Novellus Q4 2007 Mid-Quarter Update Call Transcript

Nov.29.07 | About: Novellus Systems, (NVLS-OLD)

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

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

Operator

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

Robin Yim

Thank you, Cara, and good afternoon, everyone. Thank you forjoining the Novellus Systems fourth quarter 2007 mid-quarter update conferencecall. Joining me on the call today from Asia is RickHill, 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-lookingstatements about Novellus' business outlook. These forward-looking statementsand all other statements made on this call that are not based on historicalfactors are subject to risks and uncertainties that may materially affectactual results.

Specific forward-looking statements include, but are notlimited to: our expectations regarding semiconductor industry growth andcapital 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 forthe fourth quarter of 2007; and our 2007 financial model.

We caution you that forward-looking statements areprojections and expectations regarding future events. They involve risks and uncertaintiesthat could cause actual results to differ materially from the resultscontemplated.

Information concerning these risks are contained in ourfilings with the Securities & Exchange Commission, including our Form 10-Kfor fiscal 2006, our Form 10-Q for the first, second, and third quarters of2007 and our current reports on Form 8-K. Forward-looking statements are basedon information as of November 29, 2007 and we assume no obligation to updateany such statement.

Bill Kurtz will begin today's call with an update of ourfourth quarter 2007 financial outlook and guidance. Then we'll open the callfor 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 updatedguidance for the fourth quarter. Overall, our fourth quarter guidance remainsunchanged 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 pointwhen we end the quarter within the existing ranges. Let me start with bookings.

Bookings remain forecasted at up 5% to 15% over the thirdquarter. 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. Revenueswill range from $355 million to $365 million and are also trending towards themiddle of the guidance. Gross margin is forecasted to be approximately 49%, thesame as we had forecasted earlier.

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

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

Rick Hill

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

Question-and-AnswerSession

Operator

Our first questionwill come from Gary Hsueh - CIBC World Markets.

Gary Hsueh - CIBC World Markets

Rick, any of the strength in orders coming to the high endof guidance for the December quarter that you see? Any of that underpinned bydelayed 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 dosee the fact that PC demand remains strong, as we have anticipated. It isquickly depleting DRAM inventories. There are several companies who are stillinvesting in anticipation of a depleting DRAM market. Flash remains very, verystrong. Foundries are at high levels of utilization and are beginning to addsmall increments of capacity. I thinkthose are the major drivers.

Gary Hsueh - CIBC World Markets

In terms of delayed payments, if you could quantify it, nomeaningful part of shipments or accounts receivable right now due to delayed ordeferred 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 andwe're expecting a similar result for this quarter. No noticeable change in ourDSO 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 theNAND and DRAM companies at this point that are ordering? How much of it isongoing with their plans and are you starting to see some benefit from some ofyour new products now as they move to copper and some of your new PECVD hardmask product and whatnot?

Rick Hill

I think that wedefinitely are seeing some strength in our new products as they are continuingto try to drive down their costs. But I think it is more strategic and theiranticipation of what the market is going to do going forward. Again, we're moreheavily exposed in some areas of this market than we are in others and I thinkthat 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’sview on the growth prospects next year for the semiconductor industry, and thenyour current view on the CapEx outlook for next year?

Rick Hill

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

In general, I think there is a see how the market developsand we'll add smaller increments of capacity to try to more closely match the supplyand 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 ofDell. It is another indication of the strong uptake in Vista.It is also driving increased DRAM, although there still is excess capacity andthe prices are inordinately low. That is causing some suppliers to cut backtheir plans for expansion.

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

Harlan Sur - Morgan Stanley

Your view for CapEx for '08?

Rick Hill

We still see, if welook at the underlying unit demand it's going up; given utilization rates thatwould indicate to us a need to increase CapEx. We think it will be modest. Wesaid before we anticipated flat to potentially up 5%. That would be what wewould 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, isthe mix of orders what you expected it to be? Were there any surprises in termsof which customers actually started to order?

Rick Hill

Not really, Ben. We had forecasted the growth in orders inthe 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 endand our product offering has pushed it to the high end; but other than that, itis not out of expectation, out of line from what we expected.

Operator

Your next question comes from Mark FitzGerald - Banc ofAmerica.

Mark FitzGerald - Banc of America

The problem that we hear most about is in the DRAM side ofthe 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 toDRAM or above industry exposure?

Rick Hill

I think we have industry average exposure to DRAM, but wearen't broadly exposed to DRAM. We have said this before. I think it's one ofthe reasons when there was large ordering in the Taiwanese DRAM market we didnot benefit as much as we benefit when it is ordering in the Japanese and theKorean marketplace. I think overall our business is pretty normalized relativeto 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 theyexpected DRAM CapEx to be down 40%. Does that look realistic to you at thispoint?

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 cutback 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 andDRAM and flash still has a healthy price and therefore is a fairly profitableproduct line. Consequently, they can continue to expand capacity while othersmight not. I think that's the dynamic.

Clearly I think Micron and the Intel Micron joint ventureare investing heavily in flash at this juncture, so that could be the potentialreason 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 customersthat you're talking about, how do you see the order trends playing out over thenext couple of quarters? At what point do you think the order trends have tomeet 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 isalready being demonstrated in their order profile. But I do believe that thereis going to be a crossover point probably during the first quarter whereinventory levels of DRAM will get to a point where the decisions will have tobe 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 itwas just three or four months ago.

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

Jim Covello - Goldman Sachs

How do you reconcilethe accelerating price declines in DRAM with the notion that it is gettingsnapped up at faster rates?

Rick Hill

Well, it is hard for it to go much lower, with 512 going at abuck 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 attractivecomponent within PCs and as a consequence I think they're increasing theirvolume. So inventory at these levels, it is cheap to put it in a PC and be anenrichment factor for the PC manufacturer.

Jim Covello - Goldman Sachs

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

Rick Hill

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

Operator

Your next question comes from Stephen Chin - UBS.

Analyst for StephenChin - UBS

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

Rick Hill

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

Analyst for StephenChin - UBS

Which geographies are seeing strength in your Decemberquarter, Bill?

Bill Kurtz

We provide a breakout by geography once we report revenuesand once we finalize the results for the quarter. If you could hold thatquestion, I will answer that on our January call, but we typically don'tcomment 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 ashutdown in December of two weeks. Is that still the plan?

Bill Kurtz

Yes, Tim, and that istypical for us at year end to have a two-week shutdown of the company. We haveoperations working during that time, but most of the rest of the company wouldbe under shutdown.

Timothy Arcuri - Citi

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

Bill Kurtz

Tim, we wouldn'tbreak 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 Asiaright now, that the rapid decline in DRAM pricing has accelerated some decommissioningof some of the old 8-inch capacity?

Rick Hill

I can't say that Ihave seen that, no. I don't believe that will be a factor. It is very difficultfor 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 wouldclearly be giving you some kind of sign that they were going to do this, ifthey were going to do it in the next quarter or two, right?

Rick Hill

Well, I don't knowthat they would give me that sign that they were going to do that, but there isno 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 thefoundries. Are you seeing them being a little bit more bullish? Are they buyingleading edge tools or is it more maintenance tool buying?

Rick Hill

I think there is some optimism in the foundry business. Ifthere is pessimism, it is the fact that pricing levels may not be at the levelthey would like to see them but I think if you look at the foundry business intotal and on an individual basis, I think that in general it is on an upwardtrend and it is being driven by a broad range of products. In fact, there tendsto be some shortages when we're looking at the wireless and the networkingdevices that are needed at this particular time.

Bill Ong - AmTech

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

Rick Hill

I think they'reintending to be very, very cautious and spend at the last minute. I don't thinkthey're going to spend unless they see sustainable demand and every indicationI can see is that they're beginning to see sustainable demand but they are impactedby 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 grossmargin improvement. At least with this quarter, do you believe that some of thecost-cutting moves you make, could that provide some incremental upside to thisquarter?

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 commenton the operational numbers. We really try to give a perspective more of theearnings per share, what we think the bookings are doing to give a trend andwhether or not our shipments are tracking and our revenues are tracking whichgives the market a little bit of an indication of whether or not people arechanging their direction from a standpoint of our customers. At the end of thefourth 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 ordertrough and you would think there would be two or three quarters sequentially upquarters. Given the fourth quarter order strength, what does that do for firstquarter '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 whatwe're seeing. We will give you a forecast in January when we report our fourthquarter results. We have given an indication -- which I do believe has beenrunning counter to some of the other companies -- where we're a little bit moreoptimistic, provided macroeconomic things don't cause everything to suddenly cometo a halt.

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

Obviously it remains to be seen and it is no more easy todaythan it ever was in forecasting the future; but we are just trying to give youthe 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'rehaving conversations with your customers right now. Do you think that they'rebeing a little overly conservative in their CapEx publicly versus what they'retelling you privately?

Rick Hill

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

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

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

Operator

Your next question comes from Weston Twigg - Pacific Crest.

Weston Twigg - Pacific Crest

With the bookings still guided below shipments, it lookslike your backlog will drop to less than a quarter's worth of revenue. In thepast, I believe you stated that three months is a healthy backlog level. Ifthis 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 weexpect further backlog erosion?

Rick Hill

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

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

Weston Twigg - Pacific Crest

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

Rick Hill

We sure like to hopeso.

Weston Twigg - Pacific Crest

When does that transition really become meaningful forNovellus?

Rick Hill

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

We've really tried to go in and look at what the marketneeds relative to productivity and performance in the product, and we're reallydriving that across the entire product line. We do believe that's helping ussomewhat and will continue. It is not just related to copper. It is relatedacross all our product lines from strip to our core business and PECVD. Webelieve 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 significantportion of the CapEx overall and that the outlook for DRAM is pretty depressingconsidering the 40% cuts year over year, where would you expect to see thestrength that could offset that kind of a decline in CapEx?

Rick Hill

Well, I think one of the problems with the DRAM market isyou're either in or you're out. DRAM unit demand is continuing to grow. Thenthe 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 youhave to look at.

I think as the year plays out, depending upon what DRAMdemand does and what NAND flash does, you could see some players increase theircapacity expansion disproportionately to those decreasing. It is really puttingpressure on weaker DRAM players that will ultimately at least cause some supplyto 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 costbasis, as we are going to come into a downturn. Does that mean that some ofthese underperforming segments are open for a cut, if you think that thedownturn 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 divisionunderperforming.

Rick Hill

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

Operator

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

Rick Hill

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

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!