Novellus Systems’ (NVLS) third quarter earnings beat the Zacks Consensus Estimate by 4 cents. Revenue exceeded the Zacks Consensus by 3.7%. Shares were up marginally by 0.99%, as guidance indicated uncertain demand.
Revenue
Novellus reported revenue of $367.2 million, up 14.3% sequentially and 107.6% year over year, better than management’s guidance range of $335-365 million. Management stated that Novellus continued to gain from the PC refresh cycle, as well as rapid growth in the smartphone market, which resulted in strong demand from NAND memory customers.
However, memory prices weakened during the quarter, indicating increased supply. Technology upgrades to 300mm manufacturing and 3x nm are driving strength at foundries.
Management stated that third-party comments indicated continued growth from smartphone and PC markets, with additional momentum from tablets that would compete against Apple Inc’s (AAPL) iPad.
Revenue by Region
Asia remained the largest contributor to Novellus’ revenues in the last quarter, with a 71% revenue share. Revenue from Asia was up 19.3% sequentially and 137.7% from a year ago.
The Greater China region was the largest contributor with a 36% revenue share, although revenue from the region declined 6.5% sequentially. Korea grew strongly from 21% of revenue to 31%. Japan’s revenue share increased slightly from 3% to 4%. Revenue from Asia has increased triple digits in each of the past four quarters.
Approximately 22% of revenue came from the U.S., which was up 4.7% sequentially and 52.2% year over year, reflecting the increased spending on semiconductor manufacturing in the country.
Europe accounted for the remaining 7% of revenue, flat sequentially and an 81.7% year-over-year increase.
Orders
Orders increased 5.7% during the quarter to $407 million. The year-over-year growth of 137.3% was the fourth straight quarter that orders grew triple digits on a year-over-year basis.
We estimate that backlog increased by nearly 16%, evidence that end demand continues to strengthen. Management 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
Pro forma gross margin for the quarter was 49.1%, up 30 basis points (bps) from the previous quarter’s 48.8%, at the low end of the guided range of 50%(+/- 1%). Gross margins in the last quarter benefited from higher volumes and there could be further movement toward Novellus’ 52% – 54% long-term target, if there are further volume increases.
Operating expenses of $85.8 million were up 2.4% sequentially and 18.9% year over year. The operating margin was 25.8%, up 301 bps from 22.8% recorded in the previous quarter and up 2,590 bps from -0.1% reported in the year-ago quarter. In the last quarter, both R&D and SG&A declined sequentially as a percentage of sales, while COGS was flattish. The decline in R&D was the most significant.
Net Income
Excluding the impact of restructuring charges and the consolidation of a German facility, the pro forma net income was $81.4 million or 22.2% of sales, compared to a net profit of of $63.5 million or 19.8% of sales in the previous quarter and net loss of $2.5 million or 1.4% of sales in the year-ago quarter.
Including the special items, the GAAP net income was $76.3 million (82 cents per share) compared to income of $63.3 million (66 cents per share) in the June 2010 quarter and loss of $4.0 million (4 cents per share) in the September quarter of last year.
Balance Sheet
Inventories increased 0.7%, with inventory turns incrasing from 3.3x to 3.8x. Days sales outstanding (DSOs) went up from 43 to around 49. Novellus ended with cash and short term investments of $594.5 million ($6.47 per share), up $39.6 million during the quarter.
In the last quarter, Novellus generated $82 million in cash from operations, spent $38 million on the repurchase of 1.6 million shares and $6 million on capex. Novellus has $643 million left under the current authorization plan to expire in October 2011.
Guidance
Novellus provided a very wide fourth-quarter bookings guidance of down 14% to up 10% sequentially due to uncertainty in end demand and the timing of customer orders.
Shipments are expected to increase 5-13% to the $380-410 million range, revenues to increase 0-5% to $367-385 million range. Novellus also expects gross margin of 50% (+/- 1%), GAAP earnings of 73 to 88 cents a share and non-GAAP earnings of 85 cents to a dollar per share.
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 very strong growth in smartphones and other MIDs. This is pushing up demand and thus pricing for DRAM and NAND components, helping fab buildouts and capacity expansion by memory customers.
Management comments indicate that foundries continue to generate growth, with utilization rates staying over 90% for the third straight quarter and expected to remain over 90% in the next quarter as well.
Both Gartner and SEMI expect the semiconductor equipment sector to grow triple digits this year. Novellus’ third quarter results and fourth quarter guidance indicate that the company is on track to deliver triple-digit growth (as projected by Gartner).
However, there is some caution regarding future growth, given the weaker memory prices (indicating increasing supply) and relatively weak demand for consumer PCs this holiday season. If memory customers reach equilibrium there will be a slowdown in capital spending in 2011 (as expected by Gartner and SEMI) and this would have a negative impact on equipment suppliers such as Novellus. As a result, some analysts have recently lowered estimates.
The company therefore has a short-term Hold rating (Zacks #3 Rank) on Novellus shares, similar to other equipment makers, such as KLA-Tencor Corp (KLAC), ASML Holdings (ASML) and Lam Research Corporation (LRCX).
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