Novellus: Demand slowing down, but it’s only a short-term concern

August 31, 2006 – Novellus Systems Inc. lowered its 3Q outlook on Aug. 30, citing delays in some customer deliveries, but any broader concerns about end-user demand or rising inventory levels should be short-lived, according to execs.

In the company’s mid-quarter conference call, CFO Bill Kurtz indicated bookings for 3Q would be slightly lower than expected, flat to up 5% from the June quarter’s $457.5 million (vs. earlier projections of flat-7% growth). Shipments also have been lowered to a range of $410-$420 million, flat to slightly up from the previous quarter mainly due to changes in customer delivery dates that have been pushed out to 4Q06, Kurtz said. The rest of the company’s 3Q projections remain unchanged: revenues up 7%-10% sequentially to $440-$450 million, 50.5% margins, and EPS of $0.49-$0.52, including stock option compensation expenses.

By geography, business from customers in the US and Asia has moderated, while Japan is strong, and Europe is relatively weak, according to chairman and CEO Rick Hill. He noted that customers’ attitudes about investing in equipment are still “relatively positive.”

Hill reiterated his belief that NAND flash will be a big driver in chipmakers’ capex investments. DRAM activity could pick up, particularly if Microsoft’s Vista OS leads to more memory purchases (“if people double up on memory, then yes, we could see a pop there”), but he noted that there’s a lot of underutilized DRAM capacity that could be brought on relatively quickly. Instead, Hill referred to internal research suggesting that if the notebook market consumes 32GB of NAND flash per system (e.g., embedded on a disk drive for instant-on capabilities), that will impact overall need for incremental fab capacity, translating to “very good” news for the equipment segment over the next three years.

“While there is a certain oversupply in this area, the way this market is emerging, those are short-term aberrations rather than long-term,” he said, mitigated by new products coming out, including Microsoft’s Vista operating system. He acknowledged some concern about bottoming NAND flash spot pricing, but expressed confidence that new products and applications will continue to consume NAND flash.

Other equipment suppliers including Applied Materials have suggested business is slowing down from foundry customers, and Hill also acknowledged that some foundries have lost major orders to newer competitors, having a “modest effect” on capex in the short term. But overall, he expects demand will continue to grow “unabated” in the foundry sector due to the transition to 300mm wafer processing, as more IDMs get out of the business of making wafers and capacity is absorbed by the foundries. Any moderation in foundry investments “is short-term, and not across the board,” he said.

In a research note distributed before Novellus’ update call, Bill Ong, analyst with American Technology research, also suggested that Japanese chipmakers are on track with their spending plans, driven by flash memory applications and the upcoming PlayStation3 gaming platform. Memory orders remain robust both in Korea and Korean-based chipmakers with fabs in mainland China near the Wuxi region, he added. However, foundries in Taiwan with broader product offerings “have become more cautious in their 2H06 outlook, prompting hesitation in capital equipment spending that could likely result in flattening to declining quarterly sequential fab tool orders in both 3Q and 4Q06,” he wrote.


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