##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2007
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the transition period from       to
 Commission File Number 000-17157
 NOVELLUS SYSTEMS, INC.
 (Exact name of Registrant as specified in its charter)
 California
    
    77-0024666(State or other jurisdiction of
    
    (I.R.S. Employer Identificationincorporation or organization)
    
    Number)
 4000 North First Street, San Jose, California 95134  (Address of principal executive offices including zip code)
 (408) 943-9700  (Registrants telephone number, including area code)
 þ o
  þ o o
 o þ




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##### 



NOVELLUS SYSTEMS, INC.
FORM 10-Q
QUARTER ENDED JUNE 30, 2007
 TABLE OF CONTENTS
 PagePart I: Financial InformationItem 1: Condensed Consolidated Financial Statements
    
    
    3Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2007 and July 1, 2006
    
    
    3Condensed Consolidated Balance Sheets as of June 30, 2007 and December 31, 2006
    
    
    4Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2007 and July 1, 2006
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2: Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15Item 3: Quantitative and Qualitative Disclosures About Market Risk
    
    
    21Item 4: Controls and Procedures
    
    
    21Part II: Other InformationItem 1: Legal Proceedings
    
    
    22Item 1A: Risk Factors
    
    
    23Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    29Item 4: Submission of Matters to a Vote of Security Holders
    
    
    29Item 6: Exhibits
    
    
    30Signatures
    
    
    31EXHIBIT 10.4EXHIBIT 10.10EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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##### Table of Contents



PART I: FINANCIAL INFORMATION
 
 ITEM 1: CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 NOVELLUS SYSTEMS, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 Three Months Ended
    
    

Six
Months EndedJune 30, 2007
    
    
    July 1, 2006
    
    
    June 30, 2007
    
    
    July 1, 2006(In thousands, except per share amounts)Net sales
    
    $
    416,335
    
    
    $
    410,073
    
    
    $
    813,309
    
    
    $
    775,979Cost of sales
    
    
    208,225
    
    
    
    205,309
    
    
    
    410,290
    
    
    
    403,675Gross profit
    
    
    208,110
    
    
    
    204,764
    
    
    
    403,019
    
    
    
    372,304Operating expenses:Selling, general and administrative
    
    
    72,011
    
    
    
    66,311
    
    
    
    139,111
    
    
    
    124,793Research and development
    
    
    63,374
    
    
    
    63,298
    
    
    
    123,774
    
    
    
    127,081Restructuring and other charges
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,629Legal settlement
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,250Total operating expenses
    
    
    135,385
    
    
    
    129,609
    
    
    
    262,885
    
    
    
    267,753Operating income
    
    
    72,725
    
    
    
    75,155
    
    
    
    140,134
    
    
    
    104,551Interest income, net
    
    
    8,418
    
    
    
    5,168
    
    
    
    16,388
    
    
    
    10,200Other income, net
    
    
    6,179
    
    
    
    2,443
    
    
    
    9,316
    
    
    
    3,490Interest and other income, net
    
    
    14,597
    
    
    
    7,611
    
    
    
    25,704
    
    
    
    13,690Income before provision for income taxes and cumulative
effect of a change in accounting principle
    
    
    87,322
    
    
    
    82,766
    
    
    
    165,838
    
    
    
    118,241Provision for income taxes
    
    
    29,977
    
    
    
    30,061
    
    
    
    54,710
    
    
    
    41,767Income before cumulative effect of a change in
accounting principle
    
    
    57,345
    
    
    
    52,705
    
    
    
    111,128
    
    
    
    76,474Cumulative effect of a change in accounting principle,
net of tax of $594
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    948Net income
    
    $
    57,345
    
    
    $
    52,705
    
    
    $
    111,128
    
    
    $
    77,422Net income per share:Basic:Income before cumulative effect of a change in
accounting principle
    
    $
    0.46
    
    
    $
    0.42
    
    
    $
    0.90
    
    
    $
    0.60Cumulative effect of a change in accounting principle
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.01Basic net income per share
    
    $
    0.46
    
    
    $
    0.42
    
    
    $
    0.90
    
    
    $
    0.61Diluted:Income before cumulative effect of a change in
accounting principle
    
    $
    0.45
    
    
    $
    0.42
    
    
    $
    0.88
    
    
    $
    0.59Cumulative effect of a change in accounting principle
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.01Diluted net income per share
    
    $
    0.45
    
    
    $
    0.42
    
    
    $
    0.88
    
    
    $
    0.60Shares used in basic per share calculations
    
    
    123,788
    
    
    
    125,124
    
    
    
    123,887
    
    
    
    128,113Shares used in diluted per share calculations
    
    
    126,630
    
    
    
    125,910
    
    
    
    126,792
    
    
    
    129,087
  3




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##### Table of Contents



NOVELLUS SYSTEMS, INC.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 June 30,
    
    
    December 31,2007
    
    
    2006 *(unaudited)(In thousands)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    70,376
    
    
    $
    58,463Short-term investments
    
    
    795,915
    
    
    
    794,865Accounts receivable, net
    
    
    421,898
    
    
    
    310,888Inventories
    
    
    233,345
    
    
    
    198,571Deferred tax assets, net
    
    
    80,417
    
    
    
    102,266Assets held for sale
    
    
    34,043
    
    
    
    21,966Prepaid and other current assets
    
    
    30,124
    
    
    
    18,274Total current assets
    
    
    1,666,118
    
    
    
    1,505,293Property and equipment, net
    
    
    341,901
    
    
    
    364,599Restricted cash and cash equivalents
    
    
    148,201
    
    
    
    143,769Goodwill
    
    
    229,650
    
    
    
    225,431Intangible and other assets
    
    
    128,823
    
    
    
    123,400Total assets
    
    $
    2,514,693
    
    
    $
    2,362,492LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    86,593
    
    
    $
    76,406Accrued payroll and related expenses
    
    
    67,193
    
    
    
    81,836Accrued warranty
    
    
    58,650
    
    
    
    55,349Other accrued liabilities
    
    
    68,766
    
    
    
    48,068Income taxes payable
    
    
    33,665
    
    
    
    38,879Deferred profit
    
    
    55,547
    
    
    
    41,351Current obligations under lines of credit
    
    
    16,986
    
    
    
    19,480Total current liabilities
    
    
    387,400
    
    
    
    361,369Long-term debt
    
    
    130,967
    
    
    
    127,862Other non-current liabilities
    
    
    56,665
    
    
    
    38,556Total liabilities
    
    
    575,032
    
    
    
    527,787Shareholders equity:Common stock
    
    
    1,426,998
    
    
    
    1,393,914Retained earnings
    
    
    509,378
    
    
    
    438,196Accumulated other comprehensive income
    
    
    3,285
    
    
    
    2,595Total shareholders equity
    
    
    1,939,661
    
    
    
    1,834,705Total liabilities and shareholders equity
    
    $
    2,514,693
    
    
    $
    2,362,492
 
 *
    
    Amounts are derived from the December 31, 2006 audited consolidated financial statements.  4




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##### Table of Contents



NOVELLUS SYSTEMS, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 Six Months EndedJune 30,
    
    
    July 1,2007
    
    
    2006(In thousands)Cash flows from operating activities:Net income
    
    $
    111,128
    
    
    $
    77,422Adjustments to reconcile net income to net cash provided by operating activities:Loss on disposal of property and equipment
    
    
    50
    
    
    
    1,665Non-cash portion of restructuring and other charges
    
    
    
    
    
    
    10,199Depreciation and amortization
    
    
    33,817
    
    
    
    36,959Deferred income taxes
    
    
    15,910
    
    
    
    (11,334
    )Stock-based compensation
    
    
    18,022
    
    
    
    17,600Tax benefit from stock-based compensation
    
    
    2,836
    
    
    
    12,251Excess tax benefit from stock-based compensation
    
    
    (649
    )
    
    
    (7,393
    )Other non-cash charges, net
    
    
    1,392
    
    
    
    Cumulative effect of a change in accounting principle
    
    
    
    
    
    
    (1,542
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    (112,119
    )
    
    
    (38,753
    )Inventories
    
    
    (33,851
    )
    
    
    (26,784
    )Prepaid and other assets
    
    
    (15,331
    )
    
    
    8,202Accounts payable
    
    
    10,135
    
    
    
    791Accrued payroll and related expenses
    
    
    (10,660
    )
    
    
    7,404Accrued warranty
    
    
    3,257
    
    
    
    5,351Other liabilities
    
    
    19,504
    
    
    
    703Income taxes payable
    
    
    9,820
    
    
    
    18,376Deferred profit
    
    
    14,160
    
    
    
    11,439Net cash provided by operating activities
    
    
    67,421
    
    
    
    122,556Cash flows from investing activities:Proceeds from sales of short-term investments
    
    
    465,106
    
    
    
    300,248Proceeds from maturities of short-term investments
    
    
    124,695
    
    
    
    98,314Purchases of short-term investments
    
    
    (593,364
    )
    
    
    (245,011
    )Capital expenditures
    
    
    (20,528
    )
    
    
    (20,890
    )Proceeds from sale of property and equipment
    
    
    275
    
    
    
    Increase in restricted cash and cash equivalents
    
    
    (4,432
    )
    
    
    (7,483
    )Other investing activities
    
    
    
    
    
    
    3,289Net cash (used in) provided by investing activities
    
    
    (28,248
    )
    
    
    128,467Cash flows from financing activities:Proceeds from employee stock compensation plans
    
    
    29,940
    
    
    
    9,538Proceeds from (repayments of) lines of credit, net
    
    
    (1,941
    )
    
    
    712Payments on long-term debt
    
    
    (21
    )
    
    
    (4,435
    )Repurchases of common stock
    
    
    (56,830
    )
    
    
    (239,897
    )Excess tax benefit from stock-based compensation
    
    
    649
    
    
    
    7,393Net cash used in financing activities
    
    
    (28,203
    )
    
    
    (226,689
    )Effects of exchange rate changes on cash and cash equivalents
    
    
    943
    
    
    
    (1,425
    )Net increase in cash and cash equivalents
    
    
    11,913
    
    
    
    22,909Cash and cash equivalents at the beginning of the period
    
    
    58,463
    
    
    
    40,403Cash and cash equivalents at the end of the period
    
    $
    70,376
    
    
    $
    63,312
  5




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




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OCI(In thousands)Balance as of December 31, 2006
    
    $
    (329
    )Net change on cash flow hedges
    
    
    (2,976
    )Reclassification to net sales
    
    
    329Balance as of March 31, 2007
    
    
    (2,976
    )Net change on cash flow hedges
    
    
    3,868Reclassification to net sales
    
    
    913Balance as of June 30, 2007
    
    $
    1,805
  Net Investment Hedges 
 Fair Value Hedges 
 Recent Accounting Pronouncements
    7




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Note 2. Net Income Per Share
    Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    July 1,
    
    
    June 30,
    
    
    July 1,2007
    
    
    2006
    
    
    2007
    
    
    2006(In thousands, except per share amounts)Numerator:Net income
    
    $
    57,345
    
    
    $
    52,705
    
    
    $
    111,128
    
    
    $
    77,422Denominator:Basic weighted-average shares outstanding
    
    
    123,788
    
    
    
    125,124
    
    
    
    123,887
    
    
    
    128,113Dilutive common equivalent shares
    
    
    2,842
    
    
    
    786
    
    
    
    2,905
    
    
    
    974Diluted weighted-average shares outstanding
    
    
    126,630
    
    
    
    125,910
    
    
    
    126,792
    
    
    
    129,087Basic net income per share
    
    $
    0.46
    
    
    $
    0.42
    
    
    $
    0.90
    
    
    $
    0.61Diluted net income per share
    
    $
    0.45
    
    
    $
    0.42
    
    
    $
    0.88
    
    
    $
    0.60
  Note 3. Inventories
  June 30,
    
    
    December 31,2007
    
    
    2006(In thousands)Purchased and spare parts
    
    $
    173,894
    
    
    $
    152,727Work-in-process
    
    
    46,069
    
    
    
    30,524Finished goods
    
    
    13,382
    
    
    
    15,320Total inventories
    
    $
    233,345
    
    
    $
    198,571
 8




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##### Table of Contents



Note 4. Goodwill and Intangible Assets
 Goodwill
  IndustrialSemiconductor
    
    
    ApplicationsGroup
    
    
    Group
    
    
    Total(In thousands)Balance as of December 31, 2006
    
    $
    109,059
    
    
    $
    116,372
    
    
    $
    225,431Foreign currency translation and other adjustments
    
    
    1,326
    
    
    
    1,819
    
    
    
    3,145Balance as of March 31, 2007
    
    $
    110,385
    
    
    $
    118,191
    
    
    $
    228,576Foreign currency translation and other adjustments
    
    
    
    
    
    
    1,074
    
    
    
    1,074Balance as of June 30, 2007
    
    $
    110,385
    
    
    $
    119,265
    
    
    $
    229,650
  Intangible Assets
  WeightedAverageAmortization
    
    
    
    
    
    
    AccumulatedJune 30, 2007
    
    Period
    
    
    Gross
    
    
    Amortization
    
    
    Net(Years)
    
    
    
    
    
    
    (In thousands)Patents and other intangibles
    
    
    12
    
    
    $
    16,649
    
    
    $
    (957
    )
    
    $
    15,692Developed technology
    
    
    6
    
    
    
    29,256
    
    
    
    (19,120
    )
    
    
    10,136Tradename
    
    
    10
    
    
    
    6,829
    
    
    
    (2,049
    )
    
    
    4,780Total
    
    
    8
    
    
    $
    52,734
    
    
    $
    (22,126
    )
    
    $
    30,608
 WeightedAverageAmortization
    
    
    
    
    
    
    AccumulatedDecember 31, 2006
    
    Period
    
    
    Gross
    
    
    Amortization
    
    
    Net(Years)
    
    
    
    
    
    
    (In thousands)Patents and other intangibles
    
    
    11
    
    
    $
    20,707
    
    
    $
    (2,164
    )
    
    $
    18,543Developed technology
    
    
    6
    
    
    
    28,995
    
    
    
    (16,555
    )
    
    
    12,440Tradename
    
    
    10
    
    
    
    6,663
    
    
    
    (1,666
    )
    
    
    4,997Total
    
    
    8
    
    
    $
    56,365
    
    
    $
    (20,385
    )
    
    $
    35,980
  Note 5. Product Warranty
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    July 1,
    
    
    June 30,
    
    
    July 1,2007
    
    
    2006
    
    
    2007
    
    
    2006(In thousands)Balance, beginning of period
    
    $
    55,236
    
    
    $
    55,822
    
    
    $
    55,349
    
    
    $
    54,553Warranties issued
    
    
    24,535
    
    
    
    24,386
    
    
    
    42,896
    
    
    
    44,786Settlements
    
    
    (21,112
    )
    
    
    (19,882
    )
    
    
    (39,729
    )
    
    
    (40,995
    )Net changes in liability for pre-existing warranties, including expirations
    
    
    (9
    )
    
    
    (243
    )
    
    
    134
    
    
    
    1,739Balance, end of period
    
    $
    58,650
    
    
    $
    60,083
    
    
    $
    58,650
    
    
    $
    60,083
 9




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##### Table of Contents



Note 6. Restructuring and Other Charges
      FacilitiesRestructuringLiability(In thousands)Balance as of December 31, 2006
    
    $
    17,503Cash payments
    
    
    (1,039
    )Balance as of March 31, 2007
    
    
    16,464Cash payments
    
    
    (764
    )Balance as of June 30, 2007
    
    $
    15,700
  Note 7. Long-Term Obligations
  Note 8. Other Income, Net
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    July 1,
    
    
    June 30,
    
    
    July 1,2007
    
    
    2006
    
    
    2007
    
    
    2006(In thousands)Other income
    
    $
    3,588
    
    
    $
    640
    
    
    $
    5,019
    
    
    $
    1,157Other expense
    
    
    
    
    
    
    (12
    )
    
    
    (103
    )
    
    
    (271
    )Foreign currency gain, net
    
    
    2,591
    
    
    
    1,815
    
    
    
    4,400
    
    
    
    2,604Total other income, net
    
    $
    6,179
    
    
    $
    2,443
    
    
    $
    9,316
    
    
    $
    3,490
 10




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##### Table of Contents



Note 9. Comprehensive Income
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    July 1,
    
    
    June 30,
    
    
    July 1,2007
    
    
    2006
    
    
    2007
    
    
    2006(In thousands)Net income
    
    $
    57,345
    
    
    $
    52,705
    
    
    $
    111,128
    
    
    $
    77,422Other comprehensive income:Foreign currency translation adjustments
    
    
    (752
    )
    
    
    (760
    )
    
    
    (330
    )
    
    
    968Unrealized gain (loss) on short-term investments
    
    
    (886
    )
    
    
    869
    
    
    
    (1,121
    )
    
    
    2,032Unrealized gain (loss) on derivative instruments
    
    
    4,781
    
    
    
    (1,856
    )
    
    
    2,134
    
    
    
    (1,815
    )Unrealized gain on minimum pension liability adjustment
    
    
    11
    
    
    
    
    
    
    
    7
    
    
    
    Comprehensive income
    
    $
    60,499
    
    
    $
    50,958
    
    
    $
    111,818
    
    
    $
    78,607
  June 30,
    
    
    December 31,2007
    
    
    2006(In thousands)Foreign currency translation adjustments
    
    $
    3,248
    
    
    $
    3,578Unrealized gain (loss) on short-term investments
    
    
    (897
    )
    
    
    224Unrealized gain (loss) on derivative instruments
    
    
    1,805
    
    
    
    (329
    )Unrealized loss on minimum pension liability adjustment
    
    
    (871
    )
    
    
    (878
    )Accumulated other comprehensive income
    
    $
    3,285
    
    
    $
    2,595
 Note 10. Litigation
 Linear Technology Corporation
  Derivative Litigation
 Joshua Teitelbaum, in the right of and for the benefit of
Novellus Systems, Inc., v. Richard S. Hill, Jeffrey C. Benzing, D. James Guzy, Tom Long, Robert H.
Smith, Neil R. Bonke, Youssef A. El-Mansy, J. David Litster, Yoshio Nishi, Glen G. Possley, Ann D.
Rhoads, William R. Spivey and Delbert A. Whitaker, as defendants, and the Company as a Nominal
Defendant Alaska Electrical
Pension Fund, on behalf of Novellus Systems, Inc., v. Richard S. Hill, Jeffrey C. Benzing, William
H. Kurtz, Neil R. Bonke, Youssef A. El-Mansy,
 11




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##### Table of Contents



J. David Litster, Yoshio Nishi, Glen G. Possley, Ann D. Rhoads, William R. Spivey and
Delbert Whitaker, as defendants, and the Company as a Nominal Defendant
  Other Litigation
  Note 11. Stock-Based Compensation
    Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    July 1,
    
    
    June 30,
    
    
    July 1,2007
    
    
    2006
    
    
    2007
    
    
    2006(In thousands)(1)
    
    
    (2)
    
    
    (1)
    
    
    (2)Cost of sales
    
    $
    565
    
    
    $
    538
    
    
    $
    1,075
    
    
    $
    846Selling, general and administrative
    
    
    5,248
    
    
    
    5,590
    
    
    
    10,945
    
    
    
    11,029Research and development
    
    
    3,107
    
    
    
    2,664
    
    
    
    6,002
    
    
    
    5,725Stock-based compensation expense before income taxes
    
    
    8,920
    
    
    
    8,792
    
    
    
    18,022
    
    
    
    17,600Income tax benefit
    
    
    (2,080
    )
    
    
    (3,385
    )
    
    
    (4,356
    )
    
    
    (6,776
    )Total stock-based compensation expense after income taxes
    
    $
    6,840
    
    
    $
    5,407
    
    
    $
    13,666
    
    
    $
    10,824
 
 (1)
    
    Amounts include amortization expense related to stock options of $5.0 million and $9.9
million, employee stock purchase plan of $0.9 million and $1.4 million, and restricted stock
awards of $3.1 million and $6.7 million for the three and six months ended June 30, 2007,
respectively. 12




---



##### Table of Contents



(2)
    
    Amounts include amortization expense related to stock options of $6.5 million and $12.9
million, employee stock purchase plan of $0.6 million and $1.2 million, and restricted stock
awards of $1.7 million and $3.5 million for the three and six months ended July 1, 2006,
respectively.  Three Months Ended
    
    Six Months EndedJune 30,
    
    July 1,
    
    June 30,
    
    July 1,Options
    
    2007
    
    2006
    
    2007
    
    2006Risk-free interest rate
    
    
    4.8
    %
    
    
    5.1
    %
    
    
    4.8
    %
    
    
    4.9
    %Volatility
    
    
    47.3
    %
    
    
    49.4
    %
    
    
    47.3
    %
    
    
    49.2
    %Expected term
    
    4.4 years
    
    
    4.3 years
    
    
    4.4 years
    
    
    4.3 yearsDividends
    
    None
    
    
    None
    
    
    None
    
    
    NoneWeighted-average fair value at grant date
    
    $
    13.78
    
    
    $
    10.85
    
    
    $
    13.86
    
    
    $
    11.12
 Three Months Ended
    
    Six Months EndedJune 30,
    
    July 1,
    
    June 30,
    
    July 1,ESPP
    
    2007
    
    2006
    
    2007
    
    2006Risk-free interest rate
    
    
    5.0
    %
    
    
    5.0
    %
    
    
    5.1
    %
    
    
    5.0
    %Volatility
    
    
    32.5
    %
    
    
    32.0
    %
    
    
    33.3
    %
    
    
    32.0
    %Expected term
    
    6 months
    
    
    6 months
    
    
    6 months
    
    
    6 monthsDividends
    
    None
    
    
    None
    
    
    None
    
    
    NoneWeighted-average fair value at grant date
    
    $
    7.59
    
    
    $
    6.07
    
    
    $
    7.22
    
    
    $
    6.07
   Weighted-AverageRemainingNumber of
    
    
    Weighted-Average
    
    
    Contractual
    
    
    AggregateShares
    
    
    Exercise Price
    
    
    Term (in Years)
    
    
    Intrinsic Value(In thousands)
    
    
    
    
    
    
    
    
    
    
    (In thousands)Outstanding as of December 31, 2006
    
    
    22,899
    
    
    $
    32.16
    
    
    
    6.23
    
    
    $
    102,527Grants
    
    
    351
    
    
    
    31.12Exercises
    
    
    (932
    )
    
    
    25.55Forfeitures or expirations
    
    
    (769
    )
    
    
    35.04Outstanding as of June 30, 2007
    
    
    21,549
    
    
    $
    32.33
    
    
    
    5.82
    
    
    $
    23,111Vested and expected to vest as of June 30, 2007
    
    
    20,716
    
    
    $
    32.44
    
    
    
    5.70
    
    
    $
    21,988Exercisable as of June 30, 2007
    
    
    15,919
    
    
    $
    33.56
    
    
    
    4.81
    
    
    $
    14,711
  13




---



##### Table of Contents



Weighted-AverageNumber of
    
    
    Grant DateShares
    
    
    Fair Value(In thousands)Unvested restricted stock awards as of December 31, 2006
    
    
    1,894
    
    
    $
    29.68Granted
    
    
    80
    
    
    
    31.46Vested
    
    
    (47
    )
    
    
    25.46Forfeited
    
    
    (106
    )
    
    
    28.83Unvested restricted stock awards as of June 30, 2007
    
    
    1,821
    
    
    $
    29.93
  Note 12. Operating Segments
    Three Months Ended June 30, 2007
    
    Six Months Ended June 30, 2007(In thousands)Industrial
    
    
    
    
    
    
    
    
    
    IndustrialSemiconductor
    
    Applications
    
    
    
    
    
    Semiconductor
    
    ApplicationsGroup
    
    Group
    
    Consolidated
    
    Group
    
    Group
    
    ConsolidatedSales to unaffiliated customers
    
    $
    380,207
    
    
    $
    36,128
    
    
    $
    416,335
    
    
    $
    744,402
    
    
    $
    68,907
    
    
    $
    813,309Operating income
    
    $
    69,142
    
    
    $
    3,583
    
    
    $
    72,725
    
    
    $
    133,285
    
    
    $
    6,849
    
    
    $
    140,134Three Months Ended July 1, 2006
    
    Six Months Ended July 1, 2006(In thousands)Industrial
    
    
    
    
    
    
    
    
    
    IndustrialSemiconductor
    
    Applications
    
    
    
    
    
    Semiconductor
    
    ApplicationsGroup
    
    Group
    
    Consolidated
    
    Group
    
    Group
    
    ConsolidatedSales to unaffiliated customers
    
    $
    380,333
    
    
    $
    29,740
    
    
    $
    410,073
    
    
    $
    724,425
    
    
    $
    51,554
    
    
    $
    775,979Operating income
    
    $
    71,932
    
    
    $
    3,223
    
    
    $
    75,155
    
    
    $
    100,813
    
    
    $
    3,738
    
    
    $
    104,551
 14




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##### Table of Contents



Note 13. Related Party Transactions
    
 ITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 Cautionary Note Regarding Forward-Looking Statements
  15




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##### Table of Contents



Introduction
  
    
    Overview of our Business and Industry;
    
    Results of Operations;
    
    Critical Accounting Policies; and
    
    Liquidity and Capital Resources.
 16




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##### Table of Contents



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




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##### Table of Contents



Results of Operations
 Net Sales
 Three Months Ended
    
    
    Six Months EndedJune 30, 2007
    
    
    March 31, 2007
    
    
    July 1, 2006
    
    
    June 30, 2007
    
    
    July 1, 2006(In thousands)Semiconductor Group
    
    $
    380,207
    
    
    $
    364,195
    
    
    $
    380,333
    
    
    $
    744,402
    
    
    $
    724,425Industrial Applications Group
    
    
    36,128
    
    
    
    32,779
    
    
    
    29,740
    
    
    
    68,907
    
    
    
    51,554Net sales
    
    $
    416,335
    
    
    $
    396,974
    
    
    $
    410,073
    
    
    $
    813,309
    
    
    $
    775,979
    Three Months Ended
    
    Six Months EndedJune 30, 2007
    
    March 31, 2007
    
    July 1, 2006
    
    June 30, 2007
    
    July 1, 2006North America
    
    
    29
    %
    
    
    22
    %
    
    
    29
    %
    
    
    26
    %
    
    
    31
    %Europe
    
    
    6
    %
    
    
    7
    %
    
    
    9
    %
    
    
    6
    %
    
    
    8
    %Asia
    
    
    65
    %
    
    
    71
    %
    
    
    62
    %
    
    
    68
    %
    
    
    61
    %
  Gross Profit
 Three Months Ended
    
    Six Months EndedJune 30, 2007
    
    March 31, 2007
    
    July 1, 2006
    
    June 30, 2007
    
    July 1, 2006(Dollars in thousands)Gross profit
    
    $
    208,110
    
    
    $
    194,909
    
    
    $
    204,764
    
    
    $
    403,019
    
    
    $
    372,304Gross margin
    
    
    50
    %
    
    
    49
    %
    
    
    50
    %
    
    
    50
    %
    
    
    48
    %
  Selling, General and Administrative (SG&A)
 Three Months Ended
    
    Six Months EndedJune 30, 2007
    
    March 31, 2007
    
    July 1, 2006
    
    June 30, 2007
    
    July 1, 2006(Dollars in thousands)SG&A expense
    
    $
    72,011
    
    
    $
    67,100
    
    
    $
    66,311
    
    
    $
    139,111
    
    
    $
    124,793% of net sales
    
    
    17
    %
    
    
    17
    %
    
    
    16
    %
    
    
    17
    %
    
    
    16
    %
 18




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##### Table of Contents



Research and Development (R&D)
 Three Months Ended
    
    Six Months EndedJune 30, 2007
    
    March 31, 2007
    
    July 1, 2006
    
    June 30, 2007
    
    July 1, 2006(Dollars in thousands)R&D expense
    
    $
    63,374
    
    
    $
    60,400
    
    
    $
    63,298
    
    
    $
    123,774
    
    
    $
    127,081% of net sales
    
    
    15
    %
    
    
    15
    %
    
    
    15
    %
    
    
    15
    %
    
    
    16
    %
   Interest and Other Income, Net
 Three Months Ended
    
    Six Months EndedJune 30, 2007
    
    March 31, 2007
    
    July 1, 2006
    
    June 30, 2007
    
    July 1, 2006(Dollars in thousands)Interest and other income, net
    
    $
    14,597
    
    
    $
    11,107
    
    
    $
    7,611
    
    
    $
    25,704
    
    
    $
    13,690% of net sales
    
    
    4
    %
    
    
    3
    %
    
    
    2
    %
    
    
    3
    %
    
    
    2
    %
  Income Taxes
  19




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##### Table of Contents



Critical Accounting Policies
  Liquidity and Capital Resources
        20




---



##### Table of Contents



ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 ITEM 4: CONTROLS AND PROCEDURES
 Quarterly Evaluation of Our Disclosure Controls and Internal Controls
  CEO and CFO Certifications
  Disclosure Controls and Internal Controls for Financial Reporting
  Limitations on the Effectiveness of Controls
  21




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##### Table of Contents



Scope of the Controls Evaluation
  Conclusions
  
 PART II: OTHER INFORMATION
 
 ITEM 1: LEGAL PROCEEDINGS
  Linear Technology Corporation
  Derivative Litigation
 Joshua Teitelbaum, in the right of and for the benefit of
Novellus Systems, Inc., v. Richard S. Hill, Jeffrey C. Benzing, D. James Guzy, Tom Long, Robert H.
Smith, Neil R. Bonke, Youssef A. El-Mansy, J. David Litster, Yoshio Nishi, Glen G. Possley, Ann D.
Rhoads, William R. Spivey and Delbert A. Whitaker, as defendants, and the Company as a Nominal
Defendant
 22




---



##### Table of Contents



Other Litigation
  
 ITEM 1A: RISK FACTORS
  Rapid technological change in the semiconductor industry requires substantial research and
development expenditures and responsiveness to customer needs.
    Cyclical downturns in the semiconductor industry negatively impact demand for our equipment.
  23




---



##### Table of Contents



The competitive and capital-intensive nature of the semiconductor industry increases the
difficulty of maintaining gross margin and maintaining and capturing market share.
  We are exposed to risks associated with outsourcing activities, which could result in supply
shortages that could affect our ability to meet customer demands.
   The loss of key employees could harm our business and operations.
  24




---



##### Table of Contents



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




---



##### Table of Contents



Changes in tax rates or liabilities could negatively impact our future results.
  
    
    Changes in the regulatory environment;
    
    Changes in accounting and tax standards or practices; and
    
    Overall business conditions in the semiconductor equipment industry.
 We are subject to litigation proceedings that could adversely affect our business.
 Intellectual Property Litigation
  Other Litigation
  26




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##### Table of Contents



We are exposed to risks associated with our diversification strategy.
  We are exposed to risks associated with our investment activities.
  We are exposed to risks related to our indemnification of third parties.
  We face risks associated with acquisitions.
  
    
    Difficulties in integrating the operations, technologies, products and personnel of acquired companies;
    
    Lack of synergies or the inability to realize expected synergies and cost-savings;
 27




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##### Table of Contents




    
    Revenue and expense levels of acquired entities differing from those anticipated at the time of the acquisitions;
    
    Difficulties in managing geographically dispersed operations;
    
    The potential loss of key employees, customers and strategic partners of acquired companies;
    
    Claims by terminated employees, shareholders of acquired companies or other third parties related to the transaction;
    
    The issuance of dilutive securities, assumption or incurrence of additional debt obligations or expenses, or use of
substantial portions of our cash;
    
    Diversion of managements attention from normal daily operations of the business; and
    
    The impairment of acquired intangible assets as a result of technological advancements, or worse-than-expected performance
of acquired companies.
  Our quarterly operating results and stock price are unpredictable.
  
    
    Building our systems according to forecast, instead of limited backlog information, which hinders our ability to plan
production and inventory levels;
    
    Unpredictability of demand for and variability of mix of our products in our forecast, which can cause unexpected positive
or negative inventory adjustments in a particular period;
    
    Variability in manufacturing yields;
    
    Failure to receive anticipated orders in time to permit shipment during the quarter;
    
    Timing and cancellation of customer orders and shipments, including deferring orders of our existing products due to new
product announcements by us and/or our competitors;
    
    Changing demand for and sales of lower-margin products relative to higher-margin products;
    
    Competitive pricing pressures;
    
    The effect of revenue recognized upon acceptance with little or no associated costs; and
    
    Fluctuation in warranty costs.
 Compliance with current and future environmental regulations may be costly.
  28




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##### Table of Contents



ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 Repurchase of Company Securities
 TotalNumber of
    
    ApproximateShares
    
    Dollar ValuePurchased as
    
    of SharesPart of
    
    that May yetPublicly
    
    be PurchasedTotal Number
    
    Average
    
    Announced
    
    Under theof Shares
    
    Price Paid
    
    Plans or
    
    Plans orPeriod
    
    Purchased
    
    Per Share
    
    Programs
    
    ProgramsApril 1, 2007 through May 5, 2007
    
    
    457,000
    
    
    $
    32.38
    
    
    
    457,000
    
    
    $598.5 millionMay 6, 2007 through June 2, 2007
    
    
    842,550
    
    
    $
    31.30
    
    
    
    842,550
    
    
    $572.1 millionJune 3, 2007 through June 30, 2007
    
    
    531,149
    
    
    $
    29.47
    
    
    
    531,149
    
    
    $556.5 millionTotal
    
    
    1,830,699
    
    
    $
    31.04
    
    
    
    1,830,699
    
    
    $556.5 million
 
   
 ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
   Name
of Nominee
    
    Voted For
    
    Voted AgainstRichard S. Hill
    
    
    104,174,707
    
    
    
    2,817,226Neil R. Bonke
    
    
    104,855,875
    
    
    
    2,136,058Youssef A. El-Mansy
    
    
    95,221,128
    
    
    
    11,770,805J. David Litster
    
    
    95,246,539
    
    
    
    11,745,394Yoshio Nishi
    
    
    95,210,309
    
    
    
    11,781,624Glen G. Possley
    
    
    103,508,345
    
    
    
    3,483,588Ann D. Rhoads
    
    
    104,848,123
    
    
    
    2,143,810William R. Spivey
    
    
    93,895,067
    
    
    
    13,096,866Delbert A. Whitaker
    
    
    104,859,763
    
    
    
    2,132,170
 29




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##### Table of Contents



Voted For
    
    Voted Against
    
    Abstain
    
    Broker Non-Votes66,702,686
    
    24,944,628
    
    942,003
    
    14,402,616
  Voted For
    
    Voted Against
    
    Abstain
    
    Broker Non-Votes88,998,692
    
    2,777,416
    
    813,209
    
    14,402,616
  Voted For
    
    Voted Against
    
    Abstain
    
    Broker Non-Votes103,780,831
    
    2,428,158
    
    782,943
    
    
 
 ITEM 6: EXHIBITS
  *10.4
    
    Novellus Amended and Restated 1992 Employee Stock Purchase Plan, as amended and restated.*10.10
    
    Novellus 2001 Stock Incentive Plan, as amended and restated.31.1
    
    Certification of Richard S. Hill, Chairman of the Board of Directors and Chief Executive
Officer of Novellus Systems, Inc. dated August 7, 2007 in accordance with Rules 13a-14(a)
and 15d-14(a) of the Securities Exchange Act, as amended, as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of William H. Kurtz, Executive Vice President and Chief Financial Officer
of Novellus Systems, Inc. dated August 7, 2007 in accordance with Rules 13a-14(a) and
15d-14(a) of the Securities Exchange Act, as amended, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Richard S. Hill, Chairman of the Board of Directors and Chief Executive
Officer of Novellus Systems, Inc. dated August 7, 2007 in accordance with 18 U.S.C. 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of William H. Kurtz, Executive Vice President and Chief Financial Officer
of Novellus Systems, Inc. dated August 7, 2007 in accordance with 18 U.S.C. 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
    
    Management contracts or compensatory plans or arrangements.
 30




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##### Table of Contents



SIGNATURES
  NOVELLUS SYSTEMS, INC.By:
    
    /s/ William H. KurtzWilliam H. KurtzExecutive Vice President and Chief Financial Officer(Principal Financial Officer)August 7, 2007
 31




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##### Table of Contents



EXHIBIT INDEX
 *10.4
    
    Novellus Amended and Restated 1992 Employee Stock Purchase Plan, as amended and restated.*10.10
    
    Novellus 2001 Stock Incentive Plan, as amended and restated.31.1
    
    Certification of Richard S. Hill, Chairman of the Board of Directors and Chief Executive
Officer of Novellus Systems, Inc. dated August 7, 2007 in accordance with Rules 13a-14(a)
and 15d-14(a) of the Securities Exchange Act, as amended, as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of William H. Kurtz, Executive Vice President and Chief Financial Officer
of Novellus Systems, Inc. dated August 7, 2007 in accordance with Rules 13a-14(a) and
15d-14(a) of the Securities Exchange Act, as amended, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Richard S. Hill, Chairman of the Board of Directors and Chief Executive
Officer of Novellus Systems, Inc. dated August 7, 2007 in accordance with 18 U.S.C. 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of William H. Kurtz, Executive Vice President and Chief Financial Officer
of Novellus Systems, Inc. dated August 7, 2007 in accordance with 18 U.S.C. 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
    
    Management contracts or compensatory plans or arrangements.