##### 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 March 30, 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 ____________

NOVELLUS SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)

|                                                                          |  |                                                   
|------------------------------------------------------------------------- |  | --------------------------------------------------
|California
(State or other jurisdiction of incorporation of organization) |  | 77-0024666
(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 May 1, 2002, 145,183,530 shares of the Registrants common stock, no par
value, were issued and outstanding.





---

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 RISKS                           
|PART II: OTHER INFORMATION   
|                              | ITEM 1: LEGAL PROCEEDINGS                                                                    
|                              | ITEM 5: OTHER INFORMATION                                                                    
|                              | ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURES                   



---



##### Table of Contents



NOVELLUS SYSTEMS, INC.
FORM 10-Q
QUARTER ENDED MARCH 30, 2002

TABLE OF CONTENTS

|                                     |  |         |  |                                                                                                                              |  |     
|------------------------------------ |  | ------- |  | ---------------------------------------------------------------------------------------------------------------------------- |  | ----
|                                     |  |         |  |                                                                                                                              |  | Page
|                                     |  |         |  |                                                                                                                              |  |     
|Part I:Financial
        Information |  |        
|                                     |  |         |  |                                                                                                                              |  |     
|                                     |  | Item 1: |  | Condensed Consolidated Financial
        Statements                                                                          |  |     
|                                     |  |         |  |                                                                                                                              |  |     
|                                     |  |         |  | Condensed Consolidated Statements
        of Operations for the three months ended March 30, 2002 and March 31,
        2001 |  | 3   
|                                     |  |         |  |                                                                                                                              |  |     
|                                     |  |         |  | Condensed Consolidated Balance
        Sheets at March 30, 2002 and December 31, 2001                                        |  | 4   
|                                     |  |         |  |                                                                                                                              |  |     
|                                     |  |         |  | Condensed Consolidated Statements
        of Cash Flows for the three months ended March 30, 2002 and March 31,
        2001 |  | 5   
|                                     |  |         |  |                                                                                                                              |  |     
|                                     |  |         |  | Notes to Condensed Consolidated
        Financial Statements                                                                 |  | 6   
|                                     |  |         |  |                                                                                                                              |  |     
|                                     |  | Item 2: |  | Managements Discussion
        and Analysis of Financial Condition and Results of Operations                                |  | 10  
|                                     |  |         |  |                                                                                                                              |  |     
|                                     |  | Item 3: |  | Quantitative and Qualitative
        Disclosures About Market Risk                                                           |  | 14  
|                                     |  |        
|Part II:Other
        Information    |  |        
|                                     |  |         |  |                                                                                                                              |  |     
|                                     |  | Item 1: |  | Legal Proceedings                                                                                                            |  | 15  
|                                     |  |         |  |                                                                                                                              |  |     
|                                     |  | Item 5: |  | Other Information                                                                                                            |  | 18  
|                                     |  |         |  |                                                                                                                              |  |     
|                                     |  | Item 6: |  | Exhibits and Reports on Form 8-K                                                                                             |  | 18  
|                                     |  |        
|Signatures                           |  | 18     

2



---



##### Table of Contents






PART I: FINANCIAL INFORMATION




ITEM 1: CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS


NOVELLUS SYSTEMS, INC.




CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS


|                                         |                                      |                              |         |                    |      |   |         |        |      | 
|---------------------------------------- | ------------------------------------ | ---------------------------- | ------- | ------------------ | ---- | - | ------- | ------ | ---- | 
|                                         |                                      |                              |         | Three months ended
|                                         |                                      |                              |         |                   
|(in thousands, except per share amounts) |                                      | March 30,                    |         | March 31,         
|(unaudited)                              |                                      | 2002                         |         | 2001              
|                                         |                                      |                              |         |                   
|Net sales                                |                                      | $                            | 169,679 |                    |      | $ | 458,705 |       
|Cost of sales                            |                                      |                              | 98,149  |                    |      |   | 203,720 |       
|                                         |                                      |                              |         |                    |      |   |         |       
|Gross profit                             |                                      |                              | 71,530  |                    |      |   | 254,985 |       
|Operating expenses:                      |                                      |                              |         |                    |      |   |         |       
|                                         | Selling, general, and administrative |                              |         | 34,686             |      |   |         | 68,906 |     
|                                         | Research and development             |                              |         | 54,046             |      |   |         | 70,491 |     
|                                         | Special charges                      |                              |         | 3,273              |      |   |         | 13,160 |     
|                                         | Bad debt recovery                    |                              |         | (7,662             | )    |   |         |       |     
|                                         |                                      |                              |         |                    |      |   |         |       
|Total operating expenses                 |                                      |                              | 84,343  |                    |      |   | 152,557 |       
|                                         |                                      |                              |         |                    |      |   |         |       
|Operating income (loss)                  |                                      |                              | (12,813 | )                  |      |   | 102,428 |       
|Other income, net                        |                                      |                              | 17,669  |                    |      |   | 16,560  |       
|                                         |                                      |                              |         |                    |      |   |         |       
|Income before income taxes               |                                      |                              | 4,856   |                    |      |   | 118,988 |       
|Provision for income taxes               |                                      |                              | 1,020   |                    |      |   | 36,886  |       
|                                         |                                      |                              |         |                    |      |   |         |       
|Net income                               |                                      | $                            | 3,836   |                    |      | $ | 82,102  |       
|                                         |                                      |                              |         |                    |      |   |         |       
|Net income per share:                    |                                      |                              |         |                    |      |   |         |       
|                                         |                                      | Basic net income per share   |         | $                  | 0.03 |   |         | $      | 0.58 | 
|                                         |                                      |                              |         |                    |      |   |         |       
|                                         |                                      | Diluted net income per share |         | $                  | 0.03 |   |         | $      | 0.55 | 
|                                         |                                      |                              |         |                    |      |   |         |       
|Shares used in basic calculation         |                                      |                              | 144,255 |                    |      |   | 141,009 |       
|                                         |                                      |                              |         |                    |      |   |         |       
|Shares used in diluted calculation       |                                      |                              | 150,624 |                    |      |   | 148,108 |       
|                                         |                                      |                              |         |                    |      |   |         |       

See accompanying notes.

3



---



##### Table of Contents



NOVELLUS SYSTEMS, INC.




CONDENSED CONSOLIDATED BALANCE
SHEETS


|                                               |                                               |                                            |         |             |           |              |         |           |           | 
|---------------------------------------------- | --------------------------------------------- | ------------------------------------------ | ------- | ----------- | --------- | ------------ | ------- | --------- | --------- | 
|                                               |                                               |                                            |         | March 30,   |           | December 31,
|(in thousands)                                 |                                               | 2002                                       |         | 2001*      
|                                               |                                               |                                            |         |            
|                                               |                                               |                                            |         | (unaudited) |           |              |         |          
|Assets                                         |                                               |                                            |         |             |           |              |         |          
|Current assets:                                |                                               |                                            |         |             |           |              |         |          
|                                               | Cash and cash equivalents                     |                                            | $       | 585,997     |           |              | $       | 550,640   |          
|                                               | Short-term investments                        |                                            |         | 372,177     |           |              |         | 371,182   |          
|                                               | Restricted short-term investments             |                                            |         | 1,005,890   |           |              |         | 961,643   |          
|                                               | Accounts receivable, net                      |                                            |         | 185,375     |           |              |         | 225,916   |          
|                                               | Inventories                                   |                                            |         | 261,655     |           |              |         | 244,712   |          
|                                               | Deferred tax assets, net                      |                                            |         | 80,882      |           |              |         | 82,069    |          
|                                               | Prepaid and other current assets              |                                            |         | 68,341      |           |              |         | 81,049    |          
|                                               |                                               |                                            |         |             |           |              |         |          
|                                               |                                               | Total current assets                       |         |             | 2,560,317 |              |         |           | 2,517,211 | 
|Property and equipment:                        |                                               |                                            |         |             |           |              |         |          
|                                               | Machinery and equipment                       |                                            |         | 243,270     |           |              |         | 243,677   |          
|                                               | Furniture and fixtures                        |                                            |         | 14,502      |           |              |         | 15,256    |          
|                                               | Leasehold improvements                        |                                            |         | 80,304      |           |              |         | 79,264    |          
|                                               | Land                                          |                                            |         | 8,782       |           |              |         | 8,782     |          
|                                               |                                               |                                            |         |             |           |              |         |          
|                                               |                                               |                                            | 346,858 |             |           |              | 346,979 |          
|Less accumulated depreciation and amortization |                                               |                                            | 177,411 |             |           |              | 169,378 |          
|                                               |                                               |                                            |         |             |           |              |         |          
|                                               |                                               |                                            | 169,447 |             |           |              | 177,601 |          
|Other assets                                   |                                               |                                            | 72,948  |             |           |              | 70,177  |          
|Note receivable                                |                                               |                                            | 244,673 |             |           |              | 244,673 |          
|                                               |                                               |                                            |         |             |           |              |         |          
|                                               |                                               | Total assets                               |         | $           | 3,047,385 |              |         | $         | 3,009,662 | 
|                                               |                                               |                                            |         |             |           |              |         |          
|Liabilities and shareholders equity           |                                               |                                            |         |             |           |              |         |          
|Current liabilities:                           |                                               |                                            |         |             |           |              |         |          
|                                               | Accounts payable                              |                                            | $       | 80,014      |           |              | $       | 67,317    |          
|                                               | Accrued payroll and related expenses          |                                            |         | 25,904      |           |              |         | 34,211    |          
|                                               | Accrued warranty                              |                                            |         | 34,292      |           |              |         | 43,337    |          
|                                               | Other accrued liabilities                     |                                            |         | 30,902      |           |              |         | 30,411    |          
|                                               | Restructuring accrual                         |                                            |         | 24,505      |           |              |         | 26,849    |          
|                                               | Income taxes payable                          |                                            |         | 9,858       |           |              |         | 5,870     |          
|                                               | Deferred profit                               |                                            |         | 45,206      |           |              |         | 40,835    |          
|                                               | Current obligations under lines of credit     |                                            |         | 19,198      |           |              |         | 26,179    |          
|                                               | Convertible subordinated debentures           |                                            |         | 862,806     |           |              |         | 862,659   |          
|                                               |                                               |                                            |         |             |           |              |         |          
|                                               |                                               | Total current liabilities                  |         |             | 1,132,685 |              |         |           | 1,137,668 | 
|Shareholders equity:                          |                                               |                                            |         |             |           |              |         |          
|                                               | Common stock                                  |                                            |         | 1,318,096   |           |              |         | 1,273,201 |          
|                                               | Retained earnings                             |                                            |         | 600,801     |           |              |         | 597,267   |          
|                                               | Accumulated other comprehensive income (loss) |                                            |         | (4,197      | )         |              |         | 1,526     |          
|                                               |                                               |                                            |         |             |           |              |         |          
|                                               |                                               | Total shareholders equity                 |         |             | 1,914,700 |              |         |           | 1,871,994 | 
|                                               |                                               |                                            |         |             |           |              |         |          
|                                               |                                               | Total liabilities and shareholders equity |         | $           | 3,047,385 |              |         | $         | 3,009,662 | 
|                                               |                                               |                                            |         |             |           |              |         |          



---

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

See accompanying notes.

4



---



##### Table of Contents



NOVELLUS SYSTEMS, INC.




CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


|                                                         |                                                                                   |                                                     |                   |            |                    |        |         |          |         |         |  
|-------------------------------------------------------- | --------------------------------------------------------------------------------- | --------------------------------------------------- | ----------------- | ---------- | ------------------ | ------ | ------- | -------- | ------- | ------- | -
|                                                         |                                                                                   |                                                     |                   |            | Three months ended
|                                                         |                                                                                   |                                                     |                   |            |                   
|(in thousands)                                           |                                                                                   | March 30,                                           |                   | March 31, 
|(unaudited)                                              |                                                                                   | 2002                                                |                   | 2001      
|                                                         |                                                                                   |                                                     |                   |           
|Cash flows from operating activities:                    |                                                                                   |                                                     |                   |            |                    |        |         |         
|                                                         | Net income                                                                        |                                                     | $                 | 3,836      |                    |        | $       | 82,102   |        
|                                                         | Adjustments to reconcile net income to net cash
provided by operating activities: |                                                     |                   |            |                    |        |         |          |        
|                                                         | Gain on sale of an investment                                                     |                                                     |                   | (4,602     | )                  |        |         |         |        
|                                                         | Depreciation and amortization                                                     |                                                     |                   | 12,521     |                    |        |         | 10,857   |        
|                                                         | Deferred income taxes                                                             |                                                     |                   | 1,187      |                    |        |         | 13,896   |        
|                                                         | Deferred compensation                                                             |                                                     |                   | 440        |                    |        |         | 362      |        
|                                                         | Adjustment to conform fiscal year end of GaSonics                                 |                                                     |                   |           |                    |        |         | 1,714    |        
|                                                         | Income tax benefits from employee compensation plans                              |                                                     |                   | 13,352     |                    |        |         | 373      |        
|                                                         | Changes in operating assets and liabilities:                                      |                                                     |                   |            |                    |        |         |          |        
|                                                         |                                                                                   | Accounts receivable                                 |                   |            | 40,541             |        |         |          | 63,088  |        
|                                                         |                                                                                   | Inventories                                         |                   |            | (17,843            | )      |         |          | (32,969 | )      
|                                                         |                                                                                   | Prepaid and other current assets                    |                   |            | 12,708             |        |         |          | (12,431 | )      
|                                                         |                                                                                   | Accounts payable                                    |                   |            | 12,697             |        |         |          | (30,995 | )      
|                                                         |                                                                                   | Accrued payroll and related expenses                |                   |            | (8,307             | )      |         |          | (17,480 | )      
|                                                         |                                                                                   | Accrued warranty                                    |                   |            | (9,045             | )      |         |          | 7,751   |        
|                                                         |                                                                                   | Deferred profit                                     |                   |            | 4,371              |        |         |          | (60,472 | )      
|                                                         |                                                                                   | Other accrued liabilities                           |                   |            | (1,852             | )      |         |          | (85     | )      
|                                                         |                                                                                   | Income taxes payable                                |                   |            | 3,988              |        |         |          | (26,133 | )      
|                                                         |                                                                                   |                                                     |                   |            |                    |        |         |         
|                                                         |                                                                                   |                                                     | Total adjustments |            |                    | 60,156 |         |          |         | (82,524 | )
|                                                         |                                                                                   |                                                     |                   |            |                    |        |         |         
|                                                         |                                                                                   | Net cash provided by (used in) operating activities |                   |            | 63,992             |        |         |          | (422    | )      
|Cash flows from investing activities:                    |                                                                                   |                                                     |                   |            |                    |        |         |         
|                                                         | Proceeds from the sale and maturity of available-for-sale securities              |                                                     |                   | 168,384    |                    |        |         | 641,653  |        
|                                                         | Purchases of available-for-sale securities                                        |                                                     |                   | (167,443   | )                  |        |         | (464,931 | )      
|                                                         | Proceeds from the sale and maturity of restricted short-term
investments          |                                                     |                   | 1,131,666  |                    |        |         |         |        
|                                                         | Purchases of restricted short-term investments                                    |                                                     |                   | (1,177,170 | )                  |        |         |         |        
|                                                         | Capital expenditures                                                              |                                                     |                   | (4,003     | )                  |        |         | (32,805  | )      
|                                                         | Increase in other assets                                                          |                                                     |                   | (3,889     | )                  |        |         | (7,582   | )      
|                                                         |                                                                                   |                                                     |                   |            |                    |        |         |         
|                                                         |                                                                                   | Net cash provided by (used in) investing activities |                   |            | (52,455            | )      |         |          | 136,335 |        
|Cash flows from financing activities:                    |                                                                                   |                                                     |                   |            |                    |        |         |         
|                                                         | Proceeds from employee compensation plans                                         |                                                     |                   | 30,801     |                    |        |         | 8,858    |        
|                                                         | Proceeds from (payments on) lines of credit, net                                  |                                                     |                   | (6,981     | )                  |        |         | 6,915    |        
|                                                         |                                                                                   |                                                     |                   |            |                    |        |         |         
|                                                         |                                                                                   | Net cash provided by financing activities           |                   |            | 23,820             |        |         |          | 15,773  |        
|Net increase in cash and cash equivalents                |                                                                                   |                                                     | 35,357            |            |                    |        | 151,686 |         
|Cash and cash equivalents at the beginning of the period |                                                                                   |                                                     | 550,640           |            |                    |        | 589,415 |         
|                                                         |                                                                                   |                                                     |                   |            |                    |        |         |         
|Cash and cash equivalents at the end of the period       |                                                                                   | $                                                   | 585,997           |            |                    | $      | 741,101 |         
|                                                         |                                                                                   |                                                     |                   |            |                    |        |         |         

See accompanying notes.

5



---



##### Table of Contents



NOVELLUS SYSTEMS, INC.




NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles 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-months ended March 30, 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.

Certain amounts in the prior year balances have been reclassified to conform to
current year presentation.

On January 10, 2001, the Company 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 options to purchase shares of GaSonics capital stock
were automatically converted into options to purchase approximately 1,400,000
shares of Novellus common stock. Merger related expenses of approximately
$13.2 million were recorded in the first quarter of 2001 and were included in
special charges within the 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
intangibles. As of March 30, 2002, Novellus had a goodwill balance of
approximately $20.1 million. Consequently upon adoption, the application of
the non-amortization provisions of SFAS 142 resulted in an increase in
operating income of $0.9 million in the three months ended March 30, 2002. If
Novellus had adopted the provisions of SFAS 142 in the first quarter of 2001,
the increase in operating income for the three months ended March
31, 2001 would have been $0.9 million. In the first quarter of 2002, Novellus
conducted a test for impairment of its goodwill using the two-step process
prescribed 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 revenue recognition policy
is based on guidance provided in SEC Staff
Accounting Bulletin No. 101 (SAB 101), Revenue
Recognition in Financial Statements and SAB 101: Revenue
Recognition in Financial Statements-Frequently Asked Questions and
Answers (SAB 101 FAQ.) Novellus recognizes revenue when
persuasive evidence of an arrangement exists, delivery has occurred
or services have been rendered, the sellers price is fixed or
determinable, and collectibility is reasonably assured. Certain of
Novellus' product sales are accounted for as multiple-element
arrangements. If the Company has met defined customer acceptance
experience levels with both the customer and the specific type of
equipment, then Novellus recognizes equipment revenue upon shipment
and transfer of title, with the remainder when it becomes due
(generally upon acceptance). All other equipment sales are recognized
upon customer acceptance. Revenue related to spare sales is
recognized on shipment. Revenue related to maintenance and service
contracts is recognized ratably over the duration of the contracts.
Unearned maintenance and service contract revenue is not significant and is
included in accrued liabilities.

2. RECENT ACCOUNTING PRONOUNCEMENTS

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

|                          |                 |   |           |         |              |   |         |         | 
|------------------------- | --------------- | - | --------- | ------- | ------------ | - | ------- | ------- | 
|                          |                 |   | March 30, |         | December 31,
|                          |                 |   | 2002      |         | 2001        
|                          |                 |   |           |         |             
|Purchased and spare parts |                 | $ | 205,180   |         |              | $ | 199,702 |        
|Work-in-process           |                 |   | 49,396    |         |              |   | 42,717  |        
|Finished goods            |                 |   | 7,079     |         |              |   | 2,293   |        
|                          |                 |   |           |         |              |   |         |        
|                          | Total inventory |   | $         | 261,655 |              |   | $       | 244,712 | 
|                          |                 |   |           |         |              |   |         |        

6



---



##### Table of Contents



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

4. LINES OF CREDIT

Novellus has lines of credit with four Japanese banks, which expire at various
dates through August 2002, under which the Company can borrow up to $30.2
million at the banks prime rates (ranging from 0.48% to 1.01%) as of March 30,
2002.
These facilities are available to Novellus Japanese subsidiary, Novellus
Systems Japan. At March 30, 2002 and December 31, 2001, amounts outstanding
were $19.2 million and $26.2 million, at annual weighted-average interest rates
of 0.55% and 0.62%, respectively. All borrowings under the lines of credit
were by Novellus Systems Japan.

5. NET INCOME PER SHARE

Net income per share is calculated in accordance with SFAS No. 128. Basic net
income per share excludes the dilutive effect of employee stock options.
Diluted net income per share includes the dilutive effect of employee stock
options. The following table sets forth the computation of basic and diluted
net income per share (in thousands, except per share amounts):

|                             |                                           |                                             |      |                    |         |           |      |         |         | 
|---------------------------- | ----------------------------------------- | ------------------------------------------- | ---- | ------------------ | ------- | --------- | ---- | ------- | ------- | 
|                             |                                           |                                             |      | Three months ended
|                             |                                           |                                             |      |                   
|                             |                                           |                                             |      | March 30,          |         | March 31,
|                             |                                           |                                             |      | 2002               |         | 2001     
|                             |                                           |                                             |      |                    |         |          
|Numerator:                   |                                           |                                             |      |                    |         |           |      |        
|                             | Net income                                |                                             | $    | 3,836              |         |           | $    | 82,102  |        
|                             |                                           |                                             |      |                    |         |           |      |        
|Denominator:                 |                                           |                                             |      |                    |         |           |      |        
|                             | Basic weighted-average shares outstanding |                                             |      | 144,255            |         |           |      | 141,009 |        
|                             | Employee stock options                    |                                             |      | 6,369              |         |           |      | 7,099   |        
|                             |                                           |                                             |      |                    |         |           |      |        
|                             |                                           | Diluted weighted-average shares outstanding |      |                    | 150,624 |           |      |         | 148,108 | 
|                             |                                           |                                             |      |                    |         |           |      |        
|Basic net income per share   |                                           | $                                           | 0.03 |                    |         | $         | 0.58 |        
|                             |                                           |                                             |      |                    |         |           |      |        
|Diluted net income per share |                                           | $                                           | 0.03 |                    |         | $         | 0.55 |        
|                             |                                           |                                             |      |                    |         |           |      |        

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

Novellus holds synthetic lease agreements on properties in San Jose, California
and Tualatin, Oregon. During the three months ended March 30, 2002, Novellus
drew an additional $33.3 million against its available lease financing line for
the Tualatin property. Novellus estimates that construction on the Tualatin
property will be completed in May 2002, at which time the Company will provide
the lessor with approximately $51.9 million of additional funds
related to Novellus participation in the lease
financing. The total financing under the San Jose synthetic lease has not
changed significantly since December 31, 2001.

Summary information about Novellus synthetic lease arrangements is as follows
as of March 30, 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 |             |  | $             | 292,411 |           |  | $          | 244,673 |                |  | $ | 47,738  |  |  | $ | 49,016  |  |  | $ | 259,445 | 
|Tualatin, OR |  |            | 1  |             |  |               | 108,972 |           |  |            |        |                |  |   | 108,972 |  |  |   | 119,001 |  |  |   | 97,966  | 
|             |  |            |    |             |  |               |         |           |  |            |         |                |  |   |         |  |  |   |         |  |  |   |         | 
|             |  |            | 14 |             |  | $             | 401,383 |           |  | $          | 244,673 |                |  | $ | 156,710 |  |  | $ | 168,017 |  |  | $ | 357,411 | 
|             |  |            |    |             |  |               |         |           |  |            |         |                |  |   |         |  |  |   |         |  |  |   |         | 

7



---



##### Table of Contents



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

7. CONVERTIBLE SUBORDINATED DEBENTURES

On July 26, 2001, Novellus issued
$880.0 million of Liquid Yield OptionTM Notes
(LYONs) due July 26, 2031. The net proceeds after issuance
costs (which will be amortized over 30 years) from the LYONs
offering were $862.4 million. The LYONs are zero coupon,
zero-yield subordinated debentures that may be converted into shares
of Novellus common stock, subject to specified conditions as set
forth in the indenture. The LYONs are convertible into 13.09504
shares of Novellus common stock per $1,000 LYON, or 11.5 million
shares and 7.9% of all outstanding shares as of March 30, 2002,
if (1) the sales price of Novellus common stock reaches a
specified threshold, (2) the LYONs are called for redemption,
or (3) specified corporate transactions have occurred, subject
to antidilutive adjustments.

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

Novellus deposited U.S. treasury securities into a
pledge account to secure Novellus' obligations under the LYONs until
July 26, 2002. These securities are reflected on Novellus'
balance sheet as restricted short-term investments. At March 30,
2002, restricted short-term investments related to this obligation
were approximately $872.2 million, which will mature to
$880.0 million, to secure the obligations under the LYONs on
July 26, 2002. If on July 26, 2002 the LYONs are delivered
to Novellus, the $880.0 million could be used to repurchase the
LYONs and any remaining unamortized issuance costs, approximately
$17.0 million as of July 26, 2002, would be written off as
other expense. Upon expiration of the obligations under the pledge
account, Novellus intends to use the net proceeds of the offering, if
any, for general corporate purposes. Additionally, Novellus has the
option of redeeming the LYONs on July 26, 2006, 2011, 2016,
2021, and 2026 for cash or common stock or a combination of cash and
common stock.

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

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

8. SPECIAL CHARGES

Reduction in Force

In the first quarter of 2002, Novellus reduced
its workforce in response to market conditions and recorded a special charge of
$3.3 million, primarily for the cost of severance compensation. As of March 30, 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 professional
fees, financial printing, and other related costs. Additionally, these costs
included charges related to the cancellation of various contracts and the
write-off of certain redundant assets. At March 30, 2002, 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 the Company
to its specific actions. The Company began implementing the plan during the
third quarter of 2001 and recorded restructuring and asset impairment charges
totaling $55.0 million, of which $47.9 million 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.

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

|                             |               |   |            |        |           |   |            |   |          |   |              |   |              |   |        |        |   |   |   |   |  |   |        |        |  
|---------------------------- | ------------- | - | ---------- | ------ | --------- | - | ---------- | - | -------- | - | ------------ | - | ------------ | - | ------ | ------ | - | - | - | - |  | - | ------ | ------ | -
|                             |               |   |            |        |           |   |            |   |          |   | Write-off of |   |              |   |        |        |   |   |   |   |  |   |       
|                             |               |   | Vacated    |        | Abandoned |   | Purchased  |   |          |   |              |   | Discontinued |   | Total 
|                             |               |   | Facilities |        | Assets    |   | Technology |   | Subtotal |   | Inventory    |   | Restructure 
|                             |               |   |            |        |           |   |            |   |          |   |              |   |             
|Balance at December 31, 2001 |               | $ | 26,849     |        |           |   |           |   |          |   |             |   |              | $ | 26,849 |        |   |   |  |   |  | $ | 26,849 |       
|                             | Cash payments |   |            | (2,344 | )         |   |            |  |          |   |              |  |              |   |        | (2,344 | ) |   |   |  |  |   |        | (2,344 | )
|                             |               |   |            |        |           |   |            |   |          |   |              |   |              |   |        |        |   |   |   |   |  |   |        |       
|Balance at March 30, 2002    |               | $ | 24,505     |        |           | $ |           |   |          | $ |             |   |              | $ | 24,505 |        |   | $ |  |   |  | $ | 24,505 |       
|                             |               |   |            |        |           |   |            |   |          |   |              |   |              |   |        |        |   |   |   |   |  |   |        |       

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

The charge for abandoned assets and discontinued inventory were associated with
programs exited by Novellus. The write-off of purchased technology related to
technology that was abandoned by the Company.

As of March 30, 2002, significantly all actions under the restructuring plan
have been achieved except for future rent obligations related to vacated
facilities. The remaining $24.5 million balance of the restructuring accrual
is for future rent obligations which are to be paid in cash over the next five
years.

8



---



##### Table of Contents



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

9. BAD DEBT 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 benefit to operations of $7.7
million.

10. COMPREHENSIVE INCOME (LOSS)

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

|                                                                                                                       |                                   |   |                    |        |           |   |        |        | 
|---------------------------------------------------------------------------------------------------------------------- | --------------------------------- | - | ------------------ | ------ | --------- | - | ------ | ------ | 
|                                                                                                                       |                                   |   | Three months ended
|                                                                                                                       |                                   |   |                   
|                                                                                                                       |                                   |   | March 30,          |        | March 31,
|                                                                                                                       |                                   |   | 2002               |        | 2001     
|                                                                                                                       |                                   |   |                    |        |          
|Net income                                                                                                             |                                   | $ | 3,836              |        |           | $ | 82,102 |       
|Foreign currency translation adjustment                                                                                |                                   |   | (1,800             | )      |           |   | 2,341  |       
|Unrealized gain (loss) on available-for-sale securities                                                                |                                   |   | (287               | )      |           |   | 5,196  |       
|Reclassification adjustment for a realized gain on an available-for-sale
investment included in net income, net of tax |                                   |   | (3,636             | )      |           |   |       |       
|                                                                                                                       |                                   |   |                    |        |           |   |        |       
|                                                                                                                       | Other comprehensive income (loss) |   | $                  | (1,887 | )         |   | $      | 89,639 | 
|                                                                                                                       |                                   |   |                    |        |           |   |        |       

The components of accumulated other comprehensive loss, net of related tax are as follows:

|                                                        |                                   |   |           |        |              |   |        |       | 
|------------------------------------------------------- | --------------------------------- | - | --------- | ------ | ------------ | - | ------ | ----- | 
|                                                        |                                   |   | March 30, |        | December 31,
|                                                        |                                   |   | 2002      |        | 2001        
|                                                        |                                   |   |           |        |             
|Foreign currency translation adjustment                 |                                   | $ | (3,975    | )      |              | $ | (2,175 | )    
|Unrealized gain (loss) on available-for-sale securities |                                   |   | (222      | )      |              |   | 3,701  |      
|                                                        |                                   |   |           |        |              |   |        |      
|                                                        | Other comprehensive income (loss) |   | $         | (4,197 | )            |   | $      | 1,526 | 
|                                                        |                                   |   |           |        |              |   |        |      

11. LITIGATION

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

9



---



##### Table of Contents






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 its plans to continue to invest in new
products and increase research and development spending in absolute dollars,
despite the current quarter decrease in R&D expense;
Novellus expectations
regarding the effect of the adoption of SFAS 143 on its financial condition or
results of operations and its beliefs regarding the treatment of the assets
associated with the Companys synthetic leases by FASB; statements regarding
Novellus continued participation in its synthetic leases in 2002 and its
beliefs regarding its additional cash outlays under such leases; Novellus
estimations regarding the completion of the construction on the Tualatin,
Oregon property and the payment of Novellus participation amount for the
financing of such lease; Novellus intent to use the proceeds of the LYONs
offering, if any, for general corporate purposes; Novellus expectations
regarding investments in property and equipment in fiscal 2002; Novellus
belief that its current cash position and cash generated through operations and
equity offerings will be sufficient to meet Novellus needs through at least
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 financial
condition or results of operations; and Novellus beliefs and expectations with
respect to the outcomes of the Applied Materials, Semitool, Plasma Physics, and
Linear Technology litigation matters and 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 generally, 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 from time to time in Novellus Reports on Forms 10-Q,
8-K, 10-K, and its Annual Reports to Shareholders, including Novellus most
recent Annual Report on Form 10-K for the year ended December 31, 2001.

RESULTS OF OPERATIONS

Net sales for the three months ended March 30, 2002 were $169.7 million,
compared with $458.7 million in the comparable period in the prior year, and
$200.0 million in the immediately preceding quarter. The decrease in net sales
over the comparable period in the prior year and in the immediately preceding
quarter is primarily due to customer capital spending reductions in response to
slowing worldwide demand for semiconductors.

International net sales (including export sales) for the three months ended
March 30, 2002, were 54% of total net sales, compared with 56% in the
comparable period in the prior year and 56% in the immediately preceding
quarter. The decreases from the comparable prior year period and the
immediately preceding quarter primarily relate to lower net sales to Japan and
the Pacific Rim.

Gross profit as a percentage of net sales for the three months ended March 30,
2002 was 42%, compared with 56% for the comparable period in the prior year and
48% for the immediately preceding quarter. The decrease in gross profit as a
percentage of net sales from the comparable period in the prior year is due to a
decrease in the absorption of fixed overhead cost

10



---



##### Table of Contents



as a result of lower shipments of products and from lower gross margins on
sales of 300mm systems, which have higher costs as such 300mm systems are not
yet in high volume production. The decrease in gross profit as a percentage of
sales from the immediately preceding quarter is primarily due to the cost
benefit associated with the cancellation of the 2001 bonus and profit sharing
programs in the fourth quarter of 2001, which resulted in the reversal of
expense recorded in the first three quarters of 2001.

Selling, general, and administrative (SG&A) expense for the three months ended
March 30, 2002 was $34.7 million compared with $68.9 million in the comparable
period in the prior year and $28.3 million in the immediately preceding
quarter. SG&A expense as a percentage of net sales for the three months ended
March 30, 2002 was 20% compared with 15% for the comparable period in the prior
year and 14% for the immediately preceding quarter. The increase in SG&A
expense as a percentage of net sales versus the comparable prior year period 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 period in the prior year is primarily due to the
impact of cost reduction measures implemented in 2001, including travel and
other discretionary spending reductions, workforce reductions, executive and
employee pay reductions, and facilities consolidation. The increase in SG&A
expense in absolute dollars and as a percentage of net sales from the
immediately preceding quarter was primarily due to the cost benefit associated
with the cancellation of the 2001 bonus and profit sharing programs in the
fourth quarter of 2001, which resulted in the reversal of expense recorded in
the first three quarters of 2001. Excluding the reversal of the bonus and
profit sharing programs in the fourth quarter of 2001, SG&A expense decreased
by $7.9 million due to cost reduction efforts and the discontinuation of
goodwill amortization in accordance with SFAS 142.

Research and development (R&D) expense for the three months ended March 30,
2002 was $54.0 million compared with $70.5 million for the comparable period in
the prior year and $60.7 million in the immediately preceding quarter. R&D
expense as a percentage of net sales for the three months ended March 30, 2002
was 32% compared with 15% for the comparable period in the prior year and 30%
for the immediately preceding quarter. The decrease in R&D expense in absolute
dollars over the comparable period in the prior year and over the immediately
preceding quarter is due to cost containment efforts aimed at focusing
priorities on key products necessary for long-term growth. Despite the current
quarter decrease in R&D expense in response to the substantial decline in
customer sales, Novellus continues to believe that significant investment in
R&D is required to remain competitive and plans to continue to invest in new
products and increase research and development spending in absolute dollars,
although such expenses as a percentage of net revenues may fluctuate between
periods.

In the first quarter of 2002, Novellus reduced its
workforce in response to market conditions and recorded a special
charge of $3.3 million, primarily for the cost of severance
compensation. As of March 30, 2002, all severance benefits
related to the reduction in workforce had been paid.

During the first quarter of 2001, Novellus incurred merger costs related to the
acquisition of GaSonics of $13.2 million. These costs included professional
fees, financial printing, and other related costs. Additionally, these costs
included charges related to the cancellation of various contracts and the
write-off of certain redundant assets. As of March 30, 2002, 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 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 months ended March 30,
2002 was $17.7 million compared with $16.6 million for the comparable period in
the prior year and $17.2 million in the immediately preceding quarter. The
increase over the immediately preceding quarter is primarily due to a $4.6
million gain on the sale of an investment, offset by lower average rates of
return on Novellus cash and short-term investment balances. The increase over
the comparable period in the prior year is primarily due to higher cash and
short-term investment balances, primarily as a result of the $880.0 million
LYONs offering, offset by lower average rates of return on Novellus cash and
short-term investment balances.

11



---



##### Table of Contents



Novellus effective tax rate for the three months ended March 30, 2002 was 21%
compared to 31% for the comparable period in the prior year and the immediately
preceding quarter. The decrease results from lower pretax income expected in
the current year.

Net income for the three months ended March 30, 2002 was $3.8 million or $0.03
per diluted share, compared with $82.1 million or $0.55 per diluted share for
the comparable period in the prior year and $17.2 million, or $0.12 per diluted
share for the immediately preceding quarter. Excluding the $4.6
million gain on the sale of an investment, the $7.7 million
benefit for the recovery of an account
receivable which had been previously reserved, and a $3.3 million charge
associated with a reduction in workforce, Novellus had a net loss of $3.3
million for the three months ended March 30, 2002, or $(0.02) per diluted share.

The number of shares used in the per fully diluted share calculations for the
three months ended March 30, 2002 was 150.6 million, compared with 148.1
million for the comparable period in the prior year and 148.5 million for the
immediately preceding quarter. The increase in shares used for the three
months ended March 30, 2002 compared to the comparable period in the prior year
and in the immediately preceding quarter is primarily due to shares issued
under employee compensation plans.

One customer represented 18% and 13% of Novellus sales during the three months
ended March 30, 2002 and March 31, 2001, respectively. A member of Novellus board of directors also
serves on the board of directors of this customer, and therefore, the customer
is considered a related party.

The Companys critical accounting policies are discussed in the 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.

RECENT ACCOUNTING PRONOUNCEMENTS

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

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

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 March 30, 2002 consisted
of $958.2 million of cash, cash equivalents, and short-term investments. This
amount represents an increase of $36.4 million from the December 31, 2001
balance of $921.8 million. The increase is primarily due to cash generated
through operations and through proceeds from employee compensation plans.

Net cash provided by operating activities during the three months ended March
30, 2002 was $64.0 million. This amount consisted primarily of collections on
accounts receivable of $40.5 million and an income tax benefit from employee
compensation plans of $13.4 million, partially offset by an increase in
inventory of $17.8 million.

12



---



##### Table of Contents



Net cash used in investing activities was $52.5 million during the three months
ended March 30, 2002. During this period, Novellus cash outflows consisted
primarily of $45.5 million in net purchases of restricted short-term
investments.

As of March 30, 2002, Novellus does not have any significant property and
equipment commitments. Novellus will continue to participate in its synthetic
leases in 2002 and believes the obligations under the agreements will result in
an additional cash outlay of approximately $51.9 million. See further
discussion below.

During the three months ended March 30, 2002, net cash provided by financing
activities was $23.8 million due to $30.8 million from employee compensation
plans, offset by net payments of $7.0 million on its bank lines of credit.

Novellus leases nearly all of its facilities under operating leases, including
synthetic leases, which expire at various dates through 2010. A synthetic
lease is a form of operating lease wherein a third party lessor funds 100% of
the acquisition and construction costs relating to one or more properties to be
leased to a lessee. The lessor is the owner of the leased property and must
provide at least 3% of the required funds in the form of at-risk equity. The
lessor generally borrows the balance of the funds necessary to fund the
acquisition and construction. Under certain of Novellus synthetic lease
agreements, the Company is obligated to lend approximately 87% of the cost of
the leased asset to the lessor upon completion of construction. The leases
with this requirement are known as defeased or self-funded transactions.
Additionally, Novellus synthetic leases require the Company to maintain
collateral for the benefit of the lessor. Novellus synthetic lease
arrangements are discussed in greater detail in the 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 three months ended March 30, 2002, Novellus
drew an additional $33.3 million against its available lease financing line for
the Tualatin property. Novellus estimates that construction on the Tualatin
property will be completed in May 2002, at which time the Company will provide
the lessor with approximately $51.9 million of additional funds
related to Novellus participation in the lease financing. The total financing under the San Jose
synthetic lease has not
changed significantly since December 31, 2001.

Novellus has lines of credit with four Japanese banks, which expire at various
dates through August 2002, under which the Company can borrow up to $30.2
million at the banks prime rates (ranging from 0.48% to 1.01%) as of March 30,
2002.
These facilities are available to Novellus Japanese subsidiary, Novellus
Systems Japan. At March 30, 2002 and December 31, 2001, amounts outstanding
were $19.2 million and $26.2 million, at annual weighted-average interest rates
of 0.55% 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 Liquid Yield Option Notes
(LYONs) due July 26, 2031. The net proceeds after issuance costs (which will
be amortized over 30 years) from the LYONs offering were $862.4 million. The
LYONs are zero coupon, zero-yield subordinated debentures that may be converted
into shares of Novellus common stock, subject to specified conditions as set
forth in the indenture. The LYONs are convertible into 13.09504 shares of
Novellus common stock per $1,000 LYON, or 11.5 million shares and 7.9% of all
outstanding shares as of March 30, 2002, if (1) the sales price of Novellus
common stock reaches a specified threshold, (2) the LYONs are called for
redemption, or (3) specified corporate transactions have occurred, subject to
antidilutive adjustments.

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

Novellus deposited U.S. treasury securities into a pledge account to secure
Novellus obligations under the LYONs until July 26, 2002. These securities
are reflected on Novellus balance sheet as restricted short-term investments.
At March 30, 2002, restricted short-term investments related to this
obligation were approximately $872.2 million, which will mature to $880.0
million, to secure the obligations under the LYONs on July 26, 2002. If on
July 26, 2002, the LYONs are delivered to Novellus, the $880.0 million could be
used to repurchase the LYONs and any remaining unamortized issuance costs,
approximately $17.0 million as of July 26, 2002, would be written off as other
expense. Upon expiration of the obligations under the pledge account, Novellus
intends to use the net proceeds of the offering, if any, for general corporate
purposes.

13



---



##### Table of Contents



Additionally, Novellus has the option of redeeming the LYONs on July 26, 2006,
2011, 2016, 2021, and 2026 for cash or common stock or a combination of cash
and common stock.  For further discussion, see Notes to
Condensed Consolidated Financial Statements,
Convertible Subordinated Debentures.

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




ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Not Applicable.

14



---



##### Table of Contents






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

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

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

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

On March 25, 2002, the 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 300 mm 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 noninfringement to Applied with respect to claims
27 and 28 of Novellus 597 patent and Applieds 300 mm Al WP series magnet
arrays.

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

15



---



##### Table of Contents



Semitool Litigation I

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

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

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

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

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

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

Semitool Litigation II

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

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

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

16



---



##### Table of Contents



Plasma Physics Litigation

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

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

On June 1, 2000, the Company filed a declaratory relief action against Plasma
Physics and Solar Physics requesting a judgment of non-infringement,
invalidity, and unenforceability with respect to the 897 and 784 patents.
The suit 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 the Company. Plasma Physics also asserted a
conditional counterclaim against the Company, alleging that the Companys PECVD
processing systems infringe the 784 patent. On 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, entitled Method of Forming
Semiconducting Materials and Barriers (the 648 Patent). On June 13, 2001,
Plasma Physics sent a letter to the Company, indicating that it may sue the
Companys customers for their alleged infringement of the 648 Patent.

Novellus believes that this 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 (Linear) filed a complaint
against the Company, 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. The Company
has not yet filed a response 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.

17



---



##### Table of Contents






ITEM 5: OTHER INFORMATION

The ratio of earnings to fixed charges for the three months ended March 30,
2002 and each of the five most recent fiscal years was as follows:

|                   |  |                         |       |      |  |      |       |      |  |      |      |  |  |  |      |  |  |  |   | 
|------------------ |  | ----------------------- | ----- | ---- |  | ---- | ----- | ---- |  | ---- | ---- |  |  |  | ---- |  |  |  | - | 
|                   |  | Year ended December 31,
|Three months ended |  |                        
|March 30, 2002     |  | 2001                    |       | 2000 |  | 1999 |       | 1998 |  | 1997
|                   |  |                         |       |      |  |      |       |      |  |     
|2.96               |  |                         | 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

None

(b) Reports on Form 8-K

None




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
(Chief Accounting Officer)
| | -------------------------------------------------------------------------------------------------------



| | May 10, 2002
Date
| | -----------------

18