##### 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 March 31, 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 MARCH 31, 2007
  
 TABLE OF CONTENTS
 PagePart I: Financial InformationItem 1: Condensed Consolidated Financial Statements Condensed Consolidated Statements of Operations for the three months ended March 31, 2007 and April 1, 2006
    
    3Condensed Consolidated Balance Sheets as of March 31, 2007 and December 31, 2006
    
    4Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2007 and April 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
    
    20Item 4: Controls and Procedures
    
    20Part II: Other InformationItem 1: Legal Proceedings
    
    21Item 1A: Risk Factors
    
    22Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
    
    28Item 6: Exhibits
    
    28Signatures
    
    30EXHIBIT 10.27EXHIBIT 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 EndedMarch 31, 2007
    
    
    April 1, 2006(In thousands, except per shareamounts)Net sales
    
    $
    396,974
    
    
    $
    365,906Cost of sales
    
    
    202,065
    
    
    
    198,366Gross profit
    
    
    194,909
    
    
    
    167,540Operating expenses:Selling, general and administrative
    
    
    67,100
    
    
    
    58,482Research and development
    
    
    60,400
    
    
    
    63,783Restructuring and other charges
    
    
    
    
    
    
    12,629Legal settlement
    
    
    
    
    
    
    3,250Total operating expenses
    
    
    127,500
    
    
    
    138,144Operating income
    
    
    67,409
    
    
    
    29,396Interest income, net
    
    
    7,970
    
    
    
    5,032Other income, net
    
    
    3,137
    
    
    
    1,047Interest and other income, net
    
    
    11,107
    
    
    
    6,079Income before provision for income taxes and cumulative effect of a change in
accounting principle
    
    
    78,516
    
    
    
    35,475Provision for income taxes
    
    
    24,733
    
    
    
    11,706Income before cumulative effect of a change in accounting principle
    
    
    53,783
    
    
    
    23,769Cumulative effect of a change in accounting principle, net of tax of $594
    
    
    
    
    
    
    948Net income
    
    $
    53,783
    
    
    $
    24,717Net income per share:Basic:Income before cumulative effect of a change in accounting principle
    
    $
    0.43
    
    
    $
    0.18Cumulative effect of a change in accounting principle
    
    
    
    
    
    
    0.01Basic net income per share
    
    $
    0.43
    
    
    $
    0.19Diluted:Income before cumulative effect of a change in accounting principle
    
    $
    0.42
    
    
    $
    0.18Cumulative effect of a change in accounting principle
    
    
    
    
    
    
    0.01Diluted net income per share
    
    $
    0.42
    
    
    $
    0.19Shares used in basic per share calculations
    
    
    123,979
    
    
    
    131,102Shares used in diluted per share calculations
    
    
    127,137
    
    
    
    132,264
  3




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##### Table of Contents



NOVELLUS SYSTEMS, INC.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 March 31,
    
    
    December 31,2007
    
    
    2006 *(unaudited)(In thousands)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    31,258
    
    
    $
    58,463Short-term investments
    
    
    825,289
    
    
    
    794,865Accounts receivable, net
    
    
    371,697
    
    
    
    310,888Inventories
    
    
    234,106
    
    
    
    198,571Deferred tax assets, net
    
    
    85,957
    
    
    
    102,266Assets held for sale
    
    
    34,043
    
    
    
    21,966Prepaid and other current assets
    
    
    20,274
    
    
    
    18,274Total current assets
    
    
    1,602,624
    
    
    
    1,505,293Property and equipment, net
    
    
    346,975
    
    
    
    364,599Restricted cash and cash equivalents
    
    
    144,120
    
    
    
    143,769Goodwill
    
    
    228,576
    
    
    
    225,431Intangible and other assets
    
    
    122,078
    
    
    
    123,400Total assets
    
    $
    2,444,373
    
    
    $
    2,362,492LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    94,071
    
    
    $
    76,406Accrued payroll and related expenses
    
    
    57,330
    
    
    
    81,836Accrued warranty
    
    
    55,236
    
    
    
    55,349Other accrued liabilities
    
    
    57,439
    
    
    
    48,068Income taxes payable
    
    
    21,757
    
    
    
    38,879Deferred profit
    
    
    46,535
    
    
    
    41,351Current obligations under lines of credit
    
    
    20,545
    
    
    
    19,480Total current liabilities
    
    
    352,913
    
    
    
    361,369Long-term debt
    
    
    129,842
    
    
    
    127,862Other non-current liabilities
    
    
    51,208
    
    
    
    38,556Total liabilities
    
    
    533,963
    
    
    
    527,787Shareholders equity:Common stock
    
    
    1,423,347
    
    
    
    1,393,914Retained earnings
    
    
    488,179
    
    
    
    438,196Accumulated other comprehensive (loss) income
    
    
    (1,116
    )
    
    
    2,595Total shareholders equity
    
    
    1,910,410
    
    
    
    1,834,705Total liabilities and shareholders equity
    
    $
    2,444,373
    
    
    $
    2,362,492
 
 *
    
    Amounts are derived from the December 31, 2006 audited consolidated
financial statements.  4




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NOVELLUS SYSTEMS, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited)
 Three Months EndedMarch 31,
    
    
    April 1,2007
    
    
    2006(In thousands)Cash flows from operating activities:Net income
    
    $
    53,783
    
    
    $
    24,717Adjustments to reconcile net income to net cash (used in) provided by operating activities:Loss on disposal of property and equipment
    
    
    52
    
    
    
    1,449Non-cash portion of restructuring and other charges
    
    
    
    
    
    
    10,199Depreciation and amortization
    
    
    16,796
    
    
    
    19,298Deferred income taxes
    
    
    13,137
    
    
    
    (714
    )Stock-based compensation
    
    
    9,102
    
    
    
    9,108Tax benefit from stock-based compensation
    
    
    972
    
    
    
    6,328Excess tax benefit from stock-based compensation
    
    
    (329
    )
    
    
    (3,820
    )Other non-cash charges, net
    
    
    202
    
    
    
    Cumulative effect of a change in accounting principle
    
    
    
    
    
    
    (1,542
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    (59,431
    )
    
    
    (17,584
    )Inventories
    
    
    (34,447
    )
    
    
    (34,105
    )Prepaid and other assets
    
    
    (3,882
    )
    
    
    5,442Accounts payable
    
    
    17,418
    
    
    
    12,076Accrued payroll and related expenses
    
    
    (20,468
    )
    
    
    (3,346
    )Accrued warranty
    
    
    (143
    )
    
    
    1,229Other liabilities
    
    
    17,552
    
    
    
    2,107Income taxes payable
    
    
    (17,148
    )
    
    
    6,342Deferred profit
    
    
    5,159
    
    
    
    (6,540
    )Net cash (used in) provided by operating activities
    
    
    (1,675
    )
    
    
    30,644Cash flows from investing activities:Proceeds from sales of short-term investments
    
    
    331,100
    
    
    
    139,813Proceeds from maturities of short-term investments
    
    
    58,320
    
    
    
    48,103Purchases of short-term investments
    
    
    (420,281
    )
    
    
    (141,410
    )Capital expenditures
    
    
    (10,188
    )
    
    
    (9,104
    )Proceeds from sale of property and equipment
    
    
    275
    
    
    
    Decrease in other assets
    
    
    
    
    
    
    924Increase in restricted cash and cash equivalents
    
    
    (351
    )
    
    
    (1,790
    )Net cash (used in) provided by investing activities
    
    
    (41,125
    )
    
    
    36,536Cash flows from financing activities:Proceeds from employee stock compensation plans
    
    
    15,278
    
    
    
    4,562Proceeds from (repayments of) lines of credit, net
    
    
    732
    
    
    
    (4,534
    )Repurchases of common stock
    
    
    
    
    
    
    (68,082
    )Excess tax benefit from stock-based compensation
    
    
    329
    
    
    
    3,820Net cash provided by (used in) financing activities
    
    
    16,339
    
    
    
    (64,234
    )Effects of exchange rate changes on cash and cash equivalents
    
    
    (744
    )
    
    
    1,900Net (decrease) increase in cash and cash equivalents
    
    
    (27,205
    )
    
    
    4,846Cash and cash equivalents at the beginning of the period
    
    
    58,463
    
    
    
    40,403Cash and cash equivalents at the end of the period
    
    $
    31,258
    
    
    $
    45,249
  5




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##### Table of Contents



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




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OCI(In thousands)Balance as of January 1, 2007
    
    $
    (329
    )Net change on cash flow hedges
    
    
    (2,976
    )Reclassification to cost of sales
    
    
    329Balance as of March 31, 2007
    
    $
    (2,976
    )
  Net Investment Hedging 
 Non-Designated Hedges 
 Recent Accounting Pronouncements
     7




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Note 2. Net Income Per Share
    Three Months EndedMarch 31,
    
    
    April 1,2007
    
    
    2006(In thousands, except pershare amounts)Numerator:Net income
    
    $
    53,783
    
    
    $
    24,717Denominator:Basic weighted-average shares outstanding
    
    
    123,979
    
    
    
    131,102Dilutive common equivalent shares
    
    
    3,158
    
    
    
    1,162Diluted weighted-average shares outstanding
    
    
    127,137
    
    
    
    132,264Basic net income per share
    
    $
    0.43
    
    
    $
    0.19Diluted net income per share
    
    $
    0.42
    
    
    $
    0.19
  Note 3. Inventories
  March 31,
    
    
    December 31,2007
    
    
    2006(In thousands)Purchased and spare parts
    
    $
    161,167
    
    
    $
    152,727Work-in-process
    
    
    44,596
    
    
    
    30,524Finished goods
    
    
    28,343
    
    
    
    15,320Total inventories
    
    $
    234,106
    
    
    $
    198,571
 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
    
    
    $
    228,576
 8




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Intangible Assets
  WeightedAverageAmortization
    
    
    
    
    
    AccumulatedMarch 31, 2007
    
    Period
    
    Gross
    
    
    Amortization
    
    
    Net(Years)
    
    
    
    
    
    (In thousands)Patents and other intangibles
    
    12
    
    $
    16,648
    
    
    $
    (599
    )
    
    $
    16,049Developed technology
    
    6
    
    
    29,159
    
    
    
    (17,847
    )
    
    
    11,312Tradename
    
    10
    
    
    6,768
    
    
    
    (1,861
    )
    
    
    4,907Total
    
    8
    
    $
    52,575
    
    
    $
    (20,307
    )
    
    $
    32,268
 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 EndedMarch 31,
    
    
    April 1,2007
    
    
    2006(In thousands)Balance, beginning of period
    
    $
    55,349
    
    
    $
    54,553Warranties issued
    
    
    18,361
    
    
    
    20,400Settlements
    
    
    (18,617
    )
    
    
    (21,113
    )Net changes in liability for pre-existing warranties, including expirations
    
    
    143
    
    
    
    1,982Balance, end of period
    
    $
    55,236
    
    
    $
    55,822
 Note 6. Restructuring and Other Charges
   9




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Facilities
Restructuring
Liability(In thousands)Balance as of December 31, 2006
    
    $
    17,503Cash payments
    
    
    (1,039
    )Balance as of March 31, 2007
    
    $
    16,464
  Note 7. Long-Term Obligations
  Note 8. Other Income, Net
  Three Months EndedMarch, 31
    
    
    April 1,2007
    
    
    2006(In thousands)Other income
    
    $
    1,582
    
    
    $
    517Other expense
    
    
    (254
    )
    
    
    (259
    )Foreign currency gain, net
    
    
    1,809
    
    
    
    789Total other income, net
    
    $
    3,137
    
    
    $
    1,047
 10




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Note 9. Comprehensive Income
  Three Months EndedMarch 31,
    
    
    April 1,2007
    
    
    2006(In thousands)Net income
    
    $
    53,783
    
    
    $
    24,717Other comprehensive income:Foreign currency translation adjustments
    
    
    (825
    )
    
    
    1,728Unrealized gain (loss) on short-term investments
    
    
    (235
    )
    
    
    1,163Unrealized gain (loss) on derivative instruments
    
    
    (2,647
    )
    
    
    41Unrealized loss on minimum pension liability adjustment
    
    
    (4
    )
    
    
    Comprehensive income
    
    $
    50,072
    
    
    $
    27,649
  March 31,
    
    
    December 31,2007
    
    
    2006(In thousands)Foreign currency translation adjustments
    
    $
    2,753
    
    
    $
    3,578Unrealized gain (loss) on short-term investments
    
    
    (11
    )
    
    
    224Unrealized loss on derivative instruments
    
    
    (2,976
    )
    
    
    (329
    )Unrealized loss on minimum pension liability adjustment
    
    
    (882
    )
    
    
    (878
    )Accumulated other comprehensive income (loss)
    
    $
    (1,116
    )
    
    $
    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, 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
  11




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Other Litigation
  Note 11. Stock-Based Compensation
    Three Months EndedMarch 31,
    
    
    April 1,2007
    
    
    2006(In thousands)(1)
    
    
    
    (2)Cost of sales
    
    $
    510
    
    
    $
    308Selling, general and administrative
    
    
    5,697
    
    
    
    5,439Research and development
    
    
    2,895
    
    
    
    3,061Stock-based compensation expense before income taxes
    
    
    9,102
    
    
    
    8,808Income tax benefit
    
    
    (2,276
    )
    
    
    (3,391
    )Total stock-based compensation expense after income taxes
    
    $
    6,826
    
    
    $
    5,417
 
 (1)
    
    Amounts include amortization expense related to stock options of $4.9 million, ESPP of $0.6
million and restricted stock awards of $3.6 million.(2)
    
    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. 12




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Options
    
    ESPPMarch 31,
    
    April 1,
    
    March 31,
    
    April 1,2007
    
    2006
    
    2007
    
    2006Risk-free interest rate
    
    
    4.7
    %
    
    
    4.5
    %
    
    
    5.1
    %
    
    
    4.3
    %Volatility
    
    
    47
    %
    
    
    49
    %
    
    
    34
    %
    
    
    32
    %Expected term
    
    4.4 years
    
    4.3 years
    
    6 months
    

    
    6 monthsDividends
    
    None
    
    None
    
    None
    
    NoneWeighted-average fair value at grant date
    
    $
    13.97
    
    
    $
    11.77
    
    
    $
    6.88
    
    
    $
    5.30
   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
    
    
    150
    
    
    
    31.38Exercises
    
    
    (534
    )
    
    
    25.40Forfeitures or expirations
    
    
    (412
    )
    
    
    31.56Outstanding as of March 31, 2007
    
    
    22,103
    
    
    $
    32.33
    
    
    
    6.00
    
    
    $
    62,652Vested and expected to vest as of March 31, 2007
    
    
    21,178
    
    
    $
    32.47
    
    
    
    5.87
    
    
    $
    59,514Exercisable as of March 31, 2007
    
    
    16,459
    
    
    $
    33.57
    
    
    
    5.02
    
    
    $
    41,178
    Weighted-AverageNumber of
    
    
    Grant DateShares
    
    
    Fair Value(In thousands)Unvested restricted stock awards as of December 31, 2006
    
    
    1,894
    
    
    $
    29.68Granted
    
    
    13
    
    
    
    31.94Vested
    
    
    (20
    )
    
    
    28.07Forfeited
    
    
    (94
    )
    
    
    28.63Unvested restricted stock awards as of March 31, 2007
    
    
    1,793
    
    
    $
    29.77
  13




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Note 12. Operating Segments
    Three Months Ended March 31, 2007(In thousands)IndustrialSemiconductor
    
    
    ApplicationsGroup
    
    
    Group
    
    
    ConsolidatedSales to unaffiliated customers
    
    $
    364,195
    
    
    $
    32,779
    
    
    $
    396,974Operating income
    
    $
    64,141
    
    
    $
    3,268
    
    
    $
    67,409
 Three Months Ended April 1, 2006(In thousands)IndustrialSemiconductor
    
    
    ApplicationsGroup
    
    
    Group
    
    
    ConsolidatedSales to unaffiliated customers
    
    $
    344,092
    
    
    $
    21,814
    
    
    $
    365,906Operating income
    
    $
    28,881
    
    
    $
    515
    
    
    $
    29,396
 Note 13. Related Party Transactions
    14




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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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Introduction
  
    
    Overview of our Business and Industry;
    
    Results of Operations;
    
    Critical Accounting Policies; and
    
    Liquidity and Capital Resources.
 Overview of Our Business and Industry
     Quarterly Financial Data2007
    
    2006First
    
    Fourth
    
    Third
    
    Second
    
    FirstQuarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    QuarterNet sales
    
    $
    396,974
    
    
    $
    438,505
    
    
    $
    444,032
    
    
    $
    410,073
    
    
    $
    365,906Gross profit
    
    $
    194,909
    
    
    $
    225,520
    
    
    $
    226,525
    
    
    $
    204,764
    
    
    $
    167,540Income before cumulative effect of a
change in accounting principle
    
    $
    53,783
    
    
    $
    42,574
    
    
    $
    70,020
    
    
    $
    52,705
    
    
    $
    23,769Net income
    
    $
    53,783
    
    
    $
    42,574
    
    
    $
    70,020
    
    
    $
    52,705
    
    
    $
    24,717Diluted net income per share before
cumulative effect of a change in
accounting principle
    
    $
    0.42
    
    
    $
    0.34
    
    
    $
    0.57
    
    
    $
    0.42
    
    
    $
    0.18Diluted net income per share
    
    $
    0.42
    
    
    $
    0.34
    
    
    $
    0.57
    
    
    $
    0.42
    
    
    $
    0.19Net orders
    
    $
    412,219
    
    
    $
    441,620
    
    
    $
    470,322
    
    
    $
    457,545
    
    
    $
    416,770Change in net orders from prior quarter
    
    
    (7
    )%
    
    
    (6
    )%
    
    
    3
    %
    
    
    10
    %
    
    
    19
    %
 16




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##### Table of Contents



Results of Operations
 Net Sales
 Three Months Ended
    
    

Q1 2007% Change FromMarch 31, 2007
    
    
    December 31, 2006
    
    
    April 1, 2006
    
    
    Q4 2006
    
    

Q1 2006(In thousands)Semiconductor Group
    
    $
    364,195
    
    
    $
    405,060
    
    
    $
    344,092
    
    
    
    (10
    )%
    
    
    6
    %Industrial Applications Group
    
    $
    32,779
    
    
    $
    33,445
    
    
    $
    21,814
    
    
    
    (2
    )%
    
    
    50
    %Net sales
    
    $
    396,974
    
    
    $
    438,505
    
    
    $
    365,906
    
    
    
    (9
    )%
    
    
    8
    %
   Three Months EndedMarch 31, 2007
    
    December 31, 2006
    
    April 1, 2006North America
    
    
    22
    %
    
    
    28
    %
    
    
    34
    %Europe
    
    
    7
    %
    
    
    11
    %
    
    
    7
    %Asia
    
    
    71
    %
    
    
    61
    %
    
    
    59
    %
  Gross Profit
 Three Months Ended
    
    

Q1 2007
% Change FromMarch 31, 2007
    
    
    December 31, 2006
    
    
    April 1, 2006
    
    
    Q4 2006
    
    

Q1 2006(Dollars in thousands)Gross profit
    
    $
    194,909
    
    
    $
    225,520
    
    
    $
    167,540
    
    
    
    (14
    )%
    
    
    16
    %Gross margin
    
    
    49
    %
    
    
    51
    %
    
    
    46
    %
  17




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##### Table of Contents



Selling, General and Administrative (SG&A)
 Three Months Ended
    
    

Q1 2007% Change FromMarch 31, 2007
    
    
    December 31, 2006
    
    
    April 1, 2006
    
    
    Q4 2006
    
    

Q1 2006(Dollars in thousands)SG&A expense
    
    $
    67,100
    
    
    $
    68,932
    
    
    $
    58,482
    
    
    
    (3
    )%
    
    
    15
    %% of net sales
    
    
    17
    %
    
    
    16
    %
    
    
    16
    %
   Research and Development (R&D)
 Three Months Ended
    
    

Q1 2007
% Change FromMarch 31, 2007
    
    
    December 31, 2006
    
    
    April 1, 2006
    
    
    Q4 2006
    
    

Q1 2006(Dollars in thousands)R&D expense
    
    $
    60,400
    
    
    $
    56,475
    
    
    $
    63,783
    
    
    
    7
    %
    
    
    (5
    )%% of net sales
    
    
    15
    %
    
    
    13
    %
    
    
    17
    %
   Restructuring and Other Charges (Benefits)
 Three Months Ended
    
    

Q1 2007
% Change FromMarch 31, 2007
    
    
    December 31, 2006
    
    
    April 1, 2006
    
    
    Q4 2006
    
    

Q1 2006(Dollars in thousands)Restructuring and other charges (benefits)
    
    $
    
    
    
    $
    (1,894
    )
    
    $
    12,629
    
    
    Not meaningful% of net sales
    
    
    
    %
    
    Less than 1%
    
    
    3
    %
      18




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##### Table of Contents



Interest and Other Income, Net
 Three Months Ended
    
    

Q1 2007% Change FromMarch 31, 2007
    
    
    December 31, 2006
    
    
    April 1, 2006
    
    
    Q4 2006
    
    

Q1 2006(Dollars In thousands)Interest and other income, net
    
    $
    11,107
    
    
    $
    10,881
    
    
    $
    6,079
    
    
    
    2
    %
    
    
    83
    %% of net sales
    
    
    3
    %
    
    
    2
    %
    
    
    2
    %
  Income Taxes
  Critical Accounting Policies
  Liquidity and Capital Resources
      19




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##### Table of Contents



ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 ITEM 4: CONTROLS AND PROCEDURES
 Quarterly Evaluation of Our Disclosure Controls and Internal Controls
  CEO and CFO Certifications
  Disclosure Controls and Internal Controls for Financial Reporting
  20




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##### Table of Contents



Limitations on the Effectiveness of Controls
  Scope of the Controls Evaluation
  Conclusions
  
 PART II: OTHER INFORMATION
 
 ITEM 1: LEGAL PROCEEDINGS
  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
 Other Litigation
  21




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##### Table of Contents



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.
  22




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##### 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.
  We face risks related to concentration of net sales.
  23




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##### 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 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.
   24




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##### 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
  25




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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.
  Corporate governance and financial reporting requirements have led and may continue to lead to
increased costs and may make it more difficult to attract qualified executive officers and
directors.
  We are exposed to risks related to our indemnification of third parties.
  26




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##### Table of Contents



We face risks related to the valuation of stock-based compensation.
  If our outside audit firm does not maintain its independence, we may be unable to meet our
regulatory reporting obligations.
  We face risks associated with acquisitions.
  
    
    Difficulties in integrating the operations, technologies, products and personnel of acquired companies;
 
    
    Lack of synergies or the inability to realize expected synergies and cost-savings;
 
    
    Revenue and expense levels of acquired entities differing from those anticipated at the time of the acquisitions;
 
    
    Difficulties in managing geographically dispersed operations;
 
    
    The potential loss of key employees, customers and strategic partners of acquired companies;
 
    
    Claims by terminated employees, shareholders of acquired companies or other third parties related to the transaction;
 
    
    The issuance of dilutive securities, assumption or incurrence of additional debt obligations or expenses, or use of
substantial portions of our cash;
 
    
    Diversion of managements attention from normal daily operations of the business; and
 
    
    The impairment of acquired intangible assets as a result of technological advancements, or worse-than-expected performance
of acquired companies.
  Our quarterly operating results and stock price are unpredictable.
  27




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##### Table of Contents




    
    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.
  
 ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 Repurchase of Company Securities
  
 ITEM 6: EXHIBITS
  10.27
    
    Letter Agreement by and between Novellus Systems, Inc. and Sasson Somekh dated December 20, 2006.31.1
    
    Certification of Richard S. Hill, Chairman of the Board of Directors and Chief Executive Officer
of Novellus Systems, Inc. dated May 9, 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 May
 28




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##### Table of Contents



9, 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 May 9, 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 May 9, 2007 in accordance with 18 U.S.C. 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
 29




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##### 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 9, 2007
 30




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##### Table of Contents



EXHIBIT INDEX
 10.27
    
    Letter Agreement by and between Novellus Systems, Inc. and Sasson Somekh dated December 20, 2006.31.1
    
    Certification of Richard S. Hill, Chairman of the Board of Directors and Chief Executive Officer
of Novellus Systems, Inc. dated May 9, 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 May 9, 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 May 9, 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 May 9, 2007 in accordance with 18 U.S.C. 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.