Novellus Lower on Margins, Orders

Overall, earnings are sound; CEO says shift to consumer products is driving chip growth.
By Chris Kraeuter ,

Updated from March 1

Shares of

Novellus Systems

(NVLS)

dropped after the chip-equipment maker told investors that its margins would contract during the current, or first, quarter because of the timing of recognizing certain sales, as well as the sale of some lower-end tools.

Early Wednesday, shares fell 3.9% to $29. They rose 2.2% to $30.18 during Tuesday's regular session.

Overall, Novellus' results look pretty good. The San Jose, Calif.-based company predicted earnings in the top half of its target range, sales above its target range, and better-than-expected shipments. However, investors focused on earnings not keeping pace with the sales increase and the corporation not adjusting its order estimates upward.

Specifically, Novellus projected earnings between 20 cents and 22 cents a share, sales between $330 million and $340 million, orders between $285 million and $310 million and shipments between $350 million and $360 million.

At the start of the first quarter, Novellus predicted earnings between 18 cents and 22 cents a share, sales between $320 million and $330 million, orders between $285 million and $310 million and shipments of $345 million to $355 million.

Analysts had expected earnings of 21 cents a share on sales of $326 million, on average, according to Thomson First Call.

"This is a combination of the configuration

of sales and the timing of revenue recognition that is driving this phenomenon," said Novellus CEO Richard Hill. "This is a GM issue with somewhat offsetting reductions in operating expenses."

He said the company still maintains long-term gross margin targets between 52% and 54%. In the fourth quarter, Novellus logged gross margins of 49.9%.

Order targets held steady, and at a relatively wide range, because a few expected orders from Japan might not get booked until the second quarter, said Hill. Overall, Asia is "still doing fairly well," he said. Additionally, Hill said that customers for logic chips have also pulled in orders.

The CEO spoke to investors during a scheduled midquarter update after Tuesday's closing bell. These updates are conducted every quarter, and the company does not issue a press release. Hill typically sticks to brief comments about the quarter and then provides updated financial targets.

On Tuesday, however, Hill spent part of the conference call talking about a broader, significant shift under way in the semiconductor and equipment arenas -- that the flash memory market has replaced the computer industry as the primary driver of the semiconductor industry.

"The dynamic we are seeing in the market today has shifted from an industrial-centric business to a consumer-centric business," Hill said, equating past semiconductor industry growth with gigahertz improvements in microprocessors -- the brains of computers made by the likes of

Intel

(INTC) - Get Report

and

Advanced Micro Devices

(AMD) - Get Report

-- and software upgrades, such as those from

Microsoft

(MSFT) - Get Report

, for example.

These improvements for computers would in turn pull along increased consumption of memory. Hill said the table has been turned because consumer products -- such as digital home-entertainment devices, cell phones, and MP3 players -- are now the areas that are driving semiconductor growth, but the growth is primarily for more memory.

"Flash is an enabler of new technologies, and the processor is becoming a peripheral around flash," he said. "Flash growth continues to be the area where a majority of capacity is being put in place."

Much of Hill's statements could likely stem from a trip to Korea last week. He didn't elaborate on Tuesday about his agenda while there, but Seoul is the home of

Samsung Semiconductor

, the world's largest memory-chip company and the second largest chipmaker worldwide after Intel, which primarily makes microprocessors.

During the past year or so, Samsung has been preaching a changing view of the semiconductor world, in which memory components are the key ingredients of tomorrow's digital landscape.

Indeed, Jon Kang, senior vice president of technical marketing for Samsung Semiconductor, said during a mid-February interview with

TheStreet.com

that the semiconductor industry has passed the giants of the PC era by.

"I think the obvious next battleground after the PC is the digital home and whether the PC will be the center of the digital home, or whether it will be a digital TV or some other kind of format -- like a game machine," said Kang. "Everyone that's making processors is trying to become the center of the universe, like Microsoft and Intel were for the PC."

He named Microsoft,

Sony

(SNE) - Get Report

and Intel as three players trying to take advantage of this opportunity -- as well as Samsung -- but he also sees Samsung's core memory chips as necessary to the company that winds up the ultimate winner.

"Samsung will provide from a semiconductor perspective the necessary components for whoever does that," said Kang, who heads strategy and development for Samsung's memory unit.

Hill believes the shift to be good for the semiconductor industry and for the food chain that feeds on it. "We are reasonably optimistic about the future because of this," he said, citing the conversion of analog TV broadcasting to digital TV, growth in broadband communications and even the 2008 Olympics.

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