Novellus Q4 2007 Mid-Quarter Update Call Transcript

Novellus Systems, Inc. (NVLS)

Q3 2007 Earnings Call

November 29, 2007 4:30 pm ET

Executives

Robin Yim - IR

Bill Kurtz - CFO

Rick Hill - Chairman, CEO

Analysts

Gary Hsueh - CIBC World Markets

Brett Hodess - Merrill Lynch

Harlan Sur - Morgan Stanley

Ben Pang - Caris & Co

Mark FitzGerald - Banc of America

Jim Covello - Goldman Sachs

Analyst for Stephen Chin - UBS

Timothy Arcuri - Citi

Bill Ong - AmTech

Patrick Ho -Stifel Nicolaus

Jenny Lai - JP Morgan

Weston Twigg - Pacific Crest

Peter Kim - Deutsche Bank

Presentation

Operator

Welcome to Novellus Systems fourth quarter 2007 mid-quarter update conference call. One note -- today's call is being recorded today, November 29, 2007. Now I would like to turn the conference over to Ms. Robin Yim of Novellus Systems. Please go ahead, Ms. Yim.

Robin Yim

Thank you, Cara, and good afternoon, everyone. Thank you for joining the Novellus Systems fourth quarter 2007 mid-quarter update conference call. Joining me on the call today from Asia is Rick Hill, Chairman and Chief Executive Officer; and here with me in San Jose is 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 target for the fourth 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 & Exchange Commission, including our Form 10-K for fiscal 2006, our Form 10-Q for the first, second, and third quarters of 2007 and our current reports on Form 8-K. Forward-looking statements are based on information as of November 29, 2007 and we assume no obligation to update any such statement.

Bill Kurtz will begin today's call with an update of our fourth quarter 2007 financial outlook and guidance. Then we'll open the call for the question-and-answer session.

Now I will turn the call over to Bill.

Bill Kurtz

Thank you, Robin. As Robin stated, I'll provide you with updated guidance for the fourth quarter. Overall, our fourth quarter guidance remains unchanged from our previous guidance provided on October 23. I will, however, provide you with some comments as to where we expect we will be at this point when we end the quarter within the existing ranges. Let me start with bookings.

Bookings remain forecasted at up 5% to 15% over the third quarter. At this point, we are trending closer to the high end of the range, given the current trends in orders, which have been strong.

Shipments are expected to be in the range of $365 million to $390 million are trending towards the middle of the guidance range. Revenues will range from $355 million to $365 million and are also trending towards the middle of the guidance. Gross margin is forecasted to be approximately 49%, the same as we had forecasted earlier.

Earnings per share on a FAS 123 R inclusive basis, is expected to be $0.34 to $0.37; excluding 123 Restaurant, $0.37 to $0.40, both of which are trending towards the middle of the range.

With that as a summary of our guidance for the fourth quarter, I would now like to turn it over to Rick, who is currently in Asia visiting with customers, who will open it up for Q&A.

Rick Hill

Thanks very much, Bill. What I would like to do is go right into Q&A, if anybody has any questions about our guidance. Thank you.

Question-and-Answer Session

Operator

Our first question will come from Gary Hsueh - CIBC World Markets.

Gary Hsueh - CIBC World Markets

Rick, any of the strength in orders coming to the high end of guidance for the December quarter that you see? Any of that underpinned by delayed payment terms? Are you seeing a little bit more of that?

Rick Hill

I don't see any more strength to the delayed terms, but I do see the fact that PC demand remains strong, as we have anticipated. It is quickly depleting DRAM inventories. There are several companies who are still investing in anticipation of a depleting DRAM market. Flash remains very, very strong. Foundries are at high levels of utilization and are beginning to add small increments of capacity. I think those are the major drivers.

Gary Hsueh - CIBC World Markets

In terms of delayed payments, if you could quantify it, no meaningful part of shipments or accounts receivable right now due to delayed or deferred payment terms on equipment yet? Is that right?

Rick Hill

We don't go into that level, but nothing comes to mind.

Bill Kurtz

Our DSO, you may recall last quarter, did come down and we're expecting a similar result for this quarter. No noticeable change in our DSO for the quarter.

Operator

Our next question comes from Brett Hodess - Merrill Lynch.

Brett Hodess - Merrill Lynch

Rick, I am wondering if you can talk a little bit about the NAND and DRAM companies at this point that are ordering? How much of it is ongoing with their plans and are you starting to see some benefit from some of your new products now as they move to copper and some of your new PECVD hard mask product and whatnot?

Rick Hill

I think that we definitely are seeing some strength in our new products as they are continuing to try to drive down their costs. But I think it is more strategic and their anticipation of what the market is going to do going forward. Again, we're more heavily exposed in some areas of this market than we are in others and I think that is also a factor in the benefit.

Operator

Your next question comes from Harlan Sur - Morgan Stanley.

Harlan Sur - Morgan Stanley

I am wondering what you're picking up in terms Asia’s view on the growth prospects next year for the semiconductor industry, and then your current view on the CapEx outlook for next year?

Rick Hill

I think that in general, everyone is very cautious about next year. People are concerned about macroeconomics which may affect a potential recession in the U.S. It is somewhat offset by extremely strong European currency which will continue to drive demand; as well as I think a strong product offering in the PC arena which is driving another cycle and also, again, strong products in the area of wireless and telecommunications.

In general, I think there is a see how the market develops and we'll add smaller increments of capacity to try to more closely match the supply and demand. So it becomes extremely important to watch the levels of inventory, because that will be the trigger point for, again, reordering.

It was relatively good news with the report that came out of Dell. It is another indication of the strong uptake in Vista. It is also driving increased DRAM, although there still is excess capacity and the prices are inordinately low. That is causing some suppliers to cut back their plans for expansion.

In a large percentage of those cases, we're not highly exposed and as a consequence I think that's the result of us seeing an order uptick while others might not.

Harlan Sur - Morgan Stanley

Your view for CapEx for '08?

Rick Hill

We still see, if we look at the underlying unit demand it's going up; given utilization rates that would indicate to us a need to increase CapEx. We think it will be modest. We said before we anticipated flat to potentially up 5%. That would be what we would think as the best case scenario.

Operator

Your next question comes from Ben Pang - Caris & Co.

Ben Pang - Caris & Company

Your order guidance to be trending towards the high end, is the mix of orders what you expected it to be? Were there any surprises in terms of which customers actually started to order?

Rick Hill

Not really, Ben. We had forecasted the growth in orders in the fourth quarter and they have pretty much come in where we anticipated. Again, I think some of the strength in our product has pushed it to the high end and our product offering has pushed it to the high end; but other than that, it is not out of expectation, out of line from what we expected.

Operator

Your next question comes from Mark FitzGerald - Banc of America.

Mark FitzGerald - Banc of America

The problem that we hear most about is in the DRAM side of the business. I know you don't break out your orders or revenues on this basis, but can you give us sense whether you have below industry average exposure to DRAM or above industry exposure?

Rick Hill

I think we have industry average exposure to DRAM, but we aren't broadly exposed to DRAM. We have said this before. I think it's one of the reasons when there was large ordering in the Taiwanese DRAM market we did not benefit as much as we benefit when it is ordering in the Japanese and the Korean marketplace. I think overall our business is pretty normalized relative to the DRAM market. It is just sort of skewed to certain customers.

I hope that helps, Mark.

Mark FitzGerald - Banc of America

We've heard from Micron just yesterday or today that they expected DRAM CapEx to be down 40%. Does that look realistic to you at this point?

Rick Hill

I think in some cases, I didn't hear that particular report, but what some people are telling me is they have plans to substantially cut back their CapEx because the price of DRAM has plummeted to such a low level. There are some that are able to make the capacity fungible between flash and DRAM and flash still has a healthy price and therefore is a fairly profitable product line. Consequently, they can continue to expand capacity while others might not. I think that's the dynamic.

Clearly I think Micron and the Intel Micron joint venture are investing heavily in flash at this juncture, so that could be the potential reason behind that announcement but I did not hear it.

Operator

Your next question comes from Jim Covello - Goldman Sachs.

Jim Covello - Goldman Sachs

Rick, given what the outlook from some of the DRAM customers that you're talking about, how do you see the order trends playing out over the next couple of quarters? At what point do you think the order trends have to meet up with what some of the customers are telling you about the DRAM CapEx?

Rick Hill

What some of the DRAM manufacturers are telling us is already being demonstrated in their order profile. But I do believe that there is going to be a crossover point probably during the first quarter where inventory levels of DRAM will get to a point where the decisions will have to be made on whether or not you want to add capacity to meet future demand, because I do believe that it is getting snapped up at a lot faster rate than it was just three or four months ago.

As a consequence, my expectation is to see while in general DRAM may be down in the first quarter from a bookings standpoint, we'll tend to see it go back up in the second quarter or third quarter for sure.

Jim Covello - Goldman Sachs

How do you reconcile the accelerating price declines in DRAM with the notion that it is getting snapped up at faster rates?

Rick Hill

Well, it is hard for it to go much lower, with 512 going at a buck a copy that means you're selling 300mm wafers at some between $900 and $1,000; very, very difficult to do. But it does make it an extremely attractive component within PCs and as a consequence I think they're increasing their volume. So inventory at these levels, it is cheap to put it in a PC and be an enrichment factor for the PC manufacturer.

Jim Covello - Goldman Sachs

If the volumes are picking up, why are the prices actually going down faster, recently?

Rick Hill

Well “recently” is all a relative term. I don't think the prices have continued to go down over the last six weeks and I think there has been tremendous growth over the last six weeks.

Operator

Your next question comes from Stephen Chin - UBS.

Analyst for Stephen Chin - UBS

I wanted to find out what is your DRAM CapEx for 2008, given that there is going to be accelerated deployment of copper in DRAM as well as the retirement of 200mm fabs, given the recent announcement by Samsung?

Rick Hill

We don't break out our anticipated CapEx or the industry's CapEx versus DRAM versus foundry, but you do bring up a good point that as flash moves exclusively to copper, DRAM will follow and that will drive somewhat of a bias that should be a tailwind for us. We look forward to that transition technologically and hopefully that will help us through any slowdown that does occur within the industry, if it does.

Analyst for Stephen Chin - UBS

Which geographies are seeing strength in your December quarter, Bill?

Bill Kurtz

We provide a breakout by geography once we report revenues and once we finalize the results for the quarter. If you could hold that question, I will answer that on our January call, but we typically don't comment on that at the mid-quarter update.

Operator

Your next question comes from Timothy Arcuri - Citi.

Timothy Arcuri - Citi

First of all, Bill, I think you were talking about a shutdown in December of two weeks. Is that still the plan?

Bill Kurtz

Yes, Tim, and that is typical for us at year end to have a two-week shutdown of the company. We have operations working during that time, but most of the rest of the company would be under shutdown.

Timothy Arcuri - Citi

First of all, is there some way -- this is probably tough to answer -- but is there some way to characterize the bookings composition in December versus September between share gain? So a booking where you took direct share from another supplier relative to business that you already had? What's the increment -- if any -- in December that's share gain versus what you booked in September?

Bill Kurtz

Tim, we wouldn't break that out; we do look at that. We have a fairly good understanding of it, but it is not something that we would share openly.

Timothy Arcuri - Citi

Are you seeing any signs, since you're in Asia right now, that the rapid decline in DRAM pricing has accelerated some decommissioning of some of the old 8-inch capacity?

Rick Hill

I can't say that I have seen that, no. I don't believe that will be a factor. It is very difficult for me to believe that 8-inch capacity can be viable in the memory business.

Timothy Arcuri - Citi

Even in your discussions with these companies, they would clearly be giving you some kind of sign that they were going to do this, if they were going to do it in the next quarter or two, right?

Rick Hill

Well, I don't know that they would give me that sign that they were going to do that, but there is no change since the last time we spoke, that I know of.

Operator

Your next question comes from Bill Ong - AmTech.

Bill Ong - AmTech

You mention small capacity increase coming out from the foundries. Are you seeing them being a little bit more bullish? Are they buying leading edge tools or is it more maintenance tool buying?

Rick Hill

I think there is some optimism in the foundry business. If there is pessimism, it is the fact that pricing levels may not be at the level they would like to see them but I think if you look at the foundry business in total and on an individual basis, I think that in general it is on an upward trend and it is being driven by a broad range of products. In fact, there tends to be some shortages when we're looking at the wireless and the networking devices that are needed at this particular time.

Bill Ong - AmTech

A number of the foundry providers talked about CapEx being down next year. So does it sound like they are going to probably spend a little bit more at the beginning of the year and maybe be a little bit more cautious, wait and see, towards the second half?

Rick Hill

I think they're intending to be very, very cautious and spend at the last minute. I don't think they're going to spend unless they see sustainable demand and every indication I can see is that they're beginning to see sustainable demand but they are impacted by the fact that they worry that there is a potential slowdown driven by the U.S. market.

Operator

Your next question comes from Patrick Ho - Stifel Nicolaus.

Patrick Ho - Stifel Nicolaus

You guys have made a lot of strides in terms of your gross margin improvement. At least with this quarter, do you believe that some of the cost-cutting moves you make, could that provide some incremental upside to this quarter?

Going forward, what do you see over the next six to 12 months?

Rick Hill

Well during the mid-quarter update we really don't comment on the operational numbers. We really try to give a perspective more of the earnings per share, what we think the bookings are doing to give a trend and whether or not our shipments are tracking and our revenues are tracking which gives the market a little bit of an indication of whether or not people are changing their direction from a standpoint of our customers. At the end of the fourth quarter we'll go into our typical analysis of the operating results.

Operator

Your next question comes from Jenny Lai – JP Morgan.

Jenny Lai - JP Morgan

Last quarter you said that the third quarter was your order trough and you would think there would be two or three quarters sequentially up quarters. Given the fourth quarter order strength, what does that do for first quarter '08 orders or first half '08 orders? Do you have a sense of that?

Rick Hill

Well, we don't comment beyond the mid-quarter update on what we're seeing. We will give you a forecast in January when we report our fourth quarter results. We have given an indication -- which I do believe has been running counter to some of the other companies -- where we're a little bit more optimistic, provided macroeconomic things don't cause everything to suddenly come to a halt.

We have commented that we think underlying PC demand is very robust and we think that will continue. As our customers get confidence that that will continue, we think that will begin to free up more CapEx. That's the reason we felt that the third quarter was the trough.

Obviously it remains to be seen and it is no more easy today than it ever was in forecasting the future; but we are just trying to give you the data that we look at and tell you what we see at this point in time.

Jenny Lai - JP Morgan

So you're out in Asia and you're having conversations with your customers right now. Do you think that they're being a little overly conservative in their CapEx publicly versus what they're telling you privately?

Rick Hill

Well, I can't determine whether they're conservative or not. The only thing I can look at is if I look at historical utilization levels, inventory levels and what typically happens, unit demand is growing so rapidly that if capacity isn't brought on, suddenly there will be a restriction on units.

Now hopefully that would mean prices would rise and it would trigger reordering. It is my anticipation that's what has to happen. I think we all in general look at the exact same numbers. The one thing that we do and try to do is look beyond our customer to the end market demand and then make an assessment of how strong we think new products are coming out and we have consistently targeted and highlighted the fact that we thought the new products in the PC arena, which will drive both flash and microprocessor demand, were the positive signs for us going into 2008.

In addition to that, it's certainly an election year -- although I am not sure any of these politicians can cause the U.S. not to go into a recession -- but I am not so sure that the strong euro, the relative strength of the euro coupled with China can't cause us to go right through any type of downturn that maybe the U.S. has but I don't think the rest of the world will have.

Operator

Your next question comes from Weston Twigg - Pacific Crest.

Weston Twigg - Pacific Crest

With the bookings still guided below shipments, it looks like your backlog will drop to less than a quarter's worth of revenue. In the past, I believe you stated that three months is a healthy backlog level. If this is the case, what do you think it will take to maintain a healthy backlog? Should we expect shipment levels to drop significantly or maybe should we expect further backlog erosion?

Rick Hill

If backlog continues to drop, there are only two cures for that; you either ship less or you book more to turn that around. We are seeing an uptick in bookings right now. We would like to see that continue but we can't forecast that at this particular time.

In the event it doesn't, we have been really reshaping our cost structure within the company and so we believe we're well prepared to weather a downturn if one were to come in the business, if this were a false upturn. As a consequence, we'll continue to restructure our costs so that it is appropriate for the level of business that we have.

Weston Twigg - Pacific Crest

Looking ahead a little bit, I am wondering if the NAND transition to copper might give Novellus a bit of a revenue bump compared to your peers next year, if DRAM spending drops off as many expect?

Rick Hill

We sure like to hope so.

Weston Twigg - Pacific Crest

When does that transition really become meaningful for Novellus?

Rick Hill

I think it is ongoing now and it does help us somewhat, but even the transition of memory to copper isn't like the initial transition of the logic market from aluminum to copper, because there were just many more layers. When you're dealing with aluminum, you're dealing with less layers. It will be an important factor, but it is certainly not the only factor that we rely on.

We've really tried to go in and look at what the market needs relative to productivity and performance in the product, and we're really driving that across the entire product line. We do believe that's helping us somewhat and will continue. It is not just related to copper. It is related across all our product lines from strip to our core business and PECVD. We believe that's what will maintain our competitiveness and allow us to be very, very competitive in this market going forward.

Operator

Your next question comes from Peter Kim - Deutsche Bank.

Peter Kim - Deutsche Bank

Rick, you said that you expect CapEx to be flat next year. Considering that in 2007 memory -- DRAM primarily -- represented a significant portion of the CapEx overall and that the outlook for DRAM is pretty depressing considering the 40% cuts year over year, where would you expect to see the strength that could offset that kind of a decline in CapEx?

Rick Hill

Well, I think one of the problems with the DRAM market is you're either in or you're out. DRAM unit demand is continuing to grow. Then the question is, will there be some players who decide to not spend any CapEx? And then will other players pick that CapEx up? I think that's the thing you have to look at.

I think as the year plays out, depending upon what DRAM demand does and what NAND flash does, you could see some players increase their capacity expansion disproportionately to those decreasing. It is really putting pressure on weaker DRAM players that will ultimately at least cause some supply to come off the market, 8-inch being probably the most notable.

Peter Kim - Deutsche Bank

You are talking about how you're adjusting your capital cost basis, as we are going to come into a downturn. Does that mean that some of these underperforming segments are open for a cut, if you think that the downturn is going to be severe?

Rick Hill

Are you talking operationally within the company?

Peter Kim - Deutsche Bank

Yes, for example, a lot of the talk about your TMV division underperforming.

Rick Hill

We're trying to perform delivering 15% after tax and to grow our earnings and to the extent that we do that, we're going to continue to invest in the broad product line. Our goal is to continue to grow. We can grow by growing market share in some of our stronger products. We can also do that by providing more value in big markets where we see that there is value to be delivered to the customer. We're not going to talk about operationally what we would do, but we don't have plans to cut product line.

Operator

There are no further questions at this time. Mr. Hill, I will turn the conference back over to you for any closing comments.

Rick Hill

Thank you very much for joining us for the mid-quarter update. We look forward to a good finish for fiscal year '07 and we hope that the demand for DRAM and NAND continues to grow, as we think it will, through the rest of this quarter and into the first quarter. We look for a better fiscal year '08. As we all know, the future is uncertain and there certainly are macroeconomic effects that could change things.

We appreciate your support of Novellus and we look forward to talking with you at the end of January. Thank you very much.

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