Novellus Systems, Inc. Q2 2008 Mid-Quarter Earnings Update Transcript

Novellus Systems, Inc. (NVLS)

Q2 2008 Mid-Quarter Earnings Update Call

May 29, 2008 4:30 pm ET

Executives

Robin Yin - IR

Richard Hill - Chairman and Chief Executive Officer

Analysts

Edwin Mok - Needham & Company

Timothy Arcuri – Citigroup

C. J. Muse – Lehman Brothers

Analyst for Gary Hsueh - Oppenheimer & Co.

Brett Hodess – Merrill Lynch

Keith Lee - Morgan Stanley

Satya Kumar - Credit Suisse

James Covello - Goldman Sachs

Mahesh Sanganeria – RBC Capital Markets

Patrick Ho – Stifel Nicolaus & Company, Inc.

Benedict Pang - Caris & Company

Elliot Glazer – [firm inaudible]

Presentation

Operator

Welcome to Novellus’ second quarter 2008 mid-quarter update conference call. (Operator Instructions) I would now like to turn the conference over to Ms. Robin Yin of Novella Systems.

Robin Yin

Good afternoon everyone and thank you for joining the Novellus Systems second quarter 2008 mid-quarter update conference call. Joining my on the call today are Rick Hill, Chairman and Chief Executive Officer, and Jeff Benzing, Chief Administrative 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 second quarter of 2008, and our 2008 financial model. We caution you that forward-looking statements are projections and expectations regarding future events.

They involve risks and uncertainties that could cause actual results to differ materially from the results contemplated. Information concerning these risks are contained in our filings with the Securities and Exchange Commission, including our Form 10-K for fiscal 2007, our Form 10-Q for the first quarter of 2008, and our current report on Form 8-K. Forward-looking statements are based on information as of May 29, 2008, and we assume no obligation to update any of these statements.

Rick Hill will begin today’s call with comments on the business environment followed by an update of our first quarter 2008 financial outlook and guidance and then open the call for the question and answer session.

And now I will turn the call over to Rick.

Richard Hill

As Robin stated, I will provide you with a little view of the business and then go into what our guidance is. Overall the business has not really changed from our first quarter call that we made around a month ago. The foundry business remains at a modestly low level and the memory remains at a modestly low level.

By modestly low level I mean that we have seen levels lower than we’re currently at, but we do not see a robust spending to expand capacity at this time. On a geographical basis, I would describe the U.S. as weak, Japan weak, Korea weak, basically all geographical regions as weak. Weak is characterized by selective filling out of capacity for expansion but no major expansions taking place and new FABS and also selective technology buys, particularly customer-to-customer. Some customers are investing heavily in technology while others are not investing heavily in technology.

There have been some changes in the marketplace from a standpoint of different members or different customers of ours entering into new alliances, but we cannot assess the change that that will have on overall spending patterns at this time.

There have been no material changes in the ability of our customers to secure financing, so once again, cash on the balance sheet and free cash flows are the best leading indicators of the ability for capacity expansion in our customer base.

Therefore, the second quarter guidance remains unchanged from our previous guidance given on April 21, 2008, and I will reiterate what that guidance was for you. Regarding booking, the guidance remains unchanged at (10%)-(25%) quarter-over-quarter. Shipments will range from $235 million-$260 million. That’s down (17%)-(25%). Revenues will range from $245 million-$260 million. Gross margins, again, they will be approximately 46% on a pro forma basis, excluding one-time charges. And earnings per share will range between $0.01-$0.05 pro forma, excluding one-time charges, and on a GAAP basis will be somewhere between ($0.06)-$0.00.

We continue to manage the business prudently. We’re driving for a one-to-one book-to-ship ratio and we feel this will allow us in this slow period to maintain profitability and positive cash flow.

Now with that I would like to open it up for any questions you might have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Edwin Mok with Needham & Company.

Edwin Mok - Needham & Company

One question I have is regarding the memory spending. Some of your competitors talk about potentially some memory pushed out in this quarter. Have you seen that?

Richard Hill

We have not seen any incremental push outs during this quarter.

Edwin Mok - Needham & Company

Any change in the spending plan or any color you can provide in terms of IDM either for this quarter or for the rest of the year.

Richard Hill

None that we see at this time, no changes. And we really only talk about this quarter rather than through the full year, so I can’t comment on the rest of the year. But no changes from what we anticipated at the beginning of the quarter and what we see now.

Operator

Your next question comes from Timothy Arcuri with Citi.

Timothy Arcuri – Citigroup

We have basically one month left in the quarter and yet there is still a big range to the bookings guidance and I’m wondering, you know, usually you tend to tighten the range on the mid-quarter, so I’m wondering if we can read anything into that given that it’s still a pretty big range for only one month left in the quarter.

Richard Hill

Not really, if I were going to tighten the ranges I would probably be a little bit more optimistic, but I chose not to be.

Timothy Arcuri – Citigroup

Secondly, we’ve heard some chatter recently about there being some pick up in DRAM design activity, so not that they’re spending more money, but that some of the skippage of, some of the 70nm transition, that they’ve kind of gotten through that and they’ve now moved onto taping out some kind of early 62nm-65nm designs. Have you seen any sort of that chatter amongst your DRAM customers?

Richard Hill

You know, we’ve characterized the DRAM market as an extremely competitive environment and we believe that there are some very healthy competitors that have great technology that are going to continue to push that technology to gain market share and continue to grow. So what you say is consistent with what we also see in the marketplace, so there’s really no new chatter or no new news on that.

Timothy Arcuri – Citigroup

Do you have any update in terms of some of the OpEx targets that you have given, you know, later on this year? Are you on plan? Are you a little bit ahead of plan?

Richard Hill

We will be on plan of $110 million at the end of the quarter.

Jeffrey C. Benzing

As a run rate. Going forward. Exiting run rate going forward.

Timothy Arcuri – Citigroup

$110 million run rate as of the end of June quarter.

Jeffrey C. Benzing

That’s right. Exiting, which means that’s what you would expect on a go forward basis.

Timothy Arcuri – Citigroup

Okay, so we should expect a GAAP OpEx of $110 million in the September quarter, or maybe even a little bit better.

Richard Hill

We won’t comment any more than our target was to be at $110 million run rate at the end of Q2 going into Q3 and we will be at that or better.

Operator

Your next question comes from C.J. Muse with Lehman Brothers.

C. J. Muse – Lehman Brothers

Rick, I’m intrigues by your, you said you would tighten and if you had you would be a little more optimistic. Is there one particular area where you’re seeing a little bit better strength?

Richard Hill

No, it’s just that I think we have a fairly good view of what’s transpiring in the market and what’s likely to come in. But my people keep trying to hold me back, so I try to keep it as wide as possible so we don’t disappoint you.

C. J. Muse – Lehman Brothers

And if I could revisit the cost-cutting front. Can you talk a little bit maybe about what your thoughts are on the second half, in terms of further rationalization or other places where you could have room to go?

Richard Hill

Well, we continually try to drive our costs down. At the same token, we’re continuing to drive to win market share and we believe that overall the market needs to improve. I’ve said before that based on utilization rate I am anticipating that we should see somewhat of a rebound in the foundry business and I’m confident that at least on a selective number of memory manufacturers you will begin to see increased capacity expansion there as well. Both for DRAM and for Flash.

C. J. Muse – Lehman Brothers

In your industrial business you’ve seen volatility in the last two quarters. How should we think about that for the June quarter?

Richard Hill

As we said in Q1 we had a little bit of a slippage due to some revenue recognition issues. That will be made up in the second quarter, as we had stated before. That business has a fairly nice profile associated with it. The third quarter has historically been, you know, a slow quarter in the industrial business, but overall that business is solid and on a growth curve.

Operator

Your next question comes from Analyst for Gary Hsueh with Oppenheimer.

Analyst for Gary Hsueh - Oppenheimer & Co.

DRAM price has been substantially improved in the last couple of months and also there are a lot of parts about foundries where projections are for double-digit next year. So, Rick, what’s your view on the second half of this year and do you see any recovery coming like sooner or later and what’s your outlook basically?

Richard Hill

We see the same numbers you’re tracking. There is some improvement in DRAM prices. That will have significant impact. Positive impact on certain DRAM manufacturers. We also see a firming in the Flash memory market, as well as new demand opportunities in Flash. And so overall we think that after a lull here, we should start to see a pick up. A selective pick up, with certain companies increasing their CapEx.

Those companies will be characterized as companies that have cash on the balance sheet and have some positive cash flow. It won’t be an industry-wide pick up, we don’t believe. But that’s the best visibility we can give relative to the memory.

We’re subject to the same data you’re subject to and so we only try to assess what we’ve seen in the past and what we think might logically happen. There’s always something that could happen out of the blue. The biggest constraint for an overall industry recovery is basically financing available for a broader section of the market.

In the foundry area, we’ve said that we’re a little bit surprised that foundry hasn’t rebounded sooner than it has and we do see that it’s at a very high utilization rate and should be right to see growth in the latter part of the year. But it’s very, very difficult to forecast as they’re using extremely good discipline in controlling their capacities.

Analyst for Gary Hsueh - Oppenheimer & Co.

Recently we’ve seen more companies talking about moving to copper back-end. Actually there are some stats that plan to do exclusive copper for the back-end. Any others pick up in the copper side of your products?

Richard Hill

As I’ve said before, by the middle of next year I think you will see a vast majority of all Flash being at copper and within another year you will see a vast majority of all DRAM being at copper.

Operator

Your next question comes from Bret Hodess with Merrill Lynch.

Brett Hodess – Merrill Lynch

I’m wondering if you can talk a little bit longer term about beyond getting the cost down to the $110 million this quarter. What the plan is. I think in the past you’ve talked about keeping the operating expenses in this level until you get back to a certain revenue run rate. Can you share a little bit about your thoughts on that at this point?

Richard Hill

Yes. What we had said in the past is that we were taking our operating expense to $110 million. We hold them to $110 million to roughly $400 million in quarterly revenues. That would be our target. And then we would constrain their growth substantially such that it didn’t grow nearly at the rate of revenue growth beyond that.

Operator

Your next question comes from Keith Maliq with Morgan Stanley.

Keith Lee - Morgan Stanley

Rick, you alluded to a consolidation in the DRAM space and historically Novellus has had a relatively weak share in the tier-two [inaudible] DRAM makers. I know with the Micron kind of aligning with Nonya and potentially [inaudible] going with Qimonda. How do you see your market share in the DRAM market? Are those changes net positive, negative, or neutral for Novellus’ market share?

Richard Hill

Well, from a standpoint of how these consolidations play out for us, the best thing that plays out for us is really whether or not there is capital available for people to spend. So to the extent that we have a strong DRAM price and our customers can make money, that’s the number one factor which will determine the amount of capital that’s brought in place. And so until you see that change, that would be the number one variable that would affect our ability to be successful in those businesses.

Second after that is their ability to get cash from another source, debt financing or equity financing. That would be the other thing that would stimulate growth in those areas. From a technology base I think some of the new alliances are a net positive for us.

Operator

Your next question comes from Satya Kumar from Credit Suisse.

Satya Kumar - Credit Suisse

Can you explain how you are planning to keep your OpEx flat at $110 million, even if revenue ramped to $400 million? In looking at the model, you did a pretty good job maintaining R&D flat. What changes are you making to the business?

Richard Hill

I guarantee you it won’t scale this time around.

Satya Kumar - Credit Suisse

Can you say what you are doing different with the business?

Richard Hill

No, I won’t give you any more detail other than we will not allow it to expand.

Satya Kumar - Credit Suisse

If you look at your business, at peak revenue run rates three years ago until now, revenues are down about 40%, give or take. Can you help me understand how much the [inaudible] and a portion of your revenues have tracked over the last four years? [inaudible].

Richard Hill

I think you can get that information, from a standpoint of service we don’t break it out. But I think that right now, when you look at our industrial business you can pick that right out of our 10-Qs and 10-Ks and so you can see that number directly. But it’s still a small enough portion of the business that what you see from a downward trend or 40% from peak is in fact, the majority of it in the semiconductor business. And it’s from a system standpoint.

Operator

Your next question comes from Jim Covello with Goldman Sachs.

James Covello - Goldman Sachs

I’m curious if you have any preliminary thoughts on what 2009 CapEx could shape up to be. Historically some equipment downturns have typically lost it for more than a year so I’m curious whether you have any thoughts, what would have to happen for 2009 to be another down year or whether you think we will have gone through enough of a correction this year for 2009 to be up meaningfully.

Richard Hill

It’s difficult to project 2009. It’s difficult enough in these days to predict the next quarter. But as I said before, I think that when we look at the utilization rate of foundries and we look at what’s happening in the DRAM marketplace, it tends to make you believe that we will shortly pass a point where there will be a shortage of supply. And at that point we should see a further acceleration in prices and as a result the profitability should come back to these businesses and we should see a resumption in capital expenditure.

It would be hard to conceive that that wouldn’t occur in 2009, if not earlier.

Operator

Your next question comes from Mahesh Sanganeria from RBC Capital Markets.

Mahesh Sanganeria – RBC Capital Markets

You mentioned that in the past four weeks your business has not essentially changed. How should we reconcile that and the comments like the systems are going to be down 40%? Have you seen signs of market share expansion [inaudible]?

Richard Hill

It’s tough for me to comment about their business. It’s tough enough for me to just watch my own, but what we say is what we see is happening. We do believe in some areas that we are gaining market share and we think we have a strong portfolio of products and new products, some of which will be out at Semicon and we think this bodes will for us going forward.

Operator

Your next question comes from Patrick Ho with Stifel Nicolaus.

Patrick Ho – Stifel Nicolaus & Company, Inc.

You mentioned that memory remains modestly at low levels right now, which I don’t think is a big surprise. Incrementally do you see any differences between both DRAM as well as NAN Flash in that assessment?

Richard Hill

I think they’re both very similar. DRAM probably a little worse than NAN, but both modestly low levels at this juncture.

Operator

Your next question comes from Ben Pang with Caris & Company.

Benedict Pang - Caris & Company

Rick, you’ve often commented that the key is the profitability for your customers. Given that you are seeing some stabilization in some of the memory prices, do we still have a lot further to go before you can see better profitability for your customers?

Richard Hill

Well, for some we don’t have to go very far and I think you’ll see very, very strong profitability. There’s also a dynamic, tremendous competition in this marketplace, where some customers have a substantial cost advantage and at least over the next six to nine months, a technological advantage that I think you will see continuing to get utilized in gaining market share. And so I do believe that there will be selective customers that will come back and show strong profitability in the near term. But if you look at the broader market, I think there will still be some companies that will lag and not be able to achieve the profit they need to because their cost structure is high relative to the best in the industry. So that’s how I see it playing out.

Operator

Your last question comes from Elliott Glaser with [inaudible]

Elliot Glazer

There is an industry group called Semi and Semi is going to some detail of their 2009 forecast as follows, by geographic region, they see Japan and South Korea in 2009 in terms of capital spending negative single-digits, but they see Southeast Asia and Taiwan in 2009 over 2008, up 50% and 80% respectively. Is there any comment or thoughts on that?

Richard Hill

I could only hope that Southeast Asia and Taiwan would be up 50%-80%. They have some pretty good numbers usually and some pretty good insight so that would be an optimistic note for me. I haven’t seen that at this point. Relative to Japan and South Korea, I could believe it in Japan; I tend to think that South Korea would be up. So that would just be my gut reaction to those numbers.

Operator

We have no further questions in the queue so I would like to turn the call back over to management for any additional or closing remarks.

Richard Hill

Thank you very much for joining us in our mid-quarter update. We are looking forward to talking with you at the end of the quarter and for those of you who will be coming to Semicon West, sharing with you some of our new and advanced products that are coming out to the marketplace. Thank you very much. Look forward to talking to you again.

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