##### Table of Contents



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

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 28, 2002

OR

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

For the transition period from _______ to _______

Commission File Number 000-17157

NOVELLUS SYSTEMS, INC.

(Exact name of Registrant as specified in its charter)


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

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

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

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

As of November 7, 2002,
143,001,680 shares of the Registrants common stock,
no par value, were issued and outstanding.





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TABLE OF CONTENTS



|                              |                                                                                               |  |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I: FINANCIAL INFORMATION
|                              | ITEM 1: CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                                          
|                              | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS                                              
|                              | CONDENSED CONSOLIDATED BALANCE SHEETS                                                        
|                              | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS                                              
|                              | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)                             
|                              | ITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                              | ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK                            
|                              | ITEM 4: CONTROLS AND PROCEDURES                                                              
|PART II: OTHER INFORMATION   
|                              | ITEM 1: LEGAL PROCEEDINGS                                                                    
|                              | ITEM 5: OTHER INFORMATION                                                                    
|                              | ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURES                   
|CERTIFICATION                
|Exhibit Index                
|EXHIBIT 99.1                 
|EXHIBIT 99.2                 



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##### Table of Contents



NOVELLUS SYSTEMS, INC.
FORM 10-Q
QUARTER ENDED SEPTEMBER 28, 2002

TABLE OF CONTENTS

|                              |                                                                                               |                                                                                                                               |    |      |   | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------- | -- | ---- | - | 
|                              |                                                                                               |                                                                                                                               |    | Page
|                              |                                                                                               |                                                                                                                               |    |     
|Part I: Financial Information |                                                                                               |                                                                                                                               |    |     
|                             
|                             
|                             
|                             
|                              | Item 1: Condensed Consolidated Financial Statements                                           |                                                                                                                               |    |      |  
|                             
|                             
|                             
|                             
|                              |                                                                                               | Condensed Consolidated Statements of Operations for the three and nine months ended
September 28, 2002 and September 29, 2001 |    |      | 3 | 
|                             
|                             
|                             
|                             
|                              |                                                                                               | Condensed Consolidated Balance Sheets at September 28, 2002 and December 31, 2001                                             |    |      | 4 | 
|                             
|                             
|                             
|                             
|                              |                                                                                               | Condensed Consolidated Statements of Cash Flows for the nine months ended September
28, 2002 and September 29, 2001           |    |      | 5 | 
|                             
|                             
|                             
|                             
|                              |                                                                                               | Notes to Condensed Consolidated Financial Statements                                                                          |    |      | 6 | 
|                             
|                             
|                             
|                             
|                              | Item 2: Managements Discussion and Analysis of Financial Condition and Results of Operations |                                                                                                                               |    | 14   |  
|                             
|                             
|                             
|                             
|                              | Item 3: Quantitative and Qualitative Disclosure About Market Risk                             |                                                                                                                               |    | 25   |  
|                             
|                             
|                             
|                             
|                              | Item 4: Controls and Procedures                                                               |                                                                                                                               |    | 25   |  
|                             
|                             
|                             
|                             
|Part II: Other Information    |                                                                                               |                                                                                                                               |    |     
|                             
|                             
|                             
|                             
|                              | Item 1: Legal Proceedings                                                                     |                                                                                                                               |    | 25   |  
|                             
|                             
|                             
|                             
|                              | Item 5: Other Information                                                                     |                                                                                                                               |    | 29   |  
|                             
|                             
|                             
|                             
|                              | Item 6: Exhibits and Reports on Form 8-K                                                      |                                                                                                                               |    | 29   |  
|                             
|                             
|                             
|                             
|Signatures                    |                                                                                               |                                                                                                                               | 30 |     
|                             
|                             
|                             
|                             
|Certifications                |                                                                                               |                                                                                                                               | 31 |     





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##### Table of Contents






PART I: FINANCIAL INFORMATION




ITEM 1: CONDENSED CONSOLIDATED FINANCIAL STATEMENTS




NOVELLUS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

|                                             |                                      |                                     |         |                    |      |                   |         |               |       |   |         |         |      |   |           |         |      | 
|-------------------------------------------- | ------------------------------------ | ----------------------------------- | ------- | ------------------ | ---- | ----------------- | ------- | ------------- | ----- | - | ------- | ------- | ---- | - | --------- | ------- | ---- | 
|                                             |                                      |                                     |         | Three months ended |      | Nine months ended
|                                             |                                      |                                     |         |                    |      |                  
|(in thousands, except per share amounts)     |                                      | September 28,                       |         | September 29,      |      | September 28,     |         | September 29,
|(unaudited)                                  |                                      | 2002                                |         | 2001               |      | 2002              |         | 2001         
|                                             |                                      |                                     |         |                    |      |                   |         |              
|Net sales                                    |                                      | $                                   | 230,495 |                    |      | $                 | 303,687 |               |       | $ | 622,321 |         |      | $ | 1,139,291 |        
|                                            
|                                            
|                                            
|                                            
|Cost of sales                                |                                      |                                     | 121,113 |                    |      |                   | 163,549 |               |       |   | 339,846 |         |      |   | 544,544   |        
|                                             |                                      |                                     |         |                    |      |                   |         |               |       |   |         |         |      |   |           |        
|Gross profit                                 |                                      |                                     | 109,382 |                    |      |                   | 140,138 |               |       |   | 282,475 |         |      |   | 594,747   |        
|                                            
|                                            
|                                            
|                                            
|Operating expenses:                          |                                      |                                     |         |                    |      |                   |         |               |       |   |         |         |      |   |           |        
|                                            
|                                            
|                                            
|                                            
|                                             | Selling, general, and administrative |                                     |         | 43,143             |      |                   |         | 46,844        |       |   |         | 117,307 |      |   |           | 170,218 |     
|                                            
|                                            
|                                            
|                                            
|                                             | Research and development             |                                     |         | 58,248             |      |                   |         | 68,183        |       |   |         | 171,021 |      |   |           | 211,381 |     
|                                            
|                                            
|                                            
|                                            
|                                             | Special charges                      |                                     |         |                   |      |                   |         | 47,946        |       |   |         | 3,273   |      |   |           | 61,106  |     
|                                            
|                                            
|                                            
|                                            
|                                             | Bad debt write-off (recovery)        |                                     |         |                   |      |                   |         | 7,662         |       |   |         | (7,662  | )    |   |           | 7,662   |     
|                                             |                                      |                                     |         |                    |      |                   |         |               |       |   |         |         |      |   |           |        
|Total operating expenses                     |                                      |                                     | 101,391 |                    |      |                   | 170,635 |               |       |   | 283,939 |         |      |   | 450,367   |        
|                                             |                                      |                                     |         |                    |      |                   |         |               |       |   |         |         |      |   |           |        
|Operating income (loss)                      |                                      |                                     | 7,991   |                    |      |                   | (30,497 | )             |       |   | (1,464  | )       |      |   | 144,380   |        
|                                            
|                                            
|                                            
|                                            
|Interest and other income, net               |                                      |                                     | 8,926   |                    |      |                   | 10,180  |               |       |   | 38,443  |         |      |   | 40,119    |        
|                                            
|                                            
|                                            
|                                            
|Write-off
of unamortized debt issuance costs |                                      |                                     | (17,047 | )                  |      |                   |        |               |       |   | (17,047 | )       |      |   |          |        
|                                             |                                      |                                     |         |                    |      |                   |         |               |       |   |         |         |      |   |           |        
|Income (loss) before income taxes            |                                      |                                     | (130    | )                  |      |                   | (20,317 | )             |       |   | 19,932  |         |      |   | 184,499   |        
|                                            
|                                            
|                                            
|                                            
|Provision (benefit) for income taxes         |                                      |                                     | (4,213  | )                  |      |                   | (6,298  | )             |       |   |        |         |      |   | 57,195    |        
|                                             |                                      |                                     |         |                    |      |                   |         |               |       |   |         |         |      |   |           |        
|Net income (loss)                            |                                      | $                                   | 4,083   |                    |      | $                 | (14,019 | )             |       | $ | 19,932  |         |      | $ | 127,304   |        
|                                             |                                      |                                     |         |                    |      |                   |         |               |       |   |         |         |      |   |           |        
|Net income (loss) per share:                 |                                      |                                     |         |                    |      |                   |         |               |       |   |         |         |      |   |           |        
|                                            
|                                            
|                                            
|                                            
|                                             |                                      | Basic net income (loss) per share   |         | $                  | 0.03 |                   |         | $             | (0.10 | ) |         | $       | 0.14 |   |           | $       | 0.90 | 
|                                             |                                      |                                     |         |                    |      |                   |         |               |       |   |         |         |      |   |           |        
|                                             |                                      | Diluted net income (loss) per share |         | $                  | 0.03 |                   |         | $             | (0.10 | ) |         | $       | 0.13 |   |           | $       | 0.85 | 
|                                             |                                      |                                     |         |                    |      |                   |         |               |       |   |         |         |      |   |           |        
|Shares used in basic calculation             |                                      |                                     | 143,691 |                    |      |                   | 143,218 |               |       |   | 144,355 |         |      |   | 142,165   |        
|                                             |                                      |                                     |         |                    |      |                   |         |               |       |   |         |         |      |   |           |        
|Shares used in diluted calculation           |                                      |                                     | 146,094 |                    |      |                   | 143,218 |               |       |   | 149,257 |         |      |   | 149,079   |        
|                                             |                                      |                                     |         |                    |      |                   |         |               |       |   |         |         |      |   |           |        

See accompanying notes.

3



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##### Table of Contents






NOVELLUS SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS


|                                               |                                               |                                            |         |               |           |              |         |           |           | 
|---------------------------------------------- | --------------------------------------------- | ------------------------------------------ | ------- | ------------- | --------- | ------------ | ------- | --------- | --------- | 
|                                               |                                               |                                            |         | September 28, |           | December 31,
|(in thousands)                                 |                                               | 2002                                       |         | 2001 *       
|                                               |                                               |                                            |         |              
|                                               |                                               |                                            |         | (unaudited)   |           |              |         |          
|Assets                                         |                                               |                                            |         |               |           |              |         |          
|                                              
|                                              
|                                              
|                                              
|Current assets:                                |                                               |                                            |         |               |           |              |         |          
|                                              
|                                              
|                                              
|                                              
|                                               | Cash and cash equivalents                     |                                            | $       | 473,736       |           |              | $       | 550,640   |          
|                                              
|                                              
|                                              
|                                              
|                                               | Short-term investments                        |                                            |         | 450,995       |           |              |         | 371,182   |          
|                                              
|                                              
|                                              
|                                              
|                                               | Restricted short-term investments             |                                            |         |              |           |              |         | 961,643   |          
|                                              
|                                              
|                                              
|                                              
|                                               | Accounts receivable, net                      |                                            |         | 230,233       |           |              |         | 225,916   |          
|                                              
|                                              
|                                              
|                                              
|                                               | Inventories                                   |                                            |         | 239,687       |           |              |         | 244,712   |          
|                                              
|                                              
|                                              
|                                              
|                                               | Deferred tax assets, net                      |                                            |         | 92,769        |           |              |         | 84,421    |          
|                                              
|                                              
|                                              
|                                              
|                                               | Prepaid and other current assets              |                                            |         | 12,366        |           |              |         | 81,049    |          
|                                               |                                               |                                            |         |               |           |              |         |           |          
|                                               |                                               | Total current assets                       |         |               | 1,499,786 |              |         |           | 2,519,563 | 
|                                              
|                                              
|                                              
|                                              
|Property and equipment:                        |                                               |                                            |         |               |           |              |         |          
|                                              
|                                              
|                                              
|                                              
|                                               | Machinery and equipment                       |                                            |         | 259,867       |           |              |         | 243,677   |          
|                                              
|                                              
|                                              
|                                              
|                                               | Furniture and fixtures                        |                                            |         | 16,176        |           |              |         | 15,256    |          
|                                              
|                                              
|                                              
|                                              
|                                               | Leasehold improvements                        |                                            |         | 74,953        |           |              |         | 79,264    |          
|                                              
|                                              
|                                              
|                                              
|                                               | Land                                          |                                            |         | 8,782         |           |              |         | 8,782     |          
|                                               |                                               |                                            |         |               |           |              |         |           |          
|                                               |                                               |                                            | 359,778 |               |           |              | 346,979 |          
|                                              
|                                              
|                                              
|                                              
|Less accumulated depreciation and amortization |                                               |                                            | 192,673 |               |           |              | 169,378 |          
|                                               |                                               |                                            |         |               |           |              |         |           |          
|                                               |                                               |                                            | 167,105 |               |           |              | 177,601 |          
|                                              
|                                              
|                                              
|                                              
|Other assets                                   |                                               |                                            | 50,754  |               |           |              | 54,994  |          
|                                              
|                                              
|                                              
|                                              
|Restricted investments                         |                                               |                                            | 58,995  |               |           |              | 34,293  |          
|                                              
|                                              
|                                              
|                                              
|Note receivable                                |                                               |                                            | 397,429 |               |           |              | 244,673 |          
|                                               |                                               |                                            |         |               |           |              |         |           |          
|                                               |                                               | Total assets                               |         | $             | 2,174,069 |              |         | $         | 3,031,124 | 
|                                               |                                               |                                            |         |               |           |              |         |           |          
|Liabilities and shareholders equity           |                                               |                                            |         |               |           |              |         |          
|                                              
|                                              
|                                              
|                                              
|Current liabilities:                           |                                               |                                            |         |               |           |              |         |          
|                                              
|                                              
|                                              
|                                              
|                                               | Accounts payable                              |                                            | $       | 69,410        |           |              | $       | 67,317    |          
|                                              
|                                              
|                                              
|                                              
|                                               | Accrued payroll and related expenses          |                                            |         | 35,065        |           |              |         | 34,211    |          
|                                              
|                                              
|                                              
|                                              
|                                               | Accrued warranty                              |                                            |         | 35,535        |           |              |         | 43,337    |          
|                                              
|                                              
|                                              
|                                              
|                                               | Other accrued liabilities                     |                                            |         | 37,622        |           |              |         | 30,411    |          
|                                              
|                                              
|                                              
|                                              
|                                               | Restructuring accrual                         |                                            |         | 18,484        |           |              |         | 26,849    |          
|                                              
|                                              
|                                              
|                                              
|                                               | Income taxes payable                          |                                            |         | 8,118         |           |              |         | 5,870     |          
|                                              
|                                              
|                                              
|                                              
|                                               | Deferred profit                               |                                            |         | 67,395        |           |              |         | 40,835    |          
|                                              
|                                              
|                                              
|                                              
|                                               | Current obligations under lines of credit     |                                            |         | 1,635         |           |              |         | 26,179    |          
|                                              
|                                              
|                                              
|                                              
|                                               | Convertible subordinated debentures           |                                            |         |              |           |              |         | 862,659   |          
|                                               |                                               |                                            |         |               |           |              |         |           |          
|                                               |                                               | Total current liabilities                  |         |               | 273,264   |              |         |           | 1,137,668 | 
|                                              
|                                              
|                                              
|                                              
|Deferred tax liabilities                       |                                               |                                            | 23,532  |               |           |              | 21,462  |          
|                                               |                                               |                                            |         |               |           |              |         |           |          
|                                               |                                               | Total liabilities                          |         |               | 296,796   |              |         |           | 1,159,130 | 
|                                              
|                                              
|                                              
|                                              
|Shareholders equity:                          |                                               |                                            |         |               |           |              |         |          
|                                              
|                                              
|                                              
|                                              
|                                               | Common stock                                  |                                            |         | 1,309,370     |           |              |         | 1,273,201 |          
|                                              
|                                              
|                                              
|                                              
|                                               | Retained earnings                             |                                            |         | 568,779       |           |              |         | 597,267   |          
|                                              
|                                              
|                                              
|                                              
|                                               | Accumulated other comprehensive (loss) income |                                            |         | (876          | )         |              |         | 1,526     |          
|                                               |                                               |                                            |         |               |           |              |         |           |          
|                                               |                                               | Total shareholders equity                 |         |               | 1,877,273 |              |         |           | 1,871,994 | 
|                                               |                                               |                                            |         |               |           |              |         |           |          
|                                               |                                               | Total liabilities and shareholders equity |         | $             | 2,174,069 |              |         | $         | 3,031,124 | 
|                                               |                                               |                                            |         |               |           |              |         |           |          



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|* |  | Amounts as of December 31, 2001 are derived from the December 31, 2001 audited financial statements.
|- |  | ----------------------------------------------------------------------------------------------------

See accompanying notes.

4



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##### Table of Contents






NOVELLUS SYSTEMS, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                         |  |                                                                          |                                                                                   |                                                      |                                      |   |                   |        |            |   |            |          |  
|-------------------------------------------------------- |  | ------------------------------------------------------------------------ | --------------------------------------------------------------------------------- | ---------------------------------------------------- | ------------------------------------ | - | ----------------- | ------ | ---------- | - | ---------- | -------- | -
|                                                         |  |                                                                          |                                                                                   |                                                      |                                      |   | Nine months ended
|                                                         |  |                                                                          |                                                                                   |                                                      |                                      |   |                  
|(in thousands)                                           |  | September 28,                                                            |                                                                                   | September 29,                                       
|(unaudited)                                              |  | 2002                                                                     |                                                                                   | 2001                                                
|                                                         |  |                                                                          |                                                                                   |                                                     
|Cash flows from operating activities:                    |  |                                                                          |                                                                                   |                                                      |                                      |   |                   |       
|                                                        
|                                                        
|                                                        
|                                                        
|Net income                                               |  | $                                                                        | 19,932                                                                            |                                                      |                                      | $ | 127,304           |       
|                                                        
|                                                        
|                                                        
|                                                        
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          | Adjustments to reconcile net income to net cash provided by operating activities: |                                                      |                                      |   |                   |        |            |   |           
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          |                                                                                   | Write-off of unamortized debt issuance costs         |                                      |   | 17,047            |        |            |   |           |         
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          |                                                                                   | Gain on sale of an investment                        |                                      |   | (4,602            | )      |            |   |           |         
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          |                                                                                   | Non-cash portion of special charges                  |                                      |   |                  |        |            |   | 28,902     |         
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          |                                                                                   | Impairment charge                                    |                                      |   |                  |        |            |   | 8,556      |         
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          |                                                                                   | Bad debt (recovery) write-off                        |                                      |   | (7,662            | )      |            |   | 7,662      |         
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          |                                                                                   | Depreciation and amortization                        |                                      |   | 32,292            |        |            |   | 37,695     |         
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          |                                                                                   | Deferred income taxes                                |                                      |   | (6,278            | )      |            |   | 68,674     |         
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          |                                                                                   | Stock related compensation                           |                                      |   | 4,861             |        |            |   | 5,688      |         
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          |                                                                                   | Adjustment to conform fiscal year end of GaSonics    |                                      |   |                  |        |            |   | 1,714      |         
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          |                                                                                   | Income tax benefits from employee stock option plans |                                      |   | 17,313            |        |            |   | 26,235     |         
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          |                                                                                   | Changes in operating assets and liabilities:         |                                      |   |                   |        |            |   |            |         
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          |                                                                                   |                                                      | Accounts receivable                  |   |                   | 3,345  |            |   |            | 128,537  |  
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          |                                                                                   |                                                      | Inventories                          |   |                   | 5,434  |            |   |            | (55,546  | )
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          |                                                                                   |                                                      | Prepaid and other current assets     |   |                   | 68,683 |            |   |            | (80,538  | )
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          |                                                                                   |                                                      | Accounts payable                     |   |                   | 2,093  |            |   |            | (52,569  | )
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          |                                                                                   |                                                      | Accrued payroll and related expenses |   |                   | 854    |            |   |            | (6,529   | )
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          |                                                                                   |                                                      | Accrued warranty                     |   |                   | (7,802 | )          |   |            | (2,032   | )
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          |                                                                                   |                                                      | Other accrued liabilities            |   |                   | 2,385  |            |   |            | 14,278   |  
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          |                                                                                   |                                                      | Income taxes payable                 |   |                   | 3,650  |            |   |            | (52,898  | )
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  |                                                                          |                                                                                   |                                                      | Deferred profit                      |   |                   | 26,560 |            |   |            | (139,040 | )
|                                                         |  |                                                                          |                                                                                   |                                                      |                                      |   |                   |       
|                                                         |  |                                                                          |                                                                                   | Total adjustments                                    |                                      |   | 158,173           |        |            |   | (61,211    | )       
|                                                         |  |                                                                          |                                                                                   |                                                      |                                      |   |                   |       
|                                                         |  |                                                                          |                                                                                   | Net cash provided by operating activities            |                                      |   | 178,105           |        |            |   | 66,093     |         
|                                                         |  |                                                                          |                                                                                   |                                                      |                                      |   |                   |       
|Cash flows from investing activities:                    |  |                                                                          |                                                                                   |                                                      |                                      |   |                   |       
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  | Proceeds from the sale and maturity of short-term investments            |                                                                                   |                                                      | 548,461                              |   |                   |        | 1,394,601  |  
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  | Purchases of short-term investments                                      |                                                                                   |                                                      | (627,221                             | ) |                   |        | (1,173,086 | )
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  | Proceeds from the sale and maturity of restricted short-term investments |                                                                                   |                                                      | 2,146,931                            |   |                   |        |           |  
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  | Purchases of restricted short-term investments                           |                                                                                   |                                                      | (1,186,362                           | ) |                   |        | (899,165   | )
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  | Capital expenditures                                                     |                                                                                   |                                                      | (21,412                              | ) |                   |        | (71,461    | )
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  | Decrease (increase) in other assets                                      |                                                                                   |                                                      | 1,834                                |   |                   |        | (28,969    | )
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  | Participation in synthetic leases                                        |                                                                                   |                                                      | (177,458                             | ) |                   |        | (244,673   | )
|                                                         |  |                                                                          |                                                                                   |                                                      |                                      |   |                   |       
|                                                         |  |                                                                          |                                                                                   | Net cash provided by (used in) investing activities  |                                      |   | 684,773           |        |            |   | (1,022,753 | )       
|                                                         |  |                                                                          |                                                                                   |                                                      |                                      |   |                   |       
|Cash flows from financing activities:                    |  |                                                                          |                                                                                   |                                                      |                                      |   |                   |       
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  | Proceeds from (payments on) convertible subordinated debentures          |                                                                                   |                                                      | (879,750                             | ) |                   |        | 862,400    |  
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  | Proceeds from employee stock option plans                                |                                                                                   |                                                      | 39,882                               |   |                   |        | 39,093     |  
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  | Proceeds from (payments on) lines of credit, net                         |                                                                                   |                                                      | (24,544                              | ) |                   |        | 6,548      |  
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         |  | Repurchase of common stock                                               |                                                                                   |                                                      | (75,370                              | ) |                   |        |           |  
|                                                         |  |                                                                          |                                                                                   |                                                      |                                      |   |                   |       
|                                                         |  |                                                                          |                                                                                   | Net cash provided by (used in) financing activities  |                                      |   | (939,782          | )      |            |   | 908,041    |         
|                                                         |  |                                                                          |                                                                                   |                                                      |                                      |   |                   |       
|Net decrease in cash and cash equivalents                |  |                                                                          | (76,904                                                                           | )                                                    |                                      |   | (48,619           | )     
|                                                        
|                                                        
|                                                        
|                                                        
|Cash and cash equivalents at the beginning of the period |  |                                                                          | 550,640                                                                           |                                                      |                                      |   | 589,415           |       
|                                                         |  |                                                                          |                                                                                   |                                                      |                                      |   |                   |       
|Cash and cash equivalents at the end of the period       |  | $                                                                        | 473,736                                                                           |                                                      |                                      | $ | 540,796           |       
|                                                         |  |                                                                          |                                                                                   |                                                      |                                      |   |                   |       

See accompanying notes.

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##### Table of Contents






NOVELLUS SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in
the United States of America for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they
do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the
opinion of management, all adjustments (consisting only of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three and nine months ended September 28, 2002 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 2002. For further information, refer to the consolidated
financial statements and footnotes thereto included in Novellus Annual Report
on Form 10-K for the year ended December 31, 2001.

On January 10, 2001, Novellus merged with GaSonics International Corporation
(GaSonics). The merger was accounted for as a pooling-of-interests
transaction in accordance with generally accepted accounting principles. 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 employee stock options for 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 2001 and were classified as
special charges within the condensed consolidated statement of operations.

Novellus adopted Statement of Financial Accounting Standards No. 142, (SFAS
142) Goodwill and Other Intangible Assets in the first quarter of 2002.
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 intangible
assets. As of January 1, 2002, Novellus had a goodwill balance of
approximately $20.1 million. The application of
the non-amortization provisions of SFAS 142 resulted in an increase in pre-tax
operating income of $0.9 million and $2.7 million, in the three and nine months
ended September 28, 2002, respectively. If Novellus had adopted the provisions
of SFAS 142 in the first quarter of 2001, the increase in pre-tax operating
income would have been $0.9 million and $2.7 million, in the three and nine
months ended September 29, 2001, respectively. Novellus would have recorded
a loss per share, on a diluted basis, of $(0.09) and earnings per
share of $0.87, on a diluted basis, for the three and
nine months ended September 29, 2001, respectively. In the first quarter of
2002, Novellus conducted a test for impairment of its goodwill using the
two-step process set forth in SFAS 142. The first step identifies when
impairment may have occurred, while the second step measures the amount of the
impairment, if any. The conclusion of the test was that the Companys goodwill
assets were not impaired. Novellus has concluded based upon criteria
contained in SFAS 142 that it only has one reporting
unit as it is a supplier of high productivity semiconductor equipment
used for the fabrication of integrated circuits.

Certain amounts presented in the comparative financial statements for prior
periods have been reclassified to conform to the current periods presentation.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America 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, inventory
reserves,
deferred tax assets, 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 condensed
consolidated financial statements.

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NOVELLUS SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Revenue Recognition

Novellus recognizes revenue in accordance with 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 Novellus
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 generally recognized at the later of completion of the
installation services or customer acceptance.

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

Revenue related to spare part sales is recognized 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 other accrued liabilities.

Allowance for Doubtful Accounts

Novellus evaluates its allowance for doubtful accounts based on a combination
of factors. In circumstances where Novellus is aware of a specific customers
inability to meet its financial obligations to it, Novellus records a specific
allowance for bad debt 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 debt based on a
certain percentage of total revenues, which is based on Novellus historical
experience over the past five years. If circumstances change (e.g. higher than
expected defaults or an unexpected material adverse change in a major
customers ability to meet its financial obligations to it), Novellus may amend
its estimates of the recoverability of amounts due to Novellus.

Inventory Reserves

Novellus assesses the recoverability of all inventory, including
work-in-process, finished goods, and spare parts to determine whether
adjustments for impairment are required. Inventory which is obsolete or in
excess of Novellus 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

Novellus warranty policy generally states that Novellus will
provide 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 to cost of sales upon system shipment. The estimated
cost of warranty is determined by the warranty term
as well as the average historical labor and material costs for a
specific tool. Should actual product failure rates, or material usage
differ from Novellus estimates, revisions to the estimated
warranty liability may be required.

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NOVELLUS SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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 determined that it would be able to realize its deferred tax assets in
excess of its net recorded amount, an adjustment to the deferred tax assets
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 assets in the future, an adjustment to the deferred tax
assets would decrease income in the period such determination was made.

Restructuring

Novellus accounts for the restructuring charges in accordance
with Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring), EITF 95-3, Recognition
of Liabilities in Connection with a Purchase Business Combination and Staff
Accounting Bulletin No. 100, Restructuring and Impairment Charges. In
accordance with this guidance, restructuring accruals are recorded when
management executes an exit plan that will cause the Company to incur costs
that have no future economic benefit. Also under the terms of EITF 94-3, a
liability for the restructuring charges is recognized in the period management
approves the restructuring plan. Additionally, certain restructuring charges
related to asset impairments are recorded in accordance with SFAS 144,
Accounting for the Impairment or Disposal of Long-Lived Assets. In the third
quarter of 2001, Novellus established restructuring accruals for its
operations. In the first quarter of 2002, Novellus had a reduction in force,
which required an accrual for severance benefits. These accruals required the
use of estimates. Although Novellus believes that these estimates accurately
reflect the costs of these plans, actual results may be different. See Note 8
to Condensed Consolidated Financial Statements.

Contingencies and Litigation

Novellus makes an assessment of the probability of an adverse judgment
resulting from current and threatened litigation. Novellus would accrue the
cost of an adverse judgment if, in Novellus estimation, the adverse outcome is
probable and Novellus can reasonably estimate the ultimate cost to Novellus.
Novellus has made no such accruals at September 28, 2002.

2. RECENT ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.
143, Accounting for Asset Retirement Obligations, which addresses accounting
and reporting for obligations associated with the retirement of tangible
long-lived assets and the associated asset retirement costs. SFAS 143 is
effective for fiscal years beginning after June 15, 2002. Novellus does not
expect the adoption of SFAS 143 to be material to its financial condition or
results of operations.

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

8



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NOVELLUS SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. SFAS 146 addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
EITF Issue
No. 94-3, Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring) and must be applied beginning January 1, 2003. SFAS 146
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred rather than when the exit
or disposal plan is approved. Novellus does not expect the adoption of SFAS
146 to have a material effect on its financial condition or results of
operations.

3. INVENTORIES

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

|                          |                 |   |               |         |              |   |         |         | 
|------------------------- | --------------- | - | ------------- | ------- | ------------ | - | ------- | ------- | 
|                          |                 |   | September 28, |         | December 31,
|                          |                 |   | 2002          |         | 2001        
|                          |                 |   |               |         |             
|Purchased and spare parts |                 | $ | 193,017       |         |              | $ | 199,702 |        
|                         
|                         
|                         
|                         
|Work-in-process           |                 |   | 39,461        |         |              |   | 42,717  |        
|                         
|                         
|                         
|                         
|Finished goods            |                 |   | 7,209         |         |              |   | 2,293   |        
|                          |                 |   |               |         |              |   |         |        
|                          | Total inventory |   | $             | 239,687 |              |   | $       | 244,712 | 
|                          |                 |   |               |         |              |   |         |        

4. LINES OF CREDIT

As of September 28, 2002, Novellus has lines of credit with four Japanese
banks, which expire at various dates through October 2003, under which Novellus
can borrow up to $31.9 million at the banks prime rates. These facilities are available to Novellus Japanese
subsidiary, Novellus Systems, Japan. As of September 28, 2002 and December 31,
2001, amounts outstanding were $1.6 million and $26.2 million, respectively, at
annual weighted-average interest rates of 0.5% and 0.62%, respectively. All
borrowings under the lines of credit were by Novellus Systems, Japan.

5. NET INCOME PER SHARE

Basic net income (loss) per share is computed by dividing net income (loss) by
the weighted-average number of common shares outstanding during the period. The
computation of basic net income (loss) per share for all periods presented is
derived from the information on the face of the condensed consolidated
statements of operations.

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NOVELLUS SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Diluted earnings per share is computed as though all potential common shares
that are dilutive were outstanding during the period. The following table
provides a reconciliation of the numerators and the denominators of the basic
and diluted per-share computations for income (loss) (in thousands, except per
share amounts):

|                                    |                                           |                                             |      |                    |         |                   |       |               |         |               |      |         |         |   |      |         |         | 
|----------------------------------- | ----------------------------------------- | ------------------------------------------- | ---- | ------------------ | ------- | ----------------- | ----- | ------------- | ------- | ------------- | ---- | ------- | ------- | - | ---- | ------- | ------- | 
|                                    |                                           |                                             |      | Three months ended |         | Nine months ended
|                                    |                                           |                                             |      |                    |         |                  
|                                    |                                           |                                             |      | September 28,      |         | September 29,     |       | September 28, |         | September 29,
|                                    |                                           |                                             |      | 2002               |         | 2001              |       | 2002          |         | 2001         
|                                    |                                           |                                             |      |                    |         |                   |       |               |         |              
|Numerator:                          |                                           |                                             |      |                    |         |                   |       |               |         |               |      |         |         |   |      |        
|                                   
|                                   
|                                   
|                                   
|                                    | Net income (loss)                         |                                             | $    | 4,083              |         |                   | $     | (14,019       | )       |               | $    | 19,932  |         |   | $    | 127,304 |        
|                                    |                                           |                                             |      |                    |         |                   |       |               |         |               |      |         |         |   |      |         |        
|Denominator:                        |                                           |                                             |      |                    |         |                   |       |               |         |               |      |         |         |   |      |        
|                                   
|                                   
|                                   
|                                   
|                                    | Basic weighted-average shares outstanding |                                             |      | 143,691            |         |                   |       | 143,218       |         |               |      | 144,355 |         |   |      | 142,165 |        
|                                   
|                                   
|                                   
|                                   
|                                    | Employee stock options                    |                                             |      | 2,403              |         |                   |       |              |         |               |      | 4,902   |         |   |      | 6,914   |        
|                                    |                                           |                                             |      |                    |         |                   |       |               |         |               |      |         |         |   |      |         |        
|                                    |                                           | Diluted weighted-average shares outstanding |      |                    | 146,094 |                   |       |               | 143,218 |               |      |         | 149,257 |   |      |         | 149,079 | 
|                                    |                                           |                                             |      |                    |         |                   |       |               |         |               |      |         |         |   |      |         |        
|Basic net income (loss) per share   |                                           | $                                           | 0.03 |                    |         | $                 | (0.10 | )             |         | $             | 0.14 |         |         | $ | 0.90 |        
|                                    |                                           |                                             |      |                    |         |                   |       |               |         |               |      |         |         |   |      |         |        
|Diluted net income (loss) per share |                                           | $                                           | 0.03 |                    |         | $                 | (0.10 | )             |         | $             | 0.13 |         |         | $ | 0.85 |        
|                                    |                                           |                                             |      |                    |         |                   |       |               |         |               |      |         |         |   |      |         |        

6. 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 whereby 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, Novellus 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.

Novellus holds synthetic lease agreements on properties in San Jose, California
and Tualatin, Oregon. During the nine months ended September 28, 2002,
Novellus drew an additional $87.5 million against its available lease financing
line for the Tualatin property for which construction was completed in May
2002.There are no additional amounts available under the Tualatin lease
facility. The total financing under the San Jose synthetic lease has not
changed significantly since December 31, 2001.

Summary information regarding Novellus synthetic lease arrangements is as
follows as of September 28, 2002 (currency amounts in thousands):

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

7. 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 were
being amortized over 30 years) from the LYONs offering were $862.4 million.
The LYONs are zero coupon, zero-yield subordinated debentures convertible into
shares of Novellus common stock or redeemed for cash by the security holder,
subject to specified conditions as set forth in the indenture.

10



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NOVELLUS SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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

8. SPECIAL CHARGES

Reduction in Force

In the first quarter of 2002, Novellus reduced its workforce in response to
market conditions. Novellus recorded a special charge of $3.3 million,
primarily for the cost of severance compensation. As of September 28, 2002,
all severance benefits related to the reduction in workforce 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
$9.4 million of professional
fees and financial printing and $3.8 million of other related costs. Additionally, these costs
included charges related to the cancellation of various contracts and the
write-off of certain redundant assets. All expenses
related to these accruals had been paid.

Restructuring

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 Novellus to
its specific actions. Novellus 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 was included in operating
expenses and $7.1 million was 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 were included in cost of sales.

The charge for vacated facilities was related to rent obligations after the
abandonment of certain facilities currently under long-term operating lease
agreements, the related leasehold improvements and certain fixed assets.
Anticipated future sublease income of $4.5 million relating to vacated
buildings was offset against the charge for the remaining lease payments of
$27.0 million. All leasehold improvements of $4.7 million
were abandoned representing assets relating to the vacated buildings
with no future economic benefit. Additionally,
certain fixed assets of $6.6 million associated with these facilities had no
future economic benefit and were written off.

As of December 31, 2001, significantly all actions under the restructuring plan
had been achieved except for future rent obligations related to vacated
facilities. The remaining $18.5 million balance of the restructuring accrual
is for future rent obligations which are to be paid in cash over the next five
years.

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

|                              |               |   |                    |        |  
|----------------------------- | ------------- | - | ------------------ | ------ | -
|                              |               |   | Vacated Facilities
|                              |               |   |                   
|Balance at December 31, 2001  |               | $ | 26,849             |       
|                             
|                             
|                             
|                             
|                              | Cash payments |   |                    | (8,365 | )
|                              |               |   |                    |       
|Balance at September 28, 2002 |               | $ | 18,484             |       
|                              |               |   |                    |       

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NOVELLUS SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

9. BAD DEBT WRITE-OFF (RECOVERY)

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 the first quarter of 2002, all amounts under this accounts
receivable balance were paid, resulting in a recovery of $7.7 million.

10. COMPREHENSIVE INCOME (LOSS)

The following are the components of comprehensive income (loss) (in thousands):

|                                                                         |                                   |   |                    |       |                   |   |               |        |               |   |        |        |  |   |         |         | 
|------------------------------------------------------------------------ | --------------------------------- | - | ------------------ | ----- | ----------------- | - | ------------- | ------ | ------------- | - | ------ | ------ |  | - | ------- | ------- | 
|                                                                         |                                   |   | Three months ended |       | Nine months ended
|                                                                         |                                   |   |                    |       |                  
|                                                                         |                                   |   | September 28,      |       | September 29,     |   | September 28, |        | September 29,
|                                                                         |                                   |   | 2002               |       | 2001              |   | 2002          |        | 2001         
|                                                                         |                                   |   |                    |       |                   |   |               |        |              
|Net income (loss)                                                        |                                   | $ | 4,083              |       |                   | $ | (14,019       | )      |               | $ | 19,932 |        |  | $ | 127,304 |        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Foreign currency translation adjustment                                  |                                   |   | 143                |       |                   |   | 759           |        |               |   | 818    |        |  |   | 1,579   |        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Unrealized gain (loss) on available-for-sale securities                  |                                   |   | 124                |       |                   |   | (866          | )      |               |   | 416    |        |  |   | 7,451   |        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Reclassification adjustment for a realized gain on an available-for-sale |                                   |   |                    |       |                   |   |               |        |               |   |        |        |  |   |         |        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|investment included in net income, net
of tax                            |                                   |   |                   |       |                   |   | 5,904         |        |               |   | (3,636 | )      |  |   | 5,904   |        
|                                                                         |                                   |   |                    |       |                   |   |               |        |               |   |        |        |  |   |         |        
|                                                                         | Other comprehensive income (loss) |   | $                  | 4,350 |                   |   | $             | (8,222 | )             |   | $      | 17,530 |  |   | $       | 142,238 | 
|                                                                         |                                   |   |                    |       |                   |   |               |        |               |   |        |        |  |   |         |        

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

|                                                 |                                               |   |               |      |              |   |        |       | 
|------------------------------------------------ | --------------------------------------------- | - | ------------- | ---- | ------------ | - | ------ | ----- | 
|                                                 |                                               |   | September 28, |      | December 31,
|                                                 |                                               |   | 2002          |      | 2001        
|                                                 |                                               |   |               |      |             
|Foreign currency translation adjustment          |                                               | $ | (1,357        | )    |              | $ | (2,175 | )    
|                                                
|                                                
|                                                
|                                                
|Unrealized gain on available-for-sale securities |                                               |   | 481           |      |              |   | 3,701  |      
|                                                 |                                               |   |               |      |              |   |        |      
|                                                 | Accumulated other comprehensive income (loss) |   | $             | (876 | )            |   | $      | 1,526 | 
|                                                 |                                               |   |               |      |              |   |        |      

11. INCOME TAXES

Novellus recorded a tax benefit of $4.2 million in the third quarter, which
brings the tax provision and effective tax rate to zero for the nine months
ended September 28, 2002. Novellus effective tax rate for the nine months
ended September 29, 2001 was 31%. The decrease in the effective tax rate
compared to the year-ago period is due primarily to the relative benefit of tax
credits being higher due to decreased profitability this year.

12. RELATED PARTY TRANSACTIONS

Novellus leases an aircraft from a
third-party entity wholly-owned by Richard S. Hill, Novellus Chairman and
Chief Executive Officer. Under the aircraft lease agreement, Novellus incurred
lease expense of approximately $134,000 through September 28, 2002. Novellus
believes that the amount paid for use of the aircraft approximates amounts
charged by third-party commercial charter companies for a similar type of
aircraft.

D.  James Guzy, a member of
Novellus board of directors, is also a member of
the board of directors of Intel Corporation, one of Novellus significant customers and
therefore, this customer is considered a related party. Intel Corporation
represented 8% and 11% of net sales for the three and nine months ended
September 28, 2002, respectively, and 13% and
15% of net sales during the three and nine months ended September 29, 2001,
respectively.

From time to time, Novellus issues secured relocation loans to
individuals in the Companys management and key personnel. As of September 28, 2002, these loans
were approximately $5.9 million in total. As of
September 28, 2002, Novellus does not have outstanding loans with its
executive officers or members of its board of directors.

13. PENDING ACQUISITION

On August 11, 2002, Novellus entered into a definitive agreement to acquire
SpeedFam-IPEC, Inc., a global supplier of chemical mechanical planarization
(CMP) systems used in the fabrication of advanced copper interconnects.
If the merger is completed, Novellus will acquire all outstanding shares of SpeedFam-IPEC in a
stock-for-stock merger and will assume all of SpeedFam-IPECs 6 1/4

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NOVELLUS SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

percent Convertible Subordinated Notes due 2004, totaling $115.0 million.
If the merger is
completed, SpeedFam-IPEC will become a wholly-owned subsidiary of Novellus, and
each outstanding share of SpeedFam-IPEC common stock will be converted into the
right to receive 0.1818 share of Novellus common stock on a fixed exchange
ratio basis. The merger will be accounted for as a purchase transaction and is
intended to qualify as a tax-free reorganization under applicable U.S. tax law
and regulations. In accordance with purchase accounting, the total
estimated purchase price of approximately $167.4 million
includes Novellus common stock valued at $149.3 million, assumed
options and warrants with a fair value of $14.2 million and
estimated direct transaction costs of $3.9 million. The transaction has been approved by the boards of directors
of both companies and is expected to formally close in the fourth calendar
quarter of 2002, subject to certain closing conditions, including SpeedFam-IPEC
shareholder approval. Novellus shareholder approval is not required.

14. LITIGATION

For a discussion of legal matters, see Part II: Other Information, Item 1:
Legal Proceedings.

15. SUBSEQUENT EVENT

In response to the continuing decline
in the semiconductor equipment industry, Novellus reduced its
workforce in the fourth quarter of 2002. Novellus estimates it will
record a charge of approximately $1.7 million in the fourth
quarter of 2002, primarily for the cost of severance compensation.

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ITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

This Quarterly Report on Form 10-Q contains forward-looking statements within
the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. All statements included in this Quarterly 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.
Forward-looking statements in this Quarterly Report include, without
limitation: Novellus continued belief that significant investment in R&D is
required to remain competitive and Novellus plans to continue to invest in new
products; Novellus intent to complete restructuring activities
within a year of commencement of Novellus restructuring plan
including the write-off of assets and subleasing of facilities; Novellus
expectations regarding its acquisition of SpeedFam-IPEC, Inc., including the
transactions anticipated closing date and that the acquisition will be
favorable to the Companys earnings on a per-share basis by the third calendar
quarter of 2003; Novellus expectations regarding the effect of the adoption of SFAS
143, 145 and 146 on its financial condition or results of operations; Novellus belief that it would exercise its purchase option
under the terms of the synthetic leases if the final Statement regarding the
treatment of the assets associated with Novellus synthetic leases by FASB is
consistent with Novellus interpretation of the Exposure Draft (ED),
Consolidation of Certain Special-Purpose Entities, an Interpretation of ARB
No. 51, and the Companys expectation that the adoption of the ED would not
have a significant impact on its liquidity; Novellus expectations regarding
investments in property and equipment in fiscal 2002; Novellus belief that its
current cash position, cash generated through operations and equity offerings,
and available borrowings will be sufficient to meet Novellus needs through the
next twelve months; Novellus beliefs that the ultimate outcome of the Applied
Materials, Semitool, Plasma Physics, and Linear Technology litigation matters
will not have a material adverse effect on Novellus business, financial
condition or results of operations; and Novellus beliefs and expectations with
respect to the outcomes of current patent infringement inquiries.

Novellus expectations, beliefs, objectives, anticipations, intentions and
strategies regarding the future, expected operating results, revenues and
earnings and current and potential litigation, or set forth in the other
forward-looking statements found herein, 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 including, but not limited to, the current downturn
in the U.S. economy, continued customer capital spending reductions in the
semiconductor industry; further periodic downturns in the semiconductor
industry which could have a material adverse effect on the semiconductor
industrys demand for semiconductor processing equipment, the greater
financial, marketing, technical or other resources, broader product lines, and
more established customer bases that some of Novellus competitors possess,
future competition from new market entrants, improvement of the design and
performance of Novellus competitors products, Novellus success in selecting,
developing, and marketing new products, or enhancing existing products, its
ability to enforce its patents and the inherent uncertainty in the outcome of
litigation matters, the availability of raw materials and critical
manufacturing equipment, and risks associated with regulatory and trade
environments.

All forward-looking statements included in this Quarterly Report are based on
information available to Novellus on the date hereof, and Novellus assumes no
obligation to update any such forward-looking statements. You are cautioned
not to place undue reliance on such statements, which speak only as of the date
of this Quarterly Report. You should also consult the cautionary statements
and risk factors listed in Trends, Risks and Uncertainties beginning on page 20
of this Report as the cautionary statements and risk factors listed from time
to time in this Report as well as Novellus other SEC filings,
including its most recent Annual
Report on Form 10-K for the year ended December 31, 2001,
its Quarterly Reports on Form 10-Q for the quarters ended
March 30 and June 29, 2002, and its Registration Statement
on Form S-4/A filed November 1, 2002.

CRITICAL ACCOUNTING POLICIES

Novellus discussion and analysis of its financial condition and results of
operations are based upon Novellus condensed consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States of America. The preparation of these
financial statements requires Novellus to make estimates and judgments on an
ongoing basis 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, inventory reserves,
warranty obligations, deferred tax assets, 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.

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

Revenue Recognition

Novellus recognizes revenue in accordance with 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 Novellus 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 generally recognized at the later of completion of the
installation services or customer acceptance.

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

Revenue related to spare parts 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 other accrued liabilities.

Allowance for Doubtful Accounts

Novellus evaluates its allowance for doubtful accounts based on a combination
of factors. In circumstances where Novellus is aware of a specific customers
inability to meet its financial obligations to it, Novellus records a specific
allowance for bad debt 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 debt based on a
certain percentage of total revenues, which is based on Novellus historical
experience over the past five years. If circumstances change (e.g. higher than expected
defaults or an unexpected material adverse change in a major customers ability
to meet its financial obligations to it), Novellus may amend its estimates of
the recoverability of amounts due to Novellus.

Inventory Reserves

Novellus assesses the recoverability of all inventory, including
work-in-process, finished goods, and spare parts to determine whether
adjustments for impairment are required. Inventory which is obsolete or in
excess of Novellus 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

Novellus warranty policy generally states that Novellus will
provide 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 to cost of sales upon system shipment. The estimated cost of warranty
is determined by the warranty term as well as the
average historical labor and material costs for a specific tool.
Should actual product failure rates, or material usage differ from Novellus estimates, revisions to the
estimated warranty liability may be required.

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 determined that it would be able to realize its deferred tax assets in
excess of its net recorded amount, an adjustment to the deferred tax assets
would increase income in the period

15



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such determination was made. Likewise, should Novellus determine that it would
not be able to realize all or part of its net deferred tax assets in the
future, an adjustment to the deferred tax assets would decrease income in the
period such determination was made.

Restructuring

Novellus accounts for restructuring charges in accordance
with Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring), EITF 95-3, Recognition
of Liabilities in Connection with a Purchase Business Combination and Staff
Accounting Bulletin No. 100, Restructuring and Impairment Charges. In
accordance with this guidance, restructuring accruals are recorded
when management executes an exit plan that will
cause the Company to incur costs that have no future economic benefit. Also
under the terms of EITF 94-3, a liability for the restructuring charges is
recognized in the period management approves the restructuring plan.
Additionally, certain restructuring charges related to asset
impairments are recorded in accordance with SFAS 144
Accounting for the Impairment or Disposal of Long-Lived
Assets. In the
third quarter of 2001, Novellus established restructuring accruals for its
operations. In the first quarter of 2002, Novellus had a reduction in force,
which required accruals for severance benefits. These accruals required the
use of estimates. Although Novellus believes that these estimates accurately
reflect the costs of these plans, actual results may be different. See Note 8
to Condensed Consolidated Financial Statements.

Contingencies and Litigation

Novellus makes an assessment of the probability of an adverse judgment
resulting from current and threatened litigation. Novellus would accrue the
cost of an adverse judgment if, in Novellus estimation, the adverse settlement
is probable and Novellus can reasonably estimate the ultimate cost to Novellus.
Novellus has made no such accruals at September 28, 2002.

Novellus critical accounting policies are also discussed in Novellus
Annual Report on Form 10-K for the year ended December 31, 2001, in the section
Managements Discussion and Analysis of Financial Condition and Results of
Operations and in Note 1 to the Novellus Consolidated Financial Statements for
the year ended December 31, 2001.

RESULTS OF OPERATIONS

Net sales for the three and nine months ended September 28, 2002 were $230.5
million and $622.3 million, respectively. Net sales for the three and nine
months ended September 29, 2001 were $303.7 million and $1,139.3 million,
respectively. Net sales were $222.1 million in the quarter ended June 29,
2002. The decrease in net sales over the comparable year-ago periods is
primarily due to customer capital spending reductions in response to slowing
worldwide demand for semiconductors. The slight increase in net sales over the
immediately preceding quarter is primarily due to improved market conditions
during the first half of 2002.

International net sales (including export sales) for the three and nine months
ended September 28, 2002 were 68% and 67% of total net sales, compared to 53%
and 55% for the three and nine months ended September 29, 2001, and 76% in the
immediately preceding quarter. The increase from the comparable year-ago
periods is primarily a result of a higher proportional increase in net sales in
the Asian region, which consists primarily of Taiwan, Korea and Japan. The
Asian region accounted for 61% and 58% of total net sales for the three and
nine months ended September 28, 2002 as compared to 48% and 46% for the three
and nine months ended September 29, 2001. The decrease in
international net sales as a percentage of net sales from the immediately
preceding quarter is primarily due to lower sales in the Asian region, from 69%
in the immediately preceding quarter to 61% for the three months ended
September 28, 2002.

Gross profit as a percentage of net sales for the three and nine months ended
September 28, 2002 was 47% and 45%, compared with 46% and 52%, respectively,
for the comparable year-ago periods. Gross profit as a percentage of
net sales
increased from 46% in the immediately preceding quarter. The decrease in gross
profit as a percentage of net sales from the comparable nine month
period is due
to reduced absorption of fixed overhead costs resulting from lower shipments
and from lower gross margins on Novellus 300mm systems, which have higher
costs as they are not yet in high-volume production. The increase in gross
profit as a percentage of sales from the immediately preceding quarter is
primarily due to improving margins on the 300mm systems and improved absorption
of fixed overhead costs due to increased shipments.

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Selling, general, and administrative (SG&A) expense for the three and nine
months ended September 28, 2002 was $43.1 million and $117.3 million, compared
with $46.8 million and $170.2 million in the comparable year-ago periods and
$39.5 million in the immediately preceding quarter. SG&A expense as a
percentage of net sales for both the three and nine months ended September 28,
2002 was 19%, compared with 15% for the comparable year-ago periods and 18% for
the immediately preceding quarter. The increase in SG&A expense as a
percentage of net sales versus the comparable year-ago periods is primarily due
to a substantial reduction in net sales associated with the decline in customer
capital spending. The decrease in SG&A expense in absolute dollars from the
comparable year-ago periods is primarily due to the impact of cost reduction
measures implemented in the second half of 2001, including travel, workforce
reductions and facilities consolidation.
The increase in SG&A expense in absolute dollars from the immediately
preceding quarter was primarily due to an increase in headcount.

Research and development (R&D) expense for the three and nine months ended
September 28, 2002 was $58.2 million and $171.0 million, compared with $68.2
million and $211.4 million for the comparable year-ago periods and $58.7
million in the immediately preceding quarter. R&D expense as a percentage of
net sales for the three and nine months ended September 28, 2002 was 25% and
27% compared with 22% and 19% for the comparable year-ago periods and 26% for
the immediately preceding quarter. The increase in R&D expense as a percentage
of net sales versus the comparable year-ago periods is primarily due to a
substantial reduction in net sales associated with the decline in customer
capital spending. The decrease in R&D expense in absolute dollars over the
comparable year-ago periods is primarily due to workforce reductions and facilities consolidations and other cost containment efforts
aimed at focusing Novellus R&D efforts on key products necessary for long-term
growth. The decrease in R&D expense from the immediately preceding quarter is
due to continued cost containment efforts. Novellus continues to believe that
significant investment in R&D is required to remain competitive and plans to
continue to invest in new products.

Special charges for the three and nine months ended September 28, 2002 were
zero and $3.3 million compared with $47.9 million and $61.1 million for the
comparable year-ago periods. In the first quarter of 2002, Novellus reduced
its workforce in response to market conditions. Novellus recorded a special
charge of $3.3 million, primarily for the cost of severance compensation. As
of September 28, 2002, all severance benefits related to the reduction in
workforce had been paid. In September 2001, Novellus announced its intention to restructure its
operations which was driven by the anticipated decline in Novellus orders due
to the forecasted contraction of the semiconductor equipment market from
calendar year 2000 levels. During the third quarter of 2001, the Plan was approved by
the appropriate level of management necessary to commit the Company to its
specific actions. Novellus began implementing the restructuring plan during
the third quarter of 2001 and recorded restructuring and 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 (which assumes
sublease income of $4.5 million), $9.5 million related to abandoned assets
associated with the discontinuation of certain projects, and $4.6 million
related to the write-off of purchased technology. The discontinuation of
certain projects resulted in $7.1 million of inventory write-downs, which are
included in cost of sales.

In the first quarter of 2001, Novellus incurred merger costs related to the
acquisition of GaSonics of $13.2 million. These costs included
$9.4 million of professional
fees and financial printing and $3.8 million of other related costs. These costs also included
charges related to the cancellation of various contracts and the write-off of
certain redundant assets. All expenses related to these accruals had been paid.

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 the first quarter of 2002, all amounts owed under this accounts
receivable balance were paid, resulting in a benefit to operations of $7.7
million.

Other income, including interest income, for the three and nine months ended
September 28, 2002 was $8.9 million and $38.4 million, compared with $10.2
million and $40.1 million for the comparable year-ago periods and $11.8 million
in the immediately preceding quarter. The decrease in interest income is
primarily due to a decrease in interest bearing investments as Novellus used
$880.0 million of restricted investments to pay off the Liquid
Yield OptionTM Notes (LYONs) and due to a
continued decline in interest rates. The decreases in other income from the
year-ago nine-month period has been offset by a $4.6 million gain on the sale
of an investment recorded in the first quarter of 2002.

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The write off of debt issuance costs
amounted to a $17.0 million charge related
to the retirement of $880.0 million Liquid Yield Options Notes on July 26,
2002.

Novellus recorded a tax benefit of $4.2 million in the third quarter, which
brings the tax provision and effective tax rate to zero for the nine months
ended September 28, 2002. Novellus effective tax rate for the nine months
ended September 29, 2001 was 31%. The decrease in the effective tax rate
compared to the year-ago period is primarily due to the relative benefit of tax
credits being higher due to decreased profitability this year.

Related Party Transactions

Novellus leases an aircraft from a
third-party entity wholly owned by Richard S. Hill, Novellus Chairman and
Chief Executive Officer. Under the aircraft lease agreement, Novellus incurred
lease expense of approximately $134,000 through September 28, 2002. Novellus
believes that the amount paid for use of the aircraft approximates amounts
charged by third-party commercial charter companies for a similar type of
aircraft.

D.  James Guzy, a member of Novellus board of directors, is also a member of
the board of directors of Intel Corporation, one of Novellus significant customers and
therefore, this customer is considered a related party. Intel Corporation
represented 8% and 11% of net sales for the three and nine months ended
September 28, 2002, respectively, and 13% and
15% of net sales during the three and nine months ended September 29, 2001,
respectively.

From time to time, Novellus issues secured relocation loans to
individuals in the Companys management and key personnel. As of September 28, 2002, these loans
were approximately $5.9 million in total. As of
September 28, 2002, Novellus does not have outstanding loans with its
executive officers or members of its board of directors.

Pending Acquisition

On August 11, 2002, Novellus entered into a definitive agreement to acquire
SpeedFam-IPEC, Inc., a global supplier of chemical mechanical planarization
(CMP) systems used in the fabrication of advanced copper interconnects. If the
merger is completed, Novellus will acquire all outstanding shares of
SpeedFam-IPEC in a stock-for-stock merger and will assume all of
SpeedFam-IPECs 6 1/4 percent Convertible Subordinated Notes due 2004,
totaling $115.0 million. If the merger is completed, SpeedFam-IPEC will become a wholly-owned
subsidiary of Novellus, and each outstanding share of SpeedFam-IPEC common
stock will be converted into the right to receive 0.1818 share of Novellus
common stock on a fixed exchange ratio basis. The merger will be accounted for
as a purchase transaction and is intended to qualify as a tax-free
reorganization under applicable U.S. tax law and regulations. In
accordance with purchase accounting, the total estimated purchase
price of approximately $167.4 million includes Novellus common
stock valued at $149.3 million, assumed options and warrants
with a fair value of $14.2 million and estimated direct
transaction costs of $3.9 million. The transaction
has been approved by the boards of directors of both companies and is expected
to formally close in the fourth calendar quarter of 2002, subject to certain
closing conditions, including SpeedFam-IPEC shareholder approval. Novellus
shareholder approval is not required. The transaction is expected to be
favorable to Novellus earnings on a per-share basis by the third
calendar quarter of 2003.

Subsequent Event

In response to the continuing decline
in the semiconductor equipment industry, Novellus reduced its
workforce in the fourth quarter of 2002. Novellus estimates it will
record a charge of approximately $1.7 million in the fourth quarter
of 2002, primarily for the cost of severance compensation.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.
143, Accounting for Asset Retirement Obligations, which addresses accounting
and reporting for obligations associated with the retirement of tangible
long-lived assets and the associated asset retirement costs. SFAS 143 is
effective for fiscal years beginning after June 15, 2002. Novellus does not
expect the adoption of SFAS 143 to be material to its financial condition or
results of operations.

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.
For most companies, SFAS 145 will require gains and losses on extinguishments
of debt to be classified as income or loss from continuing operations rather
than as extraordinary items as previously required under SFAS 4. Extraordinary
treatment will be required for certain extinguishments as provided in APB

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Opinion No. 30. The statement also amended SFAS 13 for certain sales-leaseback
transactions and sublease accounting. Novellus is required to adopt the
provisions of SFAS 145 effective January 1, 2003. Novellus does not expect the
adoption of SFAS 145 to have a material effect on the Companys financial
condition or results of operations.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. SFAS 146 addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring) and must be applied beginning January 1, 2003. SFAS 146
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred rather than when the exit
or disposal plan is approved. Novellus does not expect the adoption of SFAS 146
to have a material effect on its financial condition or results of operations.

In connection with its ongoing consolidations project, the FASB issued an
exposure draft (ED), Consolidation of Certain Special-Purpose Entities, an
Interpretation of ARB No. 51, in June 2002 for public comment with the comment
period ending on August 30, 2002. Currently, special purpose entities (SPE)
would be required to be consolidated based on a majority voting interest. However,
the tentative decisions reached by the FASB at its board meeting on October 16,
2002 would also require consolidation based on variable interest, which is the
means through which financial support is provided to a SPE. The entity which
provides significant financial support to and also benefits from the SPEs
activities is considered the primary beneficiary of the SPE and the SPE would
be consolidated in its financial statements. The ED will substantially change
the accounting for synthetic leases. It is expected that the FASB will issue
an Interpretation in the fourth quarter of this year and the final guidance
will become effective for Novellus in its second fiscal quarter of 2003. If
the final Interpretation is consistent with the ED, and Novellus were required
to consolidate its special purpose entity, Novellus believes that it would
exercise its purchase option under the terms of the synthetic leases and
purchase the leased assets thereunder. This treatment would result in Novellus
recording the property and equipment purchase under the leases of approximately
$456.4 million. Novellus lease receivable and cash collateral under the
synthetic leases would be returned to Novellus 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 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. Because this treatment would
result in the lease receivable and cash collateral being returned to Novellus,
the Company does not expect the adoption of the ED to have a significant impact
on its liquidity.

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 September 28, 2002
consisted of $924.7 million of cash, cash equivalents, and short-term
investments. This amount represents an increase of $2.9 million from the
December 31, 2001 balance of $921.8 million. Net cash provided by operating
activities during the nine months ended September 28, 2002 was
$178.1 million.
This amount consisted primarily of a decrease in prepaid and other current
assets of $68.7 million, an increase in deferred profit of $26.6 million and an
income tax benefit from employee stock option plans of
$17.3 million. The decrease in prepaid and other current assets
was primarily a result of an income tax refund received in the third
quarter of $49.5 million.

Net cash provided by investing activities was $684.8 million during the nine
months ended September 28, 2002. During this period, Novellus cash inflows
consisted primarily of $881.8 million in net proceeds from both restricted and
non-restricted short-term investments offset by an increase in
Novellus participation in its synthetic leases of
$177.5 million and an increase in capital expenditures of $21.4 million.

As of September 28, 2002, Novellus does not have any significant commitments to
purchase property and equipment.

During the nine months ended September 28, 2002, net cash used in financing
activities was $939.8 million, primarily due to the repurchase
of the LYONs of approximately $880.0 million. In addition, there were $75.4
million of common stock repurchases and net payments of
$24.5 million on Novellus lines of credit offset by proceeds from employee stock option plans of
$39.9 million.

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 whereby 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, Novellus is obligated to lend approximately 87% of the cost of the
leased asset to the lessor upon completion of construction. The

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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. Novellus synthetic lease
arrangements are discussed in greater detail in Novellus Annual Report on
Form 10-K for the year ended December 31, 2001, in the section Managements
Discussion and Analysis of Financial Condition and Results of Operations and
in Note 7 to the Novellus Consolidated Financial Statements for the year ended
December 31, 2001, provided that such discussion speaks only as of the date
such Form 10-K was filed.

Novellus holds synthetic lease agreements on properties in San Jose, California
and Tualatin, Oregon. During the nine months ended September 28, 2002,
Novellus utilized an additional $87.5 million against its available lease financing
line for the Tualatin property for which construction was completed in May
2002. There are no additional amounts available under the Tualatin lease
facility. The total financing under the San Jose synthetic lease has not
changed significantly since December 31, 2001.

As of September 28, 2002, Novellus has lines of credit with four Japanese
banks, which expire at various dates through October 2003, under which Novellus
can borrow up to $31.9 million at the banks prime rates. These facilities are available to Novellus Japanese
subsidiary, Novellus Systems, Japan. As of September 28, 2002 and December 31,
2001, amounts outstanding were $1.6 million and $26.2 million, respectively, at
annual weighted-average interest rates of 0.5% and 0.62%, respectively. All
borrowings under the lines of credit were by Novellus Systems, Japan.

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

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

On August 11, 2002, Novellus entered into a definitive agreement to acquire
SpeedFam-IPEC, Inc., a global supplier of chemical mechanical planarization
(CMP) systems used in the fabrication of advanced copper interconnects. If the
transaction closes, Novellus will assume all of SpeedFam-IPECs 6 1/4 percent
Convertible Subordinated Notes due 2004, totaling $115.0 million.

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

TRENDS, RISKS, AND UNCERTAINTIES

Set forth below and elsewhere in this Form 10-Q, including in Item 2,
Managements Discussion and Analysis beginning on page 14 of this Report, and
in other documents Novellus files with the Securities and Exchange Commission
are trends, risks and uncertainties that could cause Novellus actual results
to differ materially from the results contemplated by the forward-looking
statements contained in this Form 10-Q. As noted, these trends, risks, and
uncertainties are discussed below.

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 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. In particular, during a

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period of reduced demand, Novellus inventory levels have periodically exceeded
the minimum levels necessary to support production demand. Although Novellus
has historically been able to reduce inventory levels through sales and reduced
purchasing, no assurance can be given that Novellus may not be required to make
inventory valuation adjustments in future periods. 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 67% and
55%, respectively, of net sales in the nine
months ended September 28, 2002 and in fiscal year 2001, 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 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. Novellus defines the Asian region as Taiwan,
Korea and Japan, which accounted for 47% and
58% of Novellus revenues in 2001 and
for the nine months ended September 28, 2002, and is affected by banking, currency and
other difficulties that contribute to the economic developments in those
countries. Any negative economic developments within the Asian region 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

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currency fluctuations of intercompany accounts payable denominated in U.S.
Dollars recorded by the Japanese subsidiary in order to 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 Novellus 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.

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.

Novellus is Exposed to Risks Associated with Acquisitions

In addition to its pending acquisition
of SpeedFam-IPEC, Inc., Novellus has made, and may in the future make, acquisitions of, or significant
investments in, businesses with complementary products, services and
technologies. Acquisitions involve numerous risks, including, but not limited
to, failure to complete an acquisition transaction, difficulties in integrating the operations, technologies, products and
personnel of acquired companies, lack of synergies or the inability to realize
expected synergies, difficulties in managing geographically dispersed
operations, the potential loss of key employees, customers and strategic
partners of acquired companies, diversion of managements attention from normal
daily operations of the business, acquired intangible assets becoming impaired
as a result of technological advancements, or worse-than-expected performance
of acquired companies. Acquisitions are inherently risky and no assurance can
be given that Novellus previous or future acquisitions will be successful. The
inability to effectively manage the risks associated with previous or future
acquisitions could materially and adversely affect Novellus business,
financial condition and results of operations.

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 the nine months ended September 28, 2002 and in fiscal
year 2001

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accounted for 76% and 61% of net sales, respectively. For the year ended
December 31, 2001, Intel Corporation accounted for 16% of Novellus net sales.
For the year ended December 31, 2000, Intel and Taiwan Semiconductor accounted
for 14% and 10% of Novellus net sales, respectively. For the year ended
December 31, 1999, Samsung, Texas Instruments and United Microelectronics
accounted for 17%, 13% and 10% of Novellus 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 seeks 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 300 millimeter 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 the nine months ended
September 28, 2002 and fiscal year 2001, were $171.0 million and $272.0 million,
respectively, or approximately 27% and 20% of net sales, respectively.
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 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 applications or that any claims allowed from existing or

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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. Additionally, because
technology in the semiconductor industry moves quickly, the duration of patents
is not significant in determining the level of protection that such patents
afford. 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 page 25, Part II: Other Information, Item 1:
Legal Proceedings). Except as set forth beginning on page 25,
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. Novellus invests its cash in cash deposits, money market
funds, commercial paper, certificates of deposit, readily marketable debt
securities, or medium-term notes. Novellus places its investments with
high-credit-quality financial institutions and limits the credit exposure from
any one financial institution or instrument. Novellus performs ongoing credit
evaluations of its customers financial condition and generally requires no
collateral. Novellus 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 Novellus 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

In June 2002, the Financial Accounting Standards Board, or FASB, issued an
exposure draft, or ED, Consolidation of Certain Special-Purpose Entities, an
Interpretation of ARB No. 51, for public comment. The ED could substantially
change the accounting for synthetic leases. The comment period on the ED will
end on August 30, 2002, and the final guidance will become effective for
Novellus in its second fiscal quarter of 2003. If the final Statement is
consistent with the ED, and

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Novellus were required to consolidate its special purpose entity, Novellus
believes that it would exercise its purchase option under the terms of the
synthetic leases and purchase the leased assets thereunder. Because this
treatment would result in the lease receivable and cash collateral being
returned to Novellus, Novellus does not expect the adoption of the ED to
have an impact on its liquidity.

Additionally, in June 2001, the FASB issued
SFAS, No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 is
effective for fiscal years beginning after June 15, 2002. Novellus does not
expect the adoption of SFAS No. 143 to be material to its financial condition
or results of operations.

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB
Statements No. 4, 44 and 64, Amendment of SFAS No. 13, and Technical
Corrections. Novellus is required to adopt the provisions of SFAS No. 145
effective January 1, 2003. Novellus does not expect the adoption of SFAS No.
145 to have a material effect on Novellus financial condition or results of
operations.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. Novellus is currently evaluating
the impact of this adoption. Although Novellus does not expect the adoption of
these standards to have a material effect on its financial condition or results
of operations, there can be no assurances that there will not be a material
adverse affect on Novellus business, financial condition, and results of
operations in future periods.

There can be no assurances that the issuance
by FASB of additional statements of financial accounting standards in the
future would not materially adversely affect Novellus business, financial
condition, and results of operations if such were required to be adopted by
Novellus.




ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

For quantitative and qualitative
disclosures about market risk affecting Novellus, see Item 7A
Quantitative and Qualitative Disclosures about Market
Risk in our Annual Report on Form 10-K, for the fiscal
year ended December 31, 2001. Our exposure related to market
risks has not changed materially since December 31, 2001.




ITEM 4: CONTROLS AND PROCEDURES

Within 90 days prior to the filing date of this report, we carried out an
evaluation, under the supervision and with the participation of management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Rules 13a-14 and 15d-14 of the Securities Exchange Act
of 1934, as amended. Based upon that evaluation, the Chief Executive Officer
and Chief Financial Officer concluded that our disclosure controls and
procedures are effective in timely alerting management to material information
relating to the Company that is required to be included in our periodic filings
with the Securities and Exchange Commission. There have been no significant
changes in our internal controls or in other factors that could significantly
affect internal controls subsequent to the date we carried out our evaluation,
including any corrective actions with regard to significant deficiencies and
material weaknesses.




PART II: OTHER INFORMATION




ITEM 1: LEGAL PROCEEDINGS

Applied Litigation

On July 7, 1997, prior to the consummation of the purchase of the TFS business
unit from Varian Associates Inc., Applied Materials, Inc. filed a 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, which patents
are owned by Applied.

Immediately after consummation of the TFS purchase, Novellus filed a 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, or the 597 patent, 5,330,628, and 5,635,036, or the 036 patent,
which patents Novellus acquired from Varian in the TFS purchase. In its
complaint, Novellus also alleged that it is entitled to declarations from
Applied that Novellus does not infringe the Applied patents mentioned above
and/or that the

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Applied patents mentioned above are invalid and/or unenforceable. Applied has
filed counterclaims alleging that Novellus infringes the Applied patents listed
above.

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

In addition to a request for a permanent injunction against further
infringement, Applieds complaint and Applieds counterclaims to 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 mentioned above and/or that the
Applied patents mentioned above 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.

On March 25, 2002, the United States District Court issued an order: (1)
denying Applieds motion for summary judgment of no literal infringement and no
infringement under the doctrine of equivalents of claims 1 and 8 of Novellus
597 patent with respect to Applieds 300mm Al WP series magnet arrays; (2)
granting summary judgment of no literal infringement of claims 1 and 8 of
Novellus 597 patent to Applied with respect to its 200mm RH and 300mm IMP
series arrays, but denying summary judgment with respect to infringement under
the doctrine of equivalents for these products and claims; (3) denying
Novellus cross-motion for summary judgment of infringement of claims 1 and 8
of Novellus 597 patent; and (4) granting summary judgment of non-infringement
to Applied with respect to claims 27 and 28 of Novellus 597 patent and
Applieds 300mm Al WP series magnet arrays.

On May 13, 2002, the United States District Court issued an order: (1) denying
Applieds motion for summary judgment of no literal infringement of the 036
patent; and (2) granting Applieds motion to bar Novellus from proving
infringement of the 036 patent under the doctrine of equivalents.

On July 26, 2002, Applied filed a motion for summary judgment that the 036
patent is invalid for failure to comply with the best mode requirement of 35
USC § 112, ¶ 1. Novellus intends to oppose this motion, and hearing is
presently set for October 11, 2002.

On August 1, 2002, Applied filed a motion for leave of Court to amend its
former Civil LR 16-9 Response Charts to assert additional prior art and other
invalidity defenses against Novellus 036 and 597 patents. Novellus intends
to oppose this motion, and hearing is presently set for October 11, 2002.

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 Novellus for patent infringement in the
United States District Court for the Northern District of California. Semitool
alleges that Novellus SABRETM and SABRETM xT copper deposition systems
infringe two Semitool patents, U.S. Patent No. 5,222,310, or the 310 patent,
issued June 29, 1993, entitled Single Wafer Processor with a Frame, and U.S.
Patent No. 5,377,708, or the 708 patent, issued January 3, 1995, entitled
Multi-Station Semiconductor Processor with Volatilization. Semitool seeks an
injunction against Novellus manufacture and sale of the SABRETM and

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SABRETM 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, Novellus filed a
motion for summary judgment of non-infringement.

On March 17, 2000, the District Court granted Novellus motion for summary
judgment of non-infringement. The District Court ruled that Novellus
SABRETMand SABRETM 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.
On June 8, 2001, the Federal Circuit affirmed the District Courts judgment
that Novellus SABRETM and SABRETM 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. The
Supreme Court granted this writ, vacated the Federal Circuits opinion, and
remanded the case to the Federal Circuit for further consideration. On July 23, 2002,
the Federal Circuit again affirmed the District Courts judgment of
non-infringement. On October 21, 2002, Semitool elected not to file a petition with the Supreme Court. As a
result, the litigation has been resolved in Novellus favor.

Semitool Litigation II

On June 11, 2001, Semitool sued Novellus for patent infringement in the United
States District Court for the District of Oregon. Semitool alleges that
Novellus 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 Novellus 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, Novellus countersued Semitool for patent infringement in
the United States District Court for the District of Oregon. Novellus alleges
that Semitool infringes Novellus U.S. Patent Nos. 6,179,983, or the 983
patent, 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. Novellus seeks an injunction against Semitool and damages for
past infringement. Novellus also seeks treble damages for willful infringement
by Semitool. Novellus further seeks its attorneys fees and costs, and interest
on any judgment.

On July 19, 2002, Novellus and Semitool entered into and filed a stipulation
dismissing with prejudice both parties claims relating to the 983 patent.

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 business,
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 referred to as Plasma Physics, filed a patent infringement lawsuit
against many of Novellus 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 District Courts order, Plasma Physics re-filed separate complaints
against the Japanese and Korean defendants in the District Court. Many of the
defendants notified Novellus that they believed that Novellus had

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indemnification obligations and liability for the lawsuits. Novellus believes
it does not have any indemnification obligations or other liabilities related
to this lawsuit.

Plasma Physics asserted U.S. Patent Nos. 4,226,897, or the 897 patent,
5,470,784, or the 784 patent, and/or 5,543,634, or the 634 patent, 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 Novellus have since settled with Plasma Physics. Novellus
believes that it does not have any indemnification obligations or other
liabilities related to the Plasma Physics settlement against the Novellus
Japanese and Korean customers.

On June 1, 2000, Novellus 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 was entitled Novellus v. Plasma Physics and Solar Physics,Civil Action
No. 00-3146, and was pending in the United States District Court for the
Eastern District of New York. On July 31, 2000, Plasma Physics filed an Answer
and Conditional Counterclaim. Plasma Physics denied that the 897 and 784
patents are invalid and unenforceable.

Plasma Physics further denied that the 784 patent is not infringed by
Novellus. Plasma Physics also asserted a conditional counterclaim against
Novellus, alleging that Novellus PECVD processing systems infringe the 784
patent. On April 3, 2002, the suit was dismissed pursuant to a stipulation of
voluntary dismissal without prejudice.

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

On June 14, 2002, certain of Novellus customers, including Agilent
Technologies, Inc., Micron Technology, Inc., Agere Systems, Inc., National
Semiconductor Corporation, Koninklijke Philips Electronics N.V., Texas
Instruments, Inc., ST Microelectronics, Inc., LSI Logic Corporation,
International Business Machines Corporation, Conexant Systems, Inc., Motorola,
Inc., Advanced Micro Devices, and Analog Devices Inc., were sued by Plasma
Physics on certain U.S. Patents, including the 897, 784, 634, and 648
patents. Many of the defendants notified Novellus that they believed that
Novellus had indemnification obligations and liability for the lawsuits.

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

Linear Technology Litigation

On March 12, 2002, Linear Technology Corporation filed a complaint against
Novellus, among other parties, in the Superior Court of the State of California
for the County of Santa Clara, Case No. CV806004. The complaint seeks damages
(including punitive damages) and injunctions for causes of actions involving,
among other things, alleged breach of contract, fraud, unfair competition,
breach of warranty, and declaratory relief. Novellus filed a demurrer to
Linears complaint.

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 Linear. If Linear 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

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proprietary rights of others except as claimed by Applied, Semitool, Plasma
Physics, and Linear 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, Novellus believes that
the ultimate disposition of these matters will not have a material adverse
effect on Novellus business, financial condition, or results of operations.




ITEM 5: OTHER INFORMATION

The ratio of earnings to fixed charges for the nine months ended September 28,
2002 and each of the five most recent fiscal years was as follows:

|                   |  |                         |       |      |  |      |       |      |  |      |      |  |  |  |      |  |  |  |   | 
|------------------ |  | ----------------------- | ----- | ---- |  | ---- | ----- | ---- |  | ---- | ---- |  |  |  | ---- |  |  |  | - | 
|Nine months ended  |  | Year ended December 31,
|September 28, 2002 |  | 2001                    |       | 2000 |  | 1999 |       | 1998 |  | 1997
|                   |  |                         |       |      |  |      |       |      |  |     
|3.09               |  |                         | 13.41 |      |  |      | 16.30 |      |  |      | 6.95 |  |  |  | 6.33 |  |  |  |  | 

The ratio of earnings to fixed charges is computed by dividing fixed charges
into earnings before income taxes and before the cumulative effect of a change
in accounting principle plus fixed charges. Fixed charges consist of interest
expense and that portion of net rental expense deemed representative of
interest. In the year ended December 31, 1997, Novellus incurred a loss of
$92.7 million, net of an income tax benefit of $23.8 million. Fixed charges
for this period were $5.0 million.




ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K



|(a) |  | Exhibits
|--- |  | --------

|     |  |                                                                                                                                                                                                                                                                                                   
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2.1  |  | Agreement and Plan of Reorganization by and among Novellus Systems,
Inc., NHL Acquisition-Sub, Inc. and SpeedFam-IPEC, Inc. dated
August 11, 2002 (incorporated by reference to Exhibit 2.1
to Novellus Report on Form 8-K filed with the Securities
and Exchange Commission on August 14, 2002).
|    
|    
|    
|    
|     |  |                                                                                                                                                                                                                                                                                                   
|99.1 |  | Certification of Richard S. Hill, Chairman of the Board of Directors
and Chief Executive Officer of
Novellus Systems, Inc. dated November 12, 2002 in accordance
with 18 U.S.C. 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                       
|    
|    
|    
|    
|     |  |                                                                                                                                                                                                                                                                                                   
|99.2 |  | Certification of Kevin S. Royal, Vice President and Chief Financial Officer of
Novellus Systems, Inc. dated November 12, 2002 in accordance
with 18 U.S.C. 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                            
|    
|    
|    
|    
|     |  |                                                                                                                                                                                                                                                                                                   



|(b) |  | Reports on Form 8-K                                                                                                                         
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | On August 14, 2002,
Novellus filed a report on Form 8-K announcing it had
entered into a definitive agreement to acquire SpeedFam-IPEC, Inc.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.

| |  |                                                                                                                                        
| |  | ---------------------------------------------------------------------------------------------------------------------------------------
| |  | NOVELLUS SYSTEMS, INC.                                                                                                                 
|
| |  |                                                                                                                                        
|
| |  | /s/ Kevin S. Royal
Kevin S. Royal
Vice President and Chief Financial Officer
(Principal Financial Officer and
Chief Accounting Officer)

November 12, 2002

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CERTIFICATION

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

I, Richard S. Hill, certify that:



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



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



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



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



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

|                         |  |     |  |                                                                               
|------------------------ |  | --- |  | ------------------------------------------------------------------------------
|Dated: November 12, 2002 |  | By: |  | /s/ Richard S. Hill                                                           
|                         |  |     |  |                                                                               
|                         |  |     |  | Richard S. Hill
Chairman of the Board of Directors and
Chief Executive Officer

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CERTIFICATION

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

I, Kevin S. Royal, certify that:



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



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



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



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



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

|                         |  |     |  |                                                          
|------------------------ |  | --- |  | ---------------------------------------------------------
|Dated: November 12, 2002 |  | By: |  | /s/ Kevin S. Royal                                       
|                         |  |     |  |                                                          
|                         |  |     |  | Kevin S. Royal
Vice President and Chief
Financial Officer

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EXHIBIT INDEX



|     |  |                                                                                                                                                                                                                                                                                                   
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2.1  |  | Agreement and
Plan of Reorganization by and among Novellus Systems, Inc., NHL
Acquisition-Sub, Inc. and SpeedFam-IPEC, Inc. dated August 11, 2002
(incorporated by reference to Exhibit 2.1 to Novellus Report on
Form 8-K filed with the Securities and Exchange Commission on
August 14, 2002).
|    
|99.1 |  | Certification of Richard S. Hill, Chairman of the Board of Directors
and Chief Executive Officer of
Novellus Systems, Inc. dated November 12, 2002 in accordance
with 18 U.S.C. 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                       
|    
|99.2 |  | Certification of Kevin S. Royal, Vice President and Chief Financial Officer of
Novellus Systems, Inc. dated November 12, 2002 in accordance
with 18 U.S.C. 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.