##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended September 29, 2007
 OR
 o
    
    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 Identificationincorporation or 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)
 þ o
  þ o o
 o þ




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##### 



NOVELLUS SYSTEMS, INC.
FORM 10-Q
QUARTER ENDED SEPTEMBER 29, 2007
 TABLE OF CONTENTS
 PagePart I: Financial InformationItem 1: Condensed Consolidated Financial Statements
    
    
    3Condensed Consolidated Statements of Operations for the three and nine months ended
September 29, 2007 and September 30, 2006
    
    
    3Condensed Consolidated Balance Sheets as of September 29, 2007 and December 31, 2006
    
    
    4Condensed Consolidated Statements of Cash Flows for the nine months ended September 29,
2007 and September 30, 2006
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2: Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15Item 3: Quantitative and Qualitative Disclosures About Market Risk
    
    
    21Item 4: Controls and Procedures
    
    
    21Part II: Other InformationItem 1: Legal Proceedings
    
    
    23Item 1A: Risk Factors
    
    
    23Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    29Item 6: Exhibits
    
    
    30Signatures
    
    
    31EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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##### Table of Contents



PART I: FINANCIAL INFORMATION
 
 ITEM 1: CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 NOVELLUS SYSTEMS, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (Unaudited)
 Three Months Ended
    
    
    Nine Months EndedSeptember 29,
    
    
    September 30,
    
    
    September 29,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006(In thousands, except per share amounts)Net sales
    
    $
    393,277
    
    
    $
    444,032
    
    
    $
    1,206,586
    
    
    $
    1,220,011Cost of sales
    
    
    198,970
    
    
    
    217,507
    
    
    
    609,260
    
    
    
    621,182Gross profit
    
    
    194,307
    
    
    
    226,525
    
    
    
    597,326
    
    
    
    598,829Operating expenses:Selling, general and administrative
    
    
    67,420
    
    
    
    67,664
    
    
    
    206,531
    
    
    
    192,457Research and development
    
    
    61,384
    
    
    
    60,645
    
    
    
    185,158
    
    
    
    187,726Restructuring and other charges
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,629Legal settlement
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,250Total operating expenses
    
    
    128,804
    
    
    
    128,309
    
    
    
    391,689
    
    
    
    396,062Operating income
    
    
    65,503
    
    
    
    98,216
    
    
    
    205,637
    
    
    
    202,767Interest income, net
    
    
    8,617
    
    
    
    6,044
    
    
    
    25,005
    
    
    
    16,244Other income, net
    
    
    316
    
    
    
    3,530
    
    
    
    9,632
    
    
    
    7,020Interest and other income, net
    
    
    8,933
    
    
    
    9,574
    
    
    
    34,637
    
    
    
    23,264Income before provision for income taxes and cumulative
effect of a change in accounting principle
    
    
    74,436
    
    
    
    107,790
    
    
    
    240,274
    
    
    
    226,031Provision for income taxes
    
    
    24,725
    
    
    
    37,770
    
    
    
    79,435
    
    
    
    79,537Income before cumulative effect of a change in
accounting principle
    
    
    49,711
    
    
    
    70,020
    
    
    
    160,839
    
    
    
    146,494Cumulative effect of a change in accounting principle,
net of tax of $594
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    948Net income
    
    $
    49,711
    
    
    $
    70,020
    
    
    $
    160,839
    
    
    $
    147,442Net income per share:Basic:Income before cumulative effect of a change in
accounting principle
    
    $
    0.41
    
    
    $
    0.57
    
    
    $
    1.31
    
    
    $
    1.16Cumulative effect of a change in accounting principle
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.01Basic net income per share
    
    $
    0.41
    
    
    $
    0.57
    
    
    $
    1.31
    
    
    $
    1.17Diluted:Income before cumulative effect of a change in
accounting principle
    
    $
    0.41
    
    
    $
    0.57
    
    
    $
    1.28
    
    
    $
    1.15Cumulative effect of a change in accounting principle
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.01Diluted net income per share
    
    $
    0.41
    
    
    $
    0.57
    
    
    $
    1.28
    
    
    $
    1.16Shares used in basic per share calculations
    
    
    120,414
    
    
    
    122,150
    
    
    
    122,730
    
    
    
    126,125Shares used in diluted per share calculations
    
    
    121,902
    
    
    
    123,357
    
    
    
    125,244
    
    
    
    127,177
  3




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NOVELLUS SYSTEMS, INC.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 September 29,
    
    
    December 31,2007
    
    
    2006 *(unaudited)(In thousands)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    105,651
    
    
    $
    58,463Short-term investments
    
    
    751,811
    
    
    
    794,865Accounts receivable, net
    
    
    362,259
    
    
    
    310,888Inventories
    
    
    231,271
    
    
    
    198,571Deferred tax assets, net
    
    
    69,702
    
    
    
    102,266Assets held for sale
    
    
    34,043
    
    
    
    21,966Prepaid and other current assets
    
    
    19,259
    
    
    
    18,274Total current assets
    
    
    1,573,996
    
    
    
    1,505,293Property and equipment, net
    
    
    333,733
    
    
    
    364,599Restricted cash and cash equivalents
    
    
    151,003
    
    
    
    143,769Goodwill
    
    
    235,753
    
    
    
    225,431Intangible and other assets
    
    
    124,275
    
    
    
    123,400Total assets
    
    $
    2,418,760
    
    
    $
    2,362,492LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    95,515
    
    
    $
    76,406Accrued payroll and related expenses
    
    
    69,638
    
    
    
    81,836Accrued warranty
    
    
    59,337
    
    
    
    55,349Other accrued liabilities
    
    
    62,335
    
    
    
    40,534Income taxes payable
    
    
    27,714
    
    
    
    38,879Deferred profit
    
    
    57,614
    
    
    
    41,351Current obligations under lines of credit
    
    
    7,685
    
    
    
    19,480Total current liabilities
    
    
    379,838
    
    
    
    353,835Long-term debt
    
    
    137,662
    
    
    
    127,862Other non-current liabilities
    
    
    68,411
    
    
    
    46,090Total liabilities
    
    
    585,911
    
    
    
    527,787Commitments and contingenciesShareholders equity:Common stock
    
    
    1,370,752
    
    
    
    1,393,914Retained earnings
    
    
    459,471
    
    
    
    438,196Accumulated other comprehensive income
    
    
    2,626
    
    
    
    2,595Total shareholders equity
    
    
    1,832,849
    
    
    
    1,834,705Total liabilities and shareholders equity
    
    $
    2,418,760
    
    
    $
    2,362,492
 
 *
    
    Amounts are derived from the December 31, 2006 audited consolidated financial statements.  4




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##### Table of Contents



NOVELLUS SYSTEMS, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited)
 Nine Months EndedSeptember 29,
    
    
    September 30,2007
    
    
    2006(In thousands)Cash flows from operating activities:Net income
    
    $
    160,839
    
    
    $
    147,442Adjustments to reconcile net income to net cash provided by operating activities:Loss on disposal of property and equipment
    
    
    50
    
    
    
    1,834Non-cash portion of restructuring and other charges
    
    
    
    
    
    
    10,199Depreciation and amortization
    
    
    50,709
    
    
    
    53,754Deferred income taxes
    
    
    24,479
    
    
    
    1,488Stock-based compensation
    
    
    28,227
    
    
    
    26,257Tax benefit from stock-based compensation
    
    
    3,251
    
    
    
    18,297Excess tax benefit from stock-based compensation
    
    
    (782
    )
    
    
    (11,067
    )Other-than-temporary impairment of short-term investment
    
    
    1,763
    
    
    
    Other non-cash charges, net
    
    
    2,052
    
    
    
    Cumulative effect of a change in accounting principle
    
    
    
    
    
    
    (1,542
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    (48,864
    )
    
    
    (11,484
    )Inventories
    
    
    (28,183
    )
    
    
    (12,772
    )Prepaid and other assets
    
    
    (2,885
    )
    
    
    14,575Accounts payable
    
    
    7,930
    
    
    
    (2,009
    )Accrued payroll and related expenses
    
    
    (8,828
    )
    
    
    18,137Accrued warranty
    
    
    3,781
    
    
    
    2,764Other liabilities
    
    
    19,678
    
    
    
    (2,197
    )Income taxes payable
    
    
    6,859
    
    
    
    4,422Deferred profit
    
    
    15,963
    
    
    
    5,710Net cash provided by operating activities
    
    
    236,039
    
    
    
    263,808Cash flows from investing activities:Proceeds from sales of short-term investments
    
    
    669,945
    
    
    
    384,113Proceeds from maturities of short-term investments
    
    
    176,380
    
    
    
    154,711Purchases of short-term investments
    
    
    (807,424
    )
    
    
    (505,103
    )Capital expenditures
    
    
    (26,949
    )
    
    
    (28,255
    )Proceeds from sale of property and equipment
    
    
    275
    
    
    
    626Increase in restricted cash and cash equivalents
    
    
    (7,234
    )
    
    
    (4,645
    )Other investing activities
    
    
    (339
    )
    
    
    (353
    )Net cash provided by investing activities
    
    
    4,654
    
    
    
    1,094Cash flows from financing activities:Proceeds from employee stock compensation plans
    
    
    33,777
    
    
    
    11,747Proceeds from (repayments of) lines of credit, net
    
    
    (11,964
    )
    
    
    9,207Payments on long-term debt
    
    
    (21
    )
    
    
    (6,955
    )Repurchases of common stock
    
    
    (216,893
    )
    
    
    (249,864
    )Excess tax benefit from stock-based compensation
    
    
    782
    
    
    
    11,067Net cash used in financing activities
    
    
    (194,319
    )
    
    
    (224,798
    )Effects of exchange rate changes on cash and cash equivalents
    
    
    814
    
    
    
    2,992Net increase in cash and cash equivalents
    
    
    47,188
    
    
    
    43,096Cash and cash equivalents at the beginning of the period
    
    
    58,463
    
    
    
    40,403Cash and cash equivalents at the end of the period
    
    $
    105,651
    
    
    $
    83,499
  5




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NOVELLUS SYSTEMS, INC.
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)
 Note 1. Summary of Significant Accounting Policies
 Basis of Presentation
    Derivatives
  Cash Flow Hedges 
 6




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Three Months Ended
    
    
    Nine Months EndedSeptember 29,
    
    
    September 30,
    
    
    September 29,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006(In thousands)Balance, beginning of period  gains (losses)
    
    $
    1,805
    
    
    $
    1,820
    
    
    $
    (329
    )
    
    $
    Effective change of cash flow hedges
    
    
    (4,533
    )
    
    
    184
    
    
    
    (3,641
    )
    
    
    1,955Reclassification to cost of sales
    
    
    
    
    
    
    (958
    )
    
    
    
    
    
    
    (909
    )Reclassification to net sales
    
    
    (433
    )
    
    
    
    
    
    
    809
    
    
    
    Balance, end of period  gains (losses)
    
    $
    (3,161
    )
    
    $
    1,046
    
    
    $
    (3,161
    )
    
    $
    1,046
  Net Investment Hedges 
 Fair Value Hedges 
 Recent Accounting Pronouncements
   7




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##### Table of Contents



Note 2. Net Income Per Share
    Three Months Ended
    
    
    Nine Months EndedSeptember 29,
    
    
    September 30,
    
    
    September 29,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006(In thousands, except per share amounts)Numerator:Net income
    
    $
    49,711
    
    
    $
    70,020
    
    
    $
    160,839
    
    
    $
    147,442Denominator:Basic weighted-average shares outstanding
    
    
    120,414
    
    
    
    122,150
    
    
    
    122,730
    
    
    
    126,125Dilutive potential common shares
    
    
    1,488
    
    
    
    1,207
    
    
    
    2,514
    
    
    
    1,052Diluted weighted-average shares outstanding
    
    
    121,902
    
    
    
    123,357
    
    
    
    125,244
    
    
    
    127,177Basic net income per share
    
    $
    0.41
    
    
    $
    0.57
    
    
    $
    1.31
    
    
    $
    1.17Diluted net income per share
    
    $
    0.41
    
    
    $
    0.57
    
    
    $
    1.28
    
    
    $
    1.16
  Note 3. Inventories
  September 29,
    
    
    December 31,2007
    
    
    2006(In thousands)Purchased and spare parts
    
    $
    160,414
    
    
    $
    152,727Work-in-process
    
    
    52,534
    
    
    
    30,524Finished goods
    
    
    18,323
    
    
    
    15,320Total inventories
    
    $
    231,271
    
    
    $
    198,571
 8




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Note 4. Goodwill and Intangible Assets
 Goodwill
  IndustrialSemiconductor
    
    
    ApplicationsGroup
    
    
    Group
    
    
    Total(In thousands)Balance as of December 31, 2006
    
    $
    109,059
    
    
    $
    116,372
    
    
    $
    225,431Foreign currency translation and other adjustments
    
    
    1,326
    
    
    
    1,819
    
    
    
    3,145Balance as of March 31, 2007
    
    $
    110,385
    
    
    $
    118,191
    
    
    $
    228,576Foreign currency translation
    
    
    
    
    
    
    1,074
    
    
    
    1,074Balance as of June 30, 2007
    
    $
    110,385
    
    
    $
    119,265
    
    
    $
    229,650Foreign currency translation
    
    
    
    
    
    
    6,103
    
    
    
    6,103Balance as of September 29, 2007
    
    $
    110,385
    
    
    $
    125,368
    
    
    $
    235,753
  Intangible Assets
  WeightedAverageAmortization

    
    
    
    
    
    AccumulatedSeptember
29, 2007
    
    Period

    
    Gross
    
    
    Amortization
    
    
    Net(Years)

    
    
    
    
    
    (In thousands)Patents and other intangibles
    
    
    12
    
    
    $
    16,656
    
    
    $
    (1,318
    )
    
    $
    15,338Developed technology
    
    
    6
    
    
    
    29,806
    
    
    
    (20,647
    )
    
    
    9,159Tradename
    
    
    10
    
    
    
    7,178
    
    
    
    (2,333
    )
    
    
    4,845Total
    
    
    8
    
    
    $
    53,640
    
    
    $
    (24,298
    )
    
    $
    29,342
 WeightedAverageAmortization

    
    
    
    
    
    AccumulatedDecember
31, 2006
    
    Period

    
    Gross
    
    
    Amortization
    
    
    Net(Years)

    
    
    
    
    
    (In thousands)Patents and other intangibles
    
    
    11
    
    
    $
    20,707
    
    
    $
    (2,164
    )
    
    $
    18,543Developed technology
    
    
    6
    
    
    
    28,995
    
    
    
    (16,555
    )
    
    
    12,440Tradename
    
    
    10
    
    
    
    6,663
    
    
    
    (1,666
    )
    
    
    4,997Total
    
    
    8
    
    
    $
    56,365
    
    
    $
    (20,385
    )
    
    $
    35,980
  Note 5. Product Warranty
  9




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Three Months Ended
    
    
    Nine Months EndedSeptember 29,
    
    
    September 30,
    
    
    September 29,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006(In thousands)Balance, beginning of period
    
    $
    58,650
    
    
    $
    60,083
    
    
    $
    55,349
    
    
    $
    54,553Warranties issued
    
    
    18,992
    
    
    
    20,488
    
    
    
    61,888
    
    
    
    65,274Settlements
    
    
    (18,199
    )
    
    
    (20,731
    )
    
    
    (57,928
    )
    
    
    (61,726
    )Net changes in liability
for pre-existing
warranties, including
expirations
    
    
    (106
    )
    
    
    (2,320
    )
    
    
    28
    
    
    
    (581
    )Balance, end of period
    
    $
    59,337
    
    
    $
    57,520
    
    
    $
    59,337
    
    
    $
    57,520
 Note 6. Restructuring and Other Charges
      Three Months Ended
    
    
    Nine Months EndedSeptember 29,
    
    
    September 30,
    
    
    September 29,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006(In thousands)Balance, beginning of period
    
    $
    15,700
    
    
    $
    25,880
    
    
    $
    17,503
    
    
    $
    27,239Restructuring charges
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,235Non-cash adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,161Adjustment of prior restructuring costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,856
    )Cash payments
    
    
    (1,248
    )
    
    
    (2,687
    )
    
    
    (3,051
    )
    
    
    (7,586
    )Balance, end of period
    
    $
    14,452
    
    
    $
    23,193
    
    
    $
    14,452
    
    
    $
    23,193
  Note 7. Long-Term Obligations
  10




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Note 8. Other Income, Net
  Three Months Ended
    
    
    Nine Months EndedSeptember 29,
    
    
    September 30,
    
    
    September 29,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006(In thousands)Other income
    
    $
    2,723
    
    
    $
    1,926
    
    
    $
    7,742
    
    
    $
    3,083Other expense
    
    
    (426
    )
    
    
    (292
    )
    
    
    (529
    )
    
    
    (563
    )Other-than-temporary impairment of short-term investment
    
    
    (1,763
    )
    
    
    
    
    
    
    (1,763
    )
    
    
    Foreign currency gain, net
    
    
    (218
    )
    
    
    1,896
    
    
    
    4,182
    
    
    
    4,500Total other income, net
    
    $
    316
    
    
    $
    3,530
    
    
    $
    9,632
    
    
    $
    7,020
 Note 9. Comprehensive Income
  Three Months Ended
    
    
    Nine Months EndedSeptember 29,
    
    
    September 30,
    
    
    September 29,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006(In thousands)Net income
    
    $
    49,711
    
    
    $
    70,020
    
    
    $
    160,839
    
    
    $
    147,442Other comprehensive income:Foreign currency translation adjustments
    
    
    3,568
    
    
    
    2,631
    
    
    
    3,238
    
    
    
    3,599Unrealized gain (loss) on short-term investments
    
    
    783
    
    
    
    120
    
    
    
    (338
    )
    
    
    2,152Unrealized gain (loss) on derivative instruments
    
    
    (4,966
    )
    
    
    769
    
    
    
    (2,832
    )
    
    
    (1,046
    )Unrealized loss on minimum pension liability adjustment
    
    
    (44
    )
    
    
    
    
    
    
    (37
    )
    
    
    Comprehensive income
    
    $
    49,052
    
    
    $
    73,540
    
    
    $
    160,870
    
    
    $
    152,147
  September 29,
    
    
    December 31,2007
    
    
    2006(In thousands)Foreign currency translation adjustments
    
    $
    6,816
    
    
    $
    3,578Unrealized gain (loss) on short-term investments
    
    
    (114
    )
    
    
    224Unrealized loss on derivative instruments
    
    
    (3,161
    )
    
    
    (329
    )Unrealized loss on minimum pension liability adjustment
    
    
    (915
    )
    
    
    (878
    )Accumulated other comprehensive income
    
    $
    2,626
    
    
    $
    2,595
 Note 10. Litigation
 Linear Technology Corporation
  11




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##### Table of Contents



Other Litigation
  Note 11. Stock-Based Compensation
     Three Months Ended
    
    
    Nine Months EndedSeptember 29,
    
    
    September 30,
    
    
    September 29,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006(In thousands)(1)
    
    
    (2)
    
    
    (1)
    
    
    (2)Cost of sales
    
    $
    543
    
    
    $
    400
    
    
    $
    1,619
    
    
    $
    1,246Selling, general and administrative
    
    
    6,674
    
    
    
    5,516
    
    
    
    17,619
    
    
    
    16,545Research and development
    
    
    2,987
    
    
    
    2,741
    
    
    
    8,989
    
    
    
    8,466Stock-based compensation expense before income taxes
    
    
    10,204
    
    
    
    8,657
    
    
    
    28,227
    
    
    
    26,257Income tax benefit
    
    
    (3,449
    )
    
    
    (3,333
    )
    
    
    (7,805
    )
    
    
    (10,109
    )Total stock-based compensation expense after income taxes
    
    $
    6,755
    
    
    $
    5,324
    
    
    $
    20,422
    
    
    $
    16,148
 12




---



##### Table of Contents



(1)
    
    Amounts include amortization expense related to stock options of $5.4 million and $15.3
million, employee stock purchase plan of $0.8 million and $2.2 million, and restricted stock
awards of $4.0 million and $10.7 million for the three and nine months ended September 29,
2007, respectively.(2)
    
    Amounts include amortization expense related to stock options of $6.3 million and $19.2
million, employee stock purchase plan of $0.5 million and $1.7 million, and restricted stock
awards of $1.7 million and $5.2 million for the three and nine months ended September 30,
2006, respectively.  Three Months Ended
    
    Nine Months EndedSeptember 29,
    
    September 30,
    
    September 29,
    
    September 30,Options
    
    2007
    
    2006
    
    2007
    
    2006Risk-free interest rate
    
    
    4.6
    %
    
    
    4.9
    %
    
    
    4.7
    %
    
    
    4.9
    %Volatility
    
    
    48.6
    %
    
    
    49.9
    %
    
    
    47.6
    %
    
    
    49.5
    %Expected term
    
    4.4 years
    
    
    4.3 years
    
    
    4.4 years
    
    
    4.3 yearsDividends
    
    None
    
    
    None
    
    
    None
    
    
    NoneWeighted-average fair value at grant date
    
    $
    13.39
    
    
    $
    11.30
    
    
    $
    13.76
    
    
    $
    11.20
 Three Months Ended
    
    Nine Months EndedSeptember 29,
    
    September 30,
    
    September 29,
    
    September 30,ESPP
    
    2007
    
    2006
    
    2007
    
    2006Risk-free interest rate
    
    
    5.0
    %
    
    
    5.0
    %
    
    
    5.0
    %
    
    
    5.0
    %Volatility
    
    
    31.6
    %
    
    
    32.0
    %
    
    
    32.6
    %
    
    
    32.0
    %Expected term
    
    6 months
    
    
    6 months
    
    
    6 months
    
    
    6 monthsDividends
    
    None
    
    
    None
    
    
    None
    
    
    NoneWeighted-average fair value at grant date
    
    $
    7.98
    
    
    $
    6.07
    
    
    $
    7.51
    
    
    $
    6.07
   Weighted-AverageRemainingNumber of
    
    
    Weighted-Average
    
    
    Contractual
    
    
    AggregateShares
    
    
    Exercise Price
    
    
    Term (in Years)
    
    
    Intrinsic Value(In thousands)
    
    
    
    
    
    
    
    
    
    
    (In thousands)Outstanding as of December 31, 2006
    
    
    22,899
    
    
    $
    32.16
    
    
    
    6.23
    
    
    $
    102,527Grants
    
    
    449
    
    
    
    30.85Exercises
    
    
    (1,081
    )
    
    
    25.31Forfeitures or expirations
    
    
    (1,106
    )
    
    
    34.51Outstanding as of September 29, 2007
    
    
    21,161
    
    
    $
    32.36
    
    
    
    5.58
    
    
    $
    15,306Vested and expected to vest as of September 29, 2007
    
    
    20,465
    
    
    $
    32.45
    
    
    
    5.47
    
    
    $
    14,719Exercisable as of September 29, 2007
    
    
    15,788
    
    
    $
    33.53
    
    
    
    4.60
    
    
    $
    10,390
  13




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##### Table of Contents



Weighted-AverageNumber of
    
    
    Grant DateShares
    
    
    Fair Value(In thousands)Unvested restricted stock awards as of December 31, 2006
    
    
    1,894
    
    
    $
    29.68Granted
    
    
    89
    
    
    
    31.22Vested
    
    
    (57
    )
    
    
    25.60Forfeited
    
    
    (150
    )
    
    
    29.25Unvested restricted stock awards as of September 29, 2007
    
    
    1,776
    
    
    $
    29.94
  Note 12. Operating Segments
    Three Months Ended September 29, 2007
    
    Nine Months Ended September 29, 2007(In thousands)Industrial
    
    
    
    
    
    
    
    
    
    IndustrialSemiconductor
    
    Applications
    
    
    
    
    
    Semiconductor
    
    ApplicationsGroup
    
    Group
    
    Consolidated
    
    Group
    
    Group
    
    ConsolidatedSales to unaffiliated customers
    
    $
    348,625
    
    
    $
    44,652
    
    
    $
    393,277
    
    
    $
    1,093,027
    
    
    $
    113,559
    
    
    $
    1,206,586Operating income
    
    $
    58,855
    
    
    $
    6,648
    
    
    $
    65,503
    
    
    $
    192,139
    
    
    $
    13,498
    
    
    $
    205,637
 14




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##### Table of Contents



Three Months Ended September 30, 2006
    
    Nine Months Ended September 30, 2006(In thousands)Industrial
    
    
    
    
    
    
    
    
    
    IndustrialSemiconductor
    
    Applications
    
    
    
    
    
    Semiconductor
    
    ApplicationsGroup
    
    Group
    
    Consolidated
    
    Group
    
    Group
    
    ConsolidatedSales to unaffiliated customers
    
    $
    418,055
    
    
    $
    25,977
    
    
    $
    444,032
    
    
    $
    1,142,480
    
    
    $
    77,531
    
    
    $
    1,220,011Operating income
    
    $
    96,549
    
    
    $
    1,667
    
    
    $
    98,216
    
    
    $
    197,362
    
    
    $
    5,405
    
    
    $
    202,767September 29, 2007
    
    December 31, 2006(In thousands)Industrial
    
    
    
    
    
    
    
    
    
    IndustrialSemiconductor
    
    Applications
    
    
    
    
    
    Semiconductor
    
    ApplicationsGroup
    
    Group
    
    Consolidated
    
    Group
    
    Group
    
    ConsolidatedTotal assets
    
    $
    2,157,509
    
    
    $
    261,251
    
    
    $
    2,418,760
    
    
    $
    2,152,651
    
    
    $
    209,841
    
    
    $
    2,362,492
 Note 13. Related Party Transactions
    
 ITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 Cautionary Note Regarding Forward-Looking Statements
  15




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##### Table of Contents



Introduction
  
    
    Overview of our Business and Industry;
    
    Financial Performance Overview;
    
    Results of Operations;
    
    Critical Accounting Policies; and
 16




---



##### Table of Contents




    
    Liquidity and Capital Resources.
 Overview of Our Business and Industry
     Quarterly Financial Data2007
    
    2006Third
    
    Second
    
    First
    
    Fourth
    
    Third
    
    Second
    
    FirstQuarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    QuarterNet sales
    
    $
    393,277
    
    
    $
    416,335
    
    
    $
    396,974
    
    
    $
    438,505
    
    
    $
    444,032
    
    
    $
    410,073
    
    
    $
    365,906Gross profit
    
    $
    194,307
    
    
    $
    208,110
    
    
    $
    194,909
    
    
    $
    225,520
    
    
    $
    226,525
    
    
    $
    204,764
    
    
    $
    167,540Income before cumulative effect of a
change in accounting principle
    
    $
    49,711
    
    
    $
    57,345
    
    
    $
    53,783
    
    
    $
    42,574
    
    
    $
    70,020
    
    
    $
    52,705
    
    
    $
    23,769Net income
    
    $
    49,711
    
    
    $
    57,345
    
    
    $
    53,783
    
    
    $
    42,574
    
    
    $
    70,020
    
    
    $
    52,705
    
    
    $
    24,717Diluted net income per share before
cumulative effect of a change in
accounting principle
    
    $
    0.41
    
    
    $
    0.45
    
    
    $
    0.42
    
    
    $
    0.34
    
    
    $
    0.57
    
    
    $
    0.42
    
    
    $
    0.18Diluted net income per share
    
    $
    0.41
    
    
    $
    0.45
    
    
    $
    0.42
    
    
    $
    0.34
    
    
    $
    0.57
    
    
    $
    0.42
    
    
    $
    0.19Shipment revenue
    
    $
    387,817
    
    
    $
    436,382
    
    
    $
    389,052
    
    
    $
    390,151
    
    
    $
    414,213
    
    
    $
    457,320
    
    
    $
    354,160Change in shipment revenue from prior
quarter
    
    
    (11
    )%
    
    
    12
    %
    
    
    (0
    )%
    
    
    (6
    )%
    
    
    (9
    )%
    
    
    29
    %
    
    
    12
    %Net orders
    
    $
    305,329
    
    
    $
    332,201
    
    
    $
    412,219
    
    
    $
    441,620
    
    
    $
    470,322
    
    
    $
    457,545
    
    
    $
    416,770Change in net orders from prior quarter
    
    
    (8
    )%
    
    
    (19
    )%
    
    
    (7
    )%
    
    
    (6
    )%
    
    
    3
    %
    
    
    10
    %
    
    
    19
    %
   17




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##### Table of Contents



Financial Performance Overview
  
    
    Net sales decreased 11.4% to $393.3 million from $444.0 million;
    
    Net income decreased 29.0% to $49.7 million from $70.0 million;
    
    Diluted net income per share decreased to $0.41 from $0.57;
    
    Bookings decreased 35.1% to $305.3 million from $470.3 million; and
    
    Shipments decreased 6.4% to $387.8 million from $414.2 million.
 Results of Operations
 Net Sales
 % Change FromQ3 2007
    
    
    Q2 2007
    
    
    Q3 2006
    
    
    Q2 2007
    
    
    Q3 2006
    
    
    YTD 2007
    
    
    YTD 2006
    
    
    % Change(In thousands)
    
    
    
    
    
    
    
    
    
    
    (In thousands)Semiconductor Group
    
    $
    348,625
    
    
    $
    380,207
    
    
    $
    418,055
    
    
    
    (8
    )%
    
    
    (17
    )%
    
    $
    1,093,027
    
    
    $
    1,142,480
    
    
    
    (4
    )%Industrial Applications Group
    
    
    44,652
    
    
    
    36,128
    
    
    
    25,977
    
    
    
    24
    %
    
    
    72
    %
    
    
    113,559
    
    
    
    77,531
    
    
    
    46
    %Net sales
    
    $
    393,277
    
    
    $
    416,335
    
    
    $
    444,032
    
    
    
    (6
    )%
    
    
    (11
    )%
    
    $
    1,206,586
    
    
    $
    1,220,011
    
    
    
    (1
    )%
    Three Months Ended
    
    Nine Months EndedQ3 2007
    
    Q2 2007
    
    Q3 2006
    
    YTD 2007
    
    YTD 2006North America
    
    
    25
    %
    
    
    29
    %
    
    
    24
    %
    
    
    26
    %
    
    
    28
    %Europe
    
    
    9
    %
    
    
    6
    %
    
    
    9
    %
    
    
    7
    %
    
    
    8
    %Asia
    
    
    66
    %
    
    
    65
    %
    
    
    67
    %
    
    
    67
    %
    
    
    64
    %
  Gross Profit
 % Change FromQ3 2007
    
    Q2 2007
    
    Q3 2006
    
    Q2 2007
    
    Q3 2006
    
    YTD 2007
    
    YTD 2006
    
    % Change(Dollars In thousands)
    
    
    
    
    
    
    
    
    
    (Dollars In thousands)Gross profit
    
    $
    194,307
    
    
    $
    208,110
    
    
    $
    226,525
    
    
    
    (7
    )%
    
    
    (14
    )%
    
    $
    597,326
    
    
    $
    598,829
    
    
    
    (0
    )%Gross margin
    
    
    49
    %
    
    
    50
    %
    
    
    51
    %
    
    
    
    
    
    
    
    
    
    
    50
    %
    
    
    49
    %
 18




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##### Table of Contents



Selling, General and Administrative (SG&A)
 % Change FromQ3 2007
    
    Q2 2007
    
    Q3 2006
    
    Q2 2007
    
    Q3 2006
    
    YTD 2007
    
    YTD 2006
    
    % Change(Dollars In thousands)
    
    
    
    
    
    
    
    
    
    (Dollars In thousands)SG&A expense
    
    $
    67,420
    
    
    $
    72,011
    
    
    $
    67,664
    
    
    
    (6
    )%
    
    
    (0
    )%
    
    $
    206,531
    
    
    $
    192,457
    
    
    
    7
    %% of net sales
    
    
    17
    %
    
    
    17
    %
    
    
    15
    %
    
    
    
    
    
    
    
    
    
    
    17
    %
    
    
    16
    %
   Research and Development (R&D)
 % Change FromQ3 2007
    
    Q2 2007
    
    Q3 2006
    
    Q2 2007
    
    Q3 2006
    
    YTD 2007
    
    YTD 2006
    
    % Change(Dollars In thousands)
    
    
    
    
    
    
    
    
    
    
    
    
    
    (Dollars In thousands)R&D expense
    
    $
    61,384
    
    
    $
    63,374
    
    
    $
    60,645
    
    
    
    (3
    )%
    
    
    1
    %
    
    $
    185,158
    
    
    $
    187,726
    
    
    
    (1
    )%% of net sales
    
    
    16
    %
    
    
    15
    %
    
    
    14
    %
    
    
    
    
    
    
    
    
    
    
    15
    %
    
    
    15
    %
   Interest and Other Income, Net
 % Change FromQ3 2007
    
    Q2 2007
    
    Q3 2006
    
    Q2 2007
    
    Q3 2006
    
    YTD 2007
    
    YTD 2006
    
    % Change(Dollars In thousands)
    
    
    
    
    
    
    
    
    
    
    
    
    
    (Dollars In thousands)Interest and other income, net
    
    $
    8,933
    
    
    $
    14,597
    
    
    $
    9,574
    
    
    
    (39
    )%
    
    
    (7
    )%
    
    $
    34,637
    
    
    $
    23,264
    
    
    
    49
    %% of net sales
    
    
    2
    %
    
    
    4
    %
    
    
    2
    %
    
    
    
    
    
    
    
    
    
    
    3
    %
    
    
    2
    %
  19




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##### Table of Contents



Income Taxes
  Critical Accounting Policies
  Liquidity and Capital Resources
 Cash, Cash Equivalents and Short-Term Investments
 September 29,
    
    
    December 31,2007
    
    
    2006(Dollars In thousands)Cash and cash equivalents
    
    $
    105,651
    
    
    $
    58,463Short-term investments
    
    
    751,811
    
    
    
    794,865Total cash, cash equivalents and short-term investments
    
    $
    857,462
    
    
    $
    853,328
  Cash Flow Summary
 2007 YTD
    
    
    2006 YTD(Dollars In thousands)Net cash provided by (used in):Operating activities
    
    $
    236,039
    
    
    $
    263,808Investing activities
    
    
    4,654
    
    
    
    1,094Financing activities
    
    
    (194,319
    )
    
    
    (224,798
    )Effects of exchange rate changes on cash and cash equivalents
    
    
    814
    
    
    
    2,992Net increase in cash and cash equivalents
    
    $
    47,188
    
    
    $
    43,096
 Operating
  20




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##### Table of Contents



Investing
  Financing
  Liquidity
      
 ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 ITEM 4: CONTROLS AND PROCEDURES
 Quarterly Evaluation of Our Disclosure Controls and Internal Controls
  21




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##### Table of Contents



CEO and CFO Certifications
  Disclosure Controls and Internal Controls for Financial Reporting
  Limitations on the Effectiveness of Controls
  Scope of the Controls Evaluation
  Conclusions
  22




---



##### Table of Contents



PART II: OTHER INFORMATION
 
 ITEM 1: LEGAL PROCEEDINGS
  Linear Technology Corporation
  Other Litigation
  
 ITEM 1A: RISK FACTORS
  Rapid technological change in the semiconductor industry requires substantial research and
development expenditures and responsiveness to customer needs.
  23




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##### Table of Contents



Cyclical downturns in the semiconductor industry negatively impact demand for our equipment.
  The competitive and capital-intensive nature of the semiconductor industry increases the
difficulty of maintaining gross margin and maintaining and capturing market share.
  We are exposed to risks associated with outsourcing activities, which could result in supply
shortages that could affect our ability to meet customer demands.
 24




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##### Table of Contents



The loss of key employees could harm our business and operations.
  We face risks related to concentration of net sales.
  We are exposed to the risks of global operations.
  
    
    Tariffs and other trade barriers;
    
    Challenges in staffing and managing foreign operations and providing prompt and effective
field support to our customers outside of the United States;
    
    Difficulties in managing foreign distributors;
    
    Potential adverse tax consequences, including withholding tax rules that may limit the
repatriation of our earnings, and higher effective income tax rates in foreign countries where
we conduct business;
    
    Governmental controls, either by the United States or other countries, that restrict our
business overseas or the import or export of semiconductor products, or increase the cost of
our operations;
    
    Longer payment cycles and difficulties in collecting accounts receivable outside of the
United States;
    
    Inadequate protection or enforcement of our intellectual property and other legal rights in
foreign jurisdictions;
 
 25




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##### Table of Contents




    
    Global or regional economic downturns; and
    
    Geo-political instability, natural disasters, acts of war or terrorism.
   We face risks related to intellectual property.
    Changes in tax rates or liabilities could negatively impact our future results.
  
    
    Changes in the regulatory environment;
 26




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##### Table of Contents




    
    Changes in accounting and tax standards or practices; and
    
    Overall business conditions in the semiconductor equipment industry.
 We are subject to litigation proceedings that could adversely affect our business.
 Intellectual Property Litigation
  Other Litigation
  We are exposed to risks associated with our diversification strategy.
  We are exposed to risks associated with our investment activities.
  27




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##### Table of Contents



We are exposed to risks related to our indemnification of third parties.
  We face risks associated with acquisitions.
  
    
    Difficulties in integrating the operations, technologies, products and personnel of acquired
companies;
    
    Lack of synergies or the inability to realize expected synergies and cost-savings;
    
    Revenue and expense levels of acquired entities differing from those anticipated at the time
of the acquisitions;
    
    Difficulties in managing geographically dispersed operations;
    
    The potential loss of key employees, customers and strategic partners of acquired companies;
    
    Claims by terminated employees, shareholders of acquired companies or other third parties
related to the transaction;
    
    The issuance of dilutive securities, assumption or incurrence of additional debt obligations
or expenses, or use of substantial portions of our cash;
    
    Diversion of managements attention from normal daily operations of the business; and
    
    The impairment of acquired intangible assets as a result of technological advancements, or
worse-than-expected performance of acquired companies.
  Our quarterly operating results and stock price are unpredictable.
  
    
    Building our systems according to forecast, instead of limited backlog information, which
hinders our ability to plan production and inventory levels;
    
    Unpredictability of demand for and variability of mix of our products in our forecast, which
can cause unexpected positive or negative inventory adjustments in a particular period;
 
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##### Table of Contents




    
    Variability in manufacturing yields;
    
    Failure to receive anticipated orders in time to permit shipment during the quarter;
    
    Timing and cancellation of customer orders and shipments, including deferring orders of our
existing products due to new product announcements by us and/or our competitors;
    
    Changing demand for and sales of lower-margin products relative to higher-margin products;
    
    Competitive pricing pressures;
    
    The effect of revenue recognized upon acceptance with little or no associated costs; and
    
    Fluctuation in warranty costs.
 Compliance with current and future environmental regulations may be costly.
  
 ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 Repurchase of Company Securities
 ApproximateDollar Value ofShares thatTotal
    
    May yet beNumber of
    
    PurchasedShares
    
    Under thePurchased as
    
    Plans orPart of
    
    Programs (notPublicly
    
    including theTotal Number
    
    Average
    
    Announced
    
    October 29,of Shares
    
    Price Paid
    
    Plans or
    
    2007Period
    
    Purchased
    
    Per Share
    
    Programs
    
    Authorization)July 1, 2007 through August 3, 2007
    
    
    1,409,465
    
    
    $
    29.69
    
    
    
    1,409,465
    
    
    $514.8 millionAugust 4, 2007 through September 1, 2007
    
    
    2,641,804
    
    
    $
    26.99
    
    
    
    2,641,804
    
    
    $443.8 millionSeptember 2,
2007 through September 29, 2007
    
    
    2,110,495
    
    
    $
    27.22
    
    
    
    2,110,495
    
    
    $386.4 millionTotal
    
    
    6,161,764
    
    
    $
    27.60
    
    
    
    6,161,764
    
    
    $386.4 million
  29




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##### Table of Contents



ITEM 6: EXHIBITS
  31.1
    
    Certification of Richard S. Hill, Chairman of the Board of
Directors and Chief Executive Officer of Novellus Systems, Inc.
dated November 6, 2007 in accordance with Rules 13a-14(a) and
15d-14(a) of the Securities Exchange Act, as amended, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of William H. Kurtz, Executive Vice President and
Chief Financial Officer of Novellus Systems, Inc. dated November 6,
2007 in accordance with Rules 13a-14(a) and 15d-14(a) of the
Securities Exchange Act, as amended, as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Richard S. Hill, Chairman of the Board of
Directors and Chief Executive Officer of Novellus Systems, Inc.
dated November 6, 2007 in accordance with 18 U.S.C. 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of William H. Kurtz, Executive Vice President and
Chief Financial Officer of Novellus Systems, Inc. dated November 6,
2007 in accordance with 18 U.S.C. 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
 30




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##### Table of Contents



SIGNATURES
  NOVELLUS SYSTEMS, INC.By:
    
    /s/ William H. KurtzWilliam H. Kurtz
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)November 6, 2007
 31




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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 6, 2007 in accordance with Rules 13a-14(a) and
15d-14(a) of the Securities Exchange Act, as amended, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of William H. Kurtz, Executive Vice President and
Chief Financial Officer of Novellus Systems, Inc. dated November 6,
2007 in accordance with Rules 13a-14(a) and 15d-14(a) of the
Securities Exchange Act, as amended, as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Richard S. Hill, Chairman of the Board of
Directors and Chief Executive Officer of Novellus Systems, Inc.
dated November 6, 2007 in accordance with 18 U.S.C. 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of William H. Kurtz, Executive Vice President and
Chief Financial Officer of Novellus Systems, Inc. dated November 6,
2007 in accordance with 18 U.S.C. 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.