounting Pronouncements.  Overview
    of Our Business and Industry
    200-year-old
   26




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##### Table of Contents



Quarterly Financial
    DataFirst


Second


Third


Fourth


Year EndedQuarter


Quarter


Quarter


Quarter


December 31,2005:Net sales

$
339,740


$
329,585


$
338,878


$
332,268


$
1,340,471Gross profit

$
153,869


$
157,562


$
147,194


$
140,501


$
599,126Net income

$
30,471


$
33,231


$
23,415


$
22,990


$
110,107Diluted net income per share

$
0.22


$
0.24


$
0.17


$
0.17


$
0.80Net orders

$
301,594


$
309,214


$
286,929


$
351,018


$
1,248,7552004:Net sales

$
262,862


$
338,219


$
415,935


$
340,272


$
1,357,288Gross profit

$
124,605


$
169,680


$
201,111


$
169,734


$
665,130Net income

$
16,681


$
37,811


$
64,662


$
37,536


$
156,690Diluted net income per share

$
0.11


$
0.25


$
0.45


$
0.27


$
1.06Net orders

$
346,793


$
397,598


$
422,692


$
331,347


$
1,498,4302003:Net sales

$
238,410


$
239,050


$
221,099


$
226,511


$
925,070Gross profit

$
109,814


$
105,322


$
58,776


$
106,088


$
380,000Net income (loss)

$
11,872


$
7,430


$
(97,568
)

$
10,452


$
(67,814
)Diluted net income (loss) per share

$
0.08


$
0.05


$
(0.64
)

$
0.07


$
(0.45
)Net orders

$
241,825


$
198,759


$
220,775


$
275,219


$
936,578        27




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##### Table of Contents



Results
    of Operations
 (dollars in thousands, except per share amount)
  Net
    Sales
  Years Ended
    December 31,


% Change


% Change2005


2004


2003


in 2005


in 2004Net Sales

$
1,340,471


$
1,357,288


$
925,070



(1
)%


47
%     Years EndedDecember 31,2005


2004


2003North America


27
%


23
%


35
%Europe


11
%


9
%


10
%Asia


62
%


68
%


55
%     Gross
    Profit
  Years Ended
    December 31,


% Change


% Change2005


2004


2003


in 2005


in 2004Gross profit

$
599,126


$
665,130


$
380,000



(10
)%


75
%% of net sales


45
%


49
%


41
%      28




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##### Table of Contents



Selling,
    General and Administrative (SG&A)
  Years Ended
    December 31,


% Change


% Change2005


2004


2003


in 2005


in 2004SG&A

$
206,939


$
194,652


$
165,618



6
%


18
%% of net sales


15
%


14
%


18
%         Research
    and Development (R&D)
  Years Ended
    December 31,


% Change


% Change2005


2004


2003


in 2005


in 2004Research and development

$
247,315


$
252,083


$
227,439



(2
)%


11
%% of net sales


18
%


19
%


25
%        29




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##### Table of Contents



Acquired
    In-Process Research and Development (IPR&D)
  Years Ended
    December 31,


% Change


% Change2005


2004


2003


in 2005


in 2004IPR&D

$



$
6,124


$




(100
)%


100
%% of net sales






less than 1
%


           Legal
    Settlement
  Years Ended
    December 31,


% Change


% Change2005


2004


2003


in 2005


in 2004Legal settlement

$



$
5,400


$
2,691



(100
)%


101
%% of net sales






less than 1
%


less than 1
%     Restructuring
    and Other Charges
  Years Ended
    December 31,


% Change


% Change2005


2004


2003


in 2005


in 2004Restructuring and other charges

$
9,175


$
1,484


$
15,838



518
%


(91
)%% of net sales


1
%


less than 1
%


2
%    30




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##### Table of Contents



Other
    Income, net
  Years Ended
    December 31,


% Change


% Change2005


2004


2003


in 2005


in 2004Other income, net

$
22,916


$
17,804


$
16,266



29
%


9
%% of net sales


2
%


1
%


2
%       Income
    Taxes
     31




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##### Table of Contents



Critical
    Accounting Policies
    Revenue
    Recognition
      EITF 00-21,
   32




---



##### Table of Contents



Inventory
    Valuation
  work-in-process,
  Goodwill
    and Other Intangible Assets
      Deferred
    Tax Assets
    Warranty
    Obligations
    Restructuring
    and Impairment Charges   33




---



##### Table of Contents



No. 95-3,
  Foreign
    Currency Accounting
    Foreign
    Exchange Contracts
  marked-to-market,
  Liquidity
    and Capital Resources
         34




---



##### Table of Contents



Off-Balance
    Sheet Arrangements
  Variable
    Interest Entities
        Standby
    Letters of Credit
   35




---



##### Table of Contents



Guarantee
    Arrangements
  line-of-credit
        Contractual
    Obligations
      Years Ending
    December 31,


Sublease


Net2006


2007


2008


2009


2010


Thereafter


Income


Total(In thousands)Non-cancelable operating leases

$
9,080


$
8,416


$
7,817


$
7,790


$
7,709


$
32,242


$
(15,130
)

$
57,924     Years Ending
    December 31,2006


2007


2008


2009


2010


Thereafter(In thousands)Long-term debt obligations

$
38


$
38


$
38


$
123,674


$
38


$
1,032   Purchase
    Commitments
   36




---



##### Table of Contents



Recent
    Accounting Pronouncements
  No. 03-1, Other-Than-Temporary No. 03-1. EITF No. 03-1 No. 03-1 EITF 03-1-1, EITF 03-1-1. EITF 03-1-1 No. 03-1. other-than-temporary other-than-temporary
         37




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##### Table of Contents



Item 7A.
    Quantitative
    and Qualitative Disclosures about Market Risk  Interest
    Rate Risk
          Periods of Maturity





Fair ValueLess than


1 to 3


3 to 5


5 to 10


Over 10





December 31,1 Year


Years


Years


Years


Years


Total


2005(In thousands)Assets:Cash equivalents

$
40,403


$



$



$



$



$
40,403


$
40,403Average interest rate


3.77
%


















3.77.
%Marketable securities

$
175,598


$
140,448


$
10,940


$
10,685


$
273,056


$
610,727


$
608,837Average interest rate


3.65
%


4.35
%


4.99
%


5.18
%


4.98
%


4.46
%Restricted investments

$
140,212


$



$



$



$



$
140,212


$
140,212Average interest rate


4.28
%


















4.28
%Total investment securities

$
356,213


$
140,448


$
10,940


$
10,685


$
273,056


$
791,342


$
789,452Average interest rate


3.91
%


4.35
%


4.99
%


5.18
%


4.98
%


4.39
%Liabilities:Short-term borrowings

$
15,744


$



$



$



$



$
15,744


$
15,744Average interest rate


0.825
%


















0.825
%Long-term borrowings

$
38


$
115


$
123,750


$
229


$
726


$
124,858


$
124,858Average interest rate


4.0
%


4.0
%


2.63
%


4.0
%


4.0
%


2.65
%   38




---



##### Table of Contents



Periods of Maturity





Fair ValueLess than


1 to 3


3 to 5


5 to 10


Over 10





December 31,1 Year


Years


Years


Years


Years


Total


2004(In thousands)Assets:Cash equivalents

$
106,117


$



$



$



$



$
106,117


$
106,117Average interest rate


2.12
%


















2.12
%Marketable securities

$
152,205


$
157,562


$
5,000


$
6,715


$
161,150


$
482,632


$
481,645Average interest rate


1.99
%


3.46
%


2.85
%


2.46
%


1.77
%


2.75
%Restricted investments

$
176,708


$



$



$



$



$
176,708


$
176,708Average interest rate


2.18
%


















2.18
%Total investment securities

$
435,030


$
157,562


$
5,000


$
6,715


$
161,150


$
765,457


$
764,470Average interest rate


2.12
%


3.46
%


2.85
%


2.46
%


1.77
%


2.58
%Liabilities:Short-term borrowings

$
3,103


$



$



$



$



$
3,103


$
3,103Average interest rate


5.05
%


















5.05
%Long-term borrowings

$



$
618


$
160,485


$



$



$
161,103


$
161,103Average interest rate






4.82
%


2.35
%










2.36
%     Foreign
    Currency Risk
   39




---



##### Table of Contents



December 31, 2005Notional Amount


Average


Estimated Fair(Buy) Sell


Contract Rate


Value-Gain (Loss)(In thousands, except for
    average contract rate)Foreign currency forward exchange
    contracts:Japanese yen

$
156,555



105.81


$
13,267British pound


(5,026
)


0.60



1Euro


(15,974
)


0.84



(184
)Swiss franc


1,395



1.31



(3
)Singapore dollar


(13,753
)


1.66



(15
)Taiwanese dollar


657



33.06



1Chinese renminbi


(2,040
)


8.03



(11
)Malaysian ringget


(2,341
)


3.77



(7
)Korean won


(12,304
)


1,012.10



(7
)$
107,169






$
13,042   December 31, 2004Notional Amount


Average


Estimated Fair(Buy) Sell


Contract Rate


Value-Gain (Loss)(In thousands, except for
    average contract rate)Foreign currency forward exchange
    contracts:Japanese yen

$
103,035



106.61


$
(4,846
)British pound


(5,155
)


0.52



14Euro


(15,653
)


0.75



34Singapore dollar


(13,921
)


1.64



(14
)Taiwanese dollar


(18,249
)


31.89



(63
)Korean won


(2,059
)


1,044.10



2Indian rupee


(1
)


44.05



$
47,997






$
(4,873
)  40




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##### Table of Contents



Item 8.
    Financial
    Statements and Supplementary Data  NOVELLUS
    SYSTEMS, INC.
  CONSOLIDATED
    STATEMENTS OF OPERATIONS
  Years Ended
    December 31,2005


2004


2003(In thousands, except per share
    data)Net sales

$
1,340,471


$
1,357,288


$
925,070Cost of sales


741,345



692,158



545,070Gross profit


599,126



665,130



380,000Operating expenses:Selling, general and administrative


206,939



194,652



165,618Research and development


247,315



252,083



227,439Acquired in-process research and
    development






6,124



Legal settlements






5,400



2,691Restructuring and other charges


9,175



1,484



15,838Total operating expenses


463,429



459,743



411,586Operating income (loss), net


135,697



205,387



(31,586
)Other income (expense):Interest income


20,738



11,578



17,272Interest expense


(3,510
)


(2,133
)


(909
)Other, net


5,688



8,359



(97
)Other income, net


22,916



17,804



16,266Income (loss) before provision
    (benefit) for income taxes and cumulative effect of a change in
    accounting principle


158,613



223,191



(15,320
)Provision (benefit) for income
    taxes


48,506



66,501



(10,286
)Income (loss) before cumulative
    effect of a change in accounting principle


110,107



156,690



(5,034
)Cumulative effect of a change in
    accounting principle, net of tax of $33,067 for 2003










(62,780
)Net income (loss)

$
110,107


$
156,690


$
(67,814
)Net income (loss) per share:BasicIncome (loss) before cumulative
    effect of a change in accounting principle

$
0.80


$
1.07


$
(0.03
)Cumulative effect of a change in
    accounting principle










(0.42
)Basic net income (loss) per share

$
0.80


$
1.07


$
(0.45
)DilutedIncome (loss) before cumulative
    effect of a change in accounting principle

$
0.80


$
1.06


$
(0.03
)Cumulative effect of a change in
    accounting principle










(0.42
)Diluted net income (loss) per share

$
0.80


$
1.06


$
(0.45
)Shares used in basic per share
    calculations


137,447



145,956



150,680Shares used in diluted per share
    calculations


138,423



147,937



150,680    41




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  CONSOLIDATED
    BALANCE SHEETS
  December 31,2005


2004(In thousands)ASSETSCurrent assets:Cash and cash equivalents

$
40,403


$
106,117Marketable securities


608,837



481,645Accounts receivable, net of
    allowance for doubtful accounts of $987 in 2005 and $8,247 in
    2004


397,534



395,522Inventories


193,787



261,046Deferred tax assets, net


88,563



110,644Prepaid and other current assets


34,388



14,350Total current assets


1,363,512



1,369,324Property and equipment, net


423,749



476,492Restricted cash and cash
    equivalents


140,212



176,708Goodwill


255,584



278,972Intangible and other assets


107,192



100,336Total assets

$
2,290,249


$
2,401,832LIABILITIES AND
    SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable

$
83,710


$
70,446Accrued payroll and related
    expenses


57,450



64,531Accrued warranty


54,553



45,526Other accrued liabilities


58,271



54,517Income taxes payable


5,898



14,691Deferred profit


68,718



71,216Current obligations under lines of
    credit


15,744



3,103Total current liabilities


344,344



324,030Long-term debt


124,858



161,103Other non-current liabilities


41,764



54,865Total liabilities


510,966



539,998Commitments and contingencies
    (Notes 11 and 12)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  132,820 in 2005 and 140,306
    in 2004


1,418,747



1,473,829Deferred stock compensation


(24,942
)


(17,159
)Retained earnings


388,015



399,919Accumulated other comprehensive
    (loss) income


(2,537
)


5,245Total shareholders equity


1,779,283



1,861,834Total liabilities and
    shareholders equity

$
2,290,249


$
2,401,832    42




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  CONSOLIDATED
    STATEMENTS OF CASH FLOWS
  Years Ended
    December 31,2005


2004


2003(In thousands)Cash flows from operating
    activities:Net income (loss)

$
110,107


$
156,690


$
(67,814
)Adjustment to reconcile net income
    (loss) to net cash provided by operating activities:Write-off of debt issuance costs










616Gain on sale of equity investments






(303
)


Cumulative effect of a change in
    accounting principle










62,780Non-cash portion of restructuring
    and legal settlement


14,337



(7,779
)


51,895Loss on disposal of fixed assets


2,182



1,650



Depreciation and amortization


82,776



89,244



69,570Amortization of deferred
    compensation


4,209



4,093



3,329Acquired in-process research and
    development






6,124



Income tax benefits from employee
    stock plans


4,132







Changes in operating assets and
    liabilities:Accounts receivable


(6,167
)


(146,073
)


(32,562
)Inventories


52,884



(46,072
)


5,299Deferred income taxes


22,858



39,025



(14,550
)Prepaid and other current assets


(10,421
)


(5,703
)


22,586Accounts payable


1,580



10,916



(18,064
)Accrued payroll and related
    expenses


(3,541
)


31,350



(11,817
)Accrued warranty


8,795



14,718



(2,197
)Other accrued liabilities


(2,011
)


3,415



(14,128
)Income taxes payable


(5,945
)


3,747



(3,675
)Deferred profit


(2,219
)


24,160



(8,792
)Net cash provided by operating
    activities


273,556



179,202



42,476Cash flows from investing
    activities:Purchases of marketable securities


(853,334
)


(849,558
)


(841,173
)Proceeds from sales of marketable
    securities


329,434



629,378



96,493Proceeds from maturities of
    marketable securities


395,806



246,799



640,776Capital expenditures


(44,744
)


(31,732
)


(31,685
)Proceeds from sale of property and
    equipment


2,676







Decrease (increase) in restricted
    cash and cash equivalents


36,496



(173,847
)


2,861Decrease (increase) in intangible
    and other assets


3,003



(11,226
)


2,858Purchase of Voumard Machines Co.
    SA, net of cash acquired


(5,384
)






Purchase of Peter Wolters AG, net
    of cash acquired






(142,916
)


Net cash used in investing
    activities


(136,047
)


(333,102
)


(129,870
)  43




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  CONSOLIDATED
    STATEMENTS OF CASH FLOWS  (Continued)
  Years Ended
    December 31,2005


2004


2003(In thousands)Cash flows from financing
    activities:Repayments of convertible
    subordinated debentures










(117,053
)Proceeds from employee stock
    compensation plans


29,864



38,706



75,651Proceeds (repayments) from lines
    of credit, net


12,726



(10,044
)


10,224Proceeds from long-term debt






153,115



Payment on long-term debt


(19,902
)


(10,362
)


Repurchases of common stock


(226,652
)


(410,188
)


(1,312
)Net cash used in financing
    activities


(203,964
)


(238,773
)


(32,490
)Effects of exchange rate changes
    on cash and cash equivalents


741



1,612



1,218Net decrease in cash and cash
    equivalents


(65,714
)


(391,061
)


(118,666
)Cash and cash equivalents at the
    beginning of the year


106,117



497,178



615,844Cash and cash equivalents at the
    end of the year

$
40,403


$
106,117


$
497,178Supplemental disclosures:Cash paid during the year for:Interest

$
4,136


$
1,425


$
909Income taxes, net

$
14,263


$
23,908


$
6,321    44




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  CONSOLIDATED
    STATEMENTS OF SHAREHOLDERS EQUITY
  AccumulatedOtherComprehensive


TotalCommon Stock


Deferred


Retained


Income


ShareholdersShares


Amount


Compensation


Earnings


(Loss)


Equity(In thousands)Balance at December 31, 2002


149,119


$
1,494,960


$
(7,679
)

$
570,153


$
(1,746
)

$
2,055,688Components of comprehensive loss:Net loss














(67,814
)






(67,814
)Net change in unrealized loss on
    marketable securities


















172



172Foreign currency translation
    adjustments


















6,146



6,146Comprehensive loss






















(61,496
)Issuance of common stock under
    employee compensation plans


3,696



75,651















75,651Issuance of restricted common
    stock, net


116



3,963



(3,963
)










Amortization of deferred
    compensation










3,329











3,329Repurchases of common stock


(32
)


(335
)






(977
)






(1,312
)Balance at December 31, 2003


152,899



1,574,239



(8,313
)


501,362



4,572



2,071,860Components of comprehensive income:Net income














156,690







156,690Net change in unrealized loss on
    marketable securities


















(571
)


(571
)Less: reclassification adjustment
    for gain on sale of marketable securities


















(303
)


(303
)Foreign currency translation
    adjustments, net of tax of $4,194


















1,547



1,547Comprehensive income






















157,363Issuance of common stock under
    employee compensation plans, net


1,731



38,847







(141
)






38,706Issuance of restricted common
    stock, net


450



12,939



(12,939
)










Amortization of deferred
    compensation










4,093











4,093Repurchases of common stock


(14,774
)


(152,196
)






(257,992
)






(410,188
)Balance at December 31, 2004


140,306



1,473,829



(17,159
)


399,919



5,245



1,861,834Components of comprehensive income:Net income














110,107







110,107Net change in unrealized loss on
    marketable securities


















(903
)


(903
)Foreign currency translation
    adjustments, net of tax of $(2,495)


















(6,879
)


(6,879
)Comprehensive income






















102,325Issuance of common stock under
    employee compensation plans, net


1,901



33,658







(223
)






33,435Income tax benefits realized from
    activity in employee stock plans






4,132















4,132Issuance of restricted common
    stock, net


538



11,992



(11,992
)










Amortization of deferred
    compensation










4,209











4,209Repurchases of common stock


(9,925
)


(104,864
)






(121,788
)






(226,652
)Balance at December 31, 2005


132,820


$
1,418,747


$
(24,942
)

$
388,015


$
(2,537
)

$
1,779,283    45




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
  Note 1.
    Description
    of the Business        Note 2.
    Significant
    Accounting Policies  Principles of Consolidation and Basis of
    Presentation
  Stock-Based Compensation
     46




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
       Years Ended
    December 31,2005


2004


2003Net income (loss) as reported

$
110,107


$
156,690


$
(67,814
)Add back:Intrinsic value method expense
    included in reported net income (loss), net of tax


2,589



2,906



2,186Less:Fair value method expense, net of
    tax


(49,145
)


(49,086
)


(66,063
)Pro-forma net income (loss)

$
63,551


$
110,510


$
(131,691
)Pro-forma basic net income (loss)
    per share

$
0.46


$
0.76


$
(0.87
)Pro-forma diluted net income
    (loss) per share

$
0.46


$
0.75


$
(0.87
)     2005


2004


2003Dividend yield


None



None



NoneExpected volatility


54
%


74
%


78
%Risk free interest rate


4.1
%


2.7
%


2.1
%Expected lives


3.9 years



3.6 years



3.6 years       2005


2004


2003Dividend yield


None



None



NoneExpected volatility


32
%


43
%


47
%Risk free interest rate


3.3
%


1.6
%


1.3
%Expected lives


1/2 year



1/2 year



1/2 year    47




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Use of Estimates
  Revenue Recognition
    00-21,
    Cash, Cash Equivalents and Marketable
    Securities
  Restricted Cash and Cash Equivalents
  Allowance for Doubtful Accounts
 48




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Inventories and Inventory
    Valuation (first-in, work-in-process,
  Deferred Tax Assets
  Property and Equipment
  Machinery and equipment

3  10 yearsFurniture and fixtures

5  10 yearsBuildings

30  40 yearsBuilding improvements

Shorter of useful life or
    remaining lease term   Goodwill and Other Intangible Assets
  Investments in Non-Marketable Equity
    Securities
  Warranty
  Restructuring and Impairment
    Charges
 49




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Contingencies and Litigation
  Foreign Currency Translation
  Forward Foreign Exchange
    Contracts marked-to-market,
  Shipping and Handling Costs
  Advertising Expenses
  Concentrations and Other Risks
   50




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
       Recent Accounting Pronouncements No. 03-1, Other-Than-Temporary No. 03-1. No. 03-1 No. 03-1 EITF 03-1-1, EITF 03-1-1. EITF 03-1-1 No. 03-1. other-than-temporary other-than-temporary
       51




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Note 3.  Financial
    Instruments
  Marketable
    securities
    December 31, 2005Gross


GrossUnrealized


Unrealized


Estimated FairCost


Gains


Losses


ValueU.S. Government agencies

$
5,000


$



$
(20
)

$
4,980Municipal securities


344,932



2



(1,924
)


343,010Tax-exempt auction rate notes


252,730











252,730Mutual funds


8,065



52







8,117Total

$
610,727


$
54


$
(1,944
)

$
608,837   December 31, 2004Gross


GrossUnrealized


Unrealized


Estimated FairCost


Gains


Losses


ValueU.S. Government agencies

$
25,610


$



$
(155
)

$
25,455Municipal securities


272,559



324



(617
)


272,266Corporate securities


34,258







(125
)


34,133Tax-exempt auction rate notes


145,050











145,050Mutual funds


5,155







(414
)


4,741Total

$
482,632


$
324


$
(1,311
)

$
481,645  52




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     December 31, 2005

AmountDue in less than one year

$
315,102Due in 1 to 3 years


139,240Due in 3 to 5 years


10,940Due in 5 to 10 years


10,685Due in greater than 10 years


273,082Total

$
749,049       In Loss Position for Less


In Loss Position ForThan 12 Months


12 Months or Greater


TotalFair


Unrealized


Fair


Unrealized


Fair


UnrealizedValue


Losses


Value


Losses


Value


LossesU.S. Government agencies

$
4,980


$
(20
)

$



$



$
4,980


$
(20
)Municipal securities


214,105



(1,362
)


83,869



(562
)


297,974



(1,924
)Total

$
219,085


$
(1,382
)

$
83,869


$
(562
)

$
302,954


$
(1,944
)     Fair
    Value of Other Financial Instruments
    December 31,2005


2004Carrying


Estimated Fair


Carrying


Estimated FairValue


Value


Value


ValueRestricted cash & cash
    equivalents  non-current

$
140,212


$
140,212


$
176,708


$
176,708Current obligations under lines of
    credit

$
15,744


$
15,744


$
3,103


$
3,103Long-term debt

$
124,858


$
124,858


$
161,103


$
161,103    53




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Financial
    Instruments with Off-Balance Sheet Risk
    December 31,2005


2004Notional


Carrying


Estimated


Notional


Carrying


EstimatedAmount


Amount


Fair Value


Amount


Amount


Fair ValueSell (buy) foreign currencies

$
107,169


$
13,042


$
13,042


$
47,997


$
(4,873
)

$
(4,873
)     Note 4.
    Balance
    Sheet Details  Inventories
  December 31,2005


2004(In thousands)Purchased and spare parts

$
152,763


$
192,935Work-in-process


27,110



54,586Finished goods


13,914



13,525Total inventories

$
193,787


$
261,046   Property
    and equipment, net
  December 31,2005


2004(In thousands)Machinery and equipment

$
577,157


$
561,392Buildings and land


243,055



246,334Building improvements


75,681



84,229Furniture and fixtures


22,634



21,438918,527



913,393Less accumulated depreciation


494,778



436,901Total property and equipment

$
423,749


$
476,492    54




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Accrued
    warranty
    Years EndedDecember 31,2005


2004Balance, beginning of period

$
45,526


$
28,805Warranties issued


79,146



77,267Settlements


(84,632
)


(66,698
)Peter Wolters AG balance at
    acquisition






2,367Voumard Machine Co. SA balance at
    acquisition


610



Changes in liability for
    pre-existing warranties, including expirations


13,903



3,785Balance, end of period

$
54,553


$
45,526   Note 5.
    Earnings
    (Loss) Per Share        Years Ended
    December 31,2005


2004


2003Numerator:Net income (loss)

$
110,107


$
156,690


$
(67,814
)Denominator:Basic weighted-average shares
    outstanding


137,447



145,956



150,680Employee stock options and
    restricted stock


976



1,981



Diluted weighted-average shares
    outstanding


138,423



147,937



150,680Basic net income (loss) per share

$
0.80


$
1.07


$
(0.45
)Diluted net income (loss) per share

$
0.80


$
1.06


$
(0.45
)    55




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Note 6.
    Goodwill
    and Other Intangible Assets  Goodwill
    Years ended2005


2004Balance, beginning of period

$
278,972


$
173,267SpeedFam-IPEC adjustment


(11,566
)


(11,037
)Peter Wolters AG acquisition






104,221Peter Wolters AG adjustment


1,945



414Foreign currency translation


(13,767
)


12,107Balance, end of period

$
255,584


$
278,972     SpeedFam-IPEC
    Intangible
    Assets
    AccumulatedDecember 31, 2005

Gross


Amortization


NetPatents

$
4,201


$
(1,225
)

$
2,976Developed technology


28,042



(11,422
)


16,620Trademark


6,065



(903
)


5,162Other intangible assets


161



(99
)


62Total

$
38,469


$
(13,649
)

$
24,820   56




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  AccumulatedDecember 31, 2004

Gross


Amortization


NetPatents

$
4,197


$
(525
)

$
3,672Developed technology


28,095



(6,928
)


21,167Trademark


6,809



(340
)


6,469Other intangible assets


138



(81
)


57Total

$
39,239


$
(7,874
)

$
31,365     Note 7.
    Business
    Combination  Voumard
    Machine Co. SA
        Cash consideration

$
6,369Estimated transaction costs


435Total purchase price

$
6,804Assets acquired

$
19,393Liabilities assumed


(12,589
)Total net assets acquired

$
6,804   Peter
    Wolters AG
   57




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
       Cash consideration

$
149,512Transaction costs


2,100Total purchase price

$
151,612Cash and cash equivalents

$
8,696Accounts receivable


10,560Inventory


25,216Deferred tax asset


1,454Prepaid expenses and other current
    assets


147Property, plant and equipment


19,492Goodwill


104,221Developed technology


9,600Customer backlog


2,400Trademark/Tradename


6,100Other assets


23Accounts payable


(4,726
)Accrued payroll and related
    expenses


(7,399
)Accrued warranty


(1,761
)Other current liabilities


(6,634
)Deferred tax liability


(8,306
)Income tax payable


(102
)Long-term debt


(967
)Other long-term liabilities


(6,402
)Total net assets acquired

$
151,612   Intangible Assets 
  Goodwill 
 58




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Note 8.
    Restructuring
    and Other Charges      InventoryAsset





Acquisition





Write-Facilities


Impairment


Severance


Expense


Total


DownBalance at December 31, 2002

$
45,568


$



$
251


$
1,253


$
47,072


$
Restructuring charges for 2003


4,088



7,943



3,807







15,838



43,952SpeedFam-IPEC acquisition
    adjustment


11,032















11,032



Non-cash adjustment


(347
)


(7,943
)










(8,290
)


(43,952
)Cash payments


(9,828
)






(3,466
)


(138
)


(13,432
)


Balance at December 31, 2003


50,513







592



1,115



52,220



Restructuring charges (benefits)
    for 2004


(923
)


1,220



1,187







1,484



SpeedFam-IPEC acquisition
    adjustment














(799
)


(799
)


Non-cash adjustment






(1,057
)










(1,057
)


Cash payments


(7,909
)






(1,619
)


(118
)


(9,646
)


Balance at December 31, 2004


41,681



163



160



198



42,202



Restructuring charges (benefits)
    for 2005


(5,835
)


14,172



838







9,175



5,250Non-cash adjustment






(14,265
)










(14,265
)


(5,250
)Cash payments


(8,607
)


(70
)


(135
)






(8,812
)


Balance at December 31, 2005

$
27,239


$



$
863


$
198


$
28,300


$
        59




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Facilities
        Asset
    Impairment
        Severance
       60




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Acquisition
    Costs
    Inventory
    Write-downs
      Note 9.
    Long-term
    Debt            Years Ending
    December 31,2006


2007


2008


2009


2010


Thereafter(In thousands)Long-term debt obligations

$
38


$
38


$
38


$
123,674


$
38


$
1,032  61




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Note 10.
    Other,
    net    Years Ended
    December 31,2005


2004


2003Litigation proceeds

$



$
8,000


$
Other income


810



2,160



1,168Other expense


(578
)


(761
)


(345
)Foreign currency gain (loss), net


5,456



(1,040
)


(920
)Total other, net

$
5,688


$
8,359


$
(97
)   Note 11.
    Commitments
    and Guarantees  Standby
    Letters of Credit
    Guarantee
    Arrangements
  line-of-credit
        Lease
    Commitments
   62




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Years Ending
    December 31,


Sublease


Net2006


2007


2008


2009


2010


Thereafter


Income


TotalNon-cancelable operating leases

$
9,080


$
8,416


$
7,817


$
7,790



7,709


$
32,242


$
(15,130
)

$
57,924   Purchase
    Commitments
    Variable
    Interest Entities
       63




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Note 12.
    Litigation  Linear
    Technology Corporation
    Plasma
    Physics Corporation and Solar Physics Corporation
    Matter
    Other
    Litigation
   64




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Note 13.
    Income
    Taxes    Years Ended
    December 31,2005


2004


2003FederalCurrent

$
6


$
13,611


$
7,270Deferred


21,851



29,067



(30,046
)21,857



42,678



(22,776
)StateCurrent


442



1,036



405Deferred


8,737



7,438



(5,230
)9,179



8,474



(4,825
)ForeignCurrent


17,211



15,349



17,315Deferred


(3,873
)






13,338



15,349



17,315Income tax benefits attributable
    to employee stock plan activity allocated to shareholders
    equity


4,132







Total provision (benefit) for
    income taxes

$
48,506


$
66,501


$
(10,286
)     Years Ended
    December 31,2005


2004


2003Domestic

$
126,099


$
188,938


$
(66,744
)Foreign


32,514



34,253



51,424Total

$
158,613


$
223,191


$
(15,320
)  65




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     December 31,2005


2004Deferred tax assets:Reserves and accruals

$
79,986


$
100,459Capitalized in-process research
    and development


36,893



40,002Deferred profit


33,632



33,948Net operating loss carryforwards


43,923



46,387Credits


50,662



57,567Other


14,494



5,951Total deferred tax assets


259,590



284,314Valuation allowance


(67,999
)


(80,281
)Deferred tax assets, net of
    valuation allowance


191,591



204,033Deferred tax liabilities:Depreciation


(72,031
)


(67,168
)Acquisition related items


(8,091
)


(10,514
)Total net deferred tax assets

$
111,469


$
126,351        66




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Years Ended
    December 31,2005


2004


2003Expected provision at 35%

$
55,515


$
78,117


$
(5,362
)State tax, net of federal benefit


5,966



5,508



(3,136
)Tax-exempt interest


(5,885
)


(2,459
)


(420
)Research and development credits


(1,913
)


(1,309
)


(2,000
)Export sales incentive


(2,971
)


(9,781
)


Valuation allowance increase
    (decrease)






(8,827
)


322Write-off of acquired IPR&D






2,143



Other


(2,206
)


3,109



310Total provision (benefit) for
    income taxes

$
48,506


$
66,501


$
(10,286
)     Note 14.
    Shareholders
    Equity  Other
    Comprehensive (Loss) Income
    December 31,2005


2004Foreign currency translation
    adjustments, net of tax of $(2,495) and $4,194, respectively

$
(647
)

$
6,232Unrealized loss on marketable
    securities


(1,890
)


(987
)Accumulated other comprehensive
    (loss) income

$
(2,537
)

$
5,245   Common
    Stock Repurchase Program
     67




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Note 15.
    Employee
    Benefit Plans  Employee
    Stock Option Plans
  Non-Qualified
        Options Outstanding


Restricted StockShares





Weighted-





Weighted-Available


Number of


Average


Number of


Averagefor Grant


Shares


Exercise Price


Shares


FMV at GrantBalances at December 31, 2002


8,854



26,056


$
31.16



227


$
29.02Granted


(3,966
)


3,841


$
38.94



125


$
38.65Exercised






(3,015
)

$
18.70







Canceled


1,148



(1,584
)

$
45.82



(4
)

$
29.24Vested restricted stock














(99
)

$
25.56Balances at December 31, 2003


6,036



25,298


$
32.80



249


$
35.22New plan


300















Granted


(5,850
)


5,339


$
29.02



511


$
30.69Exercised






(1,292
)

$
20.13







Canceled


1,726



(2,640
)

$
36.06



(62
)

$
36.39Vested restricted stock














(10
)

$
36.50Balances at December 31, 2004


2,212



26,705


$
32.40



688


$
31.73Additional shares authorized


4,500















Granted


(3,566
)


2,911


$
24.99



655


$
24.21Exercised






(1,327
)

$
16.21







Canceled


2,679



(4,152
)

$
35.96



(117
)

$
32.04Vested restricted stock














(29
)

$
24.90Balances at December 31, 2005


5,825



24,137


$
31.79



1,197


$
27.57  68




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
       Options Outstanding


Options ExercisableWeighted-Options


Average





OptionsOutstanding


Remaining


Weighted-


Exercisable


Weighted-Range of

at December 31,


Contractual Life


Average


at December 31,


AverageExercise Prices

2005


(Years)


Exercise Price


2005


Exercise Price$ 5.89 to $ 24.76


3,644,232



7.08


$
20.76



1,413,837


$
15.17$25.08 to $ 27.02


2,648,898



4.88


$
25.68



2,206,075


$
25.64$27.04 to $ 27.91


2,619,888



8.83


$
27.53



698,865


$
27.56$28.00 to $ 29.03


556,971



7.96


$
28.59



222,619


$
28.24$29.17 to $ 29.24


2,724,650



6.95


$
29.24



2,031,776


$
29.24$29.37 to $ 31.24


3,197,659



6.18


$
30.44



3,021,452


$
30.48$31.72 to $ 38.50


1,095,470



6.78


$
33.17



1,095,470


$
33.17$38.70 to $ 38.70


3,573,515



5.97


$
38.70



3,573,515


$
38.70$38.87 to $ 41.74


2,422,079



7.74


$
40.74



2,422,079


$
40.74$41.82 to $200.43


1,653,527



5.11


$
51.55



1,653,527


$
51.55$ 5.89 to $200.43


24,136,889



6.67


$
31.79



18,339,215


$
33.46     Restricted
    Stock and Deferred Compensation
     69




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Employee
    Stock Purchase Plans
    Employee
    Savings and Retirement Plan
    Deferred
    Compensation Plan
    Profit
    Sharing Plans
    Defined
    Benefit Pension Plan
      Discount rate


4.0
%Salary increase rate


2.0
%  70




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Note 16.
    Operating
    Segments      IndustrialSemiconductor


ApplicationsGroup


Group


Consolidated2005Sales to unaffiliated customers

$
1,236,515


$
103,956


$
1,340,471Total net sales

$
1,236,515


$
103,956


$
1,340,471Operating income

$
122,231


$
13,466


$
135,697Long-lived assets

$
406,786


$
16,963


$
423,749All other identifiable assets


1,689,160



177,340



1,866,500Total assets

$
2,095,946


$
194,303


$
2,290,249   IndustrialSemiconductor


ApplicationsGroup


Group


Consolidated2004Sales to unaffiliated customers

$
1,299,918


$
57,370


$
1,357,288Total net sales

$
1,299,918


$
57,370


$
1,357,288Operating income

$
204,569


$
818


$
205,387Long-lived assets

$
456,023


$
20,469


$
476,492All other identifiable assets


1,721,646



203,694



1,925,340Total assets

$
2,177,669


$
224,163


$
2,401,832    71




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
       North America


Europe


Asia


Elimination


Consolidated2005Sales to unaffiliated customers

$
986,409


$
92,307


$
261,755


$



$
1,340,471Transfers between geographic
    locations


157,659



27,035



42,814



(227,508
)


Total net sales

$
1,144,068


$
119,342


$
304,569


$
(227,508
)

$
1,340,471Operating income

$
99,961


$
16,148


$
19,588


$



$
135,697Long-lived assets

$
406,570


$
14,542


$
2,637


$



$
423,749All other identifiable assets


1,481,647



170,640



214,213







1,866,500Total assets

$
1,888,217


$
185,182


$
216,850


$



$
2,290,249   North America


Europe


Asia


Elimination


Consolidated2004Sales to unaffiliated customers

$
1,051,553


$
47,661


$
258,074


$



$
1,357,288Transfers between geographic
    locations


134,013



24,369



36,966



(195,348
)


Total net sales

$
1,185,566


$
72,030


$
295,040


$
(195,348
)

$
1,357,288Operating income

$
164,106


$
4,060


$
37,221


$



$
205,387Long-lived assets

$
455,218


$
18,794


$
2,480


$



$
476,492All other identifiable assets


1,561,672



195,957



167,711







1,925,340Total assets

$
2,016,890


$
214,751


$
170,191


$



$
2,401,832   North America


Europe


Asia


Elimination


Consolidated2003Sales to unaffiliated customers

$
729,998


$
24,965


$
170,107


$



$
925,070Transfers between geographic
    locations


42,217



17,828



39,312



(99,357
)


Total net sales

$
772,215


$
42,793


$
209,419


$
(99,357
)

$
925,070Operating income (loss)

$
(81,960
)

$
3,608


$
46,766


$



$
(31,586
)Long-lived assets

$
503,952


$
915


$
1,700


$



$
506,567All other identifiable assets


1,690,927



24,081



117,325







1,832,333Total assets

$
2,194,879


$
24,996


$
119,025


$



$
2,338,900    72




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Note 17.
    Related
    Party Transactions          Note 18.
    Quarterly
    Financial Data (Unaudited)  Quarter EndedApril 2,


July 2,


October 1,


December 31,2005


2005


2005


2005(In thousands, except per share
    data)Net sales

$
339,740


$
329,585


$
338,878


$
332,268Gross profit

$
153,869


$
157,562


$
147,194


$
140,501Net income

$
30,471


$
33,231


$
23,415


$
22,990Basic and diluted net income per
    share

$
0.22


$
0.24


$
0.17


$
0.17Shares used in basic per share
    calculations


139,890



138,068



137,848



133,980Shares used in diluted per share
    calculations


141,099



138,944



138,895



134,752   Quarter EndedMarch 27,


June 26,


September 25,


December 31,2004


2004


2004


2004(In thousands, except per share
    data)Net sales

$
262,862


$
338,219


$
415,935


$
340,272Gross profit

$
124,605


$
169,680


$
201,111


$
169,734Net income

$
16,681


$
37,811


$
64,662


$
37,536Basic and diluted net income per
    share

$
0.11


$
0.25


$
0.45


$
0.27Shares used in basic per share
    calculations


152,911



149,112



142,333



139,466Shares used in diluted per share
    calculations


156,100



151,386



143,574



140,687    73




---



##### Table of Contents



NOVELLUS
    SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   (1)
    
    The second quarter 2005 results include a pre-tax reduction of
    $6.1 million to allowance for doubtful accounts.(2)
    
    The third quarter 2005 results include a net $8.6 million
    pre-tax charge primarily related to the decision to consolidate
    operations and streamline certain product offerings. Included in
    this charge is a pre-tax inventory write-down of
    $5.2 million within cost of goods sold. The other pre-tax
    costs associated with the restructuring were $6.3 million,
    which were partially offset by a pre-tax reversal of
    $3.0 million of a previously recorded restructuring accrual.(3)
    
    The fourth quarter 2005 results include a net pre-tax
    restructuring and other charges of $5.9 million. These
    charges include a pre-tax restructuring of $8.8 million
    related to the relocation of certain operations activities from
    Chandler, Arizona to San Jose, California, which was
    partially offset by a $2.9 million pre-tax reversal of a
    previously recorded restructuring accrual resulting from a
    change in estimated sublease income over the remaining lease
    term.(4)
    
    The first quarter 2004 results include a charge of
    $2.5 million related to the settlement of an overtime class
    action lawsuit by field service engineers and a pre-tax benefit
    to cost of sales of approximately $0.9 million for the sale
    of inventory previously reserved.(5)
    
    The second quarter 2004 results include a charge totaling
    $6.1 million for acquired in-process research and
    development in connection with the acquisition of Angstron
    Systems, Inc. and a pre-tax benefit to cost of sales of
    approximately $3.6 million for the sale of inventory
    previously reserved.(6)
    
    The third quarter 2004 results included a cash receipt of
    $8.0 million, and the reversal of $8.1 million in
    previously accrued royalty payments, as a result of the
    settlement of litigation with Applied Materials, Inc. The third
    quarter 2004 results also included a pre-tax charge of
    $2.9 million related to the settlement of litigation with
    Semitool, Inc., the reversal of a previously recorded
    restructuring accrual of $0.9 million and a pre-tax benefit
    to cost of sales of approximately $2.8 million for the sale
    of inventory previously reserved.(7)
    
    The fourth quarter results include restructuring and other
    charges of $2.4 million and the pre-tax benefit to cost of
    sales of approximately $1.7 million for the sale of
    inventory previously reserved. 74




---



##### Table of Contents



REPORT OF
    INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
  ON
    CONSOLIDATED FINANCIAL STATEMENTS
  The Board
    of Directors and Shareholders of Novellus Systems,
    Inc.
            /s/
    Ernst & Young LLP
   75




---



##### Table of Contents



Item 9.
    Changes
    in and Disagreements with Accountants on Accounting and
    Financial Disclosure    Item 9A.
    Controls
    and Procedures  Form 10-K Rule 13a-14 Form 10-K Form 10-K
  Evaluation
    of Disclosure Controls and Procedures
  Form 10-K. Form 10-K,
  Form 10-K. Form 10-Q Form 10-K.
  Form 10-K,
 76




---



##### Table of Contents



Management
    Report on Internal Control over Financial Reporting
  Rules 13a-15(f) 15d-15(f). Internal
    Control  Integrated Framework
   77




---



##### Table of Contents



Report of
    Independent Registered Public Accounting Firm on Internal
    Control
    over Financial Reporting
  The Board
    of Directors and Shareholders of Novellus Systems,
    Inc.
              /s/
    Ernst & Young LLP
   78




---



##### Table of Contents



Limitations
    on Effectiveness of Controls
    Item 9B.
    Other
    Information   PART III  Item 10.
    Directors
    and Executive Officers of the Registrant  Regulation S-K,
  Item 11.
    Executive
    Compensation    Item 12.
    Security
    Ownership of Certain Beneficial Owners and Management and
    Related Stockholder Matters    Item 13.
    Certain
    Relationships and Related Transactions    Item 14.
    Principal
    Accounting Fees and Services   79




---



##### Table of Contents



PART IV  Item 15.
    Exhibits
    and Financial Statement Schedules          Form 10-K
      Regulation S-K)
  3
.1(1)

Amended and Restated Articles of
    Incorporation of Novellus.3
.2(2)

Amended and Restated Bylaws of
    Novellus.10
.1(3)

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
.2(4)

Environmental Agreement by and
    between Varian Associates, Inc. and Novellus dated May 7,
    1997.*10
.3(5)

Novellus 1992 Stock Option
    Plan, together with forms of agreements thereunder.*10
.4(6)

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
.5(7)

Novellus 1992 Employee Stock
    Purchase Plan, as amended through April 29, 2005.*10
.6(8)

Form of Directors and Officers
    Indemnification Agreement.*10
.7(9)

GaSonics International Corporation
    Amended and Restated 1994 Stock Option/Stock Issuance Plan,
    together with forms of agreements thereunder, as assumed by
    Novellus.*10
.8(10)

Gamma Precision Technology, Inc.
    1998 Stock Option Plan, together with forms of agreements
    thereunder, as assumed by Novellus.*10
.9(11)

GaSonics International Corporation
    Supplemental Stock Option Plan, as assumed by Novellus.10
.10(12)

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
.11(13)

Novellus 2001 Stock Incentive Plan
    amended and restated March 11, 2005, together with forms of
    agreement thereunder.*10
.12(14)

SpeedFam-IPEC, Inc. Amended and
    Restated 1995 Stock Plan, as assumed by Novellus.*10
.13(15)

SpeedFam-IPEC, Inc. 2001
    Nonstatutory Stock Option Plan, together with forms of
    agreements thereunder, as assumed by Novellus.*10
.14(16)

Integrated Process Equipment
    Corporation 1992 Stock Option Plan, as assumed by Novellus.*10
.15(17)

SpeedFam International, Inc.
    Amended and Restated 1991 Employee Incentive Stock Option Plan,
    as assumed by Novellus.*10
.16(18)

SpeedFam-IPEC, Inc. Stand-Alone
    Stock Option Agreement dated June 14, 2001 between
    SpeedFam-IPEC, Inc. and Peter Simone, as assumed by Novellus. 80




---



##### Table of Contents



10
.17(19)

Lease Agreement between Seldin
    Properties and Integrated Process Equipment Corp. dated
    December 26, 1996.10
.18(20)

Purchase and Sale Agreement
    between Glen Una Management Company, Inc. and SpeedFam-IPEC,
    Inc. dated May 31, 2002.10
.19(21)

Lease Agreement between Phoenix
    Industrial Investment Partners, L.P. and SpeedFam-IPEC, Inc.
    dated June  21, 2002.10
.20(22)

First Amendment to Lease Agreement
    between Phoenix Industrial Investment Partners, L.P. and
    SpeedFam-IPEC, Inc. dated January 21, 2003.10
.21(23)

Lease Guaranty between Novellus
    and Phoenix Industrial Investment Partners, L.P. dated
    January 21, 2002.*10
.22(24)

Letter Agreement between Novellus
    and Sasson Somekh dated January 23, 2004.*10
.23(25)

Letter Agreement between Novellus
    and Thomas St. Dennis dated June 27, 2003.*10
.24(26)

Restricted Stock Purchase
    Agreement between Novellus and Richard S. Hill dated
    December 13, 2002.*10
.25(27)

Stand-Alone Stock Option Agreement
    between Novellus and Sasson Somekh dated January 23, 2004.*10
.26(28)

Stand-Alone Restricted Stock Award
    between Novellus and Sasson Somekh dated January 23, 2004.10
.27(29)

Credit Agreement between Johanna
    34 Vermogensverwaltungs GmbH, Novellus Systems BV, Novellus
    Systems, Inc. and JPMorgan Chase Bank, as Administrative Agent
    dated June 25, 2004.10
.28(30)

Guarantee and Collateral Agreement
    made by Novellus Systems, Inc. in favor of JPMorgan Chase Bank,
    as Administrative Agent dated June 25, 2004.10
.29(31)

Binding Memorandum of
    Understanding between Novellus, and Applied Materials, Inc.,
    effective as of September 3, 2004. Portions of this exhibit
    have been omitted pursuant to a request for confidential
    treatment.*10
.30(32)

Amended and Restated Employment
    Agreement between Novellus and Richard S. Hill effective as of
    March  11, 2005.10
.31 (33)

Form of Non-Employee Director
    Restricted Stock Bonus Agreement, as amended through
    April 29, 2005.10
.31 (34)

Form of Resale Restriction
    Agreement21
.1

Subsidiaries of Novellus.23
.1

Consent of Independent Registered
    Public Accounting Firm.24
.1

Power of Attorney (see
    page 84).31
.1

Certification of Richard S. Hill,
    Chairman of the Board of Directors and Chief Executive Officer
    of Novellus Systems, Inc. dated March 15, 2006 in
    accordance with
    Rules 13a-14(a)
    and
    15d-14(a) of
    the Securities Exchange Act, as amended, as adopted pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.31
.2

Certification of William H. Kurtz,
    Executive Vice President and Chief Financial Officer of Novellus
    Systems, Inc. dated March 15, 2006 in accordance with
    Rules 13a-14(a)
    and
    15d-14(a) of
    the Securities Exchange Act, as amended, as adopted pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.32
.1

Certification of Richard S. Hill,
    Chairman of the Board of Directors and Chief Executive Officer
    of Novellus Systems, Inc. dated March 15, 2006 in
    accordance with 18 U.S.C. 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.32
.2

Certification of William H. Kurtz,
    Executive Vice President and Chief Financial Officer of Novellus
    Systems, Inc. dated March 15, 2006 in accordance with
    18 U.S.C. 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.     (1)
    
    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.(2)
    
    Incorporated by reference to Exhibit 3.2 to Novellus
    Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 12,
    2004. 81




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##### Table of Contents



(3)
    
    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.(4)
    
    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.(5)
    
    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.(6)
    
    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.(7)
    
    Incorporated by reference to Exhibit 10.2 filed with
    Novellus Report on
    Form 8-K
    filed with the Securities and Exchange Commission on May 5,
    2005.(8)
    
    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.(9)
    
    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.(10)
    
    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.(11)
    
    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.(12)
    
    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.(13)
    
    Incorporated by reference to Exhibit 10.1 to Novellus
    Report on
    Form 8-K
    filed with the Securities and Exchange Commission on May 5,
    2005.(14)
    
    Incorporated by reference to Exhibit 10.30 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 5,
    2003.(15)
    
    Incorporated by reference to Exhibit 10.31 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 5,
    2003.(16)
    
    Incorporated by reference to Exhibit 10.32 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 5,
    2003.(17)
    
    Incorporated by reference to Exhibit 10.33 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 5,
    2003.(18)
    
    Incorporated by reference to Exhibit 10.34 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 5,
    2003.(19)
    
    Incorporated by reference to Exhibit 10.35 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 5,
    2003.(20)
    
    Incorporated by reference to Exhibit 10.36 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 5,
    2003.(21)
    
    Incorporated by reference to Exhibit 10.37 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 5,
    2003.(22)
    
    Incorporated by reference to Exhibit 10.38 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 5,
    2003.(23)
    
    Incorporated by reference to Exhibit 10.39 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 5,
    2003.(24)
    
    Incorporated by reference to Exhibit 10.39 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 12,
    2004.(25)
    
    Incorporated by reference to Exhibit 10.40 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 12,
    2004. 82




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##### Table of Contents



(26)
    
    Incorporated by reference to Exhibit 10.41 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 12,
    2004.(27)
    
    Incorporated by reference to Exhibit 10.42 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 12,
    2004.(28)
    
    Incorporated by reference to Exhibit 10.43 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 12,
    2004.(29)
    
    Incorporated by reference to Exhibit 10.1 to Novellus
    Report on
    Form 8-K
    filed with the Securities and Exchange Commission on
    July 12, 2004.(30)
    
    Incorporated by reference to Exhibit 10.2 to Novellus
    Report on
    Form 8-K
    filed with the Securities and Exchange Commission on
    July 12, 2004.(31)
    
    Incorporated by reference to Exhibit 99.1 to Novellus
    Report on
    Form 8-K
    filed with the Securities and Exchange Commission on
    September 24, 2004.(32)
    
    Incorporated by reference to Exhibit 10.30 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 15,
    2005.(33)
    
    Incorporated by reference to Exhibit 10.3 to Novellus
    Report on Form
    8-K filed
    with the Securities and Exchange Commission on May 5, 2005.(34)
    
    Incorporated by reference to Exhibit 10.34 to
    Novellus Report on Form
    8-K filed
    with the Securities and Exchange Commission on November 15,
    2005.*
    
    Management contracts or compensatory plans or arrangements. 83




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##### Table of Contents



SIGNATURES  Form 10-K
    By:
    /s/  Richard S. Hill    Chairman of the Board of Directors and
 Chief Executive Officer
  POWER OF
    ATTORNEY
  attorneys-in-fact, Form 10-K attorneys-in-fact,
  Form 10-K
  Signature

Title

Date/s/  Richard S. HillRichard
    S. Hill

Chairman of the Board of Directors
    and Chief Executive Officer
    (Principal Executive Officer)

March 15, 2006/s/  William H. KurtzWilliam
    H. Kurtz

Executive Vice President and Chief
    Financial Officer
    (Principal Financial Officer)

March 15, 2006/s/  Thomas R. FoyThomas
    R. Foy

Vice President and Corporate
    Controller (Principal Accounting Officer)

March 15, 2006/s/  Neil R. BonkeNeil
    R. Bonke

Director

March 15, 2006/s/  Youssef A.
    El-MansyYoussef
    A. El-Mansy

Director

March 15, 2006/s/  J. David LitsterJ.
    David Litster

Director

March 15, 2006/s/  Yoshio NishiYoshio
    Nishi

Director

March 15, 2006 84




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##### Table of Contents



Signature

Title

Date/s/  Glen G. PossleyGlen
    G. Possley

Director

March 15, 2006/s/  Ann D. RhoadsAnn
    D. Rhoads

Director

March 15, 2006/s/  William R.
    SpiveyWilliam
    R. Spivey

Director

March 15, 2006/s/  Delbert A.
    WhitakerDelbert
    A. Whitaker

Director

March 15, 2006  85




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##### Table of Contents



SCHEDULE II
  VALUATION
    AND QUALIFYING ACCOUNTS
 December 31,
    2005, 2004 and 2003
  Balance atBeginning of








Balance atYear


Additions


Deductions


End of Year(In thousands)Allowance for doubtful
    accounts(1)2005

$
8,247


$
243


$
(7,503
)

$
9872004

$
7,655


$
546


$
46


$
8,2472003

$
7,339


$



$
316


$
7,655Valuation allowance for deferred
    tax
    assets(2)2005

$
80,281


$
2,267


$
(14,549
)

$
67,9992004

$
76,510


$
14,193


$
(10,422
)

$
80,2812003

$
57,028


$
35,799


$
(16,317
)

$
76,510     (1)
    
    Deductions represent uncollectible accounts written off, net of
    recoveries and other adjustments. For 2005, deductions include a
    decrease in estimated allowance of $6.1 million during the
    second quarter.(2)
    
    Additions include $0.5 million, $14.2 million and
    $32.4 million of adjustments to goodwill, equity or other
    balance sheet accounts in the years ended December 31,
    2005, 2004 and 2003, respectively. 86




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##### Table of Contents



EXHIBIT
    INDEX
  3
.1(1)

Amended and Restated Articles of
    Incorporation of Novellus.3
.2(2)

Amended and Restated Bylaws of
    Novellus.10
.1(3)

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
.2(4)

Environmental Agreement by and
    between Varian Associates, Inc. and Novellus dated May 7,
    1997.*10
.3(5)

Novellus 1992 Stock Option
    Plan, together with forms of agreements thereunder.*10
.4(6)

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
.5(7)

Novellus 1992 Employee Stock
    Purchase Plan, as amended through April 29, 2005.*10
.6(8)

Form of Directors and Officers
    Indemnification Agreement.*10
.7(9)

GaSonics International Corporation
    Amended and Restated 1994 Stock Option/Stock Issuance Plan,
    together with forms of agreements thereunder, as assumed by
    Novellus.*10
.8(10)

Gamma Precision Technology, Inc.
    1998 Stock Option Plan, together with forms of agreements
    thereunder, as assumed by Novellus.*10
.9(11)

GaSonics International Corporation
    Supplemental Stock Option Plan, as assumed by Novellus.10
.10(12)

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
.11(13)

Novellus 2001 Stock Incentive Plan
    amended and restated March 11, 2005, together with forms of
    agreement thereunder.*10
.12(14)

SpeedFam-IPEC, Inc. Amended and
    Restated 1995 Stock Plan, as assumed by Novellus.*10
.13(15)

SpeedFam-IPEC, Inc. 2001
    Nonstatutory Stock Option Plan, together with forms of
    agreements thereunder, as assumed by Novellus.*10
.14(16)

Integrated Process Equipment
    Corporation 1992 Stock Option Plan, as assumed by Novellus.*10
.15(17)

SpeedFam International, Inc.
    Amended and Restated 1991 Employee Incentive Stock Option Plan,
    as assumed by Novellus.*10
.16(18)

SpeedFam-IPEC, Inc. Stand-Alone
    Stock Option Agreement dated June 14, 2001 between
    SpeedFam-IPEC, Inc. and Peter Simone, as assumed by Novellus.10
.17(19)

Lease Agreement between Seldin
    Properties and Integrated Process Equipment Corp. dated
    December 26, 1996.10
.18(20)

Purchase and Sale Agreement
    between Glen Una Management Company, Inc. and SpeedFam-IPEC,
    Inc. dated May 31, 2002.10
.19(21)

Lease Agreement between Phoenix
    Industrial Investment Partners, L.P. and SpeedFam-IPEC, Inc.
    dated June  21, 2002.10
.20(22)

First Amendment to Lease Agreement
    between Phoenix Industrial Investment Partners, L.P. and
    SpeedFam-IPEC, Inc. dated January 21, 2003.10
.21(23)

Lease Guaranty between Novellus
    and Phoenix Industrial Investment Partners, L.P. dated
    January 21, 2002.*10
.22(24)

Letter Agreement between Novellus
    and Sasson Somekh dated January 23, 2004.*10
.23(25)

Letter Agreement between Novellus
    and Thomas St. Dennis dated June 27, 2003.*10
.24(26)

Restricted Stock Purchase
    Agreement between Novellus and Richard S. Hill dated
    December 13, 2002.*10
.25(27)

Stand-Alone Stock Option Agreement
    between Novellus and Sasson Somekh dated January 23, 2004.*10
.26(28)

Stand-Alone Restricted Stock Award
    between Novellus and Sasson Somekh dated January 23, 2004.10
.27(29)

Credit Agreement between Johanna
    34 Vermogensverwaltungs GmbH, Novellus Systems BV, Novellus
    Systems, Inc. and JPMorgan Chase Bank, as Administrative Agent
    dated June 25, 2004.10
.28(30)

Guarantee and Collateral Agreement
    made by Novellus Systems, Inc. in favor of JPMorgan Chase Bank,
    as Administrative Agent dated June 25, 2004.




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##### Table of Contents



10
.29(31)

Binding Memorandum of
    Understanding between Novellus, and Applied Materials, Inc.,
    effective as of September 3, 2004. Portions of this exhibit
    have been omitted pursuant to a request for confidential
    treatment.*10
.30(32)

Amended and Restated Employment
    Agreement between Novellus and Richard S. Hill effective as of
    March  11, 2005.10
.31(33)

Form of Non-Employee Director
    Restricted Stock Bonus Agreement, as amended through
    April 29, 2005.10
.31(34)

Form of Resale Restriction
    Agreement21
.1

Subsidiaries of Novellus.23
.1

Consent of Independent Registered
    Public Accounting Firm.24
.1

Power of Attorney (see
    page 84).31
.1

Certification of Richard S. Hill,
    Chairman of the Board of Directors and Chief Executive Officer
    of Novellus Systems, Inc. dated March 15, 2006 in
    accordance with
    Rules 13a-14(a)
    and
    15d-14(a) of
    the Securities Exchange Act, as amended, as adopted pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.31
.2

Certification of William H. Kurtz,
    Executive Vice President and Chief Financial Officer of Novellus
    Systems, Inc. dated March 15, 2006 in accordance with
    Rules 13a-14(a)
    and
    15d-14(a) of
    the Securities Exchange Act, as amended, as adopted pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.32
.1

Certification of Richard S. Hill,
    Chairman of the Board of Directors and Chief Executive Officer
    of Novellus Systems, Inc. dated March 15, 2006 in
    accordance with 18 U.S.C. 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.32
.2

Certification of William H. Kurtz,
    Executive Vice President and Chief Financial Officer of Novellus
    Systems, Inc. dated March 15, 2006 in accordance with
    18 U.S.C. 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.     (1)
    
    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.(2)
    
    Incorporated by reference to Exhibit 3.2 to Novellus
    Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 12,
    2004.(3)
    
    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.(4)
    
    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.(5)
    
    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.(6)
    
    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.(7)
    
    Incorporated by reference to Exhibit 10.2 filed with
    Novellus Report on
    Form 8-K
    filed with the Securities and Exchange Commission on May 5,
    2005.(8)
    
    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.(9)
    
    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.  (10)
    
    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.(11)
    
    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.(12)
    
    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.




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##### Table of Contents



(13)
    
    Incorporated by reference to Exhibit 10.1 to Novellus
    Report on
    Form 8-K
    filed with the Securities and Exchange Commission on May 5,
    2005.(14)
    
    Incorporated by reference to Exhibit 10.30 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 5,
    2003.(15)
    
    Incorporated by reference to Exhibit 10.31 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 5,
    2003.(16)
    
    Incorporated by reference to Exhibit 10.32 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 5,
    2003.(17)
    
    Incorporated by reference to Exhibit 10.33 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 5,
    2003.(18)
    
    Incorporated by reference to Exhibit 10.34 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 5,
    2003.(19)
    
    Incorporated by reference to Exhibit 10.35 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 5,
    2003.(20)
    
    Incorporated by reference to Exhibit 10.36 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 5,
    2003.(21)
    
    Incorporated by reference to Exhibit 10.37 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 5,
    2003.(22)
    
    Incorporated by reference to Exhibit 10.38 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 5,
    2003.(23)
    
    Incorporated by reference to Exhibit 10.39 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 5,
    2003.(24)
    
    Incorporated by reference to Exhibit 10.39 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 12,
    2004.(25)
    
    Incorporated by reference to Exhibit 10.40 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 12,
    2004.(26)
    
    Incorporated by reference to Exhibit 10.41 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 12,
    2004.(27)
    
    Incorporated by reference to Exhibit 10.42 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 12,
    2004.(28)
    
    Incorporated by reference to Exhibit 10.43 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 12,
    2004.(29)
    
    Incorporated by reference to Exhibit 10.1 to Novellus
    Report on
    Form 8-K
    filed with the Securities and Exchange Commission on
    July 12, 2004.(30)
    
    Incorporated by reference to Exhibit 10.2 to Novellus
    Report on
    Form 8-K
    filed with the Securities and Exchange Commission on
    July 12, 2004.(31)
    
    Incorporated by reference to Exhibit 99.1 to Novellus
    Report on
    Form 8-K
    filed with the Securities and Exchange Commission on
    September 24, 2004.(32)
    
    Incorporated by reference to Exhibit 10.30 to
    Novellus Report on Form
    10-K filed
    with the Securities and Exchange Commission on March 15,
    2005.(33)
    
    Incorporated by reference to Exhibit 10.3 to Novellus
    Report on Form
    8-K filed
    with the Securities and Exchange Commission on May 5, 2005.(34)
    
    Incorporated by reference to Exhibit 10.34 to
    Novellus Report on Form
    8-K filed
    with the Securities and Exchange Commission on November 15,
    2005.*
    
    Management contracts or compensatory plans or arrangements.