##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-Q

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

For the quarterly period ended June 28, 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 incorporation of organization) |  | (I.R.S. Employer Identification Number)

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

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

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

YES  (X)    NO  (  )

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 August 11, 2003, 151,392,498 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 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|                              | ITEM 5: OTHER INFORMATION                                                                    
|                              | ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURES                   
|EXHIBIT INDEX                
|EXHIBIT 3.1                  
|EXHIBIT 10.40                
|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 JUNE 28, 2003

TABLE OF CONTENTS

|                              |                                                                                               |                                                                                                                    |    |      |   | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------ | -- | ---- | - | 
|                              |                                                                                               |                                                                                                                    |    | Page
|                              |                                                                                               |                                                                                                                    |    |     
|Part I: Financial Information |                                                                                               |                                                                                                                    |    |     
|                              | Item 1: Condensed Consolidated Financial Statements                                           |                                                                                                                    |    |      |  
|                              |                                                                                               | Condensed Consolidated Statements of Operations for the
three and six months ended June 28, 2003 and June 29, 2002 |    |      | 3 | 
|                              |                                                                                               | Condensed Consolidated Balance Sheets as of June 28, 2003
and December 31, 2002                                    |    |      | 4 | 
|                              |                                                                                               | Condensed Consolidated Statements of Cash Flows for the
six months ended June 28, 2003 and June 29, 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                            |                                                                                                                    |    | 22   |  
|                              | Item 4: Controls and Procedures                                                               |                                                                                                                    |    | 22   |  
|Part II: Other Information    |                                                                                               |                                                                                                                    |    |     
|                              | Item 1: Legal Proceedings                                                                     |                                                                                                                    |    | 23   |  
|                              | Item 4: Submission of Matters to a Vote of Security Holders                                   |                                                                                                                    |    | 25   |  
|                              | Item 5: Other Information                                                                     |                                                                                                                    |    | 26   |  
|                              | Item 6: Exhibits and Reports on Form 8-K                                                      |                                                                                                                    |    | 27   |  
|Signatures                    |                                                                                               |                                                                                                                    | 28 |     

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
(in thousands, except per share amounts)
(unaudited)

|                                             |                                     |                                        |         |                    |      |                  |         |          |      |          |         |         |      |   |         |         |      | 
|-------------------------------------------- | ----------------------------------- | -------------------------------------- | ------- | ------------------ | ---- | ---------------- | ------- | -------- | ---- | -------- | ------- | ------- | ---- | - | ------- | ------- | ---- | 
|                                             |                                     |                                        |         | Three Months Ended |      | Six Months Ended
|                                             |                                     |                                        |         |                    |      |                 
|                                             |                                     |                                        |         | June 28,           |      | June 29,         |         | June 28, |      | June 29,
|                                             |                                     |                                        |         | 2003               |      | 2002             |         | 2003     |      | 2002    
|                                             |                                     |                                        |         |                    |      |                  |         |          |      |         
|Net sales                                    |                                     | $                                      | 239,050 |                    |      | $                | 222,147 |          |      | $        | 477,460 |         |      | $ | 391,826 |        
|Cost of sales                                |                                     |                                        | 133,728 |                    |      |                  | 120,583 |          |      |          | 262,324 |         |      |   | 218,732 |        
|                                             |                                     |                                        |         |                    |      |                  |         |          |      |          |         |         |      |   |         |        
|Gross profit                                 |                                     |                                        | 105,322 |                    |      |                  | 101,564 |          |      |          | 215,136 |         |      |   | 173,094 |        
|Operating expenses:                          |                                     |                                        |         |                    |      |                  |         |          |      |          |         |         |      |   |         |        
|                                             | Selling, general and administrative |                                        |         | 44,444             |      |                  |         | 39,478   |      |          |         | 87,075  |      |   |         | 74,164  |     
|                                             | Research and development            |                                        |         | 56,509             |      |                  |         | 58,727   |      |          |         | 113,515 |      |   |         | 112,773 |     
|                                             | Special charges                     |                                        |         |                   |      |                  |         |         |      |          |         |        |      |   |         | 3,273   |     
|                                             | Bad debt recovery                   |                                        |         |                   |      |                  |         |         |      |          |         |        |      |   |         | (7,662  | )   
|                                             |                                     |                                        |         |                    |      |                  |         |          |      |          |         |         |      |   |         |        
|Total operating expenses                     |                                     |                                        | 100,953 |                    |      |                  | 98,205  |          |      |          | 200,590 |         |      |   | 182,548 |        
|                                             |                                     |                                        |         |                    |      |                  |         |          |      |          |         |         |      |   |         |        
|Operating income (loss)                      |                                     |                                        | 4,369   |                    |      |                  | 3,359   |          |      |          | 14,546  |         |      |   | (9,454  | )      
|Interest and other income, net               |                                     |                                        | 5,537   |                    |      |                  | 11,847  |          |      |          | 11,189  |         |      |   | 29,516  |        
|                                             |                                     |                                        |         |                    |      |                  |         |          |      |          |         |         |      |   |         |        
|Income before income taxes                   |                                     |                                        | 9,906   |                    |      |                  | 15,206  |          |      |          | 25,735  |         |      |   | 20,062  |        
|Provision for income taxes                   |                                     |                                        | 2,476   |                    |      |                  | 3,193   |          |      |          | 6,433   |         |      |   | 4,213   |        
|                                             |                                     |                                        |         |                    |      |                  |         |          |      |          |         |         |      |   |         |        
|Net income                                   |                                     | $                                      | 7,430   |                    |      | $                | 12,013  |          |      | $        | 19,302  |         |      | $ | 15,849  |        
|                                             |                                     |                                        |         |                    |      |                  |         |          |      |          |         |         |      |   |         |        
|Net income per share:                        |                                     |                                        |         |                    |      |                  |         |          |      |          |         |         |      |   |         |        
|                                             |                                     | Basic and diluted net income per share |         | $                  | 0.05 |                  |         | $        | 0.08 |          |         | $       | 0.13 |   |         | $       | 0.11 | 
|                                             |                                     |                                        |         |                    |      |                  |         |          |      |          |         |         |      |   |         |        
|Shares used in basic per share calculation   |                                     |                                        | 149,950 |                    |      |                  | 145,120 |          |      |          | 149,692 |         |      |   | 144,687 |        
|                                             |                                     |                                        |         |                    |      |                  |         |          |      |          |         |         |      |   |         |        
|Shares used in diluted per share calculation |                                     |                                        | 153,034 |                    |      |                  | 151,053 |          |      |          | 152,631 |         |      |   | 150,838 |        
|                                             |                                     |                                        |         |                    |      |                  |         |          |      |          |         |         |      |   |         |        

See accompanying notes to condensed consolidated financial statements.

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

|                                     |                                             |                                            |         |             |           |              |         |           |           | 
|------------------------------------ | ------------------------------------------- | ------------------------------------------ | ------- | ----------- | --------- | ------------ | ------- | --------- | --------- | 
|                                     |                                             |                                            |         | June 28,    |           | December 31,
|                                     |                                             |                                            |         | 2003        |           | 2002 *      
|                                     |                                             |                                            |         |             |           |             
|                                     |                                             |                                            |         | (unaudited) |           |              |         |          
|ASSETS                               |                                             |                                            |         |             |           |              |         |          
|Current assets:                      |                                             |                                            |         |             |           |              |         |          
|                                     | Cash and cash equivalents                   |                                            | $       | 529,833     |           |              | $       | 615,844   |          
|                                     | Short-term investments                      |                                            |         | 420,864     |           |              |         | 403,808   |          
|                                     | Accounts receivable, net                    |                                            |         | 213,215     |           |              |         | 192,862   |          
|                                     | Inventories                                 |                                            |         | 244,709     |           |              |         | 257,358   |          
|                                     | Deferred tax assets, net                    |                                            |         | 119,310     |           |              |         | 119,699   |          
|                                     | Prepaid and other current assets            |                                            |         | 31,071      |           |              |         | 44,363    |          
|                                     |                                             |                                            |         |             |           |              |         |          
|                                     |                                             | Total current assets                       |         |             | 1,559,002 |              |         |           | 1,633,934 | 
|Property and equipment, net          |                                             |                                            | 174,192 |             |           |              | 179,926 |          
|Notes receivable                     |                                             |                                            | 397,429 |             |           |              | 397,429 |          
|Goodwill                             |                                             |                                            | 163,136 |             |           |              | 163,136 |          
|Intangible and other assets          |                                             |                                            | 106,650 |             |           |              | 119,569 |          
|                                     |                                             |                                            |         |             |           |              |         |          
|                                     |                                             | Total assets                               |         | $           | 2,400,409 |              |         | $         | 2,493,994 | 
|                                     |                                             |                                            |         |             |           |              |         |           |          
|LIABILITIES AND SHAREHOLDERS EQUITY |                                             |                                            |         |             |           |              |         |          
|Current liabilities:                 |                                             |                                            |         |             |           |              |         |          
|                                     | Accounts payable                            |                                            | $       | 55,492      |           |              | $       | 71,218    |          
|                                     | Accrued payroll and related expenses        |                                            |         | 29,961      |           |              |         | 36,748    |          
|                                     | Accrued warranty                            |                                            |         | 28,371      |           |              |         | 31,002    |          
|                                     | Other accrued liabilities                   |                                            |         | 44,552      |           |              |         | 56,522    |          
|                                     | Income taxes payable                        |                                            |         | 5,944       |           |              |         | 14,070    |          
|                                     | Deferred profit                             |                                            |         | 55,019      |           |              |         | 55,613    |          
|                                     | Convertible subordinated notes              |                                            |         |            |           |              |         | 116,437   |          
|                                     |                                             |                                            |         |             |           |              |         |          
|                                     |                                             | Total current liabilities                  |         |             | 219,339   |              |         |           | 381,610   | 
|Deferred tax liabilities             |                                             |                                            | 20,386  |             |           |              | 19,502  |          
|Other liabilities                    |                                             |                                            | 37,200  |             |           |              | 37,194  |          
|                                     |                                             |                                            |         |             |           |              |         |          
|                                     |                                             | Total liabilities                          |         |             | 276,925   |              |         |           | 438,306   | 
|Shareholders equity:                |                                             |                                            |         |             |           |              |         |          
|                                     | Common stock                                |                                            |         | 1,533,834   |           |              |         | 1,487,281 |          
|                                     | Retained earnings                           |                                            |         | 589,327     |           |              |         | 570,153   |          
|                                     | Accumulated other comprehensive gain (loss) |                                            |         | 323         |           |              |         | (1,746    | )        
|                                     |                                             |                                            |         |             |           |              |         |          
|                                     |                                             | Total shareholders equity                 |         |             | 2,123,484 |              |         |           | 2,055,688 | 
|                                     |                                             |                                            |         |             |           |              |         |          
|                                     |                                             | Total liabilities and shareholders equity |         | $           | 2,400,409 |              |         | $         | 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)

|                                                         |                                           |                                                                                   |                                                                         |                                      |  |                  |         |          |  |            |        |  
|-------------------------------------------------------- | ----------------------------------------- | --------------------------------------------------------------------------------- | ----------------------------------------------------------------------- | ------------------------------------ |  | ---------------- | ------- | -------- |  | ---------- | ------ | -
|                                                         |                                           |                                                                                   |                                                                         |                                      |  | Six Months Ended
|                                                         |                                           |                                                                                   |                                                                         |                                      |  |                 
|                                                         |                                           |                                                                                   |                                                                         |                                      |  | June 28,         |         | June 29,
|                                                         |                                           |                                                                                   |                                                                         |                                      |  | 2003             |         | 2002    
|                                                         |                                           |                                                                                   |                                                                         |                                      |  |                  |         |         
|Cash flows from operating activities:                    |                                           |                                                                                   |                                                                         |                                      |  |                  |         |         
|Net income                                               |                                           | $                                                                                 | 19,302                                                                  |                                      |  | $                | 15,849  |         
|                                                         |                                           | Adjustments to reconcile net income to net cash provided by
operating activities: |                                                                         |                                      |  |                  |         |          |  |           
|                                                         |                                           |                                                                                   | Gain on sale of an investment                                           |                                      |  |                 |         |          |  | (4,602     | )     
|                                                         |                                           |                                                                                   | Loss on extinguishment of debt                                          |                                      |  | 616              |         |          |  |           |       
|                                                         |                                           |                                                                                   | Depreciation and amortization                                           |                                      |  | 25,716           |         |          |  | 24,919     |       
|                                                         |                                           |                                                                                   | Deferred income taxes                                                   |                                      |  | 1,284            |         |          |  | (1,346     | )     
|                                                         |                                           |                                                                                   | Stock-based compensation                                                |                                      |  | 2,334            |         |          |  | 873        |       
|                                                         |                                           |                                                                                   | Income tax benefits from employee stock option plans                    |                                      |  | 8,870            |         |          |  | 16,942     |       
|                                                         |                                           |                                                                                   | Changes in operating assets and liabilities:                            |                                      |  |                  |         |          |  |            |       
|                                                         |                                           |                                                                                   |                                                                         | Accounts receivable                  |  |                  | (20,353 | )        |  |            | 4,672  |  
|                                                         |                                           |                                                                                   |                                                                         | Inventories                          |  |                  | 14,859  |          |  |            | (6,313 | )
|                                                         |                                           |                                                                                   |                                                                         | Prepaid and other current assets     |  |                  | 13,292  |          |  |            | 21,891 |  
|                                                         |                                           |                                                                                   |                                                                         | Accounts payable                     |  |                  | (15,726 | )        |  |            | 28,203 |  
|                                                         |                                           |                                                                                   |                                                                         | Accrued payroll and related expenses |  |                  | (6,787  | )        |  |            | (9,154 | )
|                                                         |                                           |                                                                                   |                                                                         | Accrued warranty                     |  |                  | (2,631  | )        |  |            | (7,541 | )
|                                                         |                                           |                                                                                   |                                                                         | Other accrued liabilities            |  |                  | (11,936 | )        |  |            | (1,323 | )
|                                                         |                                           |                                                                                   |                                                                         | Income taxes payable                 |  |                  | (8,126  | )        |  |            | 5,176  |  
|                                                         |                                           |                                                                                   |                                                                         | Deferred profit                      |  |                  | (594    | )        |  |            | 10,693 |  
|                                                         |                                           |                                                                                   |                                                                         |                                      |  |                  |         |         
|                                                         | Net cash provided by operating activities |                                                                                   |                                                                         | 20,120                               |  |                  |         | 98,939   | 
|                                                         |                                           |                                                                                   |                                                                         |                                      |  |                  |         |         
|Cash flows from investing activities:                    |                                           |                                                                                   |                                                                         |                                      |  |                  |         |         
|                                                         |                                           |                                                                                   | Proceeds from sales and maturities of short-term
investments            |                                      |  | 659,484          |         |          |  | 380,313    |       
|                                                         |                                           |                                                                                   | Purchases of short-term investments                                     |                                      |  | (676,998         | )       |          |  | (425,289   | )     
|                                                         |                                           |                                                                                   | Proceeds from sales and maturities of restricted
short-term investments |                                      |  |                 |         |          |  | 1,274,583  |       
|                                                         |                                           |                                                                                   | Purchases of restricted short-term investments                          |                                      |  |                 |         |          |  | (1,186,362 | )     
|                                                         |                                           |                                                                                   | Participation in synthetic leases                                       |                                      |  |                 |         |          |  | (177,457   | )     
|                                                         |                                           |                                                                                   | Capital expenditures                                                    |                                      |  | (17,528          | )       |          |  | (12,376    | )     
|                                                         |                                           |                                                                                   | Decrease in other assets                                                |                                      |  | 10,743           |         |          |  | 1,052      |       
|                                                         |                                           |                                                                                   |                                                                         |                                      |  |                  |         |         
|                                                         |                                           |                                                                                   | Net cash used in investing activities                                   |                                      |  | (24,299          | )       |          |  | (145,536   | )     
|                                                         |                                           |                                                                                   |                                                                         |                                      |  |                  |         |         
|Cash flows from financing activities:                    |                                           |                                                                                   |                                                                         |                                      |  |                  |         |         
|                                                         |                                           |                                                                                   | Repayments of convertible subordinated notes                            |                                      |  | (117,053         | )       |          |  |           |       
|                                                         |                                           |                                                                                   | Proceeds from employee stock compensation plans                         |                                      |  | 35,260           |         |          |  | 41,750     |       
|                                                         |                                           |                                                                                   | Payments on lines of credit, net                                        |                                      |  |                 |         |          |  | (8,252     | )     
|                                                         |                                           |                                                                                   | Repurchase of common stock                                              |                                      |  | (39              | )       |          |  | (12,644    | )     
|                                                         |                                           |                                                                                   |                                                                         |                                      |  |                  |         |         
|Net cash (used in) provided by financing activities      |                                           |                                                                                   | (81,832                                                                 | )                                    |  |                  | 20,854  |         
|                                                         |                                           |                                                                                   |                                                                         |                                      |  |                  |         |         
|Net decrease in cash and cash equivalents                |                                           |                                                                                   | (86,011                                                                 | )                                    |  |                  | (25,743 | )       
|Cash and cash equivalents at the beginning of the period |                                           |                                                                                   | 615,844                                                                 |                                      |  |                  | 550,640 |         
|                                                         |                                           |                                                                                   |                                                                         |                                      |  |                  |         |         
|Cash and cash equivalents at the end of the period       |                                           | $                                                                                 | 529,833                                                                 |                                      |  | $                | 524,897 |         
|                                                         |                                           |                                                                                   |                                                                         |                                      |  |                  |         |         

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
|-- |  | ---------------------

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 six months ended June 28, 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
six months ended June 28, 2003 include the financial position, results of
operations and cash flows of SpeedFam-IPEC, Inc.

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



|2. |  | 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):

|                          |                   |   |          |         |              |   |         |         | 
|------------------------- | ----------------- | - | -------- | ------- | ------------ | - | ------- | ------- | 
|                          |                   |   | June 28, |         | December 31,
|                          |                   |   | 2003     |         | 2002        
|                          |                   |   |          |         |             
|Purchased and spare parts |                   | $ | 189,915  |         |              | $ | 205,341 |        
|Work-in-process           |                   |   | 39,505   |         |              |   | 45,487  |        
|Finished goods            |                   |   | 15,289   |         |              |   | 6,530   |        
|                          |                   |   |          |         |              |   |         |        
|                          | Total inventories |   | $        | 244,709 |              |   | $       | 257,358 | 
|                          |                   |   |          |         |              |   |         |        



|3. |  | NET INCOME PER SHARE
|-- |  | --------------------

Basic net income per share is computed by dividing net income by the
weighted-average number of common shares

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outstanding during the period. For purposes of computing basic net income per
share, the weighted-average number of outstanding shares of common stock
excludes shares of restricted stock subject to repurchase.

Diluted net 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 |         | Six Months Ended
|                                       |                                             |                                             |      |                    |         |                 
|                                       |                                             |                                             |      | June 28,           |         | June 29,         |      | June 28, |         | June 29,
|                                       |                                             |                                             |      | 2003               |         | 2002             |      | 2003     |         | 2002    
|                                       |                                             |                                             |      |                    |         |                  |      |          |         |         
|Numerator:                             |                                             |                                             |      |                    |         |                  |      |          |         |          |      |         |         |   |      |        
|                                       | Net income                                  |                                             | $    | 7,430              |         |                  | $    | 12,013   |         |          | $    | 19,302  |         |   | $    | 15,849  |        
|                                       |                                             |                                             |      |                    |         |                  |      |          |         |          |      |         |         |   |      |         |        
|Denominator:                           |                                             |                                             |      |                    |         |                  |      |          |         |          |      |         |         |   |      |        
|                                       | Basic weighted-average shares outstanding   |                                             |      | 149,950            |         |                  |      | 145,120  |         |          |      | 149,692 |         |   |      | 144,687 |        
|                                       | Employee stock options and restricted stock |                                             |      | 3,084              |         |                  |      | 5,933    |         |          |      | 2,939   |         |   |      | 6,151   |        
|                                       |                                             |                                             |      |                    |         |                  |      |          |         |          |      |         |         |   |      |         |        
|                                       |                                             | Diluted weighted-average shares outstanding |      |                    | 153,034 |                  |      |          | 151,053 |          |      |         | 152,631 |   |      |         | 150,838 | 
|                                       |                                             |                                             |      |                    |         |                  |      |          |         |          |      |         |         |   |      |         |        
|Basic and diluted net income per share |                                             | $                                           | 0.05 |                    |         | $                | 0.08 |          |         | $        | 0.13 |         |         | $ | 0.11 |        
|                                       |                                             |                                             |      |                    |         |                  |      |          |         |          |      |         |         |   |      |         |        

Options to purchase approximately 9.3 million and 2.1 million shares of common
stock at weighted-average exercise prices of $43.02 and $52.21 per share were
outstanding as of June 28, 2003 and June 29, 2002, respectively, 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.



|4. |  | COMMITMENTS AND GUARANTEES
|-- |  | --------------------------

Operating Leases

We lease nearly all of our facilities under operating leases, including
synthetic leases, which expire at various dates through 2017. Our synthetic
leases are primarily for properties in San Jose, California and Tualatin,
Oregon. A synthetic lease is a lease that is treated as an operating lease for
book purposes, but as a financing lease for tax purposes. Under our synthetic
lease agreements, a third party lessor funds 100% of the acquisition and
construction costs relating to one or more properties to be leased to a lessee.
The lessor is the owner of the leased property and must provide at least 3% of
the required funds in the form of at-risk equity. The lessor generally borrows
the balance of the funds necessary to fund the acquisition and construction.
We are obligated to lend approximately 87% of the cost of the leased asset to
the lessor upon completion of construction. The leases with this requirement
are known as defeased or self-funded transactions. In addition, our synthetic
leases require us to maintain collateral for the benefit of the lessor. The
collateral is classified within other assets on the accompanying condensed
consolidated balance sheets.

Summary information about our synthetic lease arrangements is as follows as of
June 28, 2003 (square feet and dollar amounts in thousands):

|             |  |            |    |        |  |             |       |               |  |           |         |            |  |           |         |  |  |   |        |  |  |   |        |  |  |   |         | 
|------------ |  | ---------- | -- | ------ |  | ----------- | ----- | ------------- |  | --------- | ------- | ---------- |  | --------- | ------- |  |  | - | ------ |  |  | - | ------ |  |  | - | ------- | 
|             |  |            |    |        |  | Total       |       |               |  |           |         |            |  |           |         |  |  |   |        |  |  |   |        |  |  |  
|Property     |  | Number of  |    | Square |  | Total Lease |       | Novellus      |  | Net Lease |         | Collateral |  | Residual 
|Location     |  | Properties |    | Feet   |  | Financing   |       | Participation |  | Financing |         | Value      |  | Guarantee
|             |  |            |    |        |  |             |       |               |  |           |         |            |  |          
|San Jose, CA |  |            | 13 |        |  |             | 958   |               |  | $         | 293,183 |            |  | $         | 257,042 |  |  | $ | 36,141 |  |  | $ | 36,141 |  |  | $ | 258,220 | 
|Tualatin, OR |  |            | 1  |        |  |             | 377   |               |  |           | 163,241 |            |  |           | 140,387 |  |  |   | 22,854 |  |  |   | 22,854 |  |  |   | 140,387 | 
|             |  |            |    |        |  |             |       |               |  |           |         |            |  |           |         |  |  |   |        |  |  |   |        |  |  |   |         | 
|             |  |            | 14 |        |  |             | 1,335 |               |  | $         | 456,424 |            |  | $         | 397,429 |  |  | $ | 58,995 |  |  | $ | 58,995 |  |  | $ | 398,607 | 
|             |  |            |    |        |  |             |       |               |  |           |         |            |  |           |         |  |  |   |        |  |  |   |        |  |  |   |         | 

In January 2003, the Financial Accounting Standards Board, or FASB, issued
Financial Interpretation No. 46,

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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 for the first interim or annual period
beginning after June 15, 2003.

After evaluating our synthetic leases,
we have concluded that the lessor is a variable interest entity and
that we are the primary beneficiary of the variable interest entity.
As such, we are required to consolidate the variable interest lessor
beginning on June 29, 2003. Additionally, since each of the
other lessees involved with this lessor has a variable interest in
specified assets and liabilities of the variable interest lessor, we
will only be required to consolidate in our financial statements the
specific assets, liabilities, and operating results associated with
our synthetic leases. As a result of the adoption of FIN 46 and the
expected exercise of our purchase options, property and equipment
will increase on a net basis by approximately $360.0 million and
notes receivable and other non-current assets will decrease by
$456.4 million. In addition, as a result of the adoption of FIN
46, we expect to record a non-cash net of tax charge of approximately
$63.5 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
$97.0 million of pre-tax depreciation that would have been
recorded had we owned these assets from inception of the leases. On a
prospective basis, our quarterly depreciation expense will increase by
approximately
$8.4 million, rent expenses and interest income will each
decrease by approximately $3.0 million, and our quarterly
earnings per share will be decreased by approximately $0.04. The
adoption of FIN 46 and exercise of our options to purchase the
properties will have 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 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
warranty. Changes in our accrued warranty liability were as follows (in
thousands):

|                             |                                             |   |            |         |               |   |        |         |  
|---------------------------- | ------------------------------------------- | - | ---------- | ------- | ------------- | - | ------ | ------- | -
|                             |                                             |   | Six Months |         | Twelve Months
|                             |                                             |   | Ended      |         | Ended        
|                             |                                             |   | June 28,   |         | December 31, 
|                             |                                             |   | 2003       |         | 2002         
|                             |                                             |   |            |         |              
|Balance, beginning of period |                                             | $ | 31,002     |         |               | $ | 43,337 |        
|                             | Warranties issued                           |   |            | 24,225  |               |   |        | 42,723  |  
|                             | Settlements                                 |   |            | (26,856 | )             |   |        | (56,322 | )
|                             | SpeedFam-IPEC, Inc. warranty at acquisition |   |            |        |               |   |        | 1,264   |  
|                             |                                             |   |            |         |               |   |        |        
|Balance, end of period       |                                             | $ | 28,371     |         |               | $ | 31,002 |        
|                             |                                             |   |            |         |               |   |        |        



|5. |  | CONVERTIBLE SUBORDINATED NOTES
|-- |  | ------------------------------

In connection with the 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 $616,000 in expense for
the difference

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between the carrying value as of the acquisition date and the redemption price.



|6. |  | RESTRUCTURING AND OTHER CHARGES
|-- |  | -------------------------------

The following table summarizes restructuring activity for the first two
quarters of 2003 related to the restructuring charges we recorded in 2001 and
2002 (in thousands):

|                             |  |            |        |           |  |       |     |       |  |   |       |   |  |   |        |  
|---------------------------- |  | ---------- | ------ | --------- |  | ----- | --- | ----- |  | - | ----- | - |  | - | ------ | -
|                             |  | Facilities |        | Severance |  | Other |     | Total
|                             |  |            |        |           |  |       |     |      
|Balance at December 31, 2002 |  | $          | 45,568 |           |  | $     | 251 |       |  | $ | 1,253 |   |  | $ | 47,072 |  
|Cash payments                |  |            | (2,319 | )         |  |       | (57 | )     |  |   | (40   | ) |  |   | (2,416 | )
|                             |  |            |        |           |  |       |     |       |  |   |       |   |  |   |        |  
|Balance at March 29, 2003    |  | $          | 43,249 |           |  | $     | 194 |       |  | $ | 1,213 |   |  | $ | 44,656 |  
|Cash payments                |  |            | (2,378 | )         |  |       | (25 | )     |  |   | (42   | ) |  |   | (2,445 | )
|                             |  |            |        |           |  |       |     |       |  |   |       |   |  |   |        |  
|Balance at June 28, 2003     |  | $          | 40,871 |           |  | $     | 169 |       |  | $ | 1,171 |   |  | $ | 42,211 |  
|                             |  |            |        |           |  |       |     |       |  |   |       |   |  |   |        |  



|7. |  | BAD DEBT RECOVERY
|-- |  | -----------------

In September 2001, we determined that, 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.



|8. |  | COMPREHENSIVE INCOME
|-- |  | --------------------

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

|                                                                                                         |  |                    |        |                  |  |          |        |          |  |   |        |   |  |   |        |  
|-------------------------------------------------------------------------------------------------------- |  | ------------------ | ------ | ---------------- |  | -------- | ------ | -------- |  | - | ------ | - |  | - | ------ | -
|                                                                                                         |  | Three Months Ended |        | Six Months Ended
|                                                                                                         |  |                    |        |                 
|                                                                                                         |  | June 28,           |        | June 29,         |  | June 28, |        | June 29,
|                                                                                                         |  | 2003               |        | 2002             |  | 2003     |        | 2002    
|                                                                                                         |  |                    |        |                  |  |          |        |         
|Net income                                                                                               |  | $                  | 7,430  |                  |  | $        | 12,013 |          |  | $ | 19,302 |   |  | $ | 15,849 |  
|Foreign currency translation adjustments                                                                 |  |                    | 3,285  |                  |  |          | 2,475  |          |  |   | 2,123  |   |  |   | 675    |  
|Unrealized gain (loss) on available-for-sale securities                                                  |  |                    | 79     |                  |  |          | 579    |          |  |   | (54    | ) |  |   | 292    |  
|Reclassification of realized gain on an available-for-sale
investment included in net income, net of tax |  |                    |       |                  |  |          |       |          |  |   |       |   |  |   | (3,636 | )
|                                                                                                         |  |                    |        |                  |  |          |        |          |  |   |        |   |  |   |        |  
|Comprehensive income                                                                                     |  | $                  | 10,794 |                  |  | $        | 15,067 |          |  | $ | 21,371 |   |  | $ | 13,180 |  
|                                                                                                         |  |                    |        |                  |  |          |        |          |  |   |        |   |  |   |        |  

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

|                                                 |                                             |   |          |     |              |   |        |        |  
|------------------------------------------------ | ------------------------------------------- | - | -------- | --- | ------------ | - | ------ | ------ | -
|                                                 |                                             |   | June 28, |     | December 31,
|                                                 |                                             |   | 2003     |     | 2002        
|                                                 |                                             |   |          |     |             
|Foreign currency translation adjustments         |                                             | $ | 662      |     |              | $ | (1,461 | )     
|Unrealized loss on available-for-sale securities |                                             |   | (339     | )   |              |   | (285   | )     
|                                                 |                                             |   |          |     |              |   |        |       
|                                                 | Accumulated other comprehensive gain (loss) |   | $        | 323 |              |   | $      | (1,746 | )
|                                                 |                                             |   |          |     |              |   |        |       



|9. |  | STOCK-BASED COMPENSATION
|-- |  | ------------------------

Employee Stock Option Plans

We grant options to employees under several stock option plans. Our stock
option plans provide that stock options expire ten years after the date of
grant and generally vest ratably over a four-year period on the anniversary of
the date of grant or as determined by the Board of Directors. We also award
restricted stock to our employees under our 1992 Stock Option Plan and our 2001
Stock Incentive Plan. As of June 28, 2003, there were a total of 8.9 million
options available for grant and 24.1 million options outstanding under all
stock option plans with an average

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exercise price of $31.27 per share.

Employee Stock Purchase Plans

In May 1992, we adopted a qualified Employee Stock Purchase Plan, referred to
herein as the Purchase Plan, under Sections 421 and 423 of the Internal Revenue
Code. Under the Purchase Plan, qualified employees are entitled to purchase
shares at 85% of fair market value on specified dates. As of June 28, 2003,
approximately 844,000 shares were reserved for future issuance under the
Purchase Plan.

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
Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation, or SFAS 123, 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. Had compensation
expense been determined based on the fair value at the grant date for awards,
consistent with the provisions of SFAS 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 |        | Six Months Ended
|                                                   |                                                                                    |   |                    |        |                 
|                                                   |                                                                                    |   | June 28,           |        | June 29,         |   | June 28, |        | June 29,
|                                                   |                                                                                    |   | 2003               |        | 2002             |   | 2003     |        | 2002    
|                                                   |                                                                                    |   |                    |        |                  |   |          |        |         
|Net income as reported                             |                                                                                    | $ | 7,430              |        |                  | $ | 12,013   |        |          | $ | 19,302  |        |  | $ | 15,849  |       
|                                                   |                                                                                    |   |                    |        |                  |   |          |        |          |   |         |        |  |   |         |       
|Add:                                               |                                                                                    |   |                    |        |                  |   |          |        |          |   |         |        |  |   |         |       
|                                                   | Intrinsic value method expense included in reported net
income, net of related tax |   |                    | 938    |                  |   |          | 266    |          |   |         | 1,422  |  |   |         | 509    | 
|Less:                                              |                                                                                    |   |                    |        |                  |   |          |        |          |   |         |        |  |   |         |       
|                                                   | Fair value method expense, net of related tax effects                              |   |                    | 17,520 |                  |   |          | 19,062 |          |   |         | 34,462 |  |   |         | 35,055 | 
|                                                   |                                                                                    |   |                    |        |                  |   |          |        |          |   |         |        |  |   |         |       
|Pro-forma net loss                                 |                                                                                    | $ | (9,152             | )      |                  | $ | (6,783   | )      |          | $ | (13,738 | )      |  | $ | (18,697 | )     
|                                                   |                                                                                    |   |                    |        |                  |   |          |        |          |   |         |        |  |   |         |       
|Pro-forma basic and diluted net loss per share     |                                                                                    | $ | (0.06              | )      |                  | $ | (0.05    | )      |          | $ | (0.09   | )      |  | $ | (0.13   | )     
|Basic and diluted net income per share as reported |                                                                                    | $ | 0.05               |        |                  | $ | 0.08     |        |          | $ | 0.13    |        |  | $ | 0.11    |       

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 six months ended June 28, 2003 and
June 29, 2002:

|                        |  |                    |     |                  |  |          |     |          |  |  |     |     |  |  |     |    
|----------------------- |  | ------------------ | --- | ---------------- |  | -------- | --- | -------- |  |  | --- | --- |  |  | --- | ---
|                        |  | Three Months Ended |     | Six Months Ended
|                        |  |                    |     |                 
|                        |  | June 28,           |     | June 29,         |  | June 28, |     | June 29,
|                        |  | 2003               |     | 2002             |  | 2003     |     | 2002    
|                        |  |                    |     |                  |  |          |     |         
|Dividend yield          |  | None               |     | None             |  | None     |     | None    
|Expected volatility     |  |                    | 82  | %                |  |          | 85  | %        |  |  | 82  | %   |  |  | 85  | %  
|Risk free interest rate |  |                    | 2.5 | %                |  |          | 3.3 | %        |  |  | 2.5 | %   |  |  | 3.3 | %  
|Expected lives          |  |                    | 3.6 | yrs              |  |          | 3.5 | yrs      |  |  | 3.6 | yrs |  |  | 3.5 | yrs

The weighted-average fair value of stock options granted during the period was
$14.39 and $24.85 for the three and six months ended June 28, 2003 and $15.74
and $24.73 for the three and six months ended June 29, 2002. The effects of
applying SFAS 123 on net income to determine the pro forma disclosures are not
likely to be representative of the effects on pro forma disclosures for future
years.

The pro forma net loss and net loss per share data listed above include expense
related to 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 six months ended June 28, 2003 and June 29,
2002:

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|                        |  |                    |      |                  |  |          |      |          |  |  |     |     |  |  |     |    
|----------------------- |  | ------------------ | ---- | ---------------- |  | -------- | ---- | -------- |  |  | --- | --- |  |  | --- | ---
|                        |  | Three Months Ended |      | Six Months Ended
|                        |  |                    |      |                 
|                        |  | June 28,           |      | June 29,         |  | June 28, |      | June 29,
|                        |  | 2003               |      | 2002             |  | 2003     |      | 2002    
|                        |  |                    |      |                  |  |          |      |         
|Dividend yield          |  | None               |      | None             |  | None     |      | None    
|Expected volatility     |  |                    | 50   | %                |  |          | 58   | %        |  |  | 50  | %   |  |  | 62  | %  
|Risk free interest rate |  |                    | 1.2  | %                |  |          | 2.3  | %        |  |  | 1.2 | %   |  |  | 2.3 | %  
|Expected lives          |  |                    | 0.25 | yr.              |  |          | 0.25 | yr.      |  |  | 0.5 | yr. |  |  | 0.5 | yr.

The weighted-average fair value of purchase rights granted during the period
was $6.82 and $8.71 for the three and six months ended June 28,
2003, respectively and $14.27 and $13.52 for the
three and six months ended June 29, 2002, respectively.



|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 $240,000 and $379,000 for the three and six months ended June 28,
2003, respectively, and $58,000 for both the three and six months ended June
29, 2002.

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 14% of our net sales for both the
three and six months ended June 28, 2003 and 12% and 16% for the three and
months ended June 29, 2002, respectively. Intel also accounted
for 7% and 14%
of our accounts receivable as of June 28, 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 June 28, 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 June 28, 2003 and December 31,
2002, the total outstanding balances of loans to non-executive officers and key
personnel were approximately $6.6 million and $6.0 million, respectively. Of
the total amount outstanding at June 28, 2003, $6.1 million was secured by
collateral.



|11. |  | RECENT ACCOUNTING PRONOUNCEMENTS
|--- |  | --------------------------------

In November 2002, The Emerging Issues Task Force reached a consensus on Issue
No. 00-21, Revenue Arrangements with Multiple Deliverables, or EITF 00-21.
EITF 00-21 provides guidance on accounting for arrangements that involve the
delivery of performance of multiple products, services and/or rights to use
assets. We are in the process of assessing the effect of EITF 00-21 and do not
expect the adoption of EITF 00-21, which will apply to revenue arrangements
entered into in fiscal periods beginning after June 15, 2003, to have a
material effect on our financial condition or results of operations.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities, or SFAS 149. This statement
amends SFAS 133 to clarify the financial accounting and reporting of derivative
instruments and hedging activities and requires contracts with similar
characteristics to be accounted for on a comparable basis. SFAS 149 will be
effective for all contracts entered into or modified after June 30, 2003. We
do not anticipate that the adoption of SFAS 149 will have a material effect on
our financial condition or results of operations.

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

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|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
anticipates, expects, intends, plans, believes, seeks, estimates,
and similar expressions also identify forward-looking statements.
Forward-looking statements in this Quarterly Report include, without
limitation: our expectations regarding the effect on our financial results of
the consolidation of the variable interest lessor under our synthetic leases;
our expectation that we will exercise our options to purchase the synthetic
lease properties in the third quarter; our expectation that the implementation
of FIN 46 will have no impact on our liquidity; our continued belief that
significant investment in R&D is required to remain competitive; our intent to
continue to invest in our existing products and new products and technologies;
our expectations regarding the effect of the adoption of SFAS 149, SFAS 150 and
EITF 00-21 on our financial condition or results of operations; our belief that
our current cash position, cash generated through operations and equity
offerings, and available borrowings will be sufficient to meet our needs
through the next twelve months; our intent to continue pursuing the legal
defense of our proprietary technology primarily through patent and trade secret
protection; 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;
and our belief that we have meritorious claims and/or defenses in the Applied
Materials and Semitool litigation matters.

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 failure to accurately predict the effect of our adoption of certain
accounting pronouncements; our inability to exercise our purchase options for
properties subject to synthetic leases; our inability to allocate substantial
resources to R&D; our unanticipated need for additional liquid assets in the
next twelve months; our potential inability to enforce our patents and protect
our trade secrets; our failure to accurately predict the effect of the ultimate
outcome of current litigation on our business, financial condition or results
of operations; and inherent uncertainty in the outcome of litigation matters.

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

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judgments and estimates used in the preparation of our 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, and SAB 101:
Revenue Recognition in Financial Statements-Frequently Asked Questions and
Answers, or SAB 101 FAQ. 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, then 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

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 142. SFAS 142 requires that goodwill and
identifiable intangible assets with indefinite useful lives no longer be
amortized, but instead be tested for impairment at least annually. SFAS 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 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. Furthermore, SFAS 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 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

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determine 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 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

We account for restructuring charges under the provision of SFAS No. 146,
Accounting for Cost Associated with Exit or Disposal Activities, or SFAS 146.
SFAS 146 nullifies EITF Issue No. 94-3 effective January 1, 2003 and 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.

Additionally, 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. Additionally, certain restructuring charges
related to asset impairments are recorded in accordance with SFAS 144. The
restructuring accrual related to the vacated facilities is calculated net of
estimated sublease income. Sublease income is estimated based on current
market quotes for similar properties. If we are unable to sublet these
properties on a timely basis or if we are forced to sublet them at lower rates
due to changes in market conditions, we would 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 |         | Six Months Ended
|                          |  |                    |         |                 
|                          |  | June 28, 2003      |         | June 29, 2002    |  | March 30, 2003 |         | June 28, 2003 |  | June 29, 2002
|                          |  |                    |         |                  |  |                |         |               |  |              
|Net sales                 |  | $                  | 239,050 |                  |  | $              | 222,147 |               |  | $             | 238,410 |   |  | $ | 477,460 |   |  | $ | 391,826 |  
|International net sales % |  |                    | 66      | %                |  |                | 76      | %             |  |               | 55      | % |  |   | 61      | % |  |   | 66      | %

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 three and six month periods ended June 28, 2003 from the
respective prior year periods is primarily due to improved market conditions
during the first half of 2003 and is also partially attributable to first half
revenues resulting from our December 2002 acquisition of SpeedFam-IPEC, Inc.
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 in demand from the first half of 2002, it has remained weak through
the first half of 2003.

The decrease in international net sales as a percentage of net sales for the three months ended June 28, 2003 over the respective prior year
period is primarily a result of lower net sales in the Asia region
(consisting primarily of Korea, Japan and Taiwan). The decrease for
the six months ended June 28, 2003 is primarily due to a
proportionally lower increase in net sales in the Asia region
compared to net sales in North America. The increase from the immediately preceding quarter is due to
higher net sales in the Asia region. The Asia region accounted for 53% of total net sales for the quarter
ended June 28, 2003, compared to 47% in the immediately preceding quarter.

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Gross Profit

|               |  |                    |         |                  |  |                |         |               |  |               |         |   |  |   |         |   |  |   |         |  
|-------------- |  | ------------------ | ------- | ---------------- |  | -------------- | ------- | ------------- |  | ------------- | ------- | - |  | - | ------- | - |  | - | ------- | -
|               |  | Three Months Ended |         | Six Months Ended
|               |  |                    |         |                 
|               |  | June 28, 2003      |         | June 29, 2002    |  | March 30, 2003 |         | June 28, 2003 |  | June 29, 2002
|               |  |                    |         |                  |  |                |         |               |  |              
|Gross profit   |  | $                  | 105,322 |                  |  | $              | 101,564 |               |  | $             | 109,814 |   |  | $ | 215,136 |   |  | $ | 173,094 |  
|% of net sales |  |                    | 44      | %                |  |                | 46      | %             |  |               | 46      | % |  |   | 45      | % |  |   | 44      | %

The prolonged decline in demand for semiconductor devices has continued to
affect our gross profit margin as we have not been able to fully absorb fixed
overhead costs. The decrease in gross margin as a percentage of net sales from
the second quarter of 2002 and the first quarter of 2003 is primarily due to
the change in product mix, higher product upgrades and a lower overhead absorption
rate.

Selling, General and Administrative (SG&A)

|               |  |                    |        |                  |  |                |        |               |  |               |        |   |  |   |        |   |  |   |        |  
|-------------- |  | ------------------ | ------ | ---------------- |  | -------------- | ------ | ------------- |  | ------------- | ------ | - |  | - | ------ | - |  | - | ------ | -
|               |  | Three Months Ended |        | Six Months Ended
|               |  |                    |        |                 
|               |  | June 28, 2003      |        | June 29, 2002    |  | March 30, 2003 |        | June 28, 2003 |  | June 29, 2002
|               |  |                    |        |                  |  |                |        |               |  |              
|SG&A expense   |  | $                  | 44,444 |                  |  | $              | 39,478 |               |  | $             | 42,631 |   |  | $ | 87,075 |   |  | $ | 74,164 |  
|% of net sales |  |                    | 19     | %                |  |                | 18     | %             |  |               | 18     | % |  |   | 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,
depreciation and amortization related to the assets utilized by the functions
noted above. As a percentage of net sales, SG&A expense remained relatively
flat for the three and six months ended June 28, 2003, compared to the
respective prior year periods. The increases in SG&A expense in absolute
dollars for the three and six months ended June 28, 2003 from the respective
prior year periods are primarily due to higher salaries and fringe benefits
and higher legal
expenses in preparation for impending litigation.

Research and Development (R&D)

|               |  |                    |        |                  |  |                |        |               |  |               |        |   |  |   |         |   |  |   |         |  
|-------------- |  | ------------------ | ------ | ---------------- |  | -------------- | ------ | ------------- |  | ------------- | ------ | - |  | - | ------- | - |  | - | ------- | -
|               |  | Three Months Ended |        | Six Months Ended
|               |  |                    |        |                 
|               |  | June 28, 2003      |        | June 29, 2002    |  | March 30, 2003 |        | June 28, 2003 |  | June 29, 2002
|               |  |                    |        |                  |  |                |        |               |  |              
|R&D expense    |  | $                  | 56,509 |                  |  | $              | 58,727 |               |  | $             | 57,006 |   |  | $ | 113,515 |   |  | $ | 112,773 |  
|% of net sales |  |                    | 24     | %                |  |                | 26     | %             |  |               | 24     | % |  |   | 24      | % |  |   | 29      | %

R&D expense includes compensation and benefits, project materials, repairs and
maintenance, rent, depreciation and amortization expenses associated with
patents and purchased technologies for our R&D functions. R&D expense as a
percentage of net sales and in absolute dollars for the second quarter of 2003
remained essentially flat compared to the first quarter of 2003. The decreases
in R&D expense as a percentage of net sales in the three and six months ended
June 28, 2003 from the respective prior year periods are primarily due to the
increases in net sales. The decrease in absolute dollars for the three months
ended June 28, 2003 from the respective prior year quarter and immediately
preceding quarter is primarily due to cost containment efforts aimed at
focusing our R&D efforts on key products necessary for long-term growth. We
continue to believe that significant investment in R&D is required to remain
competitive and plan to continue to invest in new products as well as
enhancement of our current product lines.

Restructuring and Other Charges

|                                |  |                    |   |                  |  |                |   |               |  |               |   |  |  |   |   |  |  |   |       |  
|------------------------------- |  | ------------------ | - | ---------------- |  | -------------- | - | ------------- |  | ------------- | - |  |  | - | - |  |  | - | ----- | -
|                                |  | Three Months Ended |   | Six Months Ended
|                                |  |                    |   |                 
|                                |  | June 28, 2003      |   | June 29, 2002    |  | March 30, 2003 |   | June 28, 2003 |  | June 29, 2002
|                                |  |                    |   |                  |  |                |   |               |  |              
|Restructuring and other charges |  | $                  |  |                  |  | $              |  |               |  | $             |  |  |  | $ |  |  |  | $ | 3,273 |  
|% of net sales                  |  |                    |  |                  |  |                |  |               |  |               |  |  |  |   |  |  |  |   | 1     | %

The $3.3 million restructuring charge in the six months ended June 29, 2002
consisted primarily of severance compensation related to a workforce reduction,
which we carried out in response to the downturn in market

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conditions.

Bad Debt Recovery

|                  |  |                    |   |                  |  |                |   |               |  |               |   |  |  |   |   |  |  |   |        |  
|----------------- |  | ------------------ | - | ---------------- |  | -------------- | - | ------------- |  | ------------- | - |  |  | - | - |  |  | - | ------ | -
|                  |  | Three Months Ended |   | Six Months Ended
|                  |  |                    |   |                 
|                  |  | June 28, 2003      |   | June 29, 2002    |  | March 30, 2003 |   | June 28, 2003 |  | June 29, 2002
|                  |  |                    |   |                  |  |                |   |               |  |              
|Bad debt recovery |  | $                  |  |                  |  | $              |  |               |  | $             |  |  |  | $ |  |  |  | $ | (7,662 | )
|% of net sales    |  |                    |  |                  |  |                |  |               |  |               |  |  |  |   |  |  |  |   | 2      | %

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 six months ended June 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 |       | Six Months Ended
|                               |  |                    |       |                 
|                               |  | June 28, 2003      |       | June 29, 2002    |  | March 30, 2003 |        | June 28, 2003 |  | June 29, 2002
|                               |  |                    |       |                  |  |                |        |               |  |              
|Interest
and other income, net |  | $                  | 5,537 |                  |  | $              | 11,847 |               |  | $             | 5,652 |   |  | $ | 11,189 |   |  | $ | 29,516 |  
|% of net sales                 |  |                    | 2     | %                |  |                | 5      | %             |  |               | 2     | % |  |   | 2      | % |  |   | 8      | %

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 six months
ended June 28, 2003 is primarily due to lower balances of interest-bearing cash
and short-term investments and lower interest rates in the first half of 2003.
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 repayment of the $117.1 million SpeedFam-IPEC, Inc. convertible
subordinated notes in January 2003. We also had a $4.6 million gain from a
sale of an equity investment in the six months ended June 29, 2002. In the
first quarter of 2003, we recorded a loss of $616,000 upon extinguishment of the
SpeedFam-IPEC, Inc. convertible subordinated notes, which contributed to the
reduction of interest and other income, net, in the six months ended June 28,
2003.

Provision for Income Taxes

Our estimated effective tax rate is 25% for both the second quarter of 2003 and
first quarter of 2003, compared to 21% for the respective prior year period.
The increase in the effective tax rate compared to the respective prior year
period is primarily due to reduced benefit from R&D tax credits.

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 $240,000 and $379,000 for the three and six months ended June 28,
2003, respectively, and $58,000 for both the three and six months ended June
29, 2002.

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 14% of our net sales for both the
three and six months ended June 28, 2003 and 12% and 16% for the three and
months ended June 29, 2002, respectively. Intel also accounted
for 7% and 14%
of our accounts receivable as of June 28, 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 June 28, 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 June 28, 2003 and December 31,
2002, the total outstanding balances of loans to non-executive

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officers and key personnel were
approximately $6.6 million and $6.0 million,
respectively. Of the total amount outstanding at June 28, 2003,
$6.1 million
was secured by collateral.

Recent Accounting Pronouncements

In November 2002, The Emerging Issues Task Force reached a consensus on Issue
No. 00-21, Revenue Arrangements with Multiple Deliverables, or EITF 00-21.
EITF 00-21 provides guidance on accounting for arrangements that involve the
delivery of performance of multiple products, services and/or rights to use
assets. We are in the process of assessing the effect of EITF 00-21 and do not
expect the adoption of EITF 00-21, which will apply to revenue arrangements
entered into in fiscal periods beginning after June 15, 2003, to have a
material effect on our financial condition or results of operations.

In April 2003, the FASB issued SFAS 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities, or SFAS 149. This statement
amends SFAS 133 to clarify the financial accounting and reporting of derivative
instruments and hedging activities and requires contracts with similar
characteristics to be accounted for on a comparable basis. SFAS 149 will be
effective for all contracts entered into or modified after June 30, 2003. We
do not anticipate the adoption of SFAS 149 to have a material effect on our
financial condition or results of operations.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity, or SFAS 150.
SFAS 150 establishes standards for the classification and measurement of
financial instruments with characteristics of both liabilities and equity.
SFAS 150 will become effective for three types of financial instruments entered
into or modified after May 31, 2003. The adoption of SFAS 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 June 28, 2003 consisted of $950.7 million of
cash, cash equivalents and short-term investments. This amount represents a
decrease of $69.0 million from $1.02 billion at December 31, 2002. The
decrease was due primarily to the repayment of the SpeedFam-IPEC, Inc.
convertible subordinated notes at a redemption price of $117.1 million and
accrued interest of $2.2 million, offset by positive cash generated from
operations, which included $18.5 million from an income tax refund, and $35.3
million of proceeds from issuance of common stock in connection with stock
option exercises.

Net cash provided by operating activities during the six months ended June 28,
2003 was $ 20.1 million. This amount consisted primarily of net income, the
effect of non-cash charges and changes in working capital accounts, which
include a decrease in prepaid and other current assets of $13.3 million, a
decrease in inventories of $14.9 million, an increase in accounts receivable of
$20.4 million, and a combined effect of decreases in accounts payable, accrued
payroll and related expenses, income tax payable and other accrued liabilities
of $42.6 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.

Net cash used in investing activities in the six months ended June 28, 2003 was
$24.3 million, which consisted primarily of capital expenditures of $17.5
million and net purchases of short-term investments of $17.5 million, offset by
a decrease in other assets of $10.7 million. As of June 28, 2003, we do not
have any significant commitments to purchase property and equipment.

Net cash used in financing activities in the six months ended June 28, 2003 was
$81.8 million, which is primarily due to the repayment of SpeedFam-IPEC, Inc.
convertible subordinated notes at a redemption price of $117.1 million,
partially offset by proceeds from employee stock compensation plans of $35.3
million.

We lease nearly all of our facilities under operating leases, including
synthetic leases, which expire at various dates through 2017. Our synthetic
leases are primarily for properties in San Jose, California and Tualatin,
Oregon. A synthetic lease is a lease that is treated as an operating lease for
book purposes, but as a financing lease for tax purposes. Under our synthetic
lease agreements, a third party lessor funds 100% of the acquisition and
construction

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costs relating to one or more properties to be leased to a lessee. The lessor
is the owner of the leased property and must provide at least 3% of the
required funds in the form of at-risk equity. The lessor generally borrows the
balance of the funds necessary to fund the acquisition and construction. We
are obligated to lend approximately 87% of the cost of the leased asset to the
lessor upon completion of construction. The leases with this requirement are
known as defeased or self-funded transactions. In addition, our synthetic
leases require us to maintain collateral for the benefit of the lessor. The
collateral is classified within other assets on the accompanying condensed
consolidated balance sheets.

Summary information about our synthetic lease arrangements is as follows as of
June 28, 2003 (square feet and dollar amounts in thousands):

|             |  |            |    |        |  |             |       |               |  |           |         |            |  |           |         |  |  |   |        |  |  |   |        |  |  |   |         | 
|------------ |  | ---------- | -- | ------ |  | ----------- | ----- | ------------- |  | --------- | ------- | ---------- |  | --------- | ------- |  |  | - | ------ |  |  | - | ------ |  |  | - | ------- | 
|             |  |            |    |        |  | Total       |       |               |  |           |         |            |  |           |         |  |  |   |        |  |  |   |        |  |  |  
|Property     |  | Number of  |    | Square |  | Total Lease |       | Novellus      |  | Net Lease |         | Collateral |  | Residual 
|Location     |  | Properties |    | Feet   |  | Financing   |       | Participation |  | Financing |         | Value      |  | Guarantee
|             |  |            |    |        |  |             |       |               |  |           |         |            |  |          
|San Jose, CA |  |            | 13 |        |  |             | 958   |               |  | $         | 293,183 |            |  | $         | 257,042 |  |  | $ | 36,141 |  |  | $ | 36,141 |  |  | $ | 258,220 | 
|Tualatin, OR |  |            | 1  |        |  |             | 377   |               |  |           | 163,241 |            |  |           | 140,387 |  |  |   | 22,854 |  |  |   | 22,854 |  |  |   | 140,387 | 
|             |  |            |    |        |  |             |       |               |  |           |         |            |  |           |         |  |  |   |        |  |  |   |        |  |  |   |         | 
|             |  |            | 14 |        |  |             | 1,335 |               |  | $         | 456,424 |            |  | $         | 397,429 |  |  | $ | 58,995 |  |  | $ | 58,995 |  |  | $ | 398,607 | 
|             |  |            |    |        |  |             |       |               |  |           |         |            |  |           |         |  |  |   |        |  |  |   |        |  |  |   |         | 

In January 2003, the Financial Accounting Standards Board, or FASB, issued
Financial 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 for the first
interim or annual period beginning after June 15, 2003.

After evaluating our synthetic leases, we have concluded that the lessor is a
variable interest entity and that we are the primary beneficiary of the
variable interest entity. As such, we are required to consolidate the variable
interest lessor beginning on June 29, 2003. Additionally, since each of the
other lessees involved with this lessor has a variable interest in specified
assets and liabilities of the variable interest lessor, we will only be
required to consolidate in our financial statements the specific assets,
liabilities and operating results associated with our synthetic leases. As a
result of the adoption of FIN 46 and the expected exercise of our
purchase options, property and equipment will increase on a net basis
by approximately $360.0 million and notes receivable and other
non-current assets will decrease by $456.4 million. In addition,
as a result of the adoption of FIN 46, we expect to record a
non-cash net of tax charge of approximately $63.5 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 $97.0 million of pre-tax depreciation
that would have been recorded had we owned these assets from
inception of the leases. On a prospective basis, our quarterly
depreciation expense will increase by approximately
$8.4 million, rent expenses and interest income will each
decrease by approximately $3.0 million, and our quarterly
earnings per share will be decreased by approximately $0.04. The
adoption of FIN 46 and exercise of our options to purchase the
properties will have no impact on our liquidity.

Our subsidiaries in Asia and Europe have available lines of credit with various
banks with total borrowing capacity of $40.2 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. There were minimal balances outstanding
under these credit facilities as of June 28, 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 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

18



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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 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 and are now at
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, both from potential new
entrants into the market 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 another vendors capital equipment, the manufacturer
is generally reliant upon that equipment vendor for the specific production
line application in question. Accordingly, we may experience difficulty in
selling a product to a particular customer for a significant period of time
when 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 manufacturing capacity or expand current 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, timely and efficient
implementation of manufacturing and assembly processes, product performance in
the field, and effective sales and marketing. There can be no assurance that 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.

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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 subsidiary operations;                                                                                                                                                                                  
| 
| |  | Difficulties in managing foreign distributors;                                                                                                                                                                                                      
| 
| |  | Potentially adverse tax consequences;                                                                                                                                                                                                               
| 
| |  | 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

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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                                                            
| 
| |  | 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,

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certain key parts may only be obtained from a single or limited source. 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

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

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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 control. 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, control 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.

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 to 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

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Applied Materials, Inc.

On June 13, 1997, we agreed to purchase the Thin Film Systems (TFS) business of
Varian Associates, Inc. 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 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. 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 Novellus and Semitool. The
case is presently scheduled to proceed to trial in January 2004. We believe
that we have meritorious claims against Semitool, 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.,

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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. For example, Conexant has filed and served a complaint against
Novellus in the Superior Court for the State of California, County of Orange,
regarding these purported indemnity and other duties and obligations allegedly
owed by Novellus. 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
recently granted, 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 is scheduled to be heard by the Court on August 12, 2003.

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.




ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

At Novellus Annual Meeting of Shareholders, held on April 15, 2003, the
following proposals were adopted by the margins indicated:



|1. |  | Election of Directors.
|-- |  | ----------------------

|                    |  |          |             |          |  |  |            | 
|------------------- |  | -------- | ----------- | -------- |  |  | ---------- | 
|Nominee             |  | In Favor |             | Withheld
|Richard S. Hill     |  |          | 100,846,743 |          |  |  | 31,098,581 | 
|D. James Guzy       |  |          | 126,587,815 |          |  |  | 5,357,509  | 
|J. David Litster    |  |          | 126,996,259 |          |  |  | 4,949,065  | 
|Yoshio Nishi        |  |          | 127,635,493 |          |  |  | 4,309,831  | 
|Glen G. Possley     |  |          | 127,630,798 |          |  |  | 4,314,526  | 
|Ann D. Rhoads       |  |          | 130,492,413 |          |  |  | 1,452,911  | 
|William R. Spivey   |  |          | 127,661,176 |          |  |  | 4,284,148  | 
|Delbert A. Whitaker |  |          | 126,989,397 |          |  |  | 4,955,927  | 



|2. |  | Re-approval of the 1998 Senior Executive Bonus Plan.
|-- |  | ----------------------------------------------------



|            |  |         |           |           |  |  |         | 
|----------- |  | ------- | --------- | --------- |  |  | ------- | 
|In Favor    |  | Opposed |           | Abstained
|            |  |         |           |          
|123,352,788 |  |         | 7,656,630 |           |  |  | 935,904 | 

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3.   Ratification of Appointment of Ernst & Young LLP as independent auditors of
Novellus for the next fiscal year ending December 31, 2003.

|            |  |         |           |           |  |  |         | 
|----------- |  | ------- | --------- | --------- |  |  | ------- | 
|In Favor    |  | Opposed |           | Abstained
|            |  |         |           |          
|123,220,180 |  |         | 7,974,644 |           |  |  | 750,500 | 




ITEM 5: OTHER INFORMATION

The ratio of earnings to fixed charges for the three months ended June 28, 2003
and each of the five most recent fiscal years was as follows:

|              |  |                          |      |      |  |      |       |      |  |      |       |  |  |  |      |  |  |  |      | 
|------------- |  | ------------------------ | ---- | ---- |  | ---- | ----- | ---- |  | ---- | ----- |  |  |  | ---- |  |  |  | ---- | 
|Quarter ended |  | Years ended December 31,
|June 28, 2003 |  | 2002                     |      | 2001 |  | 2000 |       | 1999 |  | 1998
|              |  |                          |      |      |  |      |       |      |  |     
|4.16          |  |                          | 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.

26



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##### Table of Contents






ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

|      |  |                                                                                                                                                                                                                                                          
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1   |  | Amended and Restated Bylaws of Novellus Systems, Inc.                                                                                                                                                                                                    
|      |  |                                                                                                                                                                                                                                                          
|10.40 |  | Separation Agreement between Novellus Systems, Inc. and Richard J.
Faubert dated April 18, 2003.                                                                                                                                                         
|      |  |                                                                                                                                                                                                                                                          
|31.1  |  | Certification of Richard S. Hill, Chairman of the Board of Directors and
Chief Executive Officer of Novellus Systems, Inc. dated August 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 August 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 August 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 August 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 April 14, 2003, we furnished a report on Form 8-K under items 7 and 9
announcing our results of operations for the fiscal quarter ended March 29,
2003.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------

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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)                       

August 11, 2003

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##### Table of Contents






EXHIBIT INDEX

|      |  |                                                                                                                                                                                                                                                          
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1   |  | Amended and Restated Bylaws of Novellus Systems, Inc.                                                                                                                                                                                                    
|      |  |                                                                                                                                                                                                                                                          
|10.40 |  | Separation Agreement between Novellus Systems, Inc. and Richard J.
Faubert dated April 18, 2003.                                                                                                                                                         
|      |  |                                                                                                                                                                                                                                                          
|31.1  |  | Certification of Richard S. Hill, Chairman of the Board of Directors
and Chief Executive Officer of Novellus Systems, Inc. dated August 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 August 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 August 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 August 11, 2003 in accordance
with 18 U.S.C. 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.                     

29