Novellus Systems (NVLS) reported first quarter earnings that beat the Zacks consensus by 2 cents, or 1.9%. Revenue edged past the Zacks Consensus, exceeding by 0.8%. While gross margins suffered, cost containment on the opex side resulted in higher operating margins in the quarter.
The results were not too bad, but increased caution related to the the Tsunami in Japan and its impact on Novellus drove share prices down 4.27% in after-hours trading.
Revenue
Novellus reported revenue of $413.2 million, up 7.5% sequentially and 49.6% year over year, within management’s guidance range of $395-425 million.
Novellus stated that underlying demand in the PC market remains as strong as ever, as indicated by the results reported by Intel Corp (INTC) and Advanced Micro Devices (AMD). However, economic uncertainties are likely to hurt consumer purchasing power in the near term, which could impact demand for devices, such as smartphones and tablets. Additionally, demand in China has been hard to track and project, despite the fact that the market has been growing phenomenally.
As far as pricing is concerned, DRAM has been the weakest, dropping all through 2010 and this softness continued in the last quarter. Management currently expects DRAM demand to strengthen in the back half of the year. NAND pricing has strengthened considerably since the disaster in Japan due to fear of shortage. However, while this is a positive for memory makers, it is unlikley to convert into higher capex, given the fact that this positive is currently being outweighed by concerns related to inventory imbalances right through the semiconductor supply chain. Therefore, spending is likely to get pushed out until a more stable demand environment emerges.
While technology upgrades to 300mm manufacturing and 3x nm are sources of underlying strength at foundries, they too are unlikley to materialize in the current environment.
Revenue by Geography
Asia remained the largest contributor to Novellus’ revenues in the last quarter, with a 57% revenue share. Revenues from Asia were down 1.2% sequentially and up 25.4% from a year ago. The sequential decline was due to Korea, which went from 15% of revenue in the December 2010 quarter to 9% in the last quarter. The Greater China region remained the largest contributor, with a 40% revenue share, flat sequentially. Japan jumpeds from 4% to 8% of revenue.
Approximately 34% of revenue came from the U.S., which was up 46.2% sequentially and 95.6% year over year, reflecting the increased spending on semiconductor manufacturing in the country and Novellus’ strong position at the leading edge.
Europe accounted for the remaining 9% of revenue, which although down 25.6% sequentially was up 124.4% year over year.
Orders
Orders were up slightly (up 1.1% during the quarter) to reach $415 million. The year-over-year growth of 29.2% was encouraging. Year-over-year growth in orders has been very strong over the last six quarters, but growth rates are likely to moderate going forward. Novellus saw a couple of order pushouts from the second to the third quarter in the memory and logic areas, despite which, orders will be down next quarter. We estimate that backlog went up 12.2%. Novellus did not mention the lead time, so we assume that it remained at 12-16 weeks, slightly ahead of the normal 12-week range.
Margins
The pro forma gross margin for the quarter was 50.4%, down 64 basis points (bps) from the previous quarter’s 51.0% and in the middle of the guided range of 50.5% (+/- 1%). Mix changes impacted the business in the last quarter, offset by higher volumes that helped spread fixed costs. Gross margins have been expanding rapidly and are now almost at Novellus’ long-term target of 52-54%.
Operating expenses of $95.1 million were flattish sequentially and up 18.4% year over year. The operating margin was 27.4%, up 106 bps from 26.3% recorded in the previous quarter and up 747 bps from 19.9% reported in the year-ago quarter. In the last quarter, both R&D and SG&A declined substantially as a percentage of sales.
Net Income
Excluding the impact of restructuring charges and consolidation charges and a $1 million donation to Japan victims on a tax-adjusted basis, the pro forma net income was $97.5 million or 23.6% of sales, compared to a net profit of of 94.3 million or 24.5% of sales in the previous quarter and net income of $45.5 million or 16.5% of sales in the year-ago quarter.
Including the special items, the GAAP net income was $96.4 million ($1.04 per share) compared to income of $81.5 million ($0.89 per share) in the December 2010 quarter and $41.3 million ($0.43 per share) in the March quarter of last year.
Balance Sheet
Inventories increased 5.2%, with inventory turns increasing from 3.6X to 3.7X. Days sales outstanding (DSOs) went up from 61 to around 62. DSOs have been going up for a while now. Novellus ended with cash and short term investments of $638.5 million ($7.08 per share), down $32.7 million during the quarter. In the last quarter, Novellus generated $83.8 million in cash from operations, spending $5.0 million on capex and $200.4 million on share repurchases. Novellus has $340 million left under the current authorization plan to expire in October 2011.
Guidance
Management expects semiconductor capex spend to be up 10-15% this year (down from 15-20% previously), more in line with what market research firms were projecting. This is no doubt because of the uncertainties related to Japan.
For the second quarter, Novellus expects orders to be down 10-25%, with shipments dropping 0-10% sequentially. Revenues are also expected to slump, declining 10-20% to $330-372 million. Novellus also expects a gross margin of 50% (+/- 1%) and GAAP earnings of 65 to 80 cents a share based on a 15% tax rate and flat share count. This is significantly lower than the Zacks Consensus Estimate of $1.00.
Our Take
Novellus Systems is a beneficiary of the ongoing strength in the semiconductor market, which is being driven by the corporate PC refresh cycle, as well as strong growth in smartphones and other MIDs. This is pushing up demand and thus pricing for NAND components, resulting in technology purchases and capacity expansion by memory customers.
Both Gartner and SEMI had initially projected that semiconductor equipment sales would grow mid-single digits this year. Subsequently, SEMI forecasted much higher double-digit growth.
However, notwithstanding all the positives on the demand side, Novellus is being impacted by adverse conditions on the supply side, which is impacting equipment purchases. Therefore, while longer-term drivers remain, near-term concerns will continue to weigh on the shares.
Novellus shares have a short-term Buy rating (Zacks Rank #2).
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