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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

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

For the fiscal year ended December 31, 2001

OR

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

For the transition period from _______ to _______

Commission File Number 0-01757

NOVELLUS SYSTEMS, INC.

(Exact name of Registrant as specified in its charter)


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

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

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

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

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

Common Stock, no par value
(Title of Class)

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

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

As of March 13, 2002 the aggregate market value of voting and non-voting stock
held by non-affiliates of the Registrant was approximately
$7,223,152,119 based
on the average of the high and low prices of the Common Stock as reported on
the NASDAQ National Market on such date. Shares of Common Stock held by
officers, directors and holders of more than 5% of the outstanding Common Stock
have been excluded from this calculation because such persons may be deemed to
be affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.

The number of shares of the Registrants
Common Stock outstanding on March 13,
2002 was 144,970,131.

Documents Incorporated by Reference: Part III of this Report on Form 10-K
incorporates information by reference from the Registrants Proxy Statement for
its 2002 Annual Meeting of Shareholders.





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TABLE OF CONTENTS



|              |                                                                                               |  |  |  |  |  |  | 
|------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I       
|              | ITEM 1. BUSINESS                                                                             
|              | ITEM 2. PROPERTIES                                                                           
|              | ITEM 3. LEGAL PROCEEDINGS                                                                    
|              | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|PART II      
|              | ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED SHAREHOLDER MATTERS                
|              | ITEM 6. SELECTED FINANCIAL DATA                                                              
|              | ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|              | ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                          
|              | ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                          
|              | ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 
|PART III     
|              | ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                  
|              | ITEM 11. EXECUTIVE COMPENSATION                                                              
|              | ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT                      
|              | ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                      
|PART IV      
|              | ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K                    
|SIGNATURES   
|Exhibit Index
|EXHIBIT 3.2  
|EXHIBIT 12.1 
|EXHIBIT 21.1 
|EXHIBIT 23.1 
|EXHIBIT 23.2 
|EXHIBIT 99.1 



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NOVELLUS SYSTEMS, INC

2001 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

|                   |  |          |  |                                                                                                 |  |     
|------------------ |  | -------- |  | ----------------------------------------------------------------------------------------------- |  | ----
|                   |  |          |  |                                                                                                 |  | Page
|                   |  |          |  |                                                                                                 |  |     
|Part
          I   |  |          |  |                                                                                                
|                  
|                   |  | Item 1:  |  | Business                                                                                        |  | 7   
|                   |  | Item 2:  |  | Properties                                                                                      |  | 19  
|                   |  | Item 3:  |  | Legal
          Proceedings                                                                     |  | 19  
|                   |  | Item 4:  |  | Submission
          of Matters to a Vote of Security Holders                                   |  | 22  
|                  
|Part
          II  |  |          |  |                                                                                                
|                  
|                   |  | Item 5:  |  | Market
          for Registrants Common Equity and Related Shareholder Matters                 |  | 23  
|                   |  | Item 6:  |  | Selected
          Financial Data                                                               |  | 24  
|                   |  | Item 7:  |  | Managements
          Discussion and Analysis of Financial Condition and Results of Operations |  | 25  
|                   |  | Item 7A: |  | Quantitative
          and Qualitative Disclosures about Market Risk                            |  | 39  
|                   |  | Item 8:  |  | Financial
          Statements and Supplementary Data                                           |  | 41  
|                   |  | Item 9:  |  | Changes
          in and Disagreements with Accountants on Accounting and Financial Disclosure  |  | 67  
|                  
|Part
          III |  |          |  |                                                                                                
|                  
|                   |  | Item 10: |  | Directors
          and Executive Officers of the Registrant                                    |  | 67  
|                   |  | Item 11: |  | Executive
          Compensation                                                                |  | 67  
|                   |  | Item 12: |  | Security
          Ownership of Certain Beneficial Owners and Management                        |  | 67  
|                   |  | Item 13: |  | Certain
          Relationships and Related Transactions                                        |  | 67  
|                  
|Part
          IV  |  |          |  |                                                                                                
|                  
|                   |  | Item 14: |  | Exhibits,
          Financial Statement Schedules and Reports on Form 8-K                       |  | 68  
|                  
|Signatures         |  |          |  | 73                                                                                             

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K and certain information incorporated herein by
reference contain forward-looking statements within the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. All
statements included or incorporated by reference in this Annual Report, other
than statements that are purely historical are forward-looking statements.
Words such as anticipates, expects, intends, plans, believes,
seeks, estimates and similar expressions also identify forward-looking
statements. These forward-looking statements, which include statements about
the growth of the semiconductor industry; increasing costs in the semiconductor
industry; market size, share and demand; product performance; Novellus
expectations, objectives, anticipations, intentions and strategies regarding
the future, expected operating results, revenues and earnings and current and
potential litigation are not guarantees of future performance and are subject
to risks and uncertainties that could cause actual results to differ materially
from the results contemplated by the forward-looking statements.
Forward-looking statements in this Annual Report on Form 10-K include, without
limitation:



| |  | the discussion of Novellus strategy to focus on major
semiconductor manufacturers, under the heading Item 1.
Business which is subject to the risk, among other
risks, that the semiconductor industry will continue to
experience this or another periodic downturn, which
could have a material adverse effect on the
semiconductor industrys demand for semiconductor
processing equipment, including equipment manufactured
and marketed by Novellus;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | the statements regarding (1) Novellus belief that PVD,
tantalum barrier and copper seed layers may play an
important role in replacing aluminum with copper as the
primary wiring material, (2) Novellus belief that
electroplating process technology will be extendible to
at least the 0.10 micron design rule; or, in other
words, approximately another 3 or 4 years given the
current industry evolution; (3) Novellus belief that
there will be a widespread transition from aluminum to
copper conductive lines for faster processing speeds,
and (4) Novellus belief regarding the increasing focus
of the semiconductor industry on obtaining increased
productivity, higher returns and reduced costs, under
the heading Item 1, Business - Industry Background,
which are subject to various uncertainties, including,
without limitation, shifts in demand from expensive,
high-performance products to lower price products
resulting in reduced profit for semiconductor
manufacturers, periodic downturns in the semiconductor
industry and slowdowns in the rate of capital investment
by semiconductor manufacturers;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| 
| |  | Novellus belief in the growing importance of the
surface preparation step in the manufacturing of
advanced semiconductor devices and its belief that the
acquisition of GaSonics surface preparation technology
will lead to improved integration of the cleaning and
deposition processes when building advanced devices,
particularly those manufactured with a copper dual
damascene process, under the heading Item 1, Business
- Industry Background which is subject to the risk,
among other risks, of the failure of Novellus
expectations regarding the future direction of the
semiconductor industry in moving to copper and low-k
dielectrics and the failure to combine GaSonics product
offerings and technologies with Novellus offerings;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| 
| |  | Novellus beliefs regarding Throughput, Cost per Wafer
and Film Quality, Novellus belief that within-wafer and
wafer-to-wafer uniformity levels of +/- 1% of film
thickness as measured at one standard deviation are
state-of-the-art for the industry, under the heading
Item 1, Business - The Novellus Solution, which are
subject to various uncertainties, including, without
limitation, shifts in demand from expensive,
high-performance products to lower price products
resulting in reduced profit for semiconductor
manufacturers, slowdowns in the rate of capital
investment by semiconductor manufacturers and future
product developments and introductions by competitors;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| 
| |  | the discussion of Novellus strategies under the heading
Item 1, Business - Strategy, including statements
regarding (1) Novellus objective to increase its market
share in the worldwide interconnect market and to
strengthen its position as a leading supplier of
semiconductor processing equipment; (2) Novellus
intent to retain its focus on productivity by leveraging
its multi-chamber and continuous processing architecture
in product enhancements and new product offerings; (3)
Novellus strategy to provide a family of systems which
utilize advanced CVD, PVD, Electrofilling, and dry
strip/clean technologies to address leading-edge wafer
processing needs, (4) Novellus focusing its research and
development efforts on advanced PVD and Electrofilling
technology, gap fill high-density plasma (HDP)
technology, low-k dielectric materials, advanced surface
preparation, and additional advanced technologies for
the next generation of smaller geometry fabrication
lines, (5) Novellus sales objective to work closely
with customers to secure purchase orders for multiple
systems and to seek to build customer loyalty and
achieve a high level of repeat business by offering high
reliability products, comprehensive field support and a
responsive parts replacement and service program, and
(6) Novellus belief that its outsourcing strategy
enables it to minimize its fixed costs and capital
expenditures while also providing the flexibility to
increase capacity as needed and allows Novellus to focus
on product differentiation through system design and
quality control, which is subject to various
uncertainties, including, without limitation, shifts in
demand from expensive, high-performance products to
lower priced products resulting in reduced profit for
semiconductor manufacturers, the current and other
periodic downturns in the semiconductor industry,
slowdowns in the rate of capital

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|  |  | investment by semiconductor manufacturers and future product developments,
introductions by competitors and increased competition in the semiconductor
equipment industry and risks associated with international operations,
including economic downturns and trade balance issues;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Novellus belief that substantial additional growth
potential exists in the Asian region over the long term
and that mainland China is poised to become the next
major manufacturing region for the industry, and that
Novellus intent to continue to aggressively build its
presence in Asia as an important part of its current
business strategy under the heading Item 1, Business -
Strategy, which is subject to numerous risks,
including, without limitation, periodic economic
downturns, trade balance issues, political instability
and fluctuations in interest, foreign currency exchange
rates, banking issues and other difficulties
contributing to slower economic developments in these
countries;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| 
| |  | Novellus statements and beliefs regarding its products,
including (1) Novellus belief that its Concept One-W
product is currently the only system that provides full
coverage tungsten deposition on a wafers surface under
the heading Item 1, Business - Strategy; (2) Novellus
belief that the 10-second heating period in advance of
deposition in the Concept One - dielectric is one of the
shortest preheat times of any CVD system, under the
heading Item 1, Business - Products - Concept One -
dielectric; (3) Novellus belief that the Dual ALTUS is
the solution in the industry for very high volume 200mm
wafer fabs producing 0.18 and below micron semiconductor
devices, under the heading Item 1, Business - Products
- Concept Two; (4) Novellus belief that its ARL
product offers competitive throughput and low cost of
ownership for the industry, under the heading Item 1,
Business - Products - Anti Reflection Layer, (5)
Novellus belief that the Concept Three family of
systems should offer minimal risks to its customers in
making the transition from 200mm to 300mm volume
chipmaking, under the heading Item 1, Business -
Products - Concept Three; (6) Novellus belief that HCM
technology offers better target utilization, extended
maintenance intervals, and lower cost of ownership in
comparison with collimated and other ionized sputtering
techniques, under the heading Item 1, Business -
Products - Inova System; and (7) Novellus belief that
the SABRE system is the most reliable and
technologically advanced Electrofilling system available
on the market, under the heading Item 1, Business -
Products - SABRE, which are subject to various
uncertainties and risks, among others, including 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
Novellus competitors possess, future competition from
new market entrants from overseas and domestic sources,
Novellus competitors improvement of the design and
performance of their products that may offer superior
price or performance features over Novellus products,
Novellus success in selecting, developing,
manufacturing and marketing its new products or
enhancing its existing products;
| 
| |  | Novellus beliefs and expectations that (1) its strategy
of supporting its installed base through customer
support and R&D groups, (2) its marketing efforts are
enhanced by the technical expertise of its research and
development personnel, (3) its service to its customers
is enhanced by the design simplicity of its systems, and
(4) sales of its products to relatively few customers
will continue to account for a high percentage of its
net sales in the foreseeable future and belief that
sales to certain customers will decrease in the future
(also found in Item 7, Managements Discussion and
Analysis of Financial Condition and Results of
Operations - Trends Risks and Uncertainties - A Large
Portion of Novellus Net Sales is Derived From Sales to
a Few Customers and is also subject to the risks and
uncertainties set forth in such item); under the heading
Item 1, Business - Marketing, Sales and Service; are
subject to risks, among others, that during periods of
reduced and declining demand, Novellus may not be able
to quickly and effectively align its cost structure with
prevailing market conditions and motivate and retain key
employees or that during periods of rapid growth,
Novellus may not be able to acquire and/or develop
sufficient manufacturing capacity to meet customer
demand and hire and assimilate a sufficient number of
qualified people;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| 
| |  | Novellus statement that Novellus ability to remain
competitive in this market will depend in part upon its
ability to develop new and enhanced systems and to
introduce these systems at competitive prices and on a
timely and cost-effective basis and Novellus
expectation that research and development expenditures
will continue to represent a substantial percentage of
sales, under the heading Item 1, Business - Research
and Development; are subject to certain risks, among
others, that Novellus may experience delays from time to
time in the introduction of, and certain technical and
manufacturing difficulties with, certain of its systems
and enhancements and may experience delays and technical
and manufacturing difficulties in future introductions
or volume production of new systems or enhancements or
that Novellus may incur substantial unanticipated costs
to ensure the functionality and reliability of its
future product introductions early in the products life
cycle;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| 
| |  | Novellus belief that its outsourcing strategy enables
it to minimize its fixed costs and capital expenditures
while also providing the flexibility to increase
capacity as needed and allows Novellus to focus on
product differentiation through system design and
quality control, its belief that the use of
manufacturing specialists for its subsystems incorporate
advanced technologies in robotics, gas panels and
microcomputers and the statement that Novellus seeks to
reduce it dependence on limited suppliers for certain
key parts, under the heading Item 1, Business -
Manufacturing; are subject to various uncertainties,
including, without limitation, the possible occurrence
of a disruption or termination of certain                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

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|  |  | of these sources which could have at least a temporary adverse effect on
Novellus operations and a prolonged inability to obtain certain components
could have a material adverse effect on Novellus business, financial condition
and results of operations and could result in damage to customer relationships;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Novellus belief as to its favorable competitiveness in
the deposition equipment marketplace and Novellus
belief that the acquisition of TFS and its 1998
announcement of a copper primary conductor product will
allow Novellus to develop and compete successfully in
the PVD and copper Electrofill areas of the market and
that manufacturers will be generally reliant upon
specific equipment, under the heading Item 1, Business
- Competition is subject to various risks, among
others, including 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 Novellus competitors possess, future
competition from new market entrants from overseas and
domestic sources, Novellus competitors improvement of
the design and performance of their products that may
offer superior price or performance features over
Novellus products, Novellus success in selecting,
developing, manufacturing and marketing its new
products, or enhancing its existing products;                                                               
| 
| |  | the statement that Novellus intends to continue to
pursue the legal protection of its technology primarily
through patent and trade secret protection and the
statement that in the future, litigation may be
necessary to enforce patents issued to Novellus, to
protect trade secrets or know-how owned by Novellus or
to defend Novellus against claimed infringement of the
rights of others and to determine the scope and validity
of the proprietary rights of others under the heading
Item 1, Business - Patents and Proprietary Rights is
subject to uncertainty, including that there is no
assurance that patents will be issued from any of
Novellus pending applications or that any claims allowed
from existing or pending patents will be sufficiently
broad to protect Novellus technology and that any such
litigation could result in substantial cost and
diversion of effort by Novellus and any adverse
determinations in such litigation could result in
Novellus loss of proprietary rights, subject Novellus
to significant liabilities to third parties, require
Novellus to seek licenses from third parties or prevent
Novellus from manufacturing or selling its products;
| 
| |  | the statements that the success of Novellus future
operations depends in large part on Novellus ability to
recruit and retain engineers and technicians, marketing,
sales, service and other key personnel and that
Novellus success depends to a significant extent upon a
limited number of key employees and other members of
senior management of Novellus under the heading Item
1, Business - Employees are subject to risks and
uncertainties, among others, that there can be no
assurance that Novellus will be successful in retaining
or recruiting key personnel and Novellus possible
inability to effectively manage growth, or to attract
and retain the personnel it requires;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| 
| |  | Novellus anticipations regarding the construction on
the Tualatin, Oregon site and its completion in the
second quarter of 2002 and Novellus belief that its
current properties will be sufficient to meet Novellus
requirements for the foreseeable future, under the
heading Item 2, Properties are subject to risk and
uncertainty, including unanticipated delays in
construction schedules and a greater growth in Novellus
net sales placing unexpected strains on Company
resources and properties;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| 
| |  | Novellus belief that there are meritorious defenses in
the Applied, Semitool and Plasma Physics litigation
matters, and Novellus beliefs regarding the impact on the
Company of such litigation and with respect to the
outcomes of the Applied Materials, Semitool and Plasma
Physics litigation matters and current patent
infringement inquiries, under the headings Item 3,
Legal Proceedings and Item 8. Financial Statements
and Supplementary Data - Notes to Consolidated Financial
Statements - Note 5, Litigation are subject to risk and
uncertainty regarding the outcome of such litigation
matters as the resolution of intellectual property
litigation is very fact intensive and Novellus cannot
assure that it will be successful in the resolution of
these claims;                                                                                                                                                                                                                                                                                                                                                                                                                
| 
| |  | Novellus statements regarding calculation of
allowances, reserves, and other estimates that are based
on historical experience, the judgment of management,
and on 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 Novellus beliefs about
critical accounting policies, and its more significant
judgments and estimates used in the preparation of its
consolidated financial statements in Item 7,
Managements Discussion and Analysis of Financial
Condition and Results of Operations - Results of
Operations, are subject to risk among others, that
actual product failure rates, material usage,
installation costs, customer reserves or other estimates
may be different from Novellus estimates, requiring
revisions to the Companys estimated doubtful account
allowances, additional inventory write-downs,
restructuring charges, litigation, warranty, and other
reserves;                                                                                                     
| 
| |  | Novellus strategies, beliefs, plans, expectations,
anticipations and hopes with respect to Net Sales, Gross
Profit, Selling, General and Administrative, Research
and Development, Restructuring and Other Charges, Bad
Debt Write-off, In-process Research and Development,
Other Income, Provision for Income Taxes, Net Income,
Foreign Currency Accounting and Foreign Exchange
Contracts set forth under Item 7, Managements
Discussion and Analysis of Financial Condition and
Results of Operations - Results of Operations,
including, without limitation, (1) the statement that
the decrease in SG&A expenses as a percentage of net
sales across periods reflects Novellus ongoing efforts
to control and reduce SG&A expenses despite the rapid
growth in revenues; (2) the statement that the increases
in R&D                                                                                                                                                                                                                                                                                                                                                                            

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|  |  | expenses reflect Novellus continued commitment to the development of new
products and advanced technologies for the next generation of smaller geometry
fabrication lines, and equipment to process 300mm wafers; (3) the statement
that Novellus plans to continue to invest in new products and increase research
and development spending in absolute dollars; (4) the statement that Novellus
continues to believe that significant investment in R&D is required to remain
competitive, although such expenses as a percentage of net revenues may
fluctuate between periods; (5) Novellus expectations regarding the cost
savings to be achieved through its restructuring plan; (6) its beliefs
regarding the realization of deferred tax assets; (7) the belief that Novellus
forward foreign exchange contracts do not subject Novellus to speculative risk
that would otherwise result from changes in currency exchange rates; (8) the
Companys belief regarding its participation in its synthetic
leases in 2002 and the expected cash outlay of $90.0 million; and (9) beliefs regarding the impact of the
adoption of SFAS No. 141, 142, 143, and 144, the future treatment of synthetic
leases for accounting purposes, and the impact on the Company of the Euro
conversion; and Novellus strategies, beliefs, plans, expectations,
anticipations and hopes with respect to Liquidity and Capital Resources set
forth under Item 7, Managements Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources,
including, without limitation, (1) Novellus belief regarding its exposure due
to the residual value guarantee under synthetic leases; (2) its beliefs
regarding the impact to liquidity if the Company must purchase the property
subject to the synthetic leases; (3) the Companys intention to refinance and
continue to defease its existing synthetic leases at the end of the lease
terms; (4) Novellus intent to use net proceeds from its Liquid Yield Option
Notes (LYONs) offering for general corporate purposes; (5) the belief that
Novellus current cash position, cash generated through operations and equity
offerings, and available borrowings will be sufficient to meet Novellus needs
through at least the next twelve months; and (6) Novellus expectations with
respect to the return from investments in property and equipment and the
sufficiency of funds from operations, existing cash balances and borrowing
capacity, are subject to numerous risks and uncertainties, including, without
limitation, that the semiconductor industry will continue to experience this or
another periodic downturn, which could have a material adverse effect on the
semiconductor industrys demand for semiconductor processing equipment,
including equipment manufactured and marketed by Novellus, 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 Novellus competitors possess,
future competition from new market entrants from overseas and domestic sources,
Novellus competitors improvement of the design and performance of their
products that may offer superior price or performance features over Novellus
products, Novellus success in selecting, developing, manufacturing and
marketing its new products, or enhancing its existing products;
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Novellus anticipation that export sales will account
for a significant portion of net sales for the
foreseeable future set forth under Item 7, Managements
Discussion and Analysis of Financial Condition and
Results of Operations - Trends Risks And Uncertainties -
International Operations is subject to the risks and
uncertainties set forth in such Item;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| 
| |  | Novellus expectation that it will continue to
experience significant fluctuations in its quarterly
operating results set forth under Item 7, Managements
Discussion and Analysis of Financial Condition and
Results of Operations - Trends Risks And Uncertainties -
Variability of Quarter Operating Results is subject to
the risks and uncertainties set forth in such Item; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| 
| |  | Novellus expectation that it may incur charges to
operations, which are not currently reasonably
estimable, in connection with the acquisition of
GaSonics in the first quarter of 2001 (the quarter in
which the merger was completed) or following quarters,
to reflect costs associated with integrating the two
companies set forth under Item 7, Managements
Discussion and Analysis of Financial Condition and
Results of Operations - Trends Risks and Uncertainties -
Benefits of Novellus Acquisition of GaSonics May Not Be
Realized is subject to the risks and uncertainties set
forth in such Item.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

The above forward-looking statements and any expectations based on such
forward-looking statements are subject to risks and uncertainties and other
important factors. Any of Novellus actual results could differ materially
from those included in such forward-looking statements. In addition to the
risks and uncertainties mentioned above, the above forward-looking statements
are also subject to additional risks and uncertainties further discussed under
Item 7, Managements Discussion and Analysis of Financial Condition and
Results of Operations - Trends Risks and Uncertainties.

Because such statements are subject to risks and uncertainties, actual results
may differ materially from those expressed or implied by such statements. All
forward-looking statements included in this document are based on information
available to Novellus on the date hereof, and Novellus assumes no obligation to
update any such forward-looking statements. Shareholders are cautioned not to
place undue reliance on such statements, which speak only as of the date of
this Annual Report. The reader should also consult the cautionary statements
and risk factors listed from time to time in Novellus Reports on Forms 10-Q,
8-K, 10-K and its Annual Reports to Shareholders.

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PART I




ITEM 1. BUSINESS

Novellus Systems, Inc. (Novellus or the Company) manufactures, markets, and
services semiconductor processing equipment. The Companys products are
primarily comprised of advanced systems used to deposit thin conductive and
insulating films on semiconductor devices, as well as equipment for preparing
the device surface prior to these deposition processes. Novellus is a leading
supplier of high productivity deposition and surface preparation systems used
in the fabrication of integrated circuits. Chemical Vapor Deposition (CVD)
systems employ a chemical plasma to deposit all of the dielectric (insulating)
layers and certain of the metal (conductive) layers on the surface of a
semiconductor wafer. Physical Vapor Deposition (PVD) systems are used to
deposit conductive metal layers by sputtering metallic atoms from the surface
of a target source via high DC power. Electrofill systems are used for
depositing copper conductive layers in a dual damascene design architecture
using an aqueous solution. On January 10, 2001, Novellus acquired GaSonics
International Corporation (GaSonics), a leading developer and global supplier
of photoresist and residue removal solutions used in advanced semiconductor
device manufacturing. The photoresist and residue removal systems are used to
clean and prepare the device surface after the manufacturing steps that precede
the deposition process. Novellus growth strategy focuses on major
semiconductor manufacturers and Novellus has sold one or more of its systems to
each of the 20 largest semiconductor manufacturers in the world.

Novellus was incorporated in California in April 1984 and is headquartered in
San Jose, California. The mailing address for Novellus headquarters is 4000
North First Street, San Jose, California 95134, and the Companys telephone
number is (408) 943-9700. Additional information about the Company is
available on Novellus website at www.novellus.com.

Industry Background

The semiconductor industry has experienced significant growth over the past
decade due to increased demand for personal computers and the growth of the
Internet; the expansion of the telecommunications industry (especially wireless
communications); and the emergence of new applications in consumer electronics.
In addition, significant performance advantages and lower prices for
integrated circuits have contributed to the growth and expansion of the
industry.

The late 1990s also saw the emergence of a new growth trend driven by the
increasingly rapid pace in which the size of the circuitry on chips is
decreasing. When chips decrease in size, circuits can operate more quickly.
In addition, with size reduction, more chips can be produced on a given wafer
size and the yield per manufacturing machine increases. Because more chips can
be produced per machine with smaller chips, there is less need to build new
manufacturing plants, in particular, for pure capacity expansion. However, new
equipment featuring the latest technological advances often must still be
purchased to manufacture these smaller-sized chips and, in many cases, is
retrofitted into existing manufacturing facilities.

Although the semiconductor industry has experienced significant growth, the
semiconductor market is cyclical by nature, characterized by short-term periods
of either under or over supply for both memory and logic devices. When demand
decreases, semiconductor manufacturers typically slow their purchasing of
capital equipment; conversely, when demand increases, so does the
manufacturers capital spending.

The fabrication of integrated circuits requires a number of complex and
repetitive processing steps including deposition, photolithography, and etch.
Deposition is a process in which a film of either electrically insulating
(dielectric) or electrically conductive material is deposited on the surface of
a wafer. There are three principal methods for depositing this film: CVD
(chemical vapor deposition), which can be used to deposit both dielectric and
conductive films; PVD (physical vapor deposition), which is used primarily for
sputtering conductive metals onto the wafer surface; and electroplating, a
process for depositing conductive films via an electrically charged aqueous
solution.

In the CVD process, wafers are typically placed in a reaction chamber; a
variety of pure and precisely metered gases are introduced; and some form of
energy is added to activate a chemical reaction. The result of this reaction
is the deposition of a film on the wafer. The CVD process is the traditional
method used to deposit dielectric films in an integrated circuit, including the
initial interlayer, portions of the interconnect layers, and the final
passivation layer. CVD is also used for deposition of conductive metal layers,
particularly those metals that are more difficult to deposit in smaller line
width geometry devices through conventional PVD or other deposition
technologies. CVD technology is particularly effective for depositing blanket
tungsten as a plug layer that connects one conductive metal layer to another
in a multi-level integrated

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circuit. For such applications, tungsten replaces aluminum, which has certain
physical properties that reduce its efficacy for the smaller interconnect holes
of devices with smaller line width geometries.

PVD, also known as sputtering, is a process where ions of an inert gas,
typically argon, are electrically accelerated in a high vacuum toward a target
of pure metal, such as aluminum, tantalum, or copper. Upon impact, the argon
ions sputter off bits of the target material, which then deposits on the
silicon wafer to form the thin conductive films which wire the thousands of
transistors in the computer chip together.

PVD processes are used to create conducting liner and barrier metal layers to
prevent diffusion or reactions between metals such as tungsten and the
surrounding silicon regions, and to provide an underlying foundation for the
nucleation of other metal deposition layers. Aluminum PVD is also widely used
at the present time as the primary wiring material in up to six layers of
device interconnect. Novellus believes, however, that PVD tantalum barrier and
copper seed layers will play an important role in enabling the transition from
aluminum to copper as the primary wiring material.

As the industry transitions to smaller and smaller line widths, a fundamental
change is occurring with the movement from aluminum to copper wires as the
primary conductors. Copper has a lower resistance value than aluminum, the
present conductive metal used in integrated circuits. Because of this fact,
copper has the potential to double the speed of an advanced microprocessor
while reducing the number of metal layers required by as much as 50%.

The historic electroplating process has been modified by the semiconductor
manufacturing industry to deposit copper conductive lines in extremely small
features on integrated circuits. The electroplating method allows metal to be
filled in a structure created within the circuits insulating layers in a
process called dual damascene (or alternatively, dual inlaid). This is the
reverse of the process used with aluminum, where the metal is deposited first,
etched to create lines and vias, and then filled with insulating layers between
the metal lines. The most difficult task is filling copper into interconnect
structures, which can be less than 0.18 micron in width, with aspect ratios of
up to 5:1. Electroplating employs a liquid chemistry and electrolytic
principles to deposit the copper wiring into the dielectric structure, a simple
and cost-effective process that is also highly reliable.

Electroplating processes are used to produce the primary copper conductive
layers in advanced integrated circuits (typically circuits with line widths
smaller than 0.25 micron). The technology is believed by Novellus to be
extendible until at least the 0.10 micron design rule; or in other words,
approximately another 3 or 4 years given the current industry evolution.

Advanced integrated circuit technology has created increased demand for more
sophisticated semiconductor processing equipment. Todays advanced
semiconductor devices are being designed with line width geometries as small as
0.13 microns, with up to six layers of interconnect circuitry. The next
generation of semiconductor devices will see line widths as small as 0.10
micron. As the industry transitions from 0.13 micron to 0.10 micron, Novellus
believes that there will be widespread transition from aluminum to copper
conductive lines for faster processing speeds.

Novellus acquisition of GaSonics, completed in January of 2001, illustrates
Novellus belief in the growing importance of the surface preparation step in
the manufacturing of advanced semiconductor devices. Properly preparing the
device surface is essential prior to the deposition process to ensure the
proper adhesion of the film layer, and to prevent device-killing defects. The
industry movement to new materials such as copper and low-k, as well as
shrinking line widths and smaller wafer sizes, is driving the need for more
advanced cleaning technologies that do not damage the device. Novellus
believes that its acquisition of the GaSonics surface preparation technology
will lead to improved integration of the cleaning and deposition processes when
building advanced devices, particularly those manufactured with a copper dual
damascene process.

Semiconductor manufacturers generally measure the cost performance of their
production equipment in terms of cost per wafer, which is determined by
factoring in the fixed costs for acquisition and installation of the system;
the systems variable operating costs, and its net throughput rate. A system
with higher throughput allows the semiconductor manufacturer to recover the
purchase price of the system over a greater number of wafers, thereby reducing
the cost of ownership of the system on a per wafer basis. Throughput is most
accurately measured on a net or overall basis, which takes into account the
processing speed of the system and any non-operational downtime for cleaning,
maintenance, or other repairs. Yield and film qualities are also significant
factors to the semiconductor manufacturer in selecting processing equipment.
The increased costs of larger and more complex semiconductor wafers have made
high yields extremely important to semiconductor manufacturers. To achieve
higher yields and better film quality, deposition systems must be capable of
repeating the original process on a consistent basis without a disqualifying
level of defects. This characteristic, known in the industry as

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repeatability, is extremely important in achieving commercially acceptable
yields. Repeatability is more easily achieved in those systems that can
operate at desired throughput rates without requiring the system to approach
its critical tolerance limits.

The continuing evolution of semiconductor devices to smaller line width
geometries and more complex multi-level circuitry has significantly increased
the cost and performance requirements of the capital equipment used to
manufacture these devices. An advanced 300mm wafer fabrication line can cost
close to $2 billion, representing a substantial increase over the costs of
prior generation facilities. Increased capital depreciation costs will become
a larger percentage of the aggregate production costs for semiconductor
manufacturers relative to labor, materials, and other variable manufacturing
costs. As a result, there has been an increasing focus by the semiconductor
industry on obtaining greater productivity and higher returns from its
semiconductor manufacturing equipment, thereby reducing the effective cost of
ownership of such systems.

The Novellus Solution

Novellus focuses on advanced thin film deposition systems and surface
preparation equipment  CVD, PVD, Electrofill (electroplating), photoresist
strip, and residue removal systems  that provide high film quality while
attaining the high levels of productivity required to meet the semiconductor
industrys need for high volume, low cost wafer production. Novellus
multi-station sequential processing architecture of its plasma enhanced CVD
(PECVD), CVD tungsten, and photoresist strip products enables these systems to
address each of the following critical parameters of system performance:

CVD Solutions

Throughput, Cost per Wafer.In contrast to CVD systems that process only one
wafer at a time in a chamber, Novellus multi-station sequential deposition
systems can process between four and seven wafers (depending on the system) at
the same time in a chamber, which leads to higher throughput levels. The
design simplicity and automatic cleaning capabilities of Novellus systems
further increase net throughput by reducing production downtime.

Film Quality.With Novellus unique sequential system design, each wafer
receives a fraction of the desired film thickness at each of the deposition
stations in the process chamber. The averaging effect created by this design
tends to reduce anomalies in film thickness and thereby improves film
uniformity and quality. Novellus systems can obtain within-wafer and
wafer-to-wafer uniformity levels of +/- 1% of film thickness, for most films,
as measured at one standard deviation, which the Company believes is
state-of-the-art for the industry.

Process Repeatability.Because of the inherently higher throughput potential
of continuous processing, Novellus systems are able to deposit materials at
lower, more controlled rates than single wafer processing systems, which
generally deposit at faster rates closer to the process performance limits in
order to achieve production-level throughputs. Lower deposition rates avoid
straining the systems process tolerance limits and thereby permit increased
process control and repeatability.

PVD Solutions.Through the acquisition of Varians Thin Film Systems division
in 1997, Novellus extended its deposition capabilities into PVD, introducing
the INOVA® system in April of 1998. PVD, a critical technology in the
production of advanced semiconductor logic and memory devices, enables Novellus
to provide metal deposition solutions for both aluminum primary conductor and
copper barrier/seed layers.

Copper Electroplating Solutions.Introduced in June 1998 after an extensive
joint development program with IBMs Microelectronics Division, the SABRE®
copper Electrofill tool is the industrys leading production system for
depositing copper conductive layers on sub-0.25 micron circuits. SABRE employs
a patented wafer fixture to avoid backside contamination of the wafer from the
plating bath; a unique bath cell design that ensures reproducibility of the
copper fill; and a simple system architecture that ensures both high wafer
throughput and system availability. Coupled with the INOVA PVD system,
Novellus SABRE tool offers a complete copper solution for depositing advanced
copper interconnects.

Photoresist Strip and Clean Solutions.Through the acquisition of GaSonics in
January 2001, Novellus now offers a suite of advanced photoresist strip and
clean products, including the PEP 3510Plus and the GAMMA 2100 for photoresist
strip applications, and the PEP IRIDIA for residue clean processes. All
surface preparation products, now part of Novellus Surface Integrity Group,
employ advanced dry process technology that allows more efficient removal of
complex residues without attacking or contaminating the underlying device
material.

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Strategy

Novellus objective is to increase its market share in the worldwide
interconnect market and strengthen its position as a leading supplier of
semiconductor processing equipment. The key elements of Novellus strategy are
as follows:

Emphasis on High Productivity Systems.Novellus has historically focused on
providing high productivity systems to leading semiconductor companies.
Novellus addresses the needs of semiconductor manufacturers through its
multi-chamber or unique continuous processing architectures, which enable its
systems to attain high levels of wafer throughput, yield and film quality. The
simple architecture of Novellus systems also provides a long up-time and
smaller footprint. Novellus intends to retain its focus on productivity by
leveraging its multi-chamber and continuous processing architecture in product
enhancements and new product offerings.

Leadership in dielectric deposition, metals deposition, and surface preparation
technologies.Novellus strategy is to provide a family of systems that use
advanced CVD, PVD, Electrofilling, and dry strip/clean technologies to address
leading-edge wafer processing needs. Novellus Concept One® dielectric system
offers dual frequency deposition technology to achieve results for a wide
variety of films on wafers as large as eight inches and geometries as small as
0.35 micron. Novellus Concept One-W is used by manufacturers to connect
multiple metal layers in advanced devices, and the Company believes that it is
currently the only system that provides full coverage tungsten deposition on a
wafers surface. Novellus Concept Two® system is a modular CVD system
designed to address the needs of wafer fabs that demand greater levels of wafer
processing integration, higher volume production and increased factory
automation. The Concept Three system is also a modular CVD system, but
designed to process 300mm wafers; its architecture is similar to that of the
Concept Two, but uses a single wafer loadlock. Novellus is focusing its
research and development efforts on advanced PVD and Electrofilling technology,
gap fill high-density plasma (HDP) technology, low-k dielectric materials,
advanced surface preparation, and additional advanced technologies for the next
generation of smaller geometry fabrication lines. Novellus first offering in
the advanced HDP technology market, SPEED® was introduced in February 1996.
The INOVA system provides an advanced PVD system that can deliver tantalum
barriers and copper seed layers for copper metallization, as well as high
quality Ti/Ti-nitride films with excellent particle performance. The SABRE
Electrofill tool has emerged as the industrys leading choice for the fill of
copper vias and trenches using a dual damascene process. The PEP IRIDIA, a
dual-purpose strip/clean system, is a plasma-based system for advanced,
sub-0.25 micron device production, including copper dual damascene and low-k
dielectric films. Finally, the GAMMA 2100 system is a high throughput, low
cost of ownership photoresist strip system employing a multi-station sequential
processing architecture for simplicity, reliability, and high productivity

Focus On Major Semiconductor Manufacturers.Novellus has sold one or more of
its systems to each of the 20 largest semiconductor manufacturers in the world.
Novellus sales objective is to work closely with customers to secure purchase
orders for multiple systems as these customers expand existing facilities,
retrofit old facilities with new equipment, or build new fabs. Novellus seeks
to build customer loyalty and achieve a high level of repeat business by
offering high reliability products, comprehensive field support and a
responsive parts replacement and service program.

Expansion of Asian Market Presence.While Novellus derives a significant
percentage of its net sales from the Asian marketplace, the Company believes
that substantial additional growth potential exists in the region over the long
term. Countries such as Japan, Taiwan, and Korea continue to represent a
disproportionate share of the worlds capacity for semiconductor manufacturing,
and mainland China is poised to become the next major manufacturing region for
the industry. The Asian countries are particularly dominant in the
manufacturing of memory products, which are enabling technologies for end use
consumer applications such as the Internet and telecommunications. Currently,
Novellus local presence in Asia includes sales and support offices throughout
Japan, which are operated by Novellus wholly owned subsidiary, Novellus
Systems, Japan. In addition, the Company has three offices in Korea, two
offices each in Taiwan, China, and Malaysia, and one office each in Singapore
and India. Novellus current business strategy is to continue to aggressively
build its presence in Asia to serve this strategically significant region.

Low Manufacturing Cost Structure.Novellus utilizes an outsourcing strategy
for the manufacture of major subassemblies and performs system design,
assembly, and testing in-house. Novellus believes that outsourcing enables it
to minimize its fixed costs and capital expenditures while providing the
flexibility to increase capacity as needed. This strategy also allows Novellus
to focus on product differentiation through system design and quality control.
Through the use of third party manufacturing specialists, the Company ensures
that its subsystems incorporate advanced technologies in robotics, gas panels,
and microcomputers. Novellus works closely with its suppliers to achieve
mutual cost reduction through joint design projects.

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Deposition Products

Since the introduction of its original Concept One dielectric system in 1987,
Novellus has offered a family of processing systems for the dielectric and
metal deposition markets. The Concept One dielectric deposits a variety of
dielectric films on wafers, including Oxide, Nitride, and TEOS films. In 1990,
Novellus introduced a modified version of the Concept One dielectric, the
Concept One-W, which also uses a CVD process to deposit blanket tungsten metal
films on wafers, primarily as the metal interconnect between conductor layers
in the integrated circuit layers. In November 1991, Novellus introduced the
Concept Two, a modular, integrated production system capable of depositing both
dielectric and conductive metal layers by combining one or more processing
chambers with a common, automated robotic wafer handler. In February 1996,
Novellus introduced SPEED on the Concept Two platform, targeted at advanced
inter-metal dielectric (IMD) deposition. Following the acquisition of
Varians Thin Film Systems Division, Novellus announced the introduction of its
INOVA system, an advanced PVD system that delivers Maxfill aluminum and
Ti/Ti-nitride film quality for aluminum barrier layer applications, as well as
highly conformal tantalum barrier copper seed layers (barrier/seed) for copper
conductive layers. In June 1998, Novellus announced the SABRE copper
Electrofill system for producing copper conductive layers. And most recently,
in July 2000, Novellus introduced VECTOR, a new 200mm/300mm PECVD platform
with twice the capital productivity of competitive market offerings.

Concept One® dielectric

The Concept One dielectric system is shipped in two versions: the Concept One
150, which processes 100, 125, and 150mm wafers (approximately 4, 5, and 6
inches in diameter), and the Concept One 200, which processes 125, 150 and
200mm wafers (approximately 5, 6, and 8 inches in diameter, designed for
eight-inch fabrication lines).

The Concept One consists principally of two attached chambers with associated
hardware and electronics. The first chamber of the system, called the
loadlock, isolates the process chamber from the outside environment.
Depending on the model of the Concept One dielectric, the loadlock accepts up
to 75 wafers sized from 100 to 200mm, stored in cassette carriers. The
operator inserts the cassettes of wafers in batches into the loadlock, and the
pressure inside the loadlock is decreased to create a vacuum which matches the
constant pressure level of the process chamber. A robotic arm in the center of
the loadlock, the wafer transport mechanism, transfers wafers one at a time
from the cassettes to the process chamber and, upon completion of the
deposition process, returns the finished wafers to the cassettes. The loadlock
isolates the process chamber from the fabrication environment, permitting the
process chamber to remain at constant temperature and pressure while wafers are
transferred from the clean room to the loadlock and from the loadlock to the
process chamber. These stable process chamber conditions enhance film quality,
process repeatability, and throughput. The loadlock design also reduces
particulate contamination because the robotic arm is the only moving mechanism
in the loadlock and because the wafer cassettes are isolated from the clean
room.

The process chamber for the Concept One dielectric has six or eight stations,
depending on the model. One station is used as a load/unload site and the
remaining five, six, or seven stations are used for wafer deposition. Each
deposition station employs a dedicated showerhead that delivers gases and
plasma energy to the wafer surface. In a six-station process chamber, for
example, each wafer moves through the system and stops at each of the five
deposition stations to receive one-fifth of its preprogrammed film thickness.
Some CVD products, called single wafer systems, process only one wafer at a
time in a process chamber, while multistation continuous process systems, like
the Concept One, can process numerous wafers at the same time. The continuous
processing capabilities of a multistation system generally enable such systems
to attain higher throughput while using a less critical, more repeatable
process than would be required for a single wafer system at equivalent
throughput levels. This multiple deposition design also results in greater
film uniformity and improved film quality because small variations in
deposition at any single station tend to be offset by deposition of the same
film at other stations.

After the entire batch of up to 75 wafers has been processed and returned to
the cassettes, an automatic cleaning cycle in the process chamber removes
residual deposition materials which could otherwise cause particulate
contamination in a subsequent deposition process. During this cleaning cycle,
the loadlock automatically returns to atmospheric pressure, enabling the
operator to remove the cassettes of finished wafers without impacting system
throughput.

The Concept One dielectric uses electrical radio frequency (RF) plasma energy
to enhance thermal energy, enabling the system to process wafers at a
relatively low temperature, and thus reducing the risk of heat damage to
existing metal layers during processing. The system also suppresses hillock
formation by limiting the time that the wafer is exposed to elevated
temperatures prior to deposition. The wafer is heated for 10 seconds or less
in advance of deposition in the Concept One

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system, which Novellus believes is one of the shortest preheat times of any CVD
system. Stress related defects are addressed through the system by addition of
a proprietary dual frequency, stress control option that Novellus offers.
The systems vacuum loadlock reduces the level of particles, thereby improving
film quality by isolating the process chamber of the Concept One dielectric
from temperature and pressure fluctuations. In addition, the automatic
cleaning capability and relatively simple mechanical design of the system
reduce particulate contaminants and thereby increase yields and film quality.

Concept One-W

The Concept One-W was introduced in 1990 to address the tungsten CVD market.
The Concept One-W deposits blanket tungsten metal films, used in semiconductor
devices to connect multiple metal layers in the integrated circuit. Like the
Concept One dielectric, the Concept One-W uses a multistation sequential
deposition design that achieves high throughput with desirable film properties
for the entire range of film thickness. The Concept One-W also uses an
approach patented by Novellus, the Minimum Overlap Exclusion Ring (MOER), to
provide full-coverage front-side tungsten deposition while preventing
deposition of tungsten on the backside of the wafer. This MOER capability
helps prevent the generation of damaging particles on the wafer and eliminates
the need for time-consuming etching on the backside of the wafer to remove the
film.

Concept Two®

The Concept Two, introduced in November 1991, is a modular, integrated
production system capable of depositing both dielectric and conductive metal
layers by combining one or more processing chambers around a common, robotic
wafer handler. The Concept Two enables the semiconductor manufacturer to
increase production throughput and system capability as needed without
replacing equipment, simply by adding process modules through the Concept Twos
modular configuration. The Concept Two was initially available with a tungsten
process chamber and a PVD process module for deposition of certain metal
layers. In late 1994, a dielectric process module became available for Concept
Two systems.

The Concept Two in a typical configuration incorporates a central cassette
module and wafer handler that interfaces with the clean room, and includes
multiple interfaces for process or transport modules. The cassette module,
through its robotics, manages wafer movement between the various processing
stations that can be included in a particular Concept Two configuration.
Different cassette modules are available, depending on customer requirements.
An optional isolation chamber is also available that is connected to the
cassette module to connect high vacuum process chambers and other portions of
the system.

In 1993, Novellus introduced the Concept Two ALTUS®, which combines the modular
architecture of the Concept Two system with an advanced tungsten CVD process
chamber. The system features a dual loadlock cassette module with full factory
automation capability to meet the high throughput requirements of high volume,
automated eight-inch wafer fabs. This dual loadlock cassette handler permits
continuous operation of the process chamber with one loadlock, while a second
loadlock is simultaneously being loaded or unloaded by the operator in the
clean room. Through its modular configuration, the Concept Two enables the
semiconductor manufacturer to combine multistation modules for slower processes
with single wafer modules for faster processes to balance the throughput of the
overall system. A dielectric version of the Concept Two ALTUS, the Concept Two
SEQUEL®, was introduced in late 1994. This system brought the same level of
factory automation and throughput to the dielectric market as the ALTUS did to
the metals market. The Concept Two SEQUEL was initially shipped in a single
chamber version targeted at thin dielectric films used in volume 200mm
inter-metal dielectric production applications.

In 1994, Novellus introduced the Concept Two Dual ALTUS tungsten deposition
system. The Dual ALTUS features the production proven performance of Novellus
tungsten CVD chamber in a dual chamber configuration that delivers the
throughput power to dramatically lower the cost of tungsten deposition.
Novellus believes that the Dual ALTUS is a solution in the industry for very
high volume 200mm wafer fabs producing semiconductor devices at 0.18 micron and
below.

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Subsequent to 1994, Novellus has continued to expand its Concept Two product
offerings as follows:

Concept Two Dual SEQUEL®

This dual chamber version of the SEQUEL dielectric family is designed for high
throughput deposition of thick films, such as layers before CMP (chemical
mechanical polishing), and dual layer passivation films. The Dual SEQUEL
employs two process chambers to provide the throughput power of twelve
stations, resulting in dramatic improvements in productivity for these types of
films.

Concept Two SEQUEL Express

Introduced in June of 1999, SEQUEL Express is an advanced version of the SEQUEL
system, designed to deposit Novellus CORAL family of low-k dielectric films,
as well as all other advanced films required for 0.18 micron and smaller
devices. With a throughput in excess of 110 wafers per hour, SEQUEL Express
delivers up to 40 percent higher capital productivity and up to 40 percent
lower cost of ownership than competing CVD systems.

Concept Two SPEED®

Introduced in February 1996, SPEED was the semiconductor industrys first
high-density plasma gapfill solution capable of high-volume manufacturing.
SPEED is targeted for advanced IMD deposition for 0.18-micron devices and
below. SPEED is offered either as a stand-alone gap fill system or integrated
with the Concept Two SEQUEL to provide a complete high-throughput, low-cost gap
fill and chemical mechanical polishing gap layer solution for logic
manufacturing. SPEED is a single wafer processing system, and uses a patented
hemispherical source design and a proprietary electrostatic chuck to provide
excellent fill, reproducibility, low damage and high throughput.

Anti Reflection Layer

In December 1996, Novellus announced a new plasma enhanced anti-reflection
layer film (ARL). The ARL product, PEARL®, achieves tighter levels of
critical dimension control with in-line and Deep UV lithography in advanced
semiconductor devices while reducing cost per wafer. The Company believes that
PEARL, running on Novellus PECVD systems such as SEQUEL and VECTOR, offers
competitive throughput and low cost of ownership for the industry.

CORAL Low-K dielectric Films

Commensurate with the launch of SEQUEL Express in June of 1999, Novellus
introduced the CORAL family of low dielectric constant (low-k) films, designed
for the manufacture of advanced devices down to sub-0.1 micron geometries, and
in particular, copper dual damascene structures. CORAL films are carbon-doped
oxide CVD films with dielectric constants from 3.0 k to less than 2.4 k.
Matched with Novellus thin films for copper barriers and etch stops, CORAL
films yield an effective capacitance reduction of up to 40 percent.

Concept Three

In December 1997, Novellus introduced its Concept Three family of chemical
vapor deposition systems for dielectric and tungsten applications on 300mm
wafers. The Concept Three products include the Concept Three SPEED, the
Concept Three SEQUEL, and the Concept Three ALTUS. Because the Concept Three
systems are based on the production proven Novellus Concept Two products, the
Company believes that they offer minimal risk to its customers in making the
transition from 200mm to 300mm volume chipmaking.

INOVA® System

Introduced in April 1998, the INOVA system is an advanced PVD system that
delivers tantalum barrier and copper seed layers required prior to copper
Electrofilling, as well as Maxfill aluminum and Ti/Ti-nitride films for
aluminum liner/barrier applications. The INOVA, a multi-chamber single wafer
processing system, incorporates Novellus uniquely-designed Hollow Cathode
Magnetron (HCM) technology, which the Company believes offers better target
utilization, extended maintenance intervals, and lower cost of ownership in
comparison with collimated and other ionized sputtering techniques. In

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July 2000, Novellus introduced the INOVA xT, a 300mm version of INOVA with
proven HCM extendability to the 0.10-micron technology node, as well as an
industry-leading throughput of 100 wafers per hour (wph).

SABRE®

The SABRE system was introduced in July 1998 after an extensive development
program with IBM, and is believed by Novellus to be the most reliable and
technologically advanced copper Electrofilling system available on the market.
SABRE has been proven to provide effective fill to meet todays 0.10-micron
technology node requirements. SABRE employs a proprietary Electrofilling cell
that eliminates the backside wafer contamination of copper, and features a
unique plating cell design that ensures reproducibility of the copper fill,
with a film uniformity of <5%, 3 sigma within a wafer. SABRE requires only
two types of process modules to complete the Electrofill process, one for
Electrofilling (3 stations total) and the other for bevel etch/spin/rinse/dry
(another 3 stations) within a compact footprint. The resulting simplicity of
this design is key to the systems high reliability and manufacturing
availability.

SABRE xT

The second generation SABRE xT (introduced in 1999) is a 200mm/300mm bridge
tool, and has become the market-leading electroplating platform at both wafer
sizes. Continuous improvement has led to the availability of new features on
the xT that were not found on the original SABRE, including programmable
electrical waveforms, advanced plating chemistries, integrated anneal, and
closed-loop chemical monitoring with the SmartDose+ predictive dosing system.

VECTOR

Introduced in July of 2000, VECTOR is a new PECVD system for dielectric films
that radically transforms the playing field in terms of capital productivity.
A 200mm/300mm bridge tool, VECTOR is designed to deliver a fully integrated
low-k dielectric structure at 0.10-micron and smaller design rules. VECTOR is
designed for high reliability, with 40% fewer critical subassemblies than the
nearest competitor. With approximately 2/3rds the footprint of the nearest
competitor, and a throughput of 120 wafers per hour, VECTOR delivers twice the
capital productivity of any other PECVD system currently on the market.

Surface Preparation Products

Through the acquisition of GaSonics in January 2001, Novellus Surface
Integrity Group provides a suite of high productivity/low cost of ownership
systems for the photoresist strip and clean markets, an area of semiconductor
manufacturing that is becoming increasingly important with the move to copper
dual damascene manufacturing.

PEP 3510Plus

The PEP 3510 Plus is a versatile downstream microwave photoresist removal
system designed for the clean, damage-free removal of photoresist materials.
One of the most dependable bulk strip systems on the market, the PEP 3510
routinely delivers 300 hours MTBF with 95% uptime. More than 300 PEP-based
systems have been installed in fabs around the world.

GAMMA 2100

The GAMMA 2100 photoresist removal system uses an interlaced, inductively
coupled plasma source (I2CP) to strip photoresist, resulting in a more uniform
distribution of results with reduced use of consumables. The GAMMA
architecture also features a multi-station sequential processing design with
six strip stations, resulting in a wafer throughput of up to 175-wph with a
minimal number of critical subsystems (one change, one remote dry pump, and one
gasbox support all six stations).

PEP IRIDIA

The PEP IRIDIA is an advanced cleaning system designed for sub-0.25-micron
applications and enabling technologies such as copper dual damascene. The
modular architecture of IRIDIA allows the system to be configurable for both
front-end-of-line (FEOL) and back-end-of-line clean applications down to
0.10-micron device geometries. For low-k dielectric clean applications, the
IRIDIA offers the highest capital and footprint productivity of any clean
system currently on the market.

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Marketing, Sales, and Service

Novellus markets its products worldwide to manufacturers of semiconductor
devices. These include customers with captive fabrication lines, who produce
semiconductors primarily for internal consumption, and merchant semiconductor
manufacturers, who produce semiconductors primarily for sales to third party
customers. In North America, Novellus sells its products primarily through a
direct sales force. Novellus domestic sales and support offices are located
in Salem, New Hampshire; Orlando, Florida; Austin and Dallas, Texas; Phoenix,
Arizona; Hopewell Junction, New York; Williston, Vermont; Bath, Pennsylvania;
Manassas, Virginia; Vancouver, Washington; Boise, Idaho; Hillsboro, Oregon;
Bloomington, Minnesota; and Hudson, Massachusetts. In Europe, Novellus
products are predominantly sold through a wholly owned subsidiary, Novellus
Systems, Ltd., which has sales and support facilities in England and Scotland.
Novellus also has sales and service support offices in the Netherlands, France,
Germany, Ireland, Italy, Israel, and India. In East and Southeast Asia,
Novellus sells its products through wholly owned subsidiaries in Japan, Korea,
Taiwan, Singapore, Malaysia, and China. Novellus Japanese subsidiary
maintains its headquarters near Tokyo and has nine sales offices throughout
Japan.

The ability to provide prompt and effective field support is critical to
Novellus sales efforts, due to the substantial operational and financial
commitments made by customers that purchase a deposition or surface preparation
system. Novellus believes that its strategy of supporting its installed base
through both its customer support and research and development groups has
served to encourage use of the Companys systems in production applications and
has accelerated penetration of certain key accounts. Novellus also believes
that its marketing efforts are enhanced by the technical expertise of its
research and development personnel, who provide customer process support and
participate in a number of industry forums, such as conferences and technical
symposia.

Novellus believes that its ability to service its customers is enhanced by the
design simplicity of its systems. The Company generally warrants its products
against defects in design, materials, and workmanship. In 1992, Novellus
became the first semiconductor equipment manufacturer to extend its warranty up
to 24 months from shipment, and in 1993, included the cost of consumable parts
on some systems and preventative maintenance parts under warranty. Novellus
offers maintenance contracts as an additional service to its customers.

For the year ended December 31, 2001, one customer accounted for 16% of
Novellus net sales. For the year ended December 31, 2000, two customers
accounted for 14% and 10% of Novellus net sales and in 1999, three customers
accounted for 16%, 12%, and 11% of the Companys net sales, respectively.

Export sales (including sales made by Novellus Japanese subsidiary) for the
year ended December 31, 2001 were approximately $733.9 million, or 55% of net
sales. Export sales for the year ended December 31, 2000 were approximately
$834.5 million, or 63% of net sales. For the year ended December 31, 1999,
export sales were approximately $407.7 million, or 62% of net sales.
Historically, Novellus has sold a significant proportion of its systems in any
particular period to a limited number of customers. Sales to Novellus ten
largest customers in 2001, 2000, and 1999 accounted for 61%, 71%, and 71% of
net sales, respectively. The Company expects that sales of its products to
relatively few customers will continue to account for a high percentage of its
net sales in the foreseeable future. None of Novellus customers has entered
into a long-term agreement requiring it to purchase Novellus products.

The Company believes that sales to certain of its customers will decrease in
the near future as those customers complete current purchasing requirements for
new or expanded fabrication facilities. Although the composition of the group
comprising Novellus largest customers has varied from year to year, the loss
of a significant customer or any reduction in orders from any significant
customer, including reductions due to customer departures from recent buying
patterns, market, economic or competitive conditions in the semiconductor
industry or in the industries that manufacture products utilizing integrated
circuits, could adversely affect the Companys business, financial condition
and results of operations. In addition, sales of Novellus systems depend in
significant part upon the decision of a prospective customer to increase
manufacturing capacity or to expand current manufacturing capacity, both of
which typically involve a significant capital commitment. Novellus has from
time to time experienced delays in finalizing system sales following initial
system qualification. Due to these and other factors, Novellus systems
typically have a lengthy sales cycle during which the Company may expend
substantial funds and management effort.

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Backlog

As of December 31, 2001, Novellus backlog was $266.5 million, as compared to a
backlog of $643.8 million at December 31, 2000. Novellus includes in its
backlog only those customer orders for which it has accepted purchase orders
and assigned shipment dates within twelve months. All orders are subject to
cancellation or rescheduling by customers with limited or no penalties.
Because of orders received in the same quarter in which a system is shipped,
possible changes in system delivery schedules, cancellations of orders, and
delays in systems shipments, Novellus backlog at any particular date is not
necessarily a reliable indicator of actual sales for any succeeding period.

Research and Development

The semiconductor manufacturing industry is subject to rapid technological
change and new product introductions and enhancements. Novellus ability to
remain competitive in this market depends in part on its ability to develop new
and enhanced systems, and to introduce these systems at competitive prices on a
timely and cost-effective basis. Accordingly, Novellus devotes a significant
portion of its personnel and financial resources to research and development
programs and seeks to maintain close relationships with its customers to remain
responsive to their product needs.

Novellus current research and development efforts are directed at development
of new systems and processes and improving existing system capabilities. The
Company is focusing its research and development efforts on advanced PVD
systems, advanced gap fill technology, primary conductor metals, low-K
dielectric materials, and additional advanced deposition and surface
preparation technologies for the next generation of smaller geometry
fabrication lines. All new systems being developed are capable of processing
300mm wafers.

Expenditures for research and development during 2001, 2000, and 1999 were
$272.0 million, $ 198.3 million, and $ 129.1 million, respectively, or
approximately 20%, 15%, and 20% of net sales, respectively. Novellus expects
in future years that research and development expenditures will continue to
represent a substantial percentage of net sales.

The success of Novellus in developing, introducing and selling new and enhanced
systems depends upon a variety of factors, including product selection, timely
and efficient completion of product design and development, timely and
efficient implementation of manufacturing and assembly processes, product
performance in the field, and effective sales and marketing. There can be no
assurance that Novellus will be successful in selecting, developing,
manufacturing and marketing new products or in enhancing its existing products.
As is typical in the semiconductor capital equipment market, Novellus has
experienced delays from time to time in the introduction of, and certain
technical and manufacturing difficulties with, certain of its systems and
enhancements, and may experience delays and technical and manufacturing
difficulties in future introductions or volume production of new systems or
enhancements. Novellus inability to complete the development or meet the
technical specifications of any of its new systems or enhancements or to
manufacture and ship these systems or enhancements in volume in a timely manner
would materially adversely affect the Companys business, financial condition,
and results of operations. In addition, Novellus may incur substantial
unanticipated costs to ensure the functionality and reliability of its future
product introductions early in the products life cycle. If new products have
reliability or quality problems, reduced orders, or higher manufacturing costs,
delays in collecting accounts receivable and additional service and warranty
expense may result. Any of these events could materially adversely affect
Novellus business, financial condition, and results of operations.

Manufacturing

Novellus manufacturing activities consist primarily of assembling and testing
components and subassemblies which are acquired from third party vendors and
then integrated into a finished system by Novellus. The Company utilizes an
outsourcing strategy for the manufacture of major subassemblies, and performs
system design, assembly, and testing in-house. Novellus believes that
outsourcing enables it to minimize its fixed costs and capital expenditures
while also providing the flexibility to increase production capacity. This
strategy also allows Novellus to focus on product differentiation through
system design and quality control. Through the use of outsourced product
specialists, the Company believes that its subsystems incorporate advanced
technologies in robotics, gas panels, and microcomputers. Novellus works
closely with its suppliers on achieving mutual cost reduction through joint
design efforts.

Novellus manufactures its system units in clean room environments similar to
the clean rooms used by semiconductor manufacturers for wafer fabrication.
This is intended to minimize the amount of particulates and other contaminants
in the

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final assembled system, which in turn improves yield and reduces the level of
contaminants for the customer. Following assembly, the completed system is
packaged in a plastic shrink-wrap to maintain clean room standards during
shipment.

Novellus purchases parts, components, and subassemblies (collectively, parts)
from numerous suppliers for the manufacture and support of its products.
Although Novellus makes reasonable efforts to ensure that parts are available
from multiple suppliers, this is not always possible; accordingly, certain key
parts are obtained from a single supplier or a limited group of suppliers.
These suppliers are, in some cases, thinly capitalized, independent companies
that generate significant portions of their business from Novellus and/or a
small group of other companies in the semiconductor industry. Although
Novellus seeks to reduce its dependence on these limited source suppliers,
disruption or termination of certain of these sources could occur and such
disruptions could have at least a temporary adverse effect on the Companys
operations. Moreover, a prolonged inability to obtain certain components could
have a material adverse effect on Novellus business, financial condition, and
results of operations, and could result in damage to customer relationships.

Competition

Significant competitive factors in the semiconductor equipment market include
system performance and flexibility, cost, the size of each manufacturers
installed customer base, the capability for customer support, and the breadth
of the product line. Novellus believes that it competes favorably in the
deposition equipment marketplace primarily on the basis of system performance
and flexibility, cost and customer support capability. In addition, Novellus
believes that the acquisition of Varians Thin Film Systems group in 1997 and
its 1998 announcements of a copper primary conductor product will allow the
Company to compete successfully in the PVD and copper Electrofill areas of the
market, respectively.

However, the semiconductor equipment industry is highly competitive and
characterized by increasingly rapid technological changes. Novellus faces
substantial competition in the market in which it competes from both
established competitors and potential new entrants. In the CVD and PVD areas
of the market, Novellus principal competitor is Applied Materials, Inc., which
is a major supplier of CVD and PVD systems and has established a substantial
base of CVD, PVD, and other equipment in large semiconductor manufacturers. In
the copper Electrofill area of the market, Novellus principal competitors are
Semitool (which has a large installed base of R&D tools), and Applied
Materials, which entered the market with an electroplating tool in April of
1999. In the surface preparation marketplace, Novellus principal competitors
are Mattson Technologies and Axcelis Technologies. Certain of Novellus
competitors have greater financial, marketing, technical, or other resources,
broader product lines, greater customer service capabilities, and larger and
more established sales organizations and customer bases than Novellus.

Novellus may also face future competition from new market entrants from other
overseas and domestic sources. Novellus expects its competitors to continue to
improve the design and performance of their products. There can be no
assurance that Novellus competitors will not develop enhancements to or future
generations of competitive products that will offer price or performance
features. In addition, a substantial investment is required by customers to
install and integrate capital equipment into a semiconductor production line.
As a result, once a semiconductor manufacturer has selected a particular
vendors capital equipment, Novellus believes that the manufacturer will be
generally reliant upon that equipment for the specific production line
application. Accordingly, the Company may experience difficulty in selling a
product line to a particular customer for a significant period of time if that
customer has selected a competitors product. Increased competitive pressure
could lead to lower prices for Novellus products, thereby materially adversely
affecting Novellus business, financial condition, and results of operations.
There can be no assurance that Novellus will be able to compete successfully in
the future.

Patents and Proprietary Rights

Novellus intends to continue to pursue the legal protection of its technology
primarily through patent and trade secret protection. The Company currently
holds over 100 patents and intends to file additional patent applications as
appropriate. There can be no assurance that patents will be issued from any of
these pending applications or that any claims allowed from existing or pending
patents will be sufficiently broad to protect Novellus technology. While the
Company intends to protect its intellectual property rights vigorously, there
can be no assurance that any patents held by Novellus will not be challenged,
invalidated or circumvented, or that the rights granted thereunder will provide
competitive advantages to the Company (see Item 3 Legal Proceedings).
Novellus also relies on trade secrets and proprietary technology that it seeks
to protect, in part, through confidentiality agreements with employees,
consultants, and other parties. There can be no assurance that these

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agreements will not be breached, that Novellus will have adequate remedies for
any breach, or that the Companys trade secrets will not otherwise become known
to or independently developed by others.

There has been substantial litigation regarding patent and other intellectual
property rights in semiconductor related industries. Novellus is currently
involved in such litigation (see Item 3 Legal Proceedings). Except as set
forth in Item 3, Legal Proceedings, Novellus is not aware of any significant
claim of infringement by its products of any patent or proprietary rights of
others; however, it could become involved in additional litigation in the
future. Although Novellus does not believe the outcome of the current
litigation will have a material impact on the Companys business, financial
condition, or results of operations, no assurances can be given that this
litigation or future litigation will not have such an impact. In addition to
the current litigation, Novellus operations, including the further
commercialization of the Companys products, could provoke additional claims of
infringement from third parties. In the future, litigation may be necessary to
enforce patents issued to Novellus, to protect trade secrets or know-how owned
by Novellus or to defend the Company against claimed infringement of the rights
of others and to determine the scope and validity of the proprietary rights of
others. Any such litigation could result in substantial cost and diversion of
effort by Novellus, which by itself could have a material adverse effect on the
Companys financial condition and operating results. Further, adverse
determinations in such litigation could result in Novellus loss of proprietary
rights, subject the Company to significant liabilities to third parties,
require the Company to seek licenses from third parties or prevent the Company
from manufacturing or selling its products, any of which could have a material
adverse effect on Novellus business, financial condition, and results of
operations.

Employees

At December 31, 2001, Novellus had 3,311 full-time and temporary employees.

The success of Novellus future operations depends in large part on the
Companys ability to recruit and retain engineers and technicians, as well as
marketing, sales, service and other key personnel, who in each case are in
great demand. There can be no assurance that Novellus will be successful in
retaining or recruiting key personnel.

None of Novellus employees is represented by a labor union and the Company has
never experienced a work stoppage, slowdown, or strike. Novellus currently
considers its employee relations to be good.

Novellus success depends to a significant extent upon a limited number of key
employees and other members of senior management of the Company. The loss of
the service of one or more of these key employees could have a material adverse
effect on Novellus. Novellus inability to effectively manage future growth,
or to attract and retain the personnel it requires, could have a material
adverse effect on the Companys business, financial condition, and results of
operations.

Business Combinations

On January 10, 2001, Novellus merged with GaSonics International Corporation in
a stock-for-stock merger, accounted for as a pooling-of-interests. In the
transaction, Novellus acquired all outstanding shares of GaSonics in a
stock-for-stock merger, with all outstanding shares of GaSonics capital stock
converted into approximately 9,240,000 shares of Novellus common stock. In
addition, all outstanding options to purchase shares of GaSonics capital stock
were converted into options to purchase approximately 1,400,000 shares of
Novellus common stock.

Environmental Matters

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

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ITEM 2. PROPERTIES

Novellus operations are primarily conducted in twelve buildings with
approximately 768,000 square feet of space. Ten buildings totaling
approximately 677,000 square feet are located in the San Jose, California area
and two buildings totaling approximately 91,000 square feet are located in the
Portland, Oregon area.

Novellus leases buildings located in its San Jose facility under agreements
which expire in 2006. Certain of these leases have options to extend for three
one-year renewal periods (with the lessor's consent). These buildings house three manufacturing
operations, a research and development facility, an applications demonstration
lab, various administrative and customer support offices, and the Companys
headquarters.

Novellus facilities located in the Portland area consist of two buildings in
the cities of Tualatin and Wilsonville. The Company owns the Tualatin site
totaling approximately 65,000 square feet and leases the Wilsonville site,
which consists of approximately 26,000 square feet. These locations provide
manufacturing, research and development, and customer support for the SABRE,
Novellus Electrofill product.

In April 2001, Novellus entered into a lease agreement for the development of
various facilities on 23 acres of the Companys property adjacent to its
Tualatin site. The site is currently under construction and will be developed
in several phases. The first phase, to be completed in the second quarter of
2002, consists of the construction of four buildings, which will provide
approximately 379,000 square feet of space for manufacturing, research and
development, engineering, and training facilities.

Novellus leases several sites domestically totaling approximately 98,000 square
feet of space. In addition, the Company subleases, or has available for
sublease, approximately 317,000 square feet of space in and around the San Jose
area.

The Company leases several sites internationally, which are used as sales and
customer service centers totaling approximately 150,000 square feet of space.
Novellus European offices occupy approximately 20,000 square feet of space in
various countries throughout Europe, including France, Germany, Italy, Ireland,
the Netherlands, and the United Kingdom. Novellus Asian offices occupy
approximately 130,000 square feet of space in various countries throughout
Asia, including China, India, Japan, Malaysia, Singapore, Korea, and Taiwan.
The Companys Asian operations include approximately 28,000 square feet near
Tokyo, Japan which serves as headquarters, sales office, service center, and
technology and customer demonstration center for Novellus Systems Japan.
During this fiscal year, the Company also expanded its presence in China,
India, and Malaysia to support new customer requirements.

Novellus believes that its current facilities, including those under
construction, are sufficient to meet the Companys requirements for the
foreseeable future.




ITEM 3. LEGAL PROCEEDINGS

Applied Materials, Inc. vs. Varian Associates Inc. (Case No.C-9720523 RMW) and
Novellus Systems, Inc. v. Applied Materials, Inc. (Case No. C-97-20551 RMW).

On July 7, 1997, prior to the consummation of the purchase of the TFS business
unit from Varian Associates Inc. (Varian), Applied Materials, Inc.
(Applied) filed a complaint (the Applied Complaint) against Varian in the
United States District Court for the Northern District of California San Jose
Division, Civil Action No. C-97-20523 RMW, alleging, among other things,
infringement by Varian (including the making, using, selling and/or offering
for sale of certain products and systems made by TFS) of United States Patent
Nos. 5,171,412; 5,186,718; 5,496,455; and 5,540,821 (the Applied Patents),
which patents are owned by Applied.

Immediately after consummation of the TFS purchase, Novellus filed a complaint
(the Novellus Complaint) against Applied in the same Court, Civil Action No.
C-97-20551 RMW, alleging infringement by Applied (including the making, using,
selling and/or offering for sale of certain products and systems) of United
States Patent Nos. 5,314,597; 5,330,628; and 5,635,036 (the Novellus
Patents), which patents Novellus acquired from Varian in the TFS purchase. In
the Novellus Complaint, Novellus also alleged that it is entitled to
declarations from Applied that Novellus does not infringe the Applied Patents
and/or that the Applied Patents are invalid and/or unenforceable. Applied has
filed counterclaims alleging that Novellus infringes the Applied Patents.

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Also after consummation of the TFS purchase, but some time after Novellus filed
the Novellus Complaint, Applied amended the Applied Complaint to add Novellus
as a defendant. Novellus has requested that the Court dismiss Novellus as a
defendant in Applieds lawsuit against Varian. The Court has not yet required
Novellus to file an answer to the Applied Complaint.

In addition to a request for a permanent injunction against further
infringement, the Applied Complaint and Applieds counterclaims to the Novellus
Complaint include requests for damages for alleged prior infringement and
treble damages for alleged willful infringement. In connection with the
consummation of the TFS purchase, Varian agreed, under certain circumstances,
to reimburse Novellus for certain of its legal and other expenses in connection
with the defense and prosecution of this litigation, and to indemnify Novellus
for a portion of any losses incurred by Novellus arising from this litigation
(including losses resulting from a permanent injunction). Novellus and Varian
believe that there are meritorious defenses to Applieds allegations, including
among other things, that Novellus operations (including TFS products and
systems) do not infringe the Applied Patents and/or that the Applied Patents
are invalid and/or unenforceable. However, the resolution of intellectual
property disputes is often fact intensive and, therefore, inherently uncertain.
Although Novellus believes that the ultimate outcome of the dispute with
Applied will not have a material adverse effect on Novellus business,
financial condition, or results of operations (taking into account both the
defenses available to Novellus and Varians reimbursement and indemnity
obligations), there can be no assurances that Applied will not ultimately
prevail in this dispute and that, in such an event, Varians reimbursement and
indemnity obligations will not be sufficient to fully reimburse Novellus for
its losses. If Applied were to prevail in this dispute, it could have a
material adverse effect on Novellus business, financial condition, or results
of operations.

The Novellus Complaint against Applied also includes requests for damages for
prior infringement and treble damages for willful infringement, in addition
to a request for a permanent injunction for further infringement. Novellus
believes that this litigation will not have a material adverse impact
on Novellus financial condition or results of operations,
however, there can be no assurances that Novellus will prevail
against Applied. If
Applied were to prevail against Novellus, it could have a material adverse
impact on Novellus business, financial condition, or results of operations.

Semitool, Inc. v. Novellus Systems, Inc. (Case No. C-98-3089 DLJ)

On August 10, 1998, Semitool sued the Company for patent infringement in the
United States District Court for the Northern District of California (the
District Court). Semitool alleges that the Companys SABRE and SABRE xT
copper deposition systems infringe two Semitool patents, U.S. Patent No.
5,222,310 (the 310 patent), issued June 29, 1993, entitled Single Wafer
Processor with a Frame, and U.S. Patent No. 5,377,708 (the 708 patent),
issued January 3, 1995, entitled Multi-Station Semiconductor Processor with
Volatilization. Semitool seeks an injunction against the Companys
manufacture and sale of the SABRE and SABRE xT systems, and seeks damages
for past infringement. Semitool also seeks treble damages for alleged willful
infringement. Semitool further seeks its attorneys fees and costs, and
interest on any judgment.

On September 24, 1999, the District Court ruled on the interpretation of the
claims of the 310 and 708 patents. On December 18, 1999, the Company filed a
motion for summary judgment of non-infringement.

On March 17, 2000, the District Court granted the Companys motion for summary
judgment of non-infringement. The District Court ruled that the Companys
SABRE and SABRE xT systems do not infringe the 310 and 708 patents.

On May 15, 2000, Semitool filed a notice of appeal, appealing the District
Courts judgment to the United States Court of Appeals for the Federal Circuit
(the Federal Circuit). On June 8, 2001, the Federal Circuit affirmed the
District Courts judgment that the Companys SABRE and SABRE xT systems do
not infringe the 310 and 708 patents.

On September 6, 2001, Semitool filed a petition for writ of certiorari with the
United States Supreme Court to review the judgment of the Federal Circuit. On
October 10, 2001, the Company filed an opposition to Semitools petition for
writ of certiorari. On October 24, 2001, Semitool filed a reply memorandum
responding to the Companys opposition.

Novellus believes that this litigation will not
have a material adverse impact on Novellus financial condition
or results of operations, however, there can be no assurances that
Novellus will prevail against Semitool. If
Semitool were to prevail against Novellus, it could have a material adverse
impact on Novellus business, financial condition, or results of operations.

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Semitool, Inc. v. Novellus Systems, Inc. (Case No. CV-01-874-BR)

On June 11, 2001, Semitool sued the Company for patent infringement in the
United States District Court for the District of Oregon. Semitool alleges that
the Company infringes Semitools U.S. Patent No. 6,197,181, issued March 6,
2001, entitled Apparatus and Method for Electrolytically Depositing a Metal on
a Microelectronic Workpiece. Semitool seeks an injunction against the Company
and damages for past infringement. Semitool also seeks treble damages for
alleged willful infringement. Semitool further seeks its attorneys fees and
costs, and interest on any judgment.

On November 13, 2001, the Company countersued Semitool for patent infringement
in the United States District Court for the District of Oregon. The Company
alleges that Semitool infringes the Companys U.S. Patent Nos. 6,179,983,
issued January 30, 2001 and entitled Method and Apparatus for Treating Surface
Including Virtual Anode; 6,162,344, issued December 19, 2000 and entitled
Method of Electroplating Semiconductor Wafer Using Variable Currents and Mass
Transfer to Obtain Uniform Plated Layer; 6,110,346, issued August 29, 2000 and
also entitled Method of Electroplating Semiconductor Wafer Using Variable
Currents and Mass Transfer to Obtain Uniform Plated Layer; and 6,074,544,
issued June 13, 2000 and also entitled Method of Electroplating Semiconductor
Wafer Using Variable Currents and Mass Transfer to Obtain Uniform Plated
Layer. The Company seeks an injunction against Semitool and damages for past
infringement. The Company also seeks treble damages for willful infringement
by Semitool. The Company further seeks its attorneys fees and costs, and
interest on any judgment.

Although it is inherently difficult to assess the outcome of litigation matters
when the litigation is in such an early stage, Novellus believes that
this litigation will
not have a material adverse impact on Novellus financial
condition or results of operations; however, there can be no
assurances that Novellus will prevail against Semitool. If Semitool were to prevail against
Novellus, it could have a material adverse impact on Novellus business,
financial condition, or results of operations.

Plasma Physics Litigation. (Case No. 00
CV-3146-LDW)

On December 28, 1999, Plasma Physics Corporation and Solar Physics Corporation
(collectively, Plasma Physics) filed a patent infringement lawsuit against
many of the Companys Japanese and Korean customers. The suit was entitled
Plasma Physics and Solar Physics v. Fujitsu et al., Civil Action No. 99-8593,
and was pending in the United States District Court for the Eastern District of
New York. On July 24, 2000, the Court ordered Plasma Physics to re-file
separate complaints against the Japanese and Korean defendants, whereupon,
Civil Action No. 99-8593 would be dismissed without prejudice. In accordance
with the Courts order, Plasma Physics re-filed separate complaints against the
Japanese and Korean defendants in the United States District Court for the
Eastern District of New York. Many of the defendants notified the Company that
they believed that the Company had indemnification obligations and liability
for the lawsuits.

Plasma Physics asserted U.S. Patent Nos. 4,226,897, 5,470,784, and/or 5,543,634
(the 897, 784, and 634 patents, respectively) against the defendants.
Plasma Physics sought an injunction against the defendants alleged
infringement of the 784 and 634 patents (the 897 patent had expired).
Plasma Physics also sought treble damages for alleged willful infringement.
Plasma Physics further sought its attorneys fees and costs, and interest on
any judgment. All of the Japanese and Korean defendants who are or were
customers of the Company have since settled with Plasma Physics.

On June 1, 2000, the Company filed a declaratory relief action against Plasma
Physics and Solar Physics requesting a judgment of non-infringement,
invalidity, and unenforceability with respect to the 897 and 784 patents.
The suit is entitled Novellus v. Plasma Physics and Solar Physics, Civil Action
No. 00-3146, and is pending in the United States District Court for the Eastern
District of New York. On June 30, 2000, Plasma Physics filed a motion to
dismiss the Companys complaint for a lack of subject matter jurisdiction.
Plasma Physics motion to dismiss the Companys complaint was denied without
prejudice on July 24, 2000. On July 31, 2000, Plasma Physics filed an Answer
and Conditional Counterclaim. Plasma Physics denies that the 897 and 784
patents are invalid and unenforceable. Plasma Physics further denies that the
784 patent is not infringed by the Company. Plasma Physics also asserted a
conditional counterclaim against the Company, alleging that the Companys PECVD
processing systems infringe the 784 patent.

On June 12, 2001, the United States Patent and Trademark Office issued to
Plasma Physics U.S. Patent No. 6,245,648, entitled Method of Forming
Semiconducting Materials and Barriers (the 648 Patent). On June 13, 2001,
Plasma Physics sent a letter to the Company, indicating that it may sue the
Companys customers for their alleged infringement of the 648 Patent.

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Novellus believes that this litigation will not
have a material adverse impact on Novellus financial condition
or results of operations, however,
there can be no assurances that Novellus will prevail against
Plasma Physics. If Plasma Physics were to prevail against Novellus, it could
have a material adverse impact on Novellus business, financial condition, or
results of operations.

Other Litigation

In addition, in the normal course of business, Novellus from time to time
receives inquiries with regard to possible other patent infringements.
Novellus believes it is unlikely that the outcome of the patent infringement
inquiries will have a material adverse effect on Novellus financial position
or results of operations.

There has been substantial litigation regarding patent and other intellectual
property rights in semiconductor related industries. Although Novellus is not
aware of any significant claim of infringement by its products of any patents
or proprietary rights of others except as claimed by Applied, Semitool, and
Plasma Physics, further commercialization of Novellus products could provoke
claims of infringement from third parties. In the future, litigation may be
necessary to enforce patents issued to Novellus, to protect trade secrets or
know-how owned by Novellus or to defend Novellus against claimed infringement
of the rights of others and to determine the scope and validity of the
proprietary rights of others. Any such litigation could result in substantial
cost and diversion of effort by Novellus, which by itself could have a material
adverse effect on Novellus financial condition and operating results.
Further, adverse determinations in such litigation could result in Novellus
loss of proprietary rights, subject Novellus to significant liabilities to
third parties, require Novellus to seek licenses from third parties or prevent
Novellus from manufacturing or selling its products, any of which could have a
material adverse effect on Novellus business, financial condition or results
of operations.

Novellus is a defendant or plaintiff in various actions that arose in the
normal course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on
Novellus business, financial condition, or results of operations.




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

Not applicable.

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PART II




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

Stock Information

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

|               |  |      |       |     |  |   |       | 
|-------------- |  | ---- | ----- | --- |  | - | ----- | 
|2001           |  | High |       | Low
|               |  |      |       |    
|First Quarter  |  | $    | 48.38 |     |  | $ | 35.13 | 
|Second Quarter |  |      | 58.09 |     |  |   | 33.88 | 
|Third Quarter  |  |      | 56.66 |     |  |   | 28.00 | 
|Fourth Quarter |  |      | 45.50 |     |  |   | 26.40 | 

|                 |  |      |       |     |  |   |       | 
|---------------- |  | ---- | ----- | --- |  | - | ----- | 
|2000             |  | High |       | Low
|                 |  |      |       |    
|First
Quarter(1) |  | $    | 69.94 |     |  | $ | 39.27 | 
|Second Quarter   |  |      | 66.69 |     |  |   | 40.06 | 
|Third Quarter    |  |      | 68.44 |     |  |   | 43.88 | 
|Fourth Quarter   |  |      | 47.75 |     |  |   | 25.94 | 



---

|(1) |  | Stock prices have been restated to reflect Novellus three-for-one stock
split, effective January 15, 2000.
|--- |  | -----------------------------------------------------------------------------------------------------------

Novellus has not paid cash dividends on its common stock since inception, and
its Board of Directors presently plans to reinvest the Companys earnings in
its business. Accordingly, it is anticipated that no cash dividends will be
paid to holders of common stock in the foreseeable future. As of December 31,
2001, there were 955 holders of record of Novellus common stock.

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ITEM 6. SELECTED FINANCIAL DATA

The following selected financial data of Novellus is qualified by reference to
and should be read in conjunction with the consolidated financial statements of
the Company, including the notes thereto, and Managements Discussion and
Analysis of Financial Condition and Results of Operations, which follows this
selected data. The following selected financial data of the Company includes
the operating results and financial data of the Company and GaSonics
International Corporation for all periods. The Company merged with GaSonics
International Corporation on January 10, 2001, in a transaction accounted for
as a pooling of interests.

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

|                                                                                                                               |                       |         |           |         |     |      |           |       |      |      |         |         |      |   |         |      |   |   |         |       |      | 
|------------------------------------------------------------------------------------------------------------------------------ | --------------------- | ------- | --------- | ------- | --- | ---- | --------- | ----- | ---- | ---- | ------- | ------- | ---- | - | ------- | ---- | - | - | ------- | ----- | ---- | 
|Year Ended December 31,                                                                                                        |                       | 2001    |           | 2000(3) |     | 1999 |           | 1998  |      | 1997
|                                                                                                                               |                       |         |           |         |     |      |           |       |      |     
|Consolidated Statements of Operations Data:                                                                                    |                       |         |           |         |     |      |           |       |      |      |         |         |      |   |         |      |   |   |         |      
|Net sales                                                                                                                      |                       | $       | 1,339,322 |         |     | $    | 1,319,486 |       |      | $    | 657,021 |         |      | $ | 619,208 |      |   | $ | 655,260 |      
|Gross profit                                                                                                                   |                       |         | 691,351   |         |     |      | 730,893   |       |      |      | 351,839 |         |      |   | 330,774 |      |   |   | 354,913 |      
|Income (loss) before cumulative effect of
change in accounting principle                                                       |                       |         | 144,470   | (5)     |     |      | 239,168   | (4)   |      |      | 68,707  |         |      |   | 47,115  |      |   |   | (92,657 | )(1) 
|Cumulative effect of change in accounting principle                                                                            |                       |         |          |         |     |      | (89,788   | )     |      |      |        |         |      |   |        |      |   |   |        |      
|Net income (loss)                                                                                                              |                       | $       | 144,470   |         |     | $    | 149,380   | (3)   |      | $    | 68,707  |         |      | $ | 47,115  |      |   | $ | (92,657 | )    
|Per common share:                                                                                                              |                       |         |           |         |     |      |           |       |      |      |         |         |      |   |         |      |   |   |         |      
|Income (loss) before cumulative effect of
change in accounting principle                                                       |                       |         |           |         |     |      |           |       |      |      |         |         |      |   |         |      |   |   |         |      
|                                                                                                                               | Basic                 |         | $         | 1.01    | (5) |      | $         | 1.76  | (4)  |      | $       | 0.56    |      |   | $       | 0.43 |   |   | $       | (0.87 | )   
|                                                                                                                               | Diluted               |         | $         | 0.97    | (5) |      | $         | 1.66  | (4)  |      | $       | 0.54    |      |   | $       | 0.42 |   |   | $       | (0.87 | )   
|Cumulative effect of change in accounting principle,
net of tax                                                                |                       |         |           |         |     |      |           |       |      |      |         |         |      |   |         |      |   |   |         |      
|                                                                                                                               | Basic                 |         |           |        |     |      | $         | (0.66 | )    |      |         |        |      |   |         |     |   |   |         |      |     
|                                                                                                                               | Diluted               |         |           |        |     |      | $         | (0.62 | )(3) |      |         |        |      |   |         |     |   |   |         |      |     
|Net income (loss)                                                                                                              |                       |         |           |         |     |      |           |       |      |      |         |         |      |   |         |      |   |   |         |      
|                                                                                                                               | Basic                 |         | $         | 1.01    | (5) |      | $         | 1.10  |      |      | $       | 0.56    |      |   | $       | 0.43 |   |   | $       | (0.87 | )(1)
|                                                                                                                               | Diluted               |         | $         | 0.97    | (5) |      | $         | 1.04  |      |      | $       | 0.54    |      |   | $       | 0.42 |   |   | $       | (0.87 | )(1)
|Shares used in basic per share calculations                                                                                    |                       |         | 142,462   |         |     |      | 135,728   |       |      |      | 122,261 |         |      |   | 109,406 |      |   |   | 106,860 |      
|Shares used in diluted per share calculations                                                                                  |                       |         | 148,924   |         |     |      | 143,654   |       |      |      | 127,826 |         |      |   | 112,437 |      |   |   | 106,860 | (2)  
|Pro forma amounts with the change in accounting
principle related to revenue recognition applied
retroactively: (unaudited)(3) |                       |         |           |         |     |      |           |       |      |      |         |         |      |   |         |      |   |   |         |      
|                                                                                                                               | Net revenues          |         |           |        |     |      |           |      |      |      | $       | 582,397 |      |   |         | *    |   |   |         | *     |     
|                                                                                                                               | Net income            |         |           |        |     |      |           |      |      |      |         | 39,550  |      |   |         | *    |   |   |         | *     |     
|                                                                                                                               | Net income per share: |         |           |         |     |      |           |       |      |      |         |         |      |   |         |      |   |   |         |       |     
|                                                                                                                               |                       | Basic   |           |         |    |      |           |       |     |      |         | $       | 0.32 |   |         |      | * |   |         |       | *    | 
|                                                                                                                               |                       | Diluted |           |         |    |      |           |       |     |      |         | $       | 0.31 |   |         |      | * |   |         |       | *    | 

|                                                   |  |      |           |      |  |      |           |      |  |      |           |  |  |   |         |  |  |   |         | 
|-------------------------------------------------- |  | ---- | --------- | ---- |  | ---- | --------- | ---- |  | ---- | --------- |  |  | - | ------- |  |  | - | ------- | 
|December 31,                                       |  | 2001 |           | 2000 |  | 1999 |           | 1998 |  | 1997
|                                                   |  |      |           |      |  |      |           |      |  |     
|Consolidated Balance Sheet Data:                   |  |      |           |      |  |      |           |      |  |      |           |  |  |   |         |  |  |   |         | 
|Cash, cash equivalents, and short-term investments |  | $    | 921,822   |      |  | $    | 1,219,664 |      |  | $    | 413,014   |  |  | $ | 163,156 |  |  | $ | 122,973 | 
|Working capital                                    |  |      | 1,379,543 |      |  |      | 1,410,836 |      |  |      | 646,063   |  |  |   | 344,908 |  |  |   | 283,159 | 
|Total assets                                       |  |      | 3,009,662 |      |  |      | 2,205,474 |      |  |      | 1,000,352 |  |  |   | 649,155 |  |  |   | 597,682 | 
|Long-term obligations                              |  |      |          |      |  |      |          |      |  |      |          |  |  |   | 65,223  |  |  |   | 65,401  | 
|Shareholders equity                               |  |      | 1,871,994 |      |  |      | 1,641,475 |      |  |      | 837,537   |  |  |   | 450,873 |  |  |   | 380,194 | 



---

|*   |  | Data is not available to provide pro forma information for these years.                                                                                                                                                                                                                                                                                                                                                                                            
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(1) |  | Novellus reported loss of $92.7 million or $0.87 per share for the year
ended December 31, 1997 includes pre-tax one-time charges totaling $238.1
million, consisting of $133.5 million in connection with the acquisition
of TFS, a write-off of $20.6 million in connection with outstanding
accounts receivable from Submicron Technology, Inc. and charges totaling
$84.0 million in connection with the May 4, 1997 settlement of the TEOS
patent litigation.

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|(2) |  | Excludes common stock equivalents, as they are antidilutive to the loss
per share for the year.                                                                                                                                                                                                                                  
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(3) |  | Novellus recorded a non-cash charge of $89.8 million, after reduction for
income taxes of $48.6 million, or $0.62 per diluted share, to reflect the
cumulative effect of the accounting change as of January 1, 2000 related
to the adoption of Staff Accounting Bulletin No. 101, Revenue Recognition
in Financial Statements.
|   
|(4) |  | Net income for the year ended December 31, 2000 includes a charge of $6.0
million for in-process research and development associated with the
acquisition of Gamma Precision Technology or $0.04 per diluted share.                                                                                                              
|   
|(5) |  | Novellus recorded one-time charges totaling $84.5 million, $58.2 million,
net of tax, or $0.39 per diluted share, associated with restructuring and
merger activities, the other than temporary decline in value of an
investment, and the write-off of a bad debt.                                                              




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

Novellus Systems, Inc. (Novellus or the Company) manufactures, markets, and
services advanced systems used to deposit thin conductive and insulating films
on semiconductor devices, as well as equipment for preparing the device surface
prior to these deposition processes. Demand for Novellus systems can vary
significantly from period to period as a result of various factors, including,
but not limited to, downturns in the semiconductor industry, supply and demand
for semiconductor devices, and substantial competition in the semiconductor
industry among suppliers of similar products. For these and other reasons,
Novellus results of operations for fiscal 2001, 2000, and 1999 (which include
results of operations for GaSonics International Corporation) may not
necessarily be indicative of future operating results.

As more fully described in Note 2 to the Financial Statements, Novellus merged
with GaSonics International Corporation (GaSonics), a developer and supplier
of photoresist and residue removal technologies on January 10, 2001 in a
pooling of interests transaction. The consolidated financial statements for
fiscal 2000 and 1999 have been restated to include the financial position,
results of operations, and cash flows of GaSonics. Because of differing year
ends, financial information relating to Novellus fiscal years ended December
31, 2000 and 1999 has been combined with financial information relating to
GaSonics fiscal years ended September 30, 2000 and 1999, respectively.
GaSonics net income for the three months ended December 31, 2000 was not
combined with Novellus net income, but rather was included as an adjustment to
shareholders equity. Revenue and net income of GaSonics for the three-month
period ended December 31, 2000, which is excluded from the accompanying
statements of operations, was $47.7 million and $0.9 million, respectively.
There were no transactions between GaSonics and Novellus prior to the
combination.

Critical Accounting Policies and Estimates

Novellus discussion and analysis of its financial condition and results of
operations are based upon Novellus consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires
Novellus to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an ongoing basis, Novellus evaluates its
estimates, including those related to allowance for doubtful accounts,
inventories, investments, deferred tax assets, income taxes, warranty
obligations, restructuring, and contingencies and litigation. Novellus bases
its estimates on historical experience and on 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. Actual results
may differ from these estimates under different assumptions or conditions.

Novellus believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements.

Revenue Recognition
Novellus changed its revenue recognition policy effective January 1, 2000,
based on guidance provided in SEC Staff Accounting Bulletin No. 101 (SAB
101), Revenue Recognition in Financial Statements and
SAB 101: Revenue Recognition in Financial
StatementsFrequently Asked Questions and Answers (SAB 101
FAQ). Novellus recognizes
revenue when persuasive evidence of an arrangement exists, delivery has
occurred or services have been rendered, the sellers price is

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fixed or determinable, and collectibility is reasonably assured. Certain of
Novellus product sales are accounted for as multiple-element arrangements. If
the Company has met defined customer acceptance experience levels with both the
customer and the specific type of equipment, then Novellus recognizes equipment
revenue upon shipment and transfer of title, with the remainder when it becomes
due (generally upon acceptance). All other equipment sales are recognized upon
customer acceptance. Revenue related to spare part sales is recognized on
shipment. Revenue related to maintenance and service contracts is recognized
ratably over the duration of the contracts. Unearned maintenance and service
contract revenue is not significant and is included in accrued liabilities.

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

The deferred profit balance as of January 1, 2000 was $138.4 million. This
amount is comprised of equipment that was shipped and previously recorded as
revenue but had not been accepted or did not qualify for multiple-element
accounting as of December 31, 1999. In addition to deferred revenue, deferred
profit includes deferred amounts related to cost of sales and commissions.
Related to the $138.4 million in deferred profit, $134.2 million was recognized
as revenue in fiscal 2000 with the remaining $4.2 million being recognized in
2001. The unaudited pro forma amounts presented in the income statement were
calculated assuming the accounting change was retroactive to prior periods.

Prior to 2000, Novellus revenue recognition policy was to recognize revenue at
the time the customer takes title to the product, generally at the time of
shipment. Revenue related to maintenance and service contracts was recognized
ratably over the duration of the contracts.

Allowance for Doubtful Accounts
Novellus evaluates its allowance for doubtful accounts based on a combination
of factors. In circumstances where the Company is aware of a specific
customers inability to meet its financial obligations to us (e.g. bankruptcy
filings, substantial downgrading of credit ratings), Novellus records a
specific allowance for bad debts against amounts due to reduce the net
recognized receivable to the amount Novellus reasonably believes will be
collected. For all other customers, Novellus recognizes a reserve for bad
debts based on a certain percentage of total revenues, which is based on the
Companys historical experience over five years. If circumstances change (e.g.
higher than expected defaults or an unexpected material adverse change in a
major customers ability to meet its financial obligations to us), the Company
may amend its estimates of the recoverability of amounts due to Novellus.

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

Warranty and Installation
Novellus warranty and installation policy generally states that the Company
will provide installation services as well as warranty coverage, for a
predetermined amount of time, on systems and modules for material and labor to
repair and service the equipment. Novellus records the estimated cost of
warranty coverage and installation upon system shipment. The estimated cost of
warranty and installation coverage is determined by the warranty term as well
as the average historical warranty and installation expense for a specific
tool. Should actual product failure rates, material usage, or installation
costs differ from Novellus estimates, revisions to the estimated warranty and
installation liability may be required.

Investments
The Company classifies its marketable securities as available-for-sale in
accordance with the provisions of the Statement of Financial Accounting
Standard (SFAS) No. 115, Accounting for Certain Investments in Debt and
Equity Securities. Securities classified as available-for-sale are reported
at fair market value with the related unrealized gains and losses included, net
of tax, in accumulated other comprehensive income (loss). Realized gains and
losses and declines in value of securities judged to be other than temporary
are included in other income. Interest on all securities is included in
interest income. Future adverse changes in market conditions or poor operating
results of underlying investments could result in losses or an inability to
recover the carrying value of the investments that may not be reflected in an
investments current

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carrying value, thereby possibly requiring impairment charges in the future.
The fair values of investments are determined using quoted market prices if
available and estimated using discounted cash flows and market interest rates
if quoted market prices are not available.

Deferred Tax Assets
Novellus records a valuation allowance to reduce its deferred tax assets to the
amount that is more likely than not to be realized. While Novellus has
considered future taxable income and ongoing prudent and feasible tax planning
strategies in assessing the need for the valuation allowance, in the event
Novellus were to determine that it would be able to realize its deferred tax
assets in the future in excess of its net recorded amount, an adjustment to the
deferred tax asset would increase income in the period such determination was
made. Likewise, should Novellus determine that it would not be able to realize
all or part of its net deferred tax asset in the future, an adjustment to the
deferred tax asset would be charged to income in the period such determination
was made.

Restructuring
During 2001, the Company recorded restructuring charges in connection with a
plan to restructure Novellus operations. These accruals were calculated net
of estimated future sublease income that Novellus expects to receive once
the Company sublets facilities which it has vacated. If the length of
time before the Company finds tenants for these facilities or the market rental
rates differs significantly from Novellus estimates, the Companys actual
costs will differ from the charge which was initially recorded.

Contingencies and Litigation
The Company makes an assessment of the probability of an adverse judgment
resulting from current and threatened litigation. The Company would accrue the
cost of an adverse judgment if, in the Companys estimation, the adverse
settlement is probable and the Company can reasonably estimate the ultimate
cost to the Company. Novellus has made no such accruals at
December 31, 2001.

Results Of Operations

Net Sales
Net sales were $1,339.3 million, $1,319.5 million, and $657.0 million in 2001,
2000, and 1999, respectively. The increase of approximately 2% from 2000 is
attributable to increases in Novellus Electrofill and 300mm product lines
offset by decreases in the Companys 200mm tools. The increase of
approximately 101% from 2000 compared to 1999 reflected the increase in
shipments across all product lines as the semiconductor industry increased
purchases related to both capacity and technology. International sales were
approximately 55% of net sales in 2001, a decrease from 63% in 2000. The
decrease in international sales as a percentage of net sales in 2001 is
attributable to lower demand in the Pacific Rim and Korea, partially offset by
higher demand in Japan. International sales were approximately 63% of net
sales in 2000, an increase from 62% in 1999. The increase in international
sales as a percentage of net sales in 2000 was the result of higher demand in
the Pacific Rim, Japan, and Europe partially offset by lower demand in Korea.

Gross Profit
Gross profit was $691.4 million, $730.9 million, and $351.8 million in 2001,
2000, and 1999, respectively. As a percentage of net sales, gross profit was
52% in 2001 and 55% and 54% in 2000 and 1999, respectively. Gross profit as a
percentage of net sales in 2001 decreased from prior fiscal periods due to
reduced absorption of fixed overhead resulting from lower shipments and from
lower gross margins on 300mm systems, which have higher costs as they are not
yet in high volume production, a $7.1 million charge associated with the
Companys restructuring plan, offset by the Companys decision to cancel its
2001 bonus and profit sharing programs. The increase in gross profit as a
percentage of net sales from 1999 to 2000 reflects successful cost reduction
efforts and improved absorption of fixed overhead costs due to the increased
levels of shipments.

Selling, General, and Administrative
Selling, general, and administrative (SG&A) expense was $198.6 million, $232.7
million, and $137.4 million in 2001, 2000, and 1999, respectively. As a
percentage of net sales, SG&A expense was approximately 15%, 18%, and 21% in
2001, 2000, and 1999, respectively. The decrease in absolute dollars and as a
percentage of sales in 2001 over the prior year is due to the impact of cost
reduction measures implemented in the first quarter of 2001 including mandatory
vacation days, travel and other discretionary spending reductions, temporary
work force reductions, capital spending reductions, executive and employee pay
reductions, facilities consolidation, as well as the cancellation of the 2001
bonus and profit sharing programs. The decrease in SG&A expense as a
percentage of sales in 2000 over 1999 reflects Novellus ongoing efforts to
control and reduce SG&A expense as a percentage of net sales despite the rapid
growth in revenues.

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Research and Development
Research and development (R&D) expense was $272.0 million, $198.3 million, and
$129.1 million in 2001, 2000, and 1999, respectively. The increases reflect
Novellus continued commitment to the development of new products, including
advanced PVD systems, advanced gap fill technology, primary conductor metals,
low-K dielectric materials, and additional advanced deposition and surface
preparation technologies for the next generation of smaller geometry
fabrication lines, as well as equipment to process 300mm wafers. The increase
from 2000 to 2001 was partially offset by Novellus cancellation of the 2001
bonus and profit sharing programs. The increase from 1999 to 2000 reflects a
full period of costs associated with the Companys investment in its facilities
infrastructure to support its ongoing R&D commitment. As a percentage of net
sales, R&D expense was approximately 20%, 15%, and 20% in 2001, 2000, and 1999,
respectively. Novellus continues to believe that significant investment in R&D
is required to remain competitive, and plans to continue to invest in new
products and increase research and development spending in absolute dollars,
although such expenses as a percentage of net revenues may fluctuate between
periods.

Special Charges
In September 2001, Novellus announced its intention to restructure its
operations, which was driven by the decline in Novellus orders due to the
contraction of the semiconductor capital equipment market from calendar year
2000 levels. During the third quarter of 2001, the restructuring plan was
approved by the appropriate level of management necessary to commit the Company
to its specific actions. The Company began implementing the plan during the
third quarter of 2001 and recorded restructuring and asset impairment charges
totaling $55.0 million, of which $47.9 million is included in operating
expenses and $7.1 million is included in cost of sales. The restructuring
charges included $33.8 million related to vacated facilities, $9.5 million
related to abandoned assets associated with the discontinuation of certain
projects, and $4.6 million related to the write-off of purchased technology.
Additionally, the discontinuation of certain projects resulted in $7.1 million
of inventory write-downs, which are included in cost of sales. Under the
restructuring plan, the Company expects $42.6 million in cost savings over the
next five years. However, Novellus cannot ensure that these estimated costs
savings will materialize.

The charge for vacated facilities relates to rent obligations after the
abandonment of certain facilities currently under long-term operating lease
agreements. When applicable, anticipated future sublease income relating to
vacated buildings has been offset against the charge for the remaining lease
payments. Leasehold improvements relating to the vacated buildings which have
no future economic benefit have been abandoned. Additionally, certain fixed
assets associated with these facilities had no future economic benefit and have
been written off. The charge for abandoned assets and discontinued inventory
are associated with programs exited by Novellus. The write-off of purchased
technology relates to technology which has been abandoned by the Company.
Except for the future rent obligations and the sublease of Novellus vacated
facilities, substantially all actions under the restructuring plan have been
achieved as of December 31, 2001. The remaining $26.8 million balance of the
restructuring accrual is for future rent obligations which are to be paid in
cash over the next five years. For further discussion, see Notes to
Consolidated Financial Statements, Special Charges.

Merger costs related to the acquisition of GaSonics were $13.2 million during
the year ended December 31, 2001. These costs included professional fees,
financial printing, and other related costs. Additionally, these costs
included charges related to the cancellation of various contracts and the
write-off of certain redundant assets.

In fiscal 1999, GaSonics reduced its workforce in response to market conditions
and recorded a charge of $0.4 million, primarily for costs of severance
compensation and consolidation of facilities. At December 31, 2000, the costs
had been paid in full.

Bad Debt Write-off
In September 2001, Novellus determined that due to the financial difficulties
facing one of its customers, an outstanding accounts receivable balance was at
risk for collection. Accordingly, Novellus recorded a write-off of $7.7
million.

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

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Other Income
Other income was $57.4 million, $56.3 million, and $15.2 million, in 2001,
2000, and 1999, respectively. The increase from 2000 to 2001 is attributable
to higher cash and short-term investment balances in the second half of the
year as a result of the $880.0 million convertible debenture offering,
partially offset by an $8.6 million write-down of an equity investment due to
an other than temporary decline in fair value under SFAS 115. The increase
from 1999 to 2000 is attributable to higher cash and short-term investment
balances, as a result of a public offering in April 2000 of approximately 9.0
million shares of common stock that resulted in net proceeds to the Company of
approximately $526.3 million and cash provided by operating activities. In May
of 2000, GaSonics, which at that time was a publicly held company, raised $46.6
million in a public offering of approximately 1.0 million shares (after giving
effect to the merger exchange ratio of 0.52 Novellus shares for each
outstanding GaSonics share). In addition, long-term borrowings of $65.0
million were repaid in 1999, which resulted in a
reduction of interest expense in 2000.

Provision for Income Taxes
The provision for income taxes reflects an effective tax rate of 31.0% in 2001,
31.7% in 2000, and 31.4% in 1999.

Deferred Tax Asset
As of December 31, 2001, Novellus has approximately $65.0 million of net deferred
tax assets related principally to items that are not currently deductible.
The Companys management believes the deferred tax assets will be realized due
to anticipated future income and potentially refundable taxes in available
carryback periods. Novellus also has a valuation allowance of $7.6 million
related to future tax amortization which will not be deductible until 2010 and
beyond.

Net Income
Net income for the year ended December 31, 2001 was $144.5 million or $1.01 and
$0.97 per basic and diluted shares, respectively, compared with net income for
the year ended December 31, 2000 of $149.4 million or $1.10 and $1.04 per basic
and diluted shares, respectively. Net income, before one-time charges of $84.5
million, for the year ended December 31, 2001 was $202.7 million or $1.42 and
$1.36 per basic and diluted shares, respectively.

Net income for the year ended December 31, 2000 was $149.4 million or $1.10 and
$1.04 per basic and diluted shares, respectively, compared with net income for
the year ended December 31, 1999 of $68.7 million or $0.56 and $0.54 per basic
and diluted shares, respectively. Net income, before an $89.8 million charge
related to the cumulative effect of a change in accounting principle associated
with Novellus adopting SAB 101, for the year ended December 31, 2000 was $239.2
million. On a basic and diluted share basis, earnings per share were $1.76 and
$1.66, respectively, before the charge for the cumulative effect of an
accounting change.

The number of shares used in the per share calculations for the year ended
December 31, 2001 was 142.5 million and 148.9 million shares, respectively, for
basic and diluted income per share calculations, compared with 135.7 million
and 143.7 million shares, respectively for the year ended December 31, 2000.
The increase in shares compared to the prior year is primarily due to the
issuance of 9.2 million shares associated with the stock-for-stock merger with
GaSonics in January 2001 and the exercise of stock options during the year.

The number of shares used in the per share calculations for the year ended
December 31, 2000 was 135.7 million and 143.7 million shares, respectively, for
basic and diluted income per share calculations, compared with 122.3 million
and 127.8 million shares, respectively for the year ended December 31, 1999.
The increase in shares is primarily due to an increased number of common shares
outstanding resulting from the common stock offerings of 9.0 million shares in
April 2000 and 1.0 million shares in May 2000 and the exercise of stock options
in 2000.

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

Foreign Exchange Contracts
Novellus conducts its business in various foreign currencies. The Company
enters into forward foreign exchange contracts primarily as an economic hedge
of the short-term impact of foreign currency fluctuations of intercompany
accounts payable denominated in U.S. dollars recorded by Novellus Japanese
subsidiary. Novellus also enters into forward foreign exchange contracts to
buy and sell foreign currencies as economic hedges of the parents intercompany
balances denominated in a

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currency other than the U.S. dollar. In 2001, 2000, and 1999, these hedging
contracts were denominated primarily in the Japanese Yen. The maturities of
all the forward foreign exchange contracts are generally short-term in nature.
As the impact of movements in currency exchange rates on forward foreign
exchange contracts offset the related impact on the underlying items being
hedged, Novellus believes these financial instruments do not subject the
Company to speculative risk that would otherwise result from changes in
currency exchange rates. Net foreign currency gains and losses have not been
significant.

Related Parties
One customer represented 16%, 14%, and 11% of Novellus sales
during the years ended December 31, 2001, 2000, and 1999, respectively. A member of
Novellus board of directors also serves on the board of
directors of this customer, and therefore, the customer is considered a related
party.

Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 141 (SFAS 141), Business
Combinations. SFAS 141 requires the purchase method of accounting for all
business combinations and eliminates the pooling-of-interests method for
business combinations initiated after June 30, 2001. SFAS 141 also includes
guidance on the initial recognition and measurement of goodwill and other
intangible assets arising from business combinations completed after June 30,
2001. The Company does not expect the adoption of SFAS 141 to have a material
effect on its financial condition or results of operations.

In June 2001, the FASB issued SFAS 142,
Goodwill and Other Intangible Assets.
SFAS 142 discontinues amortization of goodwill and intangible assets deemed to
have indefinite lives and requires such assets to be reviewed at least annually
for impairment. SFAS 142 also includes provisions on the identification of
intangible assets, reclassification of certain intangibles from previously
reported goodwill, and reassessment of the useful lives of existing
intangibles. Novellus will apply SFAS 142 beginning in the first quarter of
2002. Application of the non-amortization provisions of SFAS 142 is expected
to result in an increase in operating income of $3.5 million in 2002. Novellus
will test goodwill for impairment using the two-step process prescribed in SFAS
142. The first step is to screen for potential impairment, while the second
step measures the amount of the impairment, if any. Novellus expects to
perform the first of the required impairment tests of goodwill and indefinite
lived intangible assets as of January 1, 2002 in the first quarter of 2002.
Novellus does not expect the effect of these tests to be material to its
financial condition or results of operations.

In July 2001, the FASB issued SFAS 143, Accounting for Asset Retirement
Obligations, which addresses accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the associated
asset retirement costs. SFAS 143 is effective for fiscal years beginning after
June 15, 2002. The Company is currently assessing the impact of this new
standard, however, Novellus does not expect its adoption to be
material to its financial condition or results of operations.

In August 2001, the FASB issued SFAS 144, Impairment or Disposal of Long-Lived
Assets, which is effective for fiscal years beginning after December 15, 2001.
SFAS 144 supersedes SFAS 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of, and provides a single
accounting model for impairment of long-lived assets. Novellus does not expect
the adoption of SFAS 144 to have a material effect on the Companys financial
condition or results of operations.

On February 27, 2002, the FASB met and discussed changes to their
consolidations project that could substantially change the accounting for
synthetic leases. The FASB plans to allow the public to comment on an
Interpretation of FASB Statement No. 94, Consolidated
Financial Statements
which will include proposed changes which may affect the accounting for
synthetic leases. The FASB plans to issue a Draft by April 30, 2002 and to
finalize the Statement by July 31, 2002. The FASB intends to issue the final
Statement with an effective date being the first day of the first fiscal year
beginning after December 15, 2002 (January 1, 2003 for Novellus). If the final
Statement is consistent with the Companys understanding of the discussions
held through March 21, 2002, Novellus believes that assets associated with the
Companys synthetic leases would be treated as if Novellus purchased the
assets. The treatment would result in an increase to property and equipment of
approximately $464.6 million. Novellus lease receivable and cash collateral
would be returned to the Company as cash or used to offset the purchase price
of the properties. As a result of the purchase, depreciation expense would
increase by approximately $30.0 million to $35.0 million per year, and rent expense and interest
income would each decrease by approximately $15.0 million per year based on
current interest rates. For further information, see Notes to the Consolidated
Financial Statements, Commitments.

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Euro Conversion

Effective January 1, 2002, several member countries of the European Union
adopted the Euro as their new common legal currency. The introduction and use
of the Euro has not had a material effect on Novellus foreign exchange and
hedging activities or overall foreign currency risk, and the Company does not
presently expect that it will. While the Company will continue to evaluate the
impact of the Euro over time, based on currently available information,
Novellus does not believe that the use of the Euro currency will have a
material adverse impact on the Companys consolidated business, financial
position, or results of operations.

Liquidity and Capital Resources

Novellus has historically financed its operating and capital resource
requirements through cash flows from operations, sales of equity securities,
and borrowings. Novellus primary source of funds at December 31, 2001
consisted of $921.8 million of cash, cash equivalents, and short-term
investments. This amount represents a decrease of $297.8 million from the
December 31, 2000 balance of $1,219.7 million. The decrease is primarily
attributable to Novellus decision to participate in certain of its operating
leases. Novellus participation in its operating leases is further discussed
below.

Net cash provided by operating activities during the year ended December 31,
2001 was $77.1 million. This amount consisted primarily of net income of
$144.5 million and a decrease in accounts receivable of $167.7 million,
partially offset by a decrease in deferred profit of $153.1 million and an
increase in prepaids and other current assets of $66.5 million. The decreases
in accounts receivable and deferred profit were the result of decreased net
sales volume.

Net cash used in investing activities was $1,026.7 million during the year
ended December 31, 2001. During this period, Novellus cash outflows consisted
primarily of $942.4 million in net purchases of restricted investments, an
issuance of a $244.7 million lease receivable in order for the Company to
participate in its operating leases, and $80.0 million in capital expenditures.
These cash outflows were offset by net sales and maturities of
available-for-sale securities of $247.8 million.

At December 31, 2001, Novellus does not have any significant property and
equipment commitments. The Company will continue to participate in
its synthetic leases in 2002 and believes the obligations under the
agreements will result in an additional cash outlay of approximately
$90.0 million. See further discussion below.

During the year ended December 31, 2001, net cash provided by financing
activities was $910.8 million due primarily to $862.4 million in net proceeds
from the issuance of the Liquid Yield Option Notes (LYONs) and $45.5
million from common stock option exercises and purchases of common stock under
Novellus employee stock purchase plans.

The following is a table summarizing Novellus significant commitments as of
December 31, 2001 (in thousands):

|                                    |  |              |         |                  |  |                       |         |             |  |              |        |  |  |   |        |  |  |   |     | 
|----------------------------------- |  | ------------ | ------- | ---------------- |  | --------------------- | ------- | ----------- |  | ------------ | ------ |  |  | - | ------ |  |  | - | --- | 
|                                    |  |              |         |                  |  | Commitment Expiration
|                                    |  | Total Amount |         |                 
|                                    |  | Committed    |         | Less than 1 year |  | 1 - 3 years           |         | 3 - 5 years |  | Over 5 years
|                                    |  |              |         |                  |  |                       |         |             |  |             
|Operating leases                    |  | $            | 35,739  |                  |  | $                     | 7,979   |             |  | $            | 15,210 |  |  | $ | 12,447 |  |  | $ | 103 | 
|Lines of credit                     |  |              | 26,179  |                  |  |                       | 26,179  |             |  |              |       |  |  |   |       |  |  |   |    | 
|Convertible subordinated debentures |  |              | 880,000 |                  |  |                       | 880,000 |             |  |              |       |  |  |   |       |  |  |   |    | 
|                                    |  |              |         |                  |  |                       |         |             |  |              |        |  |  |   |        |  |  |   |     | 
|                                    |  | $            | 941,918 |                  |  | $                     | 914,158 |             |  | $            | 15,210 |  |  | $ | 12,447 |  |  | $ | 103 | 
|                                    |  |              |         |                  |  |                       |         |             |  |              |        |  |  |   |        |  |  |   |     | 

Novellus leases nearly all of its facilities under operating leases, including
synthetic leases, which expire at various dates through 2010. A synthetic
lease is a form of operating lease wherein a third party lessor funds 100% of
the acquisition and construction costs relating to one or more properties to be
leased to a lessee. The lessor is the owner of the leased property and must
provide at least 3% of the required funds in the form of at-risk equity. The
lessor generally borrows the balance of the funds necessary to fund the
acquisition and construction. Under certain of Novellus synthetic lease
agreements, the Company is obligated to lend approximately 87% of the cost of
the leased asset to the lessor upon completion of construction. The leases
with this requirement are known as defeased or self-funded transactions.
Additionally, Novellus synthetic leases require the Company to maintain
collateral for the benefit of the lessor.

The San Jose lease agreement covers 13 properties including land located in and
around San Jose, California, including manufacturing, research and development,
and administrative facilities, as well as Novellus corporate headquarters.
The lease has a term of five years beginning in September 2001 and includes
properties which had a total aggregate fair value of
approximately $294.6 million in September 2001, assuming full completion. The
lease agreement requires the lessor to

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provide 3% at-risk equity throughout the
term of the lease. Approximately 97% of the lessors financing was in the form
of debt, including $244.7 million which was loaned by Novellus. The Companys
receivable from the lessor is included in notes receivable in the accompanying
consolidated balance sheet. Novellus has also provided $47.8 million in
collateral to cover the remainder of the lessors financing. Of this amount,
$13.5 million is held by the lessor and $34.3 million is held by a collateral agent unrelated to the
lessor.

Under the lease agreement, Novellus has the right to purchase the properties at
any time prior to the expiration date of the lease for an amount that equals
the total lease financing amount plus any current rent due and payable. At the
end of the lease term, Novellus may renew the lease for up to three additional
years (with the lessor's consent), refinance the lease, purchase the properties under a purchase option, or
arrange to sell the properties to a third party. If Novellus chooses the sale
option, it will be obligated to the lessor under a residual value guarantee for
market value declines in the value of the facility as of the date of the sale.
The aggregate residual value guarantee related to the San Jose properties is
approximately $259.4 million, assuming full completion. At December 31, 2001,
the residual value guarantee represents an off-balance sheet contingent
liability, for which Novellus does not believe that it has any significant
exposure.

Rent payments under the lease agreement are based on the net outstanding lease
balance which includes the cost of the leased properties less the amount
defeased by the Company multiplied by the London Interbank Offer Rate (LIBOR)
plus an applicable margin. As of December 31, 2001, the net outstanding lease
balance and the amount defeased by Novellus was $278.9 million and $244.7
million respectively. Rent expense and interest income on the defeased portion
of the lease balance include $2.7 million of imputed interest at a rate of 3%
to 4% for the period from lease inception to December 31, 2001. Novellus
lease receivable from the lessor is non-interest bearing and is
repayable in full only
if the Company chooses the sale option at the end of the lease term and
successfully sells the properties for amounts in excess of the cost. Novellus
collateral is available to the lessor upon default, with certain
exceptions.

On April 18, 2001, Novellus entered into a synthetic lease agreement for the
development of a manufacturing, research and development, and administrative
facility to be constructed on 23 acres of land owned by Novellus in Tualatin,
Oregon. The land has been leased to the lessor for 50 years. Under the
Tualatin agreement, the lessor has agreed to finance a maximum of $170.0
million to develop the facility. During the construction phase, the costs of
construction, including the interest on outstanding lease balances are
capitalized into the financing facility. Novellus is required to provide
treasury bills as collateral equal to 111% of the outstanding lease balance as
security for its obligations under the lease. At December 31, 2001, collateral
of $82.1 million was held by the lessor. The collateral is interest bearing at
a market rate of interest, which was 2.27% at December 31, 2001. The lessors
ability to take possession of the collateral, which is on deposit with a third
party custodian, is subject to provisions in the lease.

Upon completion of construction, the Company is obligated to defease 86% of the
outstanding lease balance in the form of a non-interest bearing loan to the
lessor and to provide cash collateral for the remaining 14%. Both the lease
receivable and the collateral will be classified as noncurrent assets. Rent
payments, based on the net outstanding lease balance are expected to begin in
May 2002 upon completion of construction. Rent expense and interest income
will be imputed on the defeased portion of the lease.

Novellus has the right to purchase the property at any time prior to the
expiration date of the lease for an amount that equals the total lease
financing amount plus any current rent amount due and payable. At the end of
the five-year lease term, Novellus may renew the lease for up to three
additional years (with the lessor's consent), purchase the property under its purchase option for an amount
equal to the total lease financing amount, or arrange to sell the property to a
third party. If Novellus chooses the sale option, it will be obligated to the
lessor under a residual value guarantee for market value declines in the value
of the property as of the date of sale of up to $146.2 million. During
construction, Novellus maximum obligation to the lessor is generally limited
to 89.9% of the construction costs incurred to date.

If the Company purchases the San Jose and Tualatin facilities at the end of the
lease term or due to default, the purchase transactions would increase property
and equipment by approximately $464.6 million. Novellus lease receivable
would be returned to the Company as cash or used to offset the purchase price
of the properties. As a result of the purchase, depreciation expense would
increase by approximately $30.0 million to $35.0 million per year, and rent expense and interest
income would
each decrease by approximately $15.0 million per year based on current interest
rates. If, at the end of the lease term or due

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to default, the Company
purchases the properties, the Company believes there would be no material
impact on its liquidity as the cash paid to purchase the properties would be
offset by the lease receivable and collateral associated with Novellus
participation in these leases.

The synthetic lease agreements contain certain restrictive covenants, which
include quick ratio and tangible net worth tests. The Company was in
compliance with these covenants at December 31, 2001. If the Company did not
comply with these covenants, the lessor could potentially terminate the leases,
resulting in an acceleration of the sale or purchase options.

Novellus intention is to refinance and continue to defease its existing
synthetic leases at the end of the lease terms. For further discussion, see
Notes to Consolidated Financial Statements, Commitments.

Novellus has lines of credit with four Japanese banks, which expire at various
dates through May 2002, under which the Company can borrow up to $33.3 million
at the banks prime rates (ranging from 0.48% to 0.85% at December 31, 2001).
These facilities are available to Novellus Japanese subsidiary, Novellus
Systems Japan. At December 31, 2001, $26.2 million was outstanding under these
bank lines of credit. During the second quarter of 1997, Novellus entered into
a five-year $125.0 million Senior Credit Facility structured as an unsecured
revolving credit line. Novellus cancelled the Senior Credit Facility on June
8, 2001.

On July 26, 2001, Novellus issued $880.0 million of Liquid Yield Option Notes
(LYONs) due July 26, 2031. The net proceeds after issuance costs (which will
be amortized over 30 years) from the LYONs offering were $862.4 million. The
LYONs are zero coupon, zero-yield subordinated debentures that may be converted
into shares of Novellus common stock, subject to specified conditions as set
forth in the indenture. The LYONs are convertible into 13.09504 shares of
Novellus common stock per $1,000 LYON, or 11.5 million shares and 8.0% of all
outstanding shares as of December 31, 2001 if (1) the sales price of Novellus
common stock reaches a specified threshold, (2) the LYONs are called for
redemption, or (3) specified corporate transactions have occurred, subject to
antidilutive adjustments.

On July 26, 2002, the security holders have the option to deliver the LYONs to
Novellus and require the Company to repurchase the LYONs for $1,000 in cash
each, up to a maximum of $880.0 million for all outstanding LYONs.
Additionally, security holders also have the option to require the Company to
repurchase the LYONs on July 26, 2006, 2011, 2016, 2021, and 2026. On those
repurchase dates in 2006 and thereafter, Novellus has the ability to determine
whether the repurchase of the LYONs will be for cash or common stock or a
combination of cash and common stock.

Novellus deposited U.S. treasury securities into a pledge account to secure
Novellus obligations under the LYONs until July 26, 2002. These securities
are reflected on Novellus balance sheet as restricted short-term investments.
At December 31, 2001, restricted short-term investments related
to this obligation were approximately
$866.0 million to secure the obligations under the LYONs on July 26, 2002. If
on July 26, 2002, the LYONs are delivered to Novellus, the $866.0 million could
be used to repurchase the LYONs and any remaining unamortized issuance costs,
approximately $17.0 million as of July 26, 2002, would be written off as
other expense. Upon expiration of the obligations under the pledge account,
Novellus intends to use the net proceeds of the offering, if any, for general
corporate purposes. Additionally, Novellus has the option of redeeming the
LYONs on July 26, 2006, 2011, 2016, 2021, and 2026 for cash or common stock or a combination of
cash and common stock. For further discussion, see Notes to Consolidated
Financial Statements, Convertible Subordinated Debentures.

Novellus believes that its current cash position, cash generated through
operations and equity offerings, and available borrowings will be sufficient to
meet the Companys needs through at least the next twelve months.

Trends, Risks, and Uncertainties

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

Market Risk and Cyclical Downturns in the Semiconductor Industry. Novellus
business depends predominantly on capital expenditures of semiconductor
manufacturers, which in turn depends on the current and anticipated market
demand for integrated circuits and products utilizing integrated circuits. The
semiconductor industry has historically been very cyclical and has experienced
periodic downturns, which have had a material adverse effect on the
semiconductor industrys demand
for semiconductor processing equipment, including equipment manufactured and
marketed by Novellus. During periods of

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reduced and declining demand, Novellus
must be able to quickly and effectively align its cost structure with
prevailing market conditions, and motivate and retain key employees. During
periods of rapid growth, Novellus must be able to acquire and/or develop
sufficient manufacturing capacity to meet customer demand, and hire and
assimilate a sufficient number of qualified people. No assurance can be given
that Novellus net sales and operating results will not be adversely affected
if this current downturn in the semiconductor industry continues or other
downturns or slowdowns in the rate of capital investment in the semiconductor
industry occur in the future.

Demand Shifts in the PC Industry.In the PC market, a shift in demand from
more expensive, high-performance products to lower-priced products (sub-$1,000
PCs) has resulted in reduced profitability for semiconductor manufacturers.
Strengthening demand for sub-$1,000 PCs could cause further delays or decreased
demand for Novellus products.

Intense Competition in the Semiconductor Equipment Industry. The semiconductor
equipment industry is highly competitive. Novellus faces substantial
competition in the markets in which it competes from both established
competitors and potential new entrants. Certain of Novellus competitors have
greater financial, marketing, technical or other resources, broader product
lines, greater customer service capabilities and larger and more established
sales organizations and customer bases than Novellus. Novellus may also face
future competition from new market entrants from overseas and domestic sources.
Novellus expects its competitors to continue to improve the design and
performance of their products. There can be no assurance that Novellus
competitors will not develop enhancements to or future generations of
competitive products that will offer superior price or performance features
over Novellus products, and there can be no assurance that Novellus will be
successful, or as successful as its competitors, in selecting, developing,
manufacturing, and marketing its new products, or enhancing its existing
products. Failure to successfully develop new products could materially
adversely affect Novellus revenues, financial condition, and results of
operations. In addition, a substantial investment is required by Novellus
customers to install and integrate capital equipment into a semiconductor
production line. As a result, once a semiconductor manufacturer has selected
another vendors capital equipment, Novellus believes that the manufacturer
will be generally reliant upon that equipment vendor for the specific
production line application. Accordingly, Novellus may experience difficulty
in selling a product to a particular customer for a significant period of time
if that customer first selects a competitors product. Increased competitive
pressure could lead to lower prices for Novellus products, thereby adversely
affecting Novellus revenue and operating results. There can be no assurance
that Novellus will be able to compete successfully against established
competitors and new entrants in the future.

International Operations. Export sales accounted for approximately 55%, 63%,
and 62%, of net sales in 2001, 2000, and 1999, respectively. Novellus
anticipates that export sales will account for a significant portion of net
sales in the foreseeable future. As a result, a significant portion of
Novellus sales will be subject to certain risks, including tariffs and other
barriers, difficulties in staffing and managing foreign subsidiary operations,
difficulties in managing distributors, potentially adverse tax consequences and
the possibility of difficulty in accounts receivable collection. Novellus is
also subject to the risks associated with the imposition of legislation and
regulations relating to the import or export of semiconductor products.
Novellus cannot predict whether quotas, duties, taxes, or other charges or
restrictions will be implemented by the United States or any other country upon
the importation or exportation of Novellus products in the future. There can
be no assurance that any of these factors or the adoption of restrictive
policies will not have a material adverse effect on Novellus business,
financial condition, or results of operations. Moreover, each region in the
global semiconductor equipment market exhibits unique characteristics that can
cause capital equipment investment patterns to vary significantly from period
to period. Although international markets provide Novellus with significant
growth opportunities, periodic economic downturns, trade balance issues,
political instability and fluctuations in interest and foreign currency
exchange rates are all risks that could materially and adversely affect global
products and service demand, and, therefore, Novellus business operations and
financial condition. Asian countries, particularly Japan and Korea, are
affected by banking, currency and other difficulties that contribute to the
economic developments in those countries. Novellus derives a substantial
portion of its revenues from customers in Asian countries, particularly Japan
and Korea. Economic developments in late 1997 and early 1998 resulted in
decreased capital investments by Asian customers. Recent economic developments
indicate that the economies of Japan, Korea, and other Asian countries have
recovered somewhat from 1997 and 1998 levels. Any negative economic
developments or delays in the economic recovery of Asian countries could result
in the cancellation or delay of orders for Novellus products from Asian
customers, thus materially adversely affecting Novellus business, financial
condition or results of operations. In addition to the concerns described
above, sales of systems shipped by Novellus Japanese subsidiary are
denominated in Japanese Yen. Novellus sells the systems to its Japanese
subsidiary in U.S. Dollars. Novellus then enters into forward foreign exchange
contracts to hedge against the short-term impact of foreign currency
fluctuations of intercompany accounts payable denominated in U.S. Dollars
recorded by the Japanese subsidiary in order to

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manage this exposure. However, there can be no assurance that future changes
in the Japanese Yen will not have a material effect on Novellus business,
financial condition, or results of operations.

Possible Volatility of Stock Price.The price of Novellus common stock may be
subject to wide fluctuations and possible rapid increases or declines in a
short time period. These fluctuations may be due to factors specific to the
Company such as variations in quarterly operating results or changes in
analysts earnings estimates, or to factors relating to the semiconductor
industry or to the securities markets in general, which, in recent years, have
experienced significant price fluctuations. These fluctuations often have been
unrelated to the operating performance of the specific companies whose stocks
are traded. Shareholders should be willing to incur the risk of such
fluctuations. Sales of substantial amounts of common stock in the public
market after any offering of Novellus securities could adversely affect the
market price of the outstanding common stock. Additionally, the price of
Novellus stock could be adversely affected if Novellus is required to redeem
the LYONs using its common stock. Under certain circumstances, including a
change of control in Novellus or an increase in Novellus stock price, the
holders of the LYONs may surrender their LYONs to Novellus for conversion into
the Companys common stock. The LYONs are convertible into 13.09504 shares of
Novellus stock per each $1,000 LYON, or a total of 11.5 million shares and
8.0% of all outstanding shares of Novellus common stock as of December 31,
2001. For further discussion, see Notes to Consolidated Financial Statements,
Convertible Subordinated Debentures. Shareholders should be willing to incur
the risk of such fluctuations in the price of Novellus common stock.

Variability of Quarterly Operating Results.If Novellus operating results are
below the expectations of public market analysts or investors, then the market
price of its common stock could decline. Novellus has experienced and expects
to continue to experience significant fluctuations in its quarterly operating
results. During each quarter, Novellus customarily sells a relatively small
number of systems that typically sell for prices in excess of $1 million.
Novellus backlog at the beginning of each quarter does not necessarily include
all system sales needed to achieve expected net sales for that quarter.
Consequently, Novellus is often dependent on obtaining orders for shipment in
the same quarter that the order is received. Because Novellus builds its
systems according to forecast, the absence of significant backlog for an
extended period of time could hinder Novellus ability to plan production and
inventory levels, which could adversely affect operating results. Novellus
net sales and operating results could also be adversely affected for a
particular quarter if an anticipated order for even a few systems is not
received in time to permit shipment during that quarter. Moreover, customers
may reschedule or cancel shipments, with, in the case of cancellations, little
or no penalties, and production difficulties could delay shipments. A delay in
a shipment in any quarter, due, for example, to an unanticipated shipment
rescheduling, to cancellations by customers or to unexpected manufacturing
difficulties experienced by Novellus may cause net sales in such quarter to
fall significantly below expectations and may materially adversely affect
Novellus operating results for such quarter. The timing of new product
announcements and releases by Novellus may also contribute to fluctuations in
quarterly operating results, particularly in cases where new product offerings
cause customers to defer ordering products from Novellus existing product
lines. Novellus results of operations also could be affected by new product
announcements and releases by Novellus competitors, the volume, mix and timing
of orders received during a period, availability and pricing of key components,
fluctuations in foreign exchange rates, and conditions in the semiconductor
equipment industry. Novellus operating results also fluctuate based on gross
profit realized on system sales. Gross profit as a percentage of net sales may
vary based on a variety of factors, including the mix and average selling
prices of products sold and costs to manufacture upgrades and customize
systems. Because Novellus operating expenses are based on anticipated net
sales levels, and a high percentage of those expenses are relatively fixed, a
variation in the timing of recognition of net sales and the level of gross
profit from a single transaction can cause material variations in operating
results from quarter to quarter.

Benefits of Novellus Acquisition of GaSonics May Not Be Realized.The
integration of Novellus and GaSonics is not fully complete and continues to be
a complex, time consuming, and expensive process. The challenges involved in
this integration include the following: satisfying the needs of the combined
companys customers in a timely and efficient manner and maintaining GaSonics
and Novellus key customer relationships; persuading employees that Novellus
and GaSonics business cultures are compatible and retaining the combined
companys key management, marketing, customer support, and technical personnel;
maintaining managements ability to focus on anticipating, responding to or
utilizing changing technologies in the semiconductor industry; combining
GaSonics product offerings and technologies with Novellus product offerings
and technologies effectively and quickly and coordinating research and
development activities to enhance introduction of new products and
technologies; maintaining GaSonics key supplier relationships; and
the introduction of new technologies by competitors to the marketplace which reduce
GaSonics market share prior to the successful integration of the two
companies. It is not certain that Novellus and GaSonics can be successfully
integrated in a timely manner or at all or that any of the anticipated benefits
will be realized. Failure to do so could materially harm the business and
operating results of the combined company. Also, neither Novellus nor GaSonics
can assure you that the growth rate of the combined company

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will equal the historical growth rates experienced by Novellus and GaSonics.
Novellus and GaSonics employees may experience uncertainty about their future
role with the combined company until or after strategies with regard to the
combined company are announced or executed. This may adversely affect the
combined companys ability to attract and retain key management, marketing,
sales, customer support, and technical personnel, which could harm the combined
company. The combined entity incurred merger costs related to the acquisition
in the amount of $13.2 million during the year ended December 31, 2001, which
included professional fees, financial printing, and other related costs, as
well as charges related to the cancellation of various contracts and the
write-off of certain redundant assets. There is no assurance that the combined
company will not incur additional material charges in subsequent quarters to
reflect additional costs associated with the merger.

A Large Portion of Novellus Net Sales Is Derived From Sales to A Few
Customers.Historically, Novellus has sold a significant proportion of its
systems in any particular period to a limited number of customers. Sales to
Novellus ten largest customers in 2001, 2000, and 1999 accounted for 61%, 71%,
and 71% of net sales, respectively. Novellus expects that sales of its
products to relatively few customers will continue to account for a high
percentage of its net sales in the foreseeable future. None of Novellus
customers have entered into a long-term agreement requiring them to purchase
Novellus products. Novellus believes that sales to certain of its customers
will decrease in the near future as those customers complete current purchasing
requirements for new or expanded fabrication facilities. Although the
composition of the group comprising Novellus largest customers has varied from
year to year, the loss of a significant customer or any reduction in orders
from any significant customer, including reductions due to customer departures
from recent buying patterns, market, economic or competitive conditions in the
semiconductor industry or in the industries that manufacture products utilizing
integrated circuits, could adversely affect Novellus business, financial
condition and results of operations. In addition, sales of Novellus systems
depend in significant part upon the decision of a prospective customer to
increase manufacturing capacity or to expand current manufacturing capacity,
both of which typically involve a significant capital commitment. Novellus has
from time to time experienced delays in finalizing system sales following
initial system qualification. Due to these and other factors, Novellus
systems typically have a lengthy sales cycle during which Novellus may expend
substantial funds and management effort with no guarantee that Novellus will
sell a particular system.

Novellus Industry Is Characterized By
Rapidly Changing Technology. The
semiconductor manufacturing industry is subject to rapid technological change
and new product introductions and enhancements. Novellus ability to remain
competitive in this market depends in part upon Novellus ability to develop
new and enhanced systems and to introduce these systems at competitive prices
and on a timely and cost-effective basis. Accordingly, Novellus devotes a
significant portion of its personnel and financial resources to research and
development programs and seek to maintain close relationships with its
customers to remain responsive to their product needs. Novellus current
research and development efforts are directed at the development of new systems and
processes and improving existing system capabilities. Novellus is focusing its
research and development efforts on additional Concept Two modules, advanced
PVD systems, advanced gap fill technology, primary conductor metals, low-K
dielectric materials and additional advanced technologies for the next
generation of smaller geometry fabrication lines, as well as equipment to
process 300mm wafers. There is no assurance that Novellus research and
development programs will allow Novellus to remain responsive to its customers product
needs or that Novellus current or new customers will buy its new products.

Research and Development Expenditures Represent a Substantial Portion of
Novellus Net Sales. Novellus expenditures for research and development
during 2001, 2000, and 1999 were $272.0 million, $198.3 million, and $129.1
million respectively, or approximately 20%, 15%, and 20% of net sales.
Novellus expects in future years that research and development expenditures
will continue to represent a substantial percentage of its net sales.
Novellus success in developing, introducing and selling new and enhanced
systems depends upon a variety of factors, including product selection, timely
and efficient completion of product design and development, timely and
efficient implementation of manufacturing and assembly processes, product
performance in the field and effective sales and marketing. There can be no
assurance that Novellus will be successful in selecting, developing,
manufacturing and marketing new products or in enhancing its existing products.
As is typical in the semiconductor capital equipment market, Novellus has
experienced delays from time to time in the introduction of, and certain
technical and manufacturing difficulties with, certain of its systems and
enhancements and may experience delays and technical and manufacturing
difficulties in future introductions or volume production of new systems or
enhancements. Novellus inability to complete the development or meet the
technical specifications of any of its new systems or enhancements or to
manufacture and ship these systems or enhancements in volume in a timely manner
would materially adversely affect Novellus business, financial condition and
results of operations. In addition, Novellus may incur substantial
unanticipated costs to ensure the functionality and reliability of its future
product introductions early in the products life cycle. If new products have
reliability or quality problems, reduced orders or higher manufacturing costs,
delays in collecting

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accounts receivable and additional service and warranty expense may result.
Any of these events could materially adversely affect Novellus business,
financial condition, and results of operations.

Novellus Intellectual Property Is Critical To The Success Of Its Business.
Novellus intends to continue to pursue the legal protection of its technology
primarily through patent and trade secret protection. Novellus currently holds
over 100 patents and intends to file additional patent applications as
appropriate. There can be no assurance that patents will be issued from any of
these pending applications or that any claims allowed from existing or pending
patents will be sufficiently broad to protect Novellus technology. While
Novellus intends to protect its intellectual property rights vigorously, there
can be no assurance that any patents held by Novellus will not be challenged,
invalidated or circumvented, or that the rights granted thereunder will provide
competitive advantages to Novellus. Novellus also relies on trade secrets and
proprietary technology that it seeks to protect, in part, through Novellus
confidentiality agreements with employees, consultants and other parties.
There can be no assurance that these agreements will not be breached, that
Novellus will have adequate remedies for any breach, or that Novellus trade
secrets will not otherwise become known to or independently developed by
others. There has also been substantial litigation regarding patent and other
intellectual property rights in semiconductor related industries. Novellus is
currently involved in such litigation (see Item 3. Legal Proceedings). Except
as set forth in Item 3. Legal
Proceedings, Novellus is not aware of any
significant claim of infringement by Novellus products of any patent or
proprietary rights of others, however, Novellus could become involved in
additional litigation in the future. Although Novellus does not believe the
outcome of the current litigation will have a material impact on its business,
financial condition, or results of operations, no assurances can be given that
this litigation or future litigation will not have such an impact. In addition
to the current litigation, Novellus operations, including the further
commercialization of Novellus products, could provoke additional claims of
infringement from third parties. In the future, litigation may be necessary to
enforce patents issued to Novellus, to protect trade secrets or know-how owned
by Novellus or to defend Novellus against claimed infringement of the rights of
others and to determine the scope and validity of the proprietary rights of
others. Any such litigation could result in substantial cost and diversion of
effort by Novellus, which by itself could have a material adverse effect on
Novellus financial condition and operating results. Further, adverse
determinations in such litigation could result in Novellus loss of proprietary
rights, subject Novellus to significant liabilities to third parties, require
Novellus to seek licenses from third parties or prevent Novellus from
manufacturing or selling its products, any of which could have a material
adverse effect on Novellus business, financial condition and results of
operations.

Novellus Is Susceptible To Supply Shortages. Novellus uses numerous suppliers
to supply parts, components, and sub-assemblies for the manufacture and support
of its products. Although Novellus makes reasonable efforts to ensure that
such parts are available from multiple suppliers, this is not always possible.
Accordingly, Novellus obtains certain key parts from a single supplier or a
limited group of suppliers. These suppliers are, in some cases, thinly
capitalized, independent companies that generate significant portions of their
business from Novellus and/or a small group of other companies in the
semiconductor industry. Although Novellus seeks to reduce its dependence on
these limited source suppliers, disruption or termination of certain of these
sources could occur and such disruptions could have at least a temporary
adverse effect on Novellus operations. Moreover, a prolonged inability to
obtain certain components could have a material adverse effect on Novellus
business, financial condition, and results of operations and could result in
damage to its customer relationships.

Concentration of Credit Risk.Novellus uses financial instruments that
potentially subject it to concentrations of credit risk. Such instruments
include cash equivalents, short-term investments, accounts receivable, and
financial instruments used in hedging activities. The Company invests its cash
in cash deposits, money market funds, commercial paper, certificates of
deposit, readily marketable debt securities, or medium-term notes. The Company
places its investments with high-credit-quality financial institutions and
limits the credit exposure from any one financial institution or instrument.
To date, Novellus has not experienced material losses on these investments.
Novellus performs ongoing credit evaluations of its customers financial
condition and generally requires no collateral. The Company has an exposure to
nonperformance by counterparties on the foreign exchange contracts used in
hedging activities. These counterparties are large international financial
institutions and to date, no such counterparty has failed to meet its financial
obligations to Novellus. Novellus does not believe there is a significant risk
of nonperformance by these counterparties because the Company continuously
monitors its positions and the credit ratings of such counterparties and the
amount of contracts it enters into with any one party. However, there can be
no assurance that there will be no significant nonperformance by these
counterparties and that this would not materially adversely affect Novellus
business, financial condition, and results of operations.

Recent Accounting Pronouncements May Impact Novellus Financial Position and
Results of Operations.Novellus must adopt the following recent changes in
financial accounting standards. In June 2001, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standards No.
141 (SFAS 141), Business Combinations. In

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June 2001, the FASB issued SFAS 142, Goodwill and Other Intangible Assets.
In August 2001, the FASB issued SFAS 144, Impairment or Disposal of Long-Lived
Assets, which is effective for fiscal years beginning after December 15, 2001.
The Company does not expect the adoption of SFAS 141, the performance of the
first of the required impairment tests of goodwill and indefinite lived
intangible assets under SFAS 142, or the adoption of SFAS 144 to have a
material effect on its financial condition or results of operations. In July
2001, the FASB issued SFAS 143, Accounting for Asset Retirement Obligations.
The Company is currently assessing the impact of this new
standard, however, Novellus does not expect the effect of these tests
to be material to its
financial condition or results of operations. On February 27, 2002, the FASB
met and discussed changes to their consolidations project that could
substantially change the accounting for synthetic leases. If these changes are
enacted, Novellus may be required to treat the assets subject to the synthetic
leases as purchased assets. For a further discussion of how these recent
accounting pronouncements may affect Novellus, please see Item 7, Managements
Discussion and Analysis and the Notes to the Consolidated Financial Statements.
There can be no assurances that the issuance by FASB of additional statements
of financial accounting standards would not materially adversely affect
Novellus business, financial condition, and results of operations if such are
required to be adopted by Novellus in the future.

Euro Conversion.On January 1, 1999, 11 member countries of the European Union
established fixed conversion rates between their existing sovereign legacy
currencies, and adopted the Euro as their new common legal currency. As of
that date, the Euro began trading on currency exchanges while the legacy
currencies remained legal tender in the participating countries for a
transition period between January 1, 1999 and January 1, 2002. As of January
1, 2002, the transition to the Euro was completed. Novellus maintains
operations within the European Union and prepared for the Euro conversion and
the costs associated with the transition were not material. Based on current
information, Novellus does not believe that the Euro conversion will have a
material adverse effect on the Companys business, financial condition, or
results of operations.

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk.Novellus exposure to market risk for changes in interest
rates relates primarily to the Companys investment portfolio and short-term
debt obligations. Novellus does not use derivative financial instruments in
its investment portfolio. The Company places its investments with high credit
quality issuers and, by policy, limits the amount of credit exposure to any one
issuer. Novellus does not have any interest rate exposure related to the LYON
debt as the debt is zero-coupon and was issued at par. The Company recognizes
a small amount of interest expense due to the amortization of issuance costs.

Novellus mitigates default risk by investing in only the safest and highest
credit quality securities and by monitoring the credit rating of investment
issuers. The portfolio includes only marketable securities with active
secondary or resale markets to ensure portfolio liquidity.

Novellus has no material cash flow exposure due to rate changes for cash
equivalents and short-term investments. Novellus short-term borrowing is at a
fixed interest rate. Short-term borrowing is used by Novellus Japanese
subsidiary for general corporate purposes, including capital expenditures and
working capital needs.

The table below presents principal amounts and related weighted
interest rates by year of maturity for Novellus investment portfolio and debt
obligations and the fair value of each as of December 31, 2001 and 2000.

|                            |                       |      |           |      |   |      |       |      |   |      |   |            |  |       |   |      |  |  |   |   |  |  |   |   |  |   |           |      |   |   |              |  | 
|--------------------------- | --------------------- | ---- | --------- | ---- | - | ---- | ----- | ---- | - | ---- | - | ---------- |  | ----- | - | ---- |  |  | - | - |  |  | - | - |  | - | --------- | ---- | - | - | ------------ |  | 
|                            |                       |      |           |      |   |      |       |      |   |      |   |            |  |       |   |      |  |  |   |   |  |  |   |   |  |   |           |      |   |   | Fair Value  
|                            |                       |      |           |      |   |      |       |      |   |      |   |            |  |       |   |      |  |  |   |   |  |  |   |   |  |   |           |      |   |   | December 31,
|In thousands                |                       | 2002 |           | 2003 |   | 2004 |       | 2005 |   | 2006 |   | Thereafter |  | Total |   | 2001
|                            |                       |      |           |      |   |      |       |      |   |      |   |            |  |       |   |     
|Assets                      |                       |      |           |      |   |      |       |      |   |      |   |            |  |       |   |      |  |  |   |   |  |  |   |   |  |   |           |      |   |   |              | 
|Cash equivalents            |                       | $    | 550,640   |      |   |      |      |      |   |      |  |            |  |       |  |      |  |  |  |   |  |  |  |   |  | $ | 550,640   |      |   | $ | 550,640      | 
|                            | Average interest rate |      |           | 1.96 | % |      |       |     |   |      |   |           |  |       |   |     |  |  |   |  |  |  |   |  |  |   |           | 1.96 | % |   |              |  | 
|Short-term investments      |                       | $    | 364,716   |      |   | $    | 6,466 |      |   |      |  |            |  |       |  |      |  |  |  |   |  |  |  |   |  | $ | 371,182   |      |   | $ | 371,182      | 
|                            | Average interest rate |      |           | 3.28 | % |      |       | 4.84 | % |      |   |           |  |       |   |     |  |  |   |  |  |  |   |  |  |   |           | 3.31 | % |   |              |  | 
|Restricted investments      |                       | $    | 961,643   |      |   |      |      |      |   |      |  |            |  |       |  |      |  |  |  |   |  |  |  |   |  | $ | 961,643   |      |   | $ | 961,643      | 
|                            | Average interest rate |      |           | 3.34 | % |      |       |     |   |      |   |           |  |       |   |     |  |  |   |  |  |  |   |  |  |   |           | 3.34 | % |   |              |  | 
|Total investment
securities |                       | $    | 1,876,999 |      |   | $    | 6,466 |      |   |      |  |            |  |       |  |      |  |  |  |   |  |  |  |   |  | $ | 1,883,465 |      |   | $ | 1,883,465    | 
|                            | Average interest rate |      |           | 2.93 | % |      |       | 4.84 | % |      |   |           |  |       |   |     |  |  |   |  |  |  |   |  |  |   |           | 2.94 | % |   |              |  | 
|Short-term borrowing        |                       | $    | 26,179    |      |   |      |      |      |   |      |  |            |  |       |  |      |  |  |  |   |  |  |  |   |  | $ | 26,179    |      |   | $ | 26,179       | 
|                            | Average interest rate |      |           | 0.62 | % |      |       |     |   |      |   |           |  |       |   |     |  |  |   |  |  |  |   |  |  |   |           | 0.62 | % |   |              |  | 
|Convertible debentures      |                       | $    | 880,000   |      |   |      |      |      |   |      |  |            |  |       |  |      |  |  |  |   |  |  |  |   |  | $ | 880,000   |      |   | $ | 876,700      | 
|                            | Average interest rate |      |           | 0.00 | % |      |       |     |   |      |   |           |  |       |   |     |  |  |   |  |  |  |   |  |  |   |           | 0.00 | % |   |              |  | 

|                            |                       |      |           |      |   |      |        |      |   |      |       |            |   |       |   |      |  |  |   |   |  |  |   |   |  |   |           |      |   |   |              |  | 
|--------------------------- | --------------------- | ---- | --------- | ---- | - | ---- | ------ | ---- | - | ---- | ----- | ---------- | - | ----- | - | ---- |  |  | - | - |  |  | - | - |  | - | --------- | ---- | - | - | ------------ |  | 
|                            |                       |      |           |      |   |      |        |      |   |      |       |            |   |       |   |      |  |  |   |   |  |  |   |   |  |   |           |      |   |   | Fair Value  
|                            |                       |      |           |      |   |      |        |      |   |      |       |            |   |       |   |      |  |  |   |   |  |  |   |   |  |   |           |      |   |   | December 31,
|In thousands                |                       | 2001 |           | 2002 |   | 2003 |        | 2004 |   | 2005 |       | Thereafter |   | Total |   | 2000
|                            |                       |      |           |      |   |      |        |      |   |      |       |            |   |       |   |     
|Assets                      |                       |      |           |      |   |      |        |      |   |      |       |            |   |       |   |      |  |  |   |   |  |  |   |   |  |   |           |      |   |   |              | 
|Cash equivalents            |                       | $    | 589,415   |      |   |      |       |      |   |      |      |            |   |       |  |      |  |  |  |   |  |  |  |   |  | $ | 589,415   |      |   | $ | 589,415      | 
|                            | Average interest rate |      |           | 6.52 | % |      |        |     |   |      |       |           |   |       |   |     |  |  |   |  |  |  |   |  |  |   |           | 6.52 | % |   |              |  | 
|Short-term investments      |                       | $    | 611,515   |      |   | $    | 10,937 |      |   | $    | 7,797 |            |   |       |  |      |  |  |  |   |  |  |  |   |  | $ | 630,249   |      |   | $ | 630,249      | 
|                            | Average interest rate |      |           | 6.28 | % |      |        | 4.71 | % |      |       | 4.81       | % |       |   |     |  |  |   |  |  |  |   |  |  |   |           | 6.24 | % |   |              |  | 
|Total investment
securities |                       | $    | 1,200,930 |      |   | $    | 10,937 |      |   | $    | 7,797 |            |   |       |  |      |  |  |  |   |  |  |  |   |  | $ | 1,219,664 |      |   | $ | 1,219,664    | 
|                            | Average interest rate |      |           | 6.40 | % |      |        | 4.71 | % |      |       | 4.81       | % |       |   |     |  |  |   |  |  |  |   |  |  |   |           | 6.37 | % |   |              |  | 
|Short-term borrowing        |                       | $    | 21,602    |      |   |      |       |      |   |      |      |            |   |       |  |      |  |  |  |   |  |  |  |   |  | $ | 21,602    |      |   | $ | 21,602       | 
|                            | Average interest rate |      |           | 0.99 | % |      |        |     |   |      |       |           |   |       |   |     |  |  |   |  |  |  |   |  |  |   |           | 0.99 | % |   |              |  | 

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Novellus has operating lease agreements on several properties. The agreements
are for five years with interest rates that approximate the London Interbank
Offering Rate (LIBOR). Rent expense was approximately $16.9 million, $20.1
million, and $20.4 million for the years ended December 31, 2001, 2000, and
1999, respectively, net of sublease income of $7.2 million, $8.1 million, $3.0
million for the years then ended.

Excluded from the 2001 disclosure above is $279.0 million of collateralized
cash recorded within other assets and as a note receivable, related to
Novellus participation in its synthetic leases. This amount consists of $34.3
million in restricted investments and $244.7 million in a note receivable,
which have insignificant or no market risk. Market risk is not associated with
these instruments as interest is imputed for financial reporting and disclosure
purposes. For further discussion, see Notes to Consolidated Financial
Statements, Commitments.

Foreign Currency Risk.Novellus transacts business in various foreign
countries. Its primary foreign currency cash flows are in countries in Asia
and Europe. During 2001 and 2000, Novellus employed a foreign currency hedging
program utilizing foreign currency forward exchange contracts and certain
foreign currency denominated balance sheet positions. Under this program,
increases or decreases in currency commitments and balance sheet positions, as
translated into U.S. dollars, are primarily offset by realized gains and losses
on the hedging instruments. The goal of the hedging program is to economically
guarantee or lock in exchange rates on Novellus foreign currency cash outflows
and to minimize the impact to the Company of foreign currency fluctuations.
Novellus does not use foreign currency forward exchange contracts for
speculative or trading purposes.

All unsettled foreign currency contracts held by Novellus are marked-to-market
and realized and unrealized gains and losses are included as a component of
other income and expense. The following table provides information as of
December 31, 2001 and 2000 about Novellus derivative financial instruments,
which are comprised of foreign currency forward exchange contracts. The
information is provided in U.S. dollar equivalent amounts, as presented in
Novellus financial statements. The table presents the notional amounts (at
the contract exchange rates), the weighted-average contractual foreign currency
exchange rates, and the estimated fair value of those contracts.

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

|                                               |                  |                 |         |               |   |                   |  |          |  |   |        |        |  
|---------------------------------------------- | ---------------- | --------------- | ------- | ------------- | - | ----------------- |  | -------- |  | - | ------ | ------ | -
|December 31, 2000                              |                  | Notional Amount |         | Average       |   | Estimated Fair   
|In thousands, except for average contract rate |                  | (Buy) Sell      |         | Contract Rate |   | Value-Gain (Loss)
|                                               |                  |                 |         |               |   |                  
|Foreign currency forward exchange contracts:   |                  |                 |         |               |   |                   |  |          |  |   |        |       
|                                               | Japanese yen     |                 | $       | 149,916       |   |                   |  | 103.94   |  |   | $      | 10,827 |  
|                                               | British pound    |                 |         | (27           | ) |                   |  | 0.68     |  |   |        |       |  
|                                               | French franc     |                 |         | (275          | ) |                   |  | 7.21     |  |   |        | (6     | )
|                                               | Irish punt       |                 |         | (152          | ) |                   |  | 0.87     |  |   |        | (3     | )
|                                               | German mark      |                 |         | (28           | ) |                   |  | 2.15     |  |   |        | (1     | )
|                                               | Dutch guilder    |                 |         | (190          | ) |                   |  | 2.42     |  |   |        | (4     | )
|                                               | Singapore dollar |                 |         | (231          | ) |                   |  | 1.72     |  |   |        | (2     | )
|                                               | Taiwan dollar    |                 |         | (5,556        | ) |                   |  | 33.13    |  |   |        | 13     |  
|                                               | Korean won       |                 |         | (4,899        | ) |                   |  | 1,221.00 |  |   |        | 75     |  
|                                               |                  |                 |         |               |   |                   |  |          |  |   |        |       
|                                               |                  | $               | 138,558 |               |   |                   |  |          |  | $ | 10,899 |       
|                                               |                  |                 |         |               |   |                   |  |          |  |   |        |       

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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

|                                                                                                                            |                                     |                                                                   |                              |         |      |      |           |         |       |      |         |         |      |      | 
|--------------------------------------------------------------------------------------------------------------------------- | ----------------------------------- | ----------------------------------------------------------------- | ---------------------------- | ------- | ---- | ---- | --------- | ------- | ----- | ---- | ------- | ------- | ---- | ---- | 
|Year Ended December 31,                                                                                                     |                                     | 2001                                                              |                              | 2000    |      | 1999
|                                                                                                                            |                                     |                                                                   |                              |         |      |     
|Net sales                                                                                                                   |                                     | $                                                                 | 1,339,322                    |         |      | $    | 1,319,486 |         |       | $    | 657,021 |        
|Cost of sales                                                                                                               |                                     |                                                                   | 647,971                      |         |      |      | 588,593   |         |       |      | 305,182 |        
|                                                                                                                            |                                     |                                                                   |                              |         |      |      |           |         |       |      |         |        
|Gross profit                                                                                                                |                                     |                                                                   | 691,351                      |         |      |      | 730,893   |         |       |      | 351,839 |        
|Operating expenses:                                                                                                         |                                     |                                                                   |                              |         |      |      |           |         |       |      |         |        
|                                                                                                                            | Selling, general and administrative |                                                                   |                              | 198,567 |      |      |           | 232,749 |       |      |         | 137,363 |     
|                                                                                                                            | Research and development            |                                                                   |                              | 272,032 |      |      |           | 198,310 |       |      |         | 129,089 |     
|                                                                                                                            | Special charges                     |                                                                   |                              | 61,106  |      |      |           | 6,000   |       |      |         | 407     |     
|                                                                                                                            | Bad debt write-off                  |                                                                   |                              | 7,662   |      |      |           |        |       |      |         |        |     
|                                                                                                                            |                                     |                                                                   |                              |         |      |      |           |         |       |      |         |        
|Total operating expenses                                                                                                    |                                     |                                                                   | 539,367                      |         |      |      | 437,059   |         |       |      | 266,859 |        
|                                                                                                                            |                                     |                                                                   |                              |         |      |      |           |         |       |      |         |        
|Operating income                                                                                                            |                                     |                                                                   | 151,984                      |         |      |      | 293,834   |         |       |      | 84,980  |        
|Other income (expense)                                                                                                      |                                     |                                                                   |                              |         |      |      |           |         |       |      |         |        
|                                                                                                                            | Interest income                     |                                                                   |                              | 64,297  |      |      |           | 58,755  |       |      |         | 16,973  |     
|                                                                                                                            | Interest expense                    |                                                                   |                              | (1,146  | )    |      |           | (2,425  | )     |      |         | (1,746  | )   
|                                                                                                                            | Other, net                          |                                                                   |                              | (5,758  | )    |      |           |        |       |      |         |        |     
|                                                                                                                            |                                     |                                                                   |                              |         |      |      |           |         |       |      |         |        
|Other income, net                                                                                                           |                                     |                                                                   | 57,393                       |         |      |      | 56,330    |         |       |      | 15,227  |        
|                                                                                                                            |                                     |                                                                   |                              |         |      |      |           |         |       |      |         |        
|Income before provision for income taxes and
cumulative effect of change in accounting principle                            |                                     |                                                                   | 209,377                      |         |      |      | 350,164   |         |       |      | 100,207 |        
|Provision for income taxes                                                                                                  |                                     |                                                                   | 64,907                       |         |      |      | 110,996   |         |       |      | 31,500  |        
|                                                                                                                            |                                     |                                                                   |                              |         |      |      |           |         |       |      |         |        
|Income before cumulative effect of change in
accounting principle                                                           |                                     |                                                                   | 144,470                      |         |      |      | 239,168   |         |       |      | 68,707  |        
|Cumulative effect of change in accounting principle, net of tax                                                             |                                     |                                                                   |                             |         |      |      | (89,788   | )       |       |      |        |        
|                                                                                                                            |                                     |                                                                   |                              |         |      |      |           |         |       |      |         |        
|Net income                                                                                                                  |                                     | $                                                                 | 144,470                      |         |      | $    | 149,380   |         |       | $    | 68,707  |        
|                                                                                                                            |                                     |                                                                   |                              |         |      |      |           |         |       |      |         |        
|Net income per share:                                                                                                       |                                     |                                                                   |                              |         |      |      |           |         |       |      |         |        
|                                                                                                                            | Basic                               |                                                                   |                              |         |      |      |           |         |       |      |         |         |     
|                                                                                                                            |                                     | Income before cumulative effect of change in
accounting principle |                              | $       | 1.01 |      |           | $       | 1.76  |      |         | $       | 0.56 |     
|                                                                                                                            |                                     | Cumulative effect of change in accounting principle               |                              |         |     |      |           | $       | (0.66 | )    |         |         |     |     
|                                                                                                                            |                                     |                                                                   |                              |         |      |      |           |         |       |      |         |        
|                                                                                                                            |                                     |                                                                   | Basic net income per share   |         | $    | 1.01 |           |         | $     | 1.10 |         |         | $    | 0.56 | 
|                                                                                                                            |                                     |                                                                   |                              |         |      |      |           |         |       |      |         |        
|                                                                                                                            | Diluted                             |                                                                   |                              |         |      |      |           |         |       |      |         |         |     
|                                                                                                                            |                                     | Income before cumulative effect of change in
accounting principle |                              | $       | 0.97 |      |           | $       | 1.66  |      |         | $       | 0.54 |     
|                                                                                                                            |                                     | Cumulative effect of change in accounting principle               |                              |         |     |      |           | $       | (0.62 | )    |         |         |     |     
|                                                                                                                            |                                     |                                                                   |                              |         |      |      |           |         |       |      |         |        
|                                                                                                                            |                                     |                                                                   | Diluted net income per share |         | $    | 0.97 |           |         | $     | 1.04 |         |         | $    | 0.54 | 
|                                                                                                                            |                                     |                                                                   |                              |         |      |      |           |         |       |      |         |        
|Shares used in basic per share calculations                                                                                 |                                     |                                                                   | 142,462                      |         |      |      | 135,728   |         |       |      | 122,261 |        
|                                                                                                                            |                                     |                                                                   |                              |         |      |      |           |         |       |      |         |        
|Shares used in diluted per share calculations                                                                               |                                     |                                                                   | 148,924                      |         |      |      | 143,654   |         |       |      | 127,826 |        
|                                                                                                                            |                                     |                                                                   |                              |         |      |      |           |         |       |      |         |        
|Pro forma amounts with the change in accounting principle
related to revenue recognition applied retroactively (unaudited): |                                     |                                                                   |                              |         |      |      |           |         |       |      |         |        
|                                                                                                                            | Net revenues                        |                                                                   |                              |        |      |      |           |        |       |      | $       | 582,397 |     
|                                                                                                                            | Net income                          |                                                                   |                              |        |      |      |           |        |       |      |         | 39,550  |     
|                                                                                                                            | Net income per share:               |                                                                   |                              |         |      |      |           |         |       |      |         |         |     
|                                                                                                                            |                                     | Basic                                                             |                              |         |     |      |           |         |      |      |         | $       | 0.32 |     
|                                                                                                                            |                                     | Diluted                                                           |                              |         |     |      |           |         |      |      |         | $       | 0.31 |     

See accompanying notes.

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

|                                               |                                                                                                   |                                                                     |           |         |           |   |           |         |           | 
|---------------------------------------------- | ------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------- | --------- | ------- | --------- | - | --------- | ------- | --------- | 
|December 31,                                   |                                                                                                   | 2001                                                                |           | 2000   
|                                               |                                                                                                   |                                                                     |           |        
|Assets                                         |                                                                                                   |                                                                     |           |         |           |   |           |        
|Current assets:                                |                                                                                                   |                                                                     |           |         |           |   |           |        
|                                               | Cash and cash equivalents                                                                         |                                                                     | $         | 550,640 |           |   | $         | 589,415 |          
|                                               | Short-term investments                                                                            |                                                                     |           | 371,182 |           |   |           | 630,249 |          
|                                               | Restricted short-term investments                                                                 |                                                                     |           | 961,643 |           |   |           |        |          
|                                               | Accounts receivable, net of allowance for doubtful accounts
of $14,390 in 2001 and $5,392 in 2000 |                                                                     |           | 225,916 |           |   |           | 401,291 |          
|                                               | Inventories                                                                                       |                                                                     |           | 244,712 |           |   |           | 201,672 |          
|                                               | Deferred tax assets, net                                                                          |                                                                     |           | 82,069  |           |   |           | 137,929 |          
|                                               | Prepaid and other current assets                                                                  |                                                                     |           | 81,049  |           |   |           | 14,279  |          
|                                               |                                                                                                   |                                                                     |           |         |           |   |           |        
|Total current assets                           |                                                                                                   |                                                                     | 2,517,211 |         |           |   | 1,974,835 |        
|Property and equipment:                        |                                                                                                   |                                                                     |           |         |           |   |           |        
|                                               | Machinery and equipment                                                                           |                                                                     |           | 243,677 |           |   |           | 212,836 |          
|                                               | Furniture and fixtures                                                                            |                                                                     |           | 15,256  |           |   |           | 11,038  |          
|                                               | Leasehold improvements                                                                            |                                                                     |           | 79,264  |           |   |           | 60,690  |          
|                                               | Land                                                                                              |                                                                     |           | 8,782   |           |   |           | 8,782   |          
|                                               |                                                                                                   |                                                                     |           |         |           |   |           |        
|                                               |                                                                                                   |                                                                     | 346,979   |         |           |   | 293,346   |        
|Less accumulated depreciation and amortization |                                                                                                   |                                                                     | 169,378   |         |           |   | 141,791   |        
|                                               |                                                                                                   |                                                                     |           |         |           |   |           |        
|                                               |                                                                                                   |                                                                     | 177,601   |         |           |   | 151,555   |        
|Other assets                                   |                                                                                                   |                                                                     | 70,177    |         |           |   | 79,084    |        
|Note receivable                                |                                                                                                   |                                                                     | 244,673   |         |           |   |          |        
|                                               |                                                                                                   |                                                                     |           |         |           |   |           |        
|Total assets                                   |                                                                                                   | $                                                                   | 3,009,662 |         |           | $ | 2,205,474 |        
|                                               |                                                                                                   |                                                                     |           |         |           |   |           |        
|Liabilities and Shareholders Equity           |                                                                                                   |                                                                     |           |         |           |   |           |        
|Current liabilities:                           |                                                                                                   |                                                                     |           |         |           |   |           |        
|                                               | Accounts payable                                                                                  |                                                                     | $         | 67,317  |           |   | $         | 123,023 |          
|                                               | Accrued payroll and related expenses                                                              |                                                                     |           | 34,211  |           |   |           | 70,211  |          
|                                               | Accrued warranty                                                                                  |                                                                     |           | 43,337  |           |   |           | 51,343  |          
|                                               | Other accrued liabilities                                                                         |                                                                     |           | 30,411  |           |   |           | 46,187  |          
|                                               | Restructuring accrual                                                                             |                                                                     |           | 26,849  |           |   |           |        |          
|                                               | Income taxes payable                                                                              |                                                                     |           | 5,870   |           |   |           | 57,720  |          
|                                               | Deferred profit                                                                                   |                                                                     |           | 40,835  |           |   |           | 193,913 |          
|                                               | Current obligations under lines of credit                                                         |                                                                     |           | 26,179  |           |   |           | 21,602  |          
|                                               | Convertible subordinated debentures                                                               |                                                                     |           | 862,659 |           |   |           |        |          
|                                               |                                                                                                   |                                                                     |           |         |           |   |           |        
|Total current liabilities                      |                                                                                                   |                                                                     | 1,137,668 |         |           |   | 563,999   |        
|Commitments and contingencies                  |                                                                                                   |                                                                     |           |         |           |   |           |        
|Shareholders equity:                          |                                                                                                   |                                                                     |           |         |           |   |           |        
|                                               | Preferred stock, no par value; Authorized shares - 10,000                                         |                                                                     |           |         |           |   |           |         |          
|                                               |                                                                                                   | Issued and outstanding shares - none                                |           |         |           |   |           |         |           | 
|                                               | Common stock, no par value; Authorized shares - 240,000                                           |                                                                     |           |         |           |   |           |         |          
|                                               |                                                                                                   | Issued and outstanding shares - 143,606 in 2001 and 140,601 in 2000 |           |         | 1,273,201 |   |           |         | 1,200,718 | 
|                                               | Retained earnings                                                                                 |                                                                     |           | 597,267 |           |   |           | 453,250 |          
|                                               | Accumulated other comprehensive income (loss)                                                     |                                                                     |           | 1,526   |           |   |           | (12,493 | )        
|                                               |                                                                                                   |                                                                     |           |         |           |   |           |        
|Total shareholders equity                     |                                                                                                   |                                                                     | 1,871,994 |         |           |   | 1,641,475 |        
|                                               |                                                                                                   |                                                                     |           |         |           |   |           |        
|Total liabilities and shareholders equity     |                                                                                                   | $                                                                   | 3,009,662 |         |           | $ | 2,205,474 |        
|                                               |                                                                                                   |                                                                     |           |         |           |   |           |        

See accompanying notes.

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

|                                                                     |                                                                                   |                                                            |              |                                      |        |        |            |         |        |        |          |        |        |       |         |  
|-------------------------------------------------------------------- | --------------------------------------------------------------------------------- | ---------------------------------------------------------- | ------------ | ------------------------------------ | ------ | ------ | ---------- | ------- | ------ | ------ | -------- | ------ | ------ | ----- | ------- | -
|Year Ended December 31,                                              |                                                                                   | 2001                                                       |              | 2000                                 |        | 1999  
|                                                                     |                                                                                   |                                                            |              |                                      |        |       
|Operating activities                                                 |                                                                                   |                                                            |              |                                      |        |        |            |         |        |        |          |       
|Net income                                                           |                                                                                   | $                                                          | 144,470      |                                      |        | $      | 149,380    |         |        | $      | 68,707   |       
|                                                                     | Adjustments to reconcile net income to net cash
provided by operating activities: |                                                            |              |                                      |        |        |            |         |        |        |          |        |       
|                                                                     |                                                                                   | Non-cash portion of special charges                        |              |                                      | 25,501 |        |            |         |       |        |          |        |       |      
|                                                                     |                                                                                   | Investment impairment charge                               |              |                                      | 8,556  |        |            |         |       |        |          |        |       |      
|                                                                     |                                                                                   | Bad debt write-off                                         |              |                                      | 7,662  |        |            |         |       |        |          |        |       |      
|                                                                     |                                                                                   | Adjustment to conform fiscal year end of GaSonics          |              |                                      | 1,714  |        |            |         |       |        |          |        |       |      
|                                                                     |                                                                                   | Depreciation and amortization                              |              |                                      | 51,934 |        |            |         | 46,951 |        |          |        | 34,825 |      
|                                                                     |                                                                                   | Deferred compensation                                      |              |                                      | 1,451  |        |            |         | 1,780  |        |          |        |       |      
|                                                                     |                                                                                   | Cumulative effect of accounting change, net of tax benefit |              |                                      |       |        |            |         | 89,788 |        |          |        |       |      
|                                                                     |                                                                                   | In-process research and development charge                 |              |                                      |       |        |            |         | 6,000  |        |          |        |       |      
|                                                                     |                                                                                   | Income tax benefits from employee stock plans              |              |                                      | 25,037 |        |            |         | 40,247 |        |          |        | 20,544 |      
|                                                                     |                                                                                   | Changes in operating assets and liabilities:               |              |                                      |        |        |            |         |        |        |          |        |        |      
|                                                                     |                                                                                   |                                                            |              | Accounts receivable                  |        |        | 167,713    |         |        |        | (168,627 | )      |        |       | (44,274 | )
|                                                                     |                                                                                   |                                                            |              | Inventories                          |        |        | (50,079    | )       |        |        | (85,287  | )      |        |       | (28,811 | )
|                                                                     |                                                                                   |                                                            |              | Prepaid and other current assets     |        |        | (66,511    | )       |        |        | (5,755   | )      |        |       | 3,600   |  
|                                                                     |                                                                                   |                                                            |              | Deferred income taxes                |        |        | 55,860     |         |        |        | (41,378  | )      |        |       | (3,987  | )
|                                                                     |                                                                                   |                                                            |              | Accounts payable                     |        |        | (55,706    | )       |        |        | 73,894   |        |        |       | 14,155  |  
|                                                                     |                                                                                   |                                                            |              | Accrued payroll and related expenses |        |        | (36,000    | )       |        |        | 46,250   |        |        |       | 6,274   |  
|                                                                     |                                                                                   |                                                            |              | Accrued warranty                     |        |        | (8,006     | )       |        |        | 29,008   |        |        |       | (6,750  | )
|                                                                     |                                                                                   |                                                            |              | Deferred profit                      |        |        | (153,078   | )       |        |        | 55,777   |        |        |       |        |  
|                                                                     |                                                                                   |                                                            |              | Other accrued liabilities            |        |        | 11,073     |         |        |        | 12,437   |        |        |       | 6,146   |  
|                                                                     |                                                                                   |                                                            |              | Income taxes payable                 |        |        | (54,502    | )       |        |        | 40,433   |        |        |       | 8,457   |  
|                                                                     |                                                                                   |                                                            |              |                                      |        |        |            |         |        |        |          |       
|                                                                     | Total adjustments                                                                 |                                                            |              | (67,381                              | )      |        |            | 141,518 |        |        |          | 10,179 |       
|                                                                     |                                                                                   |                                                            |              |                                      |        |        |            |         |        |        |          |       
|Net cash provided by operating activities                            |                                                                                   |                                                            | 77,089       |                                      |        |        | 290,898    |         |        |        | 78,886   |       
|                                                                     |                                                                                   |                                                            |              |                                      |        |        |            |         |        |        |          |       
|Investing activities                                                 |                                                                                   |                                                            |              |                                      |        |        |            |         |        |        |          |       
|Purchases of available-for-sale securities                           |                                                                                   |                                                            | (1,315,253   | )                                    |        |        | (1,268,238 | )       |        |        | (486,842 | )     
|Proceeds from the sale and maturity of available-for-sale securities |                                                                                   |                                                            | 1,563,043    |                                      |        |        | 842,386    |         |        |        | 339,488  |       
|Purchases of restricted investments                                  |                                                                                   |                                                            | (978,518     | )                                    |        |        |           |         |        |        |         |       
|Proceeds from the maturity of restricted investments                 |                                                                                   |                                                            | 36,140       |                                      |        |        |           |         |        |        |         |       
|Capital expenditures                                                 |                                                                                   |                                                            | (79,965      | )                                    |        |        | (77,704    | )       |        |        | (29,617  | )     
|(Increase) decrease in other assets                                  |                                                                                   |                                                            | (7,443       | )                                    |        |        | 3,092      |         |        |        | (29,404  | )     
|Participation in a synthetic lease receivable                        |                                                                                   |                                                            | (244,673     | )                                    |        |        |           |         |        |        |         |       
|Acquisition of Gamma Precision Technology                            |                                                                                   |                                                            |             |                                      |        |        | (18,454    | )       |        |        |         |       
|                                                                     |                                                                                   |                                                            |              |                                      |        |        |            |         |        |        |          |       
|Net cash used in investing activities                                |                                                                                   |                                                            | (1,026,669   | )                                    |        |        | (518,918   | )       |        |        | (206,375 | )     
|                                                                     |                                                                                   |                                                            |              |                                      |        |        |            |         |        |        |          |       
|Financing activities                                                 |                                                                                   |                                                            |              |                                      |        |        |            |         |        |        |          |       
|Proceeds from convertible subordinated debentures                    |                                                                                   |                                                            | 862,400      |                                      |        |        |           |         |        |        |         |       
|Proceeds from employee compensation plans                            |                                                                                   |                                                            | 45,469       |                                      |        |        | 42,008     |         |        |        | 41,801   |       
|Proceeds from lines of credit, net                                   |                                                                                   |                                                            | 4,577        |                                      |        |        | 5,249      |         |        |        | 1,251    |       
|Common stock repurchased                                             |                                                                                   |                                                            | (1,641       | )                                    |        |        | (1,158     | )       |        |        | (3,192   | )     
|Proceeds from common stock offering, net                             |                                                                                   |                                                            |             |                                      |        |        | 572,910    |         |        |        | 255,133  |       
|Repayment under long-term debt                                       |                                                                                   |                                                            |             |                                      |        |        |           |         |        |        | (65,000  | )     
|                                                                     |                                                                                   |                                                            |              |                                      |        |        |            |         |        |        |          |       
|Net cash provided by financing activities                            |                                                                                   |                                                            | 910,805      |                                      |        |        | 619,009    |         |        |        | 229,993  |       
|                                                                     |                                                                                   |                                                            |              |                                      |        |        |            |         |        |        |          |       
|Net increase (decrease) in cash and cash equivalents                 |                                                                                   |                                                            | (38,775      | )                                    |        |        | 390,989    |         |        |        | 102,504  |       
|Cash and cash equivalents at the beginning of the year               |                                                                                   |                                                            | 589,415      |                                      |        |        | 198,426    |         |        |        | 95,922   |       
|                                                                     |                                                                                   |                                                            |              |                                      |        |        |            |         |        |        |          |       
|Cash and cash equivalents at the end of the year                     |                                                                                   | $                                                          | 550,640      |                                      |        | $      | 589,415    |         |        | $      | 198,426  |       
|                                                                     |                                                                                   |                                                            |              |                                      |        |        |            |         |        |        |          |       
|Supplemental disclosures:                                            |                                                                                   |                                                            |              |                                      |        |        |            |         |        |        |          |       
|Cash paid during the year for:                                       |                                                                                   |                                                            |              |                                      |        |        |            |         |        |        |          |       
|                                                                     |                                                                                   |                                                            | Interest     |                                      | $      | 1,146  |            |         | $      | 2,425  |          |        | $      | 1,843 |        
|                                                                     |                                                                                   |                                                            | Income taxes |                                      | $      | 63,201 |            |         | $      | 69,221 |          |        | $      | 1,989 |        

See accompanying notes.

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

|                             |                                                                                 |                      |         |              |   |          |           |               |   |               |         |         |   |   |         |             |   |   |           |         |         | 
|---------------------------- | ------------------------------------------------------------------------------- | -------------------- | ------- | ------------ | - | -------- | --------- | ------------- | - | ------------- | ------- | ------- | - | - | ------- | ----------- | - | - | --------- | ------- | ------- | 
|                             |                                                                                 |                      |         |              |   |          |           |               |   |               |         |         |   |   |         | Accumulated |   |   |           |        
|                             |                                                                                 |                      |         | Common Stock |   |          |           |               |   | Other         |         | Total  
|                             |                                                                                 |                      |         |              |   | Retained |           | Comprehensive |   | Shareholders'
|                             |                                                                                 |                      |         | Shares       |   | Amount   |           | Earnings      |   | Income (Loss) |         | Equity 
|                             |                                                                                 |                      |         |              |   |          |           |               |   |               |         |        
|Balance at January 1, 1999   |                                                                                 |                      | 110,865 |              |   | $        | 213,815   |               |   | $             | 239,314 |         |   | $ | (2,256  | )           |   | $ | 450,873   |        
|                             | Proceeds from common stock offering, net                                        |                      |         | 11,580       |   |          |           | 255,133       |   |               |         |        |   |   |         |            |   |   |           | 255,133 |        
|                             | Shares issued under employee compensation
plans                                 |                      |         | 4,220        |   |          |           | 41,801        |   |               |         |        |   |   |         |            |   |   |           | 41,801  |        
|                             | Income tax benefits realized from activity in
employee stock plans              |                      |         |             |   |          |           | 20,544        |   |               |         |        |   |   |         |            |   |   |           | 20,544  |        
|                             | Net income                                                                      |                      |         |             |   |          |           |              |   |               |         | 68,707  |   |   |         |            |   |   |           | 68,707  |        
|                             | Cumulative translation adjustment                                               |                      |         |             |   |          |           |              |   |               |         |        |   |   |         | 3,671       |   |   |           | 3,671   |        
|                             |                                                                                 |                      |         |              |   |          |           |               |   |               |         |         |   |   |         |             |   |   |           |        
|                             |                                                                                 | Comprehensive income |         |              |  |          |           |               |  |               |         |         |  |   |         |             |  |   |           |         | 72,378  | 
|                             |                                                                                 |                      |         |              |   |          |           |               |   |               |         |         |   |   |         |             |   |   |           |        
|                             | Common stock repurchased                                                        |                      |         | (122         | ) |          |           | (69           | ) |               |         | (3,123  | ) |   |         |            |   |   |           | (3,192  | )      
|                             |                                                                                 |                      |         |              |   |          |           |               |   |               |         |         |   |   |         |             |   |   |           |        
|Balance at December 31, 1999 |                                                                                 |                      | 126,543 |              |   |          | 531,224   |               |   |               | 304,898 |         |   |   | 1,415   |             |   |   | 837,537   |        
|                             | Proceeds from common stock offering, net                                        |                      |         | 10,089       |   |          |           | 572,910       |   |               |         |        |   |   |         |            |   |   |           | 572,910 |        
|                             | Shares issued under employee compensation
plans                                 |                      |         | 3,441        |   |          |           | 42,008        |   |               |         |        |   |   |         |            |   |   |           | 42,008  |        
|                             | Issuance of restricted stock                                                    |                      |         | 219          |   |          |           |              |   |               |         |        |   |   |         |            |   |   |           |        |        
|                             | Acquisition of Gamma Precision Technology                                       |                      |         | 341          |   |          |           | 12,679        |   |               |         |        |   |   |         |            |   |   |           | 12,679  |        
|                             | Amortization of deferred compensation, net
of cancellations of restricted stock |                      |         | (12          | ) |          |           | 1,780         |   |               |         |        |   |   |         |            |   |   |           | 1,780   |        
|                             | Income tax benefits realized from activity
in employee stock plans              |                      |         |             |   |          |           | 40,247        |   |               |         |        |   |   |         |            |   |   |           | 40,247  |        
|                             | Net income                                                                      |                      |         |             |   |          |           |              |   |               |         | 149,380 |   |   |         |            |   |   |           | 149,380 |        
|                             | Net change in unrealized loss on available-
for-sale securities                 |                      |         |             |   |          |           |              |   |               |         |        |   |   |         | (10,191     | ) |   |           | (10,191 | )      
|                             | Cumulative translation adjustment                                               |                      |         |             |   |          |           |              |   |               |         |        |   |   |         | (3,717      | ) |   |           | (3,717  | )      
|                             |                                                                                 |                      |         |              |   |          |           |               |   |               |         |         |   |   |         |             |   |   |           |        
|                             |                                                                                 | Comprehensive income |         |              |  |          |           |               |  |               |         |         |  |   |         |             |  |   |           |         | 135,472 | 
|                             |                                                                                 |                      |         |              |   |          |           |               |   |               |         |         |   |   |         |             |   |   |           |        
|                             | Common stock repurchased                                                        |                      |         | (20          | ) |          |           | (130          | ) |               |         | (1,028  | ) |   |         |            |   |   |           | (1,158  | )      
|                             |                                                                                 |                      |         |              |   |          |           |               |   |               |         |         |   |   |         |             |   |   |           |        
|Balance at December 31, 2000 |                                                                                 |                      | 140,601 |              |   |          | 1,200,718 |               |   |               | 453,250 |         |   |   | (12,493 | )           |   |   | 1,641,475 |        
|                             | Shares issued under employee compensation
plans                                 |                      |         | 2,954        |   |          |           | 45,469        |   |               |         |        |   |   |         |            |   |   |           | 45,469  |        
|                             | Adjustment to conform fiscal year end
of GaSonics                               |                      |         | 57           |   |          |           | 851           |   |               |         | 863     |   |   |         |            |   |   |           | 1,714   |        
|                             | Issuance of restricted stock                                                    |                      |         | 31           |   |          |           |              |   |               |         |        |   |   |         |            |   |   |           |        |        
|                             | Amortization of deferred compensation                                           |                      |         |             |   |          |           | 1,451         |   |               |         |        |   |   |         |            |   |   |           | 1,451   |        
|                             | Income tax benefits realized from activity in
employee stock plans              |                      |         |             |   |          |           | 25,037        |   |               |         |        |   |   |         |            |   |   |           | 25,037  |        
|                             | Net income                                                                      |                      |         |             |   |          |           |              |   |               |         | 144,470 |   |   |         |            |   |   |           | 144,470 |        
|                             | Net change in unrealized loss on available-
for-sale securities                 |                      |         |             |   |          |           |              |   |               |         |        |   |   |         | 7,988       |   |   |           | 7,988   |        
|                             | Cumulative translation adjustment                                               |                      |         |             |   |          |           |              |   |               |         |        |   |   |         | 127         |   |   |           | 127     |        
|                             | Other
than temporary loss included in net
income
(net of tax)                   |                      |         |             |   |          |           |              |   |               |         |        |   |   |         | 5,904       |   |   |           | 5,904   |        
|                             |                                                                                 |                      |         |              |   |          |           |               |   |               |         |         |   |   |         |             |   |   |           |        
|                             |                                                                                 | Comprehensive income |         |              |   |          |           |               |   |               |         |         |   |   |         |             |   |   |           |         | 158,489 | 
|                             |                                                                                 |                      |         |              |   |          |           |               |   |               |         |         |   |   |         |             |   |   |           |        
|                             | Common stock repurchased                                                        |                      |         | (37          | ) |          |           | (325          | ) |               |         | (1,316  | ) |   |         |            |   |   |           | (1,641  | )      
|                             |                                                                                 |                      |         |              |   |          |           |               |   |               |         |         |   |   |         |             |   |   |           |        
|Balance at December 31, 2001 |                                                                                 |                      | 143,606 |              |   | $        | 1,273,201 |               |   | $             | 597,267 |         |   | $ | 1,526   |             |   | $ | 1,871,994 |        
|                             |                                                                                 |                      |         |              |   |          |           |               |   |               |         |         |   |   |         |             |   |   |           |        

See accompanying notes.

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NOVELLUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 BUSINESS AND NATURE OF OPERATIONS

Nature of Operations

Novellus Systems, Inc. (Novellus or the Company) manufactures, markets, and
services semiconductor processing equipment used to deposit thin conductive and
insulating films on semiconductor devices, as well as equipment for preparing
the device surface prior to these deposition processes. Novellus is a leading
supplier of high productivity deposition and surface preparation systems used
in the fabrication of integrated circuits. Chemical Vapor Deposition (CVD)
systems employ a chemical plasma to deposit all of the dielectric (insulating)
layers and certain of the metal (conductive) layers on the surface of a
semiconductor wafer. Physical Vapor Deposition (PVD) systems are used to
deposit conductive metal layers by sputtering metallic atoms from the surface
of a target source via high DC power. Electrofill systems are used for
depositing copper conductive layers in a dual damascene design architecture
using an aqueous solution.

As more fully described in Note 2, Novellus merged with GaSonics International
Corporation (GaSonics), a developer and supplier of photoresist and residue
removal technologies on January 10, 2001 in a pooling of interests transaction.
Consequently, the consolidated financial statements for fiscal 2000 and 1999
have been restated to include the financial position, results of operations,
and cash flows of GaSonics. Because of differing year ends, financial
information relating to Novellus fiscal years ended December 31, 2000 and 1999
has been combined with financial information relating to GaSonics fiscal years
ended September 30, 2000 and 1999, respectively. GaSonics net income for the
three months ended December 31, 2000 was not combined with Novellus net
income, but rather was included as an adjustment to shareholders equity for
the year ended December 31, 2001. Revenue and net income of GaSonics for the
three-month period ended December 31, 2000 was $47.7 million and $0.9 million,
respectively. There were no transactions between GaSonics and Novellus prior
to the combination.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires Novellus to make
estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and the related disclosure of contingent
assets and liabilities. On an ongoing basis, Novellus evaluates its estimates,
including those related to allowance for doubtful accounts, inventories,
investments, deferred tax assets, income taxes, warranty obligations,
restructuring, and contingencies and litigation. Novellus bases its estimates
on historical experience and on 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. Actual results may differ from these
estimates under different assumptions or conditions.

Novellus believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements.

Revenue Recognition

Novellus changed its revenue recognition policy effective January 1, 2000,
based on guidance provided in SEC Staff Accounting Bulletin No. 101 (SAB
101), Revenue Recognition in Financial Statements
and SAB 101: Revenue Recognition in Financial
StatementsFrequently Asked Questions and Answers (SAB 101
FAQ). Novellus recognizes
revenue when persuasive evidence of an arrangement exists, delivery has
occurred or services have been rendered, the sellers price is fixed or
determinable, and collectibility is reasonably assured. Certain of Novellus
product sales are accounted for as multiple-element arrangements. If the
Company has met defined customer acceptance experience levels with both the
customer and the specific type of equipment, then Novellus recognizes equipment
revenue upon shipment and transfer of title, with the remainder when it becomes
due (generally upon acceptance). All other equipment sales are recognized upon
customer acceptance. Revenue related to spare part sales is recognized on
shipment. Revenue related to maintenance and service contracts is recognized
ratably over the duration of the contracts. Unearned maintenance and service
contract revenue is not significant and is included in accrued liabilities.

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

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The deferred profit balance as of January 1, 2000 was $138.4 million. This
amount is comprised of equipment that was shipped and previously recorded as
revenue but had not been accepted or did not qualify for multiple-element
accounting as of December 31, 1999. In addition to deferred revenue, deferred
profit includes deferred amounts related to cost of sales and commissions.
Related to the $138.4 million in deferred profit, $134.2 million was recognized
as revenue in fiscal 2000 with the remaining $4.2 million being recognized in
2001. The unaudited pro forma amounts presented in the income statement were
calculated assuming the accounting change was retroactive to prior periods.

Prior to 2000, Novellus revenue recognition policy was to recognize revenue at
the time the customer takes title to the product, generally at the time of
shipment. Revenue related to maintenance and service contracts was recognized
ratably over the duration of the contracts.

Allowance for Doubtful Accounts

Novellus evaluates its allowance for doubtful accounts based on a combination
of factors. In circumstances where the Company is aware of a specific
customers inability to meet its financial obligations to us (e.g. bankruptcy
filings, substantial downgrading of credit scores), Novellus records a specific
reserve for bad debts against amounts due to reduce the net recognized
receivable to the amount Novellus reasonably believes will be collected. For
all other customers, Novellus recognizes a reserve for bad debts based on a
certain percentage of total revenues, which is based on the Companys
historical experience over five years.

Inventory Reserves

Novellus assesses the recoverability of all inventory, including raw materials,
work-in-process, finished goods, and spare parts to determine whether
adjustments for impairment are required. Inventory which is obsolete or in
excess of the Companys forecasted usage is written down to its estimated
market value based on assumptions about future demand and market conditions.

Warranty and Installation

Novellus warranty and installation policy generally states that the company
will provide installation services as well as coverage, for a predetermined
amount of time, on systems and modules for material and labor to repair and
service the equipment. Novellus records the estimated cost of warranty
coverage and installation upon system shipment. The estimated cost of warranty
and installation coverage is determined by the warranty term as well as the
average historical warranty and installation expense for a specific tool.

Investments

The Company classifies its marketable securities as available-for-sale in
accordance with the provisions of the Statement of Financial Accounting
Standard (SFAS) No. 115, Accounting for Certain Investments in Debt and
Equity Securities. Securities classified as available-for-sale are reported
at fair market value with the related unrealized gains and losses included, net
of tax, in accumulated other comprehensive income (loss). Realized gains and
losses and declines in value of securities judged to be other than temporary
are included in other income. Interest on all securities is included in
interest income. Future adverse changes in market conditions or poor operating
results of underlying investments could result in losses or an inability to
recover the carrying value of the investments that may not be reflected in an
investments current carrying value, thereby possibly requiring impairment
charges in the future. The fair values of investments are determined using
quoted market prices if available and estimated using discounted cash flows and
market interest rates if quoted market prices are not available.

Deferred Tax Assets

Novellus records a valuation allowance to reduce its deferred tax assets to the
amount that is more likely than not to be realized. While Novellus has
considered future taxable income and ongoing prudent and feasible tax planning
strategies in assessing the need for the valuation allowance, in the event
Novellus were to determine that it would be able to realize its deferred tax
assets in the future in excess of its net recorded amount, an adjustment to the
deferred tax asset would increase income in the period such determination was
made.

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Restructuring

During 2001, the Company recorded restructuring charges in connection with a
plan to restructure Novellus operations. These accruals were calculated net
of estimated future sublease income that Novellus expects to receive once
the Company sublets facilities which it has vacated. If the length of
time before the Company finds tenants for these facilities or the market rental
rates differs significantly from Novellus estimates, the Companys actual
costs will differ from the charge which was initially recorded.

Contingencies and Litigation

The Company makes an assessment of the probability
of an adverse judgment resulting from current and threatened
litigation. The Company would accrue the cost of an adverse judgment
if, in the Company's estimation, the adverse settlement is probable
and the Company can reasonably estimate the ultimate cost to the
Company. Novellus has made no such accruals at December 31, 2001.

Other Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements
include the accounts of Novellus and its wholly owned subsidiaries after elimination of all significant
intercompany accounts and transactions.

Certain prior year amounts in the consolidated financial statements and the
notes thereto have been reclassified to conform to the 2001 presentation.

Cash and Cash Equivalents

The Company considers all highly liquid debt instruments with insignificant
interest rate risk and maturities of ninety days or less to be cash
equivalents.

Inventories

Inventories are stated at the lower of cost (first-in, first-out) or market.
As of the balance sheet date, inventories consisted of the following (in
thousands):

|                          |                 |      |         |         |  |   |         |         | 
|------------------------- | --------------- | ---- | ------- | ------- |  | - | ------- | ------- | 
|December 31,              |                 | 2001 |         | 2000   
|                          |                 |      |         |        
|Purchased and spare parts |                 | $    | 199,702 |         |  | $ | 135,204 |        
|Work-in-process           |                 |      | 42,717  |         |  |   | 56,997  |        
|Finished goods            |                 |      | 2,293   |         |  |   | 9,471   |        
|                          |                 |      |         |         |  |   |         |        
|                          | Total inventory |      | $       | 244,712 |  |   | $       | 201,672 | 
|                          |                 |      |         |         |  |   |         |        

Property and Equipment

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

|                        |  |                                               
|----------------------- |  | ----------------------------------------------
|Machinery and equipment |  | 3-10 years                                    
|Furniture and fixtures  |  | 3-5 years                                     
|Buildings               |  | 30 years                                      
|Leasehold improvements  |  | Shorter of useful life or remaining lease term

Foreign Currency Accounting

For all those foreign operations consolidated as
part of Novellus operations, the local currency is the functional currency. Accordingly,
translation gains or losses related to these foreign subsidiaries are included
as a component of accumulated other comprehensive income.

Forward Foreign Exchange Contracts

Novellus enters into forward foreign exchange contracts primarily as an
economic hedge against the short-term impact of foreign currency fluctuations
of intercompany accounts payable denominated in U.S. Dollars recorded by its
Japanese subsidiary. Novellus also enters into forward foreign exchange
contracts to buy and sell foreign currencies as economic

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hedges of the parents intercompany balances denominated in a currency other
than the U.S. Dollar. In 2001 and 2000, these hedging contracts were
denominated primarily in the Japanese Yen. The maturities of all the forward
foreign exchange contracts are generally short-term in nature. Because the
impact of movements in currency exchange rates on forward foreign exchange
contracts offsets the related impact on the underlying items being hedged,
these financial instruments do not subject the Company to speculative risk that
would otherwise result from changes in currency exchange rates. All unsettled
foreign currency contracts are marked-to-market and realized and unrealized
gains and losses are included as a component of other income and expense. Net
foreign currency gains and losses have not been significant.

Earnings Per Share

Earnings per share is calculated in accordance with SFAS 128. Basic earnings
per share exclude any dilutive effect of employee stock options. Diluted
earnings per share includes the dilutive effect of employee stock options.

The following table sets forth the computation of basic and diluted earnings
per share (in thousands, except per share amounts):

|                           |                                                                                |                                                                                           |      |         |         |      |      |         |         |   |      |         |         | 
|-------------------------- | ------------------------------------------------------------------------------ | ----------------------------------------------------------------------------------------- | ---- | ------- | ------- | ---- | ---- | ------- | ------- | - | ---- | ------- | ------- | 
|Year ended December 31,    |                                                                                | 2001                                                                                      |      | 2000    |         | 1999
|                           |                                                                                |                                                                                           |      |         |         |     
|Numerator:                 |                                                                                |                                                                                           |      |         |         |      |      |         |         |   |      |        
|                           | Net income                                                                     |                                                                                           | $    | 144,470 |         |      | $    | 149,380 |         |   | $    | 68,707  |        
|Denominator:               |                                                                                |                                                                                           |      |         |         |      |      |         |         |   |      |        
|                           | Denominator for basic earnings per share -
weighted-average shares outstanding |                                                                                           |      | 142,462 |         |      |      | 135,728 |         |   |      | 122,261 |        
|                           | Employee stock options                                                         |                                                                                           |      | 6,462   |         |      |      | 7,926   |         |   |      | 5,565   |        
|                           |                                                                                |                                                                                           |      |         |         |      |      |         |         |   |      |        
|                           |                                                                                | Denominator for diluted earnings per share -
adjusted weighted-average shares outstanding |      |         | 148,924 |      |      |         | 143,654 |   |      |         | 127,826 | 
|                           |                                                                                |                                                                                           |      |         |         |      |      |         |         |   |      |        
|Basic earnings per share   |                                                                                | $                                                                                         | 1.01 |         |         | $    | 1.10 |         |         | $ | 0.56 |        
|                           |                                                                                |                                                                                           |      |         |         |      |      |         |         |   |      |        
|Diluted earnings per share |                                                                                | $                                                                                         | 0.97 |         |         | $    | 1.04 |         |         | $ | 0.54 |        
|                           |                                                                                |                                                                                           |      |         |         |      |      |         |         |   |      |        

Options to purchase 3,596,000, 519,000 and 429,000 shares of common stock at
weighted-average prices of $46.77, $55.35, and $26.22 per share were
outstanding during 2001, 2000, and 1999, respectively, but were not included in
the computation of diluted net income per common share because the options
exercise price was greater than the average market price of the common shares
and, therefore, the effect would be antidilutive.

Advertising Expenses

Novellus expenses advertising costs as incurred. Advertising expenses for
2001, 2000, and 1999 were $4.7 million, $9.5 million, and $5.1 million,
respectively.

Concentration of Credit and Other Risks

Novellus uses financial instruments that potentially subject it to
concentrations of credit risk. Such instruments include cash equivalents,
short-term investments, accounts receivable, and financial instruments used in
hedging activities. The Company invests its cash in cash deposits, money
market funds, commercial paper, certificates of deposit, readily marketable
debt securities, or medium-term notes. The Company places its investments with
high-credit-quality financial institutions and limits the credit exposure from
any one financial institution or instrument. To date, Novellus has not
experienced significant losses on these investments. Novellus performs ongoing
credit evaluations of its customers financial condition and generally requires
no collateral. The Company has an exposure to nonperformance by counterparties
on the foreign exchange contracts used in hedging activities. These
counterparties are large international financial institutions and to date, no
such counterparty has failed to meet its financial obligations to Novellus.
Novellus does not believe there is a significant risk of nonperformance by
these counterparties because the Company continuously monitors its positions
and the credit ratings of such counterparties and the amount of contracts it
enters into with any one party. However, there can be no assurance that there
will be no significant nonperformance by these counterparties and that this
would not materially adversely affect Novellus business, financial condition,
and results of operations.

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Other Comprehensive Income (Loss)

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

|                                                                    |                                               |   |              |       |              |   |         |         |  
|------------------------------------------------------------------- | --------------------------------------------- | - | ------------ | ----- | ------------ | - | ------- | ------- | -
|                                                                    |                                               |   | December 31, |       | December 31,
|                                                                    |                                               |   | 2001         |       | 2000        
|                                                                    |                                               |   |              |       |             
|Foreign currency translation adjustment                             |                                               | $ | (2,175       | )     |              | $ | (2,302  | )      
|Unrealized gain (loss) on available-for-sale securities, net of tax |                                               |   | 3,701        |       |              |   | (10,191 | )      
|                                                                    |                                               |   |              |       |              |   |         |        
|                                                                    | Accumulated other comprehensive income (loss) |   | $            | 1,526 |              |   | $       | (12,493 | )
|                                                                    |                                               |   |              |       |              |   |         |        

Employee Stock Plans

Effective January 1, 1996, the Company adopted SFAS 123, Accounting for
Stock-Based Compensation. In accordance with the provisions of SFAS 123, the
Company accounts for stock-based employee compensation arrangements under the
intrinsic value method prescribed by the Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to Employees, and provides pro forma
disclosures of net income and earning per share as if the fair value method
prescribed by SFAS 123 had been applied in measuring employee compensation
expense. For further discussion, see Notes to Consolidated Financial
Statements, Employee Benefit Plans.

Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 141 (SFAS 141), Business
Combinations. SFAS 141 requires the purchase method of accounting for all
business combinations and eliminates the pooling-of-interests method for
business combinations initiated after June 30, 2001. SFAS 141 also includes
guidance on the initial recognition and measurement of goodwill and other
intangible assets arising from business combinations completed after June 30,
2001. The Company does not expect the adoption of SFAS 141 to have a material
effect on its financial condition or results of operations.

In June 2001, the FASB issued SFAS 142,
Goodwill and Other Intangible Assets.
SFAS 142 discontinues amortization of goodwill and intangible assets deemed to
have indefinite lives and requires such assets to be reviewed at least annually
for impairment. SFAS 142 also includes provisions on the identification of
intangible assets, reclassification of certain intangibles from previously
reported goodwill, and reassessment of the useful lives of existing
intangibles. Novellus will apply SFAS 142 beginning in the first quarter of
2002. Application of the non-amortization provisions of SFAS 142 is expected
to result in an increase in operating income of $3.5 million in 2002. Novellus
will test goodwill for impairment using the two-step process prescribed in SFAS
142. The first step is to screen for potential impairment, while the second
step measures the amount of the impairment, if any. Novellus expects to
perform the first of the required impairment tests of goodwill and indefinite
lived intangible assets as of January 1, 2002 in the first quarter of 2002.
Novellus does not expect the effect of these tests to be material to its
financial condition or results of operations.

In July 2001, the FASB issued SFAS 143, Accounting for Asset Retirement
Obligations, which addresses accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the associated
asset retirement costs. SFAS 143 is effective for fiscal years beginning after
June 15, 2002. The Company is currently assessing the impact of this new
standard, however, Novellus does not expect its adoption to be
material to its financial condition or results of operations.

In August 2001, the FASB issued SFAS 144, Impairment or Disposal of Long-Lived
Assets, which is effective for fiscal years beginning after December 15, 2001.
SFAS 144 supersedes SFAS 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of, and provides a single
accounting model for impairment of long-lived assets. Novellus does not expect
the adoption of SFAS 144 to have a material effect on the Companys financial
condition or results of operations.

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NOTE 2 BUSINESS COMBINATION

On January 10, 2001, the Company merged with GaSonics. In the transaction,
Novellus acquired all outstanding shares of GaSonics in a stock-for-stock
merger, with all outstanding shares of GaSonics capital stock converted into
approximately 9,240,000 shares of Novellus common stock. In addition, all
outstanding options to purchase shares of GaSonics capital stock were
automatically converted into options to purchase approximately 1,400,000 shares
of Novellus common stock. Merger related expenses of approximately $13.2
million were recorded in the first quarter of fiscal 2001 and were included in
special charges within the statement of operations.

Following is a reconciliation of the amounts of net sales and net income
previously reported for the years ended December 31, 2000 and 1999 with
restated amounts:

|                   |            |          |   |           |  |             |   |          |   |  |            |         |   |  |   |           | 
|------------------ | ---------- | -------- | - | --------- |  | ----------- | - | -------- | - |  | ---------- | ------- | - |  | - | --------- | 
|                   |            |          |   |           |  |             |   |          |   |  | Conforming |         |   |  |  
|(in thousands)     |            | Novellus |   | GaSonics  |  | Adjustments |   | Combined
|                   |            |          |   |           |  |             |   |         
|December 31, 2000: |            |          |   |           |  |             |   |          |   |  |            |         |   |  |   |          
|                   | Revenue    |          | $ | 1,173,731 |  |             | $ | 155,833  |   |  | $          | (10,078 | ) |  | $ | 1,319,486 | 
|                   | Net income |          |   | 151,065   |  |             |   | 14,381   |   |  |            | (16,066 | ) |  |   | 149,380   | 
|December 31, 1999: |            |          |   |           |  |             |   |          |   |  |            |         |   |  |   |          
|                   | Revenue    |          | $ | 592,742   |  |             | $ | 64,279   |   |  |            |        |   |  | $ | 657,021   | 
|                   | Net income |          |   | 76,574    |  |             |   | (14,082  | ) |  |            | 6,215   |   |  |   | 68,707    | 

Conforming adjustments consist of an adjustment to the provision for income
taxes for the realization of deferred tax assets in fiscal 1999, rather than in
fiscal 2000 and adjustments related to adoption of Staff Accounting Bulletin
No. 101, Revenue Recognition in Financial Statements as of the beginning of
GaSonics fiscal year 2000.

NOTE 3 FINANCIAL INSTRUMENTS

Financial Instruments with Off-Balance Sheet Risk

As part of Novellus asset and liability management, the Company enters into
various types of transactions that involve financial instruments with
off-balance sheet risk. Novellus enters into foreign forward exchange
contracts in order to manage foreign exchange risk. The notional amounts,
carrying amounts, and estimated fair values of Novellus foreign currency
forward exchange contracts are as follows at December 31 (in thousands):

|                                              |  |          |        |          |  |            |       |          |  |          |       |            |  |   |         |  |  |   |        |  |  |   |        | 
|--------------------------------------------- |  | -------- | ------ | -------- |  | ---------- | ----- | -------- |  | -------- | ----- | ---------- |  | - | ------- |  |  | - | ------ |  |  | - | ------ | 
|                                              |  | 2001     |        | 2000    
|                                              |  |          |        |         
|                                              |  | Notional |        | Carrying |  | Estimated  |       | Notional |  | Carrying |       | Estimated 
|                                              |  | Amount   |        | Amount   |  | Fair Value |       | Amount   |  | Amount   |       | Fair Value
|                                              |  |          |        |          |  |            |       |          |  |          |       |           
|Sell foreign currency, primarily
Japanese yen |  | $        | 54,914 |          |  | $          | 8,958 |          |  | $        | 8,958 |            |  | $ | 138,558 |  |  | $ | 10,899 |  |  | $ | 10,899 | 

The fair value of Novellus foreign forward exchange contracts are calculated
based on quoted market prices or pricing models using current market rates at
the end of December 31, 2001 and 2000, respectively.

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Available-for-Sale Securities

The following table presents the estimated fair value of Novellus investments
by balance sheet classification at December 31 (in thousands):

|                                 |                                               |                                     |         |         |         |      |         |         |           | 
|-------------------------------- | --------------------------------------------- | ----------------------------------- | ------- | ------- | ------- | ---- | ------- | ------- | --------- | 
|                                 |                                               |                                     |         | 2001    |         | 2000
|                                 |                                               |                                     |         |         |         |     
|Institutional money market funds |                                               | $                                   | 465,528 |         |         | $    | 297,485 |        
|Commercial paper                 |                                               |                                     | 81,912  |         |         |      | 266,152 |        
|Eurodollar time deposits         |                                               |                                     |        |         |         |      | 8,000   |        
|US Government agencies           |                                               |                                     |        |         |         |      | 17,778  |        
|Municipal securities             |                                               |                                     | 3,200   |         |         |      |        |        
|                                 |                                               |                                     |         |         |         |      |         |        
|                                 | Amounts included in cash and cash equivalents |                                     |         | 550,640 |         |      |         | 589,415 |          
|Tax-exempt auction rate notes    |                                               |                                     | 15,400  |         |         |      | 85,700  |        
|Corporate securities             |                                               |                                     | 78,302  |         |         |      | 49,580  |        
|Commercial paper                 |                                               |                                     | 33,447  |         |         |      | 460,064 |        
|US Government agencies           |                                               |                                     | 220,365 |         |         |      | 12,060  |        
|Municipal securities             |                                               |                                     | 23,668  |         |         |      | 22,845  |        
|                                 |                                               |                                     |         |         |         |      |         |        
|                                 | Amounts included in short-term investments    |                                     |         | 371,182 |         |      |         | 630,249 |          
|                                 |                                               |                                     |         |         |         |      |         |        
|                                 |                                               | Total available-for-sale securities |         | $       | 921,822 |      |         | $       | 1,219,664 | 
|                                 |                                               |                                     |         |         |         |      |         |        

As of December 31, 2001, Novellus held equity securities with a cost basis of
$8.0 million that had an associated unrealized gain of $2.9 million. As of
December 31, 2000, Novellus had unrealized losses of $9.8 million on equity
securities with a cost basis of $16.5 million. During Novellus third quarter
of 2001, the Company determined that one of its investments in equity
securities had suffered an other than temporary loss and recorded an $8.6
million charge to other expense to write-down the investment to its fair market
value as of September 29, 2001. These securities are classified in the
corporate securities line in the fair market value table above. Unrealized
gains (losses) on all other securities were not significant as of December 31,
2001 and 2000. All debt securities held at December 31, 2001 are due in less
than two years.

Fair Value of Other Financial Instruments

The carrying and estimated fair values of Novellus other financial instruments
were as follows at December 31 (in thousands):

|                                          |  |          |         |            |  |          |         |            |  |  |        |  |  |  |        | 
|----------------------------------------- |  | -------- | ------- | ---------- |  | -------- | ------- | ---------- |  |  | ------ |  |  |  | ------ | 
|                                          |  | 2001     |         | 2000      
|                                          |  |          |         |           
|                                          |  | Carrying |         | Estimated  |  | Carrying |         | Estimated 
|                                          |  | Value    |         | Fair Value |  | Value    |         | Fair Value
|                                          |  |          |         |            |  |          |         |           
|Restricted investments - current          |  |          | 961,643 |            |  |          | 961,643 |            |  |  |       |  |  |  |       | 
|Restricted investments - noncurrent       |  |          | 34,293  |            |  |          | 34,293  |            |  |  |       |  |  |  |       | 
|Note receivable                           |  |          | 244,673 |            |  |          | 244,673 |            |  |  |       |  |  |  |       | 
|Current obligations under lines of credit |  |          | 26,179  |            |  |          | 26,179  |            |  |  | 21,602 |  |  |  | 21,602 | 
|Convertible subordinated debentures       |  |          | 862,659 |            |  |          | 876,700 |            |  |  |       |  |  |  |       | 

The carrying value of the convertible subordinated
debentures is net of related issuance costs. The fair values of Novellus restricted investments are based on quoted market
prices as of December 31, 2001 and 2000. The fair value of Novellus
obligations under lines of credit is based on current rates offered to the
Company for similar debt instruments of the same remaining maturities.

NOTE 4 LINES OF CREDIT

Novellus has lines of credit with four Japanese banks, which expire at various
dates through May 2002, under which the Company can borrow up to $33.3 million
at the banks prime rates (ranging from 0.48% to 0.85% at December 31, 2001).
These facilities are available to Novellus Japanese subsidiary, Novellus
Systems Japan. Borrowings by the subsidiary are at

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the banks offshore reference rate. At December 31, 2001 and 2000, amounts
outstanding were $26.2 million and $21.6 million, at annual weighted-average
interest rates of 0.62% and 0.86%, respectively. All borrowings under the
lines of credit were by Novellus Systems Japan.

NOTE 5 CONVERTIBLE SUBORDINATED DEBENTURES

On July 26, 2001, Novellus issued $880.0 million of Liquid Yield Option Notes
(LYONs) due July 26, 2031. The net proceeds after issuance costs (which will
be amortized over 30 years) from the LYONs offering were $862.4 million. The
LYONs are zero coupon, zero-yield subordinated debentures that may be converted
into shares of Novellus common stock, subject to specified conditions as set
forth in the indenture. The LYONs are convertible into 13.09504 shares of
Novellus common stock per $1,000 LYON, or 11.5 million shares and 8.0% of all
outstanding shares as of December 31, 2001, if (1) the sales price of Novellus
common stock reaches a specified threshold, (2) the LYONs are called for
redemption, or (3) specified corporate transactions have occurred, subject to
antidilutive adjustments.

On July 26, 2002, the security holders have the option to deliver the LYONs to
Novellus and require the Company to repurchase the LYONs for $1,000 in cash
each, up to a maximum of $880.0 million for all outstanding LYONs.
Additionally, security holders also have the option to require the Company to
repurchase the LYONs on July 26, 2006, 2011, 2016, 2021, and 2026. On those
repurchase dates in 2006 and thereafter, Novellus has the ability to determine
whether the repurchase of the LYONs will be for cash or common stock or a
combination of cash and common stock.

Novellus deposited U.S. treasury securities into a pledge account to secure
Novellus obligations under the LYONs until July 26, 2002. These securities
are reflected on Novellus balance sheet as restricted short-term investments.
At December 31, 2001, restricted short-term investments related
to this obligation were approximately
$866.0 million, which will mature to $880.0 million, to secure the obligations
under the LYONs on July 26, 2002. If on July 26, 2002, the LYONs are delivered
to Novellus, the $880.0 million could be used to repurchase the LYONs and any
remaining unamortized issuance costs, approximately $17.0 million as of July
26, 2002, would be written off as other expense. Upon expiration of the
obligations under the pledge account, Novellus intends to use the net proceeds
of the offering, if any, for general corporate purposes. Additionally,
Novellus has the option of redeeming the LYONs on July 26, 2006,
2011, 2016, 2021, and 2026 for
cash or common stock or a combination of cash and common stock.

Novellus may be obligated to pay contingent interest on the LYONs during the
six-month period commencing July 27, 2004 and during any six-month period
thereafter if the average market price of a LYON for a certain measurement
period immediately preceding the applicable six-month period equals 120% or
more of the issue price of the LYONs. The amount of contingent interest
payable during any six-month period will be the sum of any contingent interest
payable in the first and the second three-month periods during such six-month
period. During any three-month period in which contingent interest is payable,
the contingent interest payable per LYON for such period will be equal to the
greater of (1) .0625% of the average market price of a LYON for the measurement
period referred to above, or (2) the sum of all regular cash dividends paid by
the Company per share on Novellus common stock during such three-month period
multiplied by the number of shares of common stock issuable upon conversion of
a LYON at the then applicable conversion rate.

If, as of the last day of any calendar quarter, the closing sales price of
common stock for at least 20 trading days in a period of 30 consecutive trading
days ending on the last trading day of such calendar quarter is more than 110%
of the conversion price per share of common stock on the last trading day of
such quarter, then on and after the first day of the immediately succeeding
calendar quarter, holders may surrender their LYONs for conversion into shares
of common stock. Upon satisfaction of the foregoing condition, the LYONs will
be thereafter convertible at any time and the convertible shares will be
included in the calculation of fully diluted shares.

Novellus is not subject to compliance ratios under the LYONs.
Payments on the LYONs will also effectively be subordinated to all existing and
future indebtedness of Novellus subsidiaries.

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NOTE 6 LITIGATION

Applied Litigation

On July 7, 1997, prior to the consummation of the purchase of the TFS business
unit from Varian Associates Inc. (Varian), Applied Materials, Inc.
(Applied) filed a complaint (the Applied Complaint) against Varian in the
United States District Court for the Northern District of California San Jose
Division, Civil Action No. C-97-20523 RMW, alleging, among other things,
infringement by Varian (including the making, using, selling and/or offering
for sale of certain products and systems made by TFS) of United States Patent
Nos. 5,171,412, 5,186,718, 5,496,455 and 5,540,821 (the Applied Patents),
which patents are owned by Applied.

Immediately after consummation of the TFS purchase, Novellus filed a complaint
(the Novellus Complaint) against Applied in the same Court, Civil Action No.
C-97-20551 RMW, alleging infringement by Applied (including the making, using,
selling and/or offering for sale of certain products and systems) of United
States Patent Nos. 5,314,597, 5,330,628, and 5,635,036 (the Novellus
Patents), which patents Novellus acquired from Varian in the TFS purchase. In
the Novellus Complaint, Novellus also alleged that it is entitled to
declarations from Applied that Novellus does not infringe the Applied Patents
and/or that the Applied Patents are invalid and/or unenforceable. Applied has
filed counterclaims alleging that Novellus infringes the Applied Patents.

Also after consummation of the TFS purchase, but some time after Novellus filed
the Novellus Complaint, Applied amended the Applied Complaint to add Novellus
as a defendant. Novellus has requested that the Court dismiss Novellus as a
defendant in Applieds lawsuit against Varian. The Court has not yet required
Novellus to file an answer to the Applied Complaint.

In addition to a request for a permanent injunction against further
infringement, the Applied Complaint and Applieds counterclaims to the Novellus
Complaint include requests for damages for alleged prior infringement and
treble damages for alleged willful infringement. In connection with the
consummation of the TFS purchase, Varian agreed, under certain circumstances,
to reimburse Novellus for certain of its legal and other expenses in connection
with the defense and prosecution of this litigation, and to indemnify Novellus
for a portion of any losses incurred by Novellus arising from this litigation
(including losses resulting from a permanent injunction). Novellus and Varian
believe that there are meritorious defenses to Applieds allegations, including
among other things, that Novellus operations (including TFS products and
systems) do not infringe the Applied Patents and/or that the Applied Patents
are invalid and/or unenforceable. However, the resolution of intellectual
property disputes is often fact intensive and, therefore, inherently uncertain.
Although Novellus believes that the ultimate outcome of the dispute with
Applied will not have a material adverse effect on Novellus business,
financial condition, or results of operations (taking into account both the
defenses available to Novellus and Varians reimbursement and indemnity
obligations), there can be no assurances that Applied will not ultimately
prevail in this dispute and that, in such an event, Varians reimbursement and
indemnity obligations will not be sufficient to fully reimburse Novellus for
its losses. If Applied were to prevail in this dispute, it could have a
material adverse effect on Novellus business, financial condition, or results
of operations.

The Novellus Complaint against Applied also includes requests for damages for
prior infringement and treble damages for willful infringement, in addition
to a request for a permanent injunction for further infringement. Novellus
believes that this litigation will not have a material adverse impact
on Novellus
financial condition or results of operations, however, there can be
no assurances that Novellus will prevail against Applied. If
Applied were to prevail against Novellus, it could have a material adverse
impact on Novellus business, financial condition, or results of operations.

Semitool Litigation I

On August 10, 1998, Semitool sued the Company for patent infringement in the
United States District Court for the Northern District of California (the
District Court). Semitool alleges that the Companys SABRE and SABRE xT
copper deposition systems infringe two Semitool patents, U.S. Patent No.
5,222,310 (the 310 patent), issued June 29, 1993, entitled Single Wafer
Processor with a Frame, and U.S. Patent No. 5,377,708 (the 708 patent),
issued January 3, 1995, entitled Multi-Station Semiconductor Processor with
Volatilization. Semitool seeks an injunction against the Companys
manufacture and sale of the SABRE and SABRE xT systems, and seeks damages
for past infringement. Semitool also seeks treble damages for alleged willful
infringement. Semitool further seeks its attorneys fees and costs, and
interest on any judgment.

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On September 24, 1999, the District Court ruled on the interpretation of the
claims of the 310 and 708 patents. On December 18, 1999, the Company filed a
motion for summary judgment of non-infringement.

On March 17, 2000, the District Court granted the Companys motion for summary
judgment of non-infringement. The District Court ruled that the Companys
SABRE and SABRE xT systems do not infringe the 310 and 708 patents.

On May 15, 2000, Semitool filed a notice of appeal, appealing the District
Courts judgment to the United States Court of Appeals for the Federal Circuit
(the Federal Circuit). On June 8, 2001, the Federal Circuit affirmed the
District Courts judgment that the Companys SABRE and SABRE xT systems do
not infringe the 310 and 708 patents.

On September 6, 2001, Semitool filed a petition for writ of certiorari with the
United States Supreme Court to review the judgment of the Federal Circuit. On
October 10, 2001, the Company filed an opposition to Semitools petition for
writ of certiorari. On October 24, 2001, Semitool filed a reply memorandum
responding to the Companys opposition.

Novellus believes that this litigation will not
have a material adverse impact on Novellus financial condition
or results of operations, however, there can be no assurances that
Novellus will prevail against Semitool. If
Semitool were to prevail against Novellus, it could have a material adverse
impact on Novellus business, financial condition, or results of operations.

Semitool Litigation II

On June 11, 2001, Semitool sued the Company for patent infringement in the
United States District Court for the District of Oregon. Semitool alleges that
the Company infringes Semitools U.S. Patent No. 6,197,181, issued March 6,
2001, entitled Apparatus and Method for Electrolytically Depositing a Metal on
a Microelectronic Workpiece. Semitool seeks an injunction against the Company
and damages for past infringement. Semitool also seeks treble damages for
alleged willful infringement. Semitool further seeks its attorneys fees and
costs, and interest on any judgment.

On November 13, 2001, the Company countersued Semitool for patent infringement
in the United States District Court for the District of Oregon. The Company
alleges that Semitool infringes the Companys U.S. Patent Nos. 6,179,983,
issued January 30, 2001 and entitled Method and Apparatus for Treating Surface
Including Virtual Anode; 6,162,344, issued December 19, 2000 and entitled
Method of Electroplating Semiconductor Wafer Using Variable Currents and Mass
Transfer to Obtain Uniform Plated Layer; 6,110,346, issued August 29, 2000 and
also entitled Method of Electroplating Semiconductor Wafer Using Variable
Currents and Mass Transfer to Obtain Uniform Plated Layer; and 6,074,544,
issued June 13, 2000 and also entitled Method of Electroplating Semiconductor
Wafer Using Variable Currents and Mass Transfer to Obtain Uniform Plated
Layer. The Company seeks an injunction against Semitool and damages for past
infringement. The Company also seeks treble damages for willful infringement
by Semitool. The Company further seeks its attorneys fees and costs, and
interest on any judgment.

Although it is inherently difficult to assess the outcome of litigation matters
when the litigation is in such an early stage, Novellus believes that
this litigation will
not have a material adverse impact on Novellus financial
condition or results of operations; however, there can be no
assurances that Novellus will prevail against Semitool. If Semitool were to prevail against
Novellus, it could have a material adverse impact on Novellus business,
financial condition, or results of operations.

Plasma Physics Litigation

On December 28, 1999, Plasma Physics Corporation and Solar Physics Corporation
(collectively, Plasma Physics) filed a patent infringement lawsuit against
many of the Companys Japanese and Korean customers. The suit was entitled
Plasma Physics and Solar Physics v. Fujitsu et al., Civil Action No. 99-8593,
and was pending in the United States District Court for the Eastern District of
New York. On July 24, 2000, the Court ordered Plasma Physics to re-file
separate complaints against the Japanese and Korean defendants, whereupon,
Civil Action No. 99-8593 would be dismissed without prejudice. In accordance
with the Courts order, Plasma Physics re-filed separate complaints against the
Japanese and Korean defendants in the United States District Court for the
Eastern District of New York. Many of the defendants notified the Company that
they believed that the Company had indemnification obligations and liability
for the lawsuits.

Plasma Physics asserted U.S. Patent Nos. 4,226,897, 5,470,784, and/or 5,543,634
(the 897, 784, and 634 patents, respectively) against the defendants.
Plasma Physics sought an injunction against the defendants alleged
infringement of the 784 and 634 patents (the 897 patent had expired).
Plasma Physics also sought treble damages for alleged willful

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infringement. Plasma Physics further sought its attorneys fees and costs, and
interest on any judgment. All of the Japanese and Korean defendants who are or
were customers of the Company have since settled with Plasma Physics.

On June 1, 2000, the Company filed a declaratory relief action against Plasma
Physics and Solar Physics requesting a judgment of non-infringement,
invalidity, and unenforceability with respect to the 897 and 784 patents.
The suit is entitled Novellus v. Plasma Physics and Solar Physics, Civil Action
No. 00-3146, and is pending in the United States District Court for the Eastern
District of New York. On June 30, 2000, Plasma Physics filed a motion to
dismiss the Companys complaint for a lack of subject matter jurisdiction.
Plasma Physics motion to dismiss the Companys complaint was denied without
prejudice on July 24, 2000. On July 31, 2000, Plasma Physics filed an Answer
and Conditional Counterclaim. Plasma Physics denies that the 897 and 784
patents are invalid and unenforceable. Plasma Physics further denies that the
784 patent is not infringed by the Company. Plasma Physics also asserted a
conditional counterclaim against the Company, alleging that the Companys PECVD
processing systems infringe the 784 patent.

On June 12, 2001, the United States Patent and Trademark Office issued to
Plasma Physics U.S. Patent No. 6,245,648, entitled Method of Forming
Semiconducting Materials and Barriers (the 648 Patent). On June 13, 2001,
Plasma Physics sent a letter to the Company, indicating that it may sue the
Companys customers for their alleged infringement of the 648 Patent.

Novellus believes that this litigation will not
have a material adverse impact on Novellus financial condition
or results of operations, however,
there can be no assurances that Novellus will prevail against
Plasma Physics. If Plasma Physics were to prevail against Novellus, it could
have a material adverse impact on Novellus business, financial condition, or
results of operations.

Other Litigation

In addition, in the normal course of business, Novellus from time to time
receives inquiries with regard to possible other patent infringements.
Novellus believes it is unlikely that the outcome of the patent infringement
inquiries will have a material adverse effect on Novellus financial position
or results of operations.

There has been substantial litigation regarding patent and other intellectual
property rights in semiconductor related industries. Although Novellus is not
aware of any significant claim of infringement by its products of any patents
or proprietary rights of others except as claimed by Applied, Semitool, and
Plasma Physics, further commercialization of Novellus products could provoke
claims of infringement from third parties. In the future, litigation may be
necessary to enforce patents issued to Novellus, to protect trade secrets or
know-how owned by Novellus or to defend Novellus against claimed infringement
of the rights of others and to determine the scope and validity of the
proprietary rights of others. Any such litigation could result in substantial
cost and diversion of effort by Novellus, which by itself could have a material
adverse effect on Novellus financial condition and operating results.
Further, adverse determinations in such litigation could result in Novellus
loss of proprietary rights, subject Novellus to significant liabilities to
third parties, require Novellus to seek licenses from third parties or prevent
Novellus from manufacturing or selling its products, any of which could have a
material adverse effect on Novellus business, financial condition or results
of operations.

Novellus is a defendant or plaintiff in various actions that arose in the
normal course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on
Novellus business, financial condition, or results of operations.

NOTE 7 COMMITMENTS

Novellus leases nearly all of its facilities under operating leases, including
synthetic leases, which expire at various dates through 2010. A synthetic
lease is a form of operating lease wherein a third party lessor funds 100% of
the acquisition and construction costs relating to one or more properties to be
leased to a lessee. The lessor is the owner of the leased property and must
provide at least 3% of the required funds in the form of at-risk equity. The
lessor generally borrows the balance of the funds necessary to fund the
acquisition and construction. Under certain of Novellus synthetic lease
agreements, the Company is obligated to lend approximately 87% of the cost of
the leased asset to the lessor upon completion of construction. The leases
with this requirement are known as defeased or self-funded transactions.
Additionally, Novellus synthetic leases require the Company to maintain
collateral for the benefit of the lessor.

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San Jose, California

The San Jose lease agreement covers 13 properties including land located in and
around San Jose, California, including manufacturing, research and development,
and administrative facilities, as well as Novellus corporate headquarters.
The lease has a term of five years beginning in September 2001 and includes
properties which had a total aggregate fair value of approximately $294.6
million in September 2001, assuming full completion. The lease agreement
requires the lessor to provide 3% at-risk equity throughout the term of the
lease. Approximately 97% of the lessors financing was in the form of debt,
including $244.7 million which was loaned by Novellus. The Companys
receivable from the lessor is included in notes receivable in the accompanying
consolidated balance sheet. Novellus has also provided $47.8 million in
collateral to cover the remainder of the lessors financing. Of this amount,
$13.5 million is held by the lessor and $34.3 million is held by a collateral agent unrelated to the
lessor.

Under the lease agreement, Novellus has the right to purchase the properties at
any time prior to the expiration date of the lease for an amount that equals
the total lease financing amount plus any current rent due and payable. At the
end of the lease term, Novellus may renew the lease for up to three additional
years (with the lessor's consent), refinance the lease, purchase the properties under a purchase option, or
arrange to sell the properties to a third party. If Novellus chooses the sale
option, it will be obligated to the lessor under a residual value guarantee for
market value declines in the value of the facility as of the date of the sale.
The aggregate residual value guarantee related to the San Jose properties is
approximately $259.4 million, assuming full completion. At December 31, 2001,
the residual value guarantee represents an off-balance sheet contingent
liability, for which Novellus does not believe that it has any significant
exposure.

Rent payments under the lease agreement are based on the net outstanding lease
balance which includes the cost of the leased properties less the amount
defeased by the Company multiplied by the London Interbank Offer Rate (LIBOR)
plus an applicable margin. As of December 31, 2001, the net outstanding lease
balance and the amount defeased by Novellus was $278.9 million and $244.7
million respectively. Rent expense and interest income on the defeased portion
of the lease balance include $2.7 million of imputed interest at a rate of 3%
to 4% for the period from lease inception to December 31, 2001. Novellus
lease receivable from the lessor is non-interest bearing and is
repayable in full only
if the Company chooses the sale option at the end of the lease term and
successfully sells the properties for amounts in excess of the cost. Novellus
collateral is available to the lessor upon default, with certain
exceptions.

Tualatin, Oregon

On April 18, 2001, Novellus entered into a synthetic lease agreement for the
development of a manufacturing, research and development, and administrative
facility to be constructed on 23 acres of land owned by Novellus in Tualatin,
Oregon. The land has been leased to the lessor for 50 years. Under the
Tualatin agreement, the lessor has agreed to finance a maximum of $170.0
million to develop the facility. During the construction phase, the costs of
construction, including the interest on outstanding lease balances are
capitalized into the financing facility. Novellus is required to provide
treasury bills as collateral equal to 111% of the outstanding lease balance as
security for its obligations under the lease. At December 31, 2001, collateral
of $82.1 million was held by the lessor. The collateral is interest bearing at
a market rate of interest, which was 2.27% at December 31, 2001. The lessors
ability to take possession of the collateral, which is on deposit with a third
party custodian, is subject to provisions in the lease.

Upon completion of construction, the Company is obligated to defease 86% of the
outstanding lease balance in the form of a non-interest bearing loan to the
lessor and to provide cash collateral for the remaining 14%. Both the lease
receivable and the collateral will be classified as noncurrent assets. Rent
payments, based on the net outstanding lease balance are expected to begin in
May 2002 upon completion of construction. Rent expense and interest income
will be imputed on the defeased portion of the lease.

Novellus has the right to purchase the property at any time prior to the
expiration date of the lease for an amount that equals the total lease
financing amount plus any current rent amount due and payable. At the end of
the five-year lease term, Novellus may renew the lease for up to three
additional years (with the lessor's consent), purchase the property under its purchase option for an amount
equal to the total lease financing amount, or arrange to sell the property to a
third party. If Novellus chooses the sale option, it will be obligated to the
lessor under a residual value guarantee for market value declines in the value
of the property as of

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the date of sale of up to $146.2 million. During construction, Novellus
maximum obligation to the lessor is generally limited to 89.9% of the
construction costs incurred to date.

Summary information about Novellus synthetic lease arrangements is as follows
as of December 31, 2001 (currency amounts in thousands):

|             |  |            |    |             |  |               |         |           |  |            |         |                |  |   |         |  |  |   |         |  |  |   |         | 
|------------ |  | ---------- | -- | ----------- |  | ------------- | ------- | --------- |  | ---------- | ------- | -------------- |  | - | ------- |  |  | - | ------- |  |  | - | ------- | 
|Property     |  | Number of  |    | Total Lease |  | Novellus      |         | Net Lease |  | Collateral |         | Residual Value
|Location     |  | Properties |    | Financing   |  | Participation |         | Financing |  | Value      |         | Guarantee     
|             |  |            |    |             |  |               |         |           |  |            |         |               
|San Jose, CA |  |            | 13 |             |  | $             | 291,249 |           |  | $          | 244,673 |                |  | $ | 46,576  |  |  | $ | 47,809  |  |  | $ | 259,400 | 
|Tualatin, OR |  |            | 1  |             |  |               | 75,705  |           |  |            |        |                |  |   | 75,705  |  |  |   | 82,092  |  |  |   | 68,059  | 
|             |  |            |    |             |  |               |         |           |  |            |         |                |  |   |         |  |  |   |         |  |  |   |         | 
|             |  |            | 14 |             |  | $             | 366,954 |           |  | $          | 244,673 |                |  | $ | 122,281 |  |  | $ | 129,901 |  |  | $ | 327,459 | 
|             |  |            |    |             |  |               |         |           |  |            |         |                |  |   |         |  |  |   |         |  |  |   |         | 

The following table summarizes Novellus future minimum lease payments under
all noncancelable operating leases, including synthetic leases and future
sublease income under noncancelable subleases. Amounts payable under the
synthetic leases exclude any payments under residual value guarantees and
relate only to the net lease financing amounts. In addition, payments under
the synthetic leases are subject to changes in LIBOR and have been included in
the table using interest rates as of December 31, 2001(in thousands):

|                             |  |   |         |  
|---------------------------- |  | - | ------- | -
|2002                         |  | $ | 7,979   |  
|2003                         |  |   | 7,945   |  
|2004                         |  |   | 7,265   |  
|2005                         |  |   | 7,006   |  
|2006                         |  |   | 5,441   |  
|Thereafter                   |  |   | 103     |  
|                             |  |   |         |  
|                             |  |   | 35,739  |  
|Less: future sublease income |  | $ | (35,054 | )
|                             |  |   |         |  
|Total minimum lease payments |  | $ | 685     |  
|                             |  |   |         |  

Rent expense was approximately $16.9 million, $20.1 million, and $20.4 million
for the years ended December 31, 2001, 2000, and 1999, respectively, net of
sublease income of $7.2 million, $8.1 million, and $3.0 million for the years
ended December 31, 2001, 2000, and 1999, respectively.

Restrictive Covenants

The synthetic lease agreements contain certain
restrictive covenants, which include quick ratio and tangible net
worth tests. The Company was in compliance with these covenants at
December 31, 2001. If the Company did not comply with these
covenants, the lessor could potentially terminate the leases,
resulting in an acceleration of the sale or purchase options.

NOTE 8 EMPLOYEE BENEFIT PLANS

Employee Stock Option Plans

Novellus grants options to employees under the 1992 Stock Option Plan (the
Plan). Under the Plan, options to purchase up to 33.3 million shares of
Novellus common stock may be granted at not less than fair market value.
Options generally vest ratably over a four-year period on the anniversary date
of the grant or as determined by the Board of Directors. Stock options expire
ten years after date of grant. At December 31, 2001, approximately 9.2 million
shares were reserved for future issuance under the Employee Stock Option Plan
and options to purchase 8.3 million shares were exercisable at a weighted
average exercise price of $19.68.

Novellus has adopted the disclosure-only provisions of SFAS 123, Accounting
for Stock-Based Compensation. Accordingly, no expense has been recognized for
options granted to employees under the Plan. SFAS 123 is applicable only to
options granted after December 31, 1995, and therefore, the pro forma effect is
not fully reflected until 1999.

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Had compensation expense for Novellus plan been determined based on the fair
value at the grant date for awards made subsequent to December 15, 1995,
consistent with the provisions of SFAS 123, the Companys net income and
earnings per share would have been reduced to the pro forma amounts indicated
below (in thousands, except per share data):

|                                       |  |      |         |      |  |      |         |  |  |   |        | 
|-------------------------------------- |  | ---- | ------- | ---- |  | ---- | ------- |  |  | - | ------ | 
|                                       |  | 2001 |         | 2000 |  | 1999
|                                       |  |      |         |      |  |     
|Net income as reported                 |  | $    | 144,470 |      |  | $    | 149,380 |  |  | $ | 68,707 | 
|Pro forma net income                   |  | $    | 75,992  |      |  | $    | 102,065 |  |  | $ | 46,150 | 
|Basic earnings per share as reported   |  | $    | 1.01    |      |  | $    | 1.10    |  |  | $ | 0.56   | 
|Diluted earnings per share as reported |  | $    | 0.97    |      |  | $    | 1.04    |  |  | $ | 0.54   | 
|Pro forma basic earnings per share     |  | $    | 0.53    |      |  | $    | 0.75    |  |  | $ | 0.38   | 
|Pro forma diluted earnings per share   |  | $    | 0.51    |      |  | $    | 0.71    |  |  | $ | 0.36   | 

In calculating pro forma compensation, the fair value of each option grant is
estimated on the date of grant using the Black-Scholes option-pricing model
with the following weighted-average assumptions for grants made in 2001, 2000,
and 1999:

|                        |  |           |  |           |  |          
|----------------------- |  | --------- |  | --------- |  | ---------
|                        |  | 2001      |  | 2000      |  | 1999     
|                        |  |           |  |           |  |          
|Dividend yield          |  | None      |  | None      |  | None     
|Expected volatility     |  | 0.85      |  | 0.83      |  | 0.73     
|Risk free interest rate |  | 4.1%      |  | 6.2%      |  | 5.6%     
|Expected lives          |  | 3.3 years |  | 3.3 years |  | 3.4 years

The weighted-average fair value of options granted during the year were $22.85,
$21.50, and $12.23 for 2001, 2000, and 1999, respectively.

The effects on pro forma disclosures of applying SFAS 123 are not likely to be
representative of the effects on pro forma disclosures of future years.

The pro forma net income and earnings per share listed above include expense
related to Novellus Employee Stock Purchase Plans. The fair value of issuance
under the employee stock purchase plans is estimated on the date of issuance
using the Black-Scholes model with the following weighted-average assumptions
for issuance made in 2001, 2000, and 1999:

|                        |  |          |  |          |  |         
|----------------------- |  | -------- |  | -------- |  | --------
|                        |  | 2001     |  | 2000     |  | 1999    
|                        |  |          |  |          |  |         
|Dividend yield          |  | None     |  | None     |  | None    
|Expected volatility     |  | 0.81     |  | 1.03     |  | 0.81    
|Risk free interest rate |  | 4.2%     |  | 6.4%     |  | 4.9%    
|Expected lives          |  | 1/2 year |  | 1/2 year |  | 1/2 year

The weighted average fair value of purchase rights granted during the year were
$16.76, $21.66 and $7.43 for 2001, 2000, and 1999, respectively.

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

|                             |                          |  |            |        |             |  |                 |        |                |   |                |                 |  |   |           |       | 
|---------------------------- | ------------------------ |  | ---------- | ------ | ----------- |  | --------------- | ------ | -------------- | - | -------------- | --------------- |  | - | --------- | ----- | 
|                             |                          |  |            |        |             |  |                 |        |                |   |                |                 |  |   | Weighted-
|                             |                          |  |            |        |             |  |                 |        |                |   |                |                 |  |   | Average  
|                             |                          |  | Authorized |        | Outstanding |  | Price per Share |        | Exercise Price
|                             |                          |  |            |        |             |  |                 |        |               
|Balance at December 31, 1998 |                          |  | 2,893      |        |             |  | 15,683          |        |                | $ | 2.88 -  $19.63 |                 |  | $ | 11.56     |      
|                             | Additional authorization |  |            | 4,200  |             |  |                 |       |                |   |                |                |  |   |           |      | 
|                             | Options granted          |  |            | (6,636 | )           |  |                 | 6,636  |                |   | $              | 15.77 -  $29.69 |  |   | $         | 23.21 | 
|                             | Options exercised        |  |            |       |             |  |                 | (3,699 | )              |   | $              | 2.88 -  $19.63  |  |   | $         | 9.62  | 
|                             | Options canceled         |  |            | 1,398  |             |  |                 | (1,398 | )              |   | $              | 6.06 -  $29.69  |  |   | $         | 15.89 | 
|                             |                          |  |            |        |             |  |                 |        |                |   |                |                 |  |   |           |      
|Balance at December 31, 1999 |                          |  | 1,855      |        |             |  | 17,222          |        |                | $ | 3.96 -  $29.69 |                 |  | $ | 16.11     |      
|                             | Additional authorization |  |            | 6,195  |             |  |                 |       |                |   |                |                |  |   |           |      | 
|                             | Options granted          |  |            | (5,022 | )           |  |                 | 5,022  |                |   | $              | 30.06 -  $58.94 |  |   | $         | 37.44 | 
|                             | Options exercised        |  |            |       |             |  |                 | (3,155 | )              |   | $              | 3.96 -  $25.56  |  |   | $         | 10.32 | 
|                             | Options canceled         |  |            | 1,095  |             |  |                 | (1,095 | )              |   | $              | 3.96 -  $58.94  |  |   | $         | 26.23 | 
|                             |                          |  |            |        |             |  |                 |        |                |   |                |                 |  |   |           |      
|Balance at December 31, 2000 |                          |  | 4,123      |        |             |  | 17,994          |        |                | $ | 3.96 -  $58.94 |                 |  | $ | 22.47     |      
|                             | Additional authorization |  |            | 12,122 |             |  |                 |       |                |   |                |                |  |   |           |      | 
|                             | Options granted          |  |            | (7,614 | )           |  |                 | 7,614  |                |   | $              | 28.00 -  $56.43 |  |   | $         | 39.85 | 
|                             | Options exercised        |  |            |       |             |  |                 | (2,506 | )              |   | $              | 3.96 -  $48.80  |  |   | $         | 14.04 | 
|                             | Options canceled         |  |            | 543    |             |  |                 | (543   | )              |   | $              | 5.89 -  $63.94  |  |   | $         | 32.64 | 
|                             |                          |  |            |        |             |  |                 |        |                |   |                |                 |  |   |           |      
|Balance at December 31, 2001 |                          |  | 9,174      |        |             |  | 22,559          |        |                | $ | 4.69 -  $86.42 |                 |  | $ | 29.04     |      
|                             |                          |  |            |        |             |  |                 |        |                |   |                |                 |  |   |           |      

The following table summarizes information about stock options outstanding at
December 31, 2001 (share information in thousands):

|                          |  |                     |        |                  |  |                |      |                |  |                |       |  |  |  |       |  |  |   |       | 
|------------------------- |  | ------------------- | ------ | ---------------- |  | -------------- | ---- | -------------- |  | -------------- | ----- |  |  |  | ----- |  |  | - | ----- | 
|Options Outstanding       |  | Options Exercisable
|                          |  |                    
|                          |  | Options             |        | Weighted-Average |  |                |      |                |  | Options        |       |  |  | 
|                          |  | Outstanding at      |        | Remaining        |  | Weighted-      |      | Exercisable at |  | Weighted-     
|Range of                  |  | December 31,        |        | Contractual Life |  | Average        |      | December 31,   |  | Average       
|Exercise Prices           |  | 2001                |        | (years)          |  | Exercise Price |      | 2001           |  | Exercise Price
|                          |  |                     |        |                  |  |                |      |                |  |               
|$4.69
          - $16.42  |  |                     | 5,412  |                  |  |                | 5.77 |                |  | $              | 12.32 |  |  |  | 4,554 |  |  | $ | 12.08 | 
|$16.67
          - $25.56 |  |                     | 4,922  |                  |  |                | 7.74 |                |  | $              | 23.96 |  |  |  | 2,387 |  |  | $ | 23.76 | 
|$25.56
          - $30.25 |  |                     | 3,637  |                  |  |                | 8.97 |                |  | $              | 29.95 |  |  |  | 849   |  |  | $ | 30.15 | 
|$30.65
          - $38.70 |  |                     | 5,958  |                  |  |                | 9.92 |                |  | $              | 38.50 |  |  |  | 74    |  |  | $ | 33.87 | 
|$40.69
          - $86.42 |  |                     | 2,630  |                  |  |                | 8.61 |                |  | $              | 50.27 |  |  |  | 464   |  |  | $ | 51.89 | 
|                          |  |                     |        |                  |  |                |      |                |  |                |       |  |  |  |       |  |  |   |       | 
|$4.69
          - $86.42  |  |                     | 22,559 |                  |  |                | 8.14 |                |  | $              | 29.04 |  |  |  | 8,328 |  |  | $ | 19.68 | 
|                          |  |                     |        |                  |  |                |      |                |  |                |       |  |  |  |       |  |  |   |       | 

Employee Stock Purchase Plans

In December 1988 and May 1992, Novellus adopted qualified Employee Stock
Purchase Plans (the Purchase Plans) under Sections 421 and 423 of the Internal Revenue Code and
reserved 1,200,000 and 900,000 shares of common stock for issuance under the
plans, respectively. In April 1998, the Board of Directors approved an
amendment to the Purchase Plan, which was subsequently ratified by shareholders
increasing the number of shares available for issuance thereunder from
2,100,000 shares to 2,850,000 shares. In April 1999, the Board of Directors
approved an amendment to the Purchase Plan, which was subsequently ratified by
shareholders increasing the number of shares available for issuance thereunder
from 2,850,000 shares to 3,900,000 shares. Under the two plans, qualified
employees are entitled to purchase shares at 85% of the fair market value on
specified dates. There were approximately 309,000, 237,000, and 433,000 shares
issued under the two plans in 2001, 2000, and 1999, respectively. At December
31, 2001, approximately 628,000 shares were reserved for future issuance under
the Employee Stock Purchase Plan.

Prior to the merger with GaSonics, a publicly held company, GaSonics adopted
the 1994 Employee Stock Purchase Plan. Participants in this plan were able to
purchase shares at 85% of the lower of the fair value of the common stock on
the

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participants entry date into the offering period or the fair market value on
the semi-annual purchase date. At December 31, 2000, 379,000 shares were
reserved for future issuance under this plan. There were approximately 49,000
and 89,000 shares issued under this plan in 2000 and 1999, respectively. Upon
the merger with GaSonics in January 2001, this plan was liquidated.

Common Stock Repurchase Program

Through December 1998, the Board of Directors approved plans to repurchase up
to 10,460,000 shares of common stock for issuance in future Company employee
benefit and compensation plans and other requirements. Through December 31,
1998, the Company had repurchased 4,731,000 shares. During 1999 and 2000, the
Company repurchased 122,000 and 20,000 shares under the program, and had
purchased a total of 4,873,000 shares as through December 31, 2000. In October
2000, Novellus and GaSonics announced that each of its Board of Directors had
rescinded its authorization for the purchase of common stock under the common
stock purchase program.

On September 19, 2001, Novellus announced that its board of directors authorized a
stock repurchase program of up to $500 million over the next two years. As of
December 31, 2001, no stock had been repurchased under this program.

Employee Savings and Retirement Plan

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

Before the merger with GaSonics, GaSonics maintained a 401(k) benefit plan
covering all employees meeting certain requirements. The plan included a
deferred compensation arrangement permitting elective contributions to be made
by the participants. Contributions made by GaSonics employees were at the
discretion of the GaSonics board of directors and were not material in 2000 and
1999. Upon consummation of the merger with GaSonics in January 2001, this plan
was liquidated.

NOTE 9 INCOME TAXES

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

|                                                                                                   |          |                                  |        |         |        |      |        |         |         |  |        |        |        | 
|-------------------------------------------------------------------------------------------------- | -------- | -------------------------------- | ------ | ------- | ------ | ---- | ------ | ------- | ------- |  | ------ | ------ | ------ | 
|                                                                                                   |          |                                  |        | 2001    |        | 2000 |        | 1999   
|                                                                                                   |          |                                  |        |         |        |      |        |        
|Federal                                                                                            |          |                                  |        |         |        |      |        |         |         |  |        |       
|                                                                                                   | Current  |                                  | $      | (40,645 | )      |      | $      | 92,781  |         |  | $      | 4,559  |       
|                                                                                                   | Deferred |                                  |        | 72,765  |        |      |        | (37,681 | )       |  |        | (4,193 | )     
|                                                                                                   |          |                                  |        |         |        |      |        |         |         |  |        |       
|                                                                                                   |          |                                  | 32,120 |         |        |      | 55,100 |         |         |  | 366    |       
|State                                                                                              |          |                                  |        |         |        |      |        |         |         |  |        |       
|                                                                                                   | Current  |                                  |        | 864     |        |      |        | 9,552   |         |  |        | 1,365  |       
|                                                                                                   | Deferred |                                  |        | 70      |        |      |        | (3,697  | )       |  |        | (201   | )     
|                                                                                                   |          |                                  |        |         |        |      |        |         |         |  |        |       
|                                                                                                   |          |                                  | 934    |         |        |      | 5,855  |         |         |  | 1,164  |       
|Foreign                                                                                            |          |                                  |        |         |        |      |        |         |         |  |        |       
|                                                                                                   | Current  |                                  |        | 6,816   |        |      |        | 9,794   |         |  |        | 9,426  |       
|Income tax benefits attributable to employee stock plan
activity allocated to shareholders equity |          |                                  | 25,037 |         |        |      | 40,247 |         |         |  | 20,544 |       
|                                                                                                   |          |                                  |        |         |        |      |        |         |         |  |        |       
|                                                                                                   |          | Total provision for income taxes |        | $       | 64,907 |      |        | $       | 110,996 |  |        | $      | 31,500 | 
|                                                                                                   |          |                                  |        |         |        |      |        |         |         |  |        |       

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Pre-tax income from foreign operations was approximately $15.0 million, $31.0
million, and $20.0 million in 2001, 2000, and 1999, respectively.

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of Novellus deferred tax assets and liabilities are as follows at December 31
(in thousands):

|                          |                                                 |                                                 |   |         |         |      |   |         |         | 
|------------------------- | ----------------------------------------------- | ----------------------------------------------- | - | ------- | ------- | ---- | - | ------- | ------- | 
|                          |                                                 |                                                 |   | 2001    |         | 2000
|                          |                                                 |                                                 |   |         |         |     
|Deferred tax assets:      |                                                 |                                                 |   |         |         |      |   |        
|                          | Financial valuation accounts                    |                                                 | $ | 16,542  |         |      | $ | 12,570  |        
|                          | Expenses not currently deductible               |                                                 |   | 41,402  |         |      |   | 25,916  |        
|                          | Capitalized in-process research and development |                                                 |   | 27,282  |         |      |   | 30,144  |        
|                          | Deferred profit                                 |                                                 |   | 22,729  |         |      |   | 95,009  |        
|                          | Other                                           |                                                 |   | 9,590   |         |      |   | 14,077  |        
|                          |                                                 |                                                 |   |         |         |      |   |        
|                          |                                                 | Total deferred tax assets                       |   |         | 117,545 |      |   |         | 177,716 | 
|                          | Valuation allowance                             |                                                 |   | (7,628  | )       |      |   | (10,728 | )      
|                          |                                                 |                                                 |   |         |         |      |   |        
|                          |                                                 | Deferred tax assets, net of valuation allowance |   |         | 109,917 |      |   |         | 166,988 | 
|Deferred tax liabilities: |                                                 |                                                 |   |         |         |      |   |        
|                          | Depreciation                                    |                                                 |   | (44,823 | )       |      |   | (29,059 | )      
|                          |                                                 |                                                 |   |         |         |      |   |        
|                          |                                                 | Total net deferred tax assets                   |   | $       | 65,094  |      |   | $       | 137,929 | 
|                          |                                                 |                                                 |   |         |         |      |   |        

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

|                                  |                                  |   |        |        |      |   |         |         |  |   |        |        | 
|--------------------------------- | -------------------------------- | - | ------ | ------ | ---- | - | ------- | ------- |  | - | ------ | ------ | 
|                                  |                                  |   | 2001   |        | 2000 |   | 1999   
|                                  |                                  |   |        |        |      |   |        
|Expected provision at 35%         |                                  | $ | 73,282 |        |      | $ | 122,557 |         |  | $ | 35,076 |       
|State tax, net of federal benefit |                                  |   | 2,886  |        |      |   | 8,307   |         |  |   | 1,750  |       
|Research and development credits  |                                  |   | (6,783 | )      |      |   | (6,490  | )       |  |   | (2,372 | )     
|Foreign sales corporation benefit |                                  |   | (7,328 | )      |      |   | (13,663 | )       |  |   | (1,338 | )     
|Valuation allowance decrease      |                                  |   | (3,100 | )      |      |   | (3,100  | )       |  |   | (3,100 | )     
|Other                             |                                  |   | 5,950  |        |      |   | 3,385   |         |  |   | 1,484  |       
|                                  |                                  |   |        |        |      |   |         |         |  |   |        |       
|                                  | Total provision for income taxes |   | $      | 64,907 |      |   | $       | 110,996 |  |   | $      | 31,500 | 
|                                  |                                  |   |        |        |      |   |         |         |  |   |        |       

NOTE 10 GEOGRAPHIC INFORMATION REPORTING AND MAJOR CUSTOMERS

Novellus operates in one segment as it manufactures, markets, and services
semiconductor processing equipment for the deposition of thin films within the
semiconductor equipment market, as well as equipment for preparing the device
surface prior to these deposition processes. Novellus is a supplier of high
productivity deposition and surface preparation systems used in the fabrication
of integrated circuits. All products and services are marketed within the
geographic regions in which the Company operates. Novellus operates as one
segment under SFAS 131, Disclosure about Segments of an Enterprise and Related
Information.

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

|                                       |                 |   |           |           |        |   |        |        |              |   |              |         |  |   |          |          |   |   |           |           | 
|-------------------------------------- | --------------- | - | --------- | --------- | ------ | - | ------ | ------ | ------------ | - | ------------ | ------- |  | - | -------- | -------- | - | - | --------- | --------- | 
|                                       |                 |   | North     |           |        |   |        |        | Pacific      |   |              |         |  |   |          |          |  
|                                       |                 |   | America   |           | Europe |   | Rim    |        | Eliminations |   | Consolidated
|                                       |                 |   |           |           |        |   |        |        |              |   |             
|2001                                   |                 |   |           |           |        |   |        |        |              |   |              |         |  |   |          |          |   |   |           |          
|Sales to unaffiliated customers        |                 | $ | 1,165,923 |           |        | $ | 7,425  |        |              | $ | 165,974      |         |  | $ |         |          |   | $ | 1,339,322 |          
|Transfers between geographic locations |                 |   | 84,257    |           |        |   | 16,185 |        |              |   | 33,347       |         |  |   | (133,789 | )        |   |   |          |          
|                                       |                 |   |           |           |        |   |        |        |              |   |              |         |  |   |          |          |   |   |           |          
|                                       | Total net sales |   |           | 1,250,180 |        |   |        | 23,610 |              |   |              | 199,321 |  |   |          | (133,789 | ) |   |           | 1,339,322 | 
|Operating income                       |                 | $ | 135,137   |           |        | $ | 2,170  |        |              | $ | 14,677       |         |  | $ |         |          |   | $ | 151,984   |          
|                                       |                 |   |           |           |        |   |        |        |              |   |              |         |  |   |          |          |   |   |           |          
|Long-lived assets                      |                 | $ | 172,494   |           |        | $ | 608    |        |              | $ | 4,499        |         |  | $ |         |          |   | $ | 177,601   |          
|All other identifiable assets          |                 |   | 2,737,365 |           |        |   | 5,475  |        |              |   | 89,221       |         |  |   |         |          |   |   | 2,832,061 |          
|                                       |                 |   |           |           |        |   |        |        |              |   |              |         |  |   |          |          |   |   |           |          
|                                       | Total assets    |   | $         | 2,909,859 |        |   | $      | 6,083  |              |   | $            | 93,720  |  |   | $        |         |   |   | $         | 3,009,662 | 
|                                       |                 |   |           |           |        |   |        |        |              |   |              |         |  |   |          |          |   |   |           |          
|2000                                   |                 |   |           |           |        |   |        |        |              |   |              |         |  |   |          |          |   |   |           |          
|Sales to unaffiliated customers        |                 | $ | 1,047,387 |           |        | $ | 9,726  |        |              | $ | 262,373      |         |  | $ |         |          |   | $ | 1,319,486 |          
|Transfers between geographic locations |                 |   | 158,258   |           |        |   | 13,387 |        |              |   | 33,994       |         |  |   | (205,639 | )        |   |   |          |          
|                                       |                 |   |           |           |        |   |        |        |              |   |              |         |  |   |          |          |   |   |           |          
|                                       | Total net sales |   |           | 1,205,645 |        |   |        | 23,113 |              |   |              | 296,367 |  |   |          | (205,639 | ) |   |           | 1,319,486 | 
|Operating income                       |                 | $ | 261,560   |           |        | $ | 1,827  |        |              | $ | 30,173       |         |  | $ | 274      |          |   | $ | 293,834   |          
|                                       |                 |   |           |           |        |   |        |        |              |   |              |         |  |   |          |          |   |   |           |          
|Long-lived assets                      |                 | $ | 137,972   |           |        | $ | 327    |        |              | $ | 10,083       |         |  | $ |         |          |   | $ | 148,382   |          
|All other identifiable assets          |                 |   | 1,894,053 |           |        |   | 6,200  |        |              |   | 158,314      |         |  |   | (1,475   | )        |   |   | 2,057,092 |          
|                                       |                 |   |           |           |        |   |        |        |              |   |              |         |  |   |          |          |   |   |           |          
|                                       | Total assets    |   | $         | 2,032,025 |        |   | $      | 6,527  |              |   | $            | 168,397 |  |   | $        | (1,475   | ) |   | $         | 2,205,474 | 
|                                       |                 |   |           |           |        |   |        |        |              |   |              |         |  |   |          |          |   |   |           |          
|1999                                   |                 |   |           |           |        |   |        |        |              |   |              |         |  |   |          |          |   |   |           |          
|Sales to unaffiliated customers        |                 | $ | 563,488   |           |        | $ | 3,587  |        |              | $ | 89,946       |         |  | $ |         |          |   | $ | 657,021   |          
|Transfers between geographic locations |                 |   | 33,682    |           |        |   | 10,601 |        |              |   | 19,409       |         |  |   | (63,692  | )        |   |   |          |          
|                                       |                 |   |           |           |        |   |        |        |              |   |              |         |  |   |          |          |   |   |           |          
|                                       | Total net sales |   |           | 597,170   |        |   |        | 14,188 |              |   |              | 109,355 |  |   |          | (63,692  | ) |   |           | 657,021   | 
|Operating income                       |                 | $ | 65,218    |           |        | $ | 639    |        |              | $ | 19,414       |         |  | $ | (291     | )        |   | $ | 84,980    |          
|                                       |                 |   |           |           |        |   |        |        |              |   |              |         |  |   |          |          |   |   |           |          
|Long-lived assets                      |                 | $ | 122,206   |           |        | $ | 223    |        |              | $ | 9,543        |         |  | $ |         |          |   | $ | 131,972   |          
|All other identifiable assets          |                 |   | 800,476   |           |        |   | 3,577  |        |              |   | 66,049       |         |  |   | (1,722   | )        |   |   | 868,380   |          
|                                       |                 |   |           |           |        |   |        |        |              |   |              |         |  |   |          |          |   |   |           |          
|                                       | Total assets    |   | $         | 922,682   |        |   | $      | 3,800  |              |   | $            | 75,592  |  |   | $        | (1,722   | ) |   | $         | 1,000,352 | 
|                                       |                 |   |           |           |        |   |        |        |              |   |              |         |  |   |          |          |   |   |           |          

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

For the year ended December 31, 2001, one customer accounted for 16% of
Novellus net sales. For the year ended December 31, 2000, two customers
accounted for 14% and 10% of Novellus net sales and in 1999, three customers
accounted for 16%, 12%, and 11% of the Companys net sales respectively.

NOTE 11 SPECIAL CHARGES

The components of special charges are as follows (in thousands):

|                                           |  |      |        |      |  |      |       |  |  |   |     | 
|------------------------------------------ |  | ---- | ------ | ---- |  | ---- | ----- |  |  | - | --- | 
|                                           |  | 2001 |        | 2000 |  | 1999
|                                           |  |      |        |      |  |     
|Restructuring and asset impairment charges |  | $    | 47,945 |      |  | $    |      |  |  | $ | 407 | 
|In-process research and development        |  |      |       |      |  |      | 6,000 |  |  |   |    | 
|Merger-related expenses                    |  |      | 13,161 |      |  |      |      |  |  |   |    | 
|                                           |  |      |        |      |  |      |       |  |  |   |     | 
|                                           |  | $    | 61,106 |      |  | $    | 6,000 |  |  | $ | 407 | 
|                                           |  |      |        |      |  |      |       |  |  |   |     | 

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Restructuring and Asset Impairment Charges

In September 2001, Novellus announced its intention to restructure its
operations, which was driven by the decline in Novellus orders due
to the  contraction of the semiconductor capital equipment market from
calendar year 2000 levels. During the third quarter of 2001, the restructuring
plan was approved by the appropriate level of management necessary to commit
the Company to its specific actions. The Company began implementing the plan
during the third quarter of 2001 and recorded restructuring and asset
impairment charges totaling
$55.0 million, of which $47.9 million is included in operating expense and $7.1
million is included in cost of sales. The restructuring charges
included $33.8 million related to vacated facilities,
$9.5 million related to abandoned assets associated with the
discontinuation of certain projects, and $4.6 million related to
the write-off of purchased technology. Additionally, the
discontinuation of certain projects resulted in $7.1 million of
inventory write-downs, which are included in cost of sales.

Below is a table summarizing activity relating to the September 2001 Plan (in
thousands):

|                                  |                       |   |            |        |          |   |         |        |                   |   |            |         |   |   |        |        | 
|--------------------------------- | --------------------- | - | ---------- | ------ | -------- | - | ------- | ------ | ----------------- | - | ---------- | ------- | - | - | ------ | ------ | 
|                                  |                       |   |            |        |          |   | Cash    |        | Non-cash          |   | Balance at
|                                  |                       |   | Provisions |        | Payments |   | Charges |        | December 31, 2001
|                                  |                       |   |            |        |          |   |         |        |                  
|Vacated facilities                |                       | $ | 33,818     |        |          | $ | (952    | )      |                   | $ | (6,017     | )       |   | $ | 26,849 |       
|Abandoned assets                  |                       |   | 9,495      |        |          |   | (1,745  | )      |                   |   | (7,750     | )       |   |   |       |       
|Write-off of purchased
technology |                       |   | 4,632      |        |          |   |        |        |                   |   | (4,632     | )       |   |   |       |       
|                                  |                       |   |            |        |          |   |         |        |                   |   |            |         |   |   |        |       
|                                  | Restructuring accrual |   |            | 47,945 |          |   | $       | (2,697 | )                 |   | $          | (18,399 | ) |   |        | 26,849 | 
|Discontinued inventory            |                       |   | 7,102      |        |          |   |        |        |                   |   | (7,102     | )       |   |   |       |       
|                                  |                       |   |            |        |          |   |         |        |                   |   |            |         |   |   |        |       
|                                  | Total                 |   | $          | 55,047 |          |   | $       | (2,697 | )                 |   | $          | (25,501 | ) |   | $      | 26,849 | 
|                                  |                       |   |            |        |          |   |         |        |                   |   |            |         |   |   |        |       

The charge for vacated facilities relates to rent obligations after the
abandonment of certain facilities currently under long-term operating lease
agreements. When applicable, anticipated future sublease income relating to
vacated buildings has been offset against the charge for the remaining lease
payments. All leasehold improvements relating to the vacated buildings which
have no future economic benefit have been abandoned. Additionally, certain
fixed assets associated with these facilities had no future economic benefit
and have been written off.

The charge for abandoned assets and discontinued inventory are associated with
programs exited by Novellus. The write-off of purchased technology relates to
technology that has been abandoned by the Company.

As of December 31, 2001, significantly all actions under the restructuring plan
have been achieved except for future rent obligations related to vacated
facilities. The remaining $26.8 million balance of the restructuring accrual
is for future rent obligations which are to be paid in cash over the
next five years.

The twelve-month period ended December 31, 1999 included pre-tax charges of
approximately $0.5 million related to costs associated with reductions in force
and the facility consolidations of GaSonics. At December 31, 2000, all
expenses related to these accruals had been paid.

Merger-Related Expense

During the first quarter of 2001, Novellus incurred merger costs related to the
acquisition of GaSonics of $13.2 million. These costs included professional
fees, financial printing, and other related costs. Additionally, these costs
included charges related to the cancellation of various contracts and the
write-off of certain redundant assets. At December 31, 2001, all expenses
related to these accruals had been paid.

In-Process Research and Development

The twelve month period ended December 31, 2000 included a pre-tax charge to
operations in connection with the acquisition of Gamma Precision Technology
(GPT) of $6.0 million for the write-off of in-process research and
development that had not reached technological feasibility and, in managements
opinion, had no alternative future use. The one-time charge is reflected in
Novellus consolidated statement of operations as in-process research and
development within operating expenses.

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NOTE 12 BAD DEBT WRITE-OFF

In September 2001, Novellus determined that due to the financial difficulties
facing one of its customers, an outstanding accounts receivable balance was at
risk for collection. Accordingly, Novellus recorded a write-off of $7.7
million.

NOTE 13 ACQUISITION OF GAMMA PRECISION TECHNOLOGY

On September 13, 2000, GaSonics completed their acquisition of Gamma Precision
Technology (GPT), a global supplier of products and services used in the
fabrication of advanced integrated circuits. GaSonics issued 340,900 (share
count adjusted for the merger exchange ratio of 0.52 Novellus share for
GaSonics share) shares of common stock and paid approximately $21.5 million in
cash in exchange for all outstanding GPT common stock, preferred stock,
warrants and vested options. In addition, GaSonics assumed all unvested options.
The total cost of the acquisition, including transaction costs, was
approximately $34.9 million.

The acquisition was accounted for as a purchase business combination, and the
results of GPT from the date of acquisition forward have been recorded in
Novellus consolidated financial statements. In connection with the
acquisition, net tangible assets of $10.4 million were acquired, of which $6.0
million is reflected as a one time charge to operations for the write-off of
in-process research and development that had not reached technological
feasibility and, in managements opinion, had no probable alternative future
use. The one-time charge is reflected in Novellus consolidated statement of
operations as in-process research and development within operating expenses.
The remaining intangible assets of $24.5 million are included in other assets
in the accompanying balance sheet and are being amortized over the useful life
of seven years.

The value assigned to acquired in-process research and development was
determined by identifying research projects in areas for which technological
feasibility had not been established. This was determined by estimating the
cost to develop the acquired in-process technology into commercially viable
products, estimating the resulting net cash flows from such projects, and
discounting the net cash flows back to their present values. The discount rate
includes a factor that takes into account the uncertainty surrounding the
successful development of the acquired in-process technology. If these
projects are not successfully developed, future revenue and profitability of
GPT products may be adversely affected. There can be no assurance that the
value of the other purchased intangible assets may not become impaired prior to
their amortization.

The purchase price was allocated to the fair market value of net assets as
acquired as follows (in thousands):

|                                                           |                     |   |        |        | 
|---------------------------------------------------------- | ------------------- | - | ------ | ------ | 
|Cash                                                       |                     | $ | 928    |       
|Accounts receivable                                        |                     |   | 4,175  |       
|Inventory                                                  |                     |   | 1,770  |       
|Property and equipment                                     |                     |   | 271    |       
|Other assets                                               |                     |   | 30     |       
|Intangibles, including in-process research and development |                     |   | 30,491 |       
|Accounts payable and accrued liabilities                   |                     |   | (2,794 | )     
|                                                           |                     |   |        |       
|                                                           | Net assets acquired |   | $      | 34,871 | 
|                                                           |                     |   |        |       

The following unaudited pro forma condensed consolidated statements of
operations has been prepared as if the acquisition was consummated as of
January 1, 1999 and does not include the $6.0 million in-process research and
development charge.

|                                              |  |                     |           |      |  |   |         | 
|--------------------------------------------- |  | ------------------- | --------- | ---- |  | - | ------- | 
|                                              |  | Twelve months ended
|                                              |  | December 31,       
|                                              |  |                    
|(In thousands, except per share data)         |  | 2000                |           | 1999
|                                              |  |                     |           |     
|Revenue                                       |  | $                   | 1,329,581 |      |  | $ | 657,590 | 
|Net income (loss)                             |  |                     | 153,288   |      |  |   | 63,836  | 
|Net income per share-basic                    |  | $                   | 1.13      |      |  | $ | 0.52    | 
|Net income per share-diluted                  |  | $                   | 1.07      |      |  | $ | 0.50    | 
|Weighted average common shares-basic          |  |                     | 135,728   |      |  |   | 122,261 | 
|Weighted average common and common equivalent |  |                     | 143,654   |      |  |   | 127,826 | 

64



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NOTE 14 RELATED PARTY TRANSACTIONS

One customer represented 16%, 14%, and 11% of
Novellus sales during the years ended December 31, 2001,
2000, and 1999, respectively. A member of Novellus board of directors also serves on the board of
directors of this customer, and therefore, the customer is considered a related
party.

NOTE 15 QUARTERLY FINANCIAL DATA (UNAUDITED)

|                                              |  |                              |         |         |  |         |         |            |  |   |         |   |  |   |         | 
|--------------------------------------------- |  | ---------------------------- | ------- | ------- |  | ------- | ------- | ---------- |  | - | ------- | - |  | - | ------- | 
|                                              |  | Year ended December 31, 2001
|                                              |  |                             
|                                              |  | First                        |         | Second  |  | Third   |         | Fourth    
|(In thousands, except per share data)         |  | Quarter                      |         | Quarter |  | Quarter |         | Quarter(1)
|                                              |  |                              |         |         |  |         |         |           
|Net sales                                     |  | $                            | 458,705 |         |  | $       | 376,899 |            |  | $ | 303,687 |   |  | $ | 200,031 | 
|Gross profit                                  |  | $                            | 254,985 |         |  | $       | 199,624 |            |  | $ | 140,138 |   |  | $ | 96,604  | 
|Net income (loss)                             |  | $                            | 82,102  |         |  | $       | 59,221  |            |  | $ | (14,019 | ) |  | $ | 17,166  | 
|Basic earnings (loss) per share               |  | $                            | 0.58    |         |  | $       | 0.42    |            |  | $ | (0.10   | ) |  | $ | 0.12    | 
|Diluted earnings (loss) per share             |  | $                            | 0.55    |         |  | $       | 0.40    |            |  | $ | (0.10   | ) |  | $ | 0.12    | 
|Shares used in basic per share calculations   |  |                              | 141,009 |         |  |         | 142,267 |            |  |   | 143,218 |   |  |   | 143,354 | 
|Shares used in diluted per share calculations |  |                              | 148,108 |         |  |         | 149,643 |            |  |   | 143,218 |   |  |   | 148,459 | 

|                                                                                        |                                   |         |                              |         |        |         |         |         |        |   |         |        |  |   |         |        | 
|--------------------------------------------------------------------------------------- | --------------------------------- | ------- | ---------------------------- | ------- | ------ | ------- | ------- | ------- | ------ | - | ------- | ------ |  | - | ------- | ------ | 
|                                                                                        |                                   |         | Year ended December 31, 2000
|                                                                                        |                                   |         |                             
|                                                                                        |                                   |         | First                        |         | Second |         | Third   |         | Fourth
|(In thousands, except per share data)                                                   |                                   | Quarter |                              | Quarter |        | Quarter |         | Quarter
|                                                                                        |                                   |         |                              |         |        |         |         |         |       
|Net sales                                                                               |                                   | $       | 219,958                      |         |        | $       | 363,963 |         |        | $ | 292,889 |        |  | $ | 442,676 |       
|Gross profit                                                                            |                                   | $       | 117,165                      |         |        | $       | 201,981 |         |        | $ | 158,581 |        |  | $ | 253,166 |       
|Net income before cumulative effect of a
change in accounting principle                 |                                   | $       | 23,817                       |         |        | $       | 78,211  |         |        | $ | 43,284  |        |  | $ | 93,856  |       
|Cumulative effect of a change in accounting
principle, net of tax                       |                                   | $       | (89,788                      | )       |        |         |        |         |        |   |        |        |  |   |        |       
|                                                                                        | Net income (loss)                 |         | $                            | (65,971 | )      |         | $       | 78,211  |        |   | $       | 43,284 |  |   | $       | 93,856 | 
|Basic earnings per share before cumulative
effect of a change in accounting principle   |                                   | $       | 0.19                         |         |        | $       | 0.58    |         |        | $ | 0.31    |        |  | $ | 0.67    |       
|Cumulative effect of a change in accounting
principle                                   |                                   | $       | (0.70                        | )       |        |         |        |         |        |   |        |        |  |   |        |       
|                                                                                        | Basic earnings (loss) per share   |         | $                            | (0.51   | )      |         | $       | 0.58    |        |   | $       | 0.31   |  |   | $       | 0.67   | 
|Diluted earnings per share before cumulative
effect of a change in accounting principle |                                   | $       | 0.17                         |         |        | $       | 0.54    |         |        | $ | 0.30    |        |  | $ | 0.64    |       
|Cumulative effect of a change in accounting
principle                                   |                                   | $       | (0.65                        | )       |        |         |        |         |        |   |        |        |  |   |        |       
|                                                                                        | Diluted earnings (loss) per share |         | $                            | (0.48   | )      |         | $       | 0.54    |        |   | $       | 0.30   |  |   | $       | 0.64   | 
|Shares used in basic per share calculations                                             |                                   |         | 128,245                      |         |        |         | 135,759 |         |        |   | 138,939 |        |  |   | 140,032 |       
|Shares used in diluted per share calculations                                           |                                   |         | 137,076                      |         |        |         | 144,249 |         |        |   | 147,121 |        |  |   | 146,023 |       



---

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

65



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REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Shareholders
Novellus Systems, Inc.

We have audited the accompanying consolidated balance sheets of Novellus
Systems, Inc. as of December 31, 2001 and 2000, and the related consolidated
statements of operations, shareholders equity, and cash flows for each of the
three years in the period ended December 31, 2001. Our audits also included
the financial statement schedule listed in the index at Item 14(a)(2). The
consolidated financial statements give retroactive effect to the merger of
Novellus Systems, Inc. and GaSonics International on January 10, 2001, which
has been accounted for using the pooling of interests method as described in
the notes to the consolidated financial statements. These financial statements
and schedule are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits. We did not audit the financial statements of
GaSonics International, which statements reflect total assets constituting 9%
in 2000, and total net sales constituting 11% in 2000 and 10% in 1999 of the
related consolidated totals. Those statements were audited by other auditors
whose report has been furnished to us, and our opinion, insofar as it relates
to the data included for GaSonics International, is based solely on the report
of the other auditors.

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

In our opinion, based on our audits and the report of the other auditors, the
financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Novellus Systems, Inc. at
December 31, 2001 and 2000, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December 31,
2001, in conformity with accounting principles generally accepted in the United
States. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
present fairly in all material respects the information set forth therein.

As discussed in Note 1 to the consolidated financial statements, in 2000, the
Company changed its method of accounting for revenue recognition in accordance
with guidance provided in SEC Staff Accounting Bulletin No. 101 (SAB 101),
Revenue Recognition in Financial Statements.

/s/ ERNST & YOUNG LLP

San Jose, California
January 20, 2002

66



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##### Table of Contents






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

Not applicable.




PART III




ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this item is included under Proposal No. 1:
Election of Directors, Other Information - Executive Officers and
Compliance with Section 16(a) of the Exchange Act in Novellus Proxy
Statement to be filed in connection with its 2002 Annual Meeting of
Shareholders and is incorporated herein by reference.




ITEM 11. EXECUTIVE COMPENSATION

The information required by this item is included under Other Information -
Executive Compensation in Novellus Proxy Statement to be filed in connection
with its 2002 Annual Meeting of Shareholders and is incorporated herein by
reference.




ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this item is included under Other Information -
Security Ownership of Certain Beneficial Owners and Management in Novellus
Proxy Statement to be filed in connection with its 2002 Annual Meeting of
Shareholders and is incorporated herein by reference.




ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this item is included under Other Information -
Certain Transactions in Novellus Proxy Statement to be filed in connection
with its 2002 Annual Meeting of Shareholders and is incorporated herein by
reference.

67



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##### Table of Contents






PART IV




ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

|    |  |                                                           |  |                                                                                                                                                          |  |   
|--- |  | --------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --
|(a) |  | The following documents are filed as part of this report: | 
|   
|    |  | (1)                                                       |  | Financial Statements and Report of Ernst & Young LLP,
Independent Auditors                                                                               |  |   
|   
|    |  |                                                           |  | Consolidated Statements of Operations - Years Ended
December 31, 2001, 2000, and 1999                                                                    |  | 41
|   
|    |  |                                                           |  | Consolidated Balance Sheets at December 31, 2001 and 2000                                                                                                |  | 42
|   
|    |  |                                                           |  | Consolidated Statements of Cash Flows - Years Ended December 31,
2001, 2000, and 1999                                                                    |  | 43
|   
|    |  |                                                           |  | Consolidated Statement of Shareholders Equity - Years Ended
December 31, 2001, 2000 and 1999                                                            |  | 44
|   
|    |  |                                                           |  | Notes to Consolidated Financial Statements                                                                                                               |  | 45
|   
|    |  |                                                           |  | Report of Ernst & Young LLP, Independent Auditors                                                                                                        |  | 66
|   
|    |  | (2)                                                       |  | Financial Statement Schedules.                                                                                                                           |  |   
|   
|    |  |                                                           |  | The following financial statement schedule is filed as part of
this Report on Form 10-K and should be read in conjunction with
the financial statements:
|   
|    |  |                                                           |  | Schedule II - Valuation and Qualifying Accounts                                                                                                          |  | 75
|   
|    |  |                                                           |  | All other schedules are omitted because they are not required or
the required information is included in the financial statements
or notes thereto.     
|   
|    |  | (3)                                                       |  | Exhibits (numbered in accordance with Item 601 of Regulation
S-K)                                                                                        |  |   

| |  |          |  |                                                                                                                                                                                                                                                                                   
| |  | -------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 3.1 (29) |  | Amended and Restated Articles
        of Incorporation of Registrant.                                                                                                                                                                                                             
| |  |          |  |                                                                                                                                                                                                                                                                                   
| |  | 3.2      |  | Form of Bylaws of Registrant
        as amended                                                                                                                                                                                                                                   
| |  |          |  |                                                                                                                                                                                                                                                                                   
| |  | 8.1 (30) |  | Written opinion regarding tax
        matters associated with the Liquid Yield Option Notes (LYONs),
        issued by Ernst & Young LLP, dated September 20,2001.                                                                                                             
| |  |          |  |                                                                                                                                                                                                                                                                                   
| |  | 10.1 (7) |  | Asset Purchase Agreement by
        and between Varian Associates, Inc. and Novellus dated May 7, 1997.                                                                                                                                                                           
| |  |          |  |                                                                                                                                                                                                                                                                                   
| |  | 10.2 (8) |  | First Amendment to Asset Purchase
        Agreement by and between Varian Associates, Inc. and Novellus dated June 20,
        1997.                                                                                                                                              
| |  |          |  |                                                                                                                                                                                                                                                                                   
| |  | 10.3 (9) |  | 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.

68



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##### Table of Contents



| |  |              |  |                                                                                                                                                                                                                                                        
| |  | ------------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 10.4 (10)    |  | Sublease (Portion of Unit 9, Palo Alto) by and between
Varian Associates, Inc. and Novellus dated May 7, 1997.                                                                                                                                         
|
| |  | 10.6 (11)    |  | Environmental Agreement by and between Varian Associates,
Inc. and Novellus dated May 7, 1997.                                                                                                                                                         
|
| |  | 10.7 (12)    |  | Cross License Agreement by and between Varian Associates,
Inc. and Novellus dated May 7, 1997.                                                                                                                                                         
|
| |  | 10.8 (13)    |  | Parts Supply Agreement by and between Varian Associates, Inc. and Novellus dated
May 7, 1997.                                                                                                                                                          
|
| |  | 10.9 (14)    |  | Settlement Agreement by and between Applied Materials, Inc. and Novellus dated
May 7, 1997. Confidential treatment has been granted with respect to portions of this Exhibit.                                                                          
|
| |  | 10.10 (15)   |  | Credit Agreement by and among ABN AMRO Bank, N.V., as agent, the lenders named
therein, and Novellus dated May 7, 1997.                                                                                                                                
|
| |  | 10.11 (16)   |  | Participation Agreement by and among Lease Plan North America, Inc. Novellus and
ABN AMRO Bank, N.V., as agent for the participations named therein, dated June 9, 1997.                                                                               
|
| |  | 10.11.1 (17) |  | Letter Amendment, dated June 20, 1997, to the Participation
Agreement by and among Lease Plan North America, Inc., Novellus and
ABN AMRO Bank, N.V., as agent for the participants named therein,
dated June 9, 1997.                                  
|
| |  | 10.11.2 (18) |  | Amendment no. 1, dated August 28, 1997, to the Participation
Agreement by and among Lease Plan North America, Inc., Novellus and
ABN AMRO Bank, N.V., as agent for the participants named therein,
dated June 9, 1997.                                 
|
| |  | 10.11.3 (19) |  | Amendment no. 2, dated September 26, 1997, to the
Participation Agreement by and among Lease Plan North America, Inc.,
Novellus and ABN AMRO Bank, N.V., as agent for the participants named
therein, dated June 9, 1997.                              
|
| |  | 10.12 (20)   |  | Amendment no. 1, dated August 28, 1997, to the Facility 2
Lease Agreement, Construction Deed of Trust With Assignment of Rents,
Security Agreement and Fixture Filing by and between Lease Plan North
America, Inc. and Novellus dated June 9, 1997.   
|
| |  | 10.13 (21)   |  | Amendment no. 2, dated September 26, 1997, to the
Facility 2 Lease Agreement, Construction Deed of Trust With
Assignment of Rents, Security Agreement and Fixture Filing by and
between Lease Plan North America, Inc. and Novellus dated June 9,
1997.
|
| |  | 10.13 (22)   |  | Amendment no. 1, dated September 26, 1997, to the
Facility 1 Lease Agreement, Deed of Trust With Assignment of Rents,
Security Agreement and Fixture Filing by and between Lease Plan North
America, Inc. and Novellus dated June 9, 1997.             
|
| |  | 10.14 (23)   |  | Participation Agreement by and among Lease Plan USA,
Inc., Novellus and ABN AMRO Bank, N.V., as agent for the participants
named therein, dated October 15, 1997.                                                                                      
|
| |  | 10.15 (24)   |  | Facility 1 Lease Agreement, Deed of Trust With Assignment
of Rents, Security Agreement and Fixture Filing by and between Lease
Plan USA, Inc. and Novellus dated October 15, 1997.                                                                     

69



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##### Table of Contents



| |   |              |  |                                                                                                                                                                                                                                    | 
| | - | ------------ |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
| |   | 10.16 (25)   |  | Facility 2 Lease
        Agreement, Construction Deed of Trust With Assignment of Rents, Security
        Agreement and Fixture Filing by and between Lease Plan USA, Inc. and Novellus
        dated October 15, 1997.           
|
| | * | 10.20 (2)    |  | Registrants
        Amended and Restated 1984 Stock Option Plan, together with forms of agreements
        thereunder.                                                                                                           
|
| | * | 10.21 (3)    |  | Registrants
        1992 Stock Option Plan, together with forms of agreements thereunder.                                                                                                                                        
|
| | * | 10.21.1 (29) |  | Form of Restated
        Stock Purchase Agreement dated December 16, 1999 between Novellus
        and Jeff Benzing, Wilbert van den Hoek and certain other employees of
        Novellus.                                        
|
| | * | 10.22 (4)    |  | Novellus
        1992 Employee Stock Purchase Plan.                                                                                                                                                                              
|
| | * | 10.23 (1)    |  | Form of Agent Indemnification
        Agreement and amendment thereto.                                                                                                                                                            
|
| | * | 10.25 (5)    |  | Employment Agreement
        dated June 15, 1992 between Novellus and Peter Hanley.                                                                                                                                               
|
| | * | 10.26 (6)    |  | Offer Letter Agreement
        dated November 1, 1993 between Novellus and Richard S. Hill.                                                                                                                                       
|
| | * | 10.27 (26)   |  | Employment Agreement
        dated October 1, 1998 between Novellus and Richard S. Hill.                                                                                                                                          
|
| | * | 10.27.1 (29) |  | Amendment dated
        December 16, 1999 to Employment Agreement between Novellus and Richard
        S. Hill.                                                                                                                   
|
| | * | 10.27.2 (29) |  | Restricted Stock
        Purchase Agreement dated December 16, 1999 between Novellus and Richard
        S. Hill.                                                                                                                 
|
| |   | 10.28 (27)   |  | First Amendment
        to Participation Agreement dated June 4, 1999.                                                                                                                                                            
|
| |   | 10.29 (28)   |  | Asset Purchase
        Agreement by and between Fairchild Technologies USA, Inc. and Novellus
        dated July 29, 1999.                                                                                                        
|
| | * | 10.30        |  | Employment Agreement
        dated January 12, 2001 between Novellus and Asuri Raghavan.                                                                                                                                          
|
| | * | 10.31        |  | GaSonics International
        Corporation 1994 Stock Option Plan, together with forms of agreements
        thereunder as assumed by Novellus.                                                                                   
|
| | * | 10.32        |  | Gamma Precision
        Technology, Inc. 1998 Stock Option Plan, together with forms of agreements
        thereunder as assumed by Novellus.                                                                                     
|
| | * | 10.33        |  | GaSonics International
        Corporation supplemental Stock Option Plan as assumed by Novellus.                                                                                                                                 
|
| | * | 10.34        |  | Form of Light Industrial
        Lease between Teachers Insurance and Annuity Association of America and
        the Registrant for office space at 2730 Junction Avenue, San Jose, California.                                   
|
| |   | 10.35 (32)   |  | Amendment
no. 2, dated April 13, 2001, to the Participation Agreement
by and among Lease Plan North America, Inc., Novellus, and ABN AMRO
Bank N.V., as agent for the participations named therein, dated
August 31, 1998.        
|
| |   | 10.36 (32)   |  | Amendment
no. 7, dated April 13, 2001, to the Participation Agreement
by and among Lease Plan North America, Inc., Novellus, and ABN AMRO
Bank N.V., as agent for the participations named therein, dated
October 15, 1997.       
|
| |   | 10.37 (32)   |  | Amendment
no. 2, dated April 13, 2001, to the Participation Agreement
by and among Lease Plan North America, Inc., Novellus, and ABN AMRO
Bank N.V., as agent for the participations named therein, dated
August 7, 1998.         
|
| |   | 10.38 (32)   |  | Amendment
no. 2, dated April 13, 2001, to the Participation Agreement
by and among Lease Plan North America, Inc., Novellus, and ABN AMRO
Bank N.V., as agent for the participations named therein, dated
June 9, 1997.           
|
| |   | 10.39 (32)   |  | Participation
Agreement by and among Lease Plan North America, Inc., Novellus, and
ABN AMRO Bank, N.V., as agent for the participations named therein,
dated April 13, 2001.                                                      
|
| |   | 10.40 (32)   |  | Participation
Agreement by and among Lease Plan North America, Inc., Novellus, and
ABN AMRO Bank, N.V., as agent for the participations named therein,
dated April 18, 2001.                                                      
|
| |   | 10.41 (32)   |  | Novellus System,
Inc. 2001 Stock Incentive Plan, dated May 11, 2001, together with
forms of agreements thereunder.                                                                                                                
|
| |   | 10.42 (33)   |  | Participation
Agreement by and among Novellus Systems, Inc., ABN AMRO Leasing,
Inc., Novellus Investment I, LLC, and ABN AMRO Bank, N.V., as agent
for the participants named therein, dated September 21,
2001.                  
|
| |   | 10.43 (33)   |  | First Amendment to
the Participation Agreement, dated April 18, 2001, by and among
Novellus Systems, Inc., ABN AMRO Leasing, Inc., and ABN AMRO Bank,
N.V., as agent for the participants named therein, dated
September 21, 2001.
|
| |   | 12.1         |  | Ratio of Fixed Charges.                                                                                                                                                                                                           
|
| |   | 21.1         |  | Subsidiaries of Novellus.                                                                                                                                                                                                         
|
| |   | 23.1         |  | Consent of Ernst & Young
        LLP, Independent Auditors.                                                                                                                                                                       
|
| |   | 23.2         |  | Consent of Arthur Andersen
        LLP, Independent Public Accountants.                                                                                                                                                           
|
| |   | 24.1         |  | Power of Attorney
        (see page 74).                                                                                                                                                                                          

70



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##### Table of Contents



| |  |      |  |                                                                | 
| |  | ---- |  | -------------------------------------------------------------- | 
| |  | 99.1 |  | Report of Arthur
Andersen LLP, Independent Public Accountants.



---

|(1)  |  | Incorporated by reference to Exhibit 10.2 filed with Novellus
Registration Statement on Form S-1, File No. 33-23011, which was
declared effective August 11, 1988.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(2)  |  | Incorporated by reference to Exhibit 10.1 filed with Novellus
Report on Form 10-K filed with the Securities and Exchange Commission
on March 30, 1992.            
|    
|(3)  |  | 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.        
|    
|(4)  |  | Incorporated by reference to Exhibit 10.31 filed with Novellus
Report on Form 10-K filed with the Securities and Exchange Commission
on February 26, 1993.        
|    
|(5)  |  | Incorporated by reference to Exhibit 10.34 filed with Novellus
Report on Form 10-K filed with the Securities and Exchange Commission
on February 26, 1993.        
|    
|(6)  |  | Incorporated by reference to Exhibit 10.41 filed with Novellus
Report on Form 10-K filed with the Securities and Exchange Commission
on February 18, 1994.        
|    
|(7)  |  | Incorporated by reference to Exhibit 2.1 to Novellus Report on
Form 8-K filed with the Securities and Exchange Commission on July 7,
1997.                        
|    
|(8)  |  | Incorporated by reference to Exhibit 2.2 to Novellus Report
on Form 8-K filed with the Securities and Exchange Commission on
July 7, 1997.                        
|    
|(9)  |  | 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.                        
|    
|(10) |  | Incorporated by reference to Exhibit 2.4 to Novellus Report on
Form 8-K filed with the Securities and Exchange Commission on July 7,
1997.                        
|    
|(11) |  | 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.                        
|    
|(12) |  | Incorporated by reference to Exhibit 2.7 to Novellus Report
on Form 8-K filed with the Securities and Exchange Commission on
July 7, 1997.                        
|    
|(13) |  | Incorporated by reference to Exhibit 2.8 to Novellus Report
on Form 8-K filed with the Securities and Exchange Commission on
July 7, 1997.                        
|    
|(14) |  | Incorporated by reference to Exhibit 10.1 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
August 11, 1997.                   
|    
|(15) |  | Incorporated by reference to Exhibit 10.2 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
August 11, 1997.                   
|    
|(16) |  | Incorporated by reference to Exhibit 10.4 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
November 10, 1997.                 
|    
|(17) |  | Incorporated by reference to Exhibit 10.1.1 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
November 10, 1997.               

71



---



##### Table of Contents





|(18) |  | Incorporated by reference to Exhibit 10.1.2 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
November 10, 1997.                                   
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(19) |  | Incorporated by reference to Exhibit 10.1.3 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
November 10, 1997.                                   
|    
|(20) |  | Incorporated by reference to Exhibit 10.2 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
November 10, 1997.                                     
|    
|(21) |  | Incorporated by reference to Exhibit 10.2.1 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
November 10, 1997.                                   
|    
|(22) |  | Incorporated by reference to Exhibit 10.3 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
November 10, 1997.                                     
|    
|(23) |  | Incorporated by reference to Exhibit 10.4 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
November 10, 1997.                                     
|    
|(24) |  | Incorporated by reference to Exhibit 10.5 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
November 10, 1997.                                     
|    
|(25) |  | Incorporated by reference to Exhibit 10.6 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
November 10, 1997.                                     
|    
|(26) |  | 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 10, 1999.   
|    
|(27) |  | Incorporated by reference to the exhibit with the corresponding
exhibit number in Novellus Form 10-Q filed with the Securities and
Exchange Commission on August 9, 1999.             
|    
|(28) |  | Incorporated by reference to the exhibit with the corresponding
exhibit number in Novellus Report on Form 10-Q filed with the
Securities and Exchange Commission on November 8, 1999. 
|    
|(29) |  | 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.   
|    
|(30) |  | Incorporated by reference to
the exhibit with the corresponding exhibit number in Novellus
Report on Form S-3 filed with the Securities and Exchange
Commission on September 25, 2001.
|    
|(31) |  | 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 23, 2001.   
|    
|(32) |  | Incorporated by reference to
the exhibit with the corresponding exhibit number in Novellus
Report on Form 10-Q filed with the Securities and Exchange
Commission on May 15, 2000.     
|    
|(33) |  | Incorporated by reference to
the exhibit with the corresponding exhibit number in Novellus
Report on Form 10-Q filed with the Securities and Exchange
Commission on November 13, 2001.
|    
|*    |  | Management contracts or compensatory plans or arrangements.                                                                                                                            



|(b) |  | Reports on Form 8-K:
|--- |  | --------------------

Not applicable.

72



---



##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this Report on Form 10-K
to be signed on its behalf by the undersigned, thereunto duly authorized, in
the City of San Jose, State of California on this 21st day of March, 2002.



| | NOVELLUS SYSTEMS, INC.
| | ----------------------



| | By: | /s/ Kevin S. Royal
Kevin S. Royal
VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
| | --- | ----------------------------------------------------------------------------

73



---



##### Table of Contents



POWER OF ATTORNEY

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

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

|                                         |  |                                                                                                         |  |               
|---------------------------------------- |  | ------------------------------------------------------------------------------------------------------- |  | --------------
|Signature                                |  | Title                                                                                                   |  | Date          
|                                         |  |                                                                                                         |  |               
|                                        
|/s/ Richard S. Hill

Richard S. Hill     |  | Chairman of the Board of Directors,
President and Chief Executive Officer
(Principal Executive Officer) |  | March 21, 2002
|                                        
|/s/ Kevin S. Royal

Kevin S. Royal       |  | Vice President and Chief Financial Officer                                                              |  | March 21, 2002
|                                        
|/s/ Robert H. Smith

Robert H. Smith     |  | Executive Vice President, Administration,
Secretary and Director                                        |  | March 21, 2002
|                                        
|/s/ D. James Guzy

D. James Guzy         |  | Director                                                                                                |  | March 21, 2002
|                                        
|/s/ Tom Long

Tom Long                   |  | Director                                                                                                |  | March 21, 2002
|                                        
|/s/ Glen Possley

Glen Possley           |  | Director                                                                                                |  | March 21, 2002
|                                        
|/s/ J. David Litster

J. David Litster   |  | Director                                                                                                |  | March 21, 2002
|                                        
|/s/ William R. Spivey

William R. Spivey |  | Director                                                                                                |  | March 21, 2002
|                                        
|/s/ Delbert Whitaker

Delbert Whitaker   |  | Director                                                                                                |  | March 21, 2002

74



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##### Table of Contents



SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)

|                                                             |  |            |       |            |  |            |       |           |  |     |     |            |  |   |        | 
|------------------------------------------------------------ |  | ---------- | ----- | ---------- |  | ---------- | ----- | --------- |  | --- | --- | ---------- |  | - | ------ | 
|                                                             |  | Balance at |       |            |  |            |       |           |  |     |     | Balance at
|                                                             |  | Beginning  |       | Charged to |  |            |       |           |  | End
|Description                                                  |  | of Period  |       | Expense    |  | Write-offs |       | of Period
|                                                             |  |            |       |            |  |            |       |          
|Year Ended December 31, 1999
Allowance for Doubtful Accounts |  | $          | 3,975 |            |  |            | 766   |           |  |     | 366 |            |  | $ | 4,375  | 
|Year Ended December 31, 2000
Allowance for Doubtful Accounts |  | $          | 4,375 |            |  |            | 1,335 |           |  |     | 318 |            |  | $ | 5,392  | 
|Year Ended December 31, 2001
Allowance for Doubtful Accounts |  | $          | 5,392 |            |  |            | 9,209 |           |  |     | 211 |            |  | $ | 14,390 | 

75



---



##### Table of Contents






EXHIBIT INDEX

| |  |          |  |                                                                                                                                                                                                                                                                                   
| |  | -------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 3.1 (29) |  | Amended and Restated Articles
        of Incorporation of Registrant.                                                                                                                                                                                                             
| |  |          |  |                                                                                                                                                                                                                                                                                   
| |  | 3.2      |  | Form of Bylaws of Registrant
        as amended.                                                                                                                                                                                                                                  
| |  |          |  |                                                                                                                                                                                                                                                                                   
| |  | 8.1      |  | Written opinion regarding tax
        matters associated with the Liquid Yield Option Notes (LYONs),
        issued by Ernst & Young LLP, dated September 20, 2001.                                                                                                            
| |  |          |  |                                                                                                                                                                                                                                                                                   
| |  | 10.1 (7) |  | Asset Purchase Agreement by
        and between Varian Associates, Inc. and Novellus dated May 7, 1997.                                                                                                                                                                           
| |  |          |  |                                                                                                                                                                                                                                                                                   
| |  | 10.2 (8) |  | First Amendment to Asset Purchase
        Agreement by and between Varian Associates, Inc. and Novellus dated June 20,
        1997.                                                                                                                                              
| |  |          |  |                                                                                                                                                                                                                                                                                   
| |  | 10.3 (9) |  | 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.





---



##### Table of Contents



| |  |              |  |                                                                                                                                                                                                                                                        
| |  | ------------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 10.4 (10)    |  | Sublease (Portion of Unit 9, Palo Alto) by and between
Varian Associates, Inc. and Novellus dated May 7, 1997.                                                                                                                                         
|
| |  | 10.6 (11)    |  | Environmental Agreement by and between Varian Associates,
Inc. and Novellus dated May 7, 1997.                                                                                                                                                         
|
| |  | 10.7 (12)    |  | Cross License Agreement by and between Varian Associates,
Inc. and Novellus dated May 7, 1997.                                                                                                                                                         
|
| |  | 10.8 (13)    |  | Parts Supply Agreement by and between Varian Associates, Inc. and Novellus dated
May 7, 1997.                                                                                                                                                          
|
| |  | 10.9 (14)    |  | Settlement Agreement by and between Applied Materials, Inc. and Novellus dated
May 7, 1997. Confidential treatment has been granted with respect to portions of this Exhibit.                                                                          
|
| |  | 10.10 (15)   |  | Credit Agreement by and among ABN AMRO Bank, N.V., as agent, the lenders named
therein, and Novellus dated May 7, 1997.                                                                                                                                
|
| |  | 10.11 (16)   |  | Participation Agreement by and among Lease Plan North America, Inc. Novellus and
ABN AMRO Bank, N.V., as agent for the participations named therein, dated June 9, 1997.                                                                               
|
| |  | 10.11.1 (17) |  | Letter Amendment, dated June 20, 1997, to the Participation
Agreement by and among Lease Plan North America, Inc., Novellus and
ABN AMRO Bank, N.V., as agent for the participants named therein,
dated June 9, 1997.                                  
|
| |  | 10.11.2 (18) |  | Amendment no. 1, dated August 28, 1997, to the Participation
Agreement by and among Lease Plan North America, Inc., Novellus and
ABN AMRO Bank, N.V., as agent for the participants named therein,
dated June 9, 1997.                                 
|
| |  | 10.11.3 (19) |  | Amendment no. 2, dated September 26, 1997, to the
Participation Agreement by and among Lease Plan North America, Inc.,
Novellus and ABN AMRO Bank, N.V., as agent for the participants named
therein, dated June 9, 1997.                              
|
| |  | 10.12 (20)   |  | Amendment no. 1, dated August 28, 1997, to the Facility 2
Lease Agreement, Construction Deed of Trust With Assignment of Rents,
Security Agreement and Fixture Filing by and between Lease Plan North
America, Inc. and Novellus dated June 9, 1997.   
|
| |  | 10.13 (21)   |  | Amendment no. 2, dated September 26, 1997, to the
Facility 2 Lease Agreement, Construction Deed of Trust With
Assignment of Rents, Security Agreement and Fixture Filing by and
between Lease Plan North America, Inc. and Novellus dated June 9,
1997.
|
| |  | 10.13 (22)   |  | Amendment no. 1, dated September 26, 1997, to the
Facility 1 Lease Agreement, Deed of Trust With Assignment of Rents,
Security Agreement and Fixture Filing by and between Lease Plan North
America, Inc. and Novellus dated June 9, 1997.             
|
| |  | 10.14 (23)   |  | Participation Agreement by and among Lease Plan USA,
Inc., Novellus and ABN AMRO Bank, N.V., as agent for the participants
named therein, dated October 15, 1997.                                                                                      
|
| |  | 10.15 (24)   |  | Facility 1 Lease Agreement, Deed of Trust With Assignment
of Rents, Security Agreement and Fixture Filing by and between Lease
Plan USA, Inc. and Novellus dated October 15, 1997.                                                                     





---



##### Table of Contents



| |   |              |  |                                                                                                                                                                                                                                    | 
| | - | ------------ |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
| |   | 10.16 (25)   |  | Facility 2 Lease
        Agreement, Construction Deed of Trust With Assignment of Rents, Security
        Agreement and Fixture Filing by and between Lease Plan USA, Inc. and Novellus
        dated October 15, 1997.           
|
| | * | 10.20 (2)    |  | Registrants
        Amended and Restated 1984 Stock Option Plan, together with forms of agreements
        thereunder.                                                                                                           
|
| | * | 10.21 (3)    |  | Registrants
        1992 Stock Option Plan, together with forms of agreements thereunder.                                                                                                                                        
|
| | * | 10.21.1 (29) |  | Form of Restated
        Stock Purchase Agreement dated December 16, 1999 between Novellus
        and Jeff Benzing, Wilbert van den Hoek and certain other employees of
        Novellus.                                        
|
| | * | 10.22 (4)    |  | Novellus
        1992 Employee Stock Purchase Plan.                                                                                                                                                                              
|
| | * | 10.23 (1)    |  | Form of Agent Indemnification
        Agreement and amendment thereto.                                                                                                                                                            
|
| | * | 10.25 (5)    |  | Employment Agreement
        dated June 15, 1992 between Novellus and Peter Hanley.                                                                                                                                               
|
| | * | 10.26 (6)    |  | Offer Letter Agreement
        dated November 1, 1993 between Novellus and Richard S. Hill.                                                                                                                                       
|
| | * | 10.27 (26)   |  | Employment Agreement
        dated October 1, 1998 between Novellus and Richard S. Hill.                                                                                                                                          
|
| | * | 10.27.1 (29) |  | Amendment dated
        December 16, 1999 to Employment Agreement between Novellus and Richard
        S. Hill.                                                                                                                   
|
| | * | 10.27.2 (29) |  | Restricted Stock
        Purchase Agreement dated December 16, 1999 between Novellus and Richard
        S. Hill.                                                                                                                 
|
| |   | 10.28 (27)   |  | First Amendment
        to Participation Agreement dated June 4, 1999.                                                                                                                                                            
|
| |   | 10.29 (28)   |  | Asset Purchase
        Agreement by and between Fairchild Technologies USA, Inc. and Novellus
        dated July 29, 1999.                                                                                                        
|
| | * | 10.30 (31)   |  | Employment Agreement
        dated January 12, 2001 between Novellus and Asuri Raghavan.                                                                                                                                          
|
| | * | 10.31 (31)   |  | GaSonics International
        Corporation 1994 Stock Option Plan, together with forms of agreements
        thereunder as assumed by Novellus.                                                                                   
|
| | * | 10.32 (31)   |  | Gamma Precision
        Technology, Inc. 1998 Stock Option Plan, together with forms of agreements
        thereunder as assumed by Novellus.                                                                                     
|
| | * | 10.33 (31)   |  | GaSonics International
        Corporation supplemental Stock Option Plan as assumed by Novellus.                                                                                                                                 
|
| | * | 10.34 (31)   |  | Form of Light Industrial
        Lease between Teachers Insurance and Annuity Association of America and
        the Registrant for office space at 2730 Junction Avenue, San Jose, California.                                   
|
| |   | 10.35 (32)   |  | Amendment
no. 2, dated April 13, 2001, to the Participation Agreement
by and among Lease Plan North America, Inc., Novellus, and ABN AMRO
Bank N.V., as agent for the participations named therein, dated
August 31, 1998.        
|
| |   | 10.36 (32)   |  | Amendment
no. 7, dated April 13, 2001, to the Participation Agreement
by and among Lease Plan North America, Inc., Novellus, and ABN AMRO
Bank N.V., as agent for the participations named therein, dated
October 15, 1997.       
|
| |   | 10.37 (32)   |  | Amendment
no. 2, dated April 13, 2001, to the Participation Agreement
by and among Lease Plan North America, Inc., Novellus, and ABN AMRO
Bank N.V., as agent for the participations named therein, dated
August 7, 1998.         
|
| |   | 10.38 (32)   |  | Amendment
no. 2, dated April 13, 2001, to the Participation Agreement
by and among Lease Plan North America, Inc., Novellus, and ABN AMRO
Bank N.V., as agent for the participations named therein, dated
June 9, 1997.           
|
| |   | 10.39 (32)   |  | Participation
Agreement by and among Lease Plan North America, Inc., Novellus, and
ABN AMRO Bank, N.V., as agent for the participations named therein,
dated April 13, 2001.                                                      
|
| |   | 10.40 (32)   |  | Participation
Agreement by and among Lease Plan North America, Inc., Novellus, and
ABN AMRO Bank, N.V., as agent for the participations named therein,
dated April 18, 2001.                                                      
|
| |   | 10.41 (32)   |  | Novellus System,
Inc. 2001 Stock Incentive Plan, dated May 11, 2001, together with
forms of agreements thereunder.                                                                                                                
|
| |   | 10.42 (33)   |  | Participation
Agreement by and among Novellus Systems, Inc., ABN AMRO Leasing,
Inc., Novellus Investment I, LLC, and ABN AMRO Bank, N.V., as agent
for the participants named therein, dated September 21,
2001.                  
|
| |   | 10.43 (33)   |  | First Amendment to
the Participation Agreement, dated April 18, 2001, by and among
Novellus Systems, Inc., ABN AMRO Leasing, Inc., and ABN AMRO Bank,
N.V., as agent for the participants named therein, dated
September 21, 2001.
|
| |   | 12.1         |  | Ratio of Fixed Charges.                                                                                                                                                                                                           
|
| |   | 21.1         |  | Subsidiaries of Novellus.                                                                                                                                                                                                         
|
| |   | 23.1         |  | Consent of Ernst & Young
        LLP, Independent Auditors.                                                                                                                                                                       
|
| |   | 23.2         |  | Consent of Arthur Andersen
        LLP, Independent Public Accountants.                                                                                                                                                           
|
| |   | 24.1         |  | Power of Attorney
        (see page 74).                                                                                                                                                                                          





---



##### Table of Contents



| |  |      |  |                                                                | 
| |  | ---- |  | -------------------------------------------------------------- | 
| |  | 99.1 |  | Report of Arthur
Andersen LLP, Independent Public Accountants.



---

|(1)  |  | Incorporated by reference to Exhibit 10.2 filed with Novellus
Registration Statement on Form S-1, File No. 33-23011, which was
declared effective August 11, 1988.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(2)  |  | Incorporated by reference to Exhibit 10.1 filed with Novellus
Report on Form 10-K filed with the Securities and Exchange Commission
on March 30, 1992.            
|    
|(3)  |  | 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.        
|    
|(4)  |  | Incorporated by reference to Exhibit 10.31 filed with Novellus
Report on Form 10-K filed with the Securities and Exchange Commission
on February 26, 1993.        
|    
|(5)  |  | Incorporated by reference to Exhibit 10.34 filed with Novellus
Report on Form 10-K filed with the Securities and Exchange Commission
on February 26, 1993.        
|    
|(6)  |  | Incorporated by reference to Exhibit 10.41 filed with Novellus
Report on Form 10-K filed with the Securities and Exchange Commission
on February 18, 1994.        
|    
|(7)  |  | Incorporated by reference to Exhibit 2.1 to Novellus Report on
Form 8-K filed with the Securities and Exchange Commission on July 7,
1997.                        
|    
|(8)  |  | Incorporated by reference to Exhibit 2.2 to Novellus Report
on Form 8-K filed with the Securities and Exchange Commission on
July 7, 1997.                        
|    
|(9)  |  | 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.                        
|    
|(10) |  | Incorporated by reference to Exhibit 2.4 to Novellus Report on
Form 8-K filed with the Securities and Exchange Commission on July 7,
1997.                        
|    
|(11) |  | 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.                        
|    
|(12) |  | Incorporated by reference to Exhibit 2.7 to Novellus Report
on Form 8-K filed with the Securities and Exchange Commission on
July 7, 1997.                        
|    
|(13) |  | Incorporated by reference to Exhibit 2.8 to Novellus Report
on Form 8-K filed with the Securities and Exchange Commission on
July 7, 1997.                        
|    
|(14) |  | Incorporated by reference to Exhibit 10.1 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
August 11, 1997.                   
|    
|(15) |  | Incorporated by reference to Exhibit 10.2 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
August 11, 1997.                   
|    
|(16) |  | Incorporated by reference to Exhibit 10.4 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
November 10, 1997.                 
|    
|(17) |  | Incorporated by reference to Exhibit 10.1.1 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
November 10, 1997.               





---



##### Table of Contents





|(18) |  | Incorporated by reference to Exhibit 10.1.2 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
November 10, 1997.                                   
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(19) |  | Incorporated by reference to Exhibit 10.1.3 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
November 10, 1997.                                   
|    
|(20) |  | Incorporated by reference to Exhibit 10.2 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
November 10, 1997.                                     
|    
|(21) |  | Incorporated by reference to Exhibit 10.2.1 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
November 10, 1997.                                   
|    
|(22) |  | Incorporated by reference to Exhibit 10.3 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
November 10, 1997.                                     
|    
|(23) |  | Incorporated by reference to Exhibit 10.4 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
November 10, 1997.                                     
|    
|(24) |  | Incorporated by reference to Exhibit 10.5 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
November 10, 1997.                                     
|    
|(25) |  | Incorporated by reference to Exhibit 10.6 to Novellus Report
on Form 10-Q filed with the Securities and Exchange Commission on
November 10, 1997.                                     
|    
|(26) |  | 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 10, 1999.   
|    
|(27) |  | Incorporated by reference to the exhibit with the corresponding
exhibit number in Novellus Form 10-Q filed with the Securities and
Exchange Commission on August 9, 1999.             
|    
|(28) |  | Incorporated by reference to the exhibit with the corresponding
exhibit number in Novellus Report on Form 10-Q filed with the
Securities and Exchange Commission on November 8, 1999. 
|    
|(29) |  | 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.   
|    
|(30) |  | Incorporated by reference to
the exhibit with the corresponding exhibit number in Novellus
Report on Form S-3 filed with the Securities and Exchange
Commission on September 25, 2001.
|    
|(31) |  | 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 23, 2001.   
|    
|(32) |  | Incorporated by reference to
the exhibit with the corresponding exhibit number in Novellus
Report on Form 10-Q filed with the Securities and Exchange
Commission on May 15, 2000.     
|    
|(33) |  | Incorporated by reference to
the exhibit with the corresponding exhibit number in Novellus
Report on Form 10-Q filed with the Securities and Exchange
Commission on November 13, 2001.
|    
|*    |  | Management contracts or compensatory plans or arrangements.