##### 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 October 1, 2005
 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(State or other jurisdiction of
incorporation of organization)
    
    77-0024666(I.R.S. Employer Identification
Number)
 4000 North First Street, San Jose, California 95134  (Address of principal executive offices including zip code)
 (408) 943-9700  (Registrants telephone number, including area code)
 YES þ NO o
 YES þ NO o
 YES o NO þ




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NOVELLUS SYSTEMS, INC.
FORM 10-Q
QUARTER ENDED OCTOBER 1, 2005
 TABLE OF CONTENTS
 PagePart I: Financial InformationItem 1: Condensed Consolidated Financial Statements
    
    
    3Condensed Consolidated Statements of Operations for the three and nine months ended October 1, 2005 and September 25, 2004
    
    
    3Condensed Consolidated Balance Sheets as of October 1, 2005 and December 31, 2004
    
    
    4Condensed Consolidated Statements of Cash Flows for the nine months ended October 1, 2005 and September 25, 2004
    
    
    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
    
    
    28Item 4: Controls and Procedures
    
    
    28Part II: Other InformationItem 1: Legal Proceedings
    
    
    29Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    29Item 6: Exhibits
    
    
    30Signatures
    
    
    31EXHIBIT 31.1`EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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PART I: FINANCIAL INFORMATION
 
 ITEM 1: CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
 Three Months Ended
    
    

Nine
Months EndedOctober 1, 2005
    
    
    September 25, 2004
    
    
    October 1, 2005
    
    
    September 25, 2004Net sales
    
    $
    338,878
    
    
    $
    415,935
    
    
    $
    1,008,203
    
    
    $
    1,017,016Cost of sales
    
    
    191,684
    
    
    
    214,824
    
    
    
    549,578
    
    
    
    521,620Gross profit
    
    
    147,194
    
    
    
    201,111
    
    
    
    458,625
    
    
    
    495,396Operating expenses:Selling, general and administrative
    
    
    53,365
    
    
    
    49,585
    
    
    
    155,450
    
    
    
    139,213Research and development
    
    
    61,263
    
    
    
    68,202
    
    
    
    186,823
    
    
    
    190,630Restructuring and other charges (benefits)
    
    
    3,361
    
    
    
    (923
    )
    
    
    3,287
    
    
    
    (923
    )Acquired in-process research and development
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,124Legal settlement
    
    
    3⁄4
    
    
    
    2,900
    
    
    
    3⁄4
    
    
    
    5,400Total operating expenses
    
    
    117,989
    
    
    
    119,764
    
    
    
    345,560
    
    
    
    340,444Operating income
    
    
    29,205
    
    
    
    81,347
    
    
    
    113,065
    
    
    
    154,952Interest income, net
    
    
    4,596
    
    
    
    1,872
    
    
    
    11,943
    
    
    
    6,995Other income (loss), net
    
    
    (2,191
    )
    
    
    7,854
    
    
    
    (2,395
    )
    
    
    8,376Interest and other income, net
    
    
    2,405
    
    
    
    9,726
    
    
    
    9,548
    
    
    
    15,371Income before income taxes
    
    
    31,610
    
    
    
    91,073
    
    
    
    122,613
    
    
    
    170,323Provision for income taxes
    
    
    8,195
    
    
    
    26,411
    
    
    
    35,496
    
    
    
    51,169Net income
    
    $
    23,415
    
    
    $
    64,662
    
    
    $
    87,117
    
    
    $
    119,154Net income per share:Basic net income per share
    
    $
    0.17
    
    
    $
    0.45
    
    
    $
    0.63
    
    
    $
    0.80Diluted net income per share
    
    $
    0.17
    
    
    $
    0.45
    
    
    $
    0.62
    
    
    $
    0.79Shares used in basic per share calculation
    
    
    137,848
    
    
    
    142,333
    
    
    
    138,602
    
    
    
    148,119Shares used in diluted per share calculation
    
    
    138,895
    
    
    
    143,574
    
    
    
    139,646
    
    
    
    150,353
  3




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CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
 October 1,
    
    
    December 31,2005
    
    
    2004 *(unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    38,531
    
    
    $
    106,117Short-term investments
    
    
    692,463
    
    
    
    481,645Accounts receivable, net
    
    
    343,884
    
    
    
    395,522Inventories
    
    
    205,607
    
    
    
    261,046Deferred tax assets, net
    
    
    105,892
    
    
    
    110,644Prepaid and other current assets
    
    
    30,205
    
    
    
    14,350Total current assets
    
    
    1,416,582
    
    
    
    1,369,324Property and equipment, net
    
    
    440,917
    
    
    
    476,492Restricted cash and cash equivalents
    
    
    148,545
    
    
    
    176,708Goodwill
    
    
    265,398
    
    
    
    278,972Intangible and other assets
    
    
    103,509
    
    
    
    100,336Total assets
    
    $
    2,374,951
    
    
    $
    2,401,832LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    59,676
    
    
    $
    70,446Accrued payroll and related expenses
    
    
    57,699
    
    
    
    64,531Accrued warranty
    
    
    49,005
    
    
    
    45,526Other accrued liabilities
    
    
    51,117
    
    
    
    54,517Income taxes payable
    
    
    16,898
    
    
    
    14,691Deferred profit
    
    
    69,869
    
    
    
    71,216Current obligations under lines of credit
    
    
    6,225
    
    
    
    3,103Total current liabilities
    
    
    310,489
    
    
    
    324,030Long term debt
    
    
    125,752
    
    
    
    161,103Other liabilities
    
    
    46,941
    
    
    
    54,865Total liabilities
    
    
    483,182
    
    
    
    539,998Shareholders equity:Common stock
    
    
    1,465,078
    
    
    
    1,473,829Deferred stock compensation
    
    
    (14,390
    )
    
    
    (17,159
    )Retained earnings
    
    
    439,847
    
    
    
    399,919Accumulated other comprehensive income
    
    
    1,234
    
    
    
    5,245Total shareholders equity
    
    
    1,891,769
    
    
    
    1,861,834Total liabilities and shareholders equity
    
    $
    2,374,951
    
    
    $
    2,401,832
 
 *
    
    Amounts as of December 31, 2004 are derived from the December 31, 2004 audited financial
statements.  4




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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 Nine Months EndedOctober 1,
    
    
    September 25,2005
    
    
    2004Cash flows from operating activities:Net income
    
    $
    87,117
    
    
    $
    119,154Adjustments to reconcile net income to net cash provided by operating activities:Gain on sale of an investment
    
    
    3⁄4
    
    
    
    (353
    )Non-cash portion of restructuring charges
    
    
    8,538
    
    
    
    (923
    )Non-cash portion of legal settlement
    
    
    3⁄4
    
    
    
    (8,076
    )Loss on disposal of fixed assets
    
    
    663
    
    
    
    1,188Depreciation and amortization
    
    
    62,772
    
    
    
    64,660Deferred income taxes
    
    
    9,963
    
    
    
    (12,720
    )Stock-based compensation
    
    
    2,700
    
    
    
    2,987Changes in operating assets and liabilities:Accounts receivable
    
    
    38,089
    
    
    
    (186,456
    )Inventories
    
    
    31,328
    
    
    
    (39,636
    )Prepaid and other current assets
    
    
    (4,800
    )
    
    
    (2,237
    )Accounts payable
    
    
    (17,019
    )
    
    
    13,383Accrued payroll and related expenses
    
    
    (6,151
    )
    
    
    37,425Accrued warranty
    
    
    3,812
    
    
    
    14,395Other accrued liabilities
    
    
    (4,407
    )
    
    
    8,401Income taxes payable
    
    
    5,038
    
    
    
    43,997Deferred profit
    
    
    (1,091
    )
    
    
    25,176Net cash provided by operating activities
    
    
    216,552
    
    
    
    80,365Cash flows from investing activities:Proceeds from sales of short-term investments
    
    
    277,839
    
    
    
    574,511Proceeds from maturities of short-term investments
    
    
    125,674
    
    
    
    233,907Purchases of short-term investments
    
    
    (614,906
    )
    
    
    (762,111
    )Capital expenditures
    
    
    (35,691
    )
    
    
    (17,238
    )Proceeds from sale of property and equipment
    
    
    2,676
    
    
    
    Increase in other assets
    
    
    26,469
    
    
    
    (177,596
    )Purchase of Peter Wolters AG, net of cash acquired
    
    
    3⁄4
    
    
    
    (142,916
    )Net cash used in investing activities
    
    
    (217,939
    )
    
    
    (291,443
    )Cash flows from financing activities:Proceeds from employee stock compensation plans
    
    
    26,920
    
    
    
    21,576Proceeds from (payments on) lines of credit, net
    
    
    3,207
    
    
    
    (7,624
    )Payments on long-term debt
    
    
    (19,838
    )
    
    
    153,115Repurchase of common stock
    
    
    (82,791
    )
    
    
    (401,661
    )Net cash used in financing activities
    
    
    (72,502
    )
    
    
    (234,594
    )Effects of exchange rate on cash and cash equivalents
    
    
    6,303
    
    
    
    381Net increase (decrease) in cash and cash equivalents
    
    
    (67,586
    )
    
    
    (445,291
    )Cash and cash equivalents at the beginning of the period
    
    
    106,117
    
    
    
    497,178Cash and cash equivalents at the end of the period
    
    $
    38,531
    
    
    $
    51,887
  5




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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 1. BASIS OF PRESENTATION
 Basis of Presentation
     Allowance for Doubtful Accounts
  Forward Foreign Exchange Contracts
  6




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Stock-Based Compensation
      Three Months Ended
    
    
    Nine Months EndedOctober 1,
    
    
    September 25,
    
    
    October 1,
    
    
    September 25,2005
    
    
    2004
    
    
    2005
    
    
    2004Net income as reported
    
    $
    23,415
    
    
    $
    64,662
    
    
    $
    87,117
    
    
    $
    119,154Add:Intrinsic value method expense
included in reported net
income, net of related tax effects
    
    
    306
    
    
    
    998
    
    
    
    1,890
    
    
    
    2,977Less:Fair value method expense, net of
related tax effects
    
    
    (6,853
    )
    
    
    (11,240
    )
    
    
    (25,592
    )
    
    
    (39,071
    )Pro-forma net income
    
    $
    16,868
    
    
    $
    54,420
    
    
    $
    63,415
    
    
    $
    83,060Pro-forma basic net income per share
    
    $
    0.12
    
    
    $
    0.38
    
    
    $
    0.46
    
    
    $
    0.56Pro-forma diluted net income per share
    
    $
    0.12
    
    
    $
    0.38
    
    
    $
    0.45
    
    
    $
    0.56Basic net income per share
as reported
    
    $
    0.17
    
    
    $
    0.45
    
    
    $
    0.63
    
    
    $
    0.80Diluted net income per share
as reported
    
    $
    0.17
    
    
    $
    0.45
    
    
    $
    0.62
    
    
    $
    0.79
 7




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Three Months Ended
    
    
    Nine Months EndedOctober 1,
    
    
    September 25,
    
    
    October 1,
    
    
    September 25,2005
    
    
    2004
    
    
    2005
    
    
    2004Dividend yield
    
    None
    
    None
    
    None
    
    NoneExpected volatility
    
    
    69%
    
    
    
    74%
    
    
    
    70%
    
    
    
    76%Risk free interest rate
    
    
    3.6%
    
    
    
    2.7%
    
    
    
    3.4%
    
    
    
    2.5%Expected lives
    
    3.7 years
    
    3.7 years
    
    3.7 years
    
    3.5 years
   Three Months Ended
    
    
    Nine Months EndedOctober 1,
    
    
    September 25,
    
    
    October 1,
    
    
    September 25,2005
    
    
    2004
    
    
    2005
    
    
    2004Dividend yield
    
    None
    
    None
    
    None
    
    NoneExpected volatility
    
    
    33%
    
    
    
    45%
    
    
    
    36%
    
    
    
    45%Risk free interest rate
    
    
    2.3%
    
    
    
    1.3%
    
    
    
    2.2%
    
    
    
    1.3%Expected lives
    
    .5 year
    
    .5 year
    
    .5 year
    
    .5 year
  Recent Accounting Pronouncements
    8




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##### Table of Contents



2. NET INCOME PER SHARE
    Three Months Ended
    
    
    Nine Months EndedOctober 1,
    
    
    September 25,
    
    
    October 1,
    
    
    September 25,2005
    
    
    2004
    
    
    2005
    
    
    2004Numerator:Net income
    
    $
    23,415
    
    
    $
    64,662
    
    
    $
    87,117
    
    
    $
    119,154Denominator:Basic weighted-average shares outstanding
    
    
    137,848
    
    
    
    142,333
    
    
    
    138,602
    
    
    
    148,119Employee stock options and restricted stock
    
    
    1,047
    
    
    
    1,241
    
    
    
    1,044
    
    
    
    2,234Diluted weighted-average shares outstanding
    
    
    138,895
    
    
    
    143,574
    
    
    
    139,646
    
    
    
    150,353Basic net income per share
    
    $
    0.17
    
    
    $
    0.45
    
    
    $
    0.63
    
    
    $
    0.80Diluted net income per share
    
    $
    0.17
    
    
    $
    0.45
    
    
    $
    0.62
    
    
    $
    0.79
  3. OTHER INCOME (LOSS), NET
  Three Months Ended
    
    
    Nine Months EndedOctober 1,
    
    
    September 25,
    
    
    October 1,
    
    
    September 25,2005
    
    
    2004
    
    
    2005
    
    
    2004Other income
    
    $
    212
    
    
    $
    146
    
    
    $
    441
    
    
    $
    1,123Other expense
    
    
    (303
    )
    
    
    (103
    )
    
    
    (434
    )
    
    
    (430
    )Litigation proceeds
    
    
    
    
    
    
    8,000
    
    
    
    
    
    
    
    8,000Foreign currency loss, net
    
    
    (2,100
    )
    
    
    (189
    )
    
    
    (2,402
    )
    
    
    (317
    )Total other income (loss), net
    
    $
    (2,191
    )
    
    $
    7,854
    
    
    $
    (2,395
    )
    
    $
    8,376
 9




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4. INVENTORIES
  October 1,
    
    
    December 31,2005
    
    
    2004Purchased and spare parts
    
    $
    161,997
    
    
    $
    192,935Work-in-process
    
    
    26,367
    
    
    
    54,586Finished goods
    
    
    17,243
    
    
    
    13,525Total inventories
    
    $
    205,607
    
    
    $
    261,046
 5. GOODWILL AND INTANGIBLE ASSETS
 Goodwill
  2005IndustrialSemiconductor
    
    
    ApplicationsGroup
    
    
    Group
    
    
    TotalBalance at December 31, 2004
    
    $
    162,230
    
    
    $
    116,742
    
    
    $
    278,972SpeedFam-IPEC adjustment
    
    
    (1,170
    )
    
    
    
    
    
    
    (1,170
    )Foreign currency translation
    
    
    
    
    
    
    (4,093
    )
    
    
    (4,093
    )Balance at April 2, 2005
    
    $
    161,060
    
    
    $
    112,649
    
    
    $
    273,709SpeedFam-IPEC adjustment
    
    
    (1,170
    )
    
    
    3⁄4
    
    
    
    (1,170
    )Foreign currency translation
    
    
    3⁄4
    
    
    
    (7,455
    )
    
    
    (7,455
    )Balance at July 2, 2005
    
    $
    159,890
    
    
    $
    105,194
    
    
    $
    265,084SpeedFam-IPEC adjustment
    
    
    (1,170
    )
    
    
    
    
    
    
    (1,170
    )Peter Wolters adjustment
    
    
    
    
    
    
    1,946
    
    
    
    1,946Foreign currency translation
    
    
    
    
    
    
    (462
    )
    
    
    (462
    )Balance at October 1, 2005
    
    $
    158,720
    
    
    $
    106,678
    
    
    $
    265,398
 2004IndustrialSemiconductor
    
    
    ApplicationsGroup
    
    
    Group
    
    
    TotalBalance at June 26, 2004
    
    $
    173,267
    
    
    $
    3⁄4
    
    
    $
    173,267SpeedFam-IPEC adjustment
    
    
    (799
    )
    
    
    
    
    
    
    (799
    )Peter Wolters acquisition
    
    
    3⁄4
    
    
    
    104,221
    
    
    
    104,221Foreign currency translation
    
    
    3⁄4
    
    
    
    1,233
    
    
    
    1,233Balance at September 25, 2004
    
    $
    172,468
    
    
    $
    105,454
    
    
    $
    277,922
   10




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Intangible Assets
  AccumulatedOctober 1, 2005
    
    Gross
    
    
    Amortization
    
    
    NetPatents
    
    $
    4,197
    
    
    $
    (1,049
    )
    
    $
    3,148Developed technology
    
    
    28,122
    
    
    
    (10,285
    )
    
    
    17,837Trademark
    
    
    6,108
    
    
    
    (764
    )
    
    
    5,344Other intangible assets
    
    
    138
    
    
    
    (87
    )
    
    
    51Total
    
    $
    38,565
    
    
    $
    (12,185
    )
    
    $
    26,380
 AccumulatedDecember 31, 2004
    
    Gross
    
    
    Amortization
    
    
    NetPatents
    
    $
    4,197
    
    
    $
    (525
    )
    
    $
    3,672Developed technology
    
    
    28,095
    
    
    
    (6,928
    )
    
    
    21,167Trademark
    
    
    6,809
    
    
    
    (340
    )
    
    
    6,469Other intangible assets
    
    
    138
    
    
    
    (81
    )
    
    
    57Total
    
    $
    39,239
    
    
    $
    (7,874
    )
    
    $
    31,365
  6. PRODUCT WARRANTY
  Three Months Ended
    
    
    Nine Months EndedOctober 1,
    
    
    September 25,
    
    
    October 1,
    
    
    September 25,2005
    
    
    2004
    
    
    2005
    
    
    2004Balance, beginning of period
    
    $
    50,493
    
    
    $
    38,264
    
    
    $
    45,526
    
    
    $
    28,805Peter Wolters balance at acquisition
    
    
    
    
    
    
    2,367
    
    
    
    
    
    
    
    2,367Warranties issued
    
    
    15,059
    
    
    
    22,589
    
    
    
    57,609
    
    
    
    59,926Settlements
    
    
    (22,729
    )
    
    
    (19,305
    )
    
    
    (63,032
    )
    
    
    (49,243
    )Changes in liability for pre-existing warranties,
including expirations
    
    
    6,182
    
    
    
    1,064
    
    
    
    8,902
    
    
    
    3,124Balance, end of period
    
    $
    49,005
    
    
    $
    44,979
    
    
    $
    49,005
    
    
    $
    44,979
 7. RESTRUCTURING AND OTHER CHARGES
  11




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##### Table of Contents



Inventory
 Acquisition
    
    
    
    
    
    InventoryFacilities
    
    
    Asset Charges
    
    
    Severance
    
    
    Expense
    
    
    Total
    
    
    Write-DownBalance at December 31, 2004
    
    $
    41,681
    
    
    $
    163
    
    
    $
    160
    
    
    $
    198
    
    
    $
    42,202
    
    
    $
    3⁄4Cash payments
    
    
    (2,209
    )
    
    
    (52
    )
    
    
    (62
    )
    
    
    
    
    
    
    (2,323
    )
    
    
    3⁄4Balance at April 2, 2005
    
    
    39,472
    
    
    
    111
    
    
    
    98
    
    
    
    198
    
    
    
    39,879
    
    
    
    3⁄4Cash payments
    
    
    (1,806
    )
    
    
    (93
    )
    
    
    
    
    
    
    
    
    
    
    (1,899
    )
    
    
    3⁄4Adjustment
    
    
    3⁄4
    
    
    
    3⁄4
    
    
    
    (74
    )
    
    
    3⁄4
    
    
    
    (74
    )
    
    
    3⁄4Balance at July 2, 2005
    
    
    37,666
    
    
    
    18
    
    
    
    24
    
    
    
    198
    
    
    
    37,906
    
    
    
    3⁄4Cash payments
    
    
    (2,217
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,217
    )
    
    
    3⁄4Restructuring charges
    
    
    1,557
    
    
    
    4,529
    
    
    
    231
    
    
    
    
    
    
    
    6,317
    
    
    
    5,250Non-cash adjustment
    
    
    (4,513
    )
    
    
    (4,529
    )
    
    
    
    
    
    
    
    
    
    
    (9,042
    )
    
    
    (5,250
    )Balance at October 1, 2005
    
    $
    32,493
    
    
    $
    18
    
    
    $
    255
    
    
    $
    198
    
    
    $
    32,964
    
    
    $
    3⁄4
 8. LONG-TERM OBLIGATIONS
  9. COMPREHENSIVE INCOME
  Three Months Ended
    
    
    Nine Months EndedOctober 1,
    
    
    September 25,
    
    
    October 1,
    
    
    September 25,2005
    
    
    2004
    
    
    2005
    
    
    2004Net income
    
    $
    23,415
    
    
    $
    64,662
    
    
    $
    87,117
    
    
    $
    119,154Other comprehensive income:Foreign currency translation adjustments, net of tax
    
    
    (1,657
    )
    
    
    (947
    )
    
    
    (5,695
    )
    
    
    (1,370
    )Unrealized change in derivative instruments
    
    
    (2,699
    )
    
    
    
    
    
    
    2,259
    
    
    
    Realized gain on available-for-sale securities, net of tax
    
    
    
    
    
    
    (12
    )
    
    
    
    
    
    
    (353
    )Unrealized gain (loss) on available-for-sale securities,
net of tax
    
    
    (24
    )
    
    
    1,043
    
    
    
    (575
    )
    
    
    182Comprehensive income
    
    $
    19,035
    
    
    $
    64,746
    
    
    $
    83,106
    
    
    $
    117,613
 12




---



##### Table of Contents



October 1,
    
    
    December 31,2005
    
    
    2004Foreign currency translation adjustments
    
    $
    537
    
    
    $
    6,232Unrealized change in derivative instruments
    
    
    2,259
    
    
    
    Unrealized loss on available-for-sale securities
    
    
    (1,562
    )
    
    
    (987
    )Accumulated other comprehensive income
    
    $
    1,234
    
    
    $
    5,245
 10. PENSION PLAN
  11. RELATED PARTY TRANSACTIONS
     12. LITIGATION
 Linear Technology Corporation
  13




---



##### Table of Contents



Other Litigation
  13. OPERATING SEGMENTS
   Three months ended October 1, 2005
    
    
    Nine months ended October 1, 2005(in thousands)
    
    
    (in thousands)Industrial
    
    
    
    
    
    
    
    
    
    
    IndustrialSemiconductor
    
    
    Applications
    
    
    
    
    
    
    Semiconductor
    
    
    ApplicationsGroup
    
    
    Group
    
    
    Consolidated
    
    
    Group
    
    
    Group
    
    
    ConsolidatedSales to unaffiliated customers
    
    $
    313,389
    
    
    $
    25,489
    
    
    $
    338,878
    
    
    $
    923,911
    
    
    $
    84,292
    
    
    $
    1,008,203Operating income
    
    $
    26,763
    
    
    $
    2,442
    
    
    $
    29,205
    
    
    $
    100,357
    
    
    $
    12,708
    
    
    $
    113,065Long-lived assets
    
    $
    424,031
    
    
    $
    16,886
    
    
    $
    440,917
    
    
    $
    424,031
    
    
    $
    16,886
    
    
    $
    440,917All other identifiable assets
    
    
    1,764,418
    
    
    
    169,616
    
    
    
    1,934,034
    
    
    
    1,764,418
    
    
    
    169,616
    
    
    
    1,934,034Total assets
    
    $
    2,188,449
    
    
    $
    186,502
    
    
    $
    2,374,951
    
    
    $
    2,188,449
    
    
    $
    186,502
    
    
    $
    2,374,951
 Three months ended September 25, 2004
    
    
    Nine months ended September 25, 2004(in thousands)
    
    
    (in thousands)Industrial
    
    
    
    
    
    
    
    
    
    
    IndustrialSemiconductor
    
    
    Applications
    
    
    
    
    
    
    Semiconductor
    
    
    ApplicationsGroup
    
    
    Group
    
    
    Consolidated
    
    
    Group
    
    
    Group
    
    
    ConsolidatedSales to unaffiliated customers
    
    $
    394,219
    
    
    $
    21,716
    
    
    $
    415,935
    
    
    $
    987,088
    
    
    $
    29,928
    
    
    $
    1,017,016Operating income (loss)
    
    $
    83,183
    
    
    $
    (1,836
    )
    
    $
    81,347
    
    
    $
    155,737
    
    
    $
    (785
    )
    
    $
    154,952Long-lived assets
    
    $
    464,888
    
    
    $
    21,341
    
    
    $
    486,229
    
    
    $
    464,888
    
    
    $
    21,341
    
    
    $
    486,229All other identifiable assets
    
    
    1,714,996
    
    
    
    197,208
    
    
    
    1,912,204
    
    
    
    1,714,996
    
    
    
    197,208
    
    
    
    1,912,204Total assets
    
    $
    2,179,884
    
    
    $
    218,549
    
    
    $
    2,398,433
    
    
    $
    2,179,884
    
    
    $
    218,549
    
    
    $
    2,398,433
 14. SUBSEQUENT EVENT
  14




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##### Table of Contents



ITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
    15




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##### Table of Contents



Introduction
  
    
    Overview of our Business and Industry;
    
    Results of Operations;
    
    Critical Accounting Policies;
    
    Liquidity and Capital Resources;
    
    Related Party Transactions; and
    
    Risk Factors.
 Overview of Our Business and Industry
     Quarterly Financial Data2005
    
    
    2004First
    
    
    Second
    
    
    Third
    
    
    First
    
    
    Second
    
    
    Third
    
    
    FourthQuarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    QuarterNet sales
    
    $
    339,740
    
    
    $
    329,585
    
    
    $
    338,878
    
    
    $
    262,862
    
    
    $
    338,219
    
    
    $
    415,935
    
    
    $
    340,272Gross profit
    
    
    153,869
    
    
    
    157,562
    
    
    
    147,194
    
    
    
    124,605
    
    
    
    169,680
    
    
    
    201,111
    
    
    
    169,734Net income
    
    
    30,471
    
    
    
    33,231
    
    
    
    23,415
    
    
    
    16,681
    
    
    
    37,811
    
    
    
    64,662
    
    
    
    37,536Diluted net income per share
    
    
    0.22
    
    
    
    0.24
    
    
    
    0.17
    
    
    
    0.11
    
    
    
    0.25
    
    
    
    0.45
    
    
    
    0.27Net orders
    
    
    301,594
    
    
    
    309,214
    
    
    
    286,929
    
    
    
    346,793
    
    
    
    397,598
    
    
    
    422,692
    
    
    
    331,347
  16




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##### Table of Contents



Results of Operations
  Net Sales
 Three Months Ended
    
    
    Nine Months EndedOctober 1, 2005
    
    
    September 25, 2004
    
    
    July 2, 2005
    
    
    October 1, 2005
    
    
    September 25, 2004Net sales
    
    $
    338,878
    
    
    $
    415,935
    
    
    $
    329,585
    
    
    $
    1,008,203
    
    
    $
    1,017,016International net sales %
    
    
    75
    %
    
    
    78
    %
    
    
    76
    %
    
    
    74
    %
    
    
    78
    %
   Three Months Ended
    
    
    Nine Months EndedOctober 1, 2005
    
    
    September 25, 2004
    
    
    July 2, 2005
    
    
    October 1, 2005
    
    
    September 25, 2004North America
    
    
    25%
    
    
    
    22%
    
    
    
    24%
    
    
    
    26%
    
    
    
    22%Europe
    
    
    13%
    
    
    
    11%
    
    
    
    8%
    
    
    
    10%
    
    
    
    9%Asia
    
    
    62%
    
    
    
    67%
    
    
    
    68%
    
    
    
    64%
    
    
    
    69%
  Gross Profit
 Three Months Ended
    
    
    Nine Months EndedOctober 1, 2005
    
    
    September 25, 2004
    
    
    July 2, 2005
    
    
    October 1, 2005
    
    
    September 25, 2004Gross profit
    
    $
    147,194
    
    
    $
    201,111
    
    
    $
    157,562
    
    
    $
    458,625
    
    
    $
    495,396% of net sales
    
    
    43
    %
    
    
    48
    %
    
    
    48
    %
    
    
    45
    %
    
    
    49
    %
  17




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##### Table of Contents



Selling, General and Administrative (SG&A)
 Three Months Ended
    
    
    Nine Months EndedOctober 1, 2005
    
    
    September 25, 2004
    
    
    July 2, 2005
        

    October 1, 2005
    
    
    September 25, 2004SG&A expense
    
    $
    53,365
    
    
    $
    49,585
    
    
    $
    50,325
    
    
    $
    155,450
    
    
    $
    139,213% of net sales
    
    
    16
    %
    
    
    12
    %
    
    
    15
    %
    
    
    15
    %
    
    
    14
    %
   Research and Development (R&D)
 Three Months Ended
    
    

    Nine Months EndedOctober 1, 2005
    

    September 25, 2004
    
    
    July 2, 2005
    
    
    October 1, 2005
    
    
    September 25, 2004R&D expense
    $61,263
    
    $68,202
    
    
    $63,512
    
    
    $186,823
    
    
    $190,630% of net sales
    18
    %
    16
    %
    
    19
    %
    
    19
    %
    
    19
    %  18




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##### Table of Contents



Restructuring and Other Charges
 Three Months Ended
    
    
    Nine Months EndedOctober 1, 2005
    
    
    September 25, 2004
    
    
    July 2, 2005
    
    
    October 1, 2005
    
    
    September 25, 2004Restructuring and other charges
    
    $
    3,361
    
    
    $
    (923
    )
    
    $
    (74
    )
    
    $
    3,287
    
    
    $
    (923
    )% of net sales
    
    
    1
    %
    
    Less than 1
    %
    Less than 1
    %
    Less than 1
    %
    Less than 1
    %
  Legal Settlement
 Three Months Ended
    
    
    Nine Months EndedOctober 1, 2005
    
    
    September 25, 2004
    
    
    July 2, 2005
    
    
    October 1, 2005
    
    
    September 25, 2004Legal settlement
    
    $
    
    
    
    $
    2,900
    
    
    $
    
    
    
    $
    
    
    
    $
    5,400% of net sales
    
    
    
    %
    
    
    1
    %
    
    
    
    %
    
    
    
    %
    
    
    1
    %
  Acquired in-process research and development
 Three Months Ended
    
    
    Nine Months EndedOctober 1, 2005
    
    
    September 25, 2004
    
    
    July 2, 2005
    
    
    October 1, 2005
    
    
    September 25, 2004Acquired in-process research
and development
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    6,124% of net sales
    
    
    
    %
    
    
    
    %
    
    
    
    %
    
    
    
    %
    
    
    1
    %
  Interest and Other Income, Net
 Three Months Ended
    
    
    Nine Months EndedOctober 1, 2005
    
    
    September 25, 2004
    
    
    July 2, 2005
    
    
    October 1, 2005
    
    
    September 25, 2004Interest and other income, net
    
    $
    2,405
    
    
    $
    9,726
    
    
    $
    3,674
    
    
    $
    9,548
    
    
    $
    15,371% of net sales
    
    
    1
    %
    
    
    2
    %
    
    
    1
    %
    
    
    1
    %
    
    
    2
    %
  Income Taxes
  19




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##### Table of Contents



Critical Accounting Policies
  Revenue Recognition
     Inventory Valuation
  Goodwill and Other Intangible Assets
  20




---



##### Table of Contents



Deferred Tax Assets
  Warranty Obligations
  Restructuring and Impairment Charges
    Foreign Currency Accounting
  Foreign Exchange Contracts
  21




---



##### Table of Contents



Liquidity and Capital Resources
        Risk Factors
  Cyclical Downturns in the Semiconductor Industry
  22




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##### Table of Contents



The Semiconductor Industry is Extremely Competitive and Capital-Intensive
  Rapidly Changing Technology
    23




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##### Table of Contents



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;
    
    Potentially adverse tax consequences, including withholding tax rules that may limit the repatriation of our
earnings, and variations in effective income tax rates among countries where we conduct business;
    
    Governmental controls, either by the United States or other countries, that restrict or make costly the operation
of our business overseas and the import or export of semiconductor products;
    
    Longer payment cycles and difficulties in collecting accounts receivables outside of the United States;
    
    Inadequate protection or enforcement of our intellectual property and other legal rights in foreign jurisdictions;
    
    Global or regional economic downturns;
    
    Geo-political instability, natural disasters, acts of war or terrorism; 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. Exchange rate volatility may also increase the cost of our exported products for
international customers and inhibit demand.
  Variability of Quarterly Operating Results
  
    
    Building our systems according to forecast, instead of limited backlog information,
which hinders our ability to plan production and inventory levels;
    
    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;
 24




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##### Table of Contents




    
    Competitive pricing pressures;
    
    Fluctuation in warranty costs; and
    
    Overall business conditions in the semiconductor equipment industry.
 Changes in Tax Rates or Liabilities Could Affect Future Results
  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.
  Diversification Strategy
  25




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##### Table of Contents



Concentration of Net Sales
  Intellectual Property
    Supply Shortages
  Outsourcing Activities
  Outside Audit Firm Independence
  26




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##### Table of Contents



Costs of Corporate Governance and Financial Reporting Compliance
  Third-Party Indemnification
  Changes in Accounting Standards for Stock Option Plans
  Investment Activities
  27




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##### Table of Contents



ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 ITEM 4: CONTROLS AND PROCEDURES
 Quarterly Evaluation of Our Disclosure Controls and Internal Controls
  CEO and CFO Certifications
  Disclosure Controls and Internal Controls for Financial Reporting
  Limitations on the Effectiveness of Controls
  28




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##### Table of Contents



Scope of the Controls Evaluation
  Conclusions
  
 PART II: OTHER INFORMATION
 
 ITEM 1: LEGAL PROCEEDINGS
  Linear Technology Corporation
  Other Litigation
  
 ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 Repurchase of Company Securities
 TotalNumber of
    
    
    ApproximateShares
    
    
    Dollar ValuePurchased
    
    
    of Sharesas Part of
    
    
    that May YetTotal
    
    
    
    
    
    
    Publicly
    
    
    Be PurchasedNumber of
    
    
    Average Price
    
    
    Announced
    
    
    Under theShares
    
    
    Paid per
    
    
    Plans or
    
    
    Plans orPeriod
    
    Purchased
    
    
    Share
    
    
    Programs
    
    
    ProgramsJuly 3, 2005 to August 6, 2005
    
    
    
    
    
    
    
    
    
    
    
    
    
    $1,020.1  millionAugust 7, 2005 to September 3, 2005
    
    
    
    
    
    
    
    
    
    
    
    
    
    $1,020.1  millionSeptember 4, 2005 to October 1, 2005
    
    
    500,000
    
    
    $
    26.24
    
    
    
    500,000
    
    
    $1,007.0  millionTotal
    
    
    500,000
    
    
    $
    26.24
    
    
    
    500,000
    
    
    $1,007.0  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
4, 2005 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 4, 2005 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
4, 2005 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 4, 2005 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. KurtzExecutive Vice President and Chief
Financial Officer
(Principal Financial Officer and Chief Accounting Officer)November 4, 2005 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
4, 2005 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 4,
2005 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
4, 2005 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 4,
2005 in accordance with 18 U.S.C. 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.