Novellus Tops, Guides Conservative - Analyst Blog

Novellus Systems’ (NVLS) first quarter earnings beat the Zacks consensus by $0.03. Revenue beat by 3.8%.

Revenue

Revenue of $276.2 million was up 13.1% sequentially, 179.3% year over year and over the high-end of the revised guidance range. This reflects continued demand from foundries and increased expenditure on the memory side, driven by strengthening prices for NAND and DRAM. Management also stated that the current strength could be attributed to the PC refresh cycle, growing demand for cell phones (particularly smartphones) and the launch of other MIDs, such as Apple, Inc’s (AAPL) iPad.

Revenue by Geography

Asia remained the largest contributor in the last quarter, with a 68% revenue share, growing 8.3% sequentially and 512.6% year over year. This was the second straight quarter that revenues from the region grew triple digits on a year-over-year basis.

The greater China region accounted for the largest chunk, generating 38% of total revenue. This was followed by Korea at 26% and Japan at 4%. Revenue from Korea witnessed a substantial increase and the company appears to be taking share in the region.

Approximately 26% of revenue came from the U.S., up 40.1% sequentially and 54.5% year over year, reflecting a very encouraging trend for semiconductor manufacturing in the country.

Europe was the only region that declined in the quarter, with a 6% share of revenue, representing a sequential decline of 15.2% and a year-over-year decline of 23.8%. Management attributed the softness in Europe to the timing of orders.

Orders

Orders continued to grow strongly, posting a 24.8% sequential increase in the last quarter. The Dec quarter was the first since the recession started that orders also grew from the year-ago period. The year-over-year growth of 313.1% was the second straight quarter that orders grew triple digits on a year-over-year basis.

We estimate that backlog increased by nearly 21%, an indication that end-demand continues to strengthen. Lead times appear to be stretching out, indicating that customers have better visibility going forward. Novellus has not lost any business on account of its inability to fulfill orders.

Margins

The pro forma gross margin for the quarter was 49.0%, up 115 basis points (bps) from the previous quarter’s 47.9%. The improvement in gross margin was on account of higher volumes, which helped fixed cost absorption as well as a more positive business mix.

Operating expenses of $80.3 million were up 7.4% on a sequential basis. The operating margin was 19.9%, up 269 bps from 17.2% recorded in the previous quarter. All the three components of cost—COGS, R&D and SG&A, decreased as a percentage of sales, although lower COGS was the largest contributor to better margin, followed by lower SG&A and then R&D.

Net Income

Excluding the impact of restructuring charges and legal expenses related to its confrontation with Linear Technology Corp (LLTC) on a tax-adjusted basis, the pro forma net income was $45.5 million or 16.5% of sales, compared to a net profit of $38.6 million or 15.8% in the previous quarter and a net loss of $45.3 million or -45.8% in the year-ago quarter.

Including these charges, the GAAP net income was $41.3 million ($0.43 per share) compared to an income of $35.2 million ($0.36 per share) in the Dec 2009 quarter and a loss of $66.4 million (-$0.69 per share) in the Mar quarter of last year.

Balance Sheet

Inventories were down 9.4%, with inventory turns flat at 3.2X. Days sales outstanding (DSOs) went down from 56 to around 51. The company ended with cash and short-term investments of $552.9 million ($5.77 per share), up $51.5 million during the quarter. In the last quarter, the company generated $62 million in cash from operations and spent $15.2 million on the repurchase of 709,000 shares. Novellus still has $788 million left under the current authorization, which expires in October 2011.

Guidance

The fourth quarter guidance is for bookings increase of 0-15%, shipments in the $300-330 million range, revenues in the $285-315 million range, gross margin of 48-50% and earnings of $0.50-$0.60 a share. While the revenue guidance appears conservative, given the ongoing strength in the industry, this is not unusual for the equipment sector, where the timing of a few large orders could either pull in or push out revenues from any given quarter.

In Summary

Novellus Systems is a beneficiary of the ongoing strength in the semiconductor market, which is being driven by the PC refresh cycle, as well as very strong growth in smartphones and other MIDs. This is pushing up demand for DRAM and NAND components, leading to much stronger pricing in the memory segment. Foundries are also seeing greater demand, with utilization rates going up over 90%, better than the normal seasonal average.

Gartner, SEMI and other market research firms have forecasted very strong growth for the semiconductor equipment sector this year. So we are not surprised by the uptrend in Novellus’ first quarter results compared to the recession-impacted first quarter of 2009.

Analysts polled by Zacks are also getting increasingly positive about Novellus, as witnessed by the upward revision to estimates in the 7 days prior to the earnings announcement. Overall, estimates for the March quarter increased 4 cents, for the June quarter 1 cent, for fiscal 2010, 6 cents and for fiscal 2011, 8 cents.

The ongoing recovery is also seen in the results of equipment companies, such as Lam Research Corporation (LRCX) and Teradyne Inc. (TER), which also beat expectations. Consequently, we are optimistic about other leading equipment providers, Applied Materials (AMAT) and KLA-Tencor Corp (KLAC), which are expected to report over the next few weeks.