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

3Q05 Earnings Call Transcript

October 17, 2005

Executives

Robin Young - Vice President, Treasurer Investor Relations

William Kurtz - Chief Financial Officer

Richard Hill - Chairman and Chief Executive Officer

Operator

Thanks for holding everyone and welcome to the Novellus Systems 2005 Third Quarter Earnings Release Conference Call. During the presentation all participants will be in a listen-only mode but afterwards you will be invited to participate in the question and answer session. Also, I would like to remind you that this conference is being recorded. Your speakers for today are Richard Hill, Chairman and Chief Executive Officer, William Kurtz, Chief Financial Officer and Robin Young, Vice President, Treasurer in Investor Relations. I would now like to the turn over to Ms. Robin Young.

Robin Young

Thank you operator. Good afternoon everyone and thank you for joining the Novellus Systems Third Quarter 2005 Earnings Conference Call. With me today are Richard Hill, Chairman and CEO, William Curtis, Executive Vice President and CFO. Financial results for our third quarter were released on PR Newswire shortly after 1:00 pm Pacific Time. You can obtain a copy of the news release in the investor section of our website at www.novellus.com. Today’s earnings call contains forward-looking statements about Novellus’ Business outlook. These forward-looking statements and all other statements made on this call that do not concern historical facts are subject to risks and uncertainties that may materially affect actually results. Specific forward-looking statements include but are not limited to our expectations regarding semiconductor industry growth in capital equipment spending. Our progress in securities bookings with leading semiconductor manufacturers, the demand for and competitiveness of the company’s products, management’s projected bookings shipments, revenues, growth margins and earnings per share target for the fourth quarter of 2005, our 2005 financial models, our anticipated tax rate for the fourth quarter of 2005 and other anticipated future events. Information concerning these risk factors is contained in today’s press release and in the company’s filings with the Securities and Exchange Commission including it’s Form 10-K for fiscal 2004 and it’s most recent Form 10-Q and Form 8-K. Forward-looking statements are based on the information as of October 17, 2005 and the company assumes no obligation to update any such statements. William Kurtz will begin today’s call with a review of the financial results for the third quarter followed by guidance for the fourth quarter of 2005. Richard Hill will then discuss the state of the business and then we will open the conference call for questions. I will now turn the call over to William.

William Kurtz

Thank you Robin and good afternoon everyone. As you know this is my first earnings call with Novellus. As Robin has indicated I will review the third quarter financial results and provide a financial outlook of our key metrics for the fourth quarter. The focus of my comments will be to provide you with insight and transparency where possible to better understand our financial results and outlook.

The key metrics for the third quarter which include bookings shipments, revenue and earnings per share, were all either inline or exceeded the guidance provided on our mid quarter update call on August 30. First I will provide you with a summary of those key metrics for the quarter and then provide additional analysis. Net bookings of $287 million were at the midpoint of our guidance and were 7% in the second quarter. By way per size bookings were 77%, 300 mm and 23%, 200mm. Shipments of $316 million was slightly above guidance and were down 9% from the previous quarter. Revenues of $339 million exceeded our guidance and were up 3% in the June quarter. Net income was $23 million or $0.17 per share on a GAAP basis. Net income on a proforma basis was $29 million or $0.21 per share, which was at the high end of our guidance range. I will provide some additional analysis to help you better understand our third quarter results. Third quarter revenues by geographic region were as follows. United States 25%, Korea 17%, Japan 16%, Taiwan 15%, Europe 13%, Southeast Asia 10% and China was 4%. Gross margins were 43.4% in the third quarter down from 47.8% in the previous quarter. Excluding restructuring charges, which were included in cost of goods sold, gross margin on a proforma basis was 35.0 for the third quarter, which was down 2.8 points from the second quarter. The decrease in gross margin on the proforma basis is primarily a result of higher warranty cost, low absorption of manufacturing overheads and other timing related effects. Higher warranty costs are a result of an increased proportion of new 300mm tools that were installed over the past several quarters, which are experiencing higher warranty costs in the earlier period of installation. We expect this higher level of warranty cost to continue for another quarter and then improve thereafter to ultimately return to historical levels. On prior earnings calls we have disclosed the effect on gross margin related to the sales of previously reserved inventory. During the third quarter the sale of previously reserved inventory was not materialized. Total operating expenses for the third quarter were approximately a $150 million, which was essentially flat with the prior quarter. Now we have initiated a comprehensive strategic planning process in September and as part of process we are reviewing our entire product portfolio over the balance of this year to assess the results achieved to date of our R&D spending programs and determine the company’s strategy and business plan for 2006 and beyond. Included in our results for the third quarter is a $9 million pretax charge primarily related to the write down of inventory and safety factors resulting from our decision to relocate our Arizona operations to California and Oregon. The details of this restructuring are contained in today’s earnings release and our memo to our Form 8-K filed earlier today. These charges reflect the consolidation of facility and operations, which will reduce future operating costs and improve our ability to more tightly integrate the CMP business with the rest of Novellus. We expect record addition charges of approximately $6 million in the fourth quarter of ’05 and $13 million in the first quarter of 2006 in connection with this restructuring. When the announced restructuring is fully implemented by Q2 ’06, the total savings are estimated at $1.2 million per quarter. Our tax rates was approximately 25.9% for the third quarter, on a proforma basis our effective tax rates were 28.7% which is about 1% lower than the prior quarter due to a recession in our fiscal ’05 net operating profit forecast. We anticipate an approximate effective tax rates just below 30% for the fourth quarter of ’05. our third quarter net income was $23 million or $0.17 per share compared a second quarter income of $33 million of $0.24 per share. And on a proforma basis net income was $29 million or $0.21 per share. Now turning the balance sheet, we ended the quarter with $889 of cash, short term investments and restricted cash which was an increase of $35 million over the prior quarter. The increase is primarily due to positive cash flow from operations of $52 million along with proceeds from employee option exercises and stock purchase plans of $10 million offset by a repurchase of common stock of $30 million and debt repayments of $12 million. Net accounts receivables of $344 million grew by $23 million in the quarter. This increase is due to mainly to the timing of shipments in the September quarter and a slight increase in payment terms which resulted in our DSO growing from 87 days to 96 days at the end of the September quarter. Inventories came in at $206 million at the end of the quarter, which is a decrease of $30 million from the June quarter. Now $5 million of this decrease was the result of the right down of inventories associated with the CMP restructuring. The remaining 25 (0905) came from operational reductions, which was the result of the main inventory model that is being led and implemented by our operations team. Capital expenditures were $9 million and depreciation and amortization totaled $20 million for the September quarter. Now with that let me turn to our outlook for the fourth quarter. For the fourth quarter we expect bookings to be flat, to up 10% compared to the third quarter, shipments are forecasted to be in the range of down 5% to 10% and revenue is also forecasted in the range of down 5% to 10%. Based on that earnings per share excluding any additional restructuring of special charges are expected to be $0.15 to $0.17. With that I would now turn it over to Richard Hill who will comment on our customer and business environment and then open it for Q&A. Richard…

Richard Hill

Thanks William. Good afternoon ladies and gentlemen. I appreciate you joining in the call the overall business is flattish to slightly up. Our bookings in this quarter, if we had $34 million of debookings, so if one look at gross bookings of 320 million it look like a fairly strong third quarter, but ended down unfortunately due to the debookings. However the new bookings front does look relatively positive, and as build just reported. We are looking at flat up again for the fourth quarter. It continues to be a difficult pricing environment particularly in some of our newer product, where we are trying to penetrate the markets specifically PVD and CMP in other areas where our products have substantial market share the pricing ability is somewhat easier.

The technical demand on all our products continuous to grow, as we make the transition from 130 to 90 and 90 to 65 nanometer technologies. On a regional basis the US was strong this quarter Japan is jump a little bit and Asia remaining fairly steady during the third quarter. The capacity drivers today are clear flash memory particularly NAND continuous to be a strong driver, and we expect that to be true going forward.

Graphics gain more is demand is very, very high, and so we see some demand within the foundries are causing capacity to be added. And of course there has been a steady PC demand well not as robust historically as it has been, it is still relatively strong and therefore unit volumes continued to grow despite ASP erosion, those with cash are continuing to vast.

Overall for our product standpoint I think we are very, very well position in PV, CVD, HDP Electrofil and tungsten, stripped has begin to win substantial markets share with in Asia, which I think both well for the future. In the area PVD, we continued to show good technical performance, but as a same time seen to not be able to convert that technical performance to repeat orders, and shipments however we are anticipating that to occur moment early CMP as I told you is a 2006 story, and we still believe that to be the case.

Service and spare parts continues to be strong, and a good business opportunity it’s also a leading indicator of capacity utilization, as we see these numbers grow we see likelihood of capacity expansion in the industries. And the macro economic front, we continued to remain conscious, because a lot of the demand that’s currently in the market place is driven by consumer product rather than an industrial products, and as subject to macro economic environmental around us.

On an operational know we have challenges in gross margin as build reported, but we are dressing those challenges continuing to drive down in material cost and increasing our overall operating efficiency. Our return on R&D is subject to our ability to continued to grow market share, and some of the newer product segments and from our asset management needs to come under control in other areas as you can see by the inventory numbers we’ve made substantial progress there. And we are continued to do so, DSO is slip back a little bit, but more due to a timely issue, then a lack of focus and I think you will see that corrected in the fourth quarter, but we still have a large he number of the evaluation systems, that are currently out in the market place, which drives up our other assets, which certainly can use some improvement. So with that flavor I will open it up to any Q&A’s you might have.

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