Novellus Q2 2009 Earnings Call Transcript

Novellus (NVLS)

Q2 2009 Earnings Call

July 13, 2009 6:30 pm ET

Executives

Richard S. Hill - Chairman of the Board, Chief Executive Officer

Jeffrey C. Benzing - Principal Financial Officer, Executive Vice President, Chief Administrative Officer

Thomas Caulfield - Executive Vice President Sales, Marketing and Customer Service

Timothy M. Archer - Executive Vice President - PECVD Business Unit and Electrofill Business Unit

Fusen Ernie Chen - Executive Vice President, Chief Technology Officer

Analysts

Jim Covello - Goldman Sachs

Chris Shankar - Merrill Lynch

Patrick Ho - Stifel Nicolaus

Steven Chen - UBS

Christopher Muse - Barclays Capital

Atif Malik - Morgan Stanley

John Voortman - J.P. Morgan

Ben Pang - Caris & Company

Brett Hiller - Banc of America Merrill Lynch

Steve O’Rourke - Deutsche Bank

Mahesh Sanganeria - RBC Capital Markets

Presentation

Operator

This presentation may contain forward-looking statements within the meaning of section 27-A of the Securities Act of 1933 as amended and section 21-E of the Securities Exchange Act of 1934 as amended, including statements related to the company’s views regarding our expectations and forecasts regarding semiconductor industry growth over several markets and capital equipment spending. Our focus on taking the required actions to return to profitability; our continued efforts and expectations related to our restructuring plans; progress in its cost reduction across several areas; and our expected savings related to our consolidation initiatives; our ability to maximize our cash flow in the third quarter despite the current economic environment and the lingering weakness in earnings coupled with growing shipments and working capital needed to support this activity; the forecasted bookings and shipment volumes; revenue, gross margin, operating expense, earnings or loss per share target for the third quarter of 2009; our revenue growth and earnings potential in the current economic environment; our expectation that the sales of electronics, semiconductor, and equipment will continue to be lower in 2009 as compared to such sales in 2008; our belief that there will continue to be momentum and growth in the electronic industry during the remainder of 2009; our belief that the two-year bookings decline has begun to turn around and will continue to rise, reset, and recover over the next four years; our belief that the semiconductor equipment manufacturers will experience the deepest reset due to idle capacity issues, longer recovery periods for semiconductor manufacturers related to the reset, our belief that the worldwide wafer fab equipment industry will not return to historic highs within the next five years; our belief that due to the reset of CapEx, the large consumers of semiconductors will be the technology leaders with the best financial performance; companies that drive efficiencies into their operations, and the top five semiconductor companies with the greatest spending that dictate the technology agenda; profitability in the current economic environment is dependent upon technology node leaders; our belief that the company is well-positioned with the top-five semiconductor companies due to our cost effective technology; our expectation that [SAM] has a 14% compounded annual growth rate; our focus on high-growth sub-segments; our belief that these key sub-segments will double between 2009 and 2013; our expectations, forecasts, and product strategies related to our served market, potential market share growth, and revenue and earnings potential in 2011 as it relates to our earnings per share; the benefits of our new fill process, TSV process, vector AHM, gamma effect on UL, SI, HDI, strip process, system extendibility, our belief that the industry needs a complete fill solution with a high quality film, our focus on developing technology for the 3X nanometer node and beyond in high growth market sub-segments, our continued efforts to strengthen our joint development relationships with the top semiconductor manufacturers and our continued focus on research and development on advanced technology, coupled with our goal to reduce the total cost of ownership as part of our design specification.

Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from the results contemplated, including declining demand for our products, customer adoption of competing products, slowing customer demand, the significance of non-consumer drivers in the semiconductor industry, an unexpected increase in excess obsolete inventory, loss of major customers, difficulties in predicting supply and demand for newly introduced products, inability to timely or effectively help customers transition to the next technology node, inability to capitalize on growth opportunities, worldwide economic or industry downturns that effect growth opportunities, unanticipated changes in the industry that do not correspond to our strengths, inaccurate basis for our growth forecast and product projections, technical or operational difficulties that affect the performance of our products and system extendibility, unexpected manufacturing and production complications impacting our ability to leverage our cost effective technology, inability to capitalize and capture a portion of the high-growth market sub-segments, uncertainties related to the financial stability of our strategic partners with which we have joint development relationships, inability to allocate sufficient resources to our research and development efforts, failure to implement growth or operational strategies and to achieve efficiencies from our restructuring plans and initiatives, whether due to problems with planning, execution, or resource allocation, as well as other risks indicated in our filings with the Securities and Exchange Commission.

For more details, please refer to our SEC filings and the amendments there to, including our annual report on Form 10-K for the year ended December 31, 2008, our quarterly reports on Form 10-Q for the quarter ended March 28, 2009, and our current reports on Form 8-K.

Forward-looking statements are made and based on information available to us on the date of this PowerPoint presentation and we assume no responsibility to update them.

Ladies and gentlemen, please welcome Novellus Systems Chairman of the Board and CEO, Rick Hill.

Richard S. Hill

Thank you. Good afternoon, everyone. Welcome to our second quarter analyst call, which is live, as well as to Semicon West 2009. Today we have a little bit of a new agenda, from the standpoint of we are going to do our traditional call whereby we’ll announce the financials, I’ll give a little bit of a color in a few moments regarding what the industry is like. But then we are going to deviate a little bit from what our normal call would be and go into some depth about the customers and the markets and what we see happening in that particular area, as well as go into some depth on new advanced product that we’ve been introducing and we’ll continue to introduce over the next six to 12 months. So I think it’s a pretty full schedule, should give you a lot of detail, some things to talk about. After we’ve made all the presentations, we’ll have a Q&A session where we’ll have a large segment of the management on the stage and allow you to fire away with questions.

So with that, I would like to bring on Jeff Benzing, who will give you the quarter two financial results. Thank you.

Jeffrey C. Benzing

Thank you, Rick. You’ll notice that due to increasing cost control, we’ve done away with the teleprompter, so you’ve got to put up with me reading my prepared remarks. Good afternoon and thank you for joining us here at the Novellus Theater for our second quarter 2009 earnings presentation, as well as thank you to those on the phone who could not be with us in person today.

As Rick outlined in the agenda for this afternoon’s event, I’ll start by reviewing our second quarter results.

Quarter two 2009 bookings were $111.2 million, up 43% off the low we saw in Q1 and at the midpoint of our guidance range of up 30% to 55%. As we discussed in our mid-quarter update, we saw momentum develop throughout the quarter, particularly from the foundries and for technology buys in the memory segment.

Quarter two shipments were $120 million, up 30% from the first quarter and on the higher end of our guidance range of $110 million to $125 million. This increase was in part attributable to the recovery we began to see in the foundry demand during the quarter.

Quarter two revenues finished at $119.2 million, which was correspondingly up 21% over Q1 and at the higher end of our guidance range of $110 million to $125 million.

Our second quarter revenues by geographic region are as follows: United States, 32%; Greater China, 28%; Korea, 21%; Japan, 5%; and Europe, 14%.

Moving to a discussion of the income statement, throughout the rest of my remarks I will be distinguishing between GAAP results and those results that excludes certain other charges. I would like to begin my remarks with a description of these charges and will refer to them collectively going forward as other items. Please note that a detailed breakout of these items by type is included in today’s press release and provided in the package to those of you here with us today.

Other items totaling $15.9 million for the second quarter include severance charges related to reductions in force, impairment of CMP inventory, write-down of certain R&D assets related to discontinued product initiatives, and adjustments to previously recognized restructuring accruals.

With that said, quarter two gross margin excluding $7.6 million in other items, came in at 32.4%, up 6.4 percentage points over Q109. This was at the high-end of our guidance range of 31% plus or minus 2%. This improvement in gross margin was the result of operational initiatives begun earlier in this year and improved absorption of fixed overhead costs as shift in volumes increased 30% in the second quarter. On a GAAP basis, including the $7.6 million in charges, quarter two gross margin was 26%.

Quarter two operating expenses totaled $80.1 million for the quarter, excluding $8.3 million in other items. On a GAAP basis, our operating expenses came in at $88.4 million. You will notice that our pro forma OpEx was up $2.9 million quarter over quarter over Q1. This is the result of specific decisions we made in the quarter concerning shut-downs and certain project spending.

As we continue to execute on our restructuring of the company, we still expect to exit Q309 with operating expenses at the $75 million per quarter level. Our Q2 effective tax rate on a GAAP basis was 8.2%. Without other items, our Q2 effective tax rate was a negative 1.8% as a vast majority of the other items charges were incurred in higher tax rate jurisdiction.

Looking forward to Q3, our GAAP basis tax rate for the third quarter is expected to be approximately 20% excluding any discrete items. As we stated earlier in the year, the tax rate in subsequent quarters can vary.

Net loss excluding the $15.9 million in charges previously discussed was $39.3 million, or a loss of $0.41 per share, which was within the guidance range of a loss of $0.45 to a loss of $0.35. On a GAAP basis including the other charges, we generated a net loss of $50 million, or $0.52 per share.

Moving to the balance sheet, we ended the quarter with $700 million in cash, short-term investments, restricted cash, and long-term investments, which was down $2 million from the $702 million in the prior quarter, but up from the $682.5 million at the beginning of the year. We did not buy back any stock under our authorized stock repurchase program in the quarter.

Cash flow from operations in the second quarter was a negative $4 million. The $50 million in net loss was mainly offset by $20.5 million in non-cash charges from depreciation, amortization, and stock compensation, and approximately $25 million of working capital changes.

Accounts receivable in the second quarter increased 33% to $96 million, due to the increase in shipment levels in the quarter. Additionally, DSOs increased to 73 days from 66 days at the end of Q1, primarily due to the increased levels and non-linearity of system shipments.

Inventory decreased by approximately $30 million on a sequential basis, as a result of ever-improving inventory controls, including tighter, just-in-time order management.

Also in the second quarter, we refinanced our EUR 80 million loan for an additional three years and it is now scheduled to mature in June 2012. As a result, it has been re-classed from short-term to long-term debt on the balance sheet.

As you can see, it was another challenging quarter. We’re continuing to make significant progress in restructuring the company in order to return to profitability well before the industry reaches historically rationalized, or historically normalized revenue levels. We’ll continue our focus on maximizing our operational cash flow in future quarters despite the current economic environment as we face the growing shipments and the resulting working capital that will be required.

Our break-even on an EBITDA basis remains at $160 million.

That concludes my prepared remarks for the operating results for the second quarter of 2009 and I’ll turn it back over to Rick who will comment on the state of the business and then give our guidance for Q3.

Richard S. Hill

Thank you, Jeff. As always, I like to give a little bit of color on what we are dealing with in the marketplace. As I’ve said many times, the key to the front-end of the engine is the PC business. In order to get robust growth in the semiconductor industry and the equipment business, we really need double-digit growth in PCs.

In recent forecasts, PCs were projected to be down 10% to 15%. On the positive side, we see that firming significantly and now only expect PCs to be down in the range of 5% to 10%. So while it isn’t what we need, it’s a definite improvement and we are seeing it in the marketplace.

We are driven largely by notebooks today and netbooks, which is a net positive as the unit volumes rise. It has the negative impact of not consuming as much memory but the fact that the volumes are significantly higher does still contribute to [inaudible] up some of the excess memory capacity that’s been in the marketplace.

Semiconductor revenues are still tracking to the high-end of 2009. Industry forecasts are down 20% to 30%. They are now moving more likely to only be down in the 18% to 24%, so over the last couple of quarters, we have seen end-demand in semiconductors, particularly in logic area, continue to firm.

Utilization levels at this particular time are relatively high in our business. They are running about 85% to 90% in the logic arena, which is from a seasonal standpoint, still a little bit low but dramatically better than the off 15 to 25 points it was running over the last eight months.

DRAM prices are up 50% year-to-date and the supply/demand imbalance has improved. Unfortunately, it’s due more to constricting of the supply than increased demand but I do believe with the stimulus going in place worldwide, we will see demand increase.

NAND prices are up dramatically, 75% year-to-date on the mainstream 16-gigabyte chips, due to both robust demand of smartphones and some supply cuts.

So we are encouraged by the improved business conditions and as the worldwide stimuluses begin to take hold, we are cautiously optimistic that business will continue to improve.

Now, despite our optimism for the improvement in business, as Jeff reported we are taking proactive steps to continually size the business for what we see as the world going forward that we are going to talk in some depth about in a few minutes. We’ve taken the action to consolidate our manufacturing operations in our [Tualatin] facility, which is located in Oregon. This will take place between now and the end of the year. It will cost us a one-time charge of about $6 million to $10 million, and we expect ongoing operating expense reductions in the $5 million to $6 million range, starting in 2010. And this action is part of an initiative to get our gross margins back up into greater than 50% gross margin area.

With that, I will now open the envelope to talk about what does the third quarter look like. Keep in mind that any of my earnings forecasts does exclude the one-time charges associated with consolidating our manufacturing.

On a bookings front, the good news is we are optimistic that bookings will be up 20% to 50% in the third quarter. They will continue to show signs of growth. Our shipments will follow with $140 million to $170 million range. Our revenues will come in at the $150 million to $180 million range, and our gross margins will be roughly 40% plus or minus 2%, and our expectation is that we should be able to be at a level of earnings somewhere in the range of a loss of $0.15 to potentially a break-even in the third quarter.

So it isn't where we want to be but clearly things are improving and they are improving not only because of the market but also because what we are doing.

And with that, I would like to turn it over to Tom Caulfield who will start to give you a little bit more in-depth view of the dynamics that are going on within the semiconductor market. Thank you very much.

Question-and-Answer Session

Unidentified Analyst

Hi, Rick. Thanks for taking my question. It sounds like you are pretty optimistic about a four-year recovery cycle in semis. I’m assuming you are very bullish on CapEx going forward but looking at things more near-term, some investors are worried that Q3 is “the last good quarter for orders”. What do you see right now in terms of the pipeline as you look out into the December quarter? Do you see strength continuing out there?

Richard S. Hill

Well, we don’t normally comment on the subsequent quarter. But I think those looking for a double dip should strictly stay at the Dairy Queen. I don’t think that a double dip is likely. I really don’t because we’ve gone to such base levels that what we are seeing now is just sort of a fundamental competitive environment where people are trying to move technology ahead, compete in a very competitive environment, and bring out new products that offer some sustainable growth. So you know, the future is tough to project, right? Even tomorrow.

Unidentified Analyst

As a quick follow-up to that, on NAND, Rick, are you assuming -- has your thought process changed on NAND CapEx at all? It seems like the solid state value proposition is struggling a little bit. What are you thinking about NAND spending as you look out into 2011 when you talked about the CapEx [inaudible]?

Richard S. Hill

Well, I’m still bullish on NAND but I’ll let Tom comment. What do you think?

Thomas Caulfield

I think it’s the solid state drive has not gone as fast as we thought. I think the value proposition is still there and there’s clearly guys driving the technology. That’s how they get the cost point.

So I think you’re right -- there’s some software operating system issues that don’t allow the full potential of a solid-state drive from a speed and access [that needed to be overcome]. I also think that maybe it needs to be marketed a little bit different. I think at some point it’s not about compare of memory to memory in size. It’s more about the access speed and the fast boot-up. So I think once it starts to get marketed a little bit where people don’t need 200 gigabytes or some crazy number in their laptop, that the affordability point becomes a lot better for that application.

Richard S. Hill

Don’t forget I can’t see everybody or I’d announced you myself, but so everybody who is on the phone knows who is talking --

Jim Covello - Goldman Sachs

Two questions -- could you give a little bit of granularity on the 3Q orders? Is that just -- in terms of the increase, is that more of the -- from the same customers as you saw for the Q2 increase or is the number of customers broadening out in Q3 as well?

Richard S. Hill

Well, I think Tom spent a lot of time trying to explain the dynamics of the market and clearly when you look at the big five, that’s where you see a majority of what’s going on transpiring and we think that’s going to continue over the near-term and probably the medium term as well.

Jim Covello - Goldman Sachs

Okay, and then relative to that reset, that was kind of my follow-up question, that the reset as you guys described it, certainly that’s been happening in the industry for a while where you’ve seen a consolidation of the customer base but is that -- has been exacerbated now because the smaller the customer, the more their CapEx got hit in the last couple of years and couldn’t -- wouldn’t some of the smaller customers also be able to increase their spending in the next couple of years if the cycle came back? So you are going to have that reset happening from a structural standpoint but cyclically, shouldn’t some of the other smaller guys come back as well as you get a little bit healthier from a cycle perspective?

Richard S. Hill

I think some of the small guys will come back as it gets healthier but that will also be a function of liquidity in the marketplace and the capital markets willing to fund that growth, and I don’t think it’s going rebound to the levels that it used to be. So clearly from a CapEx as a percent of revenue, it’s not going to hit as high as it did in the past.

Jim Covello - Goldman Sachs

Sure, but from a purely cyclical perspective, we might see the top five as a percentage of revenue decrease for a year or two as some of the smaller guys come back -- say Intel’s CapEx is the same last year, same this year, [PSN], same last year, same this year, whereas some of the smaller guys, you could see going from almost nothing to up a little bit in the next couple of years.

So structurally, I get the idea but cyclically, I would say the top five would decrease over the next couple of years.

Richard S. Hill

No, I don’t necessarily agree with that because I think the top five are really bent on increasing their percentage of the total pie and as such, they will add capacity in order to do that. So it would be if nobody was going to move, everybody was going to stay in place. I don’t think that’s going to happen during this cycle. Thanks, Jim.

Jim Covello - Goldman Sachs

Thank you.

Unidentified Analyst

Hi, [inaudible] from Needham & Company. Two questions -- one is on the industrial group -- can you talk a little bit about that? Did it grow as fast as the semiconductor in the second quarter and what do you expect in the third quarter?

Richard S. Hill

From a standpoint of the industrial group, it’s largely centered in Europe. It’s always a net drag in the second quarter on the overall company results but going forward, it should track the European market and as we see the European market recover and we also see greater and greater demand for advanced technology, the wafer planarization business will again rebound as well. But in the second quarter, they are a net negative.

Unidentified Analyst

Great, and then just a follow-up, in terms of these new products and new [inaudible] that you guys talked about for -- more for long-term growth, is it possible we can kind of maybe rank them in terms of which one you feel you are closest to getting qualifying potentially drive revenue versus which one you think would take a longer time?

Richard S. Hill

Well, I’ll let Tim comment on those because a lot of them are qualified but he knows the details of all of them.

Timothy M. Archer

Sure. In terms of qualification and also in terms of potential impact on our business, clearly Fusen talked about the new [barrier seed] process for PVD. We are very, very excited about that and it’s quite far along in terms of testing and qualification at several customers. We’ve also talked for at least two years now on the actual hard mask. Fusen talked about the technical advantages as well as some of the recently discovered yield advantages that we are seeing with customers. We have production business in that film but we expect as we move to 3X, we continue to see more of that.

And then probably the newest film that we’ve recently started to get very excited about is the [DEN T0K]. You know, this industry -- you know, I think this could be an area where finally the technical results will play out and win over the marketing that we’ve been seeing the last couple of years.

You know, Novellus has been a believer for at least two years now that [inaudible] has fundamental problems in terms of [integratibility] and yield and we are starting to see now -- if you were to integrate fundamentally a more reliable film, a film that withstands the challenges of post processing better, that film can actually yield, both in terms of yield and reliability, a better end result. And so it’s early stage for our [DEN T0K] qualification but we are very excited about the early results there.

And then the others we’re pressing but those are probably our top film opportunities.

Richard S. Hill

Back row, right here.

Chris Shankar - Merrill Lynch

Hi, Rick, [Chris Shankar] from [inaudible] Merrill Lynch. A couple of questions -- number one, in the past you had said that you think you could [do about find] $1 million in revenue in semi and about $100 million in industrial for 2009. Where would you reset that right now, given that we are here right now with a [$165 million] mid-point revenue for third quarter?

Richard S. Hill

I believe we were talking about those particular levels relative to our nuclear -- or various nuclear winter scenarios and trying to make sure that we conserve cash. Right now we are looking at a situation where we have only burned a very, very small amount of cash, not the $20 million per quarter that we predicted could be a nuclear winter case, and there is some possibility that we could see actually net zero cash flow for the year, which we think would be phenomenal performance overall.

Very, very difficult to project year-end. It will really be dependent upon A, executing on this particular quarter and seeing what the fourth quarter looks like as an up-tick and you know, then there’s opportunity to do better.

Chris Shankar - Merrill Lynch

And then I had a long-term technology question -- I’ve been hearing about the [inaudible] guys talk about the [inaudible] trend that’s happening in the memory over the next three or four or five years. How does that impact memory CapEx or specifically incremental [inaudible] opportunity for the [inaudible], or even HDP CVD?

Richard S. Hill

So Tim, do you want to take that one?

Timothy M. Archer

Sure, I’ll try. You know, fundamentally anything that drives feature scaling will drive incremental use of [actionable hard mask] and that’s clearly generation by generation, the memory device changes are driving incrementally two to three layers of additional [actionable hard mask].

We’ve also done a lot of work and Fusen mentioned some of it focused on driving the resistance of our CVD tungsten films down and that allows us then to integrated into new applications like you are talking about for future memory.

Richard S. Hill

Down in front.

Patrick Ho - Stifel Nicolaus

Two questions, Rick -- in terms of the outlook in terms of your long-term growth markets, how do you see the impact of reuse of tools on a going forward basis and does it -- is that accounted for in I guess some of the discussions you’ve had today?

Richard S. Hill

So I’ll let Tom handle that one, since we talk about it all the time.

Thomas Caulfield

Yeah, [re-use] is here to stay. We’re not going to get around from that. I mean, if you really believe there’s going to be consolidation, some people will be getting out of this business and making tools available. I mean, that’s all comprehended in our numbers.

I think from a higher order perspective though, if our market share is stronger at the top five, there’s less opportunity for re-use to be used for customers [that at] the trailing edge of technology. So while we’ll be part of the effect of that, I think we’ll be hit less than others would be on [not enough tools] being available for re-use.

The other thing about it, even in the re-use world, older technology tools still need a fair amount of technology enablement and upgrades, and there’s good revenue and profit opportunity in that as well. So you can’t fight the re-use. It’s going to be an industry dynamic and we’ve done a good job to date in being able to leverage that to our advantage to drive revenue as well.

Patrick Ho - Stifel Nicolaus

Okay, and the second question in terms of the consolidation of facilities, what other strategies are you implementing on top of that? Are you going to more of an outsource model going forward or is this just part of your overall cost-cutting strategy at the -- you know, at this point of the game.

Richard S. Hill

Yeah. You know, every time -- unfortunately, I’ve been here so long I know how it has always been. We’ve always operated on an out-source model, probably more than most companies operate on an out-source model. We’re constantly looking at when we can out-source more. Given the environment we’re in today with a very, very weak supplier chain, there are some areas where we are in fact having to in-source because the supply chain is so weak we can’t afford to subject our customers to a situation where we might not be able to get a particular part or a particular subsystem.

But in general, we’re probably the most outsourced company within the industry. So in fact, we did teach [LAM] Research how to outsource, for those that haven’t been around long enough to really know that. So thank you.

Steven Chen - UBS

Hi, Rick -- Steven [Chen] from UBS. I just wanted to circle back on the $2 in earnings power that Tom talked about in 2011? What kind of industry growth are you looking at in terms of semiconductor CapEx growth in 2010 and 2011? Tom hit that number.

Thomas Caulfield

We said the CAGR between now and 2012 is a 14% for our [served] market.

Steven Chen - UBS

And maybe I could ask the question a different way -- what kind of operating margin do you think Novellus needs to hit to get to that $2 in EPS? I’m getting about 20% to 25% -- does that sound about reasonable?

Thomas Caulfield

Well, you take 50% gross margin, 50 to 52, 20% -- 28% OpEx, and a reasonable tax rate, 28%, 30% and you’ll get to that range.

Steven Chen - UBS

And then maybe the last one for Rick -- the sales by geography, can you give us kind of any color there, Rick, as to what your thinking is going to come out of either Korea or Japan? It looks like we saw a nice recovery in Korea here in the second quarter, Japan is still relatively limited. What kind of trends do you think you’ll see in terms of geography in the third quarter?

Richard S. Hill

I think certainly the U.S. remains in somewhat of a stable position. You know, we have one solid performer in the U.S. from the standpoint of consistent CapEx. I think we are going to see Korea move the needle relative to advanced technology and capacity, as it garners a greater and greater share of the overall memory marketplace, both from a DRAM standpoint and a NAND flash standpoint. And I think clearly the model of a foundry is alive and well and you are seeing that and there isn’t going to be just one competitor in that model -- there will be multiple competitors so you’ll see the spending occur there. You’ll see it occur in Singapore and you are going to begin to see an expansion within China, which I do believe will begin to subsidize some of the semiconductor industry within China to grow it there as well.

I don’t see Europe being a big buyer. I don’t see the U.S. coming back, other than in a focus standpoint. This is an Asia business. Japan, again there’s a little bit of subsidization going on but it’s not coming back big.

Christopher Muse - Barclays Capital

I guess just to follow-on the last comment, Rick, you talked about Korea and [seeing some expanding] advanced technology as well as capacity. Could you elaborate there in terms of looking to September? Is that mostly technology [inaudible] or are you starting to see real capacity?

Richard S. Hill

Are you talking about our up-tick that we are forecasting in the third quarter?

Christopher Muse - Barclays Capital

Exactly.

Richard S. Hill

There is a combination of technology moves as well as some capacity expansion. It’s a combination of both. You can’t get these kinds of sequential jumps without having a little bit of capacity coming on, especially at 45 nanometers is what we are seeing right now.

Christopher Muse - Barclays Capital

And then I guess on the cost side in terms of the $2 earnings target, that’s about a 60% incremental operating margin from here, so I guess relative to historically 40%, 45%, what makes you think you can achieve that this time? Any color there will be very appreciated.

Richard S. Hill

Well, I think one of the things we’ve done is really refocused the R&D, okay? And obviously we all had different expectations coming into 2000 than we do today. We had built facilities. We’re rationalizing those facilities. There’s opportunities for us there to really cut structure out and I think our targeted R&D model is alive and well today. It’s operating extremely well and I think our customers recognize it, both from a standpoint of not only the quality of the products that we put out but the advances of the technology and the enablement of the technology.

Fusen talked about our PVD technology. It is clearly an enabler going forward, to really stay on the curve, get down to 22-nanometer and not give up performance, either from a speed standpoint due to shifts in RS going up or reliability from an EM standpoint or a time domain dielectric breakdown standpoint.

So those are I think the reasons why.

Atif Malik - Morgan Stanley

Rick, going back to NAND, can you provide the utilization rates for NAND and DRAM, you provided 85% to 90% utilization for logic?

Richard S. Hill

I’ll let Tom handle that.

Thomas Caulfield

It’s very customer specific, so there’s a much bigger range on that. The market leaders are running pretty much back to full steam. Some of the people at the other end of that balancing cash flow and their ability to get a price where it’s back to cash break-even for them, so it’s a much bigger range. The leaders who count are running pretty much at full utilization for memory.

Atif Malik - Morgan Stanley

So we should expect some kind of capacity orders, maybe [inaudible] if they are hitting 100% utilization? Is that a fair assumption?

Richard S. Hill

There’s an assumption that says you have to go to Dairy Queen to get a double dip, so I’d read that in there.

Atif Malik - Morgan Stanley

Okay.

Thomas Caulfield

You didn’t even see my lips move.

Atif Malik - Morgan Stanley

One more thing -- for the OpEx of $75 million per quarter, is this the OpEx for the $0.03 scenario or is there more room for improvement?

Richard S. Hill

Jeff or John, take that.

Jeffrey C. Benzing

Our $75 million OpEx clearly is the target we set for ourselves into the first part of this year, given looking at this nuclear winter that Rick spoke to. Clearly for us as we drive to that goal, there’s operational improvement for us to go farther but we feel that given where we see the rebound, where we are trying to size the business for 2010, that’s a good base model to come from. You’ll see some fluctuations plus or minus from that number but as we committed, we’re going to keep below that -- keep nominally at that number as we regrow the business.

Atif Malik - Morgan Stanley

And one last one for Fusen -- can you provide a market size estimate for [TS] remarket for electro-deposition? And then on the dielectric gap fill, you kind of left the question open-ended at the end, saying you are going to go [SOD] or [inaudible] and my understanding is you guys don’t have the [SSCVD] capability so you pretty much have only one option. Is that the correct assumption?

Fusen Ernie Chen

So [inaudible] first -- we do believe [inaudible] will be a couple hundred million dollars. And the [timing] really depends on the industry adoption, so we estimate maybe next three to five years we’ll reach to couple hundred million dollars.

And [inaudible], yeah, of course as I mentioned, the industry really has no solution and this is really a critical area, especially in STI. IOD also getting a higher [inaudible] and really have no good solution and everybody, I do believe everybody has an attempt to grow their revenue and also market share. We’ll work hard on that.

Richard S. Hill

And I would assume that we would not just try to duplicate what somebody else does in that area -- if I were you, I’d assume that. Yes.

John Voortman - J.P. Morgan

Thank you. [John Voortman], [J.P. Morgan]. Could you confirm that when you said that for Tungsten advanced technology would use more and more tungsten, you were referring to the replacement of the [dianide tride] barrier? And then at what time do you expect that replacement to happen? For which node will the [dianide tride] barrier be replaced and the type of products?

Fusen Ernie Chen

I’m sorry -- could you repeat the question?

John Voortman - J.P. Morgan

So you said earlier that the advanced technology would use more and more tungsten. Is that referring to the [dianide tride] barrier being replaced? And then at what node do you see that transition happening?

Fusen Ernie Chen

Well, I think tungsten always [inaudible] barrier and before we tried to [inaudible] tungsten [nitride], there still is titanium [inaudible]. And titanium is always a PVD solution, an optical solution and [nitride] can be an [inaudible] for [inaudible] [high aspect ratios]. And we are finding our productivity over tungsten [nitride] actually is much, much bigger than [inaudible] titanium [nitride].

So that’s the [comparable], but what I tried to mention actually is at the [inaudible] level. [inaudible] and because the [inaudible] resistance is less forgiving, it is much easier to have a [inaudible] so therefore it’s very easy for our customer to take tungsten [nitride] film to replace the titanium [inaudible] [nitride].

But we have a long-term goal to use [inaudible] [nitride] to replace more and more of titanium [inaudible] [nitride] and titanium can be [inaudible], can be [inaudible], can be PVD. But I think this is the first attempt which showed success. But our customer [has already] used our tungsten [nitride] to replace titanium [inaudible] [nitride] but in this case, titanium [inaudible] is a [inaudible].

John Voortman - J.P. Morgan

Yes, and the tungsten nitride is being used at which node then?

Fusen Ernie Chen

Tungsten nitride, I think at this moment, we believe it’s a 4X and of course, it’s extendable.

John Voortman - J.P. Morgan

Flash or DRAM or -- is this for Flash or DRAM or -- ?

Fusen Ernie Chen

This is in the memory, you know. It’s difficult for us to give you --

John Voortman - J.P. Morgan

Okay, great. Thank you.

Fusen Ernie Chen

But [it’s in the manufacturing].

Richard S. Hill

Way in the back.

Ben Pang - Caris & Company

In the scenario that you put forward for your concentration of these top five customers, what do you expect the pricing environment will look like for equipment?

Richard S. Hill

Well, the pricing environment is directly proportional to the value you have to sell and the reality is, given the productivity of the tools and the technology enablement we’re delivering, I think while it’s always a tough pricing environment because our customers have it tough, we have the ability to achieve our goal of getting a greater than 50% gross margin, both by working on the cost side but also working on the value.

Tom, what do you think? You deal with it everyday.

Timothy M. Archer

You ask this question, it’s four years running on this question -- it’s always going to be tough. The [real value you provide] is generation on generation for the same dollar amount, or a little bit more, more productivity. That’s how you hold the price. If you go generation to generation and try to give the same solution and there’s competition there, the only lever you have there then is pricing and that’s uninteresting. So our job is to continue to drive the improvement to show our customers in our pricing scheme that it’s still cheaper for them because we are giving them better value out of their tool, better capability, and better productivity.

Ben Pang - Caris & Company

And then one follow-up for Fusen along the same lines -- if you looked at the new products that you talked about, which one would be the biggest game changer where you could get the highest margin for your product?

Fusen Ernie Chen

What Tim just mentioned, we work closely with many customers, you know, [inaudible] PVD and we are confident we are growing market share on that area and Tim also made a comment, I think [inaudible]. It’s a bigger product and we have a big differentiation in productivity and integration [inaudible]. And I think these two products probably would be our growth engine.

Timothy M. Archer

And then I think just to add over the next three to five years, clearly we see copper TSV as a big growth opportunity for [inaudible]. We have very large market share in the copper interconnect in the [inaudible] world and we see no reason why we can’t translate that high market share into copper TSV market share as it starts to take off and be adopted. It’s just that that’s a very -- it’s very early in the game of TSV today.

Fusen Ernie Chen

The next couple of years, if [inaudible] moved to [20-millimeter] very quick, it might allow [inaudible] partnership and [inaudible] the wafer, you know, our industry product is going to take off as well.

Unidentified Analyst

Jagdish [inaudible], [inaudible] Research. A quick question for Tom -- as you exit 2009, which of the core products will see the greatest year-over-year change in percentage or in absolute dollars, given the dynamics of [weak] memory spending and you had seen hedged [inaudible], some kind of a shrinkage as well as ongoing copper migration? So how do you see the dynamics play out in your year-over-year change in revenues for your core products as you exit ’09?

Thomas Caulfield

Okay, so let’s talk about generic two technology, so anything in advanced patterning films -- [inaudible] hard mask, any reflective layers, things that enable advanced lithography is applicable to both memory and logic, so clearly that’s where the high growth potential is.

From a technology perspective, we talk about the UV thermal processing that the next generation dielectrics require non-traditional curing of these films, [at least] UV thermal processing and the next generation technology nodes we’ll start to see that becoming an incremental add to revenue.

When it comes to memory specific, clearly the conversion to the copper back-end, you know, incrementally makes that [inaudible] grow at a disproportionate level. If you’ll recall, I showed a chart that talked about the applications in our served market that grows at 20% versus the 14% of the overall market, so included in that was UV thermal processing, copper. We talked about TSV -- remember, that’s a market that could grow to be equivalent to our traditional copper plating market over the next five years. So a little bit longer play on that -- it’s not going into the 2010 that you asked.

So anything that’s advanced lithography for technology, typically PCVD films, and then in copper, it’s the memory transition.

Unidentified Analyst

Just a quick follow-up for Rick -- any thoughts on entering the LED market?

Richard S. Hill

We are constantly looking at new market opportunities and certainly the LED market is an area where one can intellectually see the value of more efficient production of light, given the demands on energy and green and everything else. But there’s no immediate plans to enter that market.

Brett Hiller - Banc of America Merrill Lynch

Brett [Hiller], Banc of America Merrill Lynch. Rick, I was wondering if you could talk a little bit about financial strategy. Right now, Novellus' stock is trading at a substantial discount to its peers and if you are correct about 2011 versus consensus, you’re trading about half the PE of your peers. So low valuation, you have a lot of new products that can drive growth, so not a huge need to go out and make any acquisitions or anything. In the last cycle, you were one of the most aggressive companies in stock buy-backs, buying back substantially higher percentage of your shares outstanding and now you are telling us that it might be cash flow neutral in the worst year ever for Novellus, so if things get better, you are going to generate a lot of free cash flow and you already have a good cash position.

So what do you do from here with the cash and how do you think about using some of the financial capability that you have? Could you be more aggressive about buying shares at a low point in the cycle now instead of waiting for the peak like most of your peers do? Or you know -- how -- if you could share a little bit about your thoughts from a financial standpoint, I guess.

Richard S. Hill

Well, Brett, I would love to be able to tell you that I only bought at the trough but I didn’t. I was at the trough all the way from gluttony down to starvation. Our average is pretty good. We’re still a little bit below water on our strategy for buy-backs but we operate on a very simple philosophy and that is A, we’ve got to make money. And we’ve gone in and said look, the industry has changed. Let’s adapt to the change and let’s make sure job one is getting to maintain the profitability we’ve always maintained as a company. We’ve gone in, restructured our R&D, restructured our manufacturing operations, positioning ourselves that as the industry does turn around, we do generate a lot of cash.

We’re not going to change our strategy relative to every day when we get up and we decide we’re going to make an investment to buy something, we look at how much cash we have to put in versus how much cash we’re going out, you know, would have to -- would come back in versus how much would have to go out and we make the best investment that we can at that particular time for the company.

Part and parcel to that is a strong buy-back scenario. We’ve been very, very aggressive in our buy-back. Our average price is not much higher than where we are right now but it is higher than where we are, so picking a bottom is not something what we are trying to do. But as we see sustained positive cash flow, we’ll resume our buy-back systematically as we’ve done in the past, because we do believe it’s a good use of corporate asset.

However, having said that, there are other companies that are very under-valued in the marketplace, many private companies within the industrial segment and we continue to look at those opportunities to make sure that when we do come out of this, we come out of this as a stronger Novellus and a good growth opportunity for our investors.

That’s just fundamental how we are running the company.

Brett Hiller - Banc of America Merrill Lynch

Thank you.

Steve O’Rourke - Deutsche Bank

Semiconductor capital equipment companies seem to have had a lot of trouble finding growth opportunities outside of the semiconductor industry. When you look at what Novellus has -- assets, technical capability, the business model you have, the internal capabilities -- have you been able to find or see anything outside of the semiconductor industry to which you could apply these talents? And I’m not asking you to name names but is there anything out there?

Richard S. Hill

Well, if it were easy, anybody could do it. That’s the starter. It is difficult. You know, we’ve looked long and hard, actually before everybody else did at the solar business and decided that that was a little bit of a flash in the pan, and wasn’t going to pay off. And the way I describe it the best, and Fusen is really the guy that came up with the analogy, is he says look, if you take a 300-millimeter wafer and you look at the depths of the memory business, and there’s about a thousand one-gigabyte DRAMs on a 300-millimeter wafer, and in the low point here a few months ago, they were selling at $1 a piece. So that means that wafer was selling for $1,000. And Fusen says now, if you square that wafer off, not that they are going to use 300-millimeter wafers but you have to put this reality in mind, if you squared that wafer off to turn it into a solar wafer, that square wafer would produce about eight watts of power. And the market price on that eight watts is $2 -- yeah, I can’t -- the 1.5 is too hard for me to do the multiplication, so I’m giving you it’s $2 a piece. That’s $16 for that wafer.

Now, you’ve seen what’s happened to ravage the DRAM business, trying to sell that wafer for $1,000. Somehow getting your imagination wrapped around selling it to -- for $16 is pretty tough to do. Now everybody says well, it’s not that quality a grade, there aren’t that many steps but you know, there’s a long way between $1,000 and $16, and so as you highlighted, taking our experience and putting it into businesses outside of the semiconductor capital equipment industry is a task that not very many people have done very successfully.

But what we have done I think reasonably successfully is we’ve broadened with the acquisition of our industrial group to where we really provide precision finishes for materials. Now whether you look at that wafer or whether you look at any gear or rod or axel or anything else that we do, we provide very, very precision finishes on those materials.

We’ve been able to take that management expertise on how you run a business that sells systems and incorporate that in the industrial business to where we’ve taken that business, made it a cash generating business, and been able to expand its product portfolio and grow it with double-digit performance. And so I think we have made some progress in that area -- not as fast as we would like but we are all hit with the problem that when you hit such an air pocket as we’ve done globally, macroeconomically whether it be your business or whether it be a real business that makes product, it’s tough to come through that air pocket in a matter of a quarter. But I think we are coming through that air pocket, we are seeing a return to a normalization. There are external macroeconomic stimuluses that are being put in that realistically to today haven’t even been felt in the industry and so I can’t sit here today and be all gloom and doom about what the future looks like because I believe human nature is such that it’s going to go back to the way it was and people are going to spend, they are going to demand high technology products and the fundamental driver of those high technology products are the industrial products of Novellus and the semiconductor products of Novellus. And so those are two legs of the stool. I’d like to find the third leg of that stool where we could apply our capabilities. Do I have that on the tip of my tongue right now? I don’t but we have the economic wherewithal and we have the management team that can put that in place and that’s what we’ll continue to try to do quarter in, quarter out.

Thanks.

Mahesh Sanganeria - RBC Capital Markets

I just want to go back to that PVD technology you talked about, [inaudible], if I understood that correctly. Can you give us a little bit more color on that? That sounds pretty interesting. Where are you in terms of productization and what kind of customer you are getting early traction with? Is it memory versus foundry? And the other one is, if I can sneak in technology question there, have you ironed out all your technology issues? It seems like the film could start breaking and not be continuous on the field, if you have copper moving around with 100-nanometer tech -- the [inaudible] film. If you can just give all the colors around that product. Thanks.

Fusen Ernie Chen

Okay, so let me talk about technology first. I think the technology, you know, the driving force is a somewhat dynamic driving force. The total system always tries to minimize the energy. So if the ion have enough energy, that prefer to stay in a low energy state. So the first step is you cannot control atoms. You can [inaudible]. The only you can control is the ion. So the first step is produce a very high density of the plasma, of the ion and that’s all we can do for it’s [inaudible] -- I think it’s very, very unique and we don’t believe other technology can do that. So that’s the first step.

The second step is once the ion is [inaudible] to direct, the ion has a kinetic energy and they prefer to stay in a low energy state. So because of this major -- actually this reaction is very, very quick and very, very repeatable and we believe the smaller geometry is better, because of how the driving force behind has tried to drive to total -- you know, the surface energy, so we believe this is probably the best way to put the PVD to have a better technology. And because [inaudible], and [inaudible] if you have a good [inaudible] coverage, and if ion can [diffuse through a side wall], we don’t believe a [side wall] is the problem. And then because we try to minimize total system energy, the atom tries to go to the bottom. So if we can control the bottom, we can control the side wall, you know, what else we can control?

So we are excited. I think this is repeatable and actually we start [inaudible] with a few customers. And the customers we are talking too, you know, I probably cannot give you specific names but they are quite excited.

Richard S. Hill

And just like PVD, your money is in a high energy state and it would like to go to a low energy state, so keep investing and thank you very much for following Novellus, reporting on Novellus, no matter what your views are, positive or negative, we do appreciate your inputs and always enjoy the interaction. Thank you very much.

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