Novellus Systems, Inc. Q4 2008 Mid-Quarter Update Earnings Call Transcript

| About: Novellus Systems, (NVLS-OLD)

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

Q4 2008 Mid-Quarter Update Earnings Call

November 20, 2008 4:30 pm ET

Executives

Robin Yim - Investor Relations

Rick Hill - Chairman and CEO

Jeff Benzing - EVP and Chief Administrative Officer

Analysts

Timothy Arcuri - Citi

Satya Kumar - Credit Suisse

Brett Hodess - Merrill Lynch

Gary Hsueh - Oppenheimer

CJ Muse - Barclays Capital

Mahesh Sanganeria - RBC Capital Markets

Krish Sankar - Bank of America

Ben Pang - Caris & Company

Mary Lee - Stifel Nicolaus

Atif Malik - Morgan Stanley

Jay Deahna - JPMorgan

Jim Covello - Goldman Sachs

Operator

Welcome to the Novellus' fourth quarter 2008 mid quarter update conference call.

(Operator Instructions).

I would now like to turn the conference over to Ms. Robin Yim of Novellus Systems. Please go ahead.

Robin Yim

Thank you, Stacey. Good afternoon everyone and thank you for joining the Novellus Systems fourth quarter 2008 mid-quarter update conference call.

Joining me 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 capital equipment spending and industry conditions, the demand for and competitiveness of our products, and managements projected bookings shipments, revenues, gross margins, tax rates and earnings per share targets for the fourth quarter.

We caution 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, second and third quarters of 2008, and our current reports on inform 8-K. Forward-looking statements are based on information as of November 20, 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 fourth quarter 2008 financial outlook, and guidance, and then he will open the call for the question and answer session.

And now I will turn the call over to Rick.

Rick Hill

Thank you, Robin. Good afternoon, ladies and gentlemen. As you all know, things continue to get worse in the general economy and particularly bad in the memory business. Normally during the year-end quarter, we expect to see a surge in bookings prior to year-end. This year given the economic uncertainty facing our customers, we are worried that will not be the case.

The fourth quarter guidance has been lowered as a result of continued weakness in the macroeconomic environment and here's our revised guidance.

For bookings we are lowering the guidance range to down 25% to 35%, compared to previous guidance of down 15% to up 5%. Bookings have continued to drop after I returned from Asia this Tuesday. The lowered guidance is the result of broadband memory push outs worldwide, a reduction in spares demand due to lower utilization levels, and a sharp downturn in our industrial business in the last week, which has been exacerbated by a weakening euro. Visibility in bookings is extremely poor in this environment and it is expected to remain volatile.

We are also lowering the guidance range of shipments to $185 million to 200 million, compared to previous guidance of $220 million to $245 million. We have lowered shipments to balance loadings and spending in the factory during these uncertain times. As a result of lower shipments the guidance range in revenue has been lowered to $207 million to $217 million, compared to previous guidance of $230 million to $243 million.

Gross margin is now forecasted to be approximately 42%, compared to previous guidance of 43$ to 44%. This is due primarily to lower absorption of fixed overhead. And our earnings per share will range from flat, zero, to a loss of $0.06, compared to previous guidance ranging from $0.03 positive to $0.03 negative, or breakeven.

So, you can see that our outlook for the fourth quarter is weakened, since our initial guidance was provided on October 15. I might add that it has weakened within the last week. With continued weakness in the outlook of our business, we are preparing additional cost cutting measures, which will result in further costs to be incurred during the quarter.

Also given that our stock has been trading below book value during the fourth quarter, we are evaluating whether the carrying value of our goodwill and intangible assets is impaired. Potential charges resulting from restructuring and goodwill impairment are not included in the guidance numbers I just provided, and we will not disclose any further details in the call today as actions are being evaluated at this time.

That concludes my summary of the updated guidance and forecast, and now with that, I'd like to open it up for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions). We'll go first to Timothy Arcuri with Citi.

Timothy Arcuri - Citi

A couple of things. I guess first of all, you talked last quarter about breakeven being at about the 210 level exiting the year. Given the new guidance, I am wondering what your thoughts are on kind of where you want to take breakeven.

Rick Hill

Okay. Thanks, Tim. Last quarter, I believe we said our cash breakeven was $187 million. And we will continue to lower that breakeven number based on our outlook for the marketplace.

Timothy Arcuri - Citi

Right. I guess I was talking about P&L breakeven. And I was wondering if you can give us some idea of the magnitude that you might be willing to take that down given what's going on.

Rick Hill

As I said just a few minutes ago in my comments, given we are evaluating all the potential action and we don't have those solidified at this moment, I won't discuss them any further.

Timothy Arcuri - Citi

Okay. And then, Rick, just last thing from me. One of your primary competitors about a week ago actually reported bookings that were up very, very sizably actually and they kind of pointed to some memory orders that came in that they thought that others would take in the December quarter, which seems exactly the opposite of what you're saying.

So I'm wondering is there a difference out there in terms of market share that's going on or maybe some of your peers taking bookings that in fact you're not taking? What do you think is going on?

Rick Hill

Well, one of the things that we are not doing is we are not taking extraordinary terms on bookings from a standpoint of extended payment terms and loans. And as a result, bookings that might occur in the latter half of 2009 we are not trying to go out and book and give terms that pay in 2010. So that is a major difference.

Timothy Arcuri - Citi

Okay, Rick, thanks.

Operator

We go next to Satya Kumar.

Satya Kumar - Credit Suisse

Hi. Thanks, Rick, for taking my question. Rick, I guess it's a tough environment out there, but is there anything that you can share with us on the market share front? Are you making any progress on the CVD side in particular with your newer products? How is the market share environment right now?

Rick Hill

Well, I think that from a market share standpoint, as we've said, we believe that we are taking market share particularly in the area of PECVD. We also believe we continue to maintain our market share in the Electrofill business, and we will gain market share in the PVD business.

In this particular time, in this particular period, given the uncertainty that the customers have, there is a great uncertainty on whether all our customers will survive and there is a lot of uncertainty that those that are still profitable, when they are phasing-in in investment. And we are not in a hurry to book an order to de-book an order later.

Satya Kumar - Credit Suisse

And secondly, Rick, on the cost reductions, you guys have fairly compatible gross margins versus your peers, but on operating margins, clearly there can be room for improvement to bring it more in line with your peers. As you are looking at these cost reductions, can you give us some color on the magnitude or the scale at which you're thinking about improving these costs?

I would think that for example, the OpEx could be lower maybe around the $70 million, $80 million level, which would be more commensurate with the 70 levels. Are you still committed to other programs like CMP and PVD which might be lower in revenues? How are you thinking about prioritizing those aspects as you are thinking about cost reduction?

Rick Hill

Well, as I just said a couple of minutes ago, I can't discuss any of the restructuring at this particular time, although we are evaluating various alternatives. As I said last quarter, our cash breakeven was 187. And as I just said a few minutes ago, we'll lower that breakeven lower than that.

Given this particular environment, our chief objective here will be from a standpoint of making sure that we preserve cash. So that is a major objective that we have going forward, and I think that we'll be successful in doing that.

Satya Kumar - Credit Suisse

Thank you.

Operator

And we go next to Brett Hodess with Merrill Lynch.

Brett Hodess - Merrill Lynch

Hi, Rick. On the new revenue shortfall and the fixed cost absorption, you are really only lowering the gross margin guidance about 100 basis points from the previous low end. I wonder if you can talk a little bit about why it is not a little bit bigger impact on the gross margin side and what you think happens with that as things stay weak here?

Rick Hill

I think that for one thing that we are highly outsourced from a manufacturing model, and we've been pretty adroit at shedding costs as we see the business start to come down. And there is a beneficial mix factor that offsets further absorption issues.

Brett Hodess - Merrill Lynch

Is that mix issue the fact that the industrial side is weak and that has a lot of cost and sales in euros then helps? And then also is there a semiconductor equipment side positive mix shift?

Rick Hill

There's a positive mix shift in the semiconductor side and the industrial business is really not a factor in that particular equation.

Brett Hodess - Merrill Lynch

Okay. And then final question, last week when we were talking with investors, you talked a little bit about memory adoption of copper. Now it's having just come back from Asia, is that on hold as well given how tough things have gotten?

Rick Hill

No, I don't think that's on hold at all.

Brett Hodess - Merrill Lynch

Great. Thank you.

Operator

We'll go next to Gary Hsueh with Oppenheimer.

Gary Hsueh - Oppenheimer

Hey, thanks for taking my questions. Just two quick questions; Rick on that revised order number, is that on a gross basis and should we be expecting any cancellations? It sounds like your backlog is relatively clean at this point.

Rick Hill

That is on a gross basis at this point and given the uncertainty in the market, we will be sure to be taking a hard look at backlog going forward. But at this particular time that's what we see the orders gross would be this quarter.

Gary Hsueh - Oppenheimer

Okay. And then gross bookings going down to roughly $150 million, maybe a little bit more there. Is it comprised of roughly around $40 million to $50 million in service or spares booking and the rest made up primarily of logic IDM? Is that basically the makeup of orders in Q4 now?

Rick Hill

We don't break out between spares and service and product bookings. We do aggregate them together because that's how we run the business. Needless to say, because of the fall off that we do see in utilization rates, you can anticipate that spares is a piece of that fall off and a substantial piece of that fall off as people idle equipment and some factories in fact cannibalize parts of other systems.

Gary Hsueh - Oppenheimer

Okay. Great, thank you.

Operator

We'll go next, CJ Muse with Barclays Capital.

CJ Muse - Barclays Capital

Yeah, hi, thanks for taking my question. I guess first question, could you find a little more color on the drop off in orders either by geography as well as segment?

Rick Hill

I think the drop off is purely memory, largely memory based and basically in Asia.

CJ Muse - Barclays Capital

Okay. And then secondly on the industrial side of things given the impact of the euro, how should we think about the run rate there looking into the first half of 2009?

Rick Hill

At the mid-quarter update, we don't take a look at 2009. On our conference call in January, we will be giving a forecast for the first quarter of 2009.

CJ Muse - Barclays Capital

Okay. I guess let me ask it in other way then. In terms of the (inaudible) euro, how should we think about the operating profits for that business this quarter?

Rick Hill

Just like the semiconductor business, we are looking at opportunities to bring down expenses commensurate with the fall off in revenue to maintain a cash break-even operating point with all our businesses given the turbulent economic conditions we are operating in.

CJ Muse - Barclays Capital

Great. Thank you.

Operator

We'll go next to Mahesh Sanganeria with RBC Capital Markets.

Mahesh Sanganeria - RBC Capital Markets

Thank you. Rick, going back to the Tim's question, the first question on Applied bookings; does that involve pricing and do you think that will impact your market shares since Applied is giving some attractive terms to some of the customers going forward in '09?

Rick Hill

I don't want to really discuss Applied. I'll discuss Novellus. But the reality is we've never been a large player in the Taiwanese memory manufacturing market. So, if there are losses in that marketplace, it's not really a loss to us; it's really they are maintain their market share in that particular market. But I don't know anything about their pricing as they probably don't know of anything about mine. So…

Mahesh Sanganeria - RBC Capital Markets

Okay. Just one more quick question, it's on Jeff. How do we model tax? We know that you have some kind of a minimum tax; could you just model something like if you can give us an idea of a million a quarter in positive taxes going forward or...

Jeff Benzing

Mahesh, the way that you should look at it is that year-to-date, in the first three quarters, we provided about $16.5 million in tax payments year-to-date. We don't expect that our full year tax provision will be any less than that regardless if we show a pretax loss in the quarter. Therefore, we are in essence projecting a zero percent rate in the quarter.

Mahesh Sanganeria - RBC Capital Markets

Okay. Thanks, Jeff.

Operator

We'll go next to Krish Sankar with Bank of America.

Krish Sankar - Bank of America

Yeah, thanks for taking my question. Rick, in this environment, are you taking a second look at your share buyback or is it still going per plan?

Rick Hill

If I thought the share price was good at $28, I got to think it's outstanding now. I really don't think that the current share price represents the value of Novellus and we have a buyback in place. We still have a large amount of money available to us to continue that buyback and the biggest factor will be availability of cash which we continue to generate.

Krish Sankar - Bank of America

Okay. And when you look into '09 or like pass this downturn, what do you think is going to take us, get us out of this downturn, do you think it is going to be foundry guys or is it the memory guys?

Rick Hill

I think the first thing is going to be the consumer. If we don't have consumers buying, we are not getting out of this downturn period. And while we have significantly issues relative to the semiconductor market, they are not in and of themselves inherent to the semiconductor market. They are definitely more a factor of the global economic condition today. And it's very difficult, if not impossible to project what's going to happen at this juncture.

Krish Sankar - Bank of America

Okay. Then just finally from me, when you look at the spares business, in this downturn do you think that a lot of your Asian customers are actually going to mom and pop shops in Asia get it at a cheaper price or it's nothing different from last time around in terms of the spares revenue?

Rick Hill

I think it's nothing different from a standpoint of competition in the spares market, in an attempt to do knock off spares, but from the standpoint of their utilizations and their ability to be able to sell at a profit, that will be more of a factor on their ability to fix machines.

Krish Sankar - Bank of America

Thank you very much.

Operator

We go next to Ben Pang with Caris & Company.

Ben Pang - Caris & Company

Thanks for taking my question. One question, in terms of your order guidance lowered, you mentioned two factors. Could you comment on which was a bigger factor, the industrial or the memory drop off?

Rick Hill

It was clearly the semiconductor business was a larger drop off.

Ben Pang - Caris & Company

Okay. Thank you very much.

Operator

We go next to Patrick Ho with Stifel Nicolaus.

Mary Lee - Stifel Nicolaus

Hi. Thank you for taking my questions. This is Mary Lee calling in for Patrick Ho. A few question, we know push out and shipment delays are prevalent in the industry right now, are you seeing even technology buys for next-generation nodes being pushed out as well and are most chip makers continuing to do R&D work or have they delayed these nodes being introduced?

Rick Hill

I think that technology buys, selective technology buys are still going on in the marketplace. I don't see a slowdown in the shift from aluminum to copper in the memory market. The filling out of capacity has slowed out in previous nodes, and there is a slowdown in the overall production rate in the industry as well.

Mary Lee - Stifel Nicolaus

Okay. And another quick question is, what other cost cutting initiatives are you exploring aside from workforce reductions? Are you evaluating long-term viability of some of your businesses given the current market conditions?

Rick Hill

As I said before, we are right now evaluating what we are going to do. And I will give no further color on that until the end of the fourth quarter, which will be in the end of January. And our cash breakeven was 187 and it will be lower than that by a fair amount.

Mary Lee - Stifel Nicolaus

Okay. My last question is has your Peter Walters business provided you any support for orders or revenues during the quarter to date?

Rick Hill

As I said earlier, we also saw a fall off in the European industrial business, particularly due to the automotive decline, also due to the precision bearing decline, that has been by the wind industry as an example, which has cut back. It's been a broad-based cut back and a very, very rapid and sudden cut back within Europe.

Mary Lee - Stifel Nicolaus

Thank you very much.

Operator

We go next to Atif Malik with Morgan Stanley.

Atif Malik - Morgan Stanley

Hi. Thanks for taking my question; Rick, a bigger picture question. Let's say this downturn is a long one, extended one. Can you give your thoughts on the room for consolidation in this space?

One of your peers, Tokyo Electron, mentioned on their earning that they have an increased appetite for M&A in the current environment given their balance sheet. In the past, Novellus and TEL have been speculated to be potentially in a tighter position. So can you give your thought longer term, if this is a long downturn, how different the landscape could look like exiting next year?

Rick Hill

Well, I think that there has always been rumors of Lam and Novellus, TEL and Novellus, every combination under the Sun. The thing that's true is, depending upon the extent of this downturn, the companies that are well-positioned with cash and the right customer mix are the most likely to the come out of it the strongest.

You need both cash and a good technology portfolio in order to be able to survive in this business, given the current outlook for it. But again, that could change depending upon what happens in the macroeconomic economy, because certainly semi-conductors aren't going away.

There will be a consolidation within our customer base. There is every reason to believe there could be consolidations within the equipment space.

But as you've seen, over the last 15 years that I've been here, it's been a very, very difficult task to do consolidations within the industry due to the specialized nature of the equipment and the competitive nature of the business as a whole. So, other than that, sort of big picture, that's about all I can say.

Atif Malik - Morgan Stanley

All right.

Rick Hill

Thanks.

Operator

And we go next to Jay Deahna with JPMorgan.

Jay Deahna - JPMorgan

Thanks a lot. Rick, good afternoon.

Rick Hill

Hi, Jay.

Jay Deahna - JPMorgan

Hi. You indicated that you were in Asia recently, and I presume you met with some of the big memory manufacturers. What are they telling you in terms of their expectations for solid state drives being adopted in a meaningful way into PCs?

Rick Hill

I think two factors, as I have stated before, and revolve around the right price point and the right performance characteristics, and that will be the key. But, of course, you got to have double-digit PC growth in order to be able to really have a robust marketplace that I think right now that's a problem, Jay.

Jay Deahna - JPMorgan

Okay. So do you suspect that this is an event that could potentially become meaningful for the equipment industry as a driver of equipment demand within the next two years or so or do you think it's further out than that?

Rick Hill

No, I don't think it's further out than that. I am hoping that it's certainly closer than that. But as you well know, it certainly depends upon the macroeconomics that we have.

Jay Deahna - JPMorgan

Okay. Do you get the sense from talking to them that the 32-gig NAND Flash device in volume production on 32-nanometers might create the right price point?

Rick Hill

I can't say that somebody has come out and made that prediction, no.

Jay Deahna - JPMorgan

Okay. And then last, but not the least, what do you see as a sustainable maintenance level of revenue for Novellus given kind of a minimalist level of spending in the chip industry in order to keep (inaudible) log going and just surviving as a chip maker?

Rick Hill

That's a very, very good question, a difficult one to answer. I think that there's tremendous capability to continue to restructure and recreate yourself to be able to adapt to the environment. I think we are getting down to maintenance levels at these levels but of course I've thought that when we were at higher levels as well.

But I think we have to be getting down toward the bottom based on looking when you look across the inventory in the channel and everything else, any kind of upturn will create a shortage in this particular environment. And then we'll be trying to respond very, very rapidly. But it's very difficult to say what will happen.

Jay Deahna - JPMorgan

And actual if I could one last one, when you talk to your customers top level executives, do you get the sense that right now they are just going into the bunker and putting everything they can on hold to see what demand looks like in the first half of next year and then decide at what pace to kind of get back to projects?

Rick Hill

If they are not in a bunker they are certainly in a trench, but that's a good observation.

Jay Deahna - JPMorgan

Thank you. Okay.

Operator

(Operator Instructions). We'll go next to Jim Covello with Goldman Sachs.

Jim Covello - Goldman Sachs

Great, thanks so much for taking the question. Just another way to ask the maintenance level question because that was kind of the angle that I was going to go to. How many customers do you have that are doing anything other than basic maintenance levels?

Rick Hill

There are a couple that are above maintenance levels.

Jim Covello - Goldman Sachs

Okay. And in what, is that memory or logic?

Rick Hill

A combination of both.

Jim Covello - Goldman Sachs

Okay. And then one just quick follow-up; I think you implied the tax rate would be sort of zero in the fourth quarter. Is that something that we think we could extend into 2009 or do you think you would start to get a tax benefit in 2009?

Jeff Benzing

I think that's a fourth quarter event given the structure that's had in place for the year. I think it gets trued up in those forward-looking in 2009.

Jim Covello - Goldman Sachs

I appreciate it. Thank you very much.

Operator

And this concludes our question and answer session. At this time, I would like to turn the conference back over to Mr. Rick Hill for any additional comments.

Rick Hill

Thank you very much for joining us on the mid-quarter update. I wish I had better news for all of you, but I'm sure it's been difficult for you as it is for us in this difficult environment and I look forward to better times going forward. Thanks again for your questions and your interest in Novellus. Thank you.

Operator

This does conclude today's conference. We thank you for your participation. Have a nice day.

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