##### 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 April 1, 2006
 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




---



##### 



NOVELLUS SYSTEMS, INC.
FORM 10-Q
QUARTER ENDED APRIL 1, 2006
 TABLE OF CONTENTS
  
 PagePart I: Financial Information
    
    
    3Item 1: Condensed Consolidated Financial Statements
    
    
    3Condensed Consolidated Statements of Operations for the quarters ended April 1, 2006 and April 2, 2005
    
    
    3Condensed Consolidated Balance Sheets as of April 1, 2006 and December 31, 2005
    
    
    4Condensed Consolidated Statements of Cash Flows for the quarters ended April 1, 2006 and April 2, 2005
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2: Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    18Item 3: Quantitative and Qualitative Disclosures About Market Risk
    
    
    28Item 4: Controls and Procedures
    
    
    28Part II: Other Information
    
    
    29Item 1: Legal Proceedings
    
    
    29Item 1A: Risk Factors
    
    
    29Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    35Item 6: Exhibits
    
    
    35Signatures
    
    
    37EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




---



##### 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)
 Quarters EndedApril 1, 2006
    
    
    April 2, 2005Net sales
    
    $
    365,906
    
    
    $
    339,740Cost of sales
    
    
    198,366
    
    
    
    185,871Gross profit
    
    
    167,540
    
    
    
    153,869Operating expenses:Selling, general and administrative
    
    
    58,482
    
    
    
    51,760Research and development
    
    
    63,783
    
    
    
    62,048Restructuring and other charges
    
    
    12,629
    
    
    
    Legal settlement
    
    
    3,250
    
    
    
    Total operating expenses
    
    
    138,144
    
    
    
    113,808Operating income
    
    
    29,396
    
    
    
    40,061Interest income, net
    
    
    5,032
    
    
    
    3,060Other income, net
    
    
    1,047
    
    
    
    409Interest and other income, net
    
    
    6,079
    
    
    
    3,469Income before provision for income taxes and cumulative
effect of a change in accounting principle
    
    
    35,475
    
    
    
    43,530Provision for income taxes
    
    
    11,706
    
    
    
    13,059Income before cumulative effect of a change in
accounting principle
    
    
    23,769
    
    
    
    30,471Cumulative effect of a change in accounting principle, net
of tax of $594 for the quarter ended April 1, 2006
    
    
    948
    
    
    
    Net income
    
    $
    24,717
    
    
    $
    30,471Net income per share:Basic:Income before cumulative effect of a change in
accounting principle
    
    $
    0.18
    
    
    $
    0.22Cumulative effect of a change in accounting principle
    
    
    0.01
    
    
    
    Basic net income per share
    
    $
    0.19
    
    
    $
    0.22Diluted:Income before cumulative effect of a change in
accounting principle
    
    $
    0.18
    
    
    $
    0.22Cumulative effect of a change in accounting principle
    
    
    0.01
    
    
    
    Diluted net income per share
    
    $
    0.19
    
    
    $
    0.22Shares used in basic per share calculations
    
    
    131,102
    
    
    
    139,890Shares used in diluted per share calculations
    
    
    132,264
    
    
    
    141,099
  3




---



##### Table of Contents



NOVELLUS
SYSTEMS, INC.
 
 CONDENSED
CONSOLIDATED BALANCE SHEETS
 (In thousands)
 April 1,
    
    
    December 31,2006
    
    
    2005 *(unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    45,249
    
    
    $
    40,403Short-term investments
    
    
    566,722
    
    
    
    608,837Accounts receivable, net
    
    
    415,629
    
    
    
    397,534Inventories
    
    
    223,559
    
    
    
    193,787Deferred tax assets, net
    
    
    89,678
    
    
    
    88,563Prepaid and other current assets
    
    
    29,054
    
    
    
    34,388Total current assets
    
    
    1,369,891
    
    
    
    1,363,512Property and equipment, net
    
    
    403,638
    
    
    
    423,749Restricted cash and cash equivalents
    
    
    141,902
    
    
    
    140,212Goodwill
    
    
    256,198
    
    
    
    255,584Intangibles and other assets
    
    
    105,324
    
    
    
    107,192Total assets
    
    $
    2,276,953
    
    
    $
    2,290,249LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    95,852
    
    
    $
    83,710Accrued payroll and related expenses
    
    
    50,386
    
    
    
    57,450Accrued warranty
    
    
    55,822
    
    
    
    54,553Other accrued liabilities
    
    
    58,050
    
    
    
    58,271Income taxes payable
    
    
    11,247
    
    
    
    5,898Deferred profit
    
    
    62,231
    
    
    
    68,718Current obligations under lines of credit
    
    
    11,210
    
    
    
    15,744Total current liabilities
    
    
    344,798
    
    
    
    344,344Long term debt
    
    
    126,963
    
    
    
    124,858Other non-current liabilities
    
    
    43,833
    
    
    
    41,764Total liabilities
    
    
    515,594
    
    
    
    510,966Shareholders equity:Common stock
    
    
    1,387,193
    
    
    
    1,393,805Retained earnings
    
    
    373,771
    
    
    
    388,015Accumulated other comprehensive income (loss)
    
    
    395
    
    
    
    (2,537
    )Total shareholders equity
    
    
    1,761,359
    
    
    
    1,779,283Total liabilities and shareholders equity
    
    $
    2,276,953
    
    
    $
    2,290,249
   4




---



##### Table of Contents



NOVELLUS
SYSTEMS, INC.
 
 CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
 (In thousands)
(Unaudited)
 Quarters EndedApril 1,
    
    
    April 2,2006
    
    
    2005Cash flows from operating activities:Net income
    
    $
    24,717
    
    
    $
    30,471Adjustments to reconcile net income to net cash provided by operating activities:Loss on disposal of fixed assets
    
    
    1,449
    
    
    
    287Non-cash portion of restructuring and other charges
    
    
    10,199
    
    
    
    Depreciation and amortization
    
    
    19,298
    
    
    
    21,275Deferred income taxes
    
    
    (714
    )
    
    
    (1,158
    )Stock-based compensation
    
    
    9,108
    
    
    
    1,213Tax benefit from equity awards
    
    
    6,328
    
    
    
    Excess tax benefit from stock-based compensation
    
    
    (3,820
    )
    
    
    Cumulative effect of a change in accounting principle
    
    
    (1,542
    )
    
    
    Changes in operating assets and liabilities:Accounts receivable
    
    
    (17,584
    )
    
    
    43,526Inventories
    
    
    (34,105
    )
    
    
    9,300Prepaid and other current assets
    
    
    5,442
    
    
    
    (5,618
    )Accounts payable
    
    
    12,076
    
    
    
    (3,193
    )Accrued payroll and related expenses
    
    
    (3,346
    )
    
    
    (21,889
    )Accrued warranty
    
    
    1,229
    
    
    
    2,554Other accrued liabilities
    
    
    2,107
    
    
    
    (825
    )Income taxes payable
    
    
    6,342
    
    
    
    12,412Deferred profit
    
    
    (6,540
    )
    
    
    1,095Net cash provided by operating activities
    
    
    30,644
    
    
    
    89,450Cash flows from investing activities:Proceeds from sales of short-term investments
    
    
    139,813
    
    
    
    43,750Proceeds from maturities of short-term investments
    
    
    48,103
    
    
    
    49,813Purchases of short-term investments
    
    
    (141,410
    )
    
    
    (161,356
    )Capital expenditures
    
    
    (9,104
    )
    
    
    (15,396
    )Proceeds from sale of property and equipment
    
    
    
    
    
    
    2,591Decrease in other assets
    
    
    924
    
    
    
    1,600Decrease (increase) in restricted cash and cash equivalents
    
    
    (1,790
    )
    
    
    5,302Net cash provided by (used in) investing activities
    
    
    36,536
    
    
    
    (73,696
    )Cash flows from financing activities:Proceeds from employee stock compensation plans
    
    
    4,562
    
    
    
    8,310Payments on lines of credit, net
    
    
    (4,534
    )
    
    
    (1,494
    )Payments on long-term debt
    
    
    
    
    
    
    (5,288
    )Repurchases of common stock
    
    
    (68,082
    )
    
    
    Excess tax benefit from stock-based compensation
    
    
    3,820
    
    
    
    Net cash provided by (used in) financing activities
    
    
    (64,234
    )
    
    
    1,528Effects of exchange rate changes on cash and cash equivalents
    
    
    1,900
    
    
    
    964Net change in cash and cash equivalents
    
    
    4,846
    
    
    
    18,246Cash and cash equivalents at beginning of period
    
    
    40,403
    
    
    
    106,117Cash and cash equivalents at end of period
    
    $
    45,249
    
    
    $
    124,363
  5




---



##### Table of Contents



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




---



##### Table of Contents



Recent Accounting Pronouncements
   2. NET INCOME PER SHARE
    Quarters EndedApril 1,
    
    
    April 2,2006
    
    
    2005Numerator:Net income
    
    $
    24,717
    
    
    $
    30,471Denominator:Basic weighted-average shares outstanding
    
    
    131,102
    
    
    
    139,890Employee stock options and other
    
    
    1,162
    
    
    
    1,209Diluted weighted-average shares outstanding
    
    
    132,264
    
    
    
    141,099Basic net income per share
    
    $
    0.19
    
    
    $
    0.22Diluted net income per share
    
    $
    0.19
    
    
    $
    0.22
 7




---



##### Table of Contents



3. STOCK-BASED COMPENSATION
 Adoption of SFAS 123(R )
     Quarter EndedApril 1, 2006Cost of sales
    
    $
    308Selling, general and administrative
    
    
    5,439Research and development
    
    
    3,061Stock-based compensation expense before income taxes(1)
    
    
    8,808Income tax benefit
    
    
    (3,391
    )Total stock-based compensation expense after income taxes
    
    $
    5,417
 8




---



##### Table of Contents



Quarter EndedApril 1, 2006UsingPrevious
    
    
    SFAS 123(R)
    
    
    AsAccounting
    
    
    Adjustments
    
    
    ReportedIncome from operations
    
    $
    36,473
    
    
    $
    (7,077
    )
    
    $
    29,396Income before income taxes
    
    
    42,552
    
    
    
    (7,077
    )
    
    
    35,475Income before cumulative effect of a change in
accounting principle, net of tax
    
    
    28,121
    
    
    
    (4,352
    )
    
    
    23,769Net income
    
    
    28,121
    
    
    
    (3,404
    )
    
    
    24,717Basic earnings per sharePrior to cumulative effect of a change in accounting
principle
    
    $
    0.21
    
    
    $
    (0.03
    )
    
    $
    0.18Cumulative effect of a change in accounting
principle
    
    
    
    
    
    
    0.01
    
    
    
    0.01$
    0.21
    
    
    $
    (0.02
    )
    
    $
    0.19Diluted earnings per sharePrior to cumulative effect of a change in accounting
principle
    
    $
    0.21
    
    
    $
    (0.03
    )
    
    $
    0.18Cumulative effect of a change in accounting
principle
    
    
    
    
    
    
    0.01
    
    
    
    0.01$
    0.21
    
    
    $
    (0.02
    )
    
    $
    0.19Cash flows from operating activities
    
    
    34,464
    
    
    
    (3,820
    )
    
    
    30,644Cash flows from financing activities
    
    
    (68,054
    )
    
    
    3,820
    
    
    
    (64,234
    )
    9




---



##### Table of Contents



Quarter EndedApril 2, 2005Net income as reported
    
    
    $
    30,471Add:Intrinsic value method expense included in reported net
income, net of related tax effects
    
    
    
    849Less:Fair value method expense, net of related tax effects
    
    
    
    (10,573
    )Pro-forma net income
    
    
    $
    20,747Pro-forma basic and diluted net income per share
    
    
    $
    0.15Basic and diluted net income per share as reported
    
    
    $
    0.22
 Valuation Assumptions For Stock Options
 Valuation and Amortization Method
 Expected Term.
 Expected Volatility.
 Risk-Free Interest Rate.
 Dividends.
 Forfeitures.
  Quarters EndedApril 1,
    
    April 2,2006
    
    2005Risk-free interest rate
    
    
    4.5
    %
    
    
    3.3
    %Expected volatility
    
    
    48.6
    %
    
    
    70.0
    %Expected term
    
    4.3 years
    
    3.7 yearsExpected dividends
    
    None
    
    None
 10




---



##### Table of Contents



Stock Options
  Weighted-AverageNumber
    
    
    
    
    
    
    Remainingof
    

    Weighted-Average
    
    Contractual
    

    AggregateShares
    

    Exercise Price
    
    Term (in Years)
    

    Intrinsic ValueOutstanding at January 1, 2006
    
    
    24,137
    
    
    
    $
    31.79Grants
    
    
    79
    
    
    
    
    26.65Exercises
    
    
    (260
    )
    
    
    
    19.07Forfeitures or expirations
    
    
    (525
    )
    
    
    
    32.44Outstanding at April 1, 2006
    
    
    23,431
    
    
    
    $
    31.90
    
    
    
    6.4
    
    
    
    $
    11,655Vested and expected to vest at April 1, 2006
    
    
    22,617
    
    
    
    $
    31.01
    
    
    
    6.3
    
    
    
    $
    11,553Exercisable at April 1, 2006
    
    
    17,942
    
    
    
    $
    33.56
    
    
    
    5.7
    
    
    
    $
    10,995
    Restricted Stock Awards
  11




---



##### Table of Contents



Number
    
    Weighted-Averageof
    
    Grant DateShares
    
    Fair ValueUnvested restricted stock at January 1, 2006
    
    
    1,197
    
    
    $
    27.57Granted
    
    
    5
    
    
    
    27.67Vested
    
    
    (46
    )
    
    
    33.81Forfeited
    
    
    (24
    )
    
    
    29.34Unvested restricted stock at April 1, 2006
    
    
    1,132
    
    
    $
    27.30
  ESPP
  Quarters EndedApril 1,
    
    April 2,2006
    
    2005Risk-free interest rate
    
    
    4.3
    %
    
    
    2.1
    %Expected volatility
    
    
    31.5
    %
    
    
    40.0
    %Expected term
    
    6 months
    
    6 monthsExpected dividends
    
    None
    
    None
   4. OTHER INCOME, NET
  Quarters EndedApril 1,
    
    
    April 2,2006
    
    
    2005Other income
    
    $
    517
    
    
    $
    118Other expense
    
    
    (259
    )
    
    
    (125
    )Foreign currency gain, net
    
    
    789
    
    
    
    416Total other income, net
    
    $
    1,047
    
    
    $
    409
 12




---



##### Table of Contents



5. INVENTORIES
  April 1,
    
    
    December 31,2006
    
    
    2005Purchased and spare parts
    
    $
    164,705
    
    
    $
    152,763Work-in-process
    
    
    40,085
    
    
    
    27,110Finished goods
    
    
    18,769
    
    
    
    13,914Total inventories
    
    $
    223,559
    
    
    $
    193,787
 6. GOODWILL AND INTANGIBLE ASSETS
 Goodwill
  Quarters EndedApril 1, 2006
    
    
    April 2, 2005Industrial
    
    
    
    
    
    
    
    
    
    
    IndustrialSemiconductor
    
    
    Applications
    
    
    
    
    
    
    Semiconductor
    
    
    ApplicationsGroup
    
    
    Group
    
    
    Total
    
    
    Group
    
    
    Group
    
    
    TotalBalance, beginning of period
    
    $
    150,664
    
    
    $
    104,920
    
    
    $
    255,584
    
    
    $
    162,230
    
    
    $
    116,742
    
    
    $
    278,972SpeedFam-IPEC adjustment
    
    
    (1,169
    )
    
    
    
    
    
    
    (1,169
    )
    
    
    (1,170
    )
    
    
    
    
    
    
    (1,170
    )Foreign currency translation
    
    
    
    
    
    
    1,783
    
    
    
    1,783
    
    
    
    
    
    
    
    (4,093
    )
    
    
    (4,093
    )Balance, end of period
    
    $
    149,495
    
    
    $
    106,703
    
    
    $
    256,198
    
    
    $
    161,060
    
    
    $
    112,649
    
    
    $
    273,709
   Intangible Assets
  AccumulatedApril 1, 2006
    
    Gross
    
    
    Amortization
    
    
    NetPatents
    
    $
    4,202
    
    
    $
    (1,402
    )
    
    $
    2,800Developed technology
    
    
    28,203
    
    
    
    (12,644
    )
    
    
    15,559Trademark
    
    
    6,167
    
    
    
    (1,070
    )
    
    
    5,097Other intangible assets
    
    
    161
    
    
    
    (100
    )
    
    
    61Total
    
    $
    38,733
    
    
    $
    (15,216
    )
    
    $
    23,517
 13




---



##### Table of Contents



AccumulatedDecember 31, 2005
    
    Gross
    
    
    Amortization
    
    
    NetPatents
    
    $
    4,201
    
    
    $
    (1,225
    )
    
    $
    2,976Developed technology
    
    
    28,042
    
    
    
    (11,422
    )
    
    
    16,620Trademark
    
    
    6,065
    
    
    
    (903
    )
    
    
    5,162Other intangible assets
    
    
    161
    
    
    
    (99
    )
    
    
    62Total
    
    $
    38,469
    
    
    $
    (13,649
    )
    
    $
    24,820
  7. ACQUISITION
    Cash consideration
    
    $
    6,369Estimated transaction costs
    
    
    435Total purchase price
    
    $
    6,804Assets acquired
    
    $
    19,393Liabilities assumed
    
    
    (12,589
    )Total net assets acquired
    
    $
    6,804
 8. PRODUCT WARRANTY
  14




---



##### Table of Contents



Quarters EndedApril 1,
    
    
    April 2,2006
    
    
    2005Balance, beginning of period
    
    $
    54,553
    
    
    $
    45,526Warranties issued
    
    
    20,400
    
    
    
    21,630Settlements
    
    
    (21,113
    )
    
    
    (20,304
    )Changes in liability for pre-existing warranties, including expirations
    
    
    1,982
    
    
    
    1,127Balance, end of period
    
    $
    55,822
    
    
    $
    47,979
 9. RESTRUCTURING AND OTHER CHARGES
      Facility
    
    
    Asset
    
    
    
    
    
    
    AcquisitionExit Costs
    
    
    Impairment
    
    
    Severance
    
    
    Expense
    
    
    TotalBalance at December 31, 2005
    
    $
    27,239
    
    
    $
    
    
    
    $
    863
    
    
    $
    198
    
    
    $
    28,300Restructuring charges
    
    
    6,235
    
    
    
    10,199
    
    
    
    51
    
    
    
    
    
    
    
    16,485Cash payments
    
    
    (2,408
    )
    
    
    
    
    
    
    (484
    )
    
    
    (26
    )
    
    
    (2,918
    )Non-cash adjustment
    
    
    1,161
    
    
    
    (10,199
    )
    
    
    
    
    
    
    
    
    
    
    (9,038
    )Adjustment of prior restructuring costs
    
    
    (3,856
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,856
    )Balance at April 1, 2006
    
    $
    28,371
    
    
    $
    
    
    
    $
    430
    
    
    $
    172
    
    
    $
    28,973
  10. LONG-TERM OBLIGATIONS
  15




---



##### Table of Contents



11. COMPREHENSIVE INCOME
   Quarters EndedApril 1,
    
    
    April 2,2006
    
    
    2005Net income
    
    $
    24,717
    
    
    $
    30,471Other comprehensive income:Foreign currency translation adjustments, net of tax
    
    
    1,728
    
    
    
    (2,744
    )Unrealized gain (loss) on available-for-sale securities, net of tax
    
    
    1,163
    
    
    
    (1,288
    )Unrealized change in derivative instruments, net of tax
    
    
    41
    
    
    
    Comprehensive income
    
    $
    27,649
    
    
    $
    26,439
  April 1,
    
    
    December 31,2006
    
    
    2005Foreign currency translation adjustments, net of tax
    
    $
    1,081
    
    
    $
    (647
    )Unrealized loss on marketable securities, net of tax
    
    
    (727
    )
    
    
    (1,890
    )Unrealized change in derivative instruments, net of tax
    
    
    41
    
    
    
    Accumulated other comprehensive income (loss)
    
    $
    395
    
    
    $
    (2,537
    )
 12. PENSION PLAN
  13. RELATED PARTY TRANSACTIONS
   16




---



##### Table of Contents



14. LITIGATION
 Linear Technology Corporation
  Other Litigation
   15. OPERATING SEGMENTS
  17




---



##### Table of Contents



Quarter Ended April 1, 2006IndustrialSemiconductor
    
    
    ApplicationsGroup
    
    
    Group
    
    
    TotalSales to unaffiliated customers
    
    $
    344,092
    
    
    $
    21,814
    
    
    $
    365,906Operating income
    
    $
    28,881
    
    
    $
    515
    
    
    $
    29,396Long-lived assets
    
    $
    387,523
    
    
    $
    16,115
    
    
    $
    403,638All other identifiable assets
    
    
    1,680,296
    
    
    
    193,019
    
    
    
    1,873,315Total assets
    
    $
    2,067,819
    
    
    $
    209,134
    
    
    $
    2,276,953
 Quarter Ended April 2, 2005IndustrialSemiconductor
    
    
    ApplicationsGroup
    
    
    Group
    
    
    TotalSales to unaffiliated customers
    
    $
    303,178
    
    
    $
    36,562
    
    
    $
    339,740Operating income
    
    $
    33,898
    
    
    $
    6,163
    
    
    $
    40,061Long-lived assets
    
    $
    450,964
    
    
    $
    16,427
    
    
    $
    467,391All other identifiable assets
    
    
    1,749,139
    
    
    
    195,742
    
    
    
    1,944,881Total assets
    
    $
    2,200,103
    
    
    $
    212,169
    
    
    $
    2,412,272
 16. SUBSEQUENT EVENT
  
 ITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 Cautionary Note Regarding Forward-Looking Statements
  18




---



##### Table of Contents



19




---



##### Table of Contents



Introduction
  
    
    Overview of our Business and Industry;
    
    Results of Operations;
    
    Critical Accounting Policies;
    
    Liquidity and Capital Resources; and
    
    Risk Factors.
 Overview of Our Business and Industry
     20




---



##### Table of Contents



Quarterly Financial Data2006
    
    2005First
    
    Fourth
    
    Third
    
    Second
    
    FirstQuarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    QuarterNet sales
    
    $
    365,906
    
    
    $
    332,268
    
    
    $
    338,878
    
    
    $
    329,585
    
    
    $
    339,740Gross profit
    
    $
    167,540
    
    
    $
    140,501
    
    
    $
    147,194
    
    
    $
    157,562
    
    
    $
    153,869Net income
    
    $
    24,717
    
    
    $
    22,990
    
    
    $
    23,415
    
    
    $
    33,231
    
    
    $
    30,471Diluted net income per share
    
    $
    0.19
    
    
    $
    0.17
    
    
    $
    0.17
    
    
    $
    0.24
    
    
    $
    0.22Net orders
    
    $
    416,710
    
    
    $
    351,018
    
    
    $
    286,929
    
    
    $
    309,214
    
    
    $
    301,594
   Results of Operations
 Adoption of SFAS 123(R)
   Quarters EndedApril 1, 2006
    
    
    December 31, 2005
    
    
    April 2, 2005(1)
    
    
    (2)
    
    
    (2)Cost of sales
    
    $
    308
    
    
    $
    264
    
    
    $
    212Selling, general and administrative
    
    
    5,439
    
    
    
    778
    
    
    
    625Research and development
    
    
    3,061
    
    
    
    468
    
    
    
    376Stock-based compensation expense before income taxes
    
    $
    8,808
    
    
    $
    1,510
    
    
    $
    1,213
 
 (1)
    
    Amounts include amortization expense related to stock options of $6.5 million, ESPP of
$0.6 million and restricted stock awards of $1.7 million, recorded under SFAS 123(R).(2)
    
    Amounts include amortization expense related to restricted stock awards of $1.5 million
and $1.2 million for the quarters ended December 31, 2005 and April 2, 2005, respectively,
recorded under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees.
 21




---



##### Table of Contents



Net Sales
 Quarters EndedApril 1, 2006
    
    December 31, 2005
    
    April 2, 2005(in thousands, except percentages)Net sales
    
    $
    365,906
    
    
    $
    332,268
    
    
    $
    339,740International net sales %
    
    
    66
    %
    
    
    71
    %
    
    
    72
    %
   Quarters EndedApril 1, 2006
    
    
    December 31, 2005
    
    
    April 2, 2005North America
    
    
    34
    %
    
    
    29
    %
    
    
    28
    %Europe
    
    
    7
    %
    
    
    12
    %
    
    
    9
    %Asia
    
    
    59
    %
    
    
    59
    %
    
    
    63
    %
  Gross Profit
 Quarters EndedApril 1, 2006
    
    December 31, 2005
    
    April 2, 2005(in thousands, except percentages)Gross profit
    
    $
    167,540
    
    
    $
    140,501
    
    
    $
    153,869% of net sales
    
    
    46
    %
    
    
    42
    %
    
    
    45
    %
    22




---



##### Table of Contents



Selling, General and Administrative (SG&A)
 Quarters EndedApril 1, 2006
    
    December 31, 2005
    
    April 2, 2005(in thousands, except percentages)SG&A expense
    
    $
    58,482
    
    
    $
    51,489
    
    
    $
    51,760% of net sales
    
    
    16
    %
    
    
    15
    %
    
    
    15
    %
  Research and Development (R&D)
 Quarters EndedApril 1, 2006
    
    December 31, 2005
    
    April 2, 2005(in thousands, except percentages)R&D expense
    
    $
    63,783
    
    
    $
    60,492
    
    
    $
    62,048% of net sales
    
    
    17
    %
    
    
    18
    %
    
    
    18
    %
  Restructuring and Other Charges
 Quarters EndedApril 1, 2006
    
    December 31, 2005
    
    April 2, 2005(in thousands, except percentages)Restructuring and
other charges
    
    $
    12,629
    
    
    $
    5,888
    
    
    $
    % of net sales
    
    
    3
    %
    
    
    2
    %
    
    
    
    %
    23




---



##### Table of Contents



Legal Settlement
 Quarters EndedApril 1, 2006
    
    December 31, 2005
    
    April 2, 2005(in thousands, except percentages)Legal settlement
    
    $
    3,250
    
    
    $
    
    
    
    $
    % of net sales
    
    
    1
    %
    
    
    
    %
    
    
    
    %
   Interest and Other Income, Net
 Quarters EndedApril 1, 2006
    
    December 31, 2005
    
    April 2, 2005(in thousands, except percentages)Interest and other income, net
    
    $
    6,079
    
    
    $
    13,368
    
    
    $
    3,469% of net sales
    
    
    2
    %
    
    
    4
    %
    
    
    1
    %
  Income Taxes
  Critical Accounting Policies
  24




---



##### Table of Contents



Revenue Recognition
     Inventory Valuation
  Goodwill and Other Intangible Assets
  Deferred Tax Assets
  Warranty Obligations
  25




---



##### Table of Contents



Accounting for Stock-Based Compensation
    Restructuring and Impairment Charges
  26




---



##### Table of Contents



Foreign Exchange Contracts
   Liquidity and Capital Resources
    27




---



##### Table of Contents



Risk Factors
  
 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
  28




---



##### Table of Contents



Limitations on the Effectiveness of Controls
  Scope of the Controls Evaluation
  Conclusions
  
 PART II: OTHER INFORMATION
 
 ITEM 1: LEGAL PROCEEDINGS
   
 ITEM 1A: RISK FACTORS
  29




---



##### Table of Contents



Cyclical downturns in the semiconductor industry negatively impact demand for our equipment.
  The competitive and capital-intensive nature of the semiconductor industry increases the
difficulty of maintaining and capturing market share.
  Rapid technological change in the semiconductor industry requires substantial research and
development expenditures and responsiveness to customer needs.
   30




---



##### Table of Contents



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 receivables outside of the United States;
    
    Inadequate protection or enforcement of our intellectual property and other legal rights in foreign jurisdictions;
    
    Global or regional economic downturns;
    
    Geo-political instability, natural disasters, acts of war or terrorism; and
    
    Fluctuations in interest and foreign currency exchange rates, creating the need to enter into forward foreign exchange
contracts to hedge against the short-term impact of currency fluctuations, specifically transactions denominated in
Japanese yen. Exchange rate volatility may also increase the cost of our exported products for international customers
and inhibit demand.
  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;
    
    Variability in manufacturing yields;
    
    Failure to receive anticipated orders in time to permit shipment during the quarter;
 31




---



##### Table of Contents




    
    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.
 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 face risks associated with acquisitions.
  
    
    Difficulties in integrating the operations, technologies, products and personnel of acquired companies;
    
    Lack of synergies or the inability to realize expected synergies and cost-savings;
    
    Revenue and expense levels of acquired entities differing from those anticipated at the time of the acquisitions;
    
    Difficulties in managing geographically dispersed operations;
    
    The potential loss of key employees, customers and strategic partners of acquired companies;
    
    Claims by terminated employees, shareholders of acquired companies or other third parties related to the transaction;
    
    The issuance of dilutive securities, assumption or incurrence of additional debt obligations or expenses, or use of
substantial portions of our cash;
    
    Diversion of managements attention from normal daily operations of the business; and
    
    The impairment of acquired intangible assets as a result of technological advancements, or worse-than-expected
performance of acquired companies.
  We are exposed to risks associated with our diversification strategy.
  32




---



##### Table of Contents



We face risks related to concentration of net sales.
  We face risks related to intellectual property.
    We are exposed to risks related to our indemnification of third parties.
  The loss of key employees could harm our business and operations.
  33




---



##### Table of Contents



Supply shortages could affect our ability to meet customer demands.
  We are exposed to risks associated with outsourcing activities.
  If our outside audit firm does not maintain its independence, we may be unable to meet our
regulatory reporting obligations.
   Corporate governance and financial reporting compliance requirements may lead to increased
costs and difficulty in attracting qualified executive officers and directors.
  We face risks related to changes in accounting standards for stock option plans.
  34




---



##### Table of Contents



We are exposed to risks associated with our investment activities.
  
 ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 Repurchase of Company Securities
 TotalNumber of
    
    
    ApproximateShares
    
    
    Dollar ValuePurchased
    
    
    of Sharesas Part of
    
    
    that May yetTotal
    
    
    Average
    
    
    Publicly
    
    
    be PurchasedNumber
    
    
    Price
    
    
    Announced
    
    
    Under theof Shares
    
    
    Paid
    
    
    Plans or
    
    
    Plans orPeriod
    
    Purchased(1)
    
    
    Per Share
    
    
    Programs
    
    
    ProgramsJanuary 1, 2006 to February 4, 2006
    
    
    355,150
    
    
    $
    24.15
    
    
    
    355,150
    
    
    $854.6 millionFebruary 5, 2006 to March 4, 2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    $854.6 millionMarch 5, 2006 to April 1, 2006
    
    
    2,388,700
    
    
    $
    24.91
    
    
    
    2,388,700
    
    
    $795.1 millionTotal
    
    
    2,743,850
    
    
    $
    24.81
    
    
    
    2,743,850
    
    
    $795.1 million
 (1)
    
    All shares were purchased pursuant to a publicly announced plan.
  
 ITEM 6: EXHIBITS
  31.1
    
    Certification of Richard S. Hill, Chairman of the Board of Directors
and Chief Executive Officer of Novellus Systems, Inc. dated May 11,
2006 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.
 35




---



##### Table of Contents



31.2
    
    Certification of William H. Kurtz, Executive Vice President and Chief
Financial Officer of Novellus Systems, Inc. dated May 11, 2006 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 May 11,
2006 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 May 11, 2006 in
accordance with 18 U.S.C. 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
 36




---



##### Table of Contents



SIGNATURES
  NOVELLUS SYSTEMS, INC.By: /s/ William H. Kurtz

William H. KurtzExecutive Vice President and Chief Financial Officer(Principal Financial Officer)May 11, 2006
 37




---



##### Table of Contents



EXHIBIT INDEX
 31.1
    
    Certification of Richard S. Hill, Chairman of the Board of Directors
and Chief Executive Officer of Novellus Systems, Inc. dated May 11,
2006 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 May 11, 2006
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 May 11,
2006 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 May 11, 2006
in accordance with 18 U.S.C. 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.