Novellus Q3 2007 Mid-Quarter Earnings Call Transcript

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Novellus Systems, Inc. (NVLS)
Q3 2007 Mid-Quarter Earnings Call
August 30, 2007 4:30 pm ET

Executives

Robin S. Yim - Investor Relations
Richard S. Hill - Chairman of the Board, Chief Executive Officer
William H. Kurtz - Chief Financial Officer, Executive Vice President, Principal Accounting Officer

Analysts

Jim Covello - Goldman Sachs
Brett Hodess - Merrill Lynch
Edward White - Lehman Brothers
Satya Kumar - Credit Suisse
Mahesh Sanganeria - RBC Capital Markets
Harlan Sur - Morgan Stanley
David Katz - Matrix Asset Advisors
Timothy Arcuri - Citigroup
Ben Ping - Carras & Company
Jay Deahna - J.P. Morgan
Gavin Duffy - A.G. Edwards

Presentation

Operator

Good day, everyone and welcome to Novellus' third quarter 2007 mid-quarter update conference call. As a reminder, this call is being recorded today, August 30, 2007. I would now like to turn the conference over to Ms. Robin Yim of Novellus Systems. Please go ahead, Madam.

Robin S. Yim

Thank you, Jamie. Good afternoon, everyone and thank you for joining the Novellus Systems third quarter 2007 mid-quarter update conference call. Joining me on the call today are Rick Hill, Chairman and Chief Executive Officer, and Bill Kurtz, Chief Financial Officer.

Today’s mid-quarter update call contains forward-looking statements about Novellus' business outlook. These forward-looking statements and all other statements made on this call that are not based on historical factors are subject to risks and uncertainties that may materially affect actual results. 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, the demand for and competitiveness of our products, management’s projected bookings, shipments, revenues, gross margins, tax rate and earnings per share targets for the third quarter of 2007, and our 2007 financial model.

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. Information concerning these risks are contained in our filings with the Securities and Exchange Commission, including our Form 10-K for fiscal 2006, our Form 10-Q for the first and second quarters of 2007, and our current report on Form 8-K.

Forward-looking statements are based on information as of August 30, 2007 and we assume no obligation to update any of these statements.

Bill Kurtz will begin today’s call with an update of our third quarter 2007 financial outlook and guidance. Rick Hill will comment on the business environment and then we will open the call for the question-and-answer session. Now I will turn the call over to Bill.

William H. Kurtz

Thank you, Robin. As Robin stated, I’ll provide you with an update of our third quarter financial outlook. Now, in light of the current macro economic conditions that may cause a delay in orders as the quarter comes to a close, we are widening the guidance range on bookings from plus 5% at the high end to minus 10% at the low end compared to the second quarter.

Our guidance for shipments, revenue, gross margin and EPS in the third quarter of 2007 remains unchanged, as current trends on shipments and revenues remain solid. For everyone’s benefit, I will now reiterate the specific dollar amount for the guidance ranges of our key metrics for the third quarter.

Bookings are forecasted to be in the range between $299 million and $349 million, which again is a range of plus 5% to minus 10% versus the second quarter; shipments, $370 million to $385 million; revenues, $380 million to $395 million; gross margin remains unchanged at 49% to 50%; and EPS at $0.36 to $0.39, including stock compensation and $0.39 to $0.42 excluding stock compensation.

With that as a summary of our key metrics and guidance for the third quarter, I would now like to turn the call over to Rick who will make some comments about the state of the business and then open it up for Q&A. Rick.

Richard S. Hill

Thanks, Bill. As you can see, the only number that is different than our end of second quarter call was we expanded for the first time the range of bookings. This is to accurately reflect our uncertainty and the related uncertainty of our customers.

We recognize that if all our upsides and downsides went in the wrong direction, we could hit down 10%. In other words, if none of our upside happened and all of our downside did, there would be a wider range.

Areas of uncertainty today are in Korea and there is short-term uncertainty in the key customers in this area. The foundry business, as has been reported in the news, has also showed uncertainty despite the fact that at the current utilization rate, we would typically see bookings beginning to flow. We just don’t know how to project that through the next 30 days.

In our discussions with customers, the general worry is a combination of things that would affect the U.S. consumer. Things listed, such as the current sub-prime loan issues, increased deficit within the U.S., the potential for tax increases and the most recent fall in the median price of houses decline, which is often referred to as America’s piggy bank, could precipitate a consumer-led recession and as a result, I think our customers are in a much more cautious level.

Product wise, we continue to be on track with our products and see continued improvement.

With that, I would like to open it up to any specific questions you might have that others will also have and hopefully we can share as much information with you as possible. Let’s open for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We will take our first question from Jim Covello with Goldman Sachs. Please go ahead.

Jim Covello - Goldman Sachs

Good afternoon, guys. Thanks so much. I guess the real question is if we did the bookings at the low end of the guidance and shipments stayed kind of where you had suggested, you are going to be maybe rough numbers, booking low 300s and shipping high 300s. To the extent that the shipments or the bookings and the -- the bookings become the shipments in the out couple of quarters, the numbers would need to come down quite a bit. I mean, do you think that is more of a likely scenario than maybe what you thought at Semicon when I had asked you the question then?

William H. Kurtz

When you asked me the question then, my answer was that given the tentative nature of our customers, depending upon what demand does for them, rather than pushing our bookings off and then accepting a fixed delivery, I think we are tending to see them push the bookings off and they will want to accelerate delivery. So it could smooth it out but I don’t know.

If it just delayed business because of a downturn in the consumer spending in the U.S. that precipitated a recession, then you are absolutely right. Eventually our shipments have to track down to our bookings level.

But at this point in time, we can’t say that we see that.

Jim Covello - Goldman Sachs

Okay, and then if I could just ask a follow-up; if that scenario were to play out, Bill, what do you think margins might look like if we were talking about shipments in the low 300 level?

William H. Kurtz

Well, it depends on mix, so I have to give you a depends answer, but we still feel that the 49 to 50 is a fair range for the business within that range of revenues.

Jim Covello - Goldman Sachs

I understand but we are just trying to get our models right so that we can eventually model this thing in properly and just get all this downturn stuff done and go forward. Can you give us a range of what margins might look like if shipments were 300?

William H. Kurtz

If I take the current shipments level and current revenue levels, which we have projected, and somewhere in the -- let’s call it 380, 385 range, if I take the average of those --

Jim Covello - Goldman Sachs

I’m sorry, I don’t mean to interrupt, but hypothetically if the shipments got down to the low 300s, could you --

William H. Kurtz

Yes, I know. I’m going to answer your question but I am starting from at least a point of reference, which is what we currently are projecting for the current quarter at a higher level. We are in the roughly 50% range on margin, and then if we were to lose let’s say $50 million to as much as $70 million in revenues, just from a pure absorption basis, right, we’d lose about a point.

Now, it could be a wider range depending on the mix. You could have another point that varies off of that due to mix, but just pure volume alone, if the mix stayed the same, you’d lose about a point. Does that answer your question?

Jim Covello - Goldman Sachs

That’s real helpful. Thanks, Bill. Thanks, Rick.

Operator

We’ll take our next question from Brett Hodess with Merrill Lynch.

Brett Hodess - Merrill Lynch

Rick, I’m wondering, given the weakness in Korea, there’s sort of two pulls there. They get both the Flash and NAND and the DRAM spending. Do you get a sense that there is a pause as they switch from DRAM to Flash and that’s the caution, or is it a bigger issue you think with them not feeling comfortable with where demand is going, based on the economic issues?

Richard S. Hill

I think as we’ve seen, NAND prices as we have projected, have firmed. And so NAND capacity continues to expand with some customers and in other cases, the NAND capacity due to organizational shifts, other things, is currently being reevaluated and is indeterminate at this time.

I think there is speculation on the DRAM pricing and a worry that even though it has strengthened, it may dip back down but again, I think fundamental, underlying DRAM demand and price is going to be a function of Vista absorption into the marketplace and I think that is accelerating, as I finally have my Vista on the computer. So there is some indication -- you know, I am not exactly the early adopter here, so I think that is a fairly decent sign for DRAM long-term.

So I think that this is not a systemic delay.

Brett Hodess - Merrill Lynch

Thanks.

Operator

We’ll take our next question from Edward White with Lehman Brothers.

Edward White - Lehman Brothers

Thanks. Rick, you talked about the fact that although foundry utilization is high, there’s some nervousness in orders there. Do you think there is any particular reason behind that? In other words, is there anything philosophical, any philosophical way in which they are looking at the business differently, or do you think there is some other factor behind it?

Richard S. Hill

I think philosophically, everyone is looking at the business the same, and that is they have to get a return on invested capital and a return on assets. If you put assets in place, you have to make sure you are utilizing them. They are now in the quandary of if the market is going to grow, there is very, very little doubt that you will utilize the asset. But if you start to paint a scenario where there’s a downturn in the U.S. that spreads beyond the U.S., and they don’t absorb that capacity relatively quickly, they really drive down the return on assets. I think that is the thought process.

I think it is healthy long-term for the industry but it does not make these calls any easier.

Edward White - Lehman Brothers

Okay. Second question is you’ve got a lot of new products and what role do you think those will play in bookings going forward? As you look forward, how do you think the new products will impact that?

Richard S. Hill

I think our new product portfolio is very, very strong and as a consequence, most of those are going into R&D right now. If there is a downturn, it gives us more time to get adopted into the production line and qualify, so that in the next upturn, it will give us greater potential bookings and revenue expansion. So to the extent that the downturn is longer, then the portfolio of products is broader and as a result, the revenue growth should be larger. That’s sort of a global view.

Edward White - Lehman Brothers

Okay, great. Thank you.

Operator

We’ll go next to Satya Kumar with Credit Suisse.

Satya Kumar - Credit Suisse

Rick, can you give a little bit more color in terms of this Korea weakness that you had talked about? Does it also expand to fabs that might be sort of JVs or extensions that exist in the U.S. and in China for these Korean customers? Or is it mostly activity in Korea that is not happening as much as you would have expected?

Richard S. Hill

I think these are like any global company. It affects their whole company. But I don’t think it affects it for a long period of time. But we had hoped to have more clarification but by the time of this call, we don’t have more clarification. But it is not a situation to where there is any distress in the situation. It is just a matter of typical pausing to make sure that they are on the right target and want to continue in a given way, so I don’t see this as a long-term issue.

Satya Kumar - Credit Suisse

Okay, and then secondly, some of these Korean customers obviously have the need to convert from 200 to 300. Is there any change in terms of the thought process behind upgrading those facilities? And if I can have one final follow-up, which is can you help quantify the impact of the Korean changes that you are seeing versus the Taiwanese foundry change that you are seeing? Which is having a greater impact in terms of the divergence to Q3? Thanks.

Richard S. Hill

From a standpoint of the transition to 200-millimeter to 300-millimeter, I can’t comment from a standpoint of specific customers. But I can say that within the memory market, 200 millimeters just isn’t economical and it is very unlikely that you can continue to compete at 200 millimeter wafer size, so that has to change. Whether it is this month, this quarter, or this year, or the first quarter of next year, there has to be a transition. So I think that’s clear, and so that has to happen.

Quantifying the variation of foundry impact versus Samsung, we really -- versus Samsung, Hynix, Micron, the overall Flash DRAM marketplace, we’ve really gone and tried to take a look at all of this in total and said hey, what if everything bad happened and tried to come up with a number that we would bound it, and that’s why we widened the range, because of the increasing uncertainty rather than decreasing uncertainty.

So that’s our logic. As always, I’m trying to share what’s causing us to drive the business and it’s no more complex or no more -- there’s no more to it than that.

Satya Kumar - Credit Suisse

Thank you.

Operator

We’ll take our next question from Mahesh Sanganeria with RBC Capital Markets.

Mahesh Sanganeria - RBC Capital Markets

Thank you very much. Let me just understand this one in context of your comment you made about shipment and revenues. You said the current uncertainty is fueling push-out, potential push-out in orders but pull-in in terms of shipment and revenues, so would you say that today your shipment or revenue is tracking more towards higher end with that comment, or is it unchanged?

Richard S. Hill

Well, we haven’t changed. We gave you the only thing we are going to give you, and that is unchanged.

The reality is if you think about that a second, it says that the backlog, which is capacity that has been booked in the past, for the most part people are committed to installing. They are taking a breather trying to determine what the economic outlook is long-term in placing further commitments, and I think that’s a summary of what’s happening in the market right now in the semiconductor sector.

Mahesh Sanganeria - RBC Capital Markets

A quick question; Bill, last quarter, if I remember correctly, you bought shares at about $31, something like 3 million. And you have been constantly saying that you are an opportunistic buyer, and so if I put that together, I would conclude that the $27 will be a steal right now, and so you would be buying aggressively. Is that a correct thinking or something has changed?

William H. Kurtz

Our strategy on the buy-back hasn’t changed. As we’ve reiterated, our strategy on the buy-back, which we fully intend to complete, is to use the cash flow that is generated from the business to buy back the stock, and we will report the results of that to you when we get to the third quarter release. That is consistent with what we’ve done in the past, so if you can hold on for another 45 days, we’ll give you the results for this quarter.

Mahesh Sanganeria - RBC Capital Markets

Okay. Thank you.

Operator

We’ll take our next question from Harlan Sur with Morgan Stanley. Please go ahead.

Harlan Sur - Morgan Stanley

Good afternoon. Rick, you didn’t comment on your IDM customers. Maybe some commentary on what you are seeing out there in the third quarter?

Richard S. Hill

Well, I think from a standpoint of IDMs, there’s a large segment of the IDMs that are transitioning to foundries. There are a couple remaining IDMs and their business I would say is rather steady.

Harlan Sur - Morgan Stanley

Okay, great. And then, you talked about some of the momentum on the new products. Specifically, can you just give us a quick update on Vector Express and Extreme? Our checks are indicating some pretty good momentum on these products for you guys. Maybe just a quick update there.

Richard S. Hill

Well, I think I made the comment that if I looked across the product lines, I would say that our performance is on track and we see continual improvement in every single product, and that obviously would include Express and Extreme.

Harlan Sur - Morgan Stanley

Thank you.

Operator

We’ll take our next question from David Katz with Matrix.

David Katz - Matrix Asset Advisors

Rick, I think you just gave a little bit of insight into that but I wanted to get a sense on how you thought you were doing competitively in the various areas.

Richard S. Hill

Well, competitively nobody has rolled over yet, I can assure you of that. But on the whole, I think that we are improving competitively and if we have a weakness, it might be in one product line and we are busily trying to even change that.

David Katz - Matrix Asset Advisors

Okay, and that would be the CMP area?

Richard S. Hill

No, no, I don’t -- we have to be in that market before we evaluate our competitive position. We are in the evaluation stages. I think I refer to HDP.

David Katz - Matrix Asset Advisors

Okay. Thanks, Rick.

Operator

We’ll take our next question from Timothy Arcuri with Citigroup.

Timothy Arcuri - Citigroup

Two things; first of all, as you look out to the end of the year, there’s a lot of optimism amongst investors and I think a lot of company management that orders in the fourth quarter will be up. I know that you don’t really want to talk about that on this call but relative to lowering the low-end of guidance, is it more just that a couple of things are sliding out, or are they really being removed from the overall picture?

Richard S. Hill

I don’t see anything that is being removed from the overall picture.

Timothy Arcuri - Citigroup

Okay, and I guess one more big picture question, Rick; you are pretty focused on the semiconductor market and I guess as you look at what’s gone on, you look at this big shift from IDM to foundry, and yet the foundries haven’t really ordered much equipment at all yet. We are probably six months away from the peak in utilization there and yet they really haven’t ordered much equipment. Memory is in a situation that is relatively short-lived, probably for the next few years and then we kind of revert back to a more normalized situation.

When you look at from a very big picture perspective, you are not in some of the other end markets the way some of your other peers are and I wonder if maybe you are beginning to think about taking some of your money and focusing on some different end markets.

Richard S. Hill

Well, we do have an industrial business and that does well, but I still think the semiconductor market is an extremely attractive market and I want to focus on our knitting and make sure that our products are as competitive, if not more competitive, than anything as available, and I think we’ve demonstrated we can win here and we have been investing in R&D and I do believe it will pay off.

I am not going to take my eye off the ball and suddenly jump into a totally different market wholesale because we have an economic cycle that has been going on for decades. I still think there is plenty of growth in this business and I think if you look at the value proposition that Novellus offers, it is in the sweet spot of what the semiconductor industry needs to maintain competitiveness and continue their growth curves.

So from that standpoint on a long-term basis, I am relatively optimistic and I think we have demonstrated that optimism by our continued buy-backs as opposed to running in on one day and buying back the stock all at one time. So that’s just an opinion.

Timothy Arcuri - Citigroup

Okay. Thanks, Rick.

Operator

We’ll go next to Ben [Ping] with [Carras] & Company.

Ben Ping - Carras & Company

Thank you for taking my question. You mentioned that the NAND pricing is about what you expected right now. Can you comment on the DRAM pricing and also going to the last month of the quarter for your Korean customers, what are they exactly looking at in order to make a decision?

Richard S. Hill

Well, I don’t know internally what our DRAM customers are thinking. I only know the result of them thinking, and the result of them thinking is not releasing orders at the current time to where I could say hands down they will occur in the third quarter. And I am just trying to convey that because it is what we know and the uncertainties we have in the business and I am trying to make sure that people understand the same uncertainties I understand.

Ben Ping - Carras & Company

Thank you very much.

Operator

(Operator Instructions) We will take our next question from Jay Deahna with J.P. Morgan.

Jay Deahna - J.P. Morgan

Thank you. Good afternoon. Rick, I have a couple of questions. I’ll ask them one at a time. It sounds like what you are saying is that most of your chip maker customers are pretty committed to their near-term tactical plans in terms of taking tools that have already been ordered but are slowing down, in some cases, in the case of a big foundry, perhaps and maybe some of your DRAM guys, slowing down their medium term strategic plans due to macro economic uncertainty. Is that a fair characterization?

Richard S. Hill

That’s a fair characterization and a good characterization.

Jay Deahna - J.P. Morgan

Okay. Now, if you look at the processor market, PC demand is actually looking pretty good right now.

Richard S. Hill

Really good.

Jay Deahna - J.P. Morgan

Right, so does that sort of give you any confidence that processor CapEx within IDM might be reasonably decent next year, and that the DRAM guys might be getting hit by this, maybe a little pick-up in panel prices, which is squeezing the budget on DRAM per box a little bit? Because PC demand is good but the rate at which the memory per box is coming up will sort of depend, drive the near-term DRAM price, right?

Richard S. Hill

I think that’s another good observation.

Jay Deahna - J.P. Morgan

So what is your outlook on the processor CapEx potential as we roll into next year? Because sooner or later you have to figure that if a lot of these IDM outside of processors that don’t want to build their own factories, sooner or later the foundries are like a tightening spring -- they are going to have to expand because there is just going to be nowhere else to go, right?

Richard S. Hill

You are thinking the right way.

Jay Deahna - J.P. Morgan

So I guess the question is what is your outlook on processor CapEx as we roll through the next three quarters or whatever?

Richard S. Hill

Right now, I think we are seeing strong computer demand that is driven both by CapEx within the industrial segment, the business segment, business computing. That’s again; this is the slower adoption than we had anticipated with Vista. I use myself as a case in point and so I think that is very positive. It is also overlaid with back-to-school and filling the pipeline for Christmas, and so I think as consumers have become bigger and bigger in all of these equations, I think -- and it is sort of layered on top of the business computing, we will need to see the sell-through. We’ll get a first picture of that toward the end of September and then we will get our final sell-through probably sometime mid-December, see how that’s going.

But I think those will determine whether or not there’s a flow-through or there’s a down-turn.

Jay Deahna - J.P. Morgan

Okay, so let’s say that hypothetically, between now and the end of the year, if PC sell-through is reasonably decent, would you expect processor CapEx to be up next year?

Richard S. Hill

I would.

Jay Deahna - J.P. Morgan

Okay. Thank you.

Operator

We’ll take our next question from Gavin Duffy with A.G. Edwards.

Gavin Duffy - A.G. Edwards

Thanks. I just have a quick question. I’m just trying to get a little bit better handle on the Korean customers taking a pause. Would you say any of this is just maybe a pause, maybe some of the new DRAM orders or it could be part of this saying they can shift some of their DRAM capacity over to NAND and then take a little bit of a pause and then come back to the table in Q4?

Richard S. Hill

I don’t really have that deep an insight into what they are doing internally, so I would be only speculating so I would rather not.

Gavin Duffy - A.G. Edwards

Okay, and following up on the last question, it seems like you think DRAM is going to have a pretty good tail in orders in 2008. Is that fair?

Richard S. Hill

Say that again?

Gavin Duffy - A.G. Edwards

In 2008, you expect the DRAM demand to have a pretty good tail from 2007?

Richard S. Hill

A pretty good tail -- is that tail turned up or is that tail turned down?

Gavin Duffy - A.G. Edwards

I guess turned up. Do you see corporations starting to adopt Vista next year?

Richard S. Hill

Yes, I do. I do see an accelerating adoption of Vista and I think that there is some very interesting features on Vista that solve some of the issues on security that companies with SOX-404 compliance are plagued with that can simplify that and that will have an accelerating effect. But again, that’s speculation and if I had that crystal ball, I would be over there doing your guys’ job.

Gavin Duffy - A.G. Edwards

All right. Thanks a lot.

Operator

We will go next to David Katz with Matrix.

David Katz - Matrix Asset Advisors

Beyond the economic drivers for next year, what do you think the product drivers and industry drivers that are in place for 2008? I’m not looking for an outlook but just the things that you think are going to drive the market.

Richard S. Hill

I think PCs are going to drive the market as there is a whole new wave of PCs coming out with instant-on, lower power consumption, higher speeds, more memory -- number one driver.

We’re all aware of the iPhone. I have one on my belt right now. I think that sets an objective for merging both MP3 and telephony together and I expect to see a rash of new products doing that particular technology in a lot of forms. Worldwide phone technology will also be on top of that pie and clearly there is going to be more and more accelerated use of electronics to try to address power conservation and fuel efficiency and overall emissions control.

So I think that all will be enabled by semiconductors and I think you are going to -- that’s why I don’t think there’s a downturn in semiconductors.

David Katz - Matrix Asset Advisors

Okay, thank you, and do you think any sort of slowdown now creates pent-up demand or it just starts fresh?

Richard S. Hill

Do I think there’s -- say that again, David. I missed it.

David Katz - Matrix Asset Advisors

Do you think there is a slowdown because your customers are concerned about the economy that it creates any sort of pent-up demand going into ’08?

Richard S. Hill

There is the potential that there could be shortages. If consumer demand does not take a breather, when I look at where current utilizations are, and if we pause on the orders for too long a period of time, we’ll start to see a constriction of supply, particularly in DRAM and NAND flash and potentially processor technology as well.

David Katz - Matrix Asset Advisors

Okay. Thank you.

Operator

(Operator Instructions) We’ll go next to Harlan Sur with Morgan Stanley.

Harlan Sur - Morgan Stanley

Thanks for taking my follow-up question. Rick, you know, at Semicon you outlined your view for a relatively positive growth outlook for CapEx in ’08. This was I think based on the team’s view of fab projects ramping and capacity adds, combined with a fairly reasonable consumer up-tick in products next year. Is that still your view?

Richard S. Hill

I think what the drivers we see for ’08 are an election year, an Olympic year, and a product cycle. Those are the three things.

Harlan Sur - Morgan Stanley

Okay, thanks.

Operator

Gentlemen, there appear to be no further questions. At this time, I would like to turn the call back over to you, Mr. Hill, for any additional or closing remarks.

Richard S. Hill

Thank you very much for joining our mid-quarter update. I hope this provides some value to you and I look forward to speaking with you towards the end of October with our third quarter results. Thank you very much for taking the time to join us this afternoon. We’ll see you then. Bye-bye.

Operator

That does conclude today’s conference. Thank you for your participation. You may disconnect at this time.

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