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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 27, 2008

OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from  to

Commission File Number 000-17157

NOVELLUS SYSTEMS, INC.

(Exact name of Registrant as specified in its charter)



|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|California                                                     |  | 77-0024666                             
|(State or other jurisdiction of incorporation of organization) |  | (I.R.S. Employer Identification Number)
|                                                               | 
|4000 North First Street San Jose, California                   |  | 95134                                  
|(Address of principal executive offices)                       |  | (Zip code)                             

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90
days.    Yes  þ    No   ̈

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated
filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):



|                           |  |                      |  |                                               |  |                             
|-------------------------- |  | -------------------- |  | --------------------------------------------- |  | ----------------------------
|Large accelerated filer  þ |  | Accelerated filer   ̈ |  | Non-accelerated filer   ̈                      |  | Smaller reporting company   ̈
|                           |  |                      |  | (Do not check if a smaller reporting company) |  |                             

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).    Yes   ̈    No  þ

As of October 31, 2008, 97,664,418 shares of the Registrants common stock, no par value, were issued and outstanding.









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NOVELLUS SYSTEMS, INC.

FORM 10-Q

QUARTER ENDED September 27, 2008

TABLE OF CONTENTS



|                              |  |                                                                                                                                |  |     
|----------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------ |  | ----
|                              |  |                                                                                                                                |  | Page
|Part I: Financial Information |  |                                                                                                                               
|Item 1:                       |  | Condensed Consolidated Financial Statements                                                                                    |  | 3   
|                              |  | Condensed Consolidated Statements of Operations for the three and nine months ended September 
27, 2008 and September 29, 2007 |  | 3   
|                              |  | Condensed Consolidated Balance Sheets as of September 27, 2008 and December 31, 2007                                           |  | 4   
|                              |  | Condensed Consolidated Statements of Cash Flows for the nine months ended September 27, 2008 and September 
29, 2007           |  | 5   
|                              |  | Notes to Condensed Consolidated Financial Statements                                                                           |  | 6   
|Item 2:                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                          |  | 16  
|Item 3:                       |  | Quantitative and Qualitative Disclosures About Market Risk                                                                     |  | 24  
|Item 4:                       |  | Controls and Procedures                                                                                                        |  | 24  
|Part II: Other Information    |  |                                                                                                                               
|Item 1:                       |  | Legal Proceedings                                                                                                              |  | 25  
|Item 1A:                      |  | Risk Factors                                                                                                                   |  | 26  
|Item 2:                       |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                                    |  | 33  
|Item 6:                       |  | Exhibits                                                                                                                       |  | 34  
|Signatures                    |  | 35                                                                                                                            
|EXHIBIT 10.9                  |  |                                                                                                                               
|EXHIBIT 10.28                 |  |                                                                                                                               
|EXHIBIT 31.1                  |  |                                                                                                                               
|EXHIBIT 31.2                  |  |                                                                                                                               
|EXHIBIT 32.1                  |  |                                                                                                                               
|EXHIBIT 32.2                  |  |                                                                                                                               



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PART I: FINANCIAL INFORMATION



|ITEM 1: | CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|------- | -------------------------------------------

NOVELLUS SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)



|                                              |  |                                          |         |                   |   |                   |  |                   |         |  |   |          
|--------------------------------------------- |  | ---------------------------------------- | ------- | ----------------- | - | ----------------- |  | ----------------- | ------- |  | - | ---------
|                                              |  | Three Months Ended                       |         | Nine Months Ended
|                                              |  | September 27,2008                        |         | September 29,2007 |   | September 27,2008 |  | September 29,2007
|                                              |  | (In thousands, except per share amounts)
|Net sales                                     |  | $                                        | 250,098 |                   | $ | 393,277           |  | $                 | 822,551 |  | $ | 1,206,586
|Cost of sales                                 |  |                                          | 138,574 |                   |   | 198,970           |  |                   | 455,124 |  |   | 609,260  
|                                              |  |                                          |         |                   |   |                   |  |                   |         |  |   |          
|Gross profit                                  |  |                                          | 111,524 |                   |   | 194,307           |  |                   | 367,427 |  |   | 597,326  
|Operating expenses:                           |  |                                          |         |                   |   |                   |  |                   |         |  |   |          
|Selling, general and administrative           |  |                                          | 53,858  |                   |   | 67,420            |  |                   | 176,717 |  |   | 206,531  
|Research and development                      |  |                                          | 51,649  |                   |   | 61,384            |  |                   | 168,804 |  |   | 185,158  
|                                              |  |                                          |         |                   |   |                   |  |                   |         |  |   |          
|Total operating expenses                      |  |                                          | 105,507 |                   |   | 128,804           |  |                   | 345,521 |  |   | 391,689  
|                                              |  |                                          |         |                   |   |                   |  |                   |         |  |   |          
|Operating income                              |  |                                          | 6,017   |                   |   | 65,503            |  |                   | 21,906  |  |   | 205,637  
|Interest and other income, net:               |  |                                          |         |                   |   |                   |  |                   |         |  |   |          
|Interest income, net                          |  |                                          | 2,588   |                   |   | 8,617             |  |                   | 7,667   |  |   | 25,005   
|Other income, net                             |  |                                          | 467     |                   |   | 316               |  |                   | 1,413   |  |   | 9,632    
|                                              |  |                                          |         |                   |   |                   |  |                   |         |  |   |          
|Total interest and other income, net          |  |                                          | 3,055   |                   |   | 8,933             |  |                   | 9,080   |  |   | 34,637   
|                                              |  |                                          |         |                   |   |                   |  |                   |         |  |   |          
|Income before provision for income taxes      |  |                                          | 9,072   |                   |   | 74,436            |  |                   | 30,986  |  |   | 240,274  
|Provision for income taxes                    |  |                                          | 7,675   |                   |   | 24,725            |  |                   | 16,445  |  |   | 79,435   
|                                              |  |                                          |         |                   |   |                   |  |                   |         |  |   |          
|Net income                                    |  | $                                        | 1,397   |                   | $ | 49,711            |  | $                 | 14,541  |  | $ | 160,839  
|                                              |  |                                          |         |                   |   |                   |  |                   |         |  |   |          
|Net income per share:                         |  |                                          |         |                   |   |                   |  |                   |         |  |   |          
|Basic                                         |  | $                                        | 0.01    |                   | $ | 0.41              |  | $                 | 0.15    |  | $ | 1.31     
|                                              |  |                                          |         |                   |   |                   |  |                   |         |  |   |          
|Diluted                                       |  | $                                        | 0.01    |                   | $ | 0.41              |  | $                 | 0.15    |  | $ | 1.28     
|                                              |  |                                          |         |                   |   |                   |  |                   |         |  |   |          
|Shares used in basic per share calculations   |  |                                          | 97,581  |                   |   | 120,414           |  |                   | 98,807  |  |   | 122,730  
|                                              |  |                                          |         |                   |   |                   |  |                   |         |  |   |          
|Shares used in diluted per share calculations |  |                                          | 98,348  |                   |   | 121,902           |  |                   | 99,550  |  |   | 125,244  
|                                              |  |                                          |         |                   |   |                   |  |                   |         |  |   |          

See accompanying notes to Condensed Consolidated Financial Statements.



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NOVELLUS SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS



|                                              |  |                   |           |   |                    |   |          
|--------------------------------------------- |  | ----------------- | --------- | - | ------------------ | - | ---------
|                                              |  | September 27,2008 |           |   | December 31,2007 *
|                                              |  | (Unaudited)       |           |   |                   
|                                              |  | (In thousands)   
|ASSETS                                        |  |                   |           |   |                    |   |          
|Current assets:                               |  |                   |           |   |                    |   |          
|Cash and cash equivalents                     |  | $                 | 162,231   |   |                    | $ | 175,071  
|Short-term investments                        |  |                   | 293,073   |   |                    |   | 421,695  
|Accounts receivable, net                      |  |                   | 210,445   |   |                    |   | 346,866  
|Inventories                                   |  |                   | 211,810   |   |                    |   | 212,995  
|Deferred tax assets, net                      |  |                   | 31,544    |   |                    |   | 48,965   
|Restricted cash and cash equivalents, current |  |                   | 143,314   |   |                    |   |         
|Prepaid and other current assets              |  |                   | 23,214    |   |                    |   | 18,366   
|                                              |  |                   |           |   |                    |   |          
|Total current assets                          |  |                   | 1,075,631 |   |                    |   | 1,223,958
|Property and equipment, net                   |  |                   | 287,706   |   |                    |   | 320,009  
|Restricted cash and cash equivalents          |  |                   | 3,515     |   |                    |   | 161,050  
|Investments                                   |  |                   | 100,467   |   |                    |   |         
|Goodwill                                      |  |                   | 238,492   |   |                    |   | 238,944  
|Intangible and other assets                   |  |                   | 115,433   |   |                    |   | 132,982  
|                                              |  |                   |           |   |                    |   |          
|Total assets                                  |  | $                 | 1,821,244 |   |                    | $ | 2,076,943
|                                              |  |                   |           |   |                    |   |          
|LIABILITIES AND SHAREHOLDERS EQUITY          |  |                   |           |   |                    |   |          
|Current liabilities:                          |  |                   |           |   |                    |   |          
|Accounts payable                              |  | $                 | 73,279    |   |                    | $ | 97,135   
|Accrued payroll and related expenses          |  |                   | 42,206    |   |                    |   | 73,273   
|Accrued warranty                              |  |                   | 32,477    |   |                    |   | 44,864   
|Other accrued liabilities                     |  |                   | 46,406    |   |                    |   | 50,183   
|Deferred profit                               |  |                   | 24,078    |   |                    |   | 52,252   
|Current debt obligations                      |  |                   | 129,479   |   |                    |   | 1,509    
|                                              |  |                   |           |   |                    |   |          
|Total current liabilities                     |  |                   | 347,925   |   |                    |   | 319,216  
|Long-term debt                                |  |                   | 1,325     |   |                    |   | 143,267  
|Long-term income taxes payable                |  |                   | 25,433    |   |                    |   | 27,408   
|Other non-current liabilities                 |  |                   | 49,672    |   |                    |   | 57,965   
|                                              |  |                   |           |   |                    |   |          
|Total liabilities                             |  |                   | 424,355   |   |                    |   | 547,856  
|Commitments and contingencies                 |  |                   |           |   |                    |   |          
|Shareholders equity:                         |  |                   |           |   |                    |   |          
|Common stock                                  |  |                   | 1,165,488 |   |                    |   | 1,219,533
|Retained earnings                             |  |                   | 233,767   |   |                    |   | 304,278  
|Accumulated other comprehensive income (loss) |  |                   | (2,366    | ) |                    |   | 5,276    
|                                              |  |                   |           |   |                    |   |          
|Total shareholders equity                    |  |                   | 1,396,889 |   |                    |   | 1,529,087
|                                              |  |                   |           |   |                    |   |          
|Total liabilities and shareholders equity    |  | $                 | 1,821,244 |   |                    | $ | 2,076,943
|                                              |  |                   |           |   |                    |   |          



|* | Amounts are derived from the December 31, 2007 audited consolidated financial statements.
|- | -----------------------------------------------------------------------------------------

See accompanying notes to Condensed Consolidated Financial Statements.



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NOVELLUS SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)



|                                                                                  |  |                   |          |   |                   |   |          |  
|--------------------------------------------------------------------------------- |  | ----------------- | -------- | - | ----------------- | - | -------- | -
|                                                                                  |  | Nine Months Ended |         
|                                                                                  |  | September 27,2008 |          |   | September 29,2007 |  
|                                                                                  |  | (In thousands)    |         
|Cash flows from operating activities:                                             |  |                   |          |   |                   |   |          |  
|Net income                                                                        |  | $                 | 14,541   |   |                   | $ | 160,839  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                   |          |   |                   |   |          |  
|Loss on disposal of property and equipment                                        |  |                   | 2,153    |   |                   |   | 50       |  
|Depreciation and amortization                                                     |  |                   | 47,464   |   |                   |   | 50,709   |  
|Deferred income taxes                                                             |  |                   | 6,073    |   |                   |   | 24,479   |  
|Stock-based compensation                                                          |  |                   | 24,836   |   |                   |   | 28,227   |  
|Tax benefit realized from stock-based compensation                                |  |                   | 976      |   |                   |   | 3,251    |  
|Excess tax benefit from stock-based compensation                                  |  |                   | (97      | ) |                   |   | (782     | )
|Other-than-temporary impairment of short-term investment                          |  |                   | 737      |   |                   |   | 1,763    |  
|Other non-cash charges, net                                                       |  |                   | 2,177    |   |                   |   | 2,052    |  
|Changes in operating assets and liabilities:                                      |  |                   |          |   |                   |   |          |  
|Accounts receivable, net                                                          |  |                   | 137,236  |   |                   |   | (48,864  | )
|Inventories                                                                       |  |                   | 6,525    |   |                   |   | (28,183  | )
|Prepaid and other assets                                                          |  |                   | 17,834   |   |                   |   | (2,885   | )
|Accounts payable                                                                  |  |                   | (9,423   | ) |                   |   | 7,930    |  
|Accrued payroll and related expenses                                              |  |                   | (26,632  | ) |                   |   | (8,828   | )
|Accrued warranty                                                                  |  |                   | (17,147  | ) |                   |   | 3,781    |  
|Other liabilities                                                                 |  |                   | (6,708   | ) |                   |   | 26,537   |  
|Deferred profit                                                                   |  |                   | (28,688  | ) |                   |   | 15,963   |  
|                                                                                  |  |                   |          |   |                   |   |          |  
|Net cash provided by operating activities                                         |  |                   | 171,857  |   |                   |   | 236,039  |  
|                                                                                  |  |                   |          |   |                   |   |          |  
|Cash flows from investing activities:                                             |  |                   |          |   |                   |   |          |  
|Proceeds from sales of short-term and long-term investments                       |  |                   | 311,550  |   |                   |   | 669,945  |  
|Proceeds from maturities of short-term investments                                |  |                   | 78,110   |   |                   |   | 176,380  |  
|Purchases of short-term investments                                               |  |                   | (375,304 | ) |                   |   | (807,424 | )
|Capital expenditures                                                              |  |                   | (16,677  | ) |                   |   | (26,949  | )
|Decrease (increase) in restricted cash and cash equivalents                       |  |                   | 14,221   |   |                   |   | (7,234   | )
|Other                                                                             |  |                   |         |   |                   |   | (64      | )
|                                                                                  |  |                   |          |   |                   |   |          |  
|Net cash provided by investing activities                                         |  |                   | 11,900   |   |                   |   | 4,654    |  
|                                                                                  |  |                   |          |   |                   |   |          |  
|Cash flows from financing activities:                                             |  |                   |          |   |                   |   |          |  
|Proceeds from employee stock compensation plans                                   |  |                   | 6,415    |   |                   |   | 33,777   |  
|Proceeds from (repayments of) lines of credit, net                                |  |                   | 534      |   |                   |   | (11,964  | )
|Payments on debt obligations                                                      |  |                   | (15,568  | ) |                   |   | (21      | )
|Repurchases of common stock                                                       |  |                   | (188,886 | ) |                   |   | (216,893 | )
|Excess tax benefit from stock-based compensation                                  |  |                   | 97       |   |                   |   | 782      |  
|                                                                                  |  |                   |          |   |                   |   |          |  
|Net cash used in financing activities                                             |  |                   | (197,408 | ) |                   |   | (194,319 | )
|                                                                                  |  |                   |          |   |                   |   |          |  
|Effects of exchange rate changes on cash and cash equivalents                     |  |                   | 811      |   |                   |   | 814      |  
|                                                                                  |  |                   |          |   |                   |   |          |  
|Net increase (decrease) in cash and cash equivalents                              |  |                   | (12,840  | ) |                   |   | 47,188   |  
|Cash and cash equivalents at the beginning of the period                          |  |                   | 175,071  |   |                   |   | 58,463   |  
|                                                                                  |  |                   |          |   |                   |   |          |  
|Cash and cash equivalents at the end of the period                                |  | $                 | 162,231  |   |                   | $ | 105,651  |  
|                                                                                  |  |                   |          |   |                   |   |          |  

See accompanying notes to Condensed Consolidated Financial Statements.



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NOVELLUS SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying Condensed Consolidated
Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) for interim financial information and with the instructions to the Quarterly Report on Form 10-Q and Article 10 of Regulation S-X.
The interim financial information is unaudited and does not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 27, 2008 are not necessarily indicative of the results that may be expected for the year ending
December 31, 2008 or any future period. The interim financial statements should be read in conjunction with the Consolidated Financial Statements and footnotes thereto included in Novellus Annual Report on Form 10-K for the year ended
December 31, 2007.

The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses and the related disclosures of contingent assets and liabilities. We evaluate estimates on an ongoing basis, including those related to recognition of revenue, valuation of investments,
adequacy of the allowance for doubtful accounts, valuation of inventory, valuation of deferred tax assets, valuation of goodwill and other intangible assets, adequacy of warranty obligations, measurement of restructuring and impairment charges,
compliance with hedge accounting for derivatives, contingencies and litigation, and measurement of stock-based compensation. We base estimates on historical experience and on other market-based assumptions that are believed to be reasonable under
current circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our intent is to accurately state assets and liabilities given
facts known at the time of measurement. Actual results may differ from these estimates under different assumptions or conditions.

The accompanying
Condensed Consolidated Financial Statements include our accounts and the accounts of our subsidiaries after the elimination of all significant intercompany account balances and transactions. Warranty obligations in the amount of $10.0 million have
been reclassified from Accrued warranty to Other non-current liabilities in the December 31, 2007 Condensed Consolidated Balance Sheet to conform to the 2008 financial statement presentation. This reclassification did not affect any prior
amounts of reported total assets, liabilities, stockholders equity, results of operations or cash flows.

Derivatives

Our policy is to enter into foreign currency forward exchange contracts with maturities of less than 12 months to mitigate the impact of currency exchange fluctuations on
(a) probable anticipated system sales in Japanese yen, (b) our net investment in certain foreign subsidiaries, and (c) existing monetary asset and liability balances denominated in foreign currencies. We record all derivatives at fair
value in either Prepaid and other current assets or Other accrued liabilities. We report cash flows from derivative instruments in cash flows from operating activities. We used the income approach to value our derivative instruments using observable
inputs other than quoted prices, including interest rates and credit risk.

Cash Flow Hedges

We designate and document as cash flow hedges foreign currency forward exchange contracts on sales transactions in which costs are denominated in U.S. dollars and the
related revenues are generated in Japanese yen. We evaluate and calculate each hedges effectiveness at least quarterly, using the dollar offset method, comparing the change in the forward contracts fair value on a spot-to-spot basis to
the spot-to-spot change in the anticipated transaction. The effective change is recorded in Other comprehensive income (OCI) until the sale is recognized. Ineffectiveness, along with the excluded time value of the forward contracts, is recorded in
Net sales as designated at the inception of the forward contract. During the three months ended September 27, 2008 and September 29, 2007, gains of $0.1 million and $0.8 million, respectively, were recorded in Net sales due to hedge
ineffectiveness. During the nine months ended September 27, 2008 and September 29, 2007, gains of $0.5 million and $2.7 million, respectively, were recorded in Net sales due to hedge ineffectiveness. In the event it becomes probable that
an anticipated hedged transaction will not occur as a result of the associated shipment date pushing outside of the forecasted range, the gains or losses on the related cash flow hedges are reclassified from Accumulated other comprehensive income
(loss) to Net sales in the Condensed Consolidated Statement of Operations. No such events occurred during the three months ended September 27, 2008 and September 29, 2007. During both of the nine months ended September 27, 2008 and
September 29, 2007, we reclassified losses of $0.7 million into Net sales as a result of the discontinuance of hedged anticipated transactions.



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The following table summarizes the pre-tax impact of cash flow hedges on OCI during the three and nine months ended
September 27, 2008 and September 29, 2007.



|                                              |  |                    |     |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|--------------------------------------------- |  | ------------------ | --- | - | ----------------- | - | ------ | ----------------- |  | - | ----------------- | - |  | - | ------ | -
|                                              |  | Three Months Ended |     |   | Nine Months Ended |  
|                                              |  | September 27,2008  |     |   | September 29,2007 |   |        | September 27,2008 |  |   | September 29,2007 |  
|                                              |  | (In thousands)     |    
|Balance, beginning of period  gains (losses) |  | $                  | 341 |   |                   | $ | 1,805  |                   |  | $ | (2,578            | ) |  | $ | (329   | )
|Effective portion of hedge remeasurement      |  |                    | (61 | ) |                   |   | (4,533 | )                 |  |   | (450              | ) |  |   | (3,641 | )
|Reclassification to Net sales                 |  |                    | 269 |   |                   |   | (433   | )                 |  |   | 3,577             |   |  |   | 809    |  
|                                              |  |                    |     |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|Balance, end of period  gains (losses)       |  | $                  | 549 |   |                   | $ | (3,161 | )                 |  | $ | 549               |   |  | $ | (3,161 | )
|                                              |  |                    |     |   |                   |   |        |                   |  |   |                   |   |  |   |        |  

We anticipate reclassifying the net gains recorded as of September 27, 2008 from OCI to Net sales within 12
months.

Net Investment Hedges

We hedge our net
investment in certain foreign subsidiaries to reduce economic currency risk. The foreign currency forward exchange contracts used to hedge this exposure are designated and documented as net investment hedges. Effectiveness is evaluated at least
quarterly, excluding time value, and hedges are highly effective when currency pairs and notional amounts on the forward exchange contracts are properly aligned with the net investment in subsidiaries. Changes in the spot-to-spot value are recorded
as foreign currency translation adjustments within OCI. A gain of $1.2 million and a loss of $0.1 million were recorded in OCI for net investment hedges during the three months ended September 27, 2008 and September 29, 2007, respectively,
and losses of $0.5 million and $0.4 million were recorded in OCI during the nine months ended September 27, 2008 and September 29, 2007, respectively. Ineffectiveness, if any, along with the excluded time value of the forward contracts, is
recorded as foreign currency gain or loss in Other income, net. We recorded gains due to ineffectiveness of $0.1 million during both of the three months ended September 27, 2008 and September 29, 2007 and gains of $0.5 million during both
of the nine months ended September 27, 2008 and September 29, 2007.

Other Foreign Currency Hedges

We enter into foreign currency forward exchange contracts (a) to hedge intercompany balances denominated in non-functional currencies, (b) to hedge certain
third-party receivables denominated in Japanese yen and (c) to hedge anticipated sales denominated in foreign currency that do not qualify for special hedge accounting treatment under SFAS 133 due to uncertainty surrounding the timing of
shipment. The maturities of these contracts are generally less than 12 months. Gains or losses arising from the remeasurement of these contracts to fair value each period are recorded in Other income, net. During the three months ended
September 27, 2008 and September 29, 2007, we recorded derivative losses on these hedges of $2.5 million and $3.5 million, respectively, and during the nine months ended September 27, 2008 and September 29, 2007, we recorded
derivative losses on these hedges of $6.7 million and $0.9 million, respectively.

Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value
Measurements (SFAS 157), which establishes specific criteria for the fair value measurements of financial and nonfinancial assets and liabilities that are already subject to fair value under current accounting rules. SFAS 157 also requires
expanded disclosures related to fair value measurements. See Note 3 for information about fair value measurements.

In February 2008, the FASB issued FASB
Staff Position (FSP) of Financial Accounting Standards (FAS) 157-2, Effective Date of FASB Statement No. 157 (FSP 157-2), which allows companies to elect a one-year delay in applying SFAS 157 to certain fair value measurements of
non-financial instruments, except for those recognized or disclosed at fair value on at least an annual basis. We elected the delayed adoption date for the portions of SFAS 157 impacted by FSP 157-2 and, as a result, we partially adopted SFAS 157 on
January 1, 2008. The partial adoption of SFAS 157 was prospective and did not have a significant effect on our Condensed Consolidated Financial Statements. We are currently evaluating the impact of applying the deferred portion of SFAS 157 to
the nonrecurring fair value measurements of our nonfinancial assets and nonfinancial liabilities. In accordance with FSP 157-2, the fair value measurements for these items will be adopted effective January 1, 2009.

In October 2008, the FASB issued FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active (FSP
157-3), which clarifies the application of SFAS 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not
active. FSP 157-3 was effective upon issuance, including prior periods for which financial statements had not been issued. The adoption of this standard as of September 27, 2008 did not have a significant impact on our Condensed
Consolidated Financial Statements.



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##### Table of Contents

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial
LiabilitiesIncluding an amendment of SFAS 115 (SFAS 159). SFAS 159 permits a company to voluntarily elect to use fair value, instead of historic or original cost, to account for certain financial assets and liabilities. The fair value
option is designated on an item-by-item basis, is irrevocable and requires that changes in fair value in subsequent periods be recognized in earnings in the period of change. We adopted SFAS 159 on January 1, 2008. The adoption had no impact on
our Condensed Consolidated Financial Statements as we did not make a fair value election for any of our existing financial assets and liabilities. Any election to use the fair value method for future eligible transactions will be made on a
case-by-case and instrument-by-instrument basis.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business
Combinations (SFAS 141R). Under SFAS 141R, an entity is required to recognize the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. It further
requires that acquisition-related costs be recognized separately from the acquisition and expensed as incurred, restructuring costs generally be expensed in periods subsequent to the acquisition date, and changes in accounting for deferred tax asset
valuation allowances and acquired income tax uncertainties after the measurement period impact income tax expense. In addition, acquired in-process research and development is capitalized as an intangible asset and amortized over its estimated
useful life. The adoption of SFAS 141R will change our accounting treatment for business combinations on a prospective basis beginning in the first quarter of fiscal year 2009.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statementsan amendment of Accounting Research Bulletin No. 51 (SFAS 160), which
establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a
parents ownership interest, and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. SFAS 160 also establishes disclosure requirements that clearly identify and distinguish between the interests
of the parent and the interests of the noncontrolling owners. SFAS 160 is effective for fiscal years beginning after December 15, 2008. We do not expect that the adoption of SFAS 160 will have a significant impact on our Condensed
Consolidated Financial Statements as all of our subsidiaries are currently wholly owned.

In March 2008, the FASB issued SFAS No. 161,
Disclosures about Derivative Instruments and Hedging Activitiesan amendment of FASB Statement No. 133 (SFAS 161), which requires enhanced disclosures about an entitys derivative and hedging activities and thereby
improves the transparency of financial reporting. SFAS 161 is effective for fiscal years beginning after November 15, 2008. We are currently evaluating the impact of SFAS 161 on our Condensed Consolidated Financial Statements.

In April 2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of Intangible Assets (FSP 142-3). FSP 142-3 provides guidance with respect to
estimating the useful lives of recognized intangible assets acquired on or after the effective date and requires additional disclosure related to the renewal or extension of the terms of recognized intangible assets. FSP 142-3 is effective for
fiscal years and interim periods beginning after December 15, 2008. We are currently evaluating the impact of FSP 142-3 on our Condensed Consolidated Financial Statements.

Note 2. Net Income Per Share

Basic net income per share is computed by dividing Net income by the weighted-average
number of common shares outstanding during the period. For purposes of computing basic net income per share, the weighted-average number of outstanding shares of common stock excludes unvested restricted stock awards, consisting of restricted stock
and restricted stock units that may be settled in our common shares.

Diluted net income per share is computed by dividing Net income by the
weighted-average number of common and dilutive potential common shares outstanding during the period. Dilutive potential common shares consist primarily of stock options and restricted stock awards.



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The following table provides a reconciliation of the numerators and denominators of the basic and diluted per share
computations:



|                                            |  |                                          |        |                   |   |                   |  |                   |        |  |   |        
|------------------------------------------- |  | ---------------------------------------- | ------ | ----------------- | - | ----------------- |  | ----------------- | ------ |  | - | -------
|                                            |  | Three Months Ended                       |        | Nine Months Ended
|                                            |  | September 27,2008                        |        | September 29,2007 |   | September 27,2008 |  | September 29,2007
|                                            |  | (In thousands, except per share amounts)
|Numerator:                                  |  |                                          |        |                   |   |                   |  |                   |        |  |   |        
|Net income                                  |  | $                                        | 1,397  |                   | $ | 49,711            |  | $                 | 14,541 |  | $ | 160,839
|                                            |  |                                          |        |                   |   |                   |  |                   |        |  |   |        
|Denominator:                                |  |                                          |        |                   |   |                   |  |                   |        |  |   |        
|Basic weighted-average shares outstanding   |  |                                          | 97,581 |                   |   | 120,414           |  |                   | 98,807 |  |   | 122,730
|Dilutive common equivalent shares           |  |                                          | 767    |                   |   | 1,488             |  |                   | 743    |  |   | 2,514  
|                                            |  |                                          |        |                   |   |                   |  |                   |        |  |   |        
|Diluted weighted-average shares outstanding |  |                                          | 98,348 |                   |   | 121,902           |  |                   | 99,550 |  |   | 125,244
|                                            |  |                                          |        |                   |   |                   |  |                   |        |  |   |        
|Net income per share  Basic                |  | $                                        | 0.01   |                   | $ | 0.41              |  | $                 | 0.15   |  | $ | 1.31   
|Net income per share  Diluted              |  | $                                        | 0.01   |                   | $ | 0.41              |  | $                 | 0.15   |  | $ | 1.28   

For the three months ended September 27, 2008 and September 29, 2007, 19.5 million and
15.4 million shares, respectively, and for the nine months ended September 27, 2008 and September 29, 2007, 20.1 million and 11.0 million shares, respectively, attributable to outstanding stock options were excluded from the
calculation of diluted net income per share because their inclusion would have been anti-dilutive. Generally, options are considered anti-dilutive when their exercise prices are greater than or equal to the average market value of our common shares
during the period of measurement. Restricted stock awards representing 0.8 million shares for both of the three and nine months ended September 27, 2008 and September 29, 2007 were excluded from the computation of diluted shares
outstanding as the shares underlying these awards were subject to performance conditions that had not been met.

Note 3. Financial Instruments

Assets and liabilities measured at fair value on a recurring basis are as follows at September 27, 2008:



|                           |  |                                                            |         |                                             |   |                                        |  |       |         |  |   |        
|-------------------------- |  | ---------------------------------------------------------- | ------- | ------------------------------------------- | - | -------------------------------------- |  | ----- | ------- |  | - | -------
|                           |  | Fair Value Measurement at Reporting Date Using             |         |                                            
|                           |  | Quoted Prices inActive Marketsfor IdenticalAssets(Level 1) |         | Significant OtherObservable Inputs(Level
2) |   | SignificantUnobservableInputs(Level 3) |  | Total
|                           |  | (In thousands)                                            
|Assets                     |  |                                                            |         |                                             |   |                                        |  |       |         |  |   |        
|Money market funds         |  | $                                                          | 259,518 |                                             | $ |                                       |  | $     |        |  | $ | 259,518
|Municipal bonds            |  |                                                            |        |                                             |   | 208,164                                |  |       |        |  |   | 208,164
|Variable-rate demand notes |  |                                                            |        |                                             |   | 65,156                                 |  |       |        |  |   | 65,156 
|Auction-rate securities    |  |                                                            |        |                                             |   |                                       |  |       | 102,367 |  |   | 102,367
|Derivative assets (1)      |  |                                                            |        |                                             |   | 1,972                                  |  |       |        |  |   | 1,972  
|                           |  |                                                            |         |                                             |   |                                        |  |       |         |  |   |        
|Total                      |  | $                                                          | 259,518 |                                             | $ | 275,292                                |  | $     | 102,367 |  | $ | 637,177
|                           |  |                                                            |         |                                             |   |                                        |  |       |         |  |   |        
|Liabilities                |  |                                                            |         |                                             |   |                                        |  |       |         |  |   |        
|Derivative liabilities (1) |  | $                                                          |        |                                             | $ | 1,219                                  |  | $     |        |  | $ | 1,219  
|                           |  |                                                            |         |                                             |   |                                        |  |       |         |  |   |        
|Total                      |  | $                                                          |        |                                             | $ | 1,219                                  |  | $     |        |  | $ | 1,219  
|                           |  |                                                            |         |                                             |   |                                        |  |       |         |  |   |        



|(1) | See Note 1 of our Condensed Consolidated Financial Statements.
|--- | --------------------------------------------------------------

Money Market Funds

Money market funds include $116.2 million classified as Cash and cash equivalents and $143.3 million classified
as Restricted cash and cash equivalents, current, on our Condensed Consolidated Balance Sheet.

Municipal Bonds

Municipal bonds are bonds issued by state and local governments and other governmental entities such as authorities or special districts. These are classified as
available-for-sale within Short-term investments on our Condensed Consolidated Balance Sheet. We used the market approach to value municipal bonds. We classified these securities as Level 2 instruments due to either our use of observable market
prices in less active markets or, when observable market prices were not available, our use of non-binding market prices that are corroborated by observable market data or quoted market prices for similar instruments.

Variable-Rate Demand Notes

Variable-rate demand notes are
long-term, floating-rate obligations that are payable on demand. These are classified as available-for-sale within Short-term investments on our Condensed Consolidated Balance Sheet. We used the market approach to value variable-rate demand notes.
We classified these securities as Level 2 instruments due to either our usage of observable market prices in less active markets or, when observable market prices were not available, our use of non-binding market prices that are corroborated by
observable market data or quoted market prices for similar instruments.



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Auction-Rate Securities

Auction-rate securities include auction-rate notes and auction-rate preferred shares of tax-exempt closed-end municipal funds. Our auction-rate notes consist of student loans that are substantially backed by the
federal government. Beginning in February 2008, our auction-rate securities became illiquid as their scheduled auctions failed to settle. An auction failure occurs when the parties wishing to sell securities cannot. As a result, the affected
securities begin to pay interest under their default interest rate features. We will not have access to these funds unless (a) future auctions are successful, (b) the securities are called by the issuer, (c) we sell the securities in
a secondary market, or (d) the underlying notes mature. Currently, there are no active secondary markets. As of September 27, 2008 we have recorded a temporary impairment charge of $10.7 million within OCI based upon our assessment of the
fair value of our auction-rate securities. The impairment of these securities is temporary as we have both the ability and intent to hold these securities to recovery. Our valuation of these securities incorporates our assumptions about the
anticipated term and the yield that a market participant would require to purchase such a security in the marketplace. We have included auction-rate securities, of which $1.9 million are classified as Short-term investments and $100.5 million are
classified as non-current assets on our Condensed Consolidated Balance Sheet, in the Level 3 fair value category, as there are significant unobservable inputs to our cash-flow-based valuation model.

The table below presents a reconciliation of all financial instruments measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for
the three and nine months ended September 27, 2008. We classify financial instruments in Level 3 of the fair value hierarchy when there is reliance on at least one significant unobservable input to the valuation model. In addition to these
unobservable inputs, the valuation models for Level 3 financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly. Thus, the gains and losses presented below include changes in the fair
value related to both observable and unobservable inputs. All Level 3 financial instrument activities for the three and nine months ended September 27, 2008 are related to auction-rate securities.



|                                                     |  |                                                                        |         |   |                   |   |         |  
|---------------------------------------------------- |  | ---------------------------------------------------------------------- | ------- | - | ----------------- | - | ------- | -
|                                                     |  | Fair Value Measurements UsingSignificant Unobservable Inputs (Level 3) |        
|                                                     |  | Three Months Ended                                                     |         |   | Nine Months Ended |  
|                                                     |  | September 27,2008                                                      |         |   | September 27,2008 |  
|                                                     |  | (In thousands)                                                         |        
|Balance, beginning of period                         |  | $                                                                      | 112,055 |   |                   |   |        |  
|Transfers in and/or out of Level 3                   |  |                                                                        |        |   |                   |   | 123,420 |  
|Total net gains or losses (realized and unrealized): |  |                                                                        |         |   |                   |   |         |  
|Included in Net income (loss)                        |  |                                                                        |        |   |                   |   |        |  
|Included in Other comprehensive income (loss)        |  |                                                                        | (3,588  | ) |                   |   | (10,733 | )
|Purchases, issuances and settlements, net            |  |                                                                        | (6,100  | ) |                   |   | (10,320 | )
|                                                     |  |                                                                        |         |   |                   |   |         |  
|Balance, end of period                               |  | $                                                                      | 102,367 |   |                   | $ | 102,367 |  
|                                                     |  |                                                                        |         |   |                   |   |         |  

Note 4. Inventories

Inventories are stated at the lower of cost, on a first-in, first-out basis, or market. As of the balance sheet date, inventories consisted of the following:



|                          |  |                   |         |                  |   |        
|------------------------- |  | ----------------- | ------- | ---------------- | - | -------
|                          |  | September 27,2008 |         | December 31,2007
|                          |  | (In thousands)   
|Purchased and spare parts |  | $                 | 146,175 |                  | $ | 147,475
|Work-in-process           |  |                   | 38,747  |                  |   | 39,105 
|Finished goods            |  |                   | 26,888  |                  |   | 26,415 
|                          |  |                   |         |                  |   |        
|Total inventories         |  | $                 | 211,810 |                  | $ | 212,995
|                          |  |                   |         |                  |   |        



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Note 5. Goodwill and Intangible Assets

Goodwill

A summary of changes in goodwill during the nine months ended September 27, 2008 is as follows:



|                                         |  |                    |         |                             |   |         |       |  |   |         |  
|---------------------------------------- |  | ------------------ | ------- | --------------------------- | - | ------- | ----- |  | - | ------- | -
|                                         |  | SemiconductorGroup |         | IndustrialApplicationsGroup |   |         | Total | 
|                                         |  | (In thousands)     |        
|Balance, beginning of period             |  | $                  | 108,431 |                             | $ | 130,513 |       |  | $ | 238,944 |  
|Foreign currency translation adjustments |  |                    |        |                             |   | (452    | )     |  |   | (452    | )
|                                         |  |                    |         |                             |   |         |       |  |   |         |  
|Balance, end of period                   |  | $                  | 108,431 |                             | $ | 130,061 |       |  | $ | 238,492 |  
|                                         |  |                    |         |                             |   |         |       |  |   |         |  

There have been no significant events or circumstances affecting the valuation of goodwill since our annual
impairment test was performed in the fourth quarter of 2007 when we concluded no impairment existed.

Intangible Assets

The following tables provide details of our acquired intangible assets:



|                                    |  |                                   |  |                   |        |                         |   |                |     |  |                                   |        |       |    |                         |   |        |     |   |         |   |  |   |       
|----------------------------------- |  | --------------------------------- |  | ----------------- | ------ | ----------------------- | - | -------------- | --- |  | --------------------------------- | ------ | ----- | -- | ----------------------- | - | ------ | --- | - | ------- | - |  | - | ------
|                                    |  | September 27, 2008                |  | December 31, 2007
|                                    |  | WeightedAverageAmortizationPeriod |  | Gross             |        | AccumulatedAmortization |   |                | Net |  | WeightedAverageAmortizationPeriod |        | Gross |    | AccumulatedAmortization |   |        | Net
|                                    |  | (Years)                           |  | (In thousands)    |        | (Years)                 |   | (In thousands)
|Patents and other intangible assets |  | 12                                |  | $                 | 16,661 |                         | $ | (2,755         | )   |  | $                                 | 13,906 |       | 12 |                         | $ | 16,661 |     | $ | (1,679  | ) |  | $ | 14,982
|Developed technology                |  | 6                                 |  |                   | 30,229 |                         |   | (25,952        | )   |  |                                   | 4,277  |       | 6  |                         |   | 30,270 |     |   | (22,169 | ) |  |   | 8,101 
|Trademark                           |  | 10                                |  |                   | 7,447  |                         |   | (3,165         | )   |  |                                   | 4,282  |       | 10 |                         |   | 7,473  |     |   | (2,616  | ) |  |   | 4,857 
|                                    |  |                                   |  |                   |        |                         |   |                |     |  |                                   |        |       |    |                         |   |        |     |   |         |   |  |   |       
|Total intangible assets             |  | 8                                 |  | $                 | 54,337 |                         | $ | (31,872        | )   |  | $                                 | 22,465 |       | 8  |                         | $ | 54,404 |     | $ | (26,464 | ) |  | $ | 27,940
|                                    |  |                                   |  |                   |        |                         |   |                |     |  |                                   |        |       |    |                         |   |        |     |   |         |   |  |   |       

Our estimated amortization expense for currently recognized identifiable intangible assets is approximately $1.6
million in the fourth quarter of 2008, and $4.3 million, $3.2 million, $2.1 million, $2.1 million and $2.1 million for the years ending December 31, 2009, 2010, 2011, 2012 and 2013, respectively. As of September 27, 2008, we had no
identifiable intangible assets with indefinite lives.

Note 6. Product Warranty

We record the estimated cost of warranty coverage to Cost of sales when revenue is recognized. The estimated cost of warranty is determined by the warranty term as well as the average historical labor and material
costs for a specific product. We review the actual product failure rates and material usage rates on a quarterly basis and adjust our warranty liability as necessary. Product warranty obligations that extend for more than twelve months from our
balance sheet date are included in Other non-current liabilities. Changes in the accrued warranty liability were as follows:



|                                                                            |  |                    |         |   |                   |   |         |                   |  |   |                   |   |  |   |         |  
|--------------------------------------------------------------------------- |  | ------------------ | ------- | - | ----------------- | - | ------- | ----------------- |  | - | ----------------- | - |  | - | ------- | -
|                                                                            |  | Three Months Ended |         |   | Nine Months Ended |  
|                                                                            |  | September 27,2008  |         |   | September 29,2007 |   |         | September 27,2008 |  |   | September 29,2007 |  
|                                                                            |  | (In thousands)     |        
|Balance, beginning of period                                                |  | $                  | 41,361  |   |                   | $ | 58,650  |                   |  | $ | 54,857            |   |  | $ | 55,349  |  
|Warranties issued                                                           |  |                    | 12,718  |   |                   |   | 18,992  |                   |  |   | 44,578            |   |  |   | 61,888  |  
|Settlements                                                                 |  |                    | (16,035 | ) |                   |   | (18,199 | )                 |  |   | (59,273           | ) |  |   | (57,928 | )
|Net changes in liability for pre-existing warranties, including expirations |  |                    | (250    | ) |                   |   | (106    | )                 |  |   | (2,368            | ) |  |   | 28      |  
|                                                                            |  |                    |         |   |                   |   |         |                   |  |   |                   |   |  |   |         |  
|Balance, end of period                                                      |  | $                  | 37,794  |   |                   | $ | 59,337  |                   |  | $ | 37,794            |   |  | $ | 59,337  |  
|Less: Long-term portion                                                     |  |                    | (5,317  | ) |                   |   | (11,239 | )                 |  |   | (5,317            | ) |  |   | (11,239 | )
|Accrued warranty, current                                                   |  | $                  | 32,477  |   |                   | $ | 48,098  |                   |  | $ | 32,477            |   |  | $ | 48,098  |  
|                                                                            |  |                    |         |   |                   |   |         |                   |  |   |                   |   |  |   |         |  

Note 7. Restructuring and Other Charges

As of September 27, 2008, substantially all actions under our restructuring plans were completed, except for payments of future rent obligations. The remaining excess facility costs are stated at estimated net
present value, net of estimated sublease income. We expect to pay remaining obligations in connection with vacated facilities no later than the expiration dates of the lease terms, which expire on various dates through 2017. An adjustment of prior
restructuring costs was made due to changes in estimated sublease income over the remaining lease term. This adjustment is included within Selling, general and administrative expenses. All remaining restructuring activity relates to the
Semiconductor Group (see Note 12. Operating Segments).



11



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##### Table of Contents

The following table summarizes our facilities restructuring activity for the three and nine months ended
September 27, 2008 and September 29, 2007:



|                                        |  |                    |        |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|--------------------------------------- |  | ------------------ | ------ | - | ----------------- | - | ------ | ----------------- |  | - | ----------------- | - |  | - | ------ | -
|                                        |  | Three Months Ended |        |   | Nine Months Ended |  
|                                        |  | September 27,2008  |        |   | September 29,2007 |   |        | September 27,2008 |  |   | September 29,2007 |  
|                                        |  | (In thousands)     |       
|Balance, beginning of period            |  | $                  | 16,823 |   |                   | $ | 15,700 |                   |  | $ | 17,654            |   |  | $ | 17,503 |  
|Adjustment of prior restructuring costs |  |                    | 1,819  |   |                   |   |       |                   |  |   | 2,861             |   |  |   |       |  
|Cash payments                           |  |                    | (1,234 | ) |                   |   | (1,248 | )                 |  |   | (3,107            | ) |  |   | (3,051 | )
|                                        |  |                    |        |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|Balance, end of period                  |  | $                  | 17,408 |   |                   | $ | 14,452 |                   |  | $ | 17,408            |   |  | $ | 14,452 |  
|                                        |  |                    |        |   |                   |   |        |                   |  |   |                   |   |  |   |        |  

In addition to the restructuring activity above, results of operations for the nine months ended
September 27, 2008 include $13.6 million of charges recorded in the second quarter of 2008 as a result of strategic decisions to focus on our core products and reduce our cost structure going forward. These charges include: (a) impairments
of inventory and evaluation systems of $6.4 million, (b) write-downs of certain research and development assets of $3.8 million and (c) reductions in workforce of $3.4 million. Of these charges, $6.5 million are in Cost of sales, $4.3
million are in Research and development expenses and $2.8 million are in Selling, general and administrative expenses.

Note 8. Debt Obligations

As of September 27, 2008, we had borrowings of $130.8 million denominated in Euros and Swiss francs. The weighted-average interest rate on these
borrowings was 4.5% as of September 27, 2008. Substantially all of these borrowings are secured by cash and cash equivalents and are due and payable on or before June 25, 2009. Amounts to secure these borrowings are included within
Restricted cash and cash equivalents, current on our Condensed Consolidated Balance Sheet.

Note 9. Other Income, Net

The components of other income, net are as follows:



|                                                         |  |                    |      |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|-------------------------------------------------------- |  | ------------------ | ---- | - | ----------------- | - | ------ | ----------------- |  | - | ----------------- | - |  | - | ------ | -
|                                                         |  | Three Months Ended |      |   | Nine Months Ended |  
|                                                         |  | September 27,2008  |      |   | September 29,2007 |   |        | September 27,2008 |  |   | September 29,2007 |  
|                                                         |  | (In thousands)     |     
|Other income and expenses, net                           |  | $                  | 711  |   |                   | $ | 2,297  |                   |  | $ | 3,794             |   |  | $ | 7,213  |  
|Other-than-temporary impairment of short-term investment |  |                    |     |   |                   |   | (1,763 | )                 |  |   | (737              | ) |  |   | (1,763 | )
|Foreign currency gain (loss), net                        |  |                    | (244 | ) |                   |   | (218   | )                 |  |   | (1,644            | ) |  |   | 4,182  |  
|                                                         |  |                    |      |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|Total other income, net                                  |  | $                  | 467  |   |                   | $ | 316    |                   |  | $ | 1,413             |   |  | $ | 9,632  |  
|                                                         |  |                    |      |   |                   |   |        |                   |  |   |                   |   |  |   |        |  

Note 10. Shareholders Equity

Other Comprehensive Income (Loss)

The components of other comprehensive income (loss) are as follows:



|                                                               |  |                    |        |   |                   |   |        |                   |  |   |                   |   |  |   |         |  
|-------------------------------------------------------------- |  | ------------------ | ------ | - | ----------------- | - | ------ | ----------------- |  | - | ----------------- | - |  | - | ------- | -
|                                                               |  | Three Months Ended |        |   | Nine Months Ended |  
|                                                               |  | September 27,2008  |        |   | September 29,2007 |   |        | September 27,2008 |  |   | September 29,2007 |  
|                                                               |  | (In thousands)     |       
|Net income                                                     |  | $                  | 1,397  |   |                   | $ | 49,711 |                   |  | $ | 14,541            |   |  | $ | 160,839 |  
|Other comprehensive income (loss):                             |  |                    |        |   |                   |   |        |                   |  |   |                   |   |  |   |         |  
|Foreign currency translation adjustments                       |  |                    | (3,016 | ) |                   |   | 3,568  |                   |  |   | 116               |   |  |   | 3,238   |  
|Unrealized gain (loss) on short-term and long-term investments |  |                    | (3,324 | ) |                   |   | 783    |                   |  |   | (10,885           | ) |  |   | (338    | )
|Unrealized gain (loss) on derivative instruments               |  |                    | 208    |   |                   |   | (4,966 | )                 |  |   | 3,127             |   |  |   | (2,832  | )
|Unrealized gain (loss) on minimum pension liability adjustment |  |                    | 22     |   |                   |   | (44    | )                 |  |   |                  |   |  |   | (37     | )
|                                                               |  |                    |        |   |                   |   |        |                   |  |   |                   |   |  |   |         |  
|Comprehensive income (loss)                                    |  | $                  | (4,713 | ) |                   | $ | 49,052 |                   |  | $ | 6,899             |   |  | $ | 160,870 |  
|                                                               |  |                    |        |   |                   |   |        |                   |  |   |                   |   |  |   |         |  



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The components of accumulated other comprehensive income (loss) are as follows:



|                                                        |  |                   |         |   |                  |   |        |  
|------------------------------------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------ | -
|                                                        |  | September 27,2008 |         |   | December 31,2007 |  
|                                                        |  | (In thousands)    |        
|Foreign currency translation adjustments                |  | $                 | 8,180   |   |                  | $ | 8,064  |  
|Unrealized loss on short-term and long-term investments |  |                   | (10,898 | ) |                  |   | (13    | )
|Unrealized gain (loss) on derivative instruments        |  |                   | 549     |   |                  |   | (2,578 | )
|Unrealized loss on minimum pension liability adjustment |  |                   | (197    | ) |                  |   | (197   | )
|                                                        |  |                   |         |   |                  |   |        |  
|Accumulated other comprehensive income (loss)           |  | $                 | (2,366  | ) |                  | $ | 5,276  |  
|                                                        |  |                   |         |   |                  |   |        |  

Common Stock Repurchase Program

The Board of Directors has authorized the repurchase of outstanding common stock, including approvals of $1.0 billion on September 14, 2004 and another $1.0 billion on October 26, 2007. As of
September 27, 2008, we had $845.9 million available for stock repurchases under these authorizations. For the nine months ended September 27, 2008 and September 29, 2007, 7.6 million and 8.0 million shares, respectively,
were repurchased under this plan for $173.8 million and $226.9 million, respectively, at a weighted average purchase price of $22.74 and $28.39, respectively.

Note 11. Litigation

Linear Technology Corporation

In March 2002, Linear Technology Corporation (Linear) filed a complaint against Novellus, among other parties, in the Superior Court of the State of California for the County of Santa Clara. The complaint seeks
damages (including punitive damages), declaratory relief and injunctions for causes of action involving alleged breach of contract, fraud, unfair competition and breach of warranty. The Superior Court dismissed Linears claims
for fraud and unfair competition on October 5, 2004. The Court of Appeal affirmed this dismissal on June 18, 2007. Trial on the remaining claims is currently set for May 26, 2009. At this time, we cannot
predict the ultimate outcome of this case, nor can we estimate a range of potential loss, if any. However, we believe that the ultimate disposition of these matters will not have a material adverse effect on our business, financial condition or
operating results.

Other Litigation

We are a
defendant or plaintiff in various actions that have arisen in the normal course of business. We believe that the ultimate disposition of these matters will not have a material adverse effect on our business, financial condition or results of
operations. However, due to the uncertainty surrounding litigation, we are unable at this time to estimate a range of loss, if any, that may result from any of these pending proceedings.

Note 12. Income Taxes

Our effective tax rates were 84.6% and 33.2% for the three months ended September 27,
2008 and September 29, 2007, respectively, and 53.1% and 33.1% for the nine months ended September 27, 2008 and September 29, 2007, respectively. The higher effective tax rates for 2008 are principally the result of decreased profits
before taxes and an unfavorable mix of our anticipated annual operating results, particularly in certain foreign jurisdictions. This increased our effective tax rate for the nine months ended September 27, 2008 to 53.1% from 40.0% for the six
months ended June 28, 2008 resulting in an 84.6% effective tax rate for the three months ended September 27, 2008.

Note 13. Stock-Based
Compensation

The following table summarizes the stock-based compensation expense for stock options, restricted stock and employee stock purchase plan
(ESPP) included in our Condensed Consolidated Statements of Operations:



|                                                          |  |                    |        |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|--------------------------------------------------------- |  | ------------------ | ------ | - | ----------------- | - | ------ | ----------------- |  | - | ----------------- | - |  | - | ------ | -
|                                                          |  | Three Months Ended |        |   | Nine Months Ended |  
|                                                          |  | September 27,2008  |        |   | September 29,2007 |   |        | September 27,2008 |  |   | September 29,2007 |  
|                                                          |  | (In thousands)     |       
|                                                          |  | (1)                |        |   | (2)               |   |        | (1)               |  |   | (2)               |  
|Cost of sales                                             |  | $                  | 749    |   |                   | $ | 543    |                   |  | $ | 2,166             |   |  | $ | 1,619  |  
|Selling, general and administrative                       |  |                    | 4,632  |   |                   |   | 6,674  |                   |  |   | 15,140            |   |  |   | 17,619 |  
|Research and development                                  |  |                    | 2,558  |   |                   |   | 2,987  |                   |  |   | 7,530             |   |  |   | 8,989  |  
|                                                          |  |                    |        |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|Stock-based compensation expense                          |  |                    | 7,939  |   |                   |   | 10,204 |                   |  |   | 24,836            |   |  |   | 28,227 |  
|Income tax benefit                                        |  |                    | (2,015 | ) |                   |   | (3,449 | )                 |  |   | (6,368            | ) |  |   | (7,805 | )
|                                                          |  |                    |        |   |                   |   |        |                   |  |   |                   |   |  |   |        |  
|Total stock-based compensation, net of income tax benefit |  | $                  | 5,924  |   |                   | $ | 6,755  |                   |  | $ | 18,468            |   |  | $ | 20,422 |  
|                                                          |  |                    |        |   |                   |   |        |                   |  |   |                   |   |  |   |        |  



|(1) | Amounts include amortization expense related to stock options of $4.0 million and $12.9 million, ESPP of $0.6 million and $2.0 million, and restricted stock awards of $3.3 million
and $9.9 million for the three and nine months ended September 27, 2008, respectively.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



13



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|(2) | Amounts include amortization expense related to stock options of $5.4 million and $15.3 million, ESPP of $0.8 million and $2.2 million, and restricted stock awards of $4.0 million
and $10.7 million for the three and nine months ended September 29, 2007, respectively.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Stock Options

The exercise price of each stock option equals the market price of our common stock on the date of grant. Stock options generally vest ratably over a four-year period on
the anniversary date of the grant and expire ten years after the grant date. The fair values of stock options were estimated using the Black-Scholes valuation model with the following weighted-average assumptions:



|                        |  |                    |   |  |                   |   |  |                   |   |  |                   |  
|----------------------- |  | ------------------ | - |  | ----------------- | - |  | ----------------- | - |  | ----------------- | -
|                        |  | Three Months Ended |   |  | Nine Months Ended |  
|                        |  | September 27,2008  |   |  | September 29,2007 |   |  | September 27,2008 |   |  | September 29,2007 |  
|Risk-free interest rate |  | 2.6                | % |  | 4.6               | % |  | 2.7               | % |  | 4.7               | %
|Volatility              |  | 52.7               | % |  | 48.6              | % |  | 51.7              | % |  | 47.6              | %
|Expected term           |  | 4.3 years          |   |  | 4.4 years         |   |  | 4.3 years         |   |  | 4.4 years         |  
|Dividends               |  | None               |   |  | None              |   |  | None              |   |  | None              |  

Our computation of volatility is based on a combination of historical and market-based implied volatility. Our
computation of expected term is based on historical exercise patterns. We base the risk-free interest rate on the implied yield in effect at the time of option grant on U.S. Treasury zero-coupon issues with remaining terms equivalent to the expected
term of the option.

A summary of stock option activity during the nine months ended September 27, 2008 is as follows:



|                                           |  |                 |   |  |                                |       |                                                     |      |                          |   |       
|------------------------------------------ |  | --------------- | - |  | ------------------------------ | ----- | --------------------------------------------------- | ---- | ------------------------ | - | ------
|                                           |  | Number ofShares |   |  | Weighted-AverageExercise Price |       | Weighted-AverageRemainingContractualTerm (in Years) |      | AggregateIntrinsic Value
|                                           |  | (In thousands)  |   |  |                                |       |                                                     |      | (In thousands)          
|Outstanding, beginning of period           |  | 21,774          |   |  | $                              | 31.99 |                                                     | 5.62 |                          | $ | 17,187
|Grants                                     |  | 151             |   |  |                                | 22.16 |                                                     |      |                          |   |       
|Exercises                                  |  | (114            | ) |  |                                | 14.36 |                                                     |      |                          |   |       
|Forfeitures or expirations                 |  | (2,238          | ) |  |                                | 32.53 |                                                     |      |                          |   |       
|                                           |  |                 |   |  |                                |       |                                                     |      |                          |   |       
|Outstanding, end of period                 |  | 19,573          |   |  | $                              | 31.95 |                                                     | 4.94 |                          | $ | 1,065 
|                                           |  |                 |   |  |                                |       |                                                     |      |                          |   |       
|Vested and expected to vest, end of period |  | 19,047          |   |  | $                              | 32.05 |                                                     | 4.84 |                          | $ | 1,065 
|Exercisable, end of period                 |  | 15,267          |   |  | $                              | 33.00 |                                                     | 4.05 |                          | $ | 1,065 

The aggregate intrinsic value of options outstanding is calculated as the difference between the exercise price of
the underlying options and the market price of our common stock for the 0.3 million and 7.2 million shares that had exercise prices lower than the market price of our common stock as of September 27, 2008 and December 31, 2007,
respectively. The aggregate intrinsic value of options exercised, determined as of the date of exercise, was $0.2 million and $1.1 million during the three months ended September 27, 2008 and September 29, 2007, respectively, and $0.9
million and $7.9 million during the nine months ended September 27, 2008 and September 29, 2007, respectively. The weighted-average grant date fair value of options granted during the three months ended September 27, 2008 and
September 29, 2007 was $9.40 and $13.39, respectively, and during the nine months ended September 27, 2008 and September 29, 2007 was $9.80 and $13.76, respectively. The total cash received from employees as a result of stock option
exercises was $0.7 million and $3.7 million during the three months ended September 27, 2008 and September 29, 2007, respectively, and $1.6 million and $29.1 million during the nine months ended September 27, 2008 and
September 29, 2007, respectively. In connection with these exercises and the disqualification of incentive stock options, we realized a tax benefit of $0.1 million and $0.4 million for the three months ended September 27, 2008 and
September 29, 2007, respectively, and $0.2 million and $2.4 million for the nine months ended September 27, 2008 and September 29, 2007, respectively. We settle employee stock option exercises with newly issued common shares.



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As of September 27, 2008 there was $29.1 million of unrecognized compensation cost related to unvested stock
options, of which $4.4 million is expected to be recognized in the fourth quarter of 2008, and $12.8 million, $9.1 million, $2.7 million and $0.1 million is expected to be recognized in 2009, 2010, 2011 and 2012, respectively.

Restricted Stock

Restricted stock awards include restricted
stock and restricted stock units that are settled in common stock. Restricted stock awards generally vest over three, four, or five-year periods, excluding certain awards that vest upon the achievement of specific performance targets. A summary of
restricted stock award activity during the nine months ended September 27, 2008 is as follows:



|                                                      |  |                 |   |  |                                      |      
|----------------------------------------------------- |  | --------------- | - |  | ------------------------------------ | -----
|                                                      |  | Number ofShares |   |  | Weighted-AverageGrant DateFair Value
|                                                      |  | (In thousands)  |   |  |                                     
|Unvested restricted stock awards, beginning of period |  | 2,765           |   |  | $                                    | 28.45
|Granted                                               |  | 268             |   |  |                                      | 22.94
|Vested                                                |  | (72             | ) |  |                                      | 27.64
|Forfeited                                             |  | (285            | ) |  |                                      | 28.17
|                                                      |  |                 |   |  |                                      |      
|Unvested restricted stock awards, end of period       |  | 2,676           |   |  | $                                    | 27.95
|                                                      |  |                 |   |  |                                      |      

The unvested restricted stock awards at September 27, 2008 include 1.2 million of restricted stock
units.

The total fair value of restricted stock awards that vested was $0.1 million and $0.3 million during the three months ended September 27, 2008
and September 29, 2007, respectively, and $1.7 million and $1.8 million during the nine months ended September 27, 2008 and September 29, 2007, respectively. In connection with the vesting of these awards, we realized tax benefits of
$0.1 million for the three months ended September 27, 2008 and $0.6 million for both of the nine months ended September 27, 2008 and September 29, 2007. No tax benefit was realized for the three months ended September 29, 2007.
As of September 27, 2008, there was a total of 0.8 million shares of restricted stock awards subject to performance conditions that will result in forfeiture if the conditions are not met.

As of September 27, 2008 there was $24.9 million of unrecognized compensation cost related to restricted stock awards, of which $3.5 million is expected to be
recognized in the fourth quarter of 2008, and $10.3 million, $6.3 million, $4.6 million and $0.2 million, is expected to be recognized in 2009, 2010, 2011 and 2012, respectively.

Employee Stock Purchase Plan

We have an ESPP that allows qualified employees to purchase shares of common
stock at 85 percent of the fair market value on specified dates. There were no ESPP shares issued during the third quarter of 2008 and 2007. The weighted-average grant date fair value of shares for the three months ended September 27, 2008 and
September 28, 2007 was $6.11 and $7.98, respectively, and for the nine months ended September 27, 2008 and September 29, 2007 was $6.64 and $7.51, respectively. The fair values of ESPP were estimated using the Black-Scholes valuation
model with the following weighted-average assumptions:



|                        |  |                    |   |  |                   |   |  |                   |   |  |                   |  
|----------------------- |  | ------------------ | - |  | ----------------- | - |  | ----------------- | - |  | ----------------- | -
|                        |  | Three Months Ended |   |  | Nine Months Ended |  
|                        |  | September 27,2008  |   |  | September 29,2007 |   |  | September 27,2008 |   |  | September 29,2007 |  
|Risk-free interest rate |  | 1.7                | % |  | 5.0               | % |  | 2.7               | % |  | 5.0               | %
|Volatility              |  | 40.0               | % |  | 31.6              | % |  | 39.3              | % |  | 32.6              | %
|Expected term           |  | 6 months           |   |  | 6 months          |   |  | 6 months          |   |  | 6 months          |  
|Dividends               |  | None               |   |  | None              |   |  | None              |   |  | None              |  

Note 14. Operating Segments

Our operations are organized into two segments, the Semiconductor Group and the Industrial Applications Group. The Semiconductor Group develops, manufactures, sells and supports equipment used in the fabrication of
integrated circuits, commonly called chips or semiconductors. The Industrial Applications Group is a supplier of lapping, grinding, polishing and deburring products for fine-surface optimization. The accounting policies of these segments are the
same as those described in Note 2 of our Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2007.



15



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Segment information for the periods presented is as follows:



|                                |  |                                       |           |                                      |   |              |  |                    |           |                             |   |              |  |   |         |  |   |          
|------------------------------- |  | ------------------------------------- | --------- | ------------------------------------ | - | ------------ |  | ------------------ | --------- | --------------------------- | - | ------------ |  | - | ------- |  | - | ---------
|                                |  | Three Months Ended September 27, 2008 |           | Nine Months Ended September 27, 2008
|                                |  | (In thousands)                       
|                                |  | SemiconductorGroup                    |           | IndustrialApplicationsGroup          |   | Consolidated |  | SemiconductorGroup |           | IndustrialApplicationsGroup |   | Consolidated
|Sales to unaffiliated customers |  | $                                     | 207,050   |                                      | $ | 43,048       |  | $                  | 250,098   |                             | $ | 685,672      |  | $ | 136,879 |  | $ | 822,551  
|Operating income                |  | $                                     | 3,139     |                                      | $ | 2,878        |  | $                  | 6,017     |                             | $ | 4,162        |  | $ | 17,744  |  | $ | 21,906   
|                                |  |                                      
|                                |  | Three Months Ended September 29, 2007 |           | Nine Months Ended September 29, 2007
|                                |  | (In thousands)                       
|                                |  | SemiconductorGroup                    |           | IndustrialApplicationsGroup          |   | Consolidated |  | SemiconductorGroup |           | IndustrialApplicationsGroup |   | Consolidated
|Sales to unaffiliated customers |  | $                                     | 348,625   |                                      | $ | 44,652       |  | $                  | 393,277   |                             | $ | 1,093,027    |  | $ | 113,559 |  | $ | 1,206,586
|Operating income                |  | $                                     | 58,855    |                                      | $ | 6,648        |  | $                  | 65,503    |                             | $ | 192,139      |  | $ | 13,498  |  | $ | 205,637  
|                                |  |                                      
|                                |  | September 27, 2008                    |           | December 31, 2007                   
|                                |  | (In thousands)                       
|                                |  | SemiconductorGroup                    |           | IndustrialApplicationsGroup          |   | Consolidated |  | SemiconductorGroup |           | IndustrialApplicationsGroup |   | Consolidated
|Total assets                    |  | $                                     | 1,573,402 |                                      | $ | 247,842      |  | $                  | 1,821,244 |                             | $ | 1,792,443    |  | $ | 284,500 |  | $ | 2,076,943

Note 15. Related Party Transactions

We lease an aircraft from a third-party entity wholly owned by Richard S. Hill, our Chairman and Chief Executive Officer. Under the aircraft lease agreement, we incurred lease expenses of $0.1 million and $0.2 million
for the three months ended September 27, 2008 and September 29, 2007, respectively, and $0.6 million and $0.5 million for the nine months ended September 27, 2008 and September 29, 2007, respectively.

We employ immediate family members of certain executive officers in non-executive positions. We recognized aggregate compensation expense for these employees of $0.1
million during both of the three months ended September 27, 2008 and September 29, 2007 and $0.4 million during both of the nine months ended September 27, 2008 and September 29, 2007.

As of September 27, 2008 and December 31, 2007, we had outstanding loans to non-executive vice presidents and other key personnel of $1.0 million. As of
September 27, 2008, nearly all of the outstanding balance was secured by collateral. Loans typically bear interest, except for those made for employee relocation purposes. Bad debt expense related to these types of loans has not historically
been significant.



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

Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q and certain information
incorporated herein by reference contain forward-looking statements within the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. All statements included or incorporated by reference in this Quarterly Report,
other than statements that are purely historical, are forward-looking statements. Words such as anticipate, expect, intend, plan, believe, seek, estimate, and
similar expressions also identify forward-looking statements. The forward-looking statements include, without limitation: our anticipation to reclassify net gains recorded as of September 27, 2008 from OCI to Net sales within the next twelve
months; our expectation that the adoption of certain accounting pronouncements will not have a significant impact on our Condensed Consolidated Financial Statements; our estimated amortization expense for currently recognized identifiable intangible
assets in the fourth quarter of 2008 and for the years ending December 31, 2009, 2010, 2011, 2012 and 2013, respectively; our expectation that the remaining obligations in connection with vacated facilities will be satisfied no later than the
lease terms, which expire on various dates through 2017; our expectation that the ultimate disposition of the Linear litigation will not have a material adverse effect on our business, financial condition or operating results; our expectation that
$29.1 million of unrecognized compensation cost related to unvested stock options, of which $4.4 million is expected



16



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##### Table of Contents

to be recognized in the fourth quarter of 2008, and $12.8 million, $9.1 million, $2.7 million and $0.1 million is expected to be recognized in 2009, 2010,
2011 and 2012, respectively; our expectation that $24.9 million of unrecognized compensation cost related to restricted stock awards, of which $3.5 million is expected to be recognized in the fourth quarter of 2008 and $10.3 million, $6.3 million,
$4.6 million and $0.2 million will be recognized in 2009, 2010, 2011 and 2012, respectively; our efforts to continue to work closely with our customers and make substantial investments in research and development in order to deliver innovative
products which enhance productivity for our customers to utilize the latest technology; our belief that our continued investment in research and development has positioned us for future growth; our expectation that the average selling price for
memory chips will stabilize; our expectation that our customers capital spending will increase over the long term as demand from various industries continues to steadily rise; our belief that the shift to DRAM and NAND products will stimulate the
development of more efficient tools to satisfy our customers needs; our belief that our customers are seeking more affordable technology to drive down their prices so they can continue to grow the market demand for their products; our
continued focus on operational execution and a pairing down of certain research and development activities to improve profitability by reducing our cost structure; our expectation that net orders will fluctuate due to the cyclicality of the
semiconductor industry; our plan to continue to focus on expanding our market presence in Asia; our belief that significant additional growth potential exists in the Asia region over the long term; our belief that significant investment in research
and development is required to remain competitive; our plan to continue to invest in new products and enhancement of our current product lines; our intention to hold auction-rate securities to recovery; our belief that we will ultimately be able to
liquidate our investments in auction-rate securities without significant loss through successful auctions, redemptions of securities by the issuers or upon maturity; our belief that the impairment of the auction-rate securities is temporary because
they have either been guaranteed by the federal government or in the case of closed-end funds they are backed by more than 200% collateral; our anticipation that the illiquidity of the auction-rate securities will not negatively affect our ability
to execute our current business plan and operations; our intention to continue to seek legal protection through patents and trade secrets for our proprietary technology; our belief that our current cash position, cash generated through operations
and equity offerings, and available borrowing capacity will be sufficient to meet our needs through the next twelve months; our belief that the ultimate outcome of actions that have arisen in the normal course of business will not have a material
adverse effect on our business, financial condition or results of operations; our expectation that sales of our products to relatively few customers will continue to account for a high percentage of our net sales in the foreseeable future; our
expectation to continue to experience significant fluctuations in our quarterly operating results; our expectation to use the proceeds from certain credit agreements for working capital and other general corporate purposes, including the repurchase
of shares; and our expectation to repurchase shares from time to time in the open market, through block shares or otherwise.

Our expectations, beliefs,
objectives, intentions and strategies regarding the future, including, without limitation, those concerning expected operating results, revenues and earnings and current and potential litigation are not guarantees of future performance and are
subject to risks and uncertainties that could cause actual results to differ materially from results contemplated by the forward-looking statements. These risks and uncertainties include, but are not limited to: unanticipated trends with respect to
the cyclicality of the semiconductor industry; inability to reclassify net gains from OCI to Net sales within the next twelve months; inaccuracies regarding growth potential in the Asia region over the long term; sustained decrease in or leveling
off of customer demand; inability to predict the impact of the Linear litigation on our business, financial conditions or operating results; inability to accurately predict the impact of new accounting pronouncements on our Condensed Consolidated
Financial Statements; inability to accurately assess the period in which the Company will recognize unrecognized compensation related to unvested stock options and restricted stock awards; inaccuracies related to the timing and satisfaction of
remaining obligations related to vacated leases; inability of the Company to meet certain performance conditions that may result in forfeiture of certain restricted stock awards; unexpected increase in costs associated with manufacturing memory
chips; inability to anticipate cyclical changes in customers capacity utilization and demand; the negative impact of higher cost of services on gross margins; inability to realize efficiencies from outsourcing; inefficiencies in the allocation
of funds towards our research and development efforts to our existing and new product lines; unexpected difficulties in introducing new and enhanced products in a timely manner in order to remain competitive; unexpected changing product needs of our
customers; loss of a major customer; the need to seek new customers and diversify our customer base; unanticipated need for additional liquid assets in the next twelve months; our failure to accurately predict the effect of the ultimate outcome of
current litigation on our business, financial condition, results of operations or material adjustment to our financial statements; inherent uncertainty in the outcome of litigation matters; our potential inability to enforce our patents and protect
our trade secrets; inability to accurately predict our ability to recover the carrying value of our investment in auction-rate securities, market changes negatively affecting auction-rate securities and the governments inability to guarantee
the underlying securities; inability to accurately predict customers capital spending over the long term and continued customer capital spending reductions in the semiconductor industry; further periodic downturns in the semiconductor industry which
could have a material adverse effect on the semiconductor industrys demand for semiconductor processing equipment inability to accurately predict mega-fabrication trends in memory manufacturing; uncertainties related to the acceptance of new
technology into the memory market; introduction of new products by competitors; inability to gain and leverage market position during the economic downturn; and unexpected shift in market demands for both memory and logic products; uncertainties
related to growth in the electronic industry; and inability to successfully select, develop, and market new products, or enhance existing products.



17



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##### Table of Contents

The forward-looking statements in this Quarterly Report on Form 10-Q are subject to additional risks and uncertainties
set forth under the heading Risk Factors in Item 1A of Part II, and are based on information available to us on the date hereof. We assume no obligation to update any forward-looking statements. Readers are cautioned not to place
undue reliance on forward-looking statements, which speak only as of the date of the filing of this Quarterly Report on Form 10-Q. Readers should also review carefully the cautionary statements and risk factors listed in our Annual Report on Form
10-K for the year ended December 31, 2007 and in our other filings with the SEC, including our Forms 10-Q and 8-K and our Annual Report to Shareholders.

Introduction

The following Managements Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is
intended to provide readers with an understanding of our business. The following are included in our MD&A:



| |  |  | Overview of our Business and Industry;
| | - |  | --------------------------------------



| |  |  | Financial Performance Overview;
| | - |  | -------------------------------



| |  |  | Results of Operations;
| | - |  | ----------------------



| |  |  | Critical Accounting Policies; and
| | - |  | ---------------------------------



| |  |  | Liquidity and Capital Resources.
| | - |  | --------------------------------

Overview of Our
Business and Industry

Novellus Systems, Inc. is a California corporation organized in 1984. At Novellus, we primarily develop, manufacture, sell and
support equipment used in the fabrication of integrated circuits, commonly called chips or semiconductors. Customers for these products manufacture chips for sale or for incorporation in their own products, or provide chip-manufacturing services to
third parties. The segment of our business serving this area is the Semiconductor Group. In 2004, Novellus entered into market segments beyond semiconductor manufacturing with the acquisition of Peter Wolters AG, a German company specializing in
lapping and polishing equipment for a number of industries. With the acquisition of Switzerland-based Voumard Machine Co. SA in 2005 we expanded our product offerings to include high-precision machine manufacturing tools. We call this segment the
Industrial Applications Group (IAG).

In the Semiconductor Group, our business depends on capital expenditures made by integrated circuit manufacturers,
who in turn are dependent on corporate and consumer demand for integrated circuits and the electronic products which use them. Since the industry in which we operate is driven by spending for electronic products, our business is directly affected by
growth or contraction in the global economy as well as by the adoption of new technologies. Demand for personal computers, the expansion of the Internet and telecommunications industries, and the emergence of new applications in consumer electronics
have a direct impact on our business. In addition, the industry is characterized by intense competition and rapidly changing technology. We continue to work closely with our customers and make substantial investments in research and development in
order to deliver innovative products which enhance productivity for our customers and utilize the latest technology. We believe these investments have positioned us for future growth.

In the Industrial Applications Group, our business depends on capital expenditures made by manufacturers in sectors such as vehicles, aircraft and electronic products, parts and components. At the broadest level,
machine tools demand is highly sensitive to macroeconomic conditions as our customer base includes some of the most cyclically sensitive industries in the economy. As a result, such variables as the outlook for overall economic growth, fixed
investment and durable goods shipments directly affect the growth of our business. Our industrial business also depends on niche applications in addition to the general machine tool cycle. As we continue to expand our capabilities in this segment,
our operations are increasingly impacted by the wafer industry which, similar to the semiconductor segment, is also characterized by intense competition and rapidly changing technology.

As a supplier to the global semiconductor and semiconductor-related industries, we are subject to business cycles and trends which are difficult to predict. As indicated above, our products are used to manufacture
semiconductors that are used throughout the electronics industry, including the personal computer, mobile phone, consumer electronics and portable media player markets. Our customers operate principally in the semiconductor memory and logic markets.



18



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##### Table of Contents

The demand for our products is affected by the profitability of our customers which is driven by capacity and market
supply for their products. In fiscal 2006 and 2007, our memory customers built excess capacity as they did not accurately predict demand for their products. As a result, memory capacity additions during those years outpaced the current rate of
demand. The overcapacity of memory customers coupled with weak memory pricing, tight liquidity in the credit markets, and the negative economic environment has caused those customers to delay capital spending and, in some instances, constrain or
retire some of their capacity output. These actions are expected to stabilize average selling prices for memory chips. While we have seen capital expenditures slow in the recent past, we expect our customers capital spending to increase over
the long term as demand from various industries continues to steadily rise. This is mainly driven by worldwide technology consumption of chips that has grown at an annual historical rate of 10%.

As we look further at end market demand, notwithstanding any potential worldwide economic slowdown or recession, we have also begun to see growing demand for DRAM and
NAND memory devices, enabled by lower memory average selling prices. We believe this shift will stimulate the development of more efficient tools to satisfy our customers needs. The manufacture of memory chips requires tremendous economies of
scale that involve large fabrication facilities. Our customers seek more affordable technology to drive down their costs so they can grow the market demand for their products.

Given the historically cyclical nature of the semiconductor industry, we continue to focus on operational execution and a paring down of certain research and development activities to improve profitability by reducing
our cost structure. As a result, we achieved our goal of reducing quarterly operational expenses below $110 million in the third quarter of 2008. In October 2008, we announced that we would continue to drive down operational expenses to a level
sufficient to achieve cash break-even with a quarterly revenue base of $187 million by the end of the fourth quarter. We define cash break-even as the point at which a net loss plus non-cash expenses such as those associated with stock compensation,
depreciation and amortization equals zero.

We focus on certain key quarterly financial data to manage our business. Net sales, gross profit, net income
and net income per share are the primary measures we use to monitor performance. We also use certain non-GAAP measures, such as shipments and net orders, to assess business trends and performance. Shipments consist of products shipped to customers,
without regard to net sales adjustments such as deferrals associated with customer acceptance. Net orders, which are also referred to as bookings, consist of current period orders less current period cancellations. Shipments and net orders are used
to forecast and plan future operations. We do not report orders for systems with delivery dates more than 12 months from the latest balance sheet date.

The following table sets forth certain quarterly financial information for the periods indicated (in thousands, except per share data and percentages):



|                                        |  |                          |         |    |               |   |         |              |  |   |               |    |  |              |         |    |               |   |         |              |  |   |         |    |  |   |         |   
|--------------------------------------- |  | ------------------------ | ------- | -- | ------------- | - | ------- | ------------ |  | - | ------------- | -- |  | ------------ | ------- | -- | ------------- | - | ------- | ------------ |  | - | ------- | -- |  | - | ------- | --
|                                        |  | Quarterly Financial Data |        
|                                        |  | 2008                     |         |    | 2007          |  
|                                        |  | ThirdQuarter             |         |    | SecondQuarter |   |         | FirstQuarter |  |   | FourthQuarter |    |  | ThirdQuarter |         |    | SecondQuarter |   |         | FirstQuarter | 
|Net sales                               |  | $                        | 250,098 |    |               | $ | 257,740 |              |  | $ | 314,713       |    |  | $            | 363,463 |    |               | $ | 393,277 |              |  | $ | 416,335 |    |  | $ | 396,974 |   
|Gross profit                            |  | $                        | 111,524 |    |               | $ | 110,963 |              |  | $ | 144,940       |    |  | $            | 171,863 |    |               | $ | 194,307 |              |  | $ | 208,110 |    |  | $ | 194,909 |   
|Net income (loss)                       |  | $                        | 1,397   |    |               | $ | (2,385  | )            |  | $ | 15,529        |    |  | $            | 52,861  |    |               | $ | 49,711  |              |  | $ | 57,345  |    |  | $ | 53,783  |   
|Net income (loss) per share  Diluted   |  | $                        | 0.01    |    |               | $ | (0.02   | )            |  | $ | 0.15          |    |  | $            | 0.47    |    |               | $ | 0.41    |              |  | $ | 0.45    |    |  | $ | 0.42    |   
|Shipments                               |  | $                        | 230,153 |    |               | $ | 240,320 |              |  | $ | 312,857       |    |  | $            | 363,055 |    |               | $ | 387,817 |              |  | $ | 436,382 |    |  | $ | 389,052 |   
|Change in shipments from prior quarter  |  |                          | (4      | )% |               |   | (23     | )%           |  |   | (14           | )% |  |              | (6      | )% |               |   | (11     | )%           |  |   | 12      | %  |  |   | (0      | )%
|Net orders                              |  | $                        | 202,765 |    |               | $ | 234,628 |              |  | $ | 297,025       |    |  | $            | 343,086 |    |               | $ | 305,329 |              |  | $ | 332,201 |    |  | $ | 412,219 |   
|Change in net orders from prior quarter |  |                          | (14     | )% |               |   | (21     | )%           |  |   | (13           | )% |  |              | 12      | %  |               |   | (8      | )%           |  |   | (19     | )% |  |   | (7      | )%

We expect that net orders will continue to fluctuate due to the cyclical nature of our industry. The receipt of
net orders in a particular quarter affects revenue in subsequent quarters. Net orders result in revenue either at shipment and transfer of title or upon customer acceptance of the equipment. Our revenue recognition policy addresses the distinction
between the revenue recognized upon shipment and transfer of title and the revenue recognized upon customer acceptance. Equipment generally ships within two to six months of receiving the related order and if applicable, customer acceptance is
typically received one to six months after shipment. These time lines are general estimates and actual times may vary depending on specific customer circumstances.



19



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##### Table of Contents

Financial Performance Overview

The following is an overview of our financial performance for the nine months ended September 27, 2008 compared to the nine months ended September 29, 2007:



| |  |  | Net sales decreased 31.8% to $822.6 million from $1.2 billion;
| | - |  | --------------------------------------------------------------



| |  |  | Net income decreased 91.0% to $14.5 million from $160.8 million;
| | - |  | ----------------------------------------------------------------



| |  |  | Diluted net income per share decreased to $0.15 from $1.28;
| | - |  | -----------------------------------------------------------



| |  |  | Shipments decreased 35.4% to $783.3 million from $1.2 billion; and
| | - |  | ------------------------------------------------------------------



| |  |  | Net orders decreased 30.0% to $734.4 million from $1.0 billion.
| | - |  | ---------------------------------------------------------------

Results of operations for the nine months ended September 27, 2008 include $13.6 million of charges recorded in the second quarter of 2008 due to a decision to focus on our core product lines. These charges
include: (a) impairments of inventory and evaluation systems of $6.4 million, (b) write-downs of certain research and development assets of $3.8 million and (c) reductions in workforce of $3.4 million. Of these charges, $6.5 million
are in Cost of sales, $4.3 million are in Research and development expenses and $2.8 million are in Selling, general and administrative expenses.

Results of Operations

Net Sales



|                              |  |                    |         |                   |   |                    |  |                    |         |                    |   |         |  |   |          
|----------------------------- |  | ------------------ | ------- | ----------------- | - | ------------------ |  | ------------------ | ------- | ------------------ | - | ------- |  | - | ---------
|                              |  | Three Months Ended |         | Nine Months Ended
|                              |  | September 27, 2008 |         | June 28, 2008     |   | September 29, 2007 |  | September 27, 2008 |         | September 29, 2007
|                              |  | (In thousands)    
|Semiconductor Group           |  | $                  | 207,050 |                   | $ | 208,272            |  | $                  | 348,625 |                    | $ | 685,672 |  | $ | 1,093,027
|Industrial Applications Group |  |                    | 43,048  |                   |   | 49,468             |  |                    | 44,652  |                    |   | 136,879 |  |   | 113,559  
|                              |  |                    |         |                   |   |                    |  |                    |         |                    |   |         |  |   |          
|Net sales                     |  | $                  | 250,098 |                   | $ | 257,740            |  | $                  | 393,277 |                    | $ | 822,551 |  | $ | 1,206,586

The net sales we report are correlated to shipments and the timing of customer acceptance. Deferred revenue at the
end of the third quarter of 2008 was $70.2 million.

Semiconductor Group net sales in the third quarter of 2008 remained relatively flat with the second
quarter of 2008 and are down 41% and 37% compared to the prior year third quarter and year-to-date net sales, respectively. Net sales have continued to decline compared to prior periods as a result of ongoing weakness in the overall economy and the
semiconductor industry in particular.

The primary functional currency of IAG is the Euro. Changes in the exchange rate increased IAG net sales for the
third quarter and year-to-date by 10% and 15%, respectively, compared to the same periods in the prior year. Demand decreased at IAG during the third quarter of 2008 after an increase in demand from its wafer customers for the prior four quarters.

Geographical net sales as a percentage of total net sales were as follows (based upon the location of our customers facilities):



|              |  |                    |   |  |                   |   |  |                    |   |  |                    |   |  |                    |  
|------------- |  | ------------------ | - |  | ----------------- | - |  | ------------------ | - |  | ------------------ | - |  | ------------------ | -
|              |  | Three Months Ended |   |  | Nine Months Ended |  
|              |  | September 27, 2008 |   |  | June 28, 2008     |   |  | September 29, 2007 |   |  | September 27, 2008 |   |  | September 29, 2007 |  
|Asia          |  | 58                 | % |  | 61                | % |  | 66                 | % |  | 61                 | % |  | 67                 | %
|North America |  | 29                 | % |  | 27                | % |  | 25                 | % |  | 28                 | % |  | 26                 | %
|Europe        |  | 13                 | % |  | 12                | % |  | 9                  | % |  | 11                 | % |  | 7                  | %

A significant portion of our net sales is generated in Asia, primarily because a substantial portion of the
worlds semiconductor manufacturing capacity is located there. Our Asia region includes Korea, Japan, Singapore, Malaysia, China and Taiwan. We plan to continue to focus on expanding our market presence in Asia, as we believe that significant
additional growth potential exists in this region over the long term.

Gross Profit



|             |  |                        |         |   |                   |   |         |                    |  |   |                    |   |  |                    |         |   |  |   |         |  
|------------ |  | ---------------------- | ------- | - | ----------------- | - | ------- | ------------------ |  | - | ------------------ | - |  | ------------------ | ------- | - |  | - | ------- | -
|             |  | Three Months Ended     |         |   | Nine Months Ended |  
|             |  | September 27, 2008     |         |   | June 28, 2008     |   |         | September 29, 2007 |  |   | September 27, 2008 |   |  | September 29, 2007 |        
|             |  | (Dollars in thousands) |        
|Gross profit |  | $                      | 111,524 |   |                   | $ | 110,963 |                    |  | $ | 194,307            |   |  | $                  | 367,427 |   |  | $ | 597,326 |  
|Gross margin |  |                        | 45      | % |                   |   | 43      | %                  |  |   | 49                 | % |  |                    | 45      | % |  |   | 50      | %



20



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##### Table of Contents

The increase in gross margin in the third quarter of 2008 compared to the second quarter of 2008 is due to $6.5 million
of charges incurred in the second quarter of 2008, related primarily to impairments of inventory and evaluation systems. Excluding those charges, gross margin decreased by one percentage point due to product mix and lower absorption of fixed
overhead costs as shipment volumes decreased. Gross margin in third quarter and year-to-date 2008 decreased from prior periods as a result of lower absorption due to a decline in shipment volumes and an increase in the percentage of total sales
represented by IAG products, whose margins are generally lower than those of Semiconductor Group products.

Selling, General and Administrative
(SG&A)



|               |  |                        |        |   |                   |   |        |                    |  |   |                    |   |  |                    |         |   |  |   |         |  
|-------------- |  | ---------------------- | ------ | - | ----------------- | - | ------ | ------------------ |  | - | ------------------ | - |  | ------------------ | ------- | - |  | - | ------- | -
|               |  | Three Months Ended     |        |   | Nine Months Ended |  
|               |  | September 27, 2008     |        |   | June 28, 2008     |   |        | September 29, 2007 |  |   | September 27, 2008 |   |  | September 29, 2007 |        
|               |  | (Dollars in thousands) |       
|SG&A expense   |  | $                      | 53,858 |   |                   | $ | 62,530 |                    |  | $ | 67,420             |   |  | $                  | 176,717 |   |  | $ | 206,531 |  
|% of net sales |  |                        | 22     | % |                   |   | 24     | %                  |  |   | 17                 | % |  |                    | 21      | % |  |   | 17      | %

SG&A expense includes compensation and benefits for corporate, financial, marketing, sales and administrative
personnel as well as travel expenses and professional service fees. Also included are expenses for rents, utilities, and depreciation and amortization related to the assets utilized by these functions.

SG&A expense decreased in the third quarter of 2008 from the second quarter of 2008, in part as a result of $2.8 million of charges incurred during the second
quarter related to the reduction in workforce. Excluding those charges, SG&A decreased by $5.8 million as a result of lower headcount and a focus on reducing operating expenses. The decrease in SG&A expense during the three and nine months
ended September 27, 2008 over the same prior year periods, is primarily due to lower headcount, profit sharing, commissions and other sales and marketing related costs as a result of decreased sales volumes. SG&A expense, as a percentage of
net sales, increased compared to prior year periods primarily due to the decline in net sales.

Research and Development (R&D)



|               |  |                        |        |   |                   |   |        |                    |  |   |                    |   |  |                    |         |   |  |   |         |  
|-------------- |  | ---------------------- | ------ | - | ----------------- | - | ------ | ------------------ |  | - | ------------------ | - |  | ------------------ | ------- | - |  | - | ------- | -
|               |  | Three Months Ended     |        |   | Nine Months Ended |  
|               |  | September 27, 2008     |        |   | June 28, 2008     |   |        | September 29, 2007 |  |   | September 27, 2008 |   |  | September 29, 2007 |        
|               |  | (Dollars in thousands) |       
|R&D expense    |  | $                      | 51,649 |   |                   | $ | 59,815 |                    |  | $ | 61,384             |   |  | $                  | 168,804 |   |  | $ | 185,158 |  
|% of net sales |  |                        | 21     | % |                   |   | 23     | %                  |  |   | 16                 | % |  |                    | 21      | % |  |   | 15      | %

R&D expense includes compensation and benefits for our R&D personnel, project materials, chemicals and
other direct expenses incurred in product and technology development. Also included are expenses for equipment repairs and maintenance, rents, utilities and depreciation related to product and technology development. Our significant investments in
R&D over the past several years reflect our strong commitment to the continuous improvement of our current product lines and the development of new products and technologies. We continue to believe that significant investment in R&D is
required to remain competitive, and we plan to continue to invest in new products and enhancement of our current product lines.

The decrease in R&D
expense over second quarter 2008 levels was primarily due to the write-down of certain R&D assets and the reduction of workforce in the second quarter totaling $4.3 million. Excluding the aforementioned charges, R&D expense decreased by $3.9
million due to lower headcount and a focus on reducing operating expenses. R&D expense decreased during the three and nine months ended September 27, 2008 from the prior year periods primarily as a result of reduced headcount and lower
profit sharing due to the decline in operating income. R&D expense, as a percentage of net sales, increased compared to prior year periods primarily due to the decrease in net sales.

Interest and Other Income, Net



|                               |  |                        |       |   |                   |   |       |                    |  |   |                    |   |  |                    |       |   |  |   |        |  
|------------------------------ |  | ---------------------- | ----- | - | ----------------- | - | ----- | ------------------ |  | - | ------------------ | - |  | ------------------ | ----- | - |  | - | ------ | -
|                               |  | Three Months Ended     |       |   | Nine Months Ended |  
|                               |  | September 27, 2008     |       |   | June 28, 2008     |   |       | September 29, 2007 |  |   | September 27, 2008 |   |  | September 29, 2007 |      
|                               |  | (Dollars in thousands) |      
|Interest and other income, net |  | $                      | 3,055 |   |                   | $ | 4,916 |                    |  | $ | 8,933              |   |  | $                  | 9,080 |   |  | $ | 34,637 |  
|% of net sales                 |  |                        | 1     | % |                   |   | 2     | %                  |  |   | 2                  | % |  |                    | 1     | % |  |   | 3      | %



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##### Table of Contents

Interest and other income, net, includes interest income, interest expense and other non-operating items. Interest and
other income, net decreased from the second quarter of 2008 primarily due to mark-to-market adjustments on certain hedging contracts. During the three and nine months ended September 27, 2008 interest and other income, net decreased compared to
prior year periods due to reductions in interest income and foreign currency gains. Interest income for the three and nine months ended September 27, 2008 decreased by $5.7 million and $16.2 million, respectively, as a result of declining
yields on interest bearing investments, lower balances of cash, cash equivalents and investments, and the transition to U.S. Treasuries that provided lower yields. Additionally, there were decreased gains on foreign currency transactions of $5.8
million from the nine months ended September 29, 2007.

Income Taxes

Our effective tax rates were a provision of 84.6%, a benefit of 63.1% and a provision of 33.2% for the three months ended September 27, 2008, June 28, 2008 and September 29, 2007, respectively. Our
effective tax rates were 53.1% and 33.1% for the nine months ended September 27, 2008 and September 29, 2007, respectively. The higher effective tax rates for 2008 are principally the result of decreased profits before taxes and an
unfavorable mix of our anticipated annual operating results, particularly in certain foreign jurisdictions. This increased our effective tax rate for the nine months ended September 27, 2008 to 53.1% from 40.0% for the six months ended
June 28, 2008 resulting in an 84.6% effective tax rate for the three months ended September 27, 2008. Our future effective income tax rate depends on various factors, such as the companys operating results before taxes, tax
legislation, the geographic composition of pre-tax operating results, non-deductible expenses incurred in connection with acquisitions and items outside of the annual effective tax rate such as interest expense on uncertain tax positions and stock
option and restricted stock-based deductions.

Critical Accounting Policies

The preparation of financial statements in conformity with U.S. GAAP requires that we make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the related
disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our assumptions and estimates, including those related to recognition of revenue, valuation of investments, valuation of inventory, valuation of goodwill and other
intangible assets, valuation of deferred tax assets, adequacy of warranty obligations, measurement of restructuring and impairment charges, compliance with hedge accounting for derivatives, measurement of stock-based compensation expense and
litigation. We base our estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We discuss our critical accounting policies in Managements Discussion and Analysis of
Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2007. Except for the critical accounting policy set forth below entitled Valuation of Investments, there have been no
other significant changes in our critical accounting policies or estimates since those reported in our Annual Report.

Valuation of Investments

In valuing our investments we predominantly use market data or data derived from market sources. When market data is not available, such as when
the investment is illiquid, we employ a cash-flow-based modeling technique to arrive at the recorded fair value. This process involves incorporating our assumption about the anticipated term and the yield that a market participant would require to
purchase the security in the marketplace. As of September 27, 2008 we have recorded a temporary impairment charge of $10.7 million within OCI based upon our assessment of the fair value of our auction-rate securities and our ability and intent
to hold these securities to recovery (see Note 3 to the Condensed Consolidated Financial Statements).

Liquidity and Capital Resources

Cash, Cash Equivalents and Short-Term Investments



|                                                        |  |                    |         |                   |   |        
|------------------------------------------------------- |  | ------------------ | ------- | ----------------- | - | -------
|                                                        |  | September 27, 2008 |         | December 31, 2007
|                                                        |  | (In thousands)    
|Cash and cash equivalents                               |  | $                  | 162,231 |                   | $ | 175,071
|Short-term investments                                  |  |                    | 293,073 |                   |   | 421,695
|                                                        |  |                    |         |                   |   |        
|Total cash, cash equivalents and short-term investments |  | $                  | 455,304 |                   | $ | 596,766

We have historically financed our operating and capital resource requirements through cash flows from operations,
sales of equity securities and borrowings. Our primary source of liquidity as of September 27, 2008 consisted of $455.3 million of cash, cash equivalents and short-term investments. This amount represents a decrease of $141.5 million from
$596.8 million as of December 31, 2007. The majority of this decrease is due to $100.5 million of auction-rate securities reclassified to Long-term investments in the first quarter of 2008.



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##### Table of Contents

Restricted Cash, Cash Equivalents and Long-Term Investments



|                                                |  |                    |         |                   |   |        
|----------------------------------------------- |  | ------------------ | ------- | ----------------- | - | -------
|                                                |  | September 27, 2008 |         | December 31, 2007
|                                                |  | (In thousands)    
|Restricted cash and cash equivalents            |  | $                  | 146,829 |                   | $ | 161,050
|Long-term investments                           |  |                    | 100,467 |                   |   |       
|                                                |  |                    |         |                   |   |        
|Total restricted cash and long-term investments |  | $                  | 247,296 |                   | $ | 161,050

We held $247.3 million in restricted cash and long-term investments as of September 27, 2008, an increase of
$86.2 million from $161.1 million as of December 31, 2007. As of September 27, 2008 we held $146.8 million in restricted cash and cash equivalents, which relates to debt obligations that are secured by deposits in money market funds.

As of September 27, 2008, we held $102.4 million of tax-exempt auction-rate securities, whose underlying assets are generally either student loans
substantially backed by the federal government or closed-end municipal funds. Beginning in February 2008, these auction-rate securities became illiquid because their scheduled auctions failed to settle. An auction failure occurs when the parties
wishing to sell securities at auction cannot. As a result, we may have limited or no opportunities to liquidate these investments and fully recover their stated value in the near term. When an auction fails the affected securities begin to pay
interest under their default interest rate terms. As a result of the illiquidity caused by the lack of an active market, $100.5 million of these investments were classified as non-current. As of September 27, 2008, we have recorded a temporary
impairment charge of $10.7 million within OCI based upon our assessment of the fair value of these securities. We utilized a cash-flow-based valuation method in determining the fair value of these securities, which used significant unobservable
inputs at September 27, 2008.

We believe the impairment of these securities is temporary because we have the ability and intent to hold these
securities to recovery and they have either been guaranteed by the federal government or in the case of closed-end funds they are backed by more than 200% collateral. Substantially all of our auction-rate securities are currently rated AAA, the
highest rating by a rating agency. We believe we will ultimately be able to liquidate these investments without significant loss through successful auctions, redemptions of securities by the issuers, or upon maturity. However, it could take until
the final maturity of the underlying notes to realize the investments full value. Based on our expected operating cash flows, and our other sources of cash, we do not anticipate that the current illiquidity of these investments will adversely
affect our operations.

Cash Flow Summary



|                                                              |  |                |          |   |          |   |          |  
|------------------------------------------------------------- |  | -------------- | -------- | - | -------- | - | -------- | -
|                                                              |  | 2008 YTD       |          |   | 2007 YTD |  
|                                                              |  | (In thousands) |         
|Net cash provided by (used in):                               |  |                |          |   |          |   |          |  
|Operating activities                                          |  | $              | 171,857  |   |          | $ | 236,039  |  
|Investing activities                                          |  |                | 11,900   |   |          |   | 4,654    |  
|Financing activities                                          |  |                | (197,408 | ) |          |   | (194,319 | )
|Effects of exchange rate changes on cash and cash equivalents |  |                | 811      |   |          |   | 814      |  
|                                                              |  |                |          |   |          |   |          |  
|Net increase in cash and cash equivalents                     |  | $              | (12,840  | ) |          | $ | 47,188   |  
|                                                              |  |                |          |   |          |   |          |  

Operating

Net
cash provided by operating activities during the nine months ended September 27, 2008 was $171.9 million. This amount consisted primarily of $14.5 million provided by net income, adjusted for non-cash items of $84.3 million and changes in
working capital accounts of $73.0 million. The primary reason for the decrease in cash flows from operating activities compared to the prior year period is due to lower net income and a decrease in deferred profit due to the reduction in shipments,
offset by a decrease in accounts receivable. Accounts receivable decreased by $137.2 million from year-end levels due to reduced shipments and strong collections.

Net cash provided by operating activities during the nine months ended September 29, 2007 was $236.0 million. This amount consisted primarily of $160.8 million provided by net income, adjusted for non-cash items of $109.7 million and
decreases in working capital accounts of $34.5 million.



23



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##### Table of Contents

Investing

Net cash
provided by investing activities during the nine months ended September 27, 2008 was $11.9 million, which consisted of net purchases, sales and maturities of short-term investments of $14.4 million and a decrease in restricted cash and cash
equivalents of $14.2 million, offset by capital expenditures of $16.7 million. As of September 27, 2008, we had no significant commitments to purchase property or equipment.

Net cash provided by investing activities during the nine months ended September 29, 2007 was $4.7 million, which consisted primarily of net sales and maturities of short-term investments of $38.9 million and
capital expenditures of $26.9 million.

Financing

Net
cash used in financing activities during the nine months ended September 27, 2008 was $197.4 million. This amount consisted primarily of repurchases of common stock of $188.9 million and a debt repayment of $15.6 million in the third
quarter, offset by proceeds from employee stock compensation plans of $6.4 million.

Net cash used in financing activities during the nine months ended
September 29, 2007 was $194.3 million. This amount consisted primarily of repurchases of common stock of $216.9 million and payments on lines of credit of $12.0 million, offset by proceeds from employee stock compensation plans of
$33.8 million.

Liquidity

We have
short-term credit facilities with various financial institutions totaling $96.4 million. These credit facilities bear interest at various rates and expire on various dates through June 2009. As of September 27, 2008, $2.7 million of current
obligations were outstanding at an interest rate of 5.0%, $29.0 million was pledged against outstanding letters of credit and the remaining $64.7 million was unutilized.

Current debt obligations also include a credit arrangement denominated in Euros used to fund the acquisition of Peter Wolters AG in 2004 and for general corporate purposes. As of September 27, 2008 borrowings
under this credit arrangement were $126.8 million at an interest rate of 4.6% and are secured by deposits in money market funds, which are included within Restricted cash and cash equivalents, current, on our Condensed Consolidated Balance Sheet.
Borrowings under this credit arrangement are due and payable on or before June 25, 2009. This credit arrangement includes certain financial covenants, with which we were in compliance as of September 27, 2008.

We also have long-term credit facilities with various institutions totaling $151.3 million. As of September 27, 2008 we had $1.3 million in long-term debt
outstanding under these credit arrangements at an interest rate of 4.0%, expiring in December 2037. The unutilized amount of $150.0 million relates to a senior unsecured five-year revolving credit agreement (the Agreement) expiring in 2011 with an
aggregate committed amount of $150.0 million and an option to increase the total line by up to an additional $100.0 million under certain circumstances. We expect to use the proceeds, if any, for working capital and other general corporate purposes,
including the repurchase of our own common shares. The Agreement contains customary affirmative and negative covenants, financial covenants, representations and warranties and events of default, which are subject to various exceptions and
qualifications. We were in compliance with these covenants as of September 27, 2008.

We believe that our current cash position, cash generated
through operations and equity offerings, and available borrowings will be sufficient to meet our needs at least through the next 12 months.



|ITEM 3: | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- | ----------------------------------------------------------

For
quantitative and qualitative disclosures about market risk affecting Novellus, see Item 7A: Quantitative and Qualitative Disclosures about Market Risk in our Annual Report on Form 10-K for the fiscal year ended December 31,
2007. Our exposure related to market risk has not changed materially since December 31, 2007.



|ITEM 4: | CONTROLS AND PROCEDURES
|------- | -----------------------

Quarterly Evaluation of Our
Disclosure Controls and Internal Controls

As of the end of the period covered by this Quarterly Report on Form 10-Q, we evaluated the effectiveness
of the design and operation of our disclosure controls and procedures and our internal controls and procedures for financial reporting. This control evaluation was done under the supervision and with the participation of management, including our
Chief Executive Officer and Principal Financial Officer. Rules adopted by the SEC require that in this section of the Quarterly Report on Form 10-Q, we present the conclusions of the Chief Executive Officer and the Principal Financial Officer about
the effectiveness of our disclosure controls and internal controls for financial reporting based on and as of the date of the controls evaluation.



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CEO and PFO Certifications

The certifications of the Chief Executive Officer and the Principal Financial Officer required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 are filed as exhibits to this Quarterly Report on
Form 10-Q. This section of the Quarterly Report on Form 10-Q is the information concerning the controls evaluation referred to in the Section 302 certifications and this information should be read in conjunction with the Section 302
certifications for a more complete understanding of the topics presented.

Disclosure Controls and Internal Controls for Financial Reporting

Disclosure controls are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under
the Exchange Act such as this Quarterly Report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms. Disclosure controls are also designed with the objective of ensuring
that such information is accumulated and communicated to our management, including the Chief Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Internal controls for financial
reporting are procedures which are designed with the objective of providing reasonable assurance that our transactions are properly authorized, our assets are safeguarded against unauthorized or improper use and our transactions are properly
recorded and reported, all to permit the preparation of our financial statements in conformity with U.S. GAAP.

Limitations on the Effectiveness of
Controls

Our management, including the Chief Executive Officer and the Principal Financial Officer, does not expect that our disclosure controls or
our internal controls for financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.
Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of
controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur
because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls also is based
in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because
of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Scope of the Controls Evaluation

The
evaluation of our disclosure controls and our internal controls for financial reporting by our Chief Executive Officer and our Principal Financial Officer included a review of the objective and design of the controls, our implementation of the
controls and the effect of the controls on the information generated for use in this Quarterly Report on Form 10-Q. In accordance with SEC requirements, the Chief Executive Officer and the Principal Financial Officer note that, during our most
recent fiscal quarter, there have been no changes in our internal controls for financial reporting that have materially affected or are reasonably likely to materially affect our internal controls for financial reporting.

Conclusions

Based upon the controls evaluation, our Chief
Executive Officer and our Principal Financial Officer have concluded that our disclosure controls are effective to ensure that information required to be disclosed is recorded, processed, summarized and reported within the time periods specified in
the SECs rules and forms and that material information relating to the Company is made known to management, including the Chief Executive Officer and the Principal Financial Officer, particularly during the period when our periodic reports are
being prepared, and that our internal controls for financial reporting are effective to provide reasonable assurance that our financial statements are fairly presented in conformity with U.S. GAAP.

PART II: OTHER INFORMATION



|ITEM 1: | LEGAL PROCEEDINGS
|------- | -----------------

There have been no material developments in
litigation matters during the quarter ended September 27, 2008 from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2007.



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We are a defendant or plaintiff in various actions that have arisen in the normal course of business. We believe that the
ultimate disposition of these matters will not have a material adverse effect on our business, financial condition or results of operations. However, due to the uncertainty surrounding the litigation process, we are unable to estimate a range of
loss, if any, at this time.



|ITEM 1A: | RISK FACTORS
|-------- | ------------

Set forth below and elsewhere in this Quarterly
Report on Form 10-Q, and in other documents we file with the SEC, are risks and uncertainties that could cause actual results to differ materially from the results expressed or implied by the forward-looking statements contained in this Quarterly
Report. The risk factors set forth below entitled Recent deterioration in the global economy and credit markets may adversely affect our future results of operations and We may incur impairments to goodwill or long-lived
assets have been added to this Quarterly Report on Form 10-Q to be filed with the SEC for the quarter ended September 27, 2008. The risk factor set forth below entitled Our liquidity can be affected by unanticipated events in the
debt markets has been revised from the prior statement on our Quarterly Report on Form 10-Q filed with the SEC for the quarter ended June 28, 2008.

Recent deterioration in the global economy and credit markets may adversely affect our future results of operations.

Our operations may be adversely affected by the recent deterioration in the global economy causing our customers to delay or cease spending on our products. Recent tightening of the credit markets may further negatively impact our
operations by affecting the solvency of our customers, the solvency of our key suppliers or the ability of our customers to obtain credit to finance purchases of our products. If the global economy and credit markets continue to deteriorate and our
future sales continue to decline, our financial condition and results of operations could be adversely impacted.

Downturns in the
semiconductor industry negatively impact demand for our equipment.

Our business depends predominantly on the capital expenditures of semiconductor
manufacturers, which in turn depend on current and anticipated market demand for integrated circuits and the products that use them. The semiconductor industry has historically been cyclical and has experienced periodic downturns that reduced the
demand for semiconductor processing equipment, including equipment that we manufacture and market. During periods of reduced and declining demand, we must be able to quickly and effectively align our costs with prevailing market conditions, and at
the same time motivate and retain key employees and maintain a stable management team. Our inventory levels during periods of reduced demand have at times been higher than optimal. We cannot provide any assurance that we will not be required to make
inventory valuation adjustments in future periods. During periods of rapid growth, we must be able to acquire or develop sufficient manufacturing capacity, and hire and assimilate a sufficient number of qualified people to meet customer demand. In
the period from 2001 through 2006, we implemented restructuring plans to align our business with fluctuating conditions. Future restructurings may be required. In addition, we made strategic decisions during the second quarter of 2008 to focus on
our core product lines, and we incurred charges related to impairments of inventory and evaluation systems, write-downs of certain research and development assets, and reductions in workforce. Net orders, net sales and operating results may be
adversely affected if we fail to respond to changing industry conditions in a timely and effective manner. We experienced a decrease in bookings in each of the first three quarters of 2008. We could continue to experience decreases in bookings in
the foreseeable future, and as a result, our net sales and operating results may be adversely affected.

Changes in tax rates, tax
assets or liabilities have negatively impacted our results and could further negatively impact our future results.

We are subject to taxation in
the United States and other countries. Our tax rate has fluctuated in the past and may fluctuate in the future. For example, our effective tax rate for the third quarter of 2008 is higher compared to the second quarter of 2008 and third quarter of
2007 as a result of an increase in our 2008 annual forecasted effective tax rate.

Future tax rates could continue to be affected by changes in the
composition of earnings in countries with differing tax rates, changes in the valuation of deferred tax assets and liabilities, or changes in the tax laws. We are also subject to regular examination of our tax returns by the Internal Revenue Service
(IRS) and other tax authorities, including state revenue agencies and foreign governments. The IRS and other tax authorities have increasingly focused attention on intercompany transfer pricing with respect to sales of products and services and the
use of intangible assets. We could face significant future challenges on these transfer pricing issues in one or more jurisdictions. We regularly assess the likelihood of favorable or unfavorable outcomes resulting from examinations by the IRS and
other tax authorities to determine the adequacy of our provision for income taxes. Although we believe that our tax estimates are reasonable, there can be no assurance that any final determination will not be materially different from the treatment
reflected in our historical income tax provisions and accruals. Factors that could cause estimates to be materially different include, but are not limited to:



| |  |  | Changes in the regulatory environment;
| | - |  | --------------------------------------



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| |  |  | Changes in accounting and tax standards or practices;
| | - |  | -----------------------------------------------------



| |  |  | Overall business conditions in the equipment industry; and
| | - |  | ----------------------------------------------------------



| |  |  | The Companys operating results before taxes.
| | - |  | ---------------------------------------------

Our liquidity can be affected by unanticipated events in the debt markets.

As of September 27, 2008, we
held $102.4 million of tax-exempt auction-rate securities, whose underlying assets are generally student loans, substantially backed by the federal government, or closed-end municipal funds. Beginning in February 2008, these auction-rate securities
became illiquid because their scheduled auctions failed to settle. An auction failure occurs when the parties wishing to sell securities at auction cannot. As a result, we may have limited or no opportunities to liquidate these investments and fully
recover their stated value in the near term. When an auction fails the affected securities begin to pay interest under their default interest rate terms. As a result of the illiquidity caused by the lack of an active market, $100.5 million of these
investments were classified as non-current and a temporary unrealized loss of $10.7 million has been recorded as of September 27, 2008.

We believe
the impairment of these securities is temporary because we have the ability and intent to hold these securities to recovery and they have either been guaranteed by the federal government or in the case of closed-end funds they are backed by more
than 200% collateral. Substantially all of our auction-rate securities are currently rated AAA, the highest rating by a rating agency. We evaluate our investments periodically for possible other-than-temporary impairment by reviewing factors such as
the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and insurance guarantor, and our ability and intent to hold the investment for a period of time which may be sufficient for
anticipated recovery of market value. We believe we will ultimately be able to liquidate these investments without significant loss through successful auctions, redemptions of securities by the issuers, or upon maturity. However, it could take until
the final maturity of the underlying notes to realize the investments full value. If current market conditions do not improve, an other-than-temporary impairment charge could occur in future periods which would negatively impact our results of
operations. Based on our expected operating cash flows, and our other sources of cash, we do not anticipate that the current illiquidity of these investments will adversely affect our operations.

Our financial results have fallen short and may continue to fall short of anticipated levels; forecasting net sales and profitability is complex
and our forecasts may be inaccurate.

Our financial results in the first quarter of 2008 fell short of previously announced guidance for the
quarter. This was the result of higher than anticipated manufacturing costs, higher write-downs of evaluation systems and a higher than anticipated effective tax rate. Management typically provides quarterly financial forecasts. These forecasts when
made are based on assumptions believed to be reasonable at the time. However, actual results may vary from forecasted results for a variety of reasons as evidenced by the first quarter 2008 results. Our lengthy sales cycle, coupled with
customers competing capital budget considerations, makes the timing of customer orders and product acceptances difficult to predict. In addition, our backlog at the beginning of a quarter typically does not include all orders required to
achieve our sales objectives for that quarter and is not a reliable indicator of our future sales. As a result, our revenues and operating results for a quarter depend on our shipping orders as scheduled during that quarter, receiving customer
acceptance of shipped products during the quarter, and obtaining new orders for products to be shipped in that same quarter. Any delay in, or cancellation of, scheduled shipments and customer acceptances or in shipments from new orders could
materially and adversely affect our financial results. These factors have caused and may continue to cause our financial results to differ materially from prior periods and from financial forecasts we have previously provided.

Although we believe that these forecasts provide investors and analysts with a better understanding of managements expectations for the future and are useful to
our stockholders and potential stockholders, such forecasts are comprised of forward-looking statements subject to the risks and uncertainties described in this report and in our other public filings and public statements. If our operating or
financial results for a particular period differ from our forecasts or the expectations of investment analysts, or if we change our forecasts for future periods, the market price of our common stock could decline.

Our quarterly operating results and stock price are unpredictable.

We have experienced and expect to continue to experience significant fluctuations in our quarterly operating results, which may adversely affect our stock price. Our future quarterly operating results and stock price
may not align with past trends. The factors that could lead to fluctuations in our results include, but are not limited to:



| |  |  | Changing demand for and sales of lower-margin products relative to higher-margin products;
| | - |  | ------------------------------------------------------------------------------------------



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| |  |  | Economic conditions in the electronics and semiconductor industry generally and the equipment industry specifically;
| | - |  | --------------------------------------------------------------------------------------------------------------------



| |  |  | 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;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Emergence of new industry standards;
| | - |  | ------------------------------------



| |  |  | Competitive pricing pressures;
| | - |  | ------------------------------



| |  |  | 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;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Building our systems according to forecast, instead of limited backlog information, which hinders our ability to plan production and inventory levels;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The effect of revenue recognized upon acceptance with little or no associated costs;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | Foreign currency exchange rate fluctuations;
| | - |  | --------------------------------------------



| |  |  | Fluctuation in warranty costs;
| | - |  | ------------------------------



| |  |  | Variability in manufacturing yields; and
| | - |  | ----------------------------------------



| |  |  | Ability to fund capital requirements.
| | - |  | -------------------------------------

We may incur impairments to goodwill or long-lived assets.

We review our long-lived assets, including goodwill and other intangible
assets, for impairment annually in the fourth quarter or whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable.

Significant negative industry or economic trends, including the lack of recovery in the market price of our common stock, reduced estimates of future cash flows, disruptions to our business, slower growth rates or
lack of growth in the Semiconductor Group or Industrial Applications Group could lead to an impairment charge of our long-lived assets, including goodwill and other intangible assets. If, in any period, our stock price decreases to the point where
the fair value of the Company, as determined by our market capitalization, is less than our book value, this too could indicate a potential impairment and we may be required to record an impairment charge in that period.

Our valuation methodology for assessing impairment requires management to make judgments and assumptions based on historical experience and to rely heavily on
projections of future operating performance. We operate in highly competitive environments and projections of future operating results and cash flows may vary significantly from results. Additionally, if our analysis results in an impairment to our
goodwill for the Semiconductor Group or Industrial Applications Group, we may be required to record a charge to earnings in our financial statements during a period in which such impairment is determined to exist, which may negatively impact our
results of operations.

We face risks related to concentration of net sales.

We sell to a limited number of customers, and we expect that sales to relatively few customers will continue to account for a high percentage of our net sales in the
foreseeable future. Although the composition of the group comprising our largest customers varies from year to year, the loss of a significant customer or any reduction in orders from a significant customer, including reductions due to customer
departures from recent buying patterns, as well as economic or competitive conditions in the semiconductor industry, could materially and adversely affect our business, financial condition or results of operations. Because products are configured to
customer specifications, changing, rescheduling or canceling may result in significant non-recoverable costs.



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Rapid technological change in the semiconductor industry requires substantial research and
development expenditures and responsiveness to customer needs.

We devote a significant portion of our personnel and financial resources to R&D
programs, and we seek to maintain close relationships with our customers in order to remain responsive to their product and manufacturing process needs. Our success depends in part on our ability to accurately predict evolving industry standards, to
develop innovative solutions and improve existing technologies, to win market acceptance of our new and advanced technologies and to manufacture our products in a timely and cost-effective manner. Our products and processes must address changing
customer needs in a range of materials, including copper and aluminum, at ever-smaller line widths and feature sizes, while maintaining our focus on manufacturing efficiency and product reliability. If we do not continue to gain market acceptance
for our new technologies and products, or develop and introduce improvements in a timely manner in response to changing market conditions or customer requirements, or remain focused on R&D efforts that will translate into greater revenues, our
business could be seriously harmed.

In the capital equipment market, technological innovations tend to have long development cycles. We have experienced
delays and technical and manufacturing difficulties from time to time in the introduction of certain of our products and product enhancements. In addition, we may experience delays and technical and manufacturing difficulties in future introductions
or volume production of our new systems or enhancements. The increased costs and reduced efficiencies that may be associated with the development, manufacture, sale and support of future products or product enhancements relative to our existing
products may adversely affect our operating results.

Our success in developing, introducing and selling new and enhanced systems depends upon a variety of
factors, including product selection; hiring, retaining and motivating highly qualified design and engineering personnel; timely and efficient completion of product design and development; implementation of manufacturing and assembly processes;
achieving specified product performance in the field; and effective sales and marketing. There can be no assurance that we will be successful in selecting, developing, manufacturing and marketing new products, or in enhancing our existing products.
There can be no assurance that revenue from future products or product enhancements will be sufficient to recover our investments in R&D. To ensure the functionality and reliability of our future product introductions or product improvements, we
incur substantial R&D costs early in development cycles, before we can confirm the technical feasibility or commercial viability of a product or product improvement. If new products have reliability or quality problems, reduced orders, or higher
manufacturing costs, delays in collecting accounts receivable and additional service may result and warranty expenses may rise, affecting our gross margins. Any of these events could materially and adversely affect our business, financial condition
or results of operations.

The competitive and capital-intensive nature of the semiconductor industry increases the difficulty of
maintaining gross margin and maintaining and capturing market share.

We face substantial competition in the industry, from both potential new
market entrants and established competitors. Competitors may have greater financial, marketing, technical or other resources, and greater ability to respond to pricing pressures than we do. They may also have broader product lines, ability to reduce
price through product bundling, greater experience with high-volume manufacturing, greater customer service capabilities, or larger and more established sales organizations and customer bases. To maintain or capture a position in the market, we must
develop new and enhanced systems and introduce them at competitive prices on a timely basis, while managing our R&D and warranty costs. Semiconductor equipment manufacturers incur substantial costs to install and integrate capital equipment into
their production lines. This increases the likelihood of continuing relationships with chosen equipment vendors, including our competitors, and the difficulty of penetrating new customer accounts. In addition, sales of our systems depend in
significant part upon a prospective customers decision to increase or expand manufacturing capacity  which typically involves a significant capital commitment. From time to time, we have experienced delays in finalizing system sales
following initial system qualification. Due to these and other factors, our systems typically have a lengthy sales cycle, during which we may expend substantial funds and management effort. Heightened competition may also force price reductions that
could adversely affect our results of operations.



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We are exposed to risks associated with outsourcing activities, which could result in supply
shortages that could affect our ability to meet customer demands.

We outsource the manufacture of most subassemblies, which enables us to focus on
performing system design, assembly and testing in-house, thereby minimizing our fixed costs and capital expenditures. Although we make reasonable efforts to ensure that third party providers will perform to our standards, our reliance on suppliers
and subcontractors limits our control over quality assurance and delivery schedules. Defects in workmanship, unacceptable yields, manufacturing disruptions and difficulties in obtaining export and import approvals may impair our ability to manage
inventory and cause delays in shipments and cancellation of orders that may adversely affect our relationships with current and prospective customers and enable competitors to penetrate our customer accounts. In addition, third party providers may
prioritize capacity for larger competitors or increase prices to us, which may adversely affect our profitability and our ability to respond to pricing pressures from competitors and customers.

Our growth and ability to meet customer demands depend in part on our ability to obtain from our suppliers timely deliveries of parts, components and subassemblies for
the manufacture and support of our products. Although we make reasonable efforts to ensure that such parts are available from multiple suppliers, certain key parts may be obtained only from a single source or from limited sources. These suppliers
are in some cases thinly capitalized, independent companies who derive a significant amount of their business from us or from a small group of companies in the semiconductor industry. As a result, our supply channels may be vulnerable to disruption.
Any such disruption to or termination of our supplier relationships may result in a prolonged inability to secure adequate supplies at reasonable prices or of acceptable quality, and may adversely affect our ability to bring new products to market
and deliver them to customers in a timely manner. As a result, our revenues and operations may be adversely affected.

The loss of
key employees could harm our business and operations.

Our employees are extremely important to our success, and our key management, engineering
and other employees may be difficult to replace. The expansion of high technology companies has increased demand and competition for qualified personnel. If we are unable to retain key personnel, or to attract, assimilate and retain additional
highly qualified employees to meet our needs in the future, our business and operations could be harmed.

We are exposed to the risks
of global operations.

We serve an increasingly global market. Substantial operations outside of the United States and export sales expose us to
certain risks that may adversely affect our operating results and net sales, including, but not limited to:



| |  |  | Global or regional economic downturns; and
| | - |  | ------------------------------------------



| |  |  | Adverse conditions in credit markets;
| | - |  | -------------------------------------



| |  |  | Potential 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;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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;
| | - |  | ----------------------------------------------



| |  |  | 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;
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | Political instability, natural disasters, acts of war or terrorism.
| | - |  | -------------------------------------------------------------------

We enter into foreign currency forward exchange contracts to hedge against the short-term impact of currency fluctuations, including forecasted sales transactions denominated in Japanese yen. There is no assurance
that our hedging program will be effective. Exchange rate volatility may also increase the cost of our exported products for international customers and inhibit demand.



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There can be no assurance that any of these factors will not have a material adverse effect on our business, financial
condition or results of operations. In addition, each region in the global equipment market exhibits unique market characteristics that can cause capital equipment investment patterns to vary significantly from period to period. We derive a
substantial portion of our revenues from customers in Asia. Any negative economic developments, legal or regulatory changes, terrorism in Asia or geo-political instability in Asia, including the possible outbreak of hostilities or epidemics
involving Singapore, China, Taiwan, Korea or Japan, could result in the cancellation or delay by certain significant customers of orders for our products, which could adversely affect our business, financial condition or results of operations. Our
continuing expansion in Asia renders us increasingly vulnerable to these risks.

We face risks related to intellectual property.

We intend to continue to seek legal protection, primarily through patents and trade secrets, for our proprietary technology. Seeking patent
protection is a lengthy and costly process, and there can be no assurance that patents will be issued from any pending applications, or that any claims allowed from existing or pending patents will be sufficiently broad to protect our proprietary
technology. There is also no guarantee that any patents we hold will not be challenged, invalidated or circumvented, or that the patent rights granted will provide competitive advantages to us. Our competitors have developed and may continue to
develop and obtain patents for technologies that are similar or superior to our technologies. In addition, the laws of foreign jurisdictions in which we develop, manufacture or sell our products may not protect our intellectual property rights to
the same extent as do the laws of the United States.

Adverse outcomes in current or future legal disputes regarding patent and intellectual property
rights could result in the loss of our intellectual property rights, subject us to significant liabilities to third parties, require us to seek licenses from third parties on terms that may not be reasonable or favorable to us, prevent us from
manufacturing or selling our products, or compel us to redesign our products to avoid incorporating third parties intellectual property. As a result, our product offerings may be delayed, and we may be unable to meet customers
requirements in a timely way. Regardless of the merit of any legal disputes, we incur and may be required to incur in the future substantial costs to prosecute or defend our intellectual property rights. Even in the absence of infringement by our
products of third parties intellectual property rights, we have elected in the past and may in the future elect to seek licenses or enter into settlements to avoid the costs of protracted litigation and the diversion of resources and
management attention. However, if the terms of settlements entered into with certain of our competitors are not observed or enforced, we may suffer further costs. Any of these circumstances could have a material adverse effect on our business,
financial condition or results of operations.

Our ability to develop intellectual property depends on hiring, retaining and motivating highly qualified
design and engineering staff with the knowledge and technical competence to advance our technology and productivity goals. To protect our trade secrets and proprietary information generally, we have entered into confidentiality or invention
assignment agreements with our employees, as well as with consultants and other parties. If these agreements are breached, our remedies may not be sufficient to cover our losses.

We are subject to litigation proceedings that could adversely affect our business.

Intellectual Property Litigation

We have currently received certain
claims of infringement of intellectual property rights and may receive other such claims in the future. In the future, such claims may evolve into legal proceedings or litigation against us. It is inherently difficult to assess the outcome of
litigation, and there can be no assurance that we will prevail in any specific proceedings. Any such litigation could result in substantial cost to us, including diversion of the efforts of our technical and management personnel, and this could have
a material adverse effect on our business, financial condition and operating results. If we are unable to successfully defend against such claims, we could be required to expend significant resources to develop or license alternative non-infringing
technology or to obtain a license to the subject technology. There is no assurance that we will be successful with such development, or that a license will be available on terms acceptable to us, if at all. Without such a license, we could be
enjoined from future sales of the infringing product or products, which could materially and adversely affect our business, financial condition and operating results.

Other Litigation

In addition to the litigation risks mentioned above, we are currently involved or may become
subject to legal claims or proceedings related to securities, employment, customer or third party contracts, environmental regulations, product liability or other matters. If we are required to defend against a legal claim or deem it necessary or
advisable to initiate a legal proceeding to protect our rights, the expense and distraction of such a claim or proceeding, whether or not resolved in our favor, could materially and adversely affect our business, financial condition and operating
results. Further, if a claim or proceeding were resolved against us or if we were to settle any such dispute, we could be required to pay damages or refrain from certain activities, which could have a material adverse impact on our business,
financial condition and operating results.



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We are exposed to risks associated with our diversification strategy.

Our core business and expertise has historically been in the development, manufacture, sale and support of deposition technologies, wafer surface preparation and
chemical mechanical planarization technologies. We lack experience in the high-precision machine manufacturing equipment market serviced by our IAG segment, compared with our knowledge of the semiconductor equipment industry, and cannot give any
assurance that we can maintain or improve the quality of products, level of sales and gross margins, or relations with key employees and significant customers or suppliers that are necessary to compete in this market. Our efforts to develop the
Industrial Applications Group may divert capital, management attention, R&D and other critical resources away from, and adversely affect, our core business.

We are exposed to risks related to our indemnification of third parties.

From time to time, in the normal
course of business, we indemnify third parties with whom we enter into contractual relationships, including customers and lessors, with respect to certain matters. We have agreed, under certain conditions, to hold these third parties harmless
against specified losses, such as those arising from a breach of representations or covenants, other third party claims that our products when used for their intended purposes infringe the intellectual property rights of such other third parties or
other claims made against certain parties. We have been, and in the future may be, compelled to enter into or accrue for probable settlements of alleged indemnification obligations or subject to potential liability arising from our customers
involvements in legal disputes. It is difficult to determine the maximum potential amount of liability under any indemnification obligations, whether or not asserted, due to our limited history of prior indemnification claims and the unique facts
and circumstances that are likely to be involved in each particular claim. Our business, financial condition and results of operations in a reported fiscal period could be materially adversely affected if we expend significant amounts in defending
or settling any purported claims, regardless of their merit or outcomes.

We face risks associated with acquisitions, divestitures,
and other transactions.

We have made, and may in the future make, acquisitions of or significant investments in businesses with complementary
products, services and/or technologies. Acquisitions involve numerous risks, including, but not limited to:



| |  |  | Difficulties in integrating the operations, technologies, products and personnel of acquired companies;
| | - |  | -------------------------------------------------------------------------------------------------------



| |  |  | Lack of synergies or the inability to realize expected synergies 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.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------

When we make a decision to sell assets or a business, we may encounter difficulty completing the transaction as a result of a range of
possible factors such as new or changed demands from the buyer. These circumstances may cause us to incur additional time or expense or to accept less favorable terms, which may adversely affect the overall benefits of the transaction.



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Acquisitions, divestitures, and other transactions are inherently risky, and we cannot provide any assurance that our
previous or future transactions will be successful. The inability to effectively manage the risks associated with these transactions could materially and adversely affect our business, financial condition or results of operations.

From time to time we may enhance, modify or upgrade our enterprise resource planning and other key software applications, which could cause
unexpected problems to occur and could cause disruption to the management of our business.

From time to time, we may enhance, modify or upgrade
our enterprise resource planning (ERP) system used for our worldwide operations, as well as other key software applications used in our operations. Our ERP system is integral to our ability to accurately and efficiently maintain our books and
records, record our transactions, provide critical information to our management and prepare our financial statements.

Enhancements may eventually become
more costly, difficult and time-consuming to purchase and implement than we currently anticipate. We may encounter unexpected difficulties or costs or other challenges, any of which may disrupt our business or cause delays in the reporting of our
financial results. Our existing systems, procedures or controls may not be adequate to support our operations and require us to change our internal business practices. Corrections and improvements may be required as we enhance, modify or upgrade our
systems, procedures and controls, and could cause us to incur additional costs and require additional management attention, placing burdens on our internal resources. If we fail to manage these changes effectively, it could adversely affect our
ability to manage our business and our operating results.

Compliance with current and future environmental regulations may be
costly.

We may be subject to environmental and other regulations in certain states and countries where we produce or sell our products. We also
face increasing complexity in our product design and procurement operations as we adjust to new and prospective requirements relating to the materials composition of our products, including the restrictions on lead and certain other substances in
electronics that apply to specified electronics products put on the market in the European Union (EU). The EU also makes producers of electrical goods financially responsible for specified collection, recycling, treatment and disposal of past and
future covered products. Other countries, such as the United States, China and Japan, have enacted or may enact similar laws or regulations similar to the EU. These and other future environmental regulations could require us to reengineer certain of
our existing products.



|ITEM 2: | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
|------- | -----------------------------------------------------------

Repurchase of Company Securities

All shares repurchased below were pursuant to publicly-announced plans. On February 24, 2004
we announced that our Board of Directors approved a stock repurchase plan that authorized the repurchase of up to $500.0 million of our outstanding common stock through February 13, 2007. On September 20, 2004 we announced that our
Board of Directors authorized an additional $1.0 billion for repurchase of our outstanding common stock through September 14, 2009. On October 26, 2007 we announced that our Board of Directors authorized an additional
$1.0 billion for repurchase of our outstanding common stock through October 26, 2011.



|                                           |  |                                |  |                            |       |                                                                            |           |                                                                                   |   |              
|------------------------------------------ |  | ------------------------------ |  | -------------------------- | ----- | -------------------------------------------------------------------------- | --------- | --------------------------------------------------------------------------------- | - | -------------
|Period                                     |  | Total Numberof SharesPurchased |  | AveragePrice PaidPer Share |       | Total Numberof SharesPurchased asPart of PubliclyAnnouncedPlans
orPrograms |           | ApproximateDollar Value ofShares thatMay yet bePurchasedUnder thePlans orPrograms
|June 29, 2008 through August 2, 2008       |  | 293,916                        |  | $                          | 19.77 |                                                                            | 293,916   |                                                                                   | $ | 868.9 million
|August 3, 2008 through August 30, 2008     |  | 97,117                         |  | $                          | 22.35 |                                                                            | 97,117    |                                                                                   | $ | 866.7 million
|August 31, 2008 through September 27, 2008 |  | 978,211                        |  | $                          | 21.25 |                                                                            | 978,211   |                                                                                   | $ | 845.9 million
|                                           |  |                                |  |                            |       |                                                                            |           |                                                                                   |   |              
|Total                                      |  | 1,369,244                      |  | $                          | 21.01 |                                                                            | 1,369,244 |                                                                                   | $ | 845.9 million
|                                           |  |                                |  |                            |       |                                                                            |           |                                                                                   |   |              

In addition to shares repurchased above, we withheld 506 shares through net share settlements during the three
months ended September 27, 2008 upon the vesting of restricted stock awards to cover the employees tax withholding obligations.



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|ITEM 6: | EXHIBITS
|------- | --------

(a) Exhibits



|       |  |                                                                                                                                                                                                                                                                                                                     
|------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|*10.9  |  | Novellus 2001 Stock Incentive Plan, as amended, together with forms of agreement thereunder.                                                                                                                                                                                                                        
|       | 
|*10.28 |  | Amended Executive Voluntary Deferred Compensation Plan, as amended.                                                                                                                                                                                                                                                 
|       | 
|31.1   |  | Certification of Richard S. Hill, Chairman of the Board of Directors and Chief Executive Officer of Novellus Systems, Inc. dated November 4, 2008 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 Jeffrey C. Benzing, Executive Vice President and Chief Administrative Officer of Novellus Systems, Inc. dated November 4, 2008 in accordance with Rules 13a-14(a) and 15d-14(a)
of the Securities Exchange Act, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.  
|       | 
|32.1   |  | Certification of Richard S. Hill, Chairman of the Board of Directors and Chief Executive Officer of Novellus Systems, Inc. dated November 4, 2008 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 Jeffrey C. Benzing, Executive Vice President and Chief Administrative Officer of Novellus Systems, Inc. dated November 4, 2008 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.
|- | -----------------------------------------------------------



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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



NOVELLUS SYSTEMS, INC.By:

/s/ Jeffrey C. BenzingJeffrey C. BenzingExecutive Vice President and Chief Administrative Officer(Principal Financial Officer)November 4, 2008




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##### Table of Contents

EXHIBIT INDEX



|       |  |                                                                                                                                                                                                                                                                                                                     
|------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|*10.9  |  | Novellus 2001 Stock Incentive Plan, as amended, together with forms of agreement thereunder.                                                                                                                                                                                                                        
|       | 
|*10.28 |  | Amended Executive Voluntary Deferred Compensation Plan, as amended.                                                                                                                                                                                                                                                 
|       | 
|31.1   |  | Certification of Richard S. Hill, Chairman of the Board of Directors and Chief Executive Officer of Novellus Systems, Inc. dated November 4, 2008 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 Jeffrey C. Benzing, Executive Vice President and Chief Administrative Officer of Novellus Systems, Inc. dated November 4, 2008 in accordance with Rules 13a-14(a) and 15d-14(a)
of the Securities Exchange Act, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.  
|       | 
|32.1   |  | Certification of Richard S. Hill, Chairman of the Board of Directors and Chief Executive Officer of Novellus Systems, Inc. dated November 4, 2008 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 Jeffrey C. Benzing, Executive Vice President and Chief Administrative Officer of Novellus Systems, Inc. dated November 4, 2008 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.
|- | -----------------------------------------------------------