Novellus Systems, Inc. Q4 2008 Earnings Call Transcript

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 |  About: Novellus Systems, Inc. (NVLS-OLD)
by: SA Transcripts

Novellus Systems, Inc. (NASDAQ:NVLS-OLD)

Q4 2008 Earnings Call Transcript

February 4, 2009 4:30 pm ET

Executives

Robin Yim – VP, Treasurer and IR

Jeff Benzing – EVP and Chief Administrative Officer

Rick Hill – Chairman and CEO

Analysts

Brett Hodess – Merrill Lynch

Timothy Arcuri – Citigroup

Ben Pang – Caris & Company

Satya Kumar – Credit Suisse

Gary Hsueh – Oppenheimer & Co.

Mahesh Sanganeria – RBC Capital

Atif Malik – Morgan Stanley

Steve O'Rourke – Deutsche Bank

Mary Lee – Stifel Nicolaus

Jim Covello – Goldman Sachs

Jay Deahna – JP Morgan

CJ Muse – Barclays Capital

Operator

Hello, everyone, and welcome to the Novellus fourth quarter and fiscal year-end 2008 earnings results conference call. As a reminder, this call is being recorded today, February 4, 2009. I would now like to turn the conference over to Miss. Robin Yim of Novellus Systems. Please go ahead.

Robin Yim

Thank you, operator. Good afternoon everyone, and thank you for joining the Novellus Systems fourth quarter 2008 earnings conference call. Joining me on the call today are Rick Hill, Chief Executive Officer; and Jeff Benzing, Chief Administrative Officer.

Financial results for our fourth quarter and fiscal year 2008 were released by PR Newswire shortly after 1:00 p.m. Pacific Time. You can obtain a copy of the news release in the Investor Relations section of our Web site at www.novellus.com.

Today's earnings call contains forward-looking statements about Novellus' business outlook, the future performance of Novellus, and our products and forecast of key metrics for the first quarter of 2009. Specific forward-looking statements include but are not limited to our expectations regarding semiconductor industry growth and capital equipment spending; our progress in securing bookings with leading semiconductor manufacturers; the demand for and competitiveness of our products; our expectations that we will continue to maintain our position or grow market share; our continued efforts and expected progress in cost reduction; the forecasted bookings and shipment volumes, revenue, gross margin, operating expense, and earnings per share target for the first quarter of 2009; and our tax rate for both the first quarter of 2009 and fiscal year 2009; the effect of the current economic climate on our performance over the next several quarters; and other anticipated future events.

We caution you that forward-looking statements are projections and expectations regarding future events. They involve risks and uncertainties that could cause actual results to differ materially from the results contemplated, including an inaccurate basis for our financial forecast. Information concerning risks that could cause these actual results to differ materially is contained in today's press release and our filings with the Securities and Exchange Commission, including our Form 10-K for fiscal 2007 and our Forms 10-Q and 8-K. Forward-looking statements are based on information as of today and we assume no obligation to update these statements.

Jeff Benzing will begin today's call with a review of the financial results for the fourth quarter and fiscal year 2008. Rick Hill will provide an overview of business environment and guidance for the first quarter of 2009, and then we'll open up the call for our question-and-answer session.

Now I'd like to turn the call over to Jeff.

Jeff Benzing

Thank you, Robin, and good afternoon everyone. As Robin outlined I’ll begin today's call with the review of the financial results for both the fourth quarter and the fiscal year ended December 31, 2008. The results for the fourth quarter and the fiscal year 2008 reflect the weakening global economic conditions and its impact on our customers and on Novellus. Here are the results.

New bookings for the fourth quarter of 2008 came in at $127.5 million, which was a decline of 40.9% compared to new bookings in the third quarter of $215.7 million. In the fourth quarter, we made a backlog adjustment of $44.9 million, which included a combination of customer cancellations and a proactive adjustment based primarily on our internal assessment that certain customers will most likely not be in a financial position to take delivery of these systems within the next 12-month period.

This decrease in quarterly bookings mirrors the continued weakening demand seen in the market and the low utilization rates of our foundries, memory, and logic customers as discussed in both our mid-quarter update and our pre-announcement of earnings.

Net orders for fiscal year 2008 were $817.1 million, which was down 41.3% from fiscal year 2007 as a result of reduced capital spending across all semiconductor segments. For the fourth quarter, our bookings by wafer size were 90%, 300 mm, and 10%, 200 mm; and for the full year, 82%, 300 mm, and 18%, 200 mm. Fourth-quarter shipments were $175.6 million, down $23.7 million from quarter three. Shipments for fiscal year 2008 were $959 million, a decrease of 39.2% over fiscal year 2007, consistent with the bookings trend.

Fourth-quarter revenues were $188.5 million, down 24.6% from the September quarter. Revenues for the year were $1.01 billion, a decrease of 35.6% over fiscal year 2007. Our fourth quarter revenues by geographic regions are as follows; United States, 43%; greater China, 15%; Korea, 12%; Japan, 14%; and Europe, 16%.

Our year-end backlog at the end of the fourth quarter was $188.3 million, down from $354.5 million as of fiscal year-end 2007, as a result of the weakening order environment experienced throughout 2008.

Throughout the rest of my remarks related to the P&L, I will be distinguishing between GAAP results and the results that exclude certain other charges and benefits. So I would like to practice my remarks with a description of these other charges and benefits, and will refer to them collectively going forward as "other items." Please note that a detailed breakout of these items by type and geography is in today's press release. Other items for 2008 included an impairment of goodwill related to our Industrial Applications Group, other than temporary impairments of auction rate securities, severance charges related to reductions enforced, impairment and inventory and evaluation system, and write-down of certain R&D assets all related to discontinued product initiatives and adjustments that previously recognized restructuring accruals, reversal of stock based compensation expense; and in 2007, a similar list that also includes a gain on sales of real estate assets.

Fourth quarter GAAP gross margin was 36.4%, which includes $4.1 million of other items. Excluding these other items, fourth quarter gross margin was 38.5%, down from 44.6% in the third quarter. The decline in Q4 gross margin was due primarily to further deterioration in the absorption of fixed costs as shipment volumes declined and also due to an increase to the reserves for excess and obsolete inventory as a result of decreased forecasted demand. For fiscal year 2008, GAAP gross margin was 43.1% compared to 49% in 2007. Excluding other items, fiscal year 2008 pro forma gross margin was 44.2% compared to 44.9% in 2007 for the same reasons highlighted previously.

Total GAAP expenses for the quarter were $202.4 million, which includes $99.5 million in goodwill impairment charges related to our Industrial Applications Group and $8.2 million of other items. Excluding these other items, ongoing operating expense declined to $94.7 million, which is down $10.8 million from the September quarter operating expense of $105.5 million, due, in large, to a large part of our cost reduction activities, such as redaction in variably competition liability, reductions enforced and shutdowns, and was partially offset by a slight increase in accounts receivable write off and expense in the write-down of certain R&D inventories.

In response to the weakening environment over the last year, we have realized a significant amount of (inaudible) production and lowered our ongoing operating expenses by 23.2% to approximately $123 million at the beginning of 2008 to less than $95 million by the year end. Going forward, as dictated by our fluid business environment, we will continue to adjust our operating cost structure accordingly.

Fourth quarter GAAP operating loss was $133.9 million. Excluding other items, Q4’s operating loss was $22.2 million due to reduced revenue levels and gross margin in the quarter as discussed earlier. Our operating income for fiscal year 2008, excluding other items was $17.7 million compared to $262 million in 2007.

Now turning to taxes. As most of you are aware, our international tax structure was put in place to maximize earnings in low tax jurisdictions, and that incurred losses. A majority of those losses accumulates in low tax jurisdictions as well as which minimizes the related tax benefits. For the three months ended December 31, 2008, our effective tax rate was 5.7% as we reported a pre-tax loss of $138 million and a corresponding tax benefit was $7.8 million. The low effective tax rate was as the result of accelerating losses in low tax jurisdictions combined with non-deductible goodwill charges. For the year ended December 31, 2008, our effective tax rate was a negative 8% as we reported a pre-tax loss of $107 million and a corresponding tax expense of $8.6 million as a result of non-deductible impairment charges, as well as losses incurred outside the US with no tax benefit, both of which occurred in 2008.

The pro forma effective tax rate for the three months and year ended December 31, 2008, is 12% and 73%, respectively. Again, these unusual rates are attributable to losses outside the US with no tax benefit.

Based upon of 2009 forecast small changes in our assumptions for the year may cause unusual volatility in our tax rate projection. As a result, we intend to account for our 2009 quarterly income tax expenses discreetly rather than calculating our tax expense by applying an estimated annual effective tax rate to quarterly income. We currently estimate our first quarter 2009 effective tax rate to be approximately 20%. Please note that our effective tax rate in subsequent quarters is likely to vary significantly.

Fourth quarter GAAP net loss was $130.3 million or $1.36 per share on a fully diluted basis. Fourth quarter net loss excluding other items was $20 million or $0.21 per fully diluted share. For the full year 2008, GAAP net loss was $115.7 million or $1.18 net loss per fully diluted share compared with net income of $214 million or $1.75 per fully diluted share in 2007. Excluding other items, fiscal 2008 net income was $7.1 million of $0.07 per fully diluted share, compared to fiscal 2007 net income of $207 million, which was 13% of revenues or $1.70 per fully diluted share.

Now turning to the balance sheet; we ended the year with $682.5 million of short and long-term cash investment, including $119.7 million of restricted cash. That total cash balance is net of $16.5 million of impairments to our auction rate securities portfolio. Of the $16.5 million, $3.5 million has been classified as other than temporarily impaired and a charge was taken to the P&L in the fourth quarter. The remaining $13 million reflects the balance sheet mark to market on the auction rate portfolio. We continue to see redemptions at par and currently have auction rate securities totaling $106.4 million at par values, down from $152.1 million a year ago. Including impairments, total cash declined by $75.4 million for the year.

Despite a difficult quarter and year overall, we managed to generate $17.4 million in cash flow from operations in the fourth quarter and $189.2 million in the year. Overall cash decreased in 2008, primarily due to the purchase of approximately 9 million shares of stock totaling $193 million at an average price of $21.50 a share, repayment of $26 million in debt, and capital spending of $17.9 million. In the fourth quarter, we bought back 1.3 million shares of stock for $19.2 million at an all-in cost per share of $14.41. The stock repurchase program remained active and there is approximately $827 million left under the authorization until October 2011.

Net accounts receivable at the end of Q4 totaled $144.3 million, down $66.1 million from $210.4 million at the end of the third quarter. In the fourth quarter, our DSOs declined to 69 days from 76 days at the end of Q3 and 86 days at the end of 2007, due to a focused and effective collection efforts.

Inventory levels decreased by $19.5 million quarter over quarter as we successfully managed operational inventory down in the fourth quarter, including the reclassification of evaluation system from other assets to inventory on a less restrictive basis.

With that, I would like to turn the call over to Rick to provide guidance for the first quarter of 2009, and an update on the state of the business. Rick?

Rick Hill

Thank you, Jeff, and good afternoon ladies and gentlemen. Clearly, the financial results presented here today did not represent a normal operating environment. During this conference call, I'd like to share with you our view of what's happening in the market and the potential scenarios that could play out.

As Jeff reported, fiscal year 2008 was a very challenging year. Our overall bookings decreased by 40% in fiscal year 2008 over 2007. At the end of the first half of 2008, our bookings were already down 54% from the first half of 2007 and the second half was down another 42%, highly unusual in a normal cyclical downturn within the semiconductor industry. Our shipments follow the same trend as they decreased by 39.2% from fiscal year 2007.

Revenues were helped slightly by deferred revenue, were decreased slightly and were down slightly less at 35.6%. Unfortunately, we could not bring down operating expenses as quickly as revenues fell. Our operating expenses were down 15.4% year over year. More significantly, however, is the fourth quarter 2007 operating expense was $107.3 million versus our quarter four of 2008, which was $82.6 million. This is a 23% reduction year over year. Quarter four revenues, however declined 48%. As a result of our inability to shrink expenses faster than our gross profit dollar showed our profits shrank 97% from 2007.

Our cash flow from operations was $189.2 million in fiscal year 2008, and it was down 38% from 2007. Our total cash decreased only 10% due exclusively to our continual share repurchases.

Our balance sheet improvements in AR is from 86 days to 69 days, coupled with inventory reduction of 16%, all helped cash generation. That is additional cash generation capability in both these assets, but ultimately the top line needs to improve going forward.

So what happened in 2008? What are we going to do? Clearly, this is not a cycle. It's a fundamental change in the industry and the macroeconomic situation. The fundamental change to the industry is there is no longer subsidized capital available to sustain unprofitable business model. The semiconductor industry is driven by two major segments today, which shut off completely in the fourth quarter – IT infrastructure spending for transaction processing and financial services and the consumer electronics segments slowed dramatically as the implosion of the housing market and consumer credit put consumers in a new frame of mind.

So what's going to happen going forward? Very difficult to say. I want to spend a little time, however explaining what we see and how it is driving our thought process. It's an opinion not a fact. I’ll try to give you an industry-wide perspective and Novellus specific perspective, and separate the two the best I can. The most recent piece of data we all have is the annual semiconductor sales for calendar year 2008, which was approximately $250 billion. I believe the number was $248 million, so excuse the rounding. The future of the equipment industry is clearly tied to what happens to this number and how it happened. The first thing to realize is it decreased from 2007. The second thing to realize is that it decreased lastly the fourth quarter. The third and important factor is there is no evidence that we have seen to this moment that anything has gotten better. We've seen a flurry of announcement that things will be worse for most of the semiconductor companies that we sell to in the first quarter.

For the most part, there is no underlying demand increasing for semiconductors in the immediate future. Our draconian view would be that is no increased capital requirements from the semiconductor companies until all excess capacity is absorbed into the system. In other words, the commerce for equipment is between semiconductor companies not between equipment companies and suppliers. As you see in some of the Asian regions, as certain memory manufacturers try to combine excess capital equipment will find itself deployed into some of our core companies. Given this draconian scenario, the demand for semiconductor equipment we believe would level off at about 5% to 7% of semiconductor revenue. Now if we arbitrarily say that demand for semiconductors drops 15% in the first quarter from the current levels, it would say that semiconductor revenue would drop to about $53 billion in quarter one. If it stays flat for the additional quarters, what would the market be? Now every quarter, semiconductor companies place demand on equipment companies in two areas. One is in the operating expense line; the other is in their capital expenditures. On the service line, they typically spend about 2% of their revenues on spares and service. Therefore, the spares and service oriented revenue for fiscal year 2009 could be as low as $4 billion.

In addition, there is a base of equipment that will be required for upgrades and replacement of obsolete equipment. If you assume this base level as roughly about 2.5% of their revenue; that would mean CapEx to roughly about $5.3 billion and this is just for wafer fab equipment. 50% of the companies in the industry will also spend on technology upgrades. For example, aluminum to copper or buying new LIFO tools, technology or new equipment for advanced transistor technology et cetera, et cetera. We estimate that to be about $3.5 billion worst case for new equipment purchases, because it is not capacity driven it is purely technology driven. So our worst-case scenario for revenue to equipment companies in 2008 would be $4 billion for spares and services and roughly $8 billion to $9 billion for technology shifts and sustaining equipment. This would be the number we would tend to feel is what people have been referring to as sort of a base level loading.

Now utilizing those numbers and assuming Novellus’ share variation of between 4% to 6% of those wafer fab numbers, it would project a – what we would classify a worst-case scenario of revenue in 2009 of somewhere between $500 million for semiconductors and $600 million total combined when we include our industrial applications group. So a total revenue in the neighborhood of $600 million on the low side to a high side of potentially $860 million. Now this would mean down a maximum of 58% for 2000 CapEx in the industry. So the likely scenario in the industry we feel is probably down 45% and the upside is down 32%. So for fiscal year 2009, we see a tough year.

Now usually we might optimistically forecast a hot product such as solid-state drives accelerating excess capacity absorption but given the massive ongoing contractions of consumer spending and corporate input structure spending on IT, it is difficult to project the spending spree even if they did like a hot new product. More fundamental factors affecting the industry are lack of capital availability. We see this in Europe in the memory industry, also Taiwan in the memory industry; and we also see this in Japan as their export machine continues to shut down.

So for 2008, we are planning for the worst. The key question is what is the normal level of capital expenditure for the semiconductor industry? Now we believe a very simplistic model has CapEx at approximately 13% to 16% of semiconductor revenue for their total CapEx expenditure. At $250 billion semi revenue, that would be roughly $32.5 billion to $40 billion in total CapEx. This translates to roughly $19.5 billion to $20 billion for the wafer fab equipment, which typically runs about 60% of the total. If you also assume a 2% of revenue in inflow from spares and service to the semi cap equipment companies, they would see revenues somewhere totaling $24.5 billion to $29 billion.

When we do our calculation of our share of this market and what we believe on a normal steady state, we should see it builds Novellus at a normal steady state of $1 billion to $1.2 billion. So our challenge is to align our cost structure to survive at the anemic CapEx levels of between $8 billion and $10 billion for the wafer fab equipment and be able to respond to a reasonable normal steady state of CapEx, which we believe to be up into the $19 billion level.

So the following actions are underway at the company. We are aligning our expense structure to assume we spend cash at less than a $20 million per quarter rate if revenues were to stay at first quarter anemic levels. We will do this through selected headcount reductions, where we will be reducing our support levels proportionally to the customer's output and potential going forward. In addition, we are in the process of consolidating facilities within San Jose and shedding excess real estate. We have initiated executive pay cuts and companywide shutdowns two weeks in the first quarter. Upon Board approval in February, we will eliminate our employee share purchase program beginning in June, so for the second half of the year. We will also continually manage all discretionary spending with our attempt to at these very, very low levels minimize cash consumption. The second thing we need to do is continue to drive the quality of our existing products and development of new technologies in our existing products essential to our customers’ success and growth.

Now given these two objectives and balancing them, I would like to give you the outlook for quarter one. Bookings are slated to be between $76 million and $95 million, which is down 25% to 40% from the fourth quarter. Shipments will be $90 million to $110 million as we dramatically bring down shipments to align with incoming bookings; that is down 37% to 49%. Revenues will be down equally at $95 million to $110 million, down 41% to 49%. And our gross margin is anticipated to be 25% plus or minus 2%. The single reason for the dramatic drop in gross margin is due to the large drop in shipments and the absorption of fixed manufacturing costs. Our earnings per share in the first quarter will be between a loss of $0.45 and a loss of $0.60.

With that, I would like to open it up for any questions that you might have.

Question-and-Answer Session

Operator

(Operator instructions) We will go to Brett Hodess with Merrill Lynch.

Brett Hodess – Merrill Lynch

Good afternoon, Rick. I'm wondering, you know, when you look at cost reductions that you're making at this stage, can you give us approximately what you think the breakeven is going to be when you are done with these items and can you also talk about how much of the cost reductions would you see as permanent once revenues come down back versus ones that you will have to add back in?

Rick Hill

Okay, so when I was speaking before, I had given you how much we had brought down the semi operating expenses which were very, very dramatic. We will continue to work on bringing those down lower, but we believe that from a cash breakeven standpoint, we were clearly at cash breakeven in the last quarter. So my anticipation is it is probably about halfway between what the first quarter is and what the fourth quarter was. But I don’t have that number right next to me. John, do you have that number by chance?

John Hertz

180.

Rick Hill

180 right this minute.

Brett Hodess – Merrill Lynch

180, okay. And the second part was – if revenues had to pick up, I guess it is a leverage question, how much leverage do you get versus how much do you have to add back on some of the temporary measures?

Rick Hill

Well I think clearly in manufacturing as the volume goes back up, we will bring back on expenses. In the area of R&D, G&A expenses will hold those tight for as long as we can. I believe we can probably see a substantial rise in shipments with the existing level, meaning in the order of 50%, but I think to go much higher than that, there clearly will be some add back of expenses.

Brett Hodess – Merrill Lynch

Final question was on the technology upgrade of your total equipment market that you talked about, the $3.5 billion or so. How do you see that rolling out over the course of the year, is it going to be fairly linear, back-half loaded, lumpy? Can you give us a feel for that piece?

Rick Hill

I think it is clearly customer dependent and so by its nature it will be lumpy. As you all know, there is really largely only one customer currently investing in technology. There is the expectation that one more will begin to invest during the second quarter and the first customer will tend to be shutting off within the third quarter. So it is rather lumpy but we anticipate seeing it probably some in the first quarter, some in the second quarter and then certainly in the fourth quarter is where we anticipate seeing significant upturn if there is an upturn at all in the year.

Brett Hodess – Merrill Lynch

Great, thank you.

Operator

Next we will go to Timothy Arcuri with Citi.

Timothy Arcuri – Citigroup

Hi, Rick. Thanks. Two things, love the work on maintenance and also across cycle CapEx, that was great. You know, relative to where you think the normalized size of the industry is, I'm in line with those numbers and you know, if you look at the size of your company in that sort of a situation, you would earn maybe $0.80 in kind of a normalized cycle. You know, that is not very much and I guess I am wondering does this make rethink the strategy of being in all these different product lines, because as I look at revenue levels as low, it seems like you kind of have to start to focus your efforts on a smaller number of products, so that you make more money over the cycle.

Rick Hill

Yes, well I think clearly that if those products, given a steady state can't contribute to making those numbers higher by being successful, we would clearly pair them back and have room to hold our operating expenses down for a longer period of time. So it is a moving equation. But clearly, when I spoke to steady state, I basically spoke to products that have basically a sustainable business model. And so, as I have said in the past, the key for us relative to CMP, which is the implied question, is always on whether or not it is viable. It is certainly viable internally for us in our integration work. Whether it is viable to make a business on, we will know that in very short order; and so nothing has changed strategically relative to that, but certainly, we come to the same conclusion you are. If it can't add to that steady state level of $1 billion to $1.2 billion, we can't be committed to it regardless of what it does to the industry relative to a competitive position for our customers, making them unable to have any competition in that arena.

Timothy Arcuri – Citigroup

Rick, I'm not even talking about CMP, I am talking about other bigger product lines such as strip, things like that. I guess the next question would be that if I look at back at when you were doing kind of $250 million to $300 million in quarterly revenue, which would be an implied normalized level, you were spending OpEx in the 90 to kind of a 100 range and you are not going to make very much money when you are spending that much OpEx at that revenue level. So I'm wondering what would be – in kind of your new world – what would be the normalized OpEx run rate at kind of a similar normalized $250 million to $300 million revenue run rate?

Rick Hill

I think at the normalized $250 million run rate level, I would expect to see our operating margins be able to run at probably around the $90 million to $95 million operating expense number. We were actually much higher than that before, and we brought that down dramatically; and so we will manage the business for the long term.

Timothy Arcuri – Citigroup

Okay, thanks.

Operator

And let us take a question from Ben Pang with Caris & Company.

Ben Pang – Caris & Company

Thanks for taking my question. And this is kind of a follow-on to the question that you answered but to give a little bit of a better understanding, when you talk about the $3.5 billion opportunity for technology spending, do you give Novellus more opportunity now because of the CMP and some of the other products you are working on?

Rick Hill

Well, I don't from a steady state standpoint.

Ben Pang – Caris & Company

But for 2009?

Rick Hill

For 2009, no, I don’t.

Ben Pang – Caris & Company

I mean if you don't gain traction in 2009, I mean, does that really kind of mark the end of the ability to gain share in those areas?

Rick Hill

Well, I think that is true, except gaining share and technology buys are two separate things. Okay? And we are in a mode now where the only thing that is going to transpire our technology buys. Period. And I wouldn't look at making a technology win as making a successful product. There has to be a commitment from the customer to call it a success.

Ben Pang – Caris & Company

Okay, that is very helpful. Last question is – is there any change in kind of the condition over the last couple of weeks. Are at least your customers – do you believe that their outlook has any stabilization at all?

Rick Hill

I would not say that I – in the last couple weeks, customers would say that the market has stabilized.

Ben Pang – Caris & Company

Okay, thank you very much.

Operator

And next in our queue from Credit Suisse, we have Satya Kumar.

Satya Kumar – Credit Suisse

Yes, hi. Thanks for taking my question, Rick. I guess if I look at your minimum revenue projections or I guess estimate based on this math of $600 million, you ought to get fairly sizable increase in your revenues in Q2. What exactly are you seeing right now in terms of visibility in the second quarter? You mentioned that there is another customer who is looking to spend. Do you actually see any orders from this customer? What sort of visibility do you have looking to next quarter?

Rick Hill

Our visibility is just our communication with the customer, coupled with their public announcements of what they are going to spend and knowing what they would like to achieve in a given period of time. Obviously, it is all dictated by their financial results, how much capital they are willing to bring on because of what they want to do vis-à-vis their depreciation line. But we think that we have a fairly good handle on at least two or three other customers on what their very, very likely to do. But as I said before, we are planning for the worst and we will be ready for the best.

.

Satya Kumar – Credit Suisse

Okay, is there a possibility, Rick; that acid lines of silicon factories are increasing. You know if you look at basically the technology node transitions, it seems like to me in memory for example, even if you shrink DRAM to the next node, you are not sort of getting the demand fulfilled in terms of contents of box as the shrink itself is not adding as much value as it used to. And perhaps you could make a similar case for flash, where you are not really having (inaudible). Could we go into a mode where the (inaudible) increasing structurally?

Rick Hill

I think you know the efficient deployment of capital is key in the semiconductor industry and so there is no question that there is going to be less IVMs around, that will continue. But those semiconductors are going to be made and so the dollar sold the analytics from a percent of capital, I think that is more dictated by the technology and what this industry costs to sustain itself. So it will make the industry a little bit more competitive, have downward pressure on gross margins in the equipment company, but semiconductors are not going away and neither is the equipment business

Satya Kumar – Credit Suisse

Yes, lastly a question about taxes. The stimulus package might have the provision allowing annuals to be carried back. Given the charges you are taking today, is there a possibility that you are going to (inaudible) under these new proposed tax laws?

Rick Hill

That is something we are currently evaluating right now.

Satya Kumar – Credit Suisse

Okay, thanks.

Operator

Next in our queue, we have Gary Hsueh with Oppenheimer & Co.

Gary Hsueh – Oppenheimer & Co.

Rick, just listening to your comments and sort of the excellent mathematical scenario, you seem to be making a pretty strong case for consolidation in semi cap equipment land. You know, if you look at your comments, on a $19 billion kind of steady state WSE spend and those would be only deteriorating and I get this as well roughly around $0.80 and on the net income basis, you know $80 million. And you know historically going into the 300 mm transition, on much fewer products Novellus has been generating much higher net income after tax. So it just sounds like you know we have to kind of get used to a new normal here, where steady-state earnings and net income generation is much lower than we have ever seen before and you know going into 2012, 2013 as we had to 450 mm, it seems to suggest we need some consolidation to drive more efficient R&D across a fewer number of semi cap equipment companies. Is that your viewpoint or am I just kind of looking at it through my own biased lenses?

Rick Hill

No, I mean I think that consolidation is something that has the potential to make a lot of sense. In some cases, in other cases, I think you are going to see some people go buy the wayside, which will increase the ability for others to gain market share. I mean I cannot see the status quo continuing, if that is what you are asking. And that will be basically you know a function of how much capital comes into the market. You know, for years and years, and I think what I said originally is over; there is no more subsidized capital. So you are going to have to live on your own positive cash flow. You are not going to be able to live on going out and financing the company. So I think you will see some semiconductor companies probably not surviving, you will see some equipment companies not surviving and then how the rest shakes out, it is all speculation.

Gary Hsueh – Oppenheimer & Co.

Okay. And just one kind of nuts and bolts question here. You know, you are implying that the industrial applications business should hit a $25 million per quarter run rate. Is that already baked into your guidance for Q1? You know, are we already there in terms of your guidance for Q1 in terms of (inaudible) and industrial applications?

Rick Hill

We are.

Gary Hsueh – Oppenheimer & Co.

Okay, great. Thank you.

Operator

Mahesh Sanganeria with RBC Capital is next.

Mahesh Sanganeria – RBC Capital

Thank you. Just want to verify that – for Q1, there is a tax credit, right? The 20% will be the tax credit?

Rick Hill

Yes.

Mahesh Sanganeria – RBC Capital

And so what is the implied OpEx you are guiding with the range of EPSs wise, I am not able to come up with a good OpEx number and if also you can point out how much of that OpEx reduction is temporary and how much comes back in the next couple of quarters.

Rick Hill

So from an OpEx standpoint, you should probably just sort of blueprint in $88 million to $90 million max, and I wouldn't plan on much of it coming back.

Mahesh Sanganeria – RBC Capital

Okay, one final question. I know it is kind of hard to talk about any progress on the products because nobody is probably interested in talking right now.

Rick Hill

Well said.

Mahesh Sanganeria – RBC Capital

But I'm sure you are working with some customers on advanced designs and if you can give us an update on any exciting wins or any exciting development you are seeing.

Rick Hill

I appreciate the opportunity to talk about it Mahesh, but there is nothing exciting going on right now, other than dealing with the day-to-day of catching the falling knife, which I'm sure you are fully aware of.

Mahesh Sanganeria – RBC Capital

Yes, okay that is all from me.

Operator

And next up we have Atif Malik with Morgan Stanley.

Atif Malik – Morgan Stanley

Hi, thanks for taking my questions. Jeff, how should we think about the gross margins from here assuming shipments remain at a very low volume and they remain flat from Q1 levels? I mean are there facility synergies or fixed cost synergies that can lift up the gross margins from these levels for the next few quarters or should you seem flat?

Jeff Benzing

Well clearly from a standpoint of looking at the erosion in gross margin quarter over quarter that is due primarily as Rick mentioned in his comments on the fixed costs that we have in the infrastructure just spread over a lower shipment volume, we got plans in place to consolidate (inaudible) plans in place to continue our cost reduction efforts and those will all have an impact going forward. But there was no substitute for getting increased shipment volume to drive that margin back up. But in the absence of that, I think you will see some steady improvement out there, but they're certainly not going to get any worse.

Atif Malik – Morgan Stanley

Okay and a question on your cancellations in the backlog, were they mostly semiconductor or industrial segment also?

Jeff Benzing

They were almost exclusively semiconductor.

Atif Malik – Morgan Stanley

Okay last question for Rick. Rick, just your big picture thoughts on 450 mm migration. I mean are you seeing any kind of pull from your customers to accelerate these programs or are they coming to you guys to help them more, you know, the big large cap companies and then they are concerned about the smaller guys not being able to pull their weight for 450 mm. Where do you think is the 450 mm migration right now?

Rick Hill

I think given the state of the industry, the ability to go to 450 mm is limited at best. And the economics over there is such that if the industry isn't to rebound off these levels, you couldn't have an industry that could sustain such a capital investment. So at this point in time nobody's tugging at it

Atif Malik – Morgan Stanley

Okay and one last question on the share buybacks. The shares that you bought in Q4, is it safe to assume they were bought earlier in the quarter and not at the end of the quarter?

Jeff Benzing

Yes, they were bought in the first phase of the quarter.

Atif Malik – Morgan Stanley

Okay, thanks.

Operator

Next up we have Steve O'Rourke with Deutsche Bank.

Steve O'Rourke – Deutsche Bank

Thank you, good afternoon. Couple of quick questions. How much of the $45 million in backlog adjustments were customer cancellations as opposed to adjustments; and secondly, have you had to extend any more favorable terms to customers kind of becoming the bank and the benefit or–?

Rick Hill

The cancellations were approximately half, customer requested and half of our own internal judgment. And you know, we're always getting requests for terms but as you can see in our DSO staying where they are we have been very successful in not having the order to have our products extended.

Steve O'Rourke – Deutsche Bank

Fair enough, thank you.

Operator

And next we have Patrick Ho.

Mary Lee – Stifel Nicolaus

Hi, this is Mary Lee for Patrick. Thank you for taking my question. My question is do you feel that there has been a structural change in some of the larger memory players, specifically in Korea and how they are spending. You think they are changing their spending tied in all together or is this a temporary pullback?

Rick Hill

Well, I think that given the current supply demand fixture, this is probably an intermediate step for them. If the industry shakes out and capitalism deployed to, there isn't a rush in of capital. Certainly, capacity will dwindle, give them an opportunity –certain players the opportunity to gain market share, at which point I think they will increase their CapEx. So I think this is sort of an intermediate step to see what happens within the overall industry. But I don't see it being necessarily a permanent. But I don't see it going back to spending 40% of revenue either.

Mary Lee – Stifel Nicolaus

Okay, great. And in terms of the cost cutting that you're doing, can you maybe discuss a little bit about how much will come out of OpEx and how much out of (inaudible)?

Rick Hill

I think the majority of it will be in the OpEx arena because causes predominantly are a material-driven phenomenon.

Mary Lee – Stifel Nicolaus

And you have a share count estimate for the next quarter?

Jeff Benzing

Quarter end was 96016 on a basic level of 96736. We don't forecast share count in the future quarters

Mary Lee – Stifel Nicolaus

Okay, thank you.

Operator

And we will hear next from Goldman Sachs, we have Jim Covello.

Jim Covello – Goldman Sachs

Great good afternoon guys, thank you. Rick, one thing that has gotten a ton of attention on calls especially during the upturn or the early stages in downturn, there is kind of a trajectory of commodity memory prices. We have actually seen a really significant increase in commodity memory prices off the bottom. Now recognizing that we're going to see – need to see at least another big of an increase from here in order for these companies to be profitable. Why isn't that evidence that things have gotten a little bit better, you know at least for your customers, because you made the comment that there is no evidence that things have gotten better.

Rick Hill

Yes, well because I think that has gotten better based on may be a lack of confidence in certain suppliers. So basically, customers have moved their time tracts over to people they think might be able to supply over the long-term. You know, sort of a dilemma of anybody that has financial uncertainty and rather than a increased large increase in demand. Trajectory was up because of a large increase in demand than I would say is a net positive

Jim Covello – Goldman Sachs

For sure.

Jeff Benzing

Yes, there is no demand that all let alone an increase in demand but if you cut supply enough and these customers can start to make money again, we might not sit at the bottom of the cycle forever

Rick Hill

Yes, I still think they will be very cautious from the standpoint of not trying to bring on too much supply too quickly and from an equipment standpoint, we still do have the phenomena that as certain manufacturers might take capacity out and sell the equipment in order to get cash to continue to operate, you know, you will have a very robust used market and therefore it is like a third competitor for the equipment company

Jim Covello – Goldman Sachs

Sure, okay. I appreciate it. Thanks very much.

Operator

Next up, we have Jay Deahna with JP Morgan.

Jay Deahna – JP Morgan

Thanks very much. Good afternoon. I have got two tracks of questions. The first one, (inaudible) last at your analyst meeting last year, you threw out some pretty big numbers in terms of your market share objectives throughout your product line. Are you still advertising those same numbers?

Rick Hill

Well, we aren't advertising at all. Those are long-term objectives to get to. I think from a standpoint of the capability of the products, we have the capability of the products and in fact, in a large percentage of them, given the performance of those products from a standpoint of return on invested capital, those making truly the right financial decision we should be able to achieve those particular goals. I think it's not achievable unless we see a rebound in the industry, right, because market share doesn't change if we are not bringing on capacity expansion. So, it wasn't a one-year goal. And so, I doubt if we are going to see that in this year that much gain in share, but I do believe within this year we will continue to see gain.

So what's the next track?

Jay Deahna – JP Morgan

I think CMP was one of those new indicators earlier, if you don't get some design wins there then maybe that maybe on the bubble. So I am wondering if the cost cutting necessity that through this downturn might make the share objectives in some of your products maybe not worth the investment.

Jeff Benzing

Yes, I guess, this is a business that we are in. I think our products are fundamentally, extremely competitive across the board. CMP being the one that is so new that we can't really determine at this juncture how much value it brings to the customer, but as I said before, if that doesn't bring value to the customer we will make a decision. And I've laid out what that decision is and we are still on that path.

Jay Deahna – JP Morgan

Fair enough. Now the other track is, if you look at your portfolio of products, there is the question, the electroplating is an above average growth segment of the industry and that you dominate that segment, not the biggest market but that's clearly a place where you guys dominate and that's good. You look at your core CVD products and you’ve always been very strong there and that's good. But outside of plating, generally speaking it feels like a lot of your served markets are generally speaking kind of average or below average growth segments of the industry. So if you gain share there, you kind of grow at an industry rate, and then you need to sort of double that share to grow at some of your stated objectives as to a premium to the industry rate. So it would seem like maybe now would be a good time to take a portfolio manager approach to your business line and say, hey, there’s some small companies on the ropes that might have some pretty cool products that they can't ramp because they can't afford to do it, just acquire those products, kill the PP&E and ramp them to your distribution network and juice up your growth profile.

Rick Hill

The asset strategy, obviously that we continue to look at, okay. But I think you are missing some products. I think from a standpoint of our CVD, from a standpoint of tungsten PECVD you’ve acknowledged the strong growth in PECVD. In the tungsten area, we also have a very dominant market share, and I think some of the emerging technologies coming out basically play well into our strength within the tungsten product line. So, I suspect that there is still growth opportunities in that segment that you may be underestimating. In the PVD arena, obviously that's where we go into the teeth of the dragon. And I think from a standpoint of the transitioning from aluminum to copper I think we stand very, very good chance from that standpoint to gain substantial market share there, albeit as you pointed out very accurately in your report it's not as larger market as the logic market. I also believe that advanced technology, our PVD technology, has extendibility that's desirable. And when we couple that with our joint program with TEL to direct plate on barrier, I think we offer a low risk extendibility platform to beyond 22 nm and down at 22 nm for the industry. So I think that that business still has some growth in it, so just in focusing on what we have, I think crispness of execution is critical. And I think we've improved that execution over the last 2.5 years. And what we need to do now is see a little bit of an uptick in the market. And you probably have better visibility and when you thing that might happen than even we do because you know, every time we keep taking a look at it, it keeps pushing out further and further.

Jay Deahna – JP Morgan

I see, so just for the last follow-up, just unclear, in PVD your market share has been hovering according to Dataquest in the 8%, 9% range for several years. Do you see now, is it just the memory transition to copper that opens up some sort of advantage to your technology to break out of that high single-digit PVD share or are you staying at 22 nm, there’s something happening in logic as well that could help somehow get better.

Rick Hill

I think they are a combination of both.

Jay Deahna – JP Morgan

Okay. All right. Thanks, Rick.

Operator

Our next question comes from Timothy Arcuri with Citigroup.

Timothy Arcuri – Citigroup

Rick, just a quick one. I’ve kind of just on numbers looking back from a secular point of view, and typically and this was going back like 25 years, typically whenever it comes to a wafer size transition, which tends to be very deflationary for your end of the business because capital intensity comes down. Usually, whenever it comes to your wafer size transition, and you know starts to shrink again, capital intensity goes back up. So I'm wondering I mean, yes, there is some countervailing forces now, but I'm wondering do you think that something has dramatically changed in the industry such that now that we’ve moved through a wafer size shift that capital intensity would not go higher on a secular basis from here.

Rick Hill

All right. Think to the extent that you slow down shrinks, because you are meeting a technology wall. You won’t slow down the consumption of square centimeters of silicon because the designer continually wants to use more silicon. And as a result, you are going to pump more wafers, and as a result you will have somewhat of a higher capital intensity. But I think clearly in the industry there will be an ultimate limit, which is going to be capital limit, on the availability of capital in the market. So that will be a downward pressure either on us gaining more productivity or our customers not being able to grow as rapidly. It's should be one or the other. But I think unless there is a source to subsidize capital within the industry or the profile of profitability changes dramatically growth is going to be limited by capital availability. Okay? I don't know if it answered your question. I thought it didn't. But –

Timothy Arcuri – Citigroup

That's great. Thanks, Rick.

Operator

Next off with Barclays Capital, we have CJ Muse.

CJ Muse – Barclays Capital

Yes, thank you for taking my question. And I guess Rick, don't be too down, it looks you guys didn't fall for bankruptcy.

Rick Hill

I appreciate that.

CJ Muse – Barclays Capital

First question is on the cost cutting front, whether you want to talk about it, in cash share break-even or GAAP break-even or even on the OpEx side, can you walk us through how we should think about the run rate should decline there as we exit calendar ‘09?

Jeff Benzing

Run rate as we exit ’09, I'm not sure I want to forecast out that far. Clearly, I think if you look at where we ended Q4, and you look at the range of steps [ph] that we’ve taken in Q1 continue to fair those expenses down looking at how we’ve optimized our field resources, looking how we optimized our factories resources, we are going to continue to see those drop down as it go to lower to a break even situation in quarters beyond Q1. I don't think we are going to make it there in Q1 as we spoke. We will find ourselves in a net loss situation in Q1, but it is our objective to mitigate that on a continuing basis and to the extent that the forecast continues to either materialize or move out, we will either accelerate those plans or keep them as we have them on the books today.

CJ Muse – Barclays Capital

Okay. And then I guess second question, you have debt coming due out of Europe this June, can you comment on what your plans are there, whether you plan to re-fi or just be pay that down?

Jeff Benzing

It depends we trade off on what market is for the debt versus paying it on. That's purely a math problem. And we have the cash, it's not a threat.

CJ Muse – Barclays Capital

So you are just trying to model out your other income line.

Jeff Benzing

Yes, I think you would predict that we would be able to refinance it and it will be at an equal or lesser rate.

CJ Muse – Barclays Capital

Okay and I guess last question. In terms of normalized earnings on that base case for the $1 billion to $1.2 billion revenue run rate, we heard a couple of EPS numbers given on the call, I would love to hear your thoughts on what you could achieve EPS-wise there?

Rick Hill

On which one?

CJ Muse – Barclays Capital

On normalized earnings at $1 billion to $1.2 billion top line.

Rick Hill

Yes, I think part of the problem is Tim basically looked at $1 billion, and that's the semi business at a billion run rate. That would put us at roughly $1.2 billion run rate as a company as a whole. And if you’ve modeled assuming a reasonable gross margin of 45% and operating expenses in the $90 million to $95 million range, I think you’d get dramatically better than the $0.80 per share.

CJ Muse – Barclays Capital

Great. Thank you.

Operator

Next off, we have Satya Kumar with Credit Suisse.

Satya Kumar – Credit Suisse

Yes, thanks for taking my follow up. Just a clarification on the OpEx, if revenues are flat at current levels in second quarter, should we think of OpEx having further room to go down or how would you manage that?

Jeff Benzing

OpEx will continue to go down, trend downwardly.

Satya Kumar – Credit Suisse

What's the lowest do you think that you can run the company at if you were in the world (inaudible), you don’t really go above, say, hundred and few million dollars a quarter for the next two years, so where do you think you can take OpEx through?

Rick Hill

Well, I think it's always a question, and I smile a little bit because we go through this gyration all the time. That's purely a function of how much cash you want to put at risk in order to lower your operating expenses given the current situation. There is no question that from a facility standpoint, there is dramatic consolidation we can do, and the own or these facilities. So these facilities currently are on the books, so we carry the depreciation. But it's not a cash expenses if we were leasing up. So now if we get out of those facilities and we knew we could move that equipment, we would do that or we could move those facilities we get out of the facilities to (inaudible). And we can dress up the P&L such that we will have a lot better P&L break even, but from a cash break even we might actually be worse in the short term. So, we have to balance that to what we think a real normal industry environment would be because you don't want to do dumb stuff. That's the dilemma we are in. But we could dramatically lower our costs by consolidating those facilities. If we think there is a permanence to this change, that's why I went through the little exercise to try to say what do I think is a sustainable business level, what should be a steady state level in this business. Under reasonable circumstances where our customers should be able to fund their CapEx expense and have a profitable business. That’s where we came up with $1 billion, $1.2 billion, including our IAG business. And so we've got to balance between shrinking ourselves and wasting cash getting down to the smallest facility we can, then immediately having to turn around and turn a facility back on. It's a tough question. Everybody is guessing; we are looking at it daily. If real estate were suddenly to pop in Silicon Valley to where we knew we could sell these buildings, we would consolidate much more quickly. We would spend the cash, because when we sell the building we get the cash back for the cost of you know, basically consolidating. So those are some of the trade-offs we are making in this environment, because we are so uncertain of what the future is. And so preservation of cash is extremely important, and you can see that is a lot of companies out there that haven’t preserved cash. And the only good news is we are not in that predicament. So thanks.

Satya Kumar – Credit Suisse

Thanks.

Operator

And we have no further questions at this time. Actually that's all the time we have for our question-and-answer session. Back to Rick.

Rick Hill

Okay. Thank you very much for joining us for the quarter-end 2008. The only good news is that that year is over. We are into 2009, as the year of the ox. And that means, we all got to work very, very hard this quarter in order to turn this thing around and lead to some long term profitability and growth. Thanks very much. We look forward to speaking with you at our mid-quarter update, and then again at the end of the first quarter. Thanks a lot. Bye-bye.

Operator

That does conclude today's conference call. Thank you for your participation.

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