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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-Q

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

For the quarterly period ended September 27, 2003

OR

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

For the transition period from                      to

Commission File Number 000-17157

NOVELLUS SYSTEMS, INC.

(Exact name of Registrant as specified in its charter)


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

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).

YES (X) NO(   )

As of November 7, 2003, 152,336,058 shares of the Registrants common stock, no
par value, were issued and outstanding.





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TABLE OF CONTENTS



|                              |                                                                                               |                                                      |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  | 
|PART I: FINANCIAL INFORMATION
|                              | ITEM 1: CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                                          
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS     
|                              |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS               
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                              |                                                                                               | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|                              | ITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                              | ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                           
|                              | ITEM 4: CONTROLS AND PROCEDURES                                                              
|PART II: OTHER INFORMATION   
|                              | ITEM 1: LEGAL PROCEEDINGS                                                                    
|                              | ITEM 5: OTHER INFORMATION                                                                    
|                              | ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURES                   
|EXHIBIT INDEX                
|EXHIBIT 31.1                 
|EXHIBIT 31.2                 
|EXHIBIT 32.1                 
|EXHIBIT 32.2                 



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##### Table of Contents



NOVELLUS SYSTEMS, INC.
FORM 10-Q
QUARTER ENDED SEPTEMBER 27, 2003

TABLE OF CONTENTS

|                              |                                                                                               |                                                                                                                               |    |      |   | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------- | -- | ---- | - | 
|                              |                                                                                               |                                                                                                                               |    | Page
|                              |                                                                                               |                                                                                                                               |    |     
|Part I: Financial Information |                                                                                               |                                                                                                                               |    |     
|                              | Item 1: Condensed Consolidated Financial Statements                                           |                                                                                                                               |    |      |  
|                              |                                                                                               | Condensed Consolidated Statements of Operations for the three and
nine months ended September 27, 2003 and September 28, 2002 |    |      | 3 | 
|                              |                                                                                               | Condensed Consolidated Balance Sheets as of September 27, 2003
and December 31, 2002                                          |    |      | 4 | 
|                              |                                                                                               | Condensed Consolidated Statements of Cash Flows for the nine months
ended September 27, 2003 and September 28, 2002           |    |      | 5 | 
|                              |                                                                                               | Notes to Condensed Consolidated Financial Statements                                                                          |    |      | 6 | 
|                              | Item 2: Managements Discussion and Analysis of Financial Condition
and Results of Operations |                                                                                                                               |    | 12   |  
|                              | Item 3: Quantitative and Qualitative Disclosures About Market Risk                            |                                                                                                                               |    | 21   |  
|                              | Item 4: Controls and Procedures                                                               |                                                                                                                               |    | 21   |  
|Part II: Other Information    |                                                                                               |                                                                                                                               | 23 |     
|                              | Item 1: Legal Proceedings                                                                     |                                                                                                                               |    | 23   |  
|                              | Item 5: Other Information                                                                     |                                                                                                                               |    | 25   |  
|                              | Item 6: Exhibits and Reports on Form 8-K                                                      |                                                                                                                               |    | 26   |  
|Signatures                    |                                                                                               |                                                                                                                               | 27 |     

2



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PART I: FINANCIAL INFORMATION




ITEM 1: CONDENSED CONSOLIDATED FINANCIAL STATEMENTS




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

|                                                                                            |                                     |                                                                            |                                     |        |                    |       |                   |        |               |      |               |         |       |       |         |         |      |      | 
|------------------------------------------------------------------------------------------- | ----------------------------------- | -------------------------------------------------------------------------- | ----------------------------------- | ------ | ------------------ | ----- | ----------------- | ------ | ------------- | ---- | ------------- | ------- | ----- | ----- | ------- | ------- | ---- | ---- | 
|                                                                                            |                                     |                                                                            |                                     |        | Three Months Ended |       | Nine Months Ended
|                                                                                            |                                     |                                                                            |                                     |        |                    |       |                  
|                                                                                            |                                     |                                                                            |                                     |        | September 27,      |       | September 28,     |        | September 27, |      | September 28,
|                                                                                            |                                     |                                                                            |                                     |        | 2003               |       | 2002              |        | 2003          |      | 2002         
|                                                                                            |                                     |                                                                            |                                     |        |                    |       |                   |        |               |      |              
|Net sales                                                                                   |                                     | $                                                                          | 221,099                             |        |                    | $     | 230,495           |        |               | $    | 698,559       |         |       | $     | 622,321 |        
|Cost of sales                                                                               |                                     |                                                                            | 162,323                             |        |                    |       | 121,113           |        |               |      | 424,647       |         |       |       | 339,846 |        
|                                                                                            |                                     |                                                                            |                                     |        |                    |       |                   |        |               |      |               |         |       |       |         |        
|Gross profit                                                                                |                                     |                                                                            | 58,776                              |        |                    |       | 109,382           |        |               |      | 273,912       |         |       |       | 282,475 |        
|Operating expenses:                                                                         |                                     |                                                                            |                                     |        |                    |       |                   |        |               |      |               |         |       |       |         |        
|                                                                                            | Selling, general and administrative |                                                                            |                                     | 40,123 |                    |       |                   | 43,143 |               |      |               | 127,197 |       |       |         | 117,307 |     
|                                                                                            | Research and development            |                                                                            |                                     | 59,858 |                    |       |                   | 58,248 |               |      |               | 173,374 |       |       |         | 171,021 |     
|                                                                                            | Restructuring and other charges     |                                                                            |                                     | 18,529 |                    |       |                   |       |               |      |               | 18,529  |       |       |         | 3,273   |     
|                                                                                            | Bad debt recovery                   |                                                                            |                                     |       |                    |       |                   |       |               |      |               |        |       |       |         | (7,662  | )   
|                                                                                            |                                     |                                                                            |                                     |        |                    |       |                   |        |               |      |               |         |       |       |         |        
|Total operating expenses                                                                    |                                     |                                                                            | 118,510                             |        |                    |       | 101,391           |        |               |      | 319,100       |         |       |       | 283,939 |        
|                                                                                            |                                     |                                                                            |                                     |        |                    |       |                   |        |               |      |               |         |       |       |         |        
|Operating (loss) income                                                                     |                                     |                                                                            | (59,734                             | )      |                    |       | 7,991             |        |               |      | (45,188       | )       |       |       | (1,464  | )      
|Interest and other income, net                                                              |                                     |                                                                            | 2,722                               |        |                    |       | 8,926             |        |               |      | 13,911        |         |       |       | 38,443  |        
|Write-off of unamortized debt issuance costs                                                |                                     |                                                                            |                                    |        |                    |       | (17,047           | )      |               |      |              |         |       |       | (17,047 | )      
|                                                                                            |                                     |                                                                            |                                     |        |                    |       |                   |        |               |      |               |         |       |       |         |        
|(Loss) income before income taxes and cumulative effect
of a change in accounting principle |                                     |                                                                            | (57,012                             | )      |                    |       | (130              | )      |               |      | (31,277       | )       |       |       | 19,932  |        
|Benefit for income taxes                                                                    |                                     |                                                                            | (22,224                             | )      |                    |       | (4,213            | )      |               |      | (15,791       | )       |       |       |        |        
|                                                                                            |                                     |                                                                            |                                     |        |                    |       |                   |        |               |      |               |         |       |       |         |        
|(Loss) income before cumulative effect of a change
in accounting principle                  |                                     |                                                                            | (34,788                             | )      |                    |       | 4,083             |        |               |      | (15,486       | )       |       |       | 19,932  |        
|Cumulative effect of a change in accounting
principle, net of tax                           |                                     |                                                                            | (62,780                             | )      |                    |       |                  |        |               |      | (62,780       | )       |       |       |        |        
|                                                                                            |                                     |                                                                            |                                     |        |                    |       |                   |        |               |      |               |         |       |       |         |        
|Net (loss) income                                                                           |                                     | $                                                                          | (97,568                             | )      |                    | $     | 4,083             |        |               | $    | (78,266       | )       |       | $     | 19,932  |        
|                                                                                            |                                     |                                                                            |                                     |        |                    |       |                   |        |               |      |               |         |       |       |         |        
|Net (loss) income per share:                                                                |                                     |                                                                            |                                     |        |                    |       |                   |        |               |      |               |         |       |       |         |        
|                                                                                            | Basic                               |                                                                            |                                     |        |                    |       |                   |        |               |      |               |         |       |       |         |         |     
|                                                                                            |                                     | (Loss) income before cumulative effect of a change
in accounting principle |                                     | $      | (0.23              | )     |                   | $      | 0.03          |      |               | $       | (0.10 | )     |         | $       | 0.14 |     
|                                                                                            |                                     | Cumulative effect of a change in accounting principle                      |                                     |        | (0.41              | )     |                   |        |              |      |               |         | (0.42 | )     |         |         |     |     
|                                                                                            |                                     |                                                                            |                                     |        |                    |       |                   |        |               |      |               |         |       |       |         |        
|                                                                                            |                                     |                                                                            | Basic net (loss) income per share   |        | $                  | (0.64 | )                 |        | $             | 0.03 |               |         | $     | (0.52 | )       |         | $    | 0.14 | 
|                                                                                            |                                     |                                                                            |                                     |        |                    |       |                   |        |               |      |               |         |       |       |         |        
|                                                                                            | Diluted                             |                                                                            |                                     |        |                    |       |                   |        |               |      |               |         |       |       |         |         |     
|                                                                                            |                                     | (Loss) income before cumulative effect of a change
in accounting principle |                                     | $      | (0.23              | )     |                   | $      | 0.03          |      |               | $       | (0.10 | )     |         | $       | 0.13 |     
|                                                                                            |                                     | Cumulative effect of a change in accounting principle                      |                                     |        | (0.41              | )     |                   |        |              |      |               |         | (0.42 | )     |         |         |     |     
|                                                                                            |                                     |                                                                            |                                     |        |                    |       |                   |        |               |      |               |         |       |       |         |        
|                                                                                            |                                     |                                                                            | Diluted net (loss) income per share |        | $                  | (0.64 | )                 |        | $             | 0.03 |               |         | $     | (0.52 | )       |         | $    | 0.13 | 
|                                                                                            |                                     |                                                                            |                                     |        |                    |       |                   |        |               |      |               |         |       |       |         |        
|Shares used in basic per share calculation                                                  |                                     |                                                                            | 151,280                             |        |                    |       | 143,691           |        |               |      | 150,221       |         |       |       | 144,355 |        
|                                                                                            |                                     |                                                                            |                                     |        |                    |       |                   |        |               |      |               |         |       |       |         |        
|Shares used in diluted per share calculation                                                |                                     |                                                                            | 151,280                             |        |                    |       | 146,094           |        |               |      | 150,221       |         |       |       | 149,257 |        
|                                                                                            |                                     |                                                                            |                                     |        |                    |       |                   |        |               |      |               |         |       |       |         |        

See accompanying notes to condensed consolidated financial statements.

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

|                                     |                                           |                                            |         |               |           |              |         |           |           | 
|------------------------------------ | ----------------------------------------- | ------------------------------------------ | ------- | ------------- | --------- | ------------ | ------- | --------- | --------- | 
|                                     |                                           |                                            |         | September 27, |           | December 31,
|                                     |                                           |                                            |         | 2003          |           | 2002 *      
|                                     |                                           |                                            |         |               |           |             
|                                     |                                           |                                            |         | (unaudited)   |           |              |         |          
|ASSETS                               |                                           |                                            |         |               |           |              |         |          
|Current assets:                      |                                           |                                            |         |               |           |              |         |          
|                                     | Cash and cash equivalents                 |                                            | $       | 529,483       |           |              | $       | 615,844   |          
|                                     | Short-term investments                    |                                            |         | 448,030       |           |              |         | 403,808   |          
|                                     | Accounts receivable, net                  |                                            |         | 221,308       |           |              |         | 192,862   |          
|                                     | Inventories                               |                                            |         | 200,773       |           |              |         | 257,358   |          
|                                     | Deferred tax assets, net                  |                                            |         | 155,221       |           |              |         | 119,699   |          
|                                     | Prepaid and other current assets          |                                            |         | 19,572        |           |              |         | 44,363    |          
|                                     |                                           |                                            |         |               |           |              |         |          
|                                     |                                           | Total current assets                       |         |               | 1,574,387 |              |         |           | 1,633,934 | 
|Property and equipment, net          |                                           |                                            | 513,241 |               |           |              | 179,926 |          
|Notes receivable                     |                                           |                                            |        |               |           |              | 397,429 |          
|Goodwill                             |                                           |                                            | 172,893 |               |           |              | 163,136 |          
|Intangible and other assets          |                                           |                                            | 57,315  |               |           |              | 119,569 |          
|                                     |                                           |                                            |         |               |           |              |         |          
|                                     |                                           | Total assets                               |         | $             | 2,317,836 |              |         | $         | 2,493,994 | 
|                                     |                                           |                                            |         |               |           |              |         |          
|LIABILITIES AND SHAREHOLDERS EQUITY |                                           |                                            |         |               |           |              |         |          
|Current liabilities:                 |                                           |                                            |         |               |           |              |         |          
|                                     | Accounts payable                          |                                            | $       | 69,003        |           |              | $       | 71,218    |          
|                                     | Accrued payroll and related expenses      |                                            |         | 33,766        |           |              |         | 36,748    |          
|                                     | Accrued warranty                          |                                            |         | 30,122        |           |              |         | 31,002    |          
|                                     | Other accrued liabilities                 |                                            |         | 49,018        |           |              |         | 56,522    |          
|                                     | Income taxes payable                      |                                            |         | 8,731         |           |              |         | 14,070    |          
|                                     | Deferred profit                           |                                            |         | 40,477        |           |              |         | 55,613    |          
|                                     | Current obligations under lines of credit |                                            |         | 3,164         |           |              |         |          |          
|                                     | Convertible subordinated notes            |                                            |         |              |           |              |         | 116,437   |          
|                                     |                                           |                                            |         |               |           |              |         |          
|                                     |                                           | Total current liabilities                  |         |               | 234,281   |              |         |           | 381,610   | 
|Deferred tax liabilities             |                                           |                                            |        |               |           |              | 19,502  |          
|Other liabilities                    |                                           |                                            | 48,251  |               |           |              | 37,194  |          
|                                     |                                           |                                            |         |               |           |              |         |          
|                                     |                                           | Total liabilities                          |         |               | 282,532   |              |         |           | 438,306   | 
|Shareholders equity:                |                                           |                                            |         |               |           |              |         |          
|                                     | Common stock                              |                                            |         | 1,543,604     |           |              |         | 1,487,281 |          
|                                     | Retained earnings                         |                                            |         | 491,759       |           |              |         | 570,153   |          
|                                     | Accumulated other comprehensive loss      |                                            |         | (59           | )         |              |         | (1,746    | )        
|                                     |                                           |                                            |         |               |           |              |         |          
|                                     |                                           | Total shareholders equity                 |         |               | 2,035,304 |              |         |           | 2,055,688 | 
|                                     |                                           |                                            |         |               |           |              |         |          
|                                     |                                           | Total liabilities and shareholders equity |         | $             | 2,317,836 |              |         | $         | 2,493,994 | 
|                                     |                                           |                                            |         |               |           |              |         |          



|* |  | Amounts as of December 31, 2002 are derived from the December 31,
2002 audited financial statements.
|- |  | ----------------------------------------------------------------------------------------------------

See accompanying notes to condensed consolidated financial statements.

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

|                                                         |                                                                                          |                                                                           |                                      |         |                   |         |               |          |            |        |  
|-------------------------------------------------------- | ---------------------------------------------------------------------------------------- | ------------------------------------------------------------------------- | ------------------------------------ | ------- | ----------------- | ------- | ------------- | -------- | ---------- | ------ | -
|                                                         |                                                                                          |                                                                           |                                      |         | Nine Months Ended
|                                                         |                                                                                          |                                                                           |                                      |         |                  
|                                                         |                                                                                          |                                                                           |                                      |         | September 27,     |         | September 28,
|                                                         |                                                                                          |                                                                           |                                      |         | 2003              |         | 2002         
|                                                         |                                                                                          |                                                                           |                                      |         |                   |         |              
|Cash flows from operating activities:                    |                                                                                          |                                                                           |                                      |         |                   |         |               |         
|Net (loss) income                                        |                                                                                          | $                                                                         | (78,266                              | )       |                   | $       | 19,932        |         
|                                                         | Adjustments to reconcile net (loss) income to net cash
provided by operating activities: |                                                                           |                                      |         |                   |         |               |          |           
|                                                         |                                                                                          | Write-off of unamortized debt issuance costs                              |                                      |         |                  |         |               |          | 17,047     |       
|                                                         |                                                                                          | Gain on sale of an investment                                             |                                      |         |                  |         |               |          | (4,602     | )     
|                                                         |                                                                                          | Non-cash portion of restructuring and other charges                       |                                      |         | 51,895            |         |               |          |           |       
|                                                         |                                                                                          | Loss on extinguishment of debt                                            |                                      |         | 616               |         |               |          |           |       
|                                                         |                                                                                          | Bad debt recovery                                                         |                                      |         |                  |         |               |          | (7,662     | )     
|                                                         |                                                                                          | Depreciation and amortization                                             |                                      |         | 47,962            |         |               |          | 32,292     |       
|                                                         |                                                                                          | Cumulative effect of a change in accounting principle, net of tax benefit |                                      |         | 62,780            |         |               |          |           |       
|                                                         |                                                                                          | Deferred income taxes                                                     |                                      |         | (17,396           | )       |               |          | (6,278     | )     
|                                                         |                                                                                          | Stock-based compensation                                                  |                                      |         | 3,055             |         |               |          | 4,861      |       
|                                                         |                                                                                          | Income tax benefits from employee stock option plans                      |                                      |         |                  |         |               |          | 17,313     |       
|                                                         |                                                                                          | Changes in operating assets and liabilities:                              |                                      |         |                   |         |               |          |            |       
|                                                         |                                                                                          |                                                                           | Accounts receivable                  |         |                   | (28,446 | )             |          |            | 3,345  |  
|                                                         |                                                                                          |                                                                           | Inventories                          |         |                   | 12,854  |               |          |            | 5,434  |  
|                                                         |                                                                                          |                                                                           | Prepaid and other current assets     |         |                   | 15,057  |               |          |            | 68,683 |  
|                                                         |                                                                                          |                                                                           | Accounts payable                     |         |                   | (2,215  | )             |          |            | 2,093  |  
|                                                         |                                                                                          |                                                                           | Accrued payroll and related expenses |         |                   | (2,982  | )             |          |            | 854    |  
|                                                         |                                                                                          |                                                                           | Accrued warranty                     |         |                   | (880    | )             |          |            | (7,802 | )
|                                                         |                                                                                          |                                                                           | Other accrued liabilities            |         |                   | (7,880  | )             |          |            | 2,385  |  
|                                                         |                                                                                          |                                                                           | Income taxes payable                 |         |                   | (5,339  | )             |          |            | 3,650  |  
|                                                         |                                                                                          |                                                                           | Deferred profit                      |         |                   | (15,136 | )             |          |            | 26,560 |  
|                                                         |                                                                                          |                                                                           |                                      |         |                   |         |               |         
|                                                         | Net cash provided by operating activities                                                |                                                                           |                                      | 35,679  |                   |         |               | 178,105  |           
|                                                         |                                                                                          |                                                                           |                                      |         |                   |         |               |         
|Cash flows from investing activities:                    |                                                                                          |                                                                           |                                      |         |                   |         |               |         
|                                                         |                                                                                          | Proceeds from sales and maturities of short-term investments              |                                      |         | 1,102,611         |         |               |          | 548,461    |       
|                                                         |                                                                                          | Purchases of short-term investments                                       |                                      |         | (1,147,409        | )       |               |          | (627,221   | )     
|                                                         |                                                                                          | Proceeds from sales and maturities of restricted short-term investments   |                                      |         |                  |         |               |          | 2,146,931  |       
|                                                         |                                                                                          | Purchases of restricted short-term investments                            |                                      |         |                  |         |               |          | (1,186,362 | )     
|                                                         |                                                                                          | Participation in synthetic leases                                         |                                      |         |                  |         |               |          | (177,458   | )     
|                                                         |                                                                                          | Capital expenditures                                                      |                                      |         | (23,867           | )       |               |          | (21,412    | )     
|                                                         |                                                                                          | Decrease in other assets                                                  |                                      |         | 7,373             |         |               |          | 1,834      |       
|                                                         |                                                                                          |                                                                           |                                      |         |                   |         |               |         
|                                                         | Net cash (used in) provided by investing activities                                      |                                                                           |                                      | (61,292 | )                 |         |               | 684,773  |           
|                                                         |                                                                                          |                                                                           |                                      |         |                   |         |               |         
|Cash flows from financing activities:                    |                                                                                          |                                                                           |                                      |         |                   |         |               |         
|                                                         |                                                                                          | Repayments of convertible subordinated notes                              |                                      |         | (117,053          | )       |               |          | (879,750   | )     
|                                                         |                                                                                          | Proceeds from employee stock compensation plans                           |                                      |         | 53,180            |         |               |          | 39,882     |       
|                                                         |                                                                                          | Proceeds from (payments on) lines of credit, net                          |                                      |         | 3,164             |         |               |          | (24,544    | )     
|                                                         |                                                                                          | Repurchase of common stock                                                |                                      |         | (39               | )       |               |          | (75,370    | )     
|                                                         |                                                                                          |                                                                           |                                      |         |                   |         |               |         
|                                                         | Net cash used in financing activities                                                    |                                                                           |                                      | (60,748 | )                 |         |               | (939,782 | )         
|                                                         |                                                                                          |                                                                           |                                      |         |                   |         |               |         
|Net decrease in cash and cash equivalents                |                                                                                          |                                                                           | (86,361                              | )       |                   |         | (76,904       | )       
|Cash and cash equivalents at the beginning of the period |                                                                                          |                                                                           | 615,844                              |         |                   |         | 550,640       |         
|                                                         |                                                                                          |                                                                           |                                      |         |                   |         |               |         
|Cash and cash equivalents at the end of the period       |                                                                                          | $                                                                         | 529,483                              |         |                   | $       | 473,736       |         
|                                                         |                                                                                          |                                                                           |                                      |         |                   |         |               |         

See accompanying notes to condensed consolidated financial statements.

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NOVELLUS SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.     BASIS OF PRESENTATION AND STOCK-BASED COMPENSATION

Basis of Presentation

The accompanying condensed consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United
States of America for interim financial information and with the instructions
to the Quarterly Report on Form 10-Q and Article 10 of Regulation S-X. The
interim financial information is unaudited and does not include all of the
information and footnotes required by accounting principles generally accepted
in the United States of America for complete financial statements. In the
opinion of management, all adjustments (consisting only of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three and nine months ended September 27, 2003 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 2003. For further information, refer to the consolidated
financial statements and footnotes thereto included in our Annual Report on
Form 10-K for the year ended December 31, 2002.

On December 6, 2002, we acquired SpeedFam-IPEC, Inc., a global supplier of
chemical mechanical planarization (CMP) systems used in the fabrication of
advanced copper interconnects. The acquisition was accounted for as a purchase
business combination and qualifies as a tax-free reorganization under IRS
regulations. Our condensed consolidated financial statements for the three and
nine months ended September 27, 2003 include the financial position, results of
operations and cash flows of SpeedFam-IPEC.

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

The accompanying condensed consolidated financial statements include our
accounts and the accounts of our wholly-owned subsidiaries after the
elimination of all significant intercompany account balances and transactions.

We operate primarily in one segment, the manufacturing, marketing, and
servicing of semiconductor wafer fabrication equipment. Since we operate in one
segment, all financial
information required by Statement of Financial
Accounting Standards No. 131, Disclosures About Segments of an Enterprise and
Related Information, or SFAS No. 131, is included in the condensed
consolidated financial statements.

Stock-Based Compensation

We account for stock-based employee compensation using the intrinsic value
method under Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, and have adopted the disclosure-only provisions of
SFAS No. 123, Accounting for
Stock-Based Compensation, as amended by SFAS No. 148,
Accounting for Stock-Based Compensation  Transition and Disclosures.
Accordingly, no expense has been recognized for options granted to employees at
fair value. We amortize deferred stock-based compensation on the graded vesting
method over the vesting periods of the applicable stock purchase rights and
stock options, generally four years. The graded vesting method provides for
vesting of portions of the overall awards at interim dates and results in
greater expense recorded in earlier years than the straight-line method.

SFAS No. 123 requires the use of option pricing models that were not developed
for use in valuing employee stock options. The Black-Scholes option-pricing
model was developed for use in estimating the fair value of short-lived
exchange-traded

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options that have no vesting restrictions and are fully
transferable. In addition, option-pricing models require the input of highly
subjective assumptions, including the options expected life and the price
volatility of the underlying stock. Because the Companys employee stock
options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in the opinion of management, the existing
models do not necessarily provide a reliable single measure of the fair value
of employee stock options.

Had compensation expense been determined based on the fair value at the grant
date for awards, consistent with the provisions of SFAS No. 123, we would have
reported pro forma net loss and net loss per share as follows (in thousands,
except per share data):

|                                                |                                                                                            |   |                    |         |                   |   |               |         |               |   |          |         |   |   |         |         |  
|----------------------------------------------- | ------------------------------------------------------------------------------------------ | - | ------------------ | ------- | ----------------- | - | ------------- | ------- | ------------- | - | -------- | ------- | - | - | ------- | ------- | -
|                                                |                                                                                            |   | Three Months Ended |         | Nine Months Ended
|                                                |                                                                                            |   |                    |         |                  
|                                                |                                                                                            |   | September 27,      |         | September 28,     |   | September 27, |         | September 28,
|                                                |                                                                                            |   | 2003               |         | 2002              |   | 2003          |         | 2002         
|                                                |                                                                                            |   |                    |         |                   |   |               |         |              
|Net (loss) income as reported                   |                                                                                            | $ | (97,568            | )       |                   | $ | 4,083         |         |               | $ | (78,266  | )       |   | $ | 19,932  |        
|Add:                                            |                                                                                            |   |                    |         |                   |   |               |         |               |   |          |         |   |   |         |        
|                                                | Intrinsic value method expense included in
reported net income, net of related tax effects |   |                    | 303     |                   |   |               | 269     |               |   |          | 1,737   |   |   |         | 782     |  
|Less:                                           |                                                                                            |   |                    |         |                   |   |               |         |               |   |          |         |   |   |         |        
|                                                | Fair value method expense, net of
related tax effects                                      |   |                    | (13,333 | )                 |   |               | (18,631 | )             |   |          | (48,899 | ) |   |         | (53,702 | )
|                                                |                                                                                            |   |                    |         |                   |   |               |         |               |   |          |         |   |   |         |        
|Pro-forma net loss                              |                                                                                            | $ | (110,598           | )       |                   | $ | (14,279       | )       |               | $ | (125,428 | )       |   | $ | (32,988 | )      
|                                                |                                                                                            |   |                    |         |                   |   |               |         |               |   |          |         |   |   |         |        
|Pro-forma basic and diluted net loss per share  |                                                                                            | $ | (0.73              | )       |                   | $ | (0.10         | )       |               | $ | (0.83    | )       |   | $ | (0.23   | )      
|                                                |                                                                                            |   |                    |         |                   |   |               |         |               |   |          |         |   |   |         |        
|Basic net (loss) income per share as reported   |                                                                                            | $ | (0.64              | )       |                   | $ | 0.03          |         |               | $ | (0.52    | )       |   | $ | 0.14    |        
|                                                |                                                                                            |   |                    |         |                   |   |               |         |               |   |          |         |   |   |         |        
|Diluted net (loss) income per share as reported |                                                                                            | $ | (0.64              | )       |                   | $ | 0.03          |         |               | $ | (0.52    | )       |   | $ | 0.13    |        
|                                                |                                                                                            |   |                    |         |                   |   |               |         |               |   |          |         |   |   |         |        

The fair value of each stock option is estimated on the date of grant using the
Black-Scholes option-pricing model, with the following weighted-average
assumptions for grants made in the three and nine months ended September 27,
2003 and September 28, 2002:

|                        |  |                    |     |                   |  |               |     |               |  |  |     |     |  |  |     |    
|----------------------- |  | ------------------ | --- | ----------------- |  | ------------- | --- | ------------- |  |  | --- | --- |  |  | --- | ---
|                        |  | Three Months Ended |     | Nine Months Ended
|                        |  |                    |     |                  
|                        |  | September 27,      |     | September 28,     |  | September 27, |     | September 28,
|                        |  | 2003               |     | 2002              |  | 2003          |     | 2002         
|                        |  |                    |     |                   |  |               |     |              
|Dividend yield          |  | None               |     | None              |  | None          |     | None         
|Expected volatility     |  |                    | 80  | %                 |  |               | 85  | %             |  |  | 82  | %   |  |  | 85  | %  
|Risk free interest rate |  |                    | 2.3 | %                 |  |               | 3.3 | %             |  |  | 2.4 | %   |  |  | 3.2 | %  
|Expected lives          |  |                    | 3.6 | yrs               |  |               | 3.5 | yrs           |  |  | 3.2 | yrs |  |  | 3.4 | yrs

The weighted-average fair value of stock options granted during the period was
$20.78 and $17.08 for the three and nine months ended September 27, 2003,
respectively, and $15.95 and $22.63 for the three and nine months ended
September 28, 2002, respectively.

The pro forma net loss and net loss per share data listed above include expense
related to the Employee Stock Purchase Plan, referred to herein as the Purchase
Plan. The fair value of issuances under the Purchase Plan is estimated on the
date of issuance using the Black-Scholes option-pricing model, with the
following weighted-average assumptions for issuances made in the three and nine
months ended September 27, 2003 and September 28, 2002:

|                        |  |                    |      |                   |  |               |      |               |  |  |      |     |  |  |      |    
|----------------------- |  | ------------------ | ---- | ----------------- |  | ------------- | ---- | ------------- |  |  | ---- | --- |  |  | ---- | ---
|                        |  | Three Months Ended |      | Nine Months Ended
|                        |  |                    |      |                  
|                        |  | September 27,      |      | September 28,     |  | September 27, |      | September 28,
|                        |  | 2003               |      | 2002              |  | 2003          |      | 2002         
|                        |  |                    |      |                   |  |               |      |              
|Dividend yield          |  | None               |      | None              |  | None          |      | None         
|Expected volatility     |  |                    | 46   | %                 |  |               | 58   | %             |  |  | 49   | %   |  |  | 61   | %  
|Risk free interest rate |  |                    | 1.2  | %                 |  |               | 2.3  | %             |  |  | 1.2  | %   |  |  | 2.3  | %  
|Expected lives          |  |                    | 0.24 | yr.               |  |               | 0.24 | yr.           |  |  | 0.73 | yr. |  |  | 0.73 | yr.

The weighted-average fair value of purchase rights granted during the period
was $8.83 and $8.74 for the three and nine months ended September 27, 2003,
respectively and $8.53 and $11.88 for the three and nine months ended September
28, 2002, respectively.

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2.     NET (LOSS) INCOME PER SHARE

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

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

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

|                                    |                                             |                                             |       |                    |         |                   |      |               |         |               |       |         |         |   |      |         |         | 
|----------------------------------- | ------------------------------------------- | ------------------------------------------- | ----- | ------------------ | ------- | ----------------- | ---- | ------------- | ------- | ------------- | ----- | ------- | ------- | - | ---- | ------- | ------- | 
|                                    |                                             |                                             |       | Three Months Ended |         | Nine Months Ended
|                                    |                                             |                                             |       |                    |         |                  
|                                    |                                             |                                             |       | September 27,      |         | September 28,     |      | September 27, |         | September 28,
|                                    |                                             |                                             |       | 2003               |         | 2002              |      | 2003          |         | 2002         
|                                    |                                             |                                             |       |                    |         |                   |      |               |         |              
|Numerator:                          |                                             |                                             |       |                    |         |                   |      |               |         |               |       |         |         |   |      |        
|                                    | Net (loss) income                           |                                             | $     | (97,568            | )       |                   | $    | 4,083         |         |               | $     | (78,266 | )       |   | $    | 19,932  |        
|                                    |                                             |                                             |       |                    |         |                   |      |               |         |               |       |         |         |   |      |        
|Denominator:                        |                                             |                                             |       |                    |         |                   |      |               |         |               |       |         |         |   |      |        
|                                    | Basic weighted-average shares outstanding   |                                             |       | 151,280            |         |                   |      | 143,691       |         |               |       | 150,221 |         |   |      | 144,355 |        
|                                    | Employee stock options and restricted stock |                                             |       |                   |         |                   |      | 2,403         |         |               |       |        |         |   |      | 4,902   |        
|                                    |                                             |                                             |       |                    |         |                   |      |               |         |               |       |         |         |   |      |        
|                                    |                                             | Diluted weighted-average shares outstanding |       |                    | 151,280 |                   |      |               | 146,094 |               |       |         | 150,221 |   |      |         | 149,257 | 
|                                    |                                             |                                             |       |                    |         |                   |      |               |         |               |       |         |         |   |      |        
|Basic net (loss) income per share   |                                             | $                                           | (0.64 | )                  |         | $                 | 0.03 |               |         | $             | (0.52 | )       |         | $ | 0.14 |        
|                                    |                                             |                                             |       |                    |         |                   |      |               |         |               |       |         |         |   |      |         |        
|Diluted net (loss) income per share |                                             | $                                           | (0.64 | )                  |         | $                 | 0.03 |               |         | $             | (0.52 | )       |         | $ | 0.13 |        
|                                    |                                             |                                             |       |                    |         |                   |      |               |         |               |       |         |         |   |      |         |        

For the three and nine months ended September
27, 2003, all options to purchase common stock were excluded from the
computation of net loss per share as it would be anti-dilutive
during those periods. Options to purchase approximately 3.1 million shares of common
stock at a weighted-average exercise price of $49.14 per share were
outstanding as of September 28, 2002, but
were not included in the computation of diluted net income per common share
because the respective exercise prices of these options were greater than the
average respective market prices of the common shares and, therefore, the
effect would be anti-dilutive.

3.     INVENTORIES

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

|                          |                   |   |               |         |              |   |         |         | 
|------------------------- | ----------------- | - | ------------- | ------- | ------------ | - | ------- | ------- | 
|                          |                   |   | September 27, |         | December 31,
|                          |                   |   | 2003          |         | 2002        
|                          |                   |   |               |         |             
|Purchased and spare parts |                   | $ | 158,486       |         |              | $ | 205,341 |        
|Work-in-process           |                   |   | 23,485        |         |              |   | 45,487  |        
|Finished goods            |                   |   | 18,802        |         |              |   | 6,530   |        
|                          |                   |   |               |         |              |   |         |        
|                          | Total inventories |   | $             | 200,773 |              |   | $       | 257,358 | 
|                          |                   |   |               |         |              |   |         |        

4.     GOODWILL

In September 2003, we recorded a net increase to goodwill of approximately $9.8
million. The increase in goodwill is a result of the reallocation of the
initial estimated purchase price allocation for the acquisition of
SpeedFam-IPEC and additional purchase price.

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The following table represents the adjustments to goodwill, assets acquired and
liabilities assumed (in thousands):

|                                  |                     |   |        |       | 
|--------------------------------- | ------------------- | - | ------ | ----- | 
|Directors and officers insurance  |                     | $ | 1,293  |      
|Inventory write-down              |                     |   | 3,083  |      
|Restructuring accrual             |                     |   | 11,032 |      
|Deferred tax assets  non-current |                     |   | (6,108 | )    
|Other adjustments                 |                     |   | 457    |      
|                                  |                     |   |        |      
|                                  | Goodwill adjustment |   | $      | 9,757 | 
|                                  |                     |   |        |      

The directors and officers (D&O) insurance covers the former directors and
officers of SpeedFam-IPEC. As part of our acquisition of SpeedFam-IPEC, we
agreed to purchase D&O insurance for these directors and officers, however we
did not include the cost of the D&O insurance in our initial purchase price.

The $3.1 million inventory write-down primarily relates to inventory not
properly valued as of the acquisition date. The $11.0 million adjustment to
the restructuring accrual is due to a decrease in our estimated future sublease
income on facilities leased by SpeedFam-IPEC. This revised sublease income
estimate is based on subsequent knowledge obtained about real estate conditions
that existed as of the acquisition date. These facilities were abandoned as a
result of the acquisition. The $6.1 million deferred tax asset adjustment is a
result of the purchase price allocation adjustments.

5.     COMMITMENTS AND GUARANTEES

Operating Leases

In January 2003, the Financial Accounting Standards Board, or FASB, issued FASB
Interpretation No. 46, Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51, or FIN 46. FIN 46 requires variable interest
entities to be consolidated by the primary beneficiary of the entity. An entity
is considered a variable interest entity if the equity investors in the entity
do not have the characteristics of a controlling financial interest or do not
have sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective for all new variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or acquired prior to
February 1, 2003, the provisions of FIN 46 were to be applied at the end of
periods ending after June 15, 2003. In October 2003, the FASB issued a FASB
Draft Position on FIN 46, delaying the effective date of FIN 46 to periods
ending after December 15, 2003, but encouraging early adoption. We
early-adopted FIN 46 on June 29, 2003.

After evaluating our synthetic leases, we concluded that the lessor was a
variable interest entity and that we were the primary beneficiary of the
variable interest entity. As such, we were required to consolidate the variable
interest lessor beginning on June 29, 2003. Additionally, since each of the
other lessees involved with this lessor had a variable interest in specified
assets and liabilities of the variable interest lessor, we were only required
to consolidate the specific assets, liabilities, and operating results
associated with our synthetic leases. As a result of the early adoption of FIN
46, we recorded a non-cash charge net of tax of approximately $62.8 million in
the third quarter of fiscal 2003 as a cumulative effect of a change in
accounting principle in accordance with Accounting Principles Board Opinion No.
20, Accounting Changes. The gross charge represents approximately $95.8
million of pre-tax depreciation that would have been recorded had we owned
these assets from inception of the leases. As a result of the adoption of FIN
46 and our exercise of our options to purchase the properties subject to the
synthetic leases in September 2003, property and equipment increased on a net
basis by approximately $360.6 million and notes receivable and other
non-current assets decreased by $456.4 million. The purchase of these
properties in September 2003 eliminated our interest in the variable interest
entity.

The consolidation and subsequent purchase of the facilities previously
accounted for as synthetic leases increased our third quarter depreciation
expense by approximately $8.5 million and decreased both our rent expense and
interest income by approximately $3.0 million, which decreased our quarterly
earnings per share by approximately $0.04. The adoption of FIN 46 and our
exercise of our purchase options had no impact on our liquidity.

Product Warranty

We record the estimated cost of warranty as a component of cost of sales upon
system shipment. The estimated cost is determined by the warranty term as well
as the average historical labor and material costs for a specific product.
Should actual

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product failure rates or material usage differ from our estimate,
revisions to the estimated warranty liability may be required. We review the
actual product failure rates and material usage on a quarterly basis and adjust
our warranty liability as necessary. Effective December 31, 2002, we adopted
the provisions of FIN 45, Guarantors Accounting and Disclosure Requirements
for Guarantees, including Indirect Indebtedness of Others, which requires
changes to the accounting and disclosure of guarantees, including product
warranties. Changes in our accrued warranty liability were as follows (in
thousands):

|                             |                                             |   |                    |         |                     |   |        |         |  
|---------------------------- | ------------------------------------------- | - | ------------------ | ------- | ------------------- | - | ------ | ------- | -
|                             |                                             |   | Nine Months Ended  |         | Twelve Months Ended
|                             |                                             |   | September 27, 2003 |         | December 31, 2002  
|                             |                                             |   |                    |         |                    
|Balance, beginning of period |                                             | $ | 31,002             |         |                     | $ | 43,337 |        
|                             | Warranties issued                           |   |                    | 37,151  |                     |   |        | 42,723  |  
|                             | Settlements                                 |   |                    | (38,031 | )                   |   |        | (56,322 | )
|                             | SpeedFam-IPEC, Inc. warranty at acquisition |   |                    |        |                     |   |        | 1,264   |  
|                             |                                             |   |                    |         |                     |   |        |        
|Balance, end of period       |                                             | $ | 30,122             |         |                     | $ | 31,002 |        
|                             |                                             |   |                    |         |                     |   |        |        

In addition to product warranties, from time to time, in the normal course of
business, we indemnify third parties with whom we enter into contractual
relationships, including customers, lessors, and parties to other transactions
with us, with respect to certain matters. We have agreed to hold these third
parties harmless against specified losses, such as those arising from a breach
of representations or covenants, other third party claims that our products
when used for their intended purposes infringe the intellectual property
rights of such other third parties or other claims made against certain
parties. It is not possible to determine the maximum potential amount of
liability under these indemnification obligations due to our limited history of
prior indemnification claims and the unique facts and circumstances that are
likely to be involved in each particular claim. Historically, payments made by
us under these obligations have not been material.

6.     CONVERTIBLE SUBORDINATED NOTES

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

7.     RESTRUCTURING AND OTHER CHARGES

In the third quarter of 2003, we announced a restructuring plan to align our
cost structure with current business conditions. The restructuring plan
resulted in pre-tax charges of $59.8 million in the third quarter, which is
composed of $44.0 million for inventory, $7.9 million for asset write-offs
(including fixed assets and purchased technology), $4.1 million for facilities,
and $3.8 million for severance. The inventory charge is included in cost of
sales and the other charges are included in restructuring and other charges on
the condensed consolidated statement of operations.

The following table summarizes restructuring activity for the nine months ended
September 27, 2003 related to restructuring charges we recorded in 2001, 2002,
and 2003 (in thousands):

|                              |                                      |   |            |        |            |   |           |        |         |   |       |        |             |   |       |      |   |   |           |        |   |   |   |         |  
|----------------------------- | ------------------------------------ | - | ---------- | ------ | ---------- | - | --------- | ------ | ------- | - | ----- | ------ | ----------- | - | ----- | ---- | - | - | --------- | ------ | - | - | - | ------- | -
|                              |                                      |   |            |        |            |   | Asset     |        |         |   |       |        | Acquisition |   |       |      |   |   | Inventory
|                              |                                      |   | Facilities |        | Impairment |   | Severance |        | Expense |   | Total |        | Write-down 
|                              |                                      |   |            |        |            |   |           |        |         |   |       |        |            
|Balance at December 31, 2002  |                                      | $ | 45,568     |        |            | $ |          |        |         | $ | 251   |        |             | $ | 1,253 |      |   | $ | 47,072    |        |   | $ |  |        
|                              | Restructuring charges for 2003       |   |            | 4,088  |            |   |           | 7,943  |         |   |       | 3,807  |             |   |       |     |   |   |           | 15,838 |   |   |   | 43,952  |  
|                              | Cash payments                        |   |            | (7,144 | )          |   |           |       |         |   |       | (1,401 | )           |   |       | (138 | ) |   |           | (8,683 | ) |   |   |        |  
|                              | Non-cash charges                     |   |            |       |            |   |           | (7,943 | )       |   |       |       |             |   |       |     |   |   |           | (7,943 | ) |   |   | (43,952 | )
|                              | SpeedFam-IPEC acquisition
adjustment |   |            | 11,032 |            |   |           |       |         |   |       |       |             |   |       |     |   |   |           | 11,032 |   |   |   |        |  
|                              |                                      |   |            |        |            |   |           |        |         |   |       |        |             |   |       |      |   |   |           |        |   |   |   |        
|Balance at September 27, 2003 |                                      | $ | 53,544     |        |            | $ |          |        |         | $ | 2,657 |        |             | $ | 1,115 |      |   | $ | 57,316    |        |   | $ |  |        
|                              |                                      |   |            |        |            |   |           |        |         |   |       |        |             |   |       |      |   |   |           |        |   |   |   |        

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Facilities

The facilities restructuring charge in the third quarter of 2003 primarily
relates to abandoned corporate facilities from our January 2001 acquisition of
GaSonics International Corporation. The charge consists of $1.1 million of
repair and restoration costs and a $3.0 million decrease in our future sublease
income estimate. In addition to the restructuring charge, we further lowered
our estimate of future sublease income on abandoned facilities from the
SpeedFam-IPEC acquisition by $11.0 million. The SpeedFam-IPEC facilities
adjustment resulted in an increase to goodwill due to a reallocation of our
purchase price. For further discussion on the goodwill increase, see Note 4 to
our condensed consolidated financial statements.

Asset Impairment

In the third quarter of 2003, we abandoned assets and wrote off purchased
technology of $7.9 million. The charge for abandoned assets of $2.4 million
primarily relates to previous generation lab equipment. These assets have been
abandoned as we do not expect to recover the carrying value through future cash flows. The write-off of purchased technology of $5.5 million
relates to technology previously purchased from a third party vendor for use in
certain research and development projects. The purchased technology has been
written off as these research and development projects have been cancelled and
there is no future economic benefit for the purchased technology.

Severance

In the third quarter of 2003, we reduced our workforce by approximately 7% in
response to market conditions and recorded charges of $3.8
million, primarily for the cost of severance compensation. This workforce
reduction affected approximately 200 people across all business functions,
operating units and major geographic regions.

Inventory Write-downs

The charge for inventory write-downs
of $44.0 million in the third quarter of
2003 relates to excess and obsolete inventory. During this quarter,
changes in the industry and our worldwide distribution system
resulted in revisions to forecasted demand.
These changes resulted in a portion of our inventory becoming excess or
obsolete.

8.     BAD DEBT RECOVERY

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

9.     COMPREHENSIVE (LOSS) INCOME

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

|                                                                                                         |  |                    |         |                   |  |               |       |               |  |   |         |   |  |   |        |  
|-------------------------------------------------------------------------------------------------------- |  | ------------------ | ------- | ----------------- |  | ------------- | ----- | ------------- |  | - | ------- | - |  | - | ------ | -
|                                                                                                         |  | Three Months Ended |         | Nine Months Ended
|                                                                                                         |  |                    |         |                  
|                                                                                                         |  | September 27,      |         | September 28,     |  | September 27, |       | September 28,
|                                                                                                         |  | 2003               |         | 2002              |  | 2003          |       | 2002         
|                                                                                                         |  |                    |         |                   |  |               |       |              
|Net (loss) income                                                                                        |  | $                  | (97,568 | )                 |  | $             | 4,083 |               |  | $ | (78,266 | ) |  | $ | 19,932 |  
|Foreign currency translation adjustments                                                                 |  |                    | (462    | )                 |  |               | 143   |               |  |   | 1,661   |   |  |   | 818    |  
|Unrealized gain on available-for-sale
securities, net of tax                                             |  |                    | 80      |                   |  |               | 124   |               |  |   | 26      |   |  |   | 416    |  
|Reclassification of realized gain on an
available-for-sale investment included
in net income, net of tax |  |                    |        |                   |  |               |      |               |  |   |        |   |  |   | (3,636 | )
|                                                                                                         |  |                    |         |                   |  |               |       |               |  |   |         |   |  |   |        |  
|Comprehensive (loss) income                                                                              |  | $                  | (97,950 | )                 |  | $             | 4,350 |               |  | $ | (76,579 | ) |  | $ | 17,530 |  
|                                                                                                         |  |                    |         |                   |  |               |       |               |  |   |         |   |  |   |        |  

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

|                                                 |                                      |   |               |     |              |   |        |        |  
|------------------------------------------------ | ------------------------------------ | - | ------------- | --- | ------------ | - | ------ | ------ | -
|                                                 |                                      |   | September 27, |     | December 31,
|                                                 |                                      |   | 2003          |     | 2002        
|                                                 |                                      |   |               |     |             
|Foreign currency translation adjustments         |                                      | $ | 200           |     |              | $ | (1,461 | )     
|Unrealized loss on available-for-sale securities |                                      |   | (259          | )   |              |   | (285   | )     
|                                                 |                                      |   |               |     |              |   |        |       
|                                                 | Accumulated other comprehensive loss |   | $             | (59 | )            |   | $      | (1,746 | )
|                                                 |                                      |   |               |     |              |   |        |       

10.     RELATED PARTY TRANSACTIONS

In the second quarter of 2002, we began leasing an aircraft from NVLS I, LLC, a
third-party entity wholly owned by Richard S. Hill, our Chairman and Chief
Executive Officer. Under the leasing agreement, we incurred rental expense of
approximately $227,000 and $606,000 for the three and nine months ended
September 27, 2003, respectively, and $76,000 and $134,000 for the three and
nine months ended September 28, 2002, respectively.

A member of our Board of Directors, D. James Guzy, is also a member of the
Board of Directors of Intel Corporation, one of our significant customers.
Sales to Intel represented approximately 10% of our net sales for both the
three and nine months ended September 27, 2003, respectively, and 8% and 11%
for the three and nine months ended September 28, 2002, respectively. Intel
also accounted for 11% and 14% of our accounts receivable as of September 27,
2003 and December 31, 2002, respectively.

From time to time, we have made secured relocation loans to our executive
officers, vice presidents and key personnel. As of September 27, 2003, we do
not have any outstanding loans to our executive officers as defined by the
Securities and Exchange Commission. However, we have outstanding loans to
non-executive officers and key personnel. As of September 27, 2003 and
December 31, 2002, the total outstanding balances of loans to non-executive
officers and key personnel were approximately $6.0 million. Of the total amount outstanding at September 27, 2003, $4.8
million was secured by collateral.

11.     RECENT ACCOUNTING PRONOUNCEMENTS

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity, or SFAS No.
150. SFAS No. 150 establishes standards for the classification and measurement
of three types of financial instruments with characteristics of both
liabilities and equity. SFAS No. 150 became effective for financial instruments
entered into or modified after May 31, 2003. The adoption of SFAS No. 150 does
not have a material impact on our results of operations or financial condition.

12.     LITIGATION

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




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
anticipate, expect, intend, plan, believe, seek, estimate, and
similar expressions also identify forward-looking statements. Forward-looking
statements in this Quarterly Report include, without limitation: our continued
belief that significant investment in R&D is required to remain competitive;
our intent to continue to invest in new products and in the enhancement of our
current product lines; our expectations regarding the effect of the adoption of
SFAS No. 150 on our results of operations or financial condition; our belief
that our current cash position, cash generated through operations and equity
offerings, and available borrowing capacity will be sufficient to meet our
needs through the next twelve months; our belief that the ultimate outcome of
the Applied Materials, Inc., Semitool, Inc., Plasma Physics Corporation, Solar
Physics Corporation and Linear Technology Corporation litigation matters and
various other litigations that have arisen in the normal course of business
will not have a material adverse effect on our business, financial condition or
results of operations; our belief that we have meritorious claims and/or
defenses in the Applied Materials and Semitool litigation matters; and our
intent to continue pursuing the legal defense of our propriety technology
primarily through patent and trade secret protection.

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Our expectations, beliefs, objectives, anticipations, intentions and strategies
regarding the future, including, without limitation, those concerning expected
operating results, revenues and earnings and current and potential litigation
are not guarantees of future performance and are subject to risks and
uncertainties that could cause actual results to differ materially from results
contemplated by the forward-looking statements including, but not limited to:
our inability to allocate substantial resources to R&D; our failure to
accurately predict the effect of our adoption of SFAS No. 150; our
unanticipated need for additional liquid assets in the next twelve months; our
failure to accurately predict the effect of the ultimate outcome of current
litigation on our business, financial condition or results of operations;
inherent uncertainty in the outcome of litigation matters; and our potential
inability to enforce our patents and protect our trade secrets.

The forward-looking statements in this Quarterly Report on Form 10-Q are
subject to additional risks and uncertainties set forth below in this Item 2 of
Part I, and are based on information available to us on the date hereof. We
assume no obligation to update any forward-looking statements. Readers are
cautioned not to place undue reliance on forward-looking statements, which
speak only as of the date of this Quarterly Report on Form 10-Q. Readers should
also consult the cautionary statements and risk factors listed in our Annual
Report on Form 10-K for the year ended December 31, 2002 and in our other
filings with the Securities and Exchange Commission (SEC), including our Forms
10-Q and 8-K and our Annual Reports to Shareholders.

Critical Accounting Policies

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

Revenue Recognition

We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 101,
Revenue Recognition in Financial Statements, or SAB 101, SAB 101: Revenue
Recognition in Financial Statements-Frequently Asked Questions and Answers, or
SAB 101 FAQ and EITF-00-21, Revenue Arrangements With Multiple Deliverables.
We recognize revenue when persuasive evidence of an arrangement exists,
delivery has occurred or services have been rendered, the sellers price is
fixed or determinable, and collectibility is reasonably assured.

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

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

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

Inventory Valuation

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

Goodwill and Other Intangible Assets

We account for goodwill and other intangible assets under the provisions of
Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets, or SFAS No. 142. SFAS No. 142 requires that goodwill and
identifiable intangible assets with indefinite useful lives no longer be
amortized, but instead be tested for impairment annually, or more frequently if
certain events or changes in circumstances indicate that the carrying value may
not be recoverable. We perform our annual impairment test in the fourth
quarter of our fiscal year. SFAS No. 142 also requires that intangible assets
with estimable useful lives be amortized over their respective estimated useful
lives to their estimated residual values and reviewed for impairment in
accordance with SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. Furthermore, SFAS No. 142 includes provisions on the
identification of intangible assets, reclassification of certain intangible
assets from previously reported goodwill, and reassessment of the useful lives
of existing intangible assets. Upon adoption of SFAS No. 142 in January 2002,
we reassessed the useful lives and residual values of all acquired identifiable
intangible assets to identify any necessary amortization period adjustments and
to determine whether other intangible assets should be reclassified from
goodwill. Based on that assessment, no adjustments were made to the
amortization period or residual values of identifiable intangible assets.

Deferred Tax Assets

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

Warranty Obligations

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

Restructuring and Impairment Charges

Restructuring activities initiated prior to December 31, 2002 were recorded in
accordance with EITF 94-3 and restructuring activities after December 31, 2002
were recorded under the provisions of SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities, or SFAS No. 146 and SFAS No. 112,
Employers Accounting for Postemployment Benefits. SFAS 146 requires that a
liability for costs associated with an exit or disposal activity be recognized
when the liability is incurred, rather than when the exit or disposal plan is
approved.

We account for business combination restructurings under the provisions of EITF
Issue No. 95-3, Recognition of Liabilities in Connection with a Purchase
Business Combination and SAB 100, Restructuring and Impairment Charges.
Accordingly, restructuring accruals are recorded when management initiates an
exit plan that will cause us to incur costs that have no future economic
benefit. Certain restructuring charges related to asset impairments are
recorded in accordance with SFAS No. 144. The restructuring accrual related to
vacated facilities is calculated net of estimated sublease income. Sublease
income is estimated based on current market quotes for similar properties. If
we were unable to sublet these vacated properties on a

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timely basis or if we
were forced to sublet them at lower rates due to changes in market conditions,
we will adjust the accrual accordingly.

Our critical accounting policies are also discussed in our Annual Report on
Form 10-K for the year ended December 31, 2002, in the section Managements
Discussion and Analysis of Financial Condition and Results of Operations and
in Note 1 to our Consolidated Financial Statements.

Results of Operations
(dollars in thousands)

Net Sales

|                          |  |                    |         |                    |  |               |         |                    |  |                    |         |   |  |   |         |   |  |   |         |  
|------------------------- |  | ------------------ | ------- | ------------------ |  | ------------- | ------- | ------------------ |  | ------------------ | ------- | - |  | - | ------- | - |  | - | ------- | -
|                          |  | Three Months Ended |         | Nine Months Ended 
|                          |  |                    |         |                   
|                          |  | September 27, 2003 |         | September 28, 2002 |  | June 28, 2003 |         | September 27, 2003 |  | September 28, 2002
|                          |  |                    |         |                    |  |               |         |                    |  |                   
|Net sales                 |  | $                  | 221,099 |                    |  | $             | 230,495 |                    |  | $                  | 239,050 |   |  | $ | 698,559 |   |  | $ | 622,321 |  
|International net
sales % |  |                    | 67      | %                  |  |               | 68      | %                  |  |                    | 66      | % |  |   | 62      | % |  |   | 67      | %

The semiconductor equipment industry is subject to cyclical conditions that
have played a major role in the fluctuations in our net sales. The increase in
net sales for the nine months ended September 27, 2003 from the prior year
period is primarily due to improved market conditions during 2003 and, to a
lesser extent, revenues resulting from our December 2002 acquisition of
SpeedFam-IPEC. The decline in demand for semiconductor equipment began in early
2001 and continued through the early part of 2002. While we have experienced a
modest increase from 2002, demand has remained weak through the first three
quarters of 2003.

The decrease in international net sales as a percentage of net sales for the
nine months ended September 27, 2003 over the prior year is primarily due to a
proportionally lower increase in net sales in the Asia region (consisting
primarily of Korea, Japan, and Taiwan) compared to net sales in North America.
The Asia region accounted for 52% of total net sales for the nine months ended
September 27, 2003, compared to 58% for the nine months ended September 28,
2002.

Gross Profit

|               |  |                    |        |                    |  |               |         |                    |  |                    |         |   |  |   |         |   |  |   |         |  
|-------------- |  | ------------------ | ------ | ------------------ |  | ------------- | ------- | ------------------ |  | ------------------ | ------- | - |  | - | ------- | - |  | - | ------- | -
|               |  | Three Months Ended |        | Nine Months Ended 
|               |  |                    |        |                   
|               |  | September 27, 2003 |        | September 28, 2002 |  | June 28, 2003 |         | September 27, 2003 |  | September 28, 2002
|               |  |                    |        |                    |  |               |         |                    |  |                   
|Gross profit   |  | $                  | 58,776 |                    |  | $             | 109,382 |                    |  | $                  | 105,322 |   |  | $ | 273,912 |   |  | $ | 282,475 |  
|% of net sales |  |                    | 27     | %                  |  |               | 47      | %                  |  |                    | 44      | % |  |   | 39      | % |  |   | 45      | %

The decline in gross profit percentage in the three and nine months ended
September 27, 2003 is primarily due to our $44.0 million write-down of
inventory. In the third quarter of 2003, changes in the industry and
our worldwide distribution system resulted in revisions to forecasted
demand. These changes resulted in a portion of our inventory becoming
excess or obsolete. The prolonged decline in
demand for semiconductor capital equipment has also continued to negatively
affect our gross profit margin, as we have not been able to fully absorb fixed
overhead costs.

Selling, General and Administrative (SG&A)

|               |  |                    |        |                    |  |               |        |                    |  |                    |        |   |  |   |         |   |  |   |         |  
|-------------- |  | ------------------ | ------ | ------------------ |  | ------------- | ------ | ------------------ |  | ------------------ | ------ | - |  | - | ------- | - |  | - | ------- | -
|               |  | Three Months Ended |        | Nine Months Ended 
|               |  |                    |        |                   
|               |  | September 27, 2003 |        | September 28, 2002 |  | June 28, 2003 |        | September 27, 2003 |  | September 28, 2002
|               |  |                    |        |                    |  |               |        |                    |  |                   
|SG&A expense   |  | $                  | 40,123 |                    |  | $             | 43,143 |                    |  | $                  | 44,444 |   |  | $ | 127,197 |   |  | $ | 117,307 |  
|% of net sales |  |                    | 18     | %                  |  |               | 19     | %                  |  |                    | 19     | % |  |   | 18      | % |  |   | 19      | %

SG&A expense includes compensation and benefits, travel, utilities,
communications costs and professional fees for our corporate, financial,
marketing and administrative functions. Also included are expenses for rents
and depreciation and amortization related to the assets utilized by the
functions noted above. As a percentage of net sales, SG&A expense remained
relatively unchanged for the three and nine months ended September 27, 2003,
compared to the respective prior-year periods. The increase in SG&A expense in
absolute dollars for the nine months ended September 27, 2003 from the same
period in the prior year is primarily due to higher salaries and litigation costs. The decrease in SG&A expense from the
immediately preceding quarter is due to lower salaries and litigation costs.

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Research and Development (R&D)

|               |  |                    |        |                    |  |               |        |                    |  |                    |        |   |  |   |         |   |  |   |         |  
|-------------- |  | ------------------ | ------ | ------------------ |  | ------------- | ------ | ------------------ |  | ------------------ | ------ | - |  | - | ------- | - |  | - | ------- | -
|               |  | Three Months Ended |        | Nine Months Ended 
|               |  |                    |        |                   
|               |  | September 27, 2003 |        | September 28, 2002 |  | June 28, 2003 |        | September 27, 2003 |  | September 28, 2002
|               |  |                    |        |                    |  |               |        |                    |  |                   
|R&D expense    |  | $                  | 59,858 |                    |  | $             | 58,248 |                    |  | $                  | 56,509 |   |  | $ | 173,374 |   |  | $ | 171,021 |  
|% of net sales |  |                    | 27     | %                  |  |               | 25     | %                  |  |                    | 24     | % |  |   | 25      | % |  |   | 27      | %

R&D expense includes compensation and benefits, project materials, repairs and
maintenance, rent, depreciation and amortization associated with patents and
purchased technologies for our R&D functions. R&D expense as a percentage of
net sales for the three and nine months ended September 27, 2003 remained
essentially unchanged compared to the respective prior-year periods. The
increase in R&D expense as a percentage of sales and in absolute dollars for
the three months ended September 27, 2003 from the immediately preceding
quarter is primarily due to the increase in depreciation expense resulting from
the consolidation of properties previously accounted for under synthetic
leases. We continue to believe that significant investment in R&D is required
to remain competitive, and we plan to continue to invest in new products and in
the enhancement of our current product lines.

Restructuring and Other Charges

|                                |  |                    |        |                    |  |               |   |                    |  |                    |   |  |  |   |        |   |  |   |       |  
|------------------------------- |  | ------------------ | ------ | ------------------ |  | ------------- | - | ------------------ |  | ------------------ | - |  |  | - | ------ | - |  | - | ----- | -
|                                |  | Three Months Ended |        | Nine Months Ended 
|                                |  |                    |        |                   
|                                |  | September 27, 2003 |        | September 28, 2002 |  | June 28, 2003 |   | September 27, 2003 |  | September 28, 2002
|                                |  |                    |        |                    |  |               |   |                    |  |                   
|Restructuring and other
charges |  | $                  | 18,529 |                    |  | $             |  |                    |  | $                  |  |  |  | $ | 18,529 |   |  | $ | 3,273 |  
|% of net sales                  |  |                    | 8      | %                  |  |               |  |                    |  |                    |  |  |  |   | 3      | % |  |   | 1     | %

The $18.5 million restructuring and other charges in the three and nine months
ended September 27, 2003 consisted of $7.9 million for asset write-offs
(including fixed assets and purchased technology), $4.1 million for facilities,
$3.8 million for severance, and $2.7 million for legal settlements. The asset
write-offs, facilities charges, and severance charges were recorded in
connection with activities undertaken to align our cost structure with current
business conditions. The $3.3 million restructuring charge in the nine months
ended September 28, 2002 consisted primarily of severance compensation related
to a workforce reduction, which we carried out in response to the market
downturn.

Bad Debt Recovery

|                  |  |                    |   |                    |  |               |   |                    |  |                    |   |  |  |   |   |  |  |   |        |  
|----------------- |  | ------------------ | - | ------------------ |  | ------------- | - | ------------------ |  | ------------------ | - |  |  | - | - |  |  | - | ------ | -
|                  |  | Three Months Ended |   | Nine Months Ended 
|                  |  |                    |   |                   
|                  |  | September 27, 2003 |   | September 28, 2002 |  | June 28, 2003 |   | September 27, 2003 |  | September 28, 2002
|                  |  |                    |   |                    |  |               |   |                    |  |                   
|Bad debt recovery |  | $                  |  |                    |  | $             |  |                    |  | $                  |  |  |  | $ |  |  |  | $ | (7,662 | )
|% of net sales    |  |                    |  |                    |  |               |  |                    |  |                    |  |  |  |   |  |  |  |   | 1      | %

In September 2001, we determined that an outstanding account receivable balance
was at risk for collection because the customer was facing financial
difficulties, payment was overdue and overall industry conditions continued to
deteriorate. Accordingly, we recorded a write-off of $7.7 million in the third
quarter of 2001. However, in the nine months ended September 28, 2002, the
amount owed under this account was recovered in full, resulting in a benefit to
operations of $7.7 million.

Interest and Other Income, Net

|                               |  |                    |       |                    |  |               |       |                    |  |                    |       |   |  |   |        |   |  |   |        |  
|------------------------------ |  | ------------------ | ----- | ------------------ |  | ------------- | ----- | ------------------ |  | ------------------ | ----- | - |  | - | ------ | - |  | - | ------ | -
|                               |  | Three Months Ended |       | Nine Months Ended 
|                               |  |                    |       |                   
|                               |  | September 27, 2003 |       | September 28, 2002 |  | June 28, 2003 |       | September 27, 2003 |  | September 28, 2002
|                               |  |                    |       |                    |  |               |       |                    |  |                   
|Interest and other
income, net |  | $                  | 2,722 |                    |  | $             | 8,926 |                    |  | $                  | 5,537 |   |  | $ | 13,911 |   |  | $ | 38,443 |  
|% of net sales                 |  |                    | 1     | %                  |  |               | 4     | %                  |  |                    | 2     | % |  |   | 2      | % |  |   | 6      | %

Interest and other income, net, includes interest income, interest expense and
other non-operating items. The decrease in interest and other income, net, as a
percentage of net sales and in absolute dollars for the three and nine months
ended September 27, 2003 is primarily due to lower balances of interest-bearing
cash and short-term investments, lower interest rates in the first half of
2003, and our synthetic lease accounting change. Lower cash and investment
balances resulted mainly from the repayment of the $880.0 million Liquid Yield
Option Notes (LYONs) in the third quarter of 2002 and the redemption of the
$117.1 million SpeedFam-IPEC convertible subordinated notes in January 2003.
The synthetic lease accounting change

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reduced our interest income by $3.0
million for both the three and nine months ended September 27,
2003. We also had a $4.6 million gain from the sale of an equity
investment in the nine months ended September 28, 2002. In the first quarter of
2003, we recorded a loss of $616,000 upon redemption of the SpeedFam-IPEC
convertible subordinated notes, which contributed to the reduction of interest
and other income, net, in the nine months ended September 27, 2003.

Benefit for Income Taxes

Our estimated effective tax benefit rates were 39% and 50% for the three and
nine months ended September 27, 2003. Our effective tax rate for the three and
nine months ended September 28, 2002 was zero. The difference in the effective
tax rate compared to the prior year is primarily due to the benefit of R&D tax
credits in relation to a current year loss versus prior year income.

Related Party Transactions

In the second quarter of 2002, we began leasing an aircraft from NVLS I, LLC, a
third-party entity wholly owned by Richard S. Hill, our Chairman and Chief
Executive Officer. Under the leasing agreement, we incurred rental expense of
approximately $227,000 and $606,000 for the three and nine months ended
September 27, 2003, respectively, and $76,000 and $134,000 for the three and
nine months ended September 28, 2002, respectively.

A member of our Board of Directors, D. James Guzy, is also a member of the
Board of Directors of Intel Corporation, one of our significant customers.
Sales to Intel represented approximately 10% of our net sales for
both the
three and nine months ended September 27, 2003, respectively, and 8% and 11%
for the three and nine months ended September 28, 2002, respectively. Intel
also accounted for 11% and 14% of our accounts receivable as of September 27,
2003 and December 31, 2002, respectively.

From time to time, we have made secured relocation loans to our executive
officers, vice presidents and key personnel. As of September 27, 2003, we do
not have any outstanding loans to our executive officers as defined by the
Securities and Exchange Commission. However, we have outstanding loans to
non-executive officers and key personnel. As of September 27, 2003 and December
31, 2002, the total outstanding balances of loans to non-executive officers and
key personnel were approximately $6.0 million.
Of the total amount outstanding at September 27, 2003, $4.8 million was secured
by collateral.

Recent Accounting Pronouncements

In May 2003, the Financial Accounting Standards Board, or FASB, issued SFAS No.
150, Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity, or SFAS No. 150. SFAS No. 150 establishes standards
for the classification and measurement of financial instruments with
characteristics of both liabilities and equity. SFAS No. 150 became effective
for three types of financial instruments entered into or modified after May 31,
2003. The adoption of SFAS No. 150 does not have a material impact on our
results of operations or financial condition.

Liquidity and Capital Resources

We have historically financed our operating and capital resource requirements
through cash flows from operations, sales of equity securities and borrowings.
Our primary source of funds at September 27, 2003 consisted of $977.5 million
of cash, cash equivalents and short-term investments. This amount represents a
decrease of $42.1 million from $1.02 billion at December 31, 2002. The decrease
was due primarily to the repayment of the SpeedFam-IPEC convertible
subordinated notes at a redemption price of $117.1 million, plus accrued interest
of $2.2 million, and $61.3 million of net cash used in
investing activities, partially offset by positive cash generated from
operations of $35.7 million and proceeds from the issuance of
common stock in connection with stock option exercises of $53.2 million.

Net cash provided by operating activities during the nine months ended
September 27, 2003 was $35.7 million. This amount consisted primarily of
changes in working capital accounts, which
include a decrease in prepaid and other current assets of $15.1 million, a
decrease in inventories of $12.9 million, an increase in accounts receivable of
$28.4 million, and the combined effect of decreases in accounts payable,
accrued payroll and related expenses, income tax payable, deferred
profit and other accrued
liabilities of $33.5 million. The decrease in prepaid and other current assets
was primarily attributable to an $18.5 million income tax refund received in
the first quarter of 2003.

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Net cash used in investing activities in the nine months ended September 27,
2003 was $61.3 million, which consisted primarily of capital expenditures of
$23.9 million and net purchases of short-term investments of $44.8 million,
offset by a decrease in other assets of $7.4 million. As of September 27,
2003, we did not have any significant commitments to purchase property and
equipment.

Net cash used in financing activities in the nine months ended September 27,
2003 was $60.7 million, which is primarily due to the repayment of the
SpeedFam-IPEC convertible subordinated notes at a redemption price of $117.1
million, partially offset by proceeds from employee stock compensation plans of
$53.2 million and net line of credit borrowings of
$3.2 million.

In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51, or FIN 46. FIN 46
requires variable interest entities to be consolidated by the primary
beneficiary of the entity. An entity is considered a variable interest entity
if the equity investors in the entity do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 is effective for all new variable interest
entities created or acquired after January 31, 2003. For variable interest
entities created or acquired prior to February 1, 2003, the provisions of FIN
46 must be applied at the end of periods ending after June 15, 2003. In
October 2003, the FASB issued a FASB Draft Position on FIN 46, delaying the
effective date of FIN 46 to periods ending after December 15, 2003, but
encouraging early adoption. We early-adopted FIN 46 on June 29, 2003.

After evaluating our synthetic leases, we concluded that the lessor is a
variable interest entity and that we are the primary beneficiary of the
variable interest entity. As such, we were required to consolidate the variable
interest lessor beginning on June 29, 2003. Additionally, since each of the
other lessees involved with this lessor had a variable interest in specified
assets and liabilities of the variable interest lessor, we were only required
to consolidate in our financial statements the specific assets, liabilities,
and operating results associated with our synthetic leases. As a result of the
early adoption of FIN 46 and the exercise of our purchase options in September
2003, property and equipment increased on a net basis by approximately $360.6
million and notes receivable and other non-current assets decreased by $456.4
million. In addition, as a result of the adoption of FIN 46, we recorded a
non-cash net-of-tax charge of approximately $62.8 million in the third quarter
of fiscal 2003 as a cumulative effect of a change in accounting principle in
accordance with Accounting Principles Board Opinion No. 20, Accounting
Changes. The gross charge represents approximately $95.8 million of pre-tax
depreciation that would have been recorded had we owned these assets from
inception of the leases. The purchase of the properties in September 2003
eliminated our interest in the variable interest entity.

The consolidation and subsequent purchase of the facilities previously
accounted for as synthetic leases increased our third quarter depreciation
expense by approximately $8.5 million and decreased both our rent expense and
interest income by approximately $3.0 million, which decreased our quarterly
earnings per share by approximately $0.04. The early adoption of FIN 46 and the
exercise of our options to purchase the properties had no impact on our
liquidity.

Our subsidiaries in Asia and Europe have available lines of credit with various
banks with total borrowing capacity of $38.5 million. The lines of credit bear
interest at various rates, expire on various dates through April 2004 and can
be used for general operating purposes. Borrowings of $3.2 million were
outstanding under these credit facilities as of September 27, 2003.

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

Risk Factors

Set forth below and elsewhere in this Quarterly Report on Form 10-Q, including
in Part I: Item 2: Managements Discussion and Analysis of Financial Condition
and Results of Operations, and in other documents we file with the Securities
and Exchange Commission are trends, risks and uncertainties that could cause
our actual results to differ materially from the results contemplated by the
forward-looking statements contained in this Quarterly Report on Form 10-Q.

Cyclical Downturns in the Semiconductor Industry

Our business depends predominantly on the capital expenditures of semiconductor
manufacturers, which in turn depend on current and anticipated market demand
for integrated circuits and the products that use them. The semiconductor
industry has

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

The Semiconductor Industry is Intensely Competitive and Capital-Intensive

We face substantial competition in the industry, from both potential new market
entrants and established competitors. Some of these companies may have greater
financial, marketing, technical or other resources than we do, as well as
broader product lines, greater customer service capabilities, or larger and
more established sales organizations and customer bases. Remaining competitive
in the market depends in part upon our ability to develop new and enhanced
systems and to introduce them at competitive prices on a timely basis. Our
customers must incur substantial expenditures to install and integrate capital
equipment into their semiconductor production lines. Once a manufacturer has
selected a vendors capital equipment for a particular product line, the
manufacturer is likely to continue with the selected equipment vendor for that
specific application at that location. Accordingly, we may experience
difficulty in selling a product to a particular customer for a significant
period of time after that customer has selected a competitors product. In
addition, sales of our systems depend in significant part upon a prospective
customers decision to increase or expand manufacturing capacityboth of which
typically involve a significant capital commitment. From time to time, we have
experienced delays in finalizing system sales following initial system
qualification. Due to these and other factors, our systems typically have a
lengthy sales cycle, during which we may expend substantial funds and
management effort.

Rapidly Changing Technology

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

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

International Operations

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



| |  | Tariffs and other trade barriers;                      
|- |  | -------------------------------------------------------
| 
| |  | Challenges in staffing and managing foreign operations;
| 
| |  | Difficulties in managing foreign distributors;         
| 
| |  | Potentially adverse tax consequences;                  

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| |  | Imposition of legislation and regulations relating to the import
or export of semiconductor products, either by the United States or other
countries;                                                                                               
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Periodic economic downturns;                                                                                                                                                                                                                        
| 
| |  | Political instability; and                                                                                                                                                                                                                          
| 
| |  | Fluctuations in interest and foreign currency exchange rates,
creating the need to enter into forward foreign exchange contracts to
hedge against the short-term impact of foreign currency fluctuations,
specifically yen-denominated transactions.

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

Variability of Quarterly Operating Results

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



| |  | Building our systems according to forecast, and not using limited
backlog information, which hinders our ability to plan production and
inventory levels;                                                            
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | Failure to receive anticipated orders in time to permit shipment
during the quarter;                                                                                                                                 
| 
| |  | Customers rescheduling or canceling shipments;                                                                                                                                                                       
| 
| |  | Manufacturing difficulties;                                                                                                                                                                                          
| 
| |  | Customers deferring orders of our existing products due to new
product announcements by us and/or our competitors; and                                                                                               
| 
| |  | Overall business conditions in the semiconductor equipment
industry.                                                                                                                                                 
| 
| |  | Variations in quarterly operating results or changes in analysts
earnings estimates may subject the price of our common stock to wide
fluctuations and possible rapid increases or decreases in a short time
period.

Acquisitions

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



| |  | Difficulties in integrating the operations, technologies, products
and personnel of acquired companies;          
|- |  | -----------------------------------------------------------------------------------------------------------------
| 
| |  | Lack of synergies or the inability to realize expected synergies;                                                
| 
| |  | Revenue and expense levels of acquired entities differing from
those anticipated at the time of the acquisitions;
| 
| |  | Difficulties in managing geographically dispersed operations;                                                    
| 
| |  | The potential loss of key employees, customers and strategic
partners of acquired companies;                     
| 
| |  | Diversion of managements attention from normal daily operations
of the business; and                            

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| |  | The impairment of acquired intangible assets as a result of
technological advancements, or worse-than-expected performance of acquired
companies.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

Intellectual Property

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

We are currently involved in a number of legal disputes regarding patent and
other intellectual property rights. Except as set forth in Part II: Other
Information, Item 1: Legal Proceedings in this document, we are not aware of
any significant claim of infringement by our products of any patent or
proprietary rights of others. Adverse outcomes in current or future legal
disputes could result in the loss of our proprietary rights, subject the
company to significant liabilities to third parties, require us to seek
licenses from third parties, or prevent us from manufacturing or selling our
products. Any of these circumstances could have a material adverse effect on
our business, financial condition or results of operations.

Supply Shortages

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




ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

For quantitative and qualitative disclosures about market risk affecting
Novellus, see Item 7A: Quantitative and Qualitative Disclosures about Market
Risk in our Annual Report on Form 10-K, for the fiscal year ended December 31,
2002. Our exposure related to market risk has not changed materially since
December 31, 2002.




ITEM 4: CONTROLS AND PROCEDURES

Quarterly Evaluation of Our Disclosure Controls and Internal Controls

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

CEO and CFO Certifications

The certifications of the Chief Executive Officer and the Chief Financial
Officer required in accordance with Section 302 of the Sarbanes-Oxley Act of
2002 are filed as exhibits to this Quarterly Report on Form 10-Q. This section
of the Quarterly Report on Form 10-Q is the information concerning the controls
evaluation referred to in the Section 302 certifications and this information
should be read in conjunction with the Section 302 certifications for a more
complete understanding of the topics presented.

Disclosure Controls and Internal Controls for Financial Reporting

Disclosure controls are procedures that are designed with the objective of
ensuring that information required to be disclosed in our reports filed under
the Securities Exchange Act of 1934, or the Exchange Act, such as this
Quarterly Report on Form 10-Q, is recorded, processed, summarized and reported
within the time periods specified in the SECs rules and forms. Disclosure
controls are also designed with the objective of ensuring that such information
is accumulated and communicated to our management, including the Chief
Executive Officer and Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure. Internal controls for financial
reporting are procedures which are designed with the objective of providing
reasonable assurance that our transactions are properly authorized, our assets
are safeguarded against unauthorized or improper use and our transactions are
properly recorded and reported, all to permit the preparation of our financial
statements in conformity with accounting principles generally accepted in the
United States of America.

Limitations on the Effectiveness of Controls

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

Scope of the Controls Evaluation

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

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Among other matters, we sought in our evaluation to determine whether there
were any significant deficiencies or material weaknesses in the companys
internal controls for financial reporting, or whether the company had
identified any acts of fraud involving personnel who have a significant role in
the companys internal controls for financial reporting. This information was
important both for the controls evaluation generally and because items 5 and 6
in the Section 302 certifications of the Chief Executive Officer and the Chief
Financial Officer require that the Chief Executive Officer and the Chief
Financial Officer disclose that information to our Boards Audit Committee and
to our independent auditors and report on related matters in this section of
the Quarterly Report on Form 10-Q. In the professional auditing literature,
significant deficiencies are referred to as reportable conditions. These
are control issues that could have a significant adverse effect on the ability
to record, process, summarize and report financial data in the financial
statements. A material weakness is defined in the auditing literature as a
particularly serious reportable condition where the internal control for
financial reporting does not reduce to a relatively low level the risk that
misstatements caused by error or fraud may occur in amounts that would be
material in relation to the financial statements and not be detected within a
timely period by employees in the normal course of performing their assigned
functions. We also sought to deal with other controls matters in the controls
evaluation, and in each case if a problem was identified, we considered what
revision, improvement and/or correction to make in accordance with our ongoing
procedures. In accordance with SEC requirements, the Chief Executive Officer
and the Chief Financial Officer note that, during our most recent fiscal
quarter, there have been no changes in internal controls for financial
reporting that have actually affected or are reasonably likely to materially
affect our internal controls for financial reporting.

Conclusions

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




PART II: OTHER INFORMATION




ITEM 1: LEGAL PROCEEDINGS

Applied Materials, Inc.

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

On June 23, 1997, we sued Applied in the United States District Court for the
Northern District of California, claiming infringement by Applied of several of
our PVD patents acquired from Varian in the TFS purchase. Applied has filed
counterclaims in this suit, alleging that we infringe Applieds patents.

We seek an injunction against future infringement by Applied, damages for past
infringement, and treble damages for willful infringement.

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

The relief requested by Applied in both suits includes a permanent injunction
against future infringement, damages for alleged past infringement, and treble
damages for alleged willful infringement. Trial is currently set to commence
on January 20, 2004. Applied has recently indicated, however, that it will not
be seeking any relief against Novellus in this trial.

We believe that we have meritorious claims against Applied. We also believe,
should Applied attempt to assert claims against us, we have meritorious
defenses to any such claim, including the defense that our operations and
products (including TFS products and systems) do not infringe the Applied
Patents, and that the Applied Patents are invalid, unenforceable or both. As

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a
result of court rulings adverse to Applied  and in light of certain indemnity
obligations undertaken by Varian, which include reimbursement of certain legal
expenses and a portion of any losses incurred from this litigation  we do not
believe that these potential claims will have a material adverse effect on our
business, financial condition, or results of operations.

Semitool, Inc.

On June 11, 2001, Semitool, Inc. (Semitool) sued Novellus for patent
infringement in the United States District Court for the District of Oregon.
In this lawsuit, Semitool alleges that Novellus infringes one of Semitools
patents related to copper electroplating. Semitool seeks an injunction against
future infringement by Novellus, damages for past infringement, and treble
damages for alleged willful infringement.

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

The Court has issued claim construction orders regarding all of the
patents-in-suit and discovery has closed. The Court has not yet ruled on any
of the motions for summary judgment submitted by Semitool against the Novellus
patents. The case is presently scheduled to proceed to trial in November of
2004. We believe that we have meritorious claims against Semitool and
meritorious defenses to Semitools claims against us, and that this litigation
will not have a material adverse impact on our business, financial condition,
or results of operations. However, the outcome of patent disputes is often
affected by uncertainty in the resolution of complex issues of fact and law.
If Semitool were to prevail against us, the adverse effect on our business,
financial condition, or results of operations could be material.

Plasma Physics Corporation and Solar Physics Corporation

On June 14, 2002, certain of our present and former customers  including
Agilent Technologies, Inc., Micron Technology, Inc., Agere Systems, Inc.,
National Semiconductor Corporation, Koninklijke Philips Electronics N.V., Texas
Instruments, Inc., ST Microelectronics, Inc., LSI Logic Corporation,
International Business Machines Corporation, Conexant Systems, Inc., Motorola,
Inc., Advanced Micro Devices, Inc. and Analog Devices Inc.  were sued for
patent infringement by Plasma Physics Corporation (Plasma Physics) and Solar
Physics Corporation (Solar Physics). We have not been sued by Plasma Physics,
Solar Physics, or any other party for infringement of any Plasma Physics or
Solar Physics patent. Certain defendants in the case, however, contend that we
allegedly have indemnification obligations and liability relating to these
lawsuits. We believe that these matters will not have a material adverse
impact on our business, financial condition, or results of operations. There
can be no assurance, however, that we will prevail in the above lawsuit or in
any other lawsuit filed in connection with the alleged indemnification
obligations. If one or more parties were to prevail against us in such a suit
and damages were awarded, the adverse impact on our business, financial
condition, or results of operations could be material.

Linear Technology Corporation

On March 12, 2002, Linear Technology Corporation (Linear) filed a complaint
against Novellus, among other parties, in the Superior Court of the State of
California for the County of Santa Clara. The complaint seeks damages
(including punitive damages) and injunctions for causes of actions involving
alleged breach of contract, fraud, unfair competition, breach of warranty, and
declaratory relief. We filed a demurrer to Linears complaint, which the court
granted on April 11, 2003, with leave to amend. On May 2, 2003, Linear filed a
second amended complaint. We filed a demurrer to Linears second amended
complaint, which the court granted on August 14, 2003, with leave to amend. On
September 15, 2003, Linear filed a third amended complaint. We filed a
demurrer to Linears third amended complaint, which is scheduled to be heard on
January 15, 2004.

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

Other Litigation

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

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ITEM 5: OTHER INFORMATION

The ratio of earnings to fixed charges for the nine months ended September 27,
2003 and each of the five most recent fiscal years was as follows:

|                   |  |                          |      |      |  |      |       |      |  |      |       |  |  |  |      |  |  |  |      | 
|------------------ |  | ------------------------ | ---- | ---- |  | ---- | ----- | ---- |  | ---- | ----- |  |  |  | ---- |  |  |  | ---- | 
|                   |  | Years ended December 31,
|Nine months ended  |  |                         
|September 27, 2003 |  | 2002                     |      | 2001 |  | 2000 |       | 1999 |  | 1998
|                   |  |                          |      |      |  |      |       |      |  |     
|                  |  |                          | 2.69 |      |  |      | 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 nine months ended September 27, 2003, Novellus incurred a
loss of $78.3 million, net of an income tax benefit of $15.8 million. Fixed
charges for this period were $6.5 million.

25



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##### Table of Contents






ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K

(a)  Exhibits

|     |  |                                                                                                                                                                                                                                                            
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|31.1 |  | Certification of Richard S. Hill, Chairman of the Board of Directors and
Chief Executive Officer of Novellus Systems, Inc. dated
November 11, 2003
in accordance with 18 U.S.C. 1350, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
|     |  |                                                                                                                                                                                                                                                            
|31.2 |  | Certification of Kevin S. Royal, Vice President and Chief Financial Officer of
Novellus Systems, Inc. dated November 11, 2003 in accordance with
18 U.S.C. 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.                     
|     |  |                                                                                                                                                                                                                                                            
|32.1 |  | Certification of Richard S. Hill, Chairman of the Board of Directors and
Chief Executive Officer of Novellus Systems, Inc. dated
November 11, 2003
in accordance with 18 U.S.C. 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
|     |  |                                                                                                                                                                                                                                                            
|32.2 |  | Certification of Kevin S. Royal, Vice President and Chief Financial Officer of
Novellus Systems, Inc. dated November 11, 2003 in accordance with
18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.                     

(b)  Reports on Form 8-K



| |                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| | On July 21, 2003, we furnished a report on Form 8-K under items 7 and 12
announcing our results of operations for the fiscal quarter ended June 28,
2003.

26



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##### Table of Contents






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.

| |  |                                                          
| |  | ---------------------------------------------------------
| |  | By: /s/ Kevin S. Royal                                   
| |  |                                                          
| |  | Kevin S. Royal
Vice President and Chief Financial Officer
| |  | (Principal Financial Officer and Chief                   
| |  | Accounting Officer)                                      
| |  | November 11, 2003                                        

27



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##### Table of Contents






EXHIBIT INDEX

|     |  |                                                                                                                                                                                                                                                            
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|31.1 |  | Certification of Richard S. Hill, Chairman of the Board of Directors and
Chief Executive Officer of Novellus Systems, Inc. dated
November 11, 2003
in accordance with 18 U.S.C. 1350, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
|     |  |                                                                                                                                                                                                                                                            
|31.2 |  | Certification of Kevin S. Royal, Vice President and Chief Financial Officer of
Novellus Systems, Inc. dated November 11, 2003 in accordance with
18 U.S.C. 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.                     
|     |  |                                                                                                                                                                                                                                                            
|32.1 |  | Certification of Richard S. Hill, Chairman of the Board of Directors and
Chief Executive Officer of Novellus Systems, Inc. dated
November 11, 2003
in accordance with 18 U.S.C. 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
|     |  |                                                                                                                                                                                                                                                            
|32.2 |  | Certification of Kevin S. Royal, Vice President and Chief Financial Officer of
Novellus Systems, Inc. dated November 11, 2003 in accordance with
18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.