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Novellus Undone by Merrill Downgrade

On the conference call, analysts peppered Novellus management with questions about whether customer demand for new equipment may peaking out. "Right now, our best visibility is we don't see the downturn," said Chief Financial Officer Kevin Royal, adding Novellus has "fairly good visibility through the third quarter" and that he remains "cautiously optimistic." He said the company is on track to exceed its 2000 peak in revenue and bookings.

Royal said he'd get nervous if he saw a decrease in industrial spending. But so far such buying has only continued to accelerate -- albeit at a more modest pace than in the past, reflecting what he called "rational deployment of capital."

Unlike the heady days of the late 1990s, when capital markets offered companies a seemingly endlessly supply of easy cash to spend, they must now finance spending out of their internal operations, he said. That's made companies more cautious about expanding capacity; rather than install a whole semiconductor factory in one go, they're currently more likely to add capacity gradually, in three or four phases. "We're not getting immediately into an overcapacity situation," Royal said.

"I believe because actual supply and demand are more closely mapped together, the downturn will be less severe," he said.

On a geographic basis, Japanese customers are currently pushing much of the growth in the equipment industry, followed by Chinese suppliers, the company said. As for end markets, Novellus sales have benefited from the high demand for digital consumer electronics and the expansion of applications for flash memory, along with a generally improved industrial investment on computing, management said on the conference call.

Novellus reported second-quarter shipments of $366.1 million, representing a sequential increase of 17.7%, while deferred revenue rose 18.2% from the first quarter to $181.1 million at June 26, 2004. The company's gross margin was 50.5% in the most recent quarter, up from 44.1% in the year-ago period. Total operating expenses were 34.5% of sales in the 2004 period, compared with 42.2% a year ago.

"Bookings are strong and we continue to experience operating leverage to drive superior financial results for our shareholders," the company said in a statement. "Novellus is experiencing further strengthening of its 300-millimeter market penetration, particularly in advanced copper applications, due to our technological excellence and a continued focus on productivity."

Novellus bought back 5.5 million shares during the quarter for $167.1 million.
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