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Lam Research Corporation (NASDAQ:LRCX)

Q4 2014 Earnings Conference Call

July 30, 2014 4:30 PM ET

Executives

Carol Raeburn – IR

Martin Anstice – President and CEO

Douglas Bettinger – EVP and CFO

Analysts

C. J. Muse – ISI Group

Timothy Arcuri – Cowen and Company, LLC

Harlan Sur – JPMorgan

James Covello – Goldman Sachs

Krish Sankar – Bank of America Merrill Lynch

Romit Shah – Nomura

Mahesh Sanganeria – RBC Capital Markets

Edwin Mok – Needham & Company

Patrick Ho – Stifel Nicolaus

Operator

Good day and welcome to the Lam Research Corporation June 2014 Quarterly Results Conference Call. At this time I would like to turn the conference over to Ms. Carol Raeburn. Please go ahead ma’am.

Carol Raeburn

Good afternoon, everyone, and welcome to the Lam Research quarterly conference call. With me today are Martin Anstice, President and Chief Executive Officer; and Doug Bettinger, Executive Vice President and Chief Financial Officer.

During today’s call we will share our outlook on the business environment and review our financial results for the June 2014 quarter and our outlook for the September 2014 quarter. The press release detailing our financial results was distributed a little after 1 PM this afternoon. It can also be found on the Investor Relations section of the company’s website, along with the presentation slides that accompany today’s call.

Today’s presentation and Q&A will include statements about our expectations and beliefs regarding certain future outcomes including our guidance. A more comprehensive list of forward-looking topics that we expect to cover is shown on the slide deck accompanying my remarks.

All statements made that are not historical in fact are forward-looking statements based on current information and are subject to risks and uncertainties that may cause actual results to differ materially. We encourage you to review the risk factor disclosures in our public filings, including our 10-K and 10-Q. The company undertakes no obligation to update forward-looking statements.

Today’s discussion of our financial results will be presented in a non-GAAP financial basis unless otherwise specified. A detailed reconciliation between GAAP and non-GAAP results can be found in today’s earnings press release. This call is scheduled to last until 3 PM Pacific time and as always we ask that you limit questions to one per firm with a very brief follow-up so that we can accommodate as many questions as possible. As a reminder a webcast replay of this call will be available later this afternoon on our website.

With that I will now hand over call over to you Martin.

Martin Anstice

Thank you, Carol and good afternoon everyone. I’ll start today by commenting on our performance in the June quarter and 2014 fiscal year, then provide a little more color on our view for the outlook for wafer fab equipment spending in the second half of calendar 14 and the full year 2015 before transitioning to Doug. I will conclude with thoughts on Lam growth and describe areas of focus for the company, that should provide you with helpful context.

In the June quarter Lam continued a trend of outperformance and we delivered another quarter of strong execution across the business. Results topped the midpoint of our guided ranges across all metrics, reinforcing our confidence in our recently updated long term financial models.

The June quarter marks the end of our fiscal year, a truly remarkable year for Lam. In a period of transformation within our company and the industry generally we reported record revenues in each successive quarter and operating income that more than doubled year-over-year. We believe that a major theme for Lam in our recent year and more importantly in our future is the opportunity for sustainable out performance.

This is made possible through our position and focus on markets leadership in the segments of WFE that we serve, our critical applications growth strategy targeted to deliver leading edge solutions through significant technology inflections and our demonstrated ability to execute predictably meeting commitments to the full community of stake holders. These strengths all combined to provide a path for Lam to create value of substance for shareholders over the next several years, value creation that should accelerate with continued execution in our markets as they represent expanding proportion of WFE due to the primary technology inflections, most notably in areas related to patenting, 3D devices and advance packaging.

Overall, we estimate that approximately 25% of total WFE investments this year will be directly associated with the inflection technologies and based on the importance of these enabling transitions to our customers and the current pace of pilots and production ramps we maintain our view of WFE spending within a $32 billion range.

For our company due to the complement of our strengths with the spending bias of our customers we continue to remain optimistic that the second half of calendar 2014 can achieve a revenue level reasonably similar to the first half of the year. Although much can change at this time it would be fair to characterize that we expect December to be stronger than September.

Now to the segment details, starting with NAND flash memory we continue to see balance between supply and demand of bits as sustainable profitability continues to be a strong customer focus. We believe that customers are supplementing and converting capacity in a very rational manner with WFE spending relatively consistent with earlier expectations. Investment is focused on 16-nanometer and below planar conversions as well as initial 3D NAND capacity. As noted at our investor and analyst event recently we continue to expect planar investments to represent the major of NAND’s WFE spending this year, representing approximately two-thirds of the total. Our outlook for 2014 NAND supply bit growth remains in the lower 40% range.

In DRAM we saw continued strength and investments in the June quarter. Strong DRAM ASP with a supply constrained market are underpinning an industry focus on realizing healthy returns on investments made. Accordingly investments are primarily being made to enable the transition to mid 2x and below technology nodes, transitions which we believe offer meaningful value to customers from a very efficient upgrade oriented spending. Projections for DRAM bit growth are approximately 30% this year. Overall in memory we maintain our projection for 2014 WFE at $12 billion to $13 billion.

Lastly in both the foundry and broader logic segments our outlook remains more or less consistent with the prior view. The ramp plans for 20 nanometer foundry and 14 nanometer logic appear from our perspective to be progressing largely as expected with a foundry focus on 20 nanometer investments in the first half of the year and the second half of the year weighted to early FinFET purchases and a broadening of participants. Restating my earlier message we expect WFE at the $32 billion level in calendar year ‘14 and revenues at Lam to materially outperform to that baseline year-over-year comparison.

For 2015, we continue to believe that WFE spending levels are biased to be stronger than ‘14 with key opportunity and risk being defined by success of latest generation devices, utilizing new enabling technology measured by performance and cost benefits in their markets and the conviction of participants to grow profitably in an increasingly consolidated and competitive semiconductor industry.

For Lam we believe that the share of WFE that would be attributed to markets that we serve will increase as technology inflections become more mainstream and represent perhaps approximately one-third of total spending next year by our customers. Combined with this sound growth outperformance, we believe our technology inflections applications market share is in excess of 50% across the portfolio of deposition edge and clean products.

We remain excited by this unique opportunity and work hard each day to make our commit – to meet our commitments and continuously strengthen the trust that our customer place in our company and the individuals who work here. This commitment, out performance and execution is evidenced in our reported 90% success rate in targeted penetration and defense activities in the first half of calendar ‘14. This is one of the most fundamental measures of the trust in Lam and the quality of our people, our product and technology roadmap and our ability to execute.

Our momentum, particularly in the most challenging critical applications is enabled by our commitment to invest in the inflections for the long term and emphasis on customer collaboration in pursuit of solutions to their most critical challenges. Execution in these areas is underpinned by the fact that we have shipped 17 new product configurations in the last 12 months, marking perhaps the most active period of innovation in our company, in a company that has long prided itself on its innovation at the leading edge.

Our focus areas are on the critical path for our customers and this shared value proposition is providing significant growth opportunities for Lam. Illustratively our leadership in the patenting area is aligned with customers’ need for scaling solutions in advance of next generation Litho, our leadership in back end of line clean is aligned with customers critical yield initiatives. As we discussed in some detail recently we are also focused on expanding our engagement with customers related to their installed based partnering to achieve the level of performance they need to be successful over the long term.

An opportunity exists for Lam to differentiate itself through comprehensive and configurable lifecycle solutions, partnering with our customer to innovate through the economic challenges of scaling. That is a key focus for our customer service business group. The capability to rapidly address customer challenges with innovative and cost effective solutions, combined with increasing level of support we are receiving from customers globally is fundamental to executing our vision. Neither the outperformance we have delivered to-date nor the opportunities presented here would be possible without successful collaborations with our customers and partners more broadly through the industry. We thank them all sincerely and are delighted by the recognition we have received for our efforts.

As we shared a couple of weeks ago, the next six months are a very busy period for us at the customer interface, supporting them with critical ramps and focusing on the significant number of equipment selection decisions outstanding for this year, staying aligned with our customer on their needs, planning and executing accordingly.

As you might expect, for a company that is targeted to grow between 20% and 25% year-over-year in calendar ‘14, in turn creating approximately $1 billion of cash from operations, for a company with a vision to grow meaningfully, through a multi-year technology inflection period, Lam leadership is committed to successful scaling of our company in a manner that is transparent and value creating for our customers and shareholders.

In conclusion and notwithstanding the formidable strength of our competitors we continue to believe we are well positioned to outperform in the coming years. We plan to execute to win key applications and with a $2 billion SAM expansion opportunity through calendar 2017 we are very excited about a future of growth.

Last but not least I would like to recognize the Lam, the full complement of 6,700 employees globally who worked tirelessly through a complex and transformative period for the company, who believed in the opportunity and prioritized their role modeling, our values of customer first, company and then individual and achieving our vision objective of being number one in customer trust above all else. Many thanks to everybody.

With that I’ll hand the call over to Doug.

Douglas Bettinger

Okay, thanks Martin. Good afternoon everyone. And I want to thank you today for joining us during what I know is a busy earnings season for your guys. Let me just begin by saying we are very pleased with the results from our June quarter which topped off very strong performance for fiscal year 2014.

Operating income continued to outpace revenue growth, growing at roughly twice the rate both in the quarter as well as in the year. Gross margin and earnings per share both came in above the midpoint of our guidance demonstrating the strength of our business model. We continue to execute on our plans to outperform the industry around the key technology inflections as well as to deliver on our financial commitments.

Shipments in the June quarter were above the midpoint of our guidance range at $1.160 billion, which was down about a $100 million sequentially but up slightly when you compare to the December quarter. The memory segment represented 59% of total system shipments and that was down from 66% in the March quarter. Within that NAND shipment contributed approximately 20% of total system shipments and I’ll just point we still anticipated the planar NAND node conversions will represent the majority of NAND investments for the full year and we do expect to see an increase in planar investments in the back half of the calendar year.

DRAM shipments were strong at 39% of system shipments. That was up from 3% in March quarter. With healthy pricing in the DRAM market and supply remaining tight relative to demand we have seen an increase in spending to support both 25 nanometer and 20 nanometer node conversions. Our successfully product positions from multi patterning applications continue to be a tailwind with respect to the DRAM segment.

Foundry shipments were 30% of total system shipments and this was up from 28% in the prior quarter. We expect to see a strengthening in foundry investment in the second half of the calendar year with a broadening of the customer base investing in FinFET pilot production as well as additional investment in the 28 and 20 nanometer nodes.

And finally logic and other shipments comprised 11% of total system shipments and this was up from 6% in the March quarter. Revenue for the June quarter came in at $1.249 billion setting a new high for the fifth consecutive quarter. June gross margin percentage came in at 46.4%, an increase of about 90 basis points compared to the March quarter.

And as we shared with you in the past business volumes and overall business mix contribute to the variability in our gross margin performance and we expect to see fluctuation in gross margins on a quarterly basis. Our operating expenses were within our expectations for the June quarter at $322 million holding steady at about 26% of revenue. We continue to prudently manage SG&A cost to allow us to appropriately fund strategic development programs that are expected to generate growth in future revenues.

Our R&D spending is focused at the leading edge technology nodes as well as the technology inflections that you heard us talk about during our investor meeting earlier this month. We are spending on products and etching our position that will move us further into atomic scale processing.

We are spending on products in clean to deliver next generation yield solutions for our customers. Operating income delivered in the June quarter was $258 million and this was up about $10 million from the March quarter. Our operating margin came in at 20.6% above the midpoint of our guidance range, reflecting the leverage in our model.

The tax rate for the June quarter was approximately 15% .I do expect this rate to raise somewhat as we move into our 2015 fiscal year. I would be modeling a rate in the high-teens for the near future. This increase is driven by a more significant amount of our revenue being generated domestically where tax rates are a little bit higher. I should point out to you that this tax rate estimate does not include any benefit from the potential extension of the R&D tax credit in the United States. If that tax credit is extended it would lower our rate by two to three percentage points.

The resulting earnings per share for the quarter came in at $1.25 and that was above the midpoint of our guidance range. The majority of the upside is attributable to our improved gross margin for the quarter. Our earnings per share were based on a share count of roughly 173 million shares. The share count includes the dilutive effect of 8.2 million shares from the 2041 convertible note. And I’ll just remind you that the dilution schedules for this note as well as now the 2016 and 2018 notes are posted on our investor relations website to help you with your modeling. As our share price has ticked up in the last quarter modeling the dilutive impact from our converts now requires looking at all three of the notes.

Cash from operations was robust at $246 million, generated in June quarter and this was about 20% of revenue. Cash from operations benefited from continued focus on working capital metrics. Day sales outstanding improved in June to 58 days and that compared to 61 days in the March quarter. Inventory turns did decline slightly as we added a little bit of inventory for future business growth.

Now let me turn to balance sheet. We ended the quarter with gross cash and short term investments which include our restricted cash of $3.2 billion. This was up 11% from $2.9 billion in the March quarter. Cash in the quarter was bolstered by $135 million from the sale of some non-essential real estate assets. We had deferred revenue of $362 million which does not include $34 million in shipments to Japanese customers which will convert to revenue in future quarters.

And I’ll just remind you on April 29th we announced that the Board of Directors approved a $1 billion capital return program which consists of an $850 million share repurchase authorization along with the first quarterly dividend in the 34 year history of the company. During the June quarter we spend $36 million on the repurchase of approximately 624,000 shares at an average price of $56.89. We expect to complete the balance of the share repurchases over the next two years. The quarterly dividend was initiated at $0.18 which was paid out on July 2nd. The scope of the capital return program demonstrates the confidence we and the Board of Directors have in the cash generation capability of this company.

Let me now turn to our non-GAAP guidance for the September quarter. We expect shipments to come in at $1.110 billion plus or minus a range of $50 million. We expect revenue of $1.150 billion again plus or minus $50 million. Shipments and revenue reflect a sequential decrease in total memory spending offset by a growth in foundry spending. We expect gross margin to come in at 45.5% plus or minus one percentage point. We are forecasting operating margins of 17.5% plus or minus one percentage point. And finally we forecast earnings per share of $0.92 plus or minus $0.07 based on a share count of approximately 177 million shares.

And I’d just like to pause for a moment and point out to you that within the midpoint of this EPS guidance is the impact of roughly $0.05 from the incremental dilution from the converts as well the increase in tax rate. Operator, that concludes my prepared remarks. Martin and I would now like to open up the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). We’ll go first to C. J. Muse with ISI Group. Please go ahead.

C. J. Muse – ISI Group

Yeah. Good afternoon. Thank you for taking my question. I guess first question, in terms of the implied guide for second half revenues consistent with the first half, it looks like you’re looking at revenues growing roughly 15% sequentially into the December quarter. And I guess the question there is one, can you talk about visibility? And then two, how much of that will be an increase in shipments versus a drive down of deferred revenues?

Douglas Bettinger

Well, I think the first to thing to say is the visibility for something six months away isn’t as good as the visibility three months away, but we certainly, we do our best C.J. to kind give you an appropriate linkage between commentary from the customers and the opportunity for the company. I will remind you that I said approximately similar, not precisely the same. So first half, second half side, I’d be sensitive to being a little too precise in the calculation here but for all intents and purposes we believe we got a revenue expansion, revenue opportunity and expansion between September and December that will be approximately equal first half and second half.

We don’t typically disclose our backlog and orders in a conversation like this. Obviously we have to file a 10-K and there will be a backlog number in there. But I will comment the backlog for the company, the difference between the orders received from customers and shipments made to customers has built by more than $200 million in the last two quarters. So we’re kind of building backlog. And frankly speaking the relationship between shipments and revenues is reasonably consistent from one period to another. So in answer to the second part of your question, is it a draw down, it would only ever be draw down if the circumstances of the customer were causing us to respond to their request that way but there isn’t a fundamental message on shift in revenue turns that would kind of undermine the outlook that we’ve shared with you.

C. J. Muse – ISI Group

That’s very helpful. And then Doug if I could ask you a quick question here. In terms of greater tax generated here in the U.S. how does that change your thinking in terms of perhaps being more aggressive on buybacks and/or upside to that $850 million?

Douglas Bettinger

It doesn’t really. The two are not related in my mind, C.J. I mean we announced a capital return program before I really modeled what I expected the tax rate for the next fiscal year to be. So in my mind it’s not inter-related. And again the uptick just to clarify in the tax rate has a lot to do with the fact that we are shipping more systems into the U.S. which has higher tax rate than when we ship them elsewhere. But the two things are independent in my C.J.

C. J. Muse – ISI Group

Okay, thank you.

Douglas Bettinger

Thanks C.J.

Operator

We’ll take our next question from Timothy Arcuri with Cowen and Company.

Timothy Arcuri – Cowen and Company, LLC

Thanks a lot. Just Doug a question on calendar Q4. I know that you don’t want to talk too much about it but if you just look at your guidance to grow the revenue between 20% and 25% for the year and you take the midpoint, certainly it suggests that the revenue in December is going to be a little bit better than what it was in June. And I am wondering from a gross margin perspective is there anything abnormal in the shipment concentration and what’s likely to ship in December that would make gross margin or the profile any different because that would argue that your gross margin should be better in December than it was in June Thanks.

Douglas Bettinger

You know Tim, I am not going to answer that question. We’re not going to get into giving hard guidance more than one quarter out. I think you’re thinking on the topline is probably directionally right. I haven’t quite gone through where all of the mix would fall out. I would kind of take you back though to the financial model that we out as the best guide post for how I would be thinking about the profitability and the gross margin of the company, Tim.

Timothy Arcuri – Cowen and Company, LLC

Okay, great, Doug. Thanks. And then Martin can you talk a little bit about are there concrete examples? I know you probably don’t want to get too much into the specifics but are there examples, when you talk your customers that you have gained share or you’ve gain a slot as a result of the ongoing proposed merger that’s happening out there with your larger peers. Are there any examples of you absolutely gaining share as a result of that merger? Thanks.

Martin Anstice

There is a lot of evidence that we’re gaining share. Whether it’s precisely a byproduct of the customer’s reaction to a planned merger or not is a conversation I don’t waste my time having with a customer honestly. So I am sure that the value proposition, to the extent the customers are not positive and you will need to talk to customers directly to figure out whether they are or are not. But to the extent that they are not positive about that time – my personal opinion is that the benefit is more a kind of medium and long term benefit to the company, not short-term.

So the simple reason that it takes a long time to make changes to market share of this company and when you get selected or you’re working on a selection they tend to stick pretty well. So I am sure there is an example or two along the way where we might be able to claim that was because of reaction but frankly speaking I think it’s not a conversation that we tend to have. We just focus on delivering the best solution that we can and focusing on established differentiation in the critical application space and we try to articulate that in our forward-looking targets and we try to articulate it at the most recent analyst call by reminding everybody that in the patterning space we’re addressing two-thirds of all the multi-patterning critical steps. And in the 3D NAND conversion we have 90% position on the critical applications across all memory customers and more than 60% on all applications.

So gaining share and growing our company is all about critical applications focus and inflections. And if along the way, whether it’s associated with the reaction to a competitor’s merger plan or not, if we gain other business by building customer trust, than we are excited about that opportunity as well.

Timothy Arcuri – Cowen and Company, LLC

Thanks very much.

Martin Anstice

Thanks.

Douglas Bettinger

Thanks, Tim.

Operator

Our next question will come from John [Fitzer] with Credit Suisse.

Unidentified Analyst

Yeah, good afternoon guys. Thanks for letting me ask the question. I guess Martin my first question just relates to some incremental news on EUB that was out in the market today, that clearly impacted, I think your stock and some of peers’ stock. I am kind of curious from your perspective if the timing of EUB in your mind has changed all that much. I know you addressed this at Analyst Day but I will be curious again to get a better understanding from your perspective if EUB gets inserted quicker than we think what that might do to that $2 billion TAM opportunity that you’ve talked about?

Martin Anstice

Hi, very, very simply my view of the intercept point on the EUB is no different today than it was the last time we were in public domain. And relative to the impact of EUB insertions to the 2017 $2 billion SAM expansion, little or nothing of impact. And that’s just a commentary that I would extract from the statements of our customers. Our customers have almost without exception stated no intercept to 10 nanometers in logic and maybe there is a back haul opportunity but it’s one or two levels, one or two passes. So I think fundamentally no change in view of intercept and no impact of substance to the $2 billion SAM expansion we articulated.

Unidentified Analyst

That’s helpful. Then maybe as my follow up, I know you talked about directionally WFE being up in calendar year ‘15. I am wondering if you could attempt to qualify that or at least if not quantify, kind of qualify the puts and takes within the broader buckets of NAND, DRAM and FinFET. And I guess I’m particularly interested in FinFET because the sense I get is this time last year looking a year out the visibility on 20 nanometers seemed to be a lot more tangible than the visibility on 1614 is for the next 12 months, maybe you can address that, that will be helpful.

Martin Anstice

Yeah, I am going to resist the temptation to respond quantitatively, it feels too early to do that but as I said in the analyst meet I think there is two or three levels to the conclusion on [BIAS 2] growth next year – statement of capital intensity. I think in each of these transitions whether it’s kind of patterning, the incremental patterning steps that we articulated or in logic and DRAM whether it’s the incremental SAM expansion that exist in the NAND flash. And even in litho I believe there is an opinion that there is capital intensity increased in a planar to 3D transition. So capital intensity I think is part of the story.

I think the general commentary on demand for electronics consumer and enterprise and IC units, if you kind of begin with a GDP commentary is a little bit more positive in ‘15 than it is in ‘14. I think the competitive dynamic that exist in a consolidated semiconductor world tends to deliver two things to us. It tends to deliver discipline in spending and it creates very high risk reward opportunities for growth for our customers. And so I think there is a tremendous amount of conviction associated with establishing market share leadership positions through these technology inflections and clearly calendar ‘15 is the first year of substance when we are going from private line investments into an HVM regime. So I kind of – I look at the sum of all of the data points that are available to us and none of them seemed particularly negative if negative at all and we will kind of part [inaudible] and maybe by the time we get to the October earnings call put a number out to you but I would say at this point, we expect WFE to be stronger and we expect our share of that expansion to be a positive story as well, remember our view of proportion of WFE that inflection related goes from that 25% in calendar 14 to approximately one-third in calendar 15.

Unidentified Analyst

Thanks guys.

Martin Anstice

Thanks John.

Operator

And our next question will come from Harlan Sur with JPMorgan.

Harlan Sur – JPMorgan

Hi, good afternoon. Nice job on the quarterly execution. At your analyst day you mentioned inflexion technology spend of about third of WFE spend next year versus 25% this year. Looking at at a lot more granular level, it seems like you still expect 3D NAND to kind of exit this year at about kind of 6-7% of total installed NAND capacity. Can you just give us some numbers on why you expect 20 nanometer DRAM mix to be in terms of the installed capacity exiting this year and what I am trying to get out is or get a sense for, what is the upgrade tail wind as we look into 2015?

Douglas Bettinger

When you say 29 nanometer, did you say 20 nanometer DRAM or 20 nanometer (inaudible).

Harlan Sur – JPMorgan

20 Nanometer DRAM.

Martin Anstice

Well I think the opportunity for kind of sustainable upgrade is pretty significant. I mean our estimate for the end of calendar ‘14 is that there is probably 450,000 wafer starts per month capacity at 3X or above which is a pretty significant number and our estimates on the 2X proportion by the end of calendar year is still a pretty low number. So I think conversion opportunity down to 20 nanometer is going to be a significant part of the story for a calendar 15 and even more so for the company because of the transitions in terms of double patenting. I will remind you that there three to four steps of multi-patterning in a mid 2X technology node, there are 15 to 20 steps of multi patenting at 20 nanometer and 30 to 40 steps at 1X. And as David Hemker, our CTO explains in the analyst meeting there are multiple process for each one of those steps.

So I think the story in terms of sustainable investment through upgrades is going to have a very prominent theme for WFE next year and I think it will be even stronger for the company for the reasons that I just stated.

Harlan Sur – JPMorgan

Yeah. Makes a lot of sense and then Martin within our balance first half, second half shipping outlook, last quarter you had anticipated about in and out of the spenders in the second half, looking at our shipment guide for September and kind of the pipeline for the second half of the year, is it unfolding this way, I know you mentioned a broader base of spenders in logic and foundry. Are you also seeing a broader set of customers spending in memory as well here in the second half?

Douglas Bettinger

Yeah, Harlan, this is Doug, I will take that one. The memory cap spending it’s the same guys. In memory, when we look first half, second half is maybe a little bit first half weighted. Conversely is foundry logic is a little bit second half weighted and broadening out that we described to you a quarter ago we’re absolutely still expecting to see – you are seeing a broadening out of people spending out in FinFET, we are seeing some investment at 28 and 20 nanometer as well and it’s more substantial in terms of the number of people spending in the second half than the first.

Harlan Sur – JPMorgan

Got it. Okay thank you very much.

Douglas Bettinger

Yeah, you are welcome, Harlan thanks.

Operator

Our next question will come from Jim Covello with Goldman Sachs.

James Covello – Goldman Sachs

Great, thanks so much for taking the question, I appreciate it. Martin I hate to go back to kind of the noise of the day, but I think it was important as John Fitzer suggested relative to some of the stocks. Could you offer us your perspective just from a technical standpoint on if indeed the wafers that IBM was talking about processing were processed without any photo resist on them, what exactly that would mean in terms of what kind of test that would be from an industry perspective and a technical perspective?

Martin Anstice

Yeah, I don’t think, I mean I can kind of give you some fairly superficial commentary. We are not the experts here, we are not qualified and we don’t know enough about what they stated. I mean I read a bunch of reports.

James Covello – Goldman Sachs

I promise you, you know more than I do.

Martin Anstice

That may be true but the basic headline for the company is the multiple patterning opportunities of growth for us are fundamental. They are real and they are not likely impacted in the 2017 timeframe by any EUB conversation. There is a tremendous amount of learning still ahead of the industry, relative to EUB, very clear and every year that passes, that builds an installed base of alternatives, in terms of etch and depositions systems for spacer based DRAM multiple patterning or emergent litho and X systems in logic, every year that passes, the bigger the installed base is, the motivation for reuse is very significant. And so the economic tradeoff on the intercept actually is even more challenging, not less challenging as every year passes.

So I don’t know the people are really processing that but clearly the long term benefit for the customer if the productivity performance that is being described by SML is achieved in a production environments is a good thing for the industry in sustaining Morse law. But in the meantime, we got a lot of things to focus on and certainly in the 2017 timeline I don’t think there is much of anything to talk about today.

James Covello – Goldman Sachs

Helpful thank you. As a follow-up you and a lot of folks have talked a lot about the broadening out of a foundry spend and the second tier foundry customers starting to spend a little bit more money. Can you walk us through a little bit of differences in timing on when you may see orders and deliver shipments of some of the second tier foundries versus some of the other peers in the industry and how that could impact you know have one and growth and even how that might affect your visibility into the early part of 2015 shipments to the extent that maybe some of those orders are coming for you in the back half of 2014 whereas some of them whereas some of those orders from the second tier foundries might have come to some of your peers in the earlier part of 2014.

Martin Anstice

Yeah, I mean not to be semantic but I mean to the best of my knowledge there aren’t so many equipment companies with a big back log today. So, it’s much less about an orders conversation and it’s much more about the quality of conversation and the demonstrative performance of the customer in that conversation to plan and commitments communicated to us. And there is an expectation in our first half and second half that as Doug said, the foundry business and the proportionate shipments in foundry have a meaningful increase and relative to concentration you know just take a kind of quick look at numbers, there is not a customer in that population that’s outside of the biggest guy in that list is 30%-40% of our shipments.

So it’s a fairly diverse participation level and it’s happening at a time when there is a very unique and very critical opportunity to establish market share leadership in a FinFET device marketplace. And so when I think through kind of risk as I said multiple times this year, I think the risk profile for calendar ‘14 is actually pretty low. I mean there is always some adjustment a little bit here or there but that’s in the scheme of things there is noise, where things get a little bit more unpredictable is being able to articulate a view on transitions out of privates line to HPM. I mean headline is there are only so many customers today for the equipment industry, there are only so many semiconductor company spending money adding leading edge capacity and it is critically important that they validate their capability to do that.

So that when someone is in the marketplace whether there is going to be a follower or a leader with a competitive device in terms of performance of cost, they can move quickly. And so I actually don’t feel like there is tremendous amount of exposure to the commentary of the company in the second half of the year. I might be wrong but that’s how I feel. I feel like calendar ‘15 is much more challenging to predict.

James Covello – Goldman Sachs

Very helpful. Thank you.

Martin Anstice

Thanks Jim.

Operator

And our next question will come from Krish Sankar with Bank of America Merrill Lynch. Please go ahead

Krish Sankar – Bank of America Merrill Lynch

Yeah, hi thank you taking my question. First one Martin just wondering if you could take a – you highlighted how a third of WFE next year would go the inflection, if you were to take a slag which should be the biggest bucket of spending among that will it be FinFET, 3D NAND or multi patterning DRAM?

Martin Anstice

Well, wow I thought you were going to ask me a slight different so – I next year I mean I have got an answer for the question for the three year yeah, I don’t I am going to rather take a kind of flyer I am going to kind of hold off. I mean clearly in the $2 billion context we have said that the foundry logic transition which is a mixture of patenting in the FinFET device of the single largest portion for us. Next is NAND Flash 3D NAND and the third in this is multi-patterning DRAM. And the fourth is advanced packaging. I guess it’s a reasonable commentary from I just said to conclude that the foundry implications in 3D NAND are greater than DRAM next year but for our company we clearly have very strong participation in DRAM as well.

Krish Sankar – Bank of America Merrill Lynch

Got it, got it, that’s helpful. And then question for Doug if I look at the margin structure, are there any other level for improving the margin or even to be floating around the mid-40’s gross margin and maybe mid the 20’s margin is it purely a function of revenue from here or do you have other levers to improve the margin?

Martin Anstice

The thing I understand Chris when you are running a company the scale and scope of Lam Research you got to be driving cost reduction everyday every year you have to be making sure your efficiencies and things like that in the manufacturing and supply chain are being pushed as far as they can be pushed. We got do it year-over-year and we are absolutely doing that this year as hard as we did last year and we will do it just as hard next year, because we have expectations from our customers that they are going to get some pricing reduction. You got to at least drive cost as fast as just mostly in place.

Douglas Bettinger

I think I would then take you to Chris is go back to the financial models that we just put out at the beginning of this month. That’s the way you should be thinking about the profitability level of the company we put in the ‘14-’15 model gross margin at 45 going over the next three to four years to 46 and approaching 47. That’s a way you should be thinking about things and there will be puts and takes quarter by quarter around those numbers but we constructed those models and tried to be very thoughtful about how the portfolio of the business was going to look.

Martin Anstice

And just to add to that, if you don’t do what Doug say if you don’t just float you drown. So it is correctly important to focus on the totality of the thing that influence the gross margin and the operating expenses of the company and we have two levels simply stated in gross margin, one of them is cost and one of them is revenue and the pricing consequences are all byproduct of a competitive environment and differentiation, which is why we make such an investment to position the product and technology portfolio to be as strong as it can be it and it can always be stronger, but it can [in some] differentiation. And the last thing that we think about when we position profitability in our long-term model is what we think is a fair distribution of profits over the supply chain and what do we think is defendable sustainable position to take with customers.

As best I can tell economics still represents a significant component of risk relative to Moore’s law in just physics and if you get that long-term positioning wrong you create a customer trust exposure which in my opinion is really high. So we try to position profitability levels in ways that we feel comfortable, just defining at customer interface. And in that context we believe we’re positioned for best customer trust and ultimately best partnership, best collaboration and if we execute in the way that we intend to ultimately out performance of revenues and profits as well.

Krish Sankar – Bank of America Merrill Lynch

Got it, thank you. It’s very helpful, thanks Martin and Doug.

Martin Anstice

Thanks Krish.

Operator

Our next question comes from Romit Shah with Nomura. Please go ahead.

Romit Shah – Nomura

Thanks, great job on gross margin. Doug I noticed the incremental gross margin in the quarter was extremely high. It was roughly 100%. Was there anything one time worth highlighting here in the June period?

Douglas Bettinger

No, there was nothing one time. I mean as I tried to describe the impact of different kinds of mix characterizations, different customer mixes, different tool mixes, not everything here has the same profitability. We benefited from pretty favorable mix last quarter and it’s kind of coming back to where it was in the previous quarter in our current guidance.

Romit Shah – Nomura

Okay and then how are you thinking about the share count going forward with the authorization you have in place?

Douglas Bettinger

With the $850 buyback authorization we are only just starting on it. We are going to execute that buyback over approximately the next two years and you should assume we will consistently be in the market buying that back. What’s moving against us a little bit right now is the dilution from those convertible notes and even though we were in the market last quarter share counts ticking up and it’s really all about what happening from an increasing share price and the impact on those converts. So we will continue to be aggressive with the buyback. What I can’t control is kind of the note dilution right.

Romit Shah – Nomura

Thanks Doug.

Douglas Bettinger

Yeah, thanks Romit.

Operator

We will take the next question from Mahesh Sanganeria with RBC Capital Markets.

Mahesh Sanganeria – RBC Capital Markets

Thank you very much. Just a follow-up on the foundry spending in the second-half. If we can make an attempt at 25 the broadness of the foundry putting in two buckets, 28 nanometer and higher and 20 nanometer lower, can you break down your expectation for the second half in those two buckets.

Martin Anstice

Yeah, more of it is at the leading edge Mahesh. The 20 nanometer in the FinFET investment is more substantial than 28 by a decent amount.

Mahesh Sanganeria – RBC Capital Markets

Okay, that’s very helpful and the second on, I think on the memory, memory has been very strong this year and your first-half is about 55% on average. We have seen a wild fluctuation in memory investment in last three years. Now with the increased capital density will you be able to make a guess at how do you see a normalized percent spending of memory going forward like is it 40% you expect or 50% or 30% in that range? Just a very high ball park number, that will be helpful.

Douglas Bettinger

I wish I can help but we are not going to. Frankly you it is getting for those folks who have conversations about memory or cycles again it’s really hard to do that because I don’t know how to do that anymore, right. What I can see is a community of ten customers or 15 that each have their own cycles, that are spending consistent with their windows of opportunity and they are being very disciplined and very effective in terms of operating and the pace at which they add capacity, keeping supply and demand in balance. When I think about extendibility and sustainability of spending I focus on profitability levels of customers and as best I can tell in memory today that’s pretty good. And I focus on the proportion of capacity that is still available for upgrade to known near term technology road map transitions.

And as I already said in the DRAM world we exit this year even with a significant level of spending but probably 450,000 wafer starts per month of capacity at 3x or above and in the NAND flash world we probably exit his year with maybe 500,000 wafer starts per month of capacity at 20 nanometer or above. So there are known upgrade pause of near-term significance and those are both opportunities that on their own represent the same type of spending level that exists in calendar ‘14. That’s how I think though sustainability. I don’t spend much time trying to correlate the spending of customer this year which is intended to support revenues next year and beyond with the revenues of this year, I have never understood that.

Mahesh Sanganeria – RBC Capital Markets

Okay, that’s very helpful. Thank you very much.

Douglas Bettinger

Thank you.

Martin Anstice

Thanks Mahesh.

Operator

Our next question comes from Edwin Mok with Needham & Company.

Edwin Mok – Needham & Company

Hi, thanks for taking my questions. So I have a question regarding your comment I heard that you talk about logic be more back half this year I was wondering is that to do with more to do with your share gain in the logic space or is it the customer is not ramping investment. I am just trying to get some color on that.

Douglas Bettinger

Yeah, I mean my comment was around our shipments being a little more back end back half loaded. I think WFE and this kind of eye balling it here right now is maybe a little bit back half loaded. It’s not significant headwind but it is a little second-half weighted and memory conversely is little bit front weighted.

Martin Anstice

So we have an assumption that in about a $13 billion foundry WFE is the first-half at six and the second-half at seven.

Edwin Mok – Needham & Company

Just to clarify it on the logical foundry or both there is – I thought you mentioned in logics specially, just give me a little bit update?

Martin Anstice

Yeah, that was foundry and in the world of microprocessor and other logic we are to Doug’s points reasonably balanced.

Edwin Mok – Needham & Company

I see, okay, great, thanks for clarifying that. And then any further update you can provide on the Clean products I understand you have it in the marketplace now and you probably start to get customer data on that any update on that when you expect [inaudible] share of the product and how do we start to think about that as potentially a growth driver for you guys.

Martin Anstice

Yeah, the first update is we still have one. The second update is we have really nice engagement with the three customers we have talked about I think we have been very pleased with the kind of validation, the productivity, the reliability of these systems some really can performance in fact I would say we saw that up and the performance we had in start-ups has surpassed expectations frankly for products of this maturity. So that’s really good. The process learning is kind of the focus of the company in the second-half of the year and that’s why everything comes together because now are delivering results from a wafer and you are yield, validated yield improvements for the customer. So that’s kind of a critical phase and we have kind of pulled from two further customers and I believe we are scheduled for shipments in the September quarter for the second too who will receive the early our next generation clean system.

So I feel as good as we could at this point but I would kind of register that obviously there is a significant amount of process learning ahead of us and as far as modeling is concerned, I’ll remind you that although in percentage terms the clean market share growth plans are the largest in the company. They are the 5% to 10% clean market share over the timeline 316 and 317. There also the market share growth plans which are most hockey stick. So in your modeling please don’t linearize the growth of the company in clean.

Edwin Mok – Needham & Company

Great. That’s all I have. Thank you.

Martin Anstice

Thank you.

Operator

And our next question comes from Patrick Ho with Stifel Nicolaus.

Patrick Ho – Stifel Nicolaus

Thank you very much. Martin, in one of your comments and I think to one another question, you talked about how unpredictable it is to get the timing of pilot to high-volume manufacturing. Maybe as it relates to 3D NAND, as you mentioned that you’re seeing more planar conversions in the second half of the year. How fungible, how balance can you be if the customers decide to accelerate 3D NAND versus doing planar conversion how do you react to any of those type of changes?

Martin Anstice

Well, as we articulated there is – I mean we have a great participation in both of them but we have higher share in 3D NAND than we do Planar and we have a significantly greater SAM in 3D than we do in Planar as well.

So, I mean the consequence of acceleration of 3D NAND is we got a lot more output leaving factories which means we need to be proactive, ensuring we got capacity in factories to build things. We got capacity in supply chain to buy things and we got capacity in the field service organization to install systems.

So because of the uncertainty we end up kind of running a level of kind risk management and has some level of cost in the company we try to keep it manageable but there is a cost to uncertainty. And what we clearly got to do is be able to execute because we put a lot of time, effort and money into creating the opportunity to outperform and so we got to be resource sufficiently to execute it.

As best I can tell, in every, every one of the four NAND flash today has invested in some level of planar scaling and also 3D NAND expansion and every one of them has some fairly specific plans of substance emerging in the back half of this year and obviously calendar ‘15. And I do expect the calendar ‘15 is obviously a big year for demonstrated performance and cost benefits of the 3D device.

Patrick Ho – Stifel Nicolaus

Great, that’s helpful. Maybe a question for Doug. In terms of the services opportunity that you talked about at the Analyst Day. What are some of levers for both the cost of goods line as well as on OpEx line as it relates to services business that will help you keep the corporate margins where they are or at least at their targeted model?

Douglas Bettinger

Patrick we had – really the slide that I had, I am sure that showed out performance in terms of top line growth from that services business. I mean that success there is comprehended in that model. So – and I think you know typically the gross margin a little bit lower in that business but the operating income is actually quite good. So the success of that part of business is comprehended in those financials models that we –

Martin Anstice

So I’ll add one thing and that is a commentary on mix. So and this is kind of where the rubber meets the road in terms of economy of the company. If our focus is on percentage of profitability than selling more upgrades to customers is the right answer because the upgrades business of the company is very highly profitable business for the company in relative terms.

But the downside of that is it’s a much lower door than on original equipment sales. So, we try to focus on the long term financial performance which means doing what is right for the customer in the long term is the guiding principle. So, we’re not going to – flow between new system sales and upgrades on a win trying to manage percentage versus dollars. We’re going to do the right thing for the customer relative to straight off. That’s an important lever but one that responds to the needs of the customers more than it does a particular orientation of the company.

Carol Raeburn

Operator we have time for one more call.

Operator

Thank you. And our last question will come from Sandip [inaudible] with Jefferies.

Unidentified Analyst

Hi guys. Thanks for taking the call. As we think about a potentially large migration of end customer business from one big foundry to another next year what level of capacity build do you expect to see over the next 12 to 18 months and what portion of it would be new greenfield capacity versus upgrades to existing capacity particularly in 14 nanometer FinFET? And as follow up to that, given the competition in foundry has increased dramatically do you think there is a chance of an overbuild of foundry capacity near term?

Martin Anstice

I am going to start with the back end of your question first. I think there is tremendous discipline and I don’t think there is a material risk of over capacity. And my frame of reference to that is that’s 28 nanometer technology nodes there is probably 350,000 waters starts of installed capacity. And even with the competitive environment that you just described I believe that by the end of this year the sum of the 28 nanometer Planar and first generation FinFET 1614 is going to be in the range of 120,000 to 140,000 water starts capacity. So it’s doesn’t feel like it’s anywhere close to a high kind of risk profile.

In answer to your question how much capacity to get there, that’s a little hard to tell but frankly speaking most of the last three years have seen capacity editions in one node or another at foundries all around about 100,000 water start per month level. And certainly I would expect that to be directionally relevant for calendar ‘15 maybe a little stronger. And as we mentioned many times because of the multi patterning effects of the company and the positioning in terms of share we shared some out performance potential in that context.

Unidentified Analyst

Thank you very much.

Martin Anstice

Thanks Sandip.

Carol Raeburn

That concludes our call for today. Thank you for joining us. A webcast of this call will be available on our Investor Relations website this afternoon. That concludes our comment. Good bye.

Operator

Thank you. As a reminder that does conclude today’s call and we thank you for your participation.

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Source: Lam Research's (LRCX) CEO Martin Anstice on Q4 2014 Results - Earnings Call Transcript
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