Novellus Systems, Inc. Q4 2007 Earnings Call Transcript

Novellus Systems, Inc. (NVLS)

Q4 2007 Earnings Call Transcript

January 30, 2008 4:30 pm ET

Executives

Robin Yim – Investor Relations

Jeff Benzing – Chief Administrative Officer

Rick Hill – Chairman, CEO

Analysts

Satya Kumar – Credit Suisse

Brett Hodess – Merrill Lynch

Gary Hsueh – Oppenheimer & Co.

Jim Covello – Goldman Sachs

Steven O’Rourke – Deutsche Bank Securities

Mahesh Sanganeria – RBC Capital Markets

Patrick Ho – Stifel Nicolaus & Company

Timothy Arcuri – Citigroup

Jay Deahna – J.P. Morgan

Ben Pang – Caris & Company

Analyst for Stephen Chin – UBS

C.J. Muse – Lehman Brothers

Presentation

Operator

Please stand by. Good day everyone and welcome to the Novellus fourth quarter and fiscal year end 2007 earnings results conference call. As a reminder, this call is being recorded today, January 30, 2008. I would now like to turn the conference over to Ms. Robin Yim of Novellus Systems, please go ahead.

Robin Yim

Thank you Jason. Good afternoon and thank you for joining the Novellus Systems fourth quarter 2007 earnings and fiscal year end conference call. Joining me on the call today are Rick Hill, Chairman and Chief Executive Officer and Jeff Benzing, Chief Administrative Officer. Financial results for our fourth quarter and fiscal year 2007 were released by PR newsier shortly after 1:00 PM Pacific time. You can obtain a copy of the news release in the investor relations section of our website at www.novellus.com.

Today’s earnings call contains forward looking statements about Novellus’ business outlook, the future performance of Novellus and our products and forecasts of key metrics for the first quarter of 2008. 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 with leading semiconductor manufacturers, the demand for and competitiveness of our products, our expectations that we will continue to maintain our position or grow market share, the forecasted bookings and shipment volumes, revenue, gross margin, operating expense, tax rate and earnings per share targets for the first quarter of 2008, our financial model for 2008 and other anticipated future events.

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, including an inaccurate basis for our financial forecast. Information concerning risks that could cause actual results to differ materially is contained in today’s press release and our filings with the Securities and Exchange Commission, including our form 10K for fiscal 2006 and our form 10Q and 8K. Forward looking statements are based on information as of today and we assume no obligation to update these statements.

Jeff Benzing will begin today’s call with a review of the financial results for the fourth quarter and fiscal year 2007. Rick Hill will provide an overview of the business environment and guidance for the first quarter of 2008 and then we’ll open up the call for a question and answer session. Now I’d like to turn the call over to Jeff.

Jeff Benzing

Thank you Robin and good afternoon everyone. As Robin outlined, I’ll begin today’s call with a review of the financial results for both the fourth quarter and fiscal year 2007. Each of our key metrics in the fourth quarter was in line with the guidance provided in our mid quarter update on November 29 with the exception of shipments and gross margin which came in lower than guidance. Here are the results.

Fourth quarter net bookings of approximately 343 million were up 12.4% from the third quarter, near the high end of the guidance as stated in our mid quarter update call. The increase in the quarter’s bookings was primarily due to a yearend resurgence in demand from our memory customers. By wafer size, bookings for the quarter were 94% 300 millimeter, 6% 200 millimeter and for the year, 84% 300 millimeter and 16% 200 millimeter.

Net new orders for the year in total were approximately $1.4 billion, a decrease of 22% over fiscal year 2006. Fourth quarter shipments were approximately 363 million, down 6.4% compared to the prior quarter and came in slightly below our guidance range of flat to down 6%. Shipments for the year were approximately 1.6 billion, a slight decrease of 39.5 million or 2.4% lower than 2006. Fourth quarter revenues were approximately $363 million, down 7.6% from the September quarter and on the high side of our mid quarter guidance range of down 7-10%.

Our yearend backlog at the end of the fourth quarter was approximately 355 million. Revenues for the year were approximately $1.6 billion, a decrease of $88 million or 5.3% over fiscal year 2006. Our fourth quarter revenues by geographic region are as follows. The United States, 29%, Greater China, 28%, Korea, 18%, Japan, 15% and Europe, 10%. Fourth quarter margin was 47.3% versus guidance of 49%. For 2007, gross margin was 49% compared to 49.7% in 2006.

The decline in Q4’s gross margin was due primarily to product and customer mix, lower absorption of fixed costs as shipment volume decreased and higher than anticipated write downs on evaluation units on a lower of cost to market basis. Fiscal year gross margin decreased to 49% from 49.7% in 2006 for the same reasons highlighted previously. Total operating expenses for the quarter were approximately $107 million which were down approximately $21.5 million from the September quarter due in large part to $16.4 million in nonrecurring items, including a $9.1 million net gain from the sale of excess property in San Jose, offset by a nominal $1.1 million of restructuring and other charges and an $8.4 million reversal of previously recognized share based compensation expense.

Going forward, as dictated by the business environment, we will continue to tighten our expense controls and focus on further lowering our operating cost structure. Fourth quarter operating profit margin came in at 17.8% on a GAAP basis. Excluding special charges and other benefits, Q4 operating expense was $5 million lower than third quarter 2007. For the year, on a pro forma basis, excluding certain charges and benefits as previously discussed, operating margin declined to 16.5% in 2007 from 19.1% in 2006.

Now turning to taxes, the implementation of our new global business structure has yielded an effective tax rate in Q4 of ’07 of 29.1% and 32.1% for fiscal 2007 which is in line with the forecasted tax rate provided to you last January and down from 44% in fiscal 2006 which included the onetime items related to the implementation of our new structure. For fiscal year 2008 we expect our effective tax rate to be approximately 32% based on our current forecasted geographic mix of revenues.

Fourth quarter GAAP net income was approximately $53 million or $0.47 per share on a fully diluted basis, including certain charges and benefits noted in my previous comments. Fourth quarter pro forma net income was approximately $41.2 million or $0.37 per fully diluted share, which is the high end of our EPS guidance range. Approximately $0.02 in EPS resulted from stock buybacks in Q4 ’07. For the full year 2007, GAAP net income was approximately $214 million or $1.75 per fully diluted share compared to $190 million or $1.50 per fully diluted share in 2006.

On a pro forma basis, excluding net restructuring benefits and charges, the stock compensation reversal and real estate gains, fiscal 2007 net income was $206 million which is 13% of revenues or $1.69 per fully diluted share versus $235 million which is approximately 14% of total revenue or $1.86 per fully diluted share in 2006. Now turning to the balance sheet, we ended the year with $758 million of cash, short term investments and restricted cash, which represented a decrease of approximately $239 million for the year.

Cash flow from operations remained strong at approximately $306 million plus the $47 million from the sale of real estate. Overall cash decreased in 2007 due to the purchase of 21.7 million shares of stock totaling $593.6 million. In the fourth quarter, we bought back 13.7 million shares of stock for $366.7 million at an all in cost per share of $26.68. Net accounts receivable at the end of Q4 totaled $346.9 million, down $15 million from $362 million of Q3 2007. Overall our DSO on a shipment basis improved to 76 days at the end of Q4 from 83 days at the end of Q3.

Inventory levels decreased by 18.3 million from 231.3 million in Q3 07 to 213 in Q4 07 due to continued management and tight controls of our global inventories. So with that, I’d like to turn the call over to Rick to provide guidance for the first quarter and to give an update on our products and the state of the business.

Rick Hill

Thank you Jeff, good afternoon ladies and gentlemen and as Jeff just reported, our bookings for Q4 were up 12.4% over Q3. Shipments were down 6.4%, revenues were down 7.6%, EPS was $0.48 per share on a GAAP basis and $0.50 per share excluding stock option expensing. And of course as he reported, when we extract the real estate gain and a reversal of a previous charge for performance based stock options, it came out to be right around 37 which was at the high end of our guidance. Needless to say we are operating in a very challenging environment.

The good news is, PC demand stays strong and we believe it’s likely to get stronger as corporations strive to improve employee efficiency and their overall operational efficiency. Demand for Vista is very strong, it’s even stronger than we had expected prior to the release of service pack one. We believe it is poised to accelerate and this will help drive DRAM prices to stabilize and firm over the next three months. New laptop computers with flash based drives have hit the market and we believe demand for these products will be robust, further strengthening demand for flash. Both Samsung and Intel have announced increased capital plans for 2008 as we had anticipated.

The bad news, however, is it appears we’re slipping into a recession, it’s clearly too early to tell, if the 1.25% drop in interest rates by the Feds can turn this around. In the semiconductor cap ex market, there is an increasing demand by our customers to book and ship product within our historical lead times, much, much shorter lead times. They prefer not to take the risk of having excess capacity available. This is making it much harder to predict the business going forward.

Overall, Q4 met our expectations from a financial perspective and exceeded our expectations on a product perspective. Q4 showed very strong demand for our new products and PECVD, HDP, PVD and electrofill. Bookings overall, geographically in the US are strong but we expect them to weaken. Japan has been weak in the fourth quarter, but we expect steady demand but not significant growth in Japan. Europe is steady but we look for it to weaken. Korea is strong and continuing to be strong we believe and Greater China is steady and will remain steady through the first half of the year.

Operationally, we’ve been and will continue to focus on the following things. Number one, products, products, products. Two, cost, cost, cost, we want to lower our breakeven point in this somewhat murky environment. We want to continue to increase asset utilization and optimize all of the assets within our control and continued strong cash flow, as Jeff reported, fiscal year 07 had a total of $353 million of cash generated, $307 million from operations. Our goal in 2008 will be to lower our overall operating expense to about $110 million per quarter.

On a product basis, success in vector extreme, speed max and nova ionics, a very new product called PDO oxide and saber extreme has further confirmed our belief in the important focus on the product portfolio. When we look at these new product introductions and the wins in the latter half of Q4 and continuing wins in Q1, we believe we are extremely well positioned to gain market share in large amounts during 2008.

The competitive nature of our business, however, requires that we continue to adapt our cost structure to remain competitive. We need to further drive down our material costs, continue to drive down our operating expenses as I had articulated, our goal in 2008 is $110 million per quarter spend rate and in addition we plan to further consolidate our operation and facilities and overall real estate holdings.

During the quarter we bought back an additional 13.7 million shares and a total of 21.7 million for the year, totaling $593.6 million. Going forward, the outlook, our bookings for Q1 are expected to be flat to down 15%, our shipments will be in the range of 325 million to 350 million. Revenues will be 315 million to 325 million. The reason revenues are significantly down from shipments is due to the fact that a large number of new products that will be shipped to customers for the first time require us to defer any revenue recognition until acceptance. And so, as a result, there’s a disconnect this quarter between shipments and revenues.

Our gross margin is expected to be approximately 47% and our earnings per share will be adversely impacted by the deferred revenue problem and are expected to come into the range of $0.21-$0.24 per share. So with that I’d like to open it up to any questions you might have.

Question-and-Answer Session

Operator

Thank you sir, at this time if you do have a question please signal us by pressing star one on your touchtone telephone. Once again that is star one on your phone if you have a question. We will take questions in the order that you signal us and take as many questions as time permits. We remind you that if using a speakerphone, please pick up your handset before signaling. We’ll pause for a moment to give everyone a chance to respond. Again star one for questions. First we’ll go to Satya Kumar in San Francisco, please go ahead.

Satya Kumar – Credit Suisse

Yeah, hi, thanks for taking my question. Just wanted to get a sense of how much you’re handicapping the risk that’s out there. It seems like several products are getting pushed out and you’re guiding down for orders. How much of your bookings in the first quarter and as you look into the second quarter has any meaningful amount of DRAM orders in the forecast. How do you feel that you’ve handicapped that in your guidance?

Rick Hill

Well I think that had we not had a potential slowdown in some memory investment, we would have anticipated the order outlook to be up this quarter. The reality is within the last few weeks we’ve been informed of a large push out that’s been involved in the DRAM business and that’s what’s caused us to change the forecast from flat to down from flat to up. So it is handicapped in those numbers.

Satya Kumar – Credit Suisse

Okay that’s very helpful. Can I have a quick follow up, it sounded like you were a lot more optimistic with your new products this time around, on the other hand there is also a slight decline in your gross margins. Last week one of your competitors talked about increasing pricing pressures, are your products sufficiently differentiated here that you don’t have to price discount in order to gain share or how should we think about that?

Rick Hill

Well I think one thing is you have to compete competitively with price in this business and have since the very beginning. I think that the pressure on margins is largely one of mix in this particular case and it’s not really a focus or a cause because of our new products. In fact, just the opposite, I think the performance of the new products are so significantly better than anything out there on the market, if anything they’ll have a positive impact at gross margin.

Operator

Next we move on to Brett Hodess in San Francisco as well.

Brett Hodess – Merrill Lynch

Hi, good afternoon, Rick I’m wondering if you could talk a little bit more about the new product momentum and mix and the impact on margins and sort of the profile for your revenues as we look through the year with a high mix early in the year that you can’t recognize revenues on, that means that you have more revenues in the early part of the year from the older maybe little bit lower margin products and then maybe later in the year we’ll [fact] to recognize these and recognize the higher margins that these things are getting? Is that how we should be sort of looking at the year?

Rick Hill

That’s how I would model the year Brett. The reality is we’ve gone through and been working very, very hard over the last 18 months to really take a hard look at all of our products and drive their performance. We were very heartened in the fourth quarter by the acceptance of these products by some of the toughest customers in the world and we believe it gives them a substantial performance edge and cost edge that’s being really understood and envisioned across the board in the customer base, the significant value that we’re bringing to the market. And definitely from a standpoint of our ability to be able to maintain price, because of the designed in performance characteristics, is greater with this set of products.

Brett Hodess – Merrill Lynch

Okay, thanks.

Operator

Next question will come from Gary Hsueh with, in San Francisco.

Gary Hsueh – Oppenheimer & Co.

Hi, can you hear me? Thanks for taking my question. Rick, just a quick question, you mentioned that your gross margin was adversely effected by valuation write downs, what would have gross margin been ex those write downs? And a second question just relates to a product you didn’t talk about, CMP, any of those write downs related to CMP and what’s the strategy going forward here looking at a fresh year in 08 on CMP?

Rick Hill

Yeah, it was about a half a point impact on the gross margin and yes there was some related to CMP.

Gary Hsueh – Oppenheimer & Co.

Rick would you care to elaborate on what that write down and the evaluation unit might mean for the CMP business in 2008 and if that’s a part of the step down in op ex that you alluded to getting to $110 million per quarter?

Rick Hill

If we call them out as a special restructuring charge then we’ll elaborate on them, otherwise its part of an ongoing operation.

Gary Hsueh – Oppenheimer & Co.

Got it and then just what’s the roadmap to $110 million per quarter in op ex, is that a [stem] function down in one quarter or is that gradual over two years, one year, try and give me a sense on the profile.

Rick Hill

It’s on its way to that number already. We’ve made substantial changes both from a structural standpoint as well as an operational standpoint to hit those targets. We’re not at it right now but I suspect to be at it certainly by the end of the second quarter.

Gary Hsueh – Oppenheimer & Co.

Okay great, thanks a lot.

Operator

Moving on we move to Jim Covello in New York.

Jim Covello – Goldman Sachs

Hey guys, thanks so much, Rick, you know question you talked about the Vista demand being good and [unintelligible] drives demand potentially coming in, you know the demand seems pretty good across the board but it’s the supply that’s hurting us, how much more do you think supply needs to get cut before we can find some kind of balance?

Rick Hill

Well I don’t think, unfortunately, I don’t think you’re going to cut the supply as you’re just going to have demand continue to grow so that you sap up that supply and I think one of the things that you do see today is there are some people who are spending and then there is a large contingent that have completely shut off capital expenditure and I think that as we can drive demand, which I do believe will accelerate, DRAM in particular, more so than flash, [audible beep overlay] expand, I think you will see that get sapped up relatively quickly which will have prices come back, you’ll have the guys that have continued to spend make some money and then you know we’ll have another round of significant investment.

Jim Covello – Goldman Sachs

If I could just ask a follow up on that, do you think, so it’s a point well taken about the capacity is not going to come down you kind of have to grow into it but hopefully the capacity growth can slow. Do you think it’s more likely from here that [audible beep overlay] really cut a lot will cut more or those one or two guys that are still spending very aggressively maybe in an attempt to gain share or hurt the competition would eventually slow down themselves, because that could really help the cause in terms of finding a balance.

Rick Hill

Yeah, I think that in this particular business, you’re going to see those that are strong get stronger and those that are weak get weaker.

Jim Covello – Goldman Sachs

Okay, that’s helpful, thank you very much.

Operator

Going to Steven O’Rourke in New York.

Steven O’Rourke – Deutsche Bank Securities

Thank you, good afternoon. Rick I think at the mid update you mentioned that you thought that cap ex would be flat to up in 2008. With the recent developments, how do you see it now?

Rick Hill

You know, I think we said we thought it would be flat, right? But I don’t remember exactly. We thought it would be flat. I’m still not ready to give up on flat for the complete year, I definitely think if I look at where we’re exposed the largest, we will tend to be those capital expenditures are the people that we largely supply to is tending to look more flat to up than flat to down.

Steven O’Rourke – Deutsche Bank Securities

How do you see a spending dynamic from the foundries kind of playing out throughout the year?

Rick Hill

I think that the foundries are ratably increasing capacity. I think there was been a lot of constriction of foundry capacity over 2007, actually a lot more than I can figure out how it can be constricted given the number of players who have decided to go FAB light, ultimately that technology has to be produced somewhere. So I’m a little dismayed that the capital expenditures haven’t come out a little bit more quickly, so I anticipate we could see in the first quarter and the second quarter a little bit of an uptick from the foundries. That would be my expectation, but I haven’t had anybody walk in my door and say gee here’s a big checkbook, just write the size check you’d like.

Steven O’Rourke – Deutsche Bank Securities

Fair enough and lastly, how much of your business is turns?

Rick Hill

We don’t really disclose that number and I prefer not to, but it’s probably three times what it used to be.

Steven O’Rourke – Deutsche Bank Securities

Fair enough, thank you.

Operator

Pardon me for pronunciation, we have Mahesh Sanganeria [audible beep overlay].

Mahesh Sanganeria – RBC Capital Markets

Thank you, Rick you usually talk about PEC within, and this time I noticed you talking about STP, is there a change in the STP product, have you stopped losing the market share there? Is that stabilized? Can you give us an update on that one?

Rick Hill

Yeah, actually I did talk about PECVD, I should have talked about strip, it’s just I don’t want to just name everything, but clearly within PECVD and in HDP, our organizations have done an absolutely phenomenal job in increasing the performance of these products in a very, very difficult technical environment. We’re pushing some of the limits for a lot of these applications and I think we’ve been able to demonstrate over the last three to four months some pretty significant technological advances that I think position us extremely well in both of those products. Now clearly in the area of PVD, technologically, we’ve always had the lead in that particularly area, we’ve stumbled on ourselves a few times. I think that’s behind us.

I think in the area of strip that we talk about, everyone knows that if you’re really concerned about silicon loss and particle performance, you’re into our strip system. If that’s not a concern for you, you can buy a paint scraper and take of photo resist. But the reality is, I think from a technological standpoint, this last year, we’ve done a very, very good job of regaining our focus on product execution and we’ve begun to see the fruits of that in the bookings for the fourth quarter, again bookings support in the first quarter and I think follow on production as the industry begins to ramp.

Mahesh Sanganeria – RBC Capital Markets

Just a quick follow up on the HDP breakthrough you talked about. Is that directed towards [logic] application or memory [applics] and is it towards a specific application or across the board?

Rick Hill

HDP is pretty much across the board but certainly memory has the greatest advantage for it.

Mahesh Sanganeria – RBC Capital Markets

Okay, thank you.

Operator

Next from Dallas we have a question from Patrick Ho.

Patrick Ho – Stifel Nicolaus & Company

Thanks a lot. Rick, you know I think a lot of us know that a lot of the issues with memory have arisen on the DRAM side of things, can you give us an update what you’re seeing on the NAN flash side?

Rick Hill

From a standpoint of supply and demand?

Patrick Ho – Stifel Nicolaus & Company

Supply and demand and how your customers feel on that front.

Rick Hill

Yeah, I think that as I have been for at least the last two years, I’m still very bullish on NAN, I believe my customers are very bullish on NAN and even suppliers of NAN in general are extremely positive on NAN.

Patrick Ho – Stifel Nicolaus & Company

Any near term changes, do you feel that the investment ramps that we’ve heard about, do you feel confident about [audible beep overlay] as opposed to the ones on the DRAM side of things?

Rick Hill

I feel very comfortable about them. I really think with NAN flash, we’re just beginning to see a real explosive use of NAN flash. I mean you can never predict the future but I think within the next 18 months you’ll see us all buying desktop computers with flash hard drives and a portable disk drive as opposed to buying it the opposite way.

Patrick Ho – Stifel Nicolaus & Company

That’s great, in terms of your margin profile, it looks like you guys are actually holding a [audible beep overlay] lot in potential downturn [audible beep overlay] in the past, what’s the biggest lever over the next few quarters that will prevent you from having the swings that you’ve had in the past?

Rick Hill

Are you talking about on a gross margin basis?

Patrick Ho – Stifel Nicolaus & Company

Yes.

Rick Hill

I think that operationally we’ve honed our organization, we’ve really done a good job with inventory, I think that’s been one of our major areas and also from a standpoint of warranty and installation expense. That’s the last thing that I think dramatically hurt us in a previous downturn and I think we have that well under control and so I don’t see that coming back up and biting us. The real big key is value and it always has been. We’re focused on trying to sell the customer, deliver to them as much value as possible, that should help us control pricing a little bit more and as a result be able to maintain our margins.

Patrick Ho – Stifel Nicolaus & Company

Great and a final question, what’s the tax rate we can look for in 2008?

Rick Hill

32 is the best we can give you right at this time.

Patrick Ho – Stifel Nicolaus & Company

Great, thanks a lot.

Operator

Next we take a question from Timothy Arcuri.

Timothy Arcuri – Citigroup

Hi Rick, couple things, I guess first of all, it looks like your authorization of your buyback is just about used up. Is that correct? And what are your intentions going forward for the buyback?

Rick Hill

Well it’s not used up because we increased it by another $1 billion in October. We have close to $1 billion left.

Timothy Arcuri – Citigroup

Okay, with respect to the product line, if you just run, if you take the lower end of your bookings range and if you kind of run that through the P&L, you’re going to earn maybe $0.15 a quarter, roughly $0.60 a year. That’s pretty low and I guess when you think about the product line, not to say that you would earn that little a year, but when you think about the product line and how quickly the business might come back, what’s the decision tree to kind of get you to potentially pare back the product line over 2008 and 2009? Is there some [audible beep overlay] business that you or some kind of normalized earnings level that you are driving to?

Rick Hill

Well, we’re driving to a strategy first of all and that is to be a major player in the semiconductor capital equipment market and therefore you need a portfolio of products and clearly I think hidden in your question is the, gee what are you doing, you know are you guys going to get out of CMP. I can tell you that from an expense standpoint and the levels and the way we do R&D, I don’t believe that the amount of money we’re spending on CMP is greatly affecting adversely our overall P&L. There are areas where we can become more efficient.

We put in capacity back in 2000 as when everyone else did. We’re somewhat more adversely affected because we have it on the balance sheet. We do own it, but it is a non cash expense and as a consequence that is one of the reasons we have extremely good cash flow and will continue to have that. We will be consolidating some facilities and doing it in areas where we feel we can liquidate that real estate if that’s required and that will be one way for us to continue to lower our overall operating expense, but from a product standpoint right now, every product line except for CMP is at a critical mass and is adding positively overall to the bottom line.

Would we make a decision to pull out of that business? As I’ve said before we have both an offensive strategy for that business and a defensive strategy for that business. I think you see a little bit of the impact of applied exiting the INM plant business on their ability to defend against assaults. If you look at the ability of [varian] to drive that gross margin up with no competition, it’s one thing if your competitor doesn’t have other weapons they can use against your product, it’s another thing if you compete with them across a broad spectrum and we’re unique to a point in that way in that every time we don’t have a product to compete with them, we get ourselves into a situation where they can bundle and shift costs and so that’s the other consideration we have to have.

Timothy Arcuri – Citigroup

Okay I guess just one quick on Rick, when you talk about the op ex guidance for the year of driving toward $110 per quarter, is that including options expense or is that ex options expense?

Rick Hill

We call it GAAP.

Timothy Arcuri – Citigroup

Okay, great, thanks.

Operator

And that’s star one to ask a question, we move on to Jay Deahna in Newport Beach.

Jay Deahna – J.P. Morgan

Thank you very much, can you hear me? Okay, good afternoon Rick and Jeff. Rick with your revenue growth in 07 in the, looks like it was minus 5% range, looks like you under grew away from fab equipment by about 7-8% points, I presume that was because Taiwan was such a big spender in the DRAM side and you got a little limited exposure there. But I’m just wondering what do you think is the sustained growth rate of your company over time compared to wafer fab equipment in light of the fact that you don’t have exposure to lithography process control in some of the faster growing segments? And the other question I had is I thought Bill was a pretty good CFO, just kind of wondering what happened with that and what the strategy is to get a new CFO in place?

Rick Hill

Well, first of all, the new CFO right now in the chair is Jeff, okay and Bill was a good CFO but Bill has other ideas of what he would like to do and he’s going to go do that.

From a standpoint of growth, the reality is yes, we did under grow last year and you’re very accurate that it was due to the lack of exposure to the Taiwan DRAM manufacturers. We’ve made some progress in that area lately but until they come back and spend in significant volumes we won’t see that, but clearly we don’t have the exposure there that we do in other DRAM manufacturers. That has been by design in the past, it may have strategically been wrong but it was by design.

Our growth opportunity going forward though I think is pretty good for several reasons. Number one, when you look at the core of the business and what we focus on is that the heart of what the problem is in the semiconductor industry, you’ve got to get a return on assets, you’ve got to be able to have the most productive tools and I think it’s the area where our expertise is the strongest. And as more and more people find it more and more difficult to get money I think they’re more acceptable at really truly evaluating tools on a cost of ownership basis and I think we have a distinct advantage there.

So our goal as always is to try to grow 50% faster than the market. As you point out, if we don’t have full exposure to the market and you get an upturn, that can be difficult. On average, over 50% of the time we do in fact meet our goal of growing faster than the market in an upturn, 50% faster, and in a downturn, decreasing at half the rate of the market and I think we have the ability to be able to do that once again within this downturn. So overall, with a market growth profile of roughly 7%, that should enable us to grow somewhere around 10-12%.

Now having said that, we just had growth because of our ability to be able to gain market share and focus on the key technologies and values that the customer needs. In addition to that, however, we want to grow at our target rate which is 15% per year, we have to do some other things. One of those things we acquired Peter Walters, that’s helped us this last year to sort of mitigate some of the downside in the semiconductor business just as some of our competitors have mitigated their downside with flat panel business and solar business. Obviously the industrial product isn’t as dynamic as solar but it does help us mitigate the downturn. But in addition to that we’ve got to look for new opportunities and so that’s overall what we’re doing.

Jay Deahna – J.P. Morgan

Just a quick follow up Rick, if you look at the change in process steps at 45 nanometers versus say 90 compared to going to the adoption of copper several years ago, the significantly larger increase in transistor level steps versus the interconnect being a faster increase in the past when the industry went to copper, do you view that as a good phenomenon or a bad phenomenon for Novellus to achieve your share gain if you know what I mean? And then number two, when does memory adopt copper in a big way that could actually help you there given your dominance in electroplating.

Rick Hill

Right, good question. Certainly down at the transistor level, we’re not as engaged as we are in the interconnect level, but that doesn’t mean that we’re not engaged and in fact several of our products are keenly focused on key areas within the transistor level and certainly when you look at our strip product, it’s largely focused on the front end business as well as now PECVD and HDP. I think that from a, so we’re not 100% exposed there but we’re certainly I think have good exposure at the transistor level and will be increasing that exposure there. From the standpoint of memory going to copper, I think in a big way that will occur over the next 12-18 months. In fact I would anticipate 18 months from now 100% of capacity to be put in place will be copper.

Jay Deahna – J.P. Morgan

At every level or just the top one for memory?

Rick Hill

Every level.

Jay Deahna – J.P. Morgan

Okay, thanks.

Operator

And the next question comes from Ben Pang.

Ben Pang – Caris & Company

Thanks for taking my question. I have two questions. First in your comments on the kind of regional direction for orders, you commented that Greater China was strong and it continues to be strong but we’ve heard a lot of weakness coming out of Taiwan in terms of fourth quarter the orders seemed to be good but first quarter they’re going down. Are you seeing some increase in other parts of non-Taiwan Greater China?

Rick Hill

You know from a standpoint of Taiwan going down you’re referring basically to the DRAM purchases I assume.

Ben Pang – Caris & Company

Correct.

Rick Hill

Yeah. Clearly the DRAM market is a limited marketplace and I think you’re accurate in that front. Balancing off of that of course is the foundry which I articulated before, I’m a little perplexed that we’re not seeing a little bit strong investment levels from the foundries so I expect that could change in the near term. But yeah there are also anybody who is in the memory business that’s not a major competitor I think has a lot of duress, particularly in the DRAM. If you’re not in flash or you don’t have the ability to flex capacity between NAN and DRAM, I think there’s a lot of stress right now in that business and no matter where it is, whether it’s in China or whether it’s in Taiwan, that’s somewhat slow and sketchy business.

Ben Pang – Caris & Company

And the second question is, you are getting a lot of momentum from your new products. Is the lead time any different or your ability to do turns on the new products different?

Rick Hill

I wish it was but I’ll tell you we’ve learned to adapt and try to fill our customer needs and the guys have just done a spectacular job of adapting and so the lead times aren’t any different.

Ben Pang – Caris & Company

Thank you very much.

Operator

Next question comes from Stephen Chin.

Analyst for Stephen Chin – UBS

Hi, this is Jagdish here on behalf of Stephen. Rick I had two questions, the first question is you talked a lot about new product momentum. Can you help us understand how many percentage points of market share you hope to gain in the three areas of PECVD PVD and HDP in 2008 please?

Rick Hill

Well I’d rather not give you a number that I hope to but they’re good sized chunks, but I don’t want to outline my strategy on a conference call.

Analyst for Stephen Chin – UBS

Okay and as we compare, if you look at 2006 versus 2007, can you help us understand which product had probably the greatest increase in momentum in terms of your revenue sales. I know the [unintelligible] comes out sometime in March or April but can you help us understand that one please?

Rick Hill

Well now I’ll let that come out in March and April. Okay.

Analyst for Stephen Chin – UBS

Okay, thanks.

Operator

Next we have a follow up question from Timothy Arcuri.

Timothy Arcuri – Citigroup

Hi Rick, just a follow up on that product question I asked you. I wasn’t so much talking about CMP, I’m more thinking about you know how the market is changing and if you look at the companies that are really having the most success, they’re the ones who seem to be focusing on a smaller number of products and kind of doing it really well and I’m wondering, A, do you think that the market is changing, that customers don’t want a suite of products, multiple products, they want to buy the best products from the best vendor, and if so, I guess I’m trying to get at, what your decision tree would be or if it’s even on the table to get rid of to pare back some products like strip for example or some of the other non CMP products. Thanks.

Rick Hill

Yeah, again, every company has a different strategy and most companies would like a strategy that they can do more than one thing. Whether it be LAN, KLA, whoever, they certainly don’t want just a single product line. So in some cases they go into those products that wasn’t successful, they get out. I think we’ve demonstrated clear success in PECVD, HDP, electro fill, [audible beep overlay] we’ve had I would say modest success at PVD, I’d like it to be better. We’re doing things to make it better.

I think we’ve had very good success in strip, particularly over the last year in gaining market share. I think we could in fact continue to do that and even gain more market share as the requirements becomes more technologically driven than something anyone can do. We have not demonstrated success yet in CMP. I still feel we can be successful in CMP and the guys have made tremendous progress. We’ve had very, very positive feedback, but we’re not quite where we need to be yet and so I haven’t given up on it. But I don’t plan on going back to a single product strategy.

We plan to continue to build and grow the business. We’ve done it profitably now in the 15 years I’ve been here. Could we be more profitable, I think you can be for a short period of time, but the object is to be it for a long period of time. We believe in our product portfolio. We’ve been buying back the stock, we’ll continue to do that as part of our strategy and continue to try to drive the produce portfolio. To the extent we believe we can’t be successful at something, we’ll kill it in a New York minute.

Timothy Arcuri – Citigroup

Okay, last thing from me, Jeff, what’s the guidance for options expense, what do you think options expense will be in 08 roughly?

Jeff Benzing

About $0.02-$0.03 per share.

Timothy Arcuri – Citigroup

Great, thanks.

Operator

Next we’ll go to C.J. Muse in New York.

C.J. Muse – Lehman Brothers

Yeah, good afternoon, thank you for taking my question. Clearly in 07 the Taiwan DRAM or lack of leverage there worked against you but in 08 it looks like you’re leveraged to the right customers. So I guess my question here is, excluding share gains, how many points faster do you think you can grow than WFE?

Rick Hill

It’s a good question. We debate that internally all the time. I think that in the market segments that we compete in, we can grow probably we think we can achieve the 50% faster than the market in that arena or we’ll go down half as much as anybody else does in that arena and that’s the number that we try to drive to.

C.J. Muse – Lehman Brothers

And you think that’s achievable in 2008?

Rick Hill

I absolutely think it’s achievable in 2008.

C.J. Muse – Lehman Brothers

But is that including market share wins or not?

Rick Hill

That’s including some market share wins.

C.J. Muse – Lehman Brothers

Okay and then on your industrial applications group, it looks like that group grew 35% plus in 07, and I guess the question is, is that solely Peter Walters, have you added any sort of clip on acquisitions there? How should we think about growth in 2008?

Rick Hill

Yeah, in 2008 obviously that 35%, there’s a certain amount of that growth that’s due to Euros, so it’s not intrinsically 35%. But it is still substantial growth in 2007 and we anticipate the ability to be able to grow that at a similar rate this year but there are bolt ons associated with it.

C.J. Muse – Lehman Brothers

There were bolt ons in 07?

Rick Hill

No not in 07, there were bolt ons in 07.

C.J. Muse – Lehman Brothers

Okay so that was all organic?

Rick Hill

All organic. Organic with the company that was acquired the year before, [Lomar].

C.J. Muse – Lehman Brothers

Yup, okay and then final question, what is the share count you’re assuming within your EPS guide?

Rick Hill

105.

C.J. Muse – Lehman Brothers

Great, thank you.

Operator

There are no more questions in the queue at this time, I’ll turn things back over to Mr. Hill for any further or concluding comments.

Rick Hill

Well thank you for joining us for the conference call. [inaudible] Thank you.

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