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Novellus Systems reported fourth quarter earnings that missed the Zacks Consensus by 2 cents, or 4.4%. Both revenue and margins were better than guided, although the tax rate was much higher.

Shares were up just 0.32% in after-hours trading, as the upside is likely to be short-lived, given that semi capex spending is not expected to be exceptional this year. In line with market expectations, heavy-weights Intel Corp (INTC - Analyst Report), Taiwan Semiconductor Manufacturing Company (TSM - Snapshot Report) and Globalfoundries are expecting to spend less this year.

Revenue

Novellus reported revenue of $306.7 million, down 7.8% sequentially and 26.4% year over year, better than management’s guidance range of $$260-290 million and street expectations of $277.2 million.

Revenue by Geography

Asia remained the largest contributor to Novellus’ revenues in the last quarter, with a 53% revenue share. However, revenues from Asia were down 7.8% sequentially and 37.1% from a year ago. The sequential decline was due to weakness in Japan and Korea, which were down 44.7% and 12.2%, respectively.

The Greater China region rebounded after a weak third quarter, growing 13.1%. Overall, Greater China, Korea and Japan contributed 27%, 20% and 6% of quarterly revenue, respectively.

Approximately 35% of revenue came from the U.S., which was down 10.4% sequentially and up 3.0% year over year. Novellus is very strongly positioned here and should see improvement as market conditions improve.

Europeaccounted for the remaining 12% of revenue, which was flat sequentially sequentially and down 32.1% year over year.

Sequential fluctuations in revenue from different geographies is not that indicative of Novellus’ performance, since a certain amount of lumpiness is natural given the high-value low-volume equipment that it sells.

Orders

Orders were up 26.4% sequentially and down 30.1% year over year. In the last quarter, Novellus saw its orders touch $286.9 million. Backlog increased 4.6%. Novellus did not mention the lead time, so we assume that it remained at 12-16 weeks, slightly higher than the normal 12-week range.

Margins

The pro forma gross margin for the quarter was 46.8%, down 145 basis points (bps) from the previous quarter’s 48.2% and at the higher end of the guided range of 46% (+/- 1%). Novellus’ long-term target of 52-54% seems very far away right now and given that the semi capex market is likely to remain depressed, there may not be much improvement until the back half of 2012.

Operating expenses of $89.2 million were down 3.6% sequentially and 6.0% year over year. The operating margin was 15.2%, down 282 bps from 18.0% recorded in the previous quarter and down 1,113 bps from 26.3% reported in the year-ago quarter. As a percentage of sales, all expenses except R&D increased both sequentially and year over year. R&D was flat sequentially after increasing very significantly in the previous quarter.

Net Income

Novellus reported pro forma net income of $30.8 million or a 10.9% net income  margin, compared to $50.5 million or 16.5% in the previous quarter and $94.3 million or 24.5% in the year-ago quarter.

Including restructuring charges, a one-time gain from the trial with Linear Technologies (LLTC - Analyst Report), gain on the sale of an IAG building, merger-related costs and the associated tax impact, the GAAP net income was $38.5 million or 56 cents a share compared to $51.1 million or 73 cents in the September 2011 quarter and $81.5 million or 89 cents a share in the December quarter of 2010.

Balance Sheet

Inventories were down 1.4%, with inventory turns going from 2.9X to 2.8X. Days sales outstanding (DSOs) went from 66 to 61. Novellus ended with cash and short term investments of $918.7 million ($13.80 per share), up $182.1 million during the quarter. In the last quarter, Novellus generated $84.7 million in cash from operations, spending $10.0 million on capex and $9.4 million on share repurchases.  

Guidance

For the first quarter, Novellus expects orders to be up 20-30%, with shipments coming in at $300-330 million. Revenues are expected to grow 6-17% to $300-330 million, much better than street expectations of around $288 million. As a result, gross margins will go up to 47% (+/- 1%).

Based on a tax rate of 10% (+/- 2%) and a share count of 76 million, the GAAP earnings are expected to come in at 71 to 86, including a  one-time tax benefit of 21 cents. Therefore, the non-GAAP EPS of 50 to 71 cents is much better than the Zacks Consensus of 50 cents.

Our Take

Novellus’ fourth quarter results were better than expected, due to stronger demand from both foundry and logic customers. Management appeared optimistic on account of the upcoming PC refresh cycle driven by the adoption of solid state drives for notebooks. Novellus expects these trends, along with 3D NAND and mobile DRAM to drive demand at both logic and foundry customers.

While the increase in orders is welcome at any time, the more encouraging takeaway was the growth in backlog, which saw double-digit declines in the two preceding quarters.

Add to this, the company’s strong market position, and broad exposure to both Asian and U.S.-based manufacturers. We think this positioning will play a key role in 2012 and beyond.

We therefore have a short-term (1-3 months) Strong Buy recommendation on the shares.

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