Lam Research F3Q07 (Qtr End 3/25/07) Earnings Call Transcript

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 |  About: Lam Research Corporation (LRCX)
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Lam Research Corporation (NASDAQ:LRCX)

F3Q07 Earnings Call

April 12, 2007 5:00 pm ET

Executives

Martin Anstice - CFO

Steve Newberry - President, CEO

Julie Cimino – IR

Analysts

Bill Ong - American Technology Research

Gary Hsueh - CIBC World Markets

Tim Arcuri - CItigroup

Jim Covello - Goldman Sachs

Satya Kumar - Credit Suisse

Harlan Sur - Morgan Stanley

Steve O'Rourke - Deutsche Bank

Robert Maire - Needham & Company

C.J. Muse - Lehman Brothers

Chris Blansett – JP Morgan

Mark Fitzgerald - Banc of America Securities

Mark Bachman - Pacific Crest

Patrick Ho - Stifel Nicolaus

Steven Paleo - HSBC

Zhao Ping - Caris & Company

Brett Hodess - Merrill Lynch

Stephen Chin - UBS

Presentation

Operator

Welcome to the March quarter 2007 financial results conference call. (Operator Instructions) I would now like to turn the conference over to Julie Cimino, Investor Relations. Please go ahead, ma'am.

Julie Cimino

Thank you, Mary. Good afternoon and thank you for joining us to discuss the financial results for the quarter ending March 25, 2007 and the business outlook for the June 2007 quarter. By now you should have received a copy of today's press release which was distributed by Business Wire at approximately 1:10 p.m. We are webcasting a slide presentation in conjunction with today's commentary. The presentation can be accessed through the investor section of our website at www.LamResearch.com and will also be available as a podcast following today's call.

Here today are Steve Newberry, President and Chief Executive Officer and Martin Anstice, Chief Financial Officer.

Except for historical information, the information Lam is about to provide and the questions Lam answers during the call may contain certain forward-looking statements including, but not limited to: statements that relate to the company's future revenue, margins, and operating expenses, management's plans and objectives for future operations and product development, management's plans for continuing the company's stock repurchase program, global economic conditions including consumer sentiment and customer spending and the demand acceptance and competitiveness of the company's products.

These statements are subject to various risks, uncertainties, and changes in conditions, significance, value, and effect that could cause results to differ materially and in ways not readily foreseeable and which are detailed in the company's SEC reports. We encourage you to read those reports in their entirety.

Lam would also like to disclaim any obligation to correct or update any of the information we are about to provide. This call is scheduled to last until 3 p.m., and we ask that you please limit your questions to one per firm. I will now turn the call over to Martin for a review of the financial results.

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Martin Anstice

Thank you, Julie. This afternoon we will discuss our March 2007 quarter financial results. Highlights of today's reported earnings include shipments of $620 million -- slightly stronger than anticipated -- revenues of $650 million at the high end of our guidance range with a gross margin of 50.2%; compelling operating income performance of 29.1% of revenues supporting our investments in long-term profitable growth opportunities; cash from operations of approximately $151 million in the quarter, contributing to a free cash flow yield of approximately 7.7% at today's closing share price level and March ending diluted share counts.

Diluted EPS of $1.15 compared to our $1.05 guidance mid-point, $0.05 of the improvement from operating performance, and $0.05 from our tax strategy and corporate finance agenda combined.

Share repurchase resulting in a reduction of share counts of 5.2 million shares absolute and 1.8 million shares weighted in the quarter.

As we have explained for some time now and reinforced through the quarter, we are refocusing our disclosure going forward on what we consider higher quality content. Accordingly, actual and guidance commentary today is focused on shipments and revenues and not orders and backlog. Of course, consistent with our fiscal year reporting obligations, we will report backlog in the 10-K.

Shipments at $620 million were marginally stronger than we had anticipated representing a sequential decrease of 4% from the December 2006 quarter. Our leading edge application strength continues to be illustrated by 300mm applications, representing approximately 85% of total systems shipments and applications at less than or equal to the 90-nanometer technology node representing 95%.

Memory segment customers in the quarter represented 78% of total systems shipments with the NAND component accounting for approximately 25% of total memory. Logic other was 12%, and foundry was 10% of the total system shipments. This shipment segmentation is generally consistent with the profile reported in January for our December quarter orders. Revenue of $650 million was at the high point of our guidance range with gross margin for the quarter slightly exceeding expectations at 50.2%.

As previously communicated, we have generally concluded our targeted consumable spare parts pricing reductions in the quarter. We continue to target a regional sourcing strategy to leverage cost in consumer service improvement opportunities going forward. For more complete details on the geographic breakdown of our shipments and revenues, please see today's press release and our website for a reconciliation of shipments, revenues, deferred revenues, and the free cash flow yield previously spoken to.

Operating expenses for the company of $137 million increased as planned by approximately $9 million, the majority concentrated in R&D reflecting additional headcounts, the impact of merit, seasonally high payroll taxes and the recent all-employee RSU focal round.

To clarify classifications of our income statements, all the costs associated with our investment in new products are expensed to R&D in the period incurred including materials, labor, and overhead for evaluation units shipped to customers. Products released and the realization of certain markets and commercial thresholds are the triggering events for more traditional accounts and presentation that includes inventory valuation, deferred costs on shipments, and ultimately costs of goods sold on revenues. We have entered this inventory versus expense accounting regime for the bevel, patterning, and MEMs products which, as noted in our press release today were released this quarter.

Taken together, our market share driven revenue expansion and operational execution drive operating income performance of 29.1% of revenues, again stronger than anticipated. Our total net cash balance including restricted cash was $1.2 billion at the end of March. We generated cash from operations of $151 million, inventory performance was 5.7 turns, accounts receivable day sales outstanding was 65 days. Deferred revenue and deferred profit balances are $277 million and $166 million respectively. In addition, there is approximately $49 million of anticipated future revenue value for previously made shipments to Japanese customers. We repaid $50 million of our long-term debt; consequently restricted cash balance is reduced.

In the quarter, we used $239 million to repurchase slightly more than 5.2 million shares at an average price of $45.78. We have $768 million remaining in our board-approved stock repurchase authorization at the end of the quarter. Compared to our guidance assumption of 144.5 million shares, the earnings per share benefit of the repurchase activity was approximately $0.01.

Our efficient tax strategy facilitated a number of discreet tax items that contributed to the quarterly rate of 19.1% compared to the guidance assumption of 22%, again driving EPS benefit of approximately $0.04 when compared to our guidance.

In the quarter, capital expenditures were $19 million, depreciation and amortization was $12 million. We received $11 million from the exercise of employee equity plans. Equity compensation expense was $11 million, including $2 million cost of goods sold, $5 million R&D, $4 million SG&A.

As we invest in our organization to support our expanding Etch market share and multi-product growth opportunities, employment levels increased by about 100 in the quarter to approximately 2,900. These additions were concentrated in R&D, field service and operations.

Now to Steve's comments.

Steve Newberry

Thank you, Martin. Good afternoon, everyone and thank you for joining us for our March quarter conference call. To start with I want to state how pleased I am with how the company executed in the March quarter both financially and operationally. We had a number of key accomplishments in the quarter highlighted by the release to market of three new products: our 2300 Bevel-Clean system, our 2300 Motif patterning system, and our deep silicon Etch MEMs product.

In addition, we were successful in winning a number of key 45-nanometer applications for both dielectronic and silicone Etch applications in memory as well as logic. These decisions support our objective of continued market share consolidation and gains while validating the competitiveness of our next generation Etch products as well as the trust our customers have in the capability of our integrated global organization.

Looking at the big picture, progress remains well in line with our multi-year strategic plan. As we have communicated over the past year, this plan is built around three central themes:

First, strong growth in IC unit demand driven largely by consumer electronics applications that increasingly require more semiconductor content, leading to the need for approximately $150 billion in wafer fab equipment investment over the 2007 through 2010 timeframe.

Second, Lam's development of new products adjacent to the Etch market that provide the opportunity to double our served available market and potentially grow the company 2.5 times faster than the overall total growth in wafer fab equipment spending through 2010.

Third, continuing to leverage our business model to generate best in class financial performance while consolidating and growing our current Etch market share position.

With that as a context, I will provide some color around each of these key strategic elements starting with the industry environment. As we have progressed through the year-to-date, customer plans for capacity additions in calendar year 2007 remained essentially on track with what we laid out for you on our January conference call. We continue to expect an increase of wafer fab equipment spending of about 5% in 2007 and IC unit growth is expected to be about 10%. as we progress through a period of adjustment in the rate of expansion for additional wafer start capacity and long-term unit demand trends remain firmly in place.

Memory is the obvious dominant factor driving IC unit growth. Relative to the outlook presented in January, it has become clear in recent weeks that there will be a smoothing of memory-related shipments this year from what we previously saw as a roughly 65% to 35% split between first and second half shipments to what looks more like a 55% to 45% slit today. All told, this smoothing of memory deliveries does not materially change our view of the disciplined spending growth in memory this year or of Lam's overall shipment expectation for 2007.

More specifically relative to the memory market, we continue to expect approximately $17 billion of spending for wafer fab equipment with about two-thirds of that targeted towards DRAM capacity expansion and one-third toward NAND Flash which represents approximately a 20% increase in DRAM investment and a 15% decline in NAND Flash investment year over year. The current pricing environment for DRAM and NAND Flash is generally consistent with our expectations of how industry supply/demand dynamics will play out over the calendar year.

We expect that as we move forward through the year we will see deceleration of the current price declines in DRAM, resulting in an anticipated average year-over-year price decline of 30% to 35% while NAND Flash pricing will be in a stable to upward environment resulting in an anticipated average year-over-year price decline of 60% to 65%.

Going forward, we expect that increasing demand will utilize the available supply output. This outlook supports that forecasted wafer fab equipment spending growth in total memory of about 8% this calendar year is reasonably aligned to the expected demand.

Spending activity in the foundry segment is increasing as we go forward relative to March as fabs begin to move more aggressively to the 65-nanometer node. Lam, with greater than 50% market share in this segment, is well positioned to benefit from the increasing investment in foundry capacity. In fact, this segment represents the single biggest market share expansion for Lam in the migration from 90-nanometers to 65-nanometers. Meanwhile, spending by IDMs for logic, microprocessors and analog is currently tracking within the range of plus or minus 5% that was discussed in January.

With our outlook for wafer fab equipment spending remaining relatively unchanged, let me comment now on our progress relative to our adjacent market expansion initiative. As mentioned, three new products were released to market as planned in the March quarter. These three releases in addition to our previously released productivity enhancing software tools support our ability to deliver the new product shipment and revenue targets we laid out for 2007. We also continue to make excellent progress toward release of our new clean system later this year with four to six new evaluation units scheduled for delivery this quarter. This product continues to show differentiated results on the wafer at the 45-nanometer node, and we're pleased with the positive customer feedback on the product.

As we've discussed over the last quarter, we have accelerated development of the product's front end aligned cleaning capability on so that our offering will address both front end and back end applications. This pulls forward by approximately one year our ability to address an expanded served available market at the time of product release. Our development activities are in sync with the timing of our customer's needs for production worthy technically enabling solutions for the 45-nanometer node.

I will now turn to the third key strategic element, leveraging our business model to deliver superior financial performance while consolidating and building on our Etch market share gains. As previously discussed, Lam gained about 9 percentage points in shift market share in 2006. We have consistently grown market share at each succeeding technology node, achieving a 50% market share position at the 65-nanometer node.

Looking forward, we are well positioned as we start to see customer decisions being made at the 45-nanometer node. We are focused on reinforcing our technology leadership and productivity positions to consolidate and then grow share at 45-nanometer and below. While few decisions have been made to date at 45-nanometer, we did win five key technical decisions that were made in the quarter, and we expect to win many more over the next 12 to 18 months.

Let me comment now on our financial performance expectations. Revenue is expected to come in at $655 million to $675 million in the June quarter. We see sequential June quarter over March quarter shipment growth of 10% to 15%. With the lower than expected decline in March quarter shipments and the general smoothing of delivery timing in memory discussed earlier, we are now targeting 2% to 4% shipment growth for the first half of 2007 versus the second half of 2006, and we continue to anticipate 5% to 10% calendar year sequential shipments growth now biased to the high end of that range.

Additionally, we expect that revenue for calendar year 2007 based on the 5% increase in wafer fab equipment spending scenario for calendar year 2007 will now grow higher than previously expected to 15% to 20% over calendar 2006 with EPS in the $4.50 to $4.70 range.

Revenue for the June quarter in the described range should result in a gross margin of 50% and operating margins of 29% plus or minus 1%. We anticipate EPS in a range of $1.13 to $1.17 which assumes a tax rate in the range of 21.5% and reflects a share count of 139 million shares incorporating the full quarter impact of our March quarter repurchase activity.

In summary, Lam's near-term performance remains very strong, and our longer-term opportunities remain compelling. I continue to be delighted with the performance of our employees across Lam Research and want to thank them for their hard work and outstanding results.

We will now open for questions.

Question-and-Answer Session

Operator

Our first question comes from Bill Ong - American Technology Research.

Bill Ong - American Technology Research

If you had 100% Etch market share right now, what would your current business mix be between memory, logic and foundry? When do you think you can close that gap to be more properly balanced with global Etch spending?

Steve Newberry

If we had 100% Etch market share?

Bill Ong - American Technology Research

Yes. What I meant is that you're definitely very skewed towards memory. So if you actually had evenly balanced spending within the Etch market, what would the mix be?

Steve Newberry

Memory is about 52% of total wafer fab equipment spending, I think foundry is about 20%, microprocessors about 12%, and then general purpose logic and analog would be the remainder.

Martin Anstice

Bill, I would probably add something here. I think in the transition from 90- to 65-nanometer, one of the things we try to emphasize pretty consistently here is that the sensitivity and bias to spending levels dissipates some. We are, we believe, greater than 50% share in memory, greater than 50% in general purpose logic, and greater than 50% share in foundry, and that's a headline at 65 that's obviously slightly different than the headline at 90-nanometers.

Operator

Our next question is from Gary Hsueh - CIBC World Markets.

Gary Hsueh - CIBC World Markets

Steve, did I hear you correctly, you said shipments up 10% to 15% quarter over quarter in June due to some of the smoothing in the memory business?

Steve Newberry

That's correct.

Gary Hsueh - CIBC World Markets

Relative to your prior guidance taking the mid-point of March, you're basically falling short in terms of shipments in June by roughly around $65 million. I don't know if you talk about orders. I know you don't, but are those orders basically pushed or are you getting this longer visibility on orders? What's driving that push out in terms of shipments? That roughly $65 million I would have expected you to see in June? Because I frankly think that fundamentals of memory remain intact, like you said.

Steve Newberry

Yes, I think it is not an order environment issue. If we look at where we were in January and if you look at the broad range of memory suppliers whether they're first tier or second tier, we had many of those companies requesting deliveries in the June quarter. Over the last four to six weeks a number of those companies for a variety of reasons have come back and some of them have said, well, actually we want it in July/August instead of May/June.

Sometimes it is a facilities issue. Sometimes it is a decision about whether they want to go with DRAM as planned or they're shifting to NAND, so we see a lot of that activity going on. What we basically have seen is that some of that front-end loading that we talked about in terms of 65% of planned memory shipments occurring in the first half, it is, like I mentioned, it is now 55/45, and not all that surprising that we've actually seen the smoothing that now is in place. But it is not about orders, it is about requested delivery dates.

Operator

Your next question comes from Tim Arcuri - Citigroup.

Tim Arcuri - CItigroup

If I look at the cash balance, it is about 20% of the market cap, and I can certainly appreciate that you just had the sizable buyback announcement. I look at how much money you're making and I hear how bullish you are in memory, and I think that there is quite a bit of memory left out there to be converted from 200 up to 300mm. It is kind of inconceivable that you are going to even get anywhere close to losing money in the next couple years.

So I guess I am a little surprised that your buyback is not even bigger and that you're not getting even more aggressive. I think you can layer some debt on the balance sheet, you can do something a lot more aggressive than you're doing. What's stopping you from doing that? Thanks.

Martin Anstice

I think the answer is pretty consistent with the answer for the last year or so. We do feel that we have responsibility to the shareholders to return excess cash to them, and we have a chosen vehicle for doing that, it is the stock repurchase. The board of directors along with the executive team takes that responsibility very seriously, and we put in context the full spectrum of opportunities to return value to the shareholders. We have an authorization. We're executing it exactly as planned, and that really is as much as I can characterize for you.

Operator

Your next question comes from Jim Covello - Goldman Sachs.

Jim Covello - Goldman Sachs

On the memory spending, Steve, do you think the DRAM guys are going to continue if they fall into significant loss-making in Q2 and Q3?

Steve Newberry

Well, that's a good question. I think historically you would say that they would most likely not continue to invest at necessarily the same pace that they're planning to, but the reality is I am not the best person to ask that question. You would really have to ask the memory manufacturers.

I do think that some of these manufacturers who are able to both produce DRAM and NAND have some additional flexibility today that wasn't necessarily present in prior cycles, and so I would expect that we'll continue to hear examples of various companies who will modify what their plans were in terms of how many DRAM starts. They may increase them or reduce them and flex to NAND, et cetera.

I do think that what you have here is a situation where 8% increase in wafer fab equipment investment in '07 versus '06, if the demand scenario plays out as we think it will, then I think the supply/demand situation will be in a reasonably good balance and we'll see this year play out as we're talking about. But if the demand doesn't materialize and supply gets out in front of it, then things could certainly change.

Operator

The next question comes from Satya Kumar - Credit Suisse.

Satya Kumar - Credit Suisse

A question on market share. You guys have talked about in the past of getting your market share to 46% in calendar '06 but the DataQuest number showed you guys only at 40%. Were you guys perhaps under estimating the progress you were making in the Etch segment or can you explain what's leading to the discrepancy?

Secondly I don't know if you gave out a number for your new product revenues this year, wonder if I missed that, if you could just help us with that. Thanks.

Steve Newberry

So DataQuest produces two charts. One is a big broad Etch market that includes a number of activities that really aren't in what we would call the Etch market. In other words, they include compounds, semiconductors, Photomask; activities which we don't. If you look at the DataQuest data for Etch market share for dielectric and conductor films, then DataQuest has us at 42%.

The big delta between why we believe we're at 45%, 46%, and they have us at 42% is I am talking about shipment-based market share which very closely correlates to customer CapEx and wafer fab equipment spending. DataQuest uses revenue-based reporting which in our case institutes a two to three-month delay between as our shipments have grown our revenue lags. If you calculate that delay represents about $120 million or about 3 market share points, and so if you did it on the basis of shipment, their numbers would show us in the 45% range.

Martin Anstice

To the last part of your question, Satya, we didn't communicate a new number on new product revenues, but we did communicate that we were still targeting the amount we discussed previously.

Operator

Our next question comes from Harlan Sur - Morgan Stanley.

Harlan Sur - Morgan Stanley

Steve, while memory has been strong, the foundries as you mentioned have been fairly disciplined on the capacity expansion front thus far. What is the shape of the shipment trends you think as we move into the second half of the year as overall utilizations improve and as some of the 65-nanometer chip designs start to ramp into production?

Steve Newberry

What we're seeing and what I commented in my commentary was that shipments to the foundries are beginning to accelerate, and the June quarter shipments for foundry will be higher than March. We would expect that as we go forward throughout the rest of the year that the second half shipments for foundry will be greater than the first half shipments for foundry, and that's consistent with what most of us have felt we would see going on in the foundry industry as they go through their typical first quarter utilization lull and they begin to ramp up. In this case with this year you have got a significant amount of activity related to 65-nanometer tapeouts and that activity is really going forward full bore, and so I expect that we'll see a good foundry investment profile as the year plays out.

Operator

Your next question comes from Steve O'Rourke with Deutsche Bank.

Steve O’Rourke - Deutsche Bank

Deferred revenue was down a little bit quarter over quarter. This is the first time I think it's declined in about five quarters. What prompted the decline, and should we expect deferred revenue to be down in the June quarter?

Martin Anstice

The pattern of deferred revenues, I have characterized this quite a lot in the last quarter. At the end of the day we ship to customers when they need product, and we revenue our systems when we successfully and have the customer agree that we have installed and performed to the specification that we sold. So ultimately the customer has a tremendous amount of control over both of those things. We can influence them for sure, but there is an ebb and a flow around the period of time it takes from shipment to acceptance. In fact, that range was in the kind of one to five-month range, I would say six to nine months ago. It is probably closer to two to five months today.

I don't think there is a material message to convey to you today relative to deferred revenues. It does ebb and flow, and what is obviously the most fundamental way to characterize that is the shipment guidance that we've given you for June and the revenue guidance for June which together derive the deferred revenue number at the end of this coming quarter.

Operator

Your next question comes from Robert Maire - Needham & Company.

Robert Maire - Needham

You mentioned that you expect to ship four to six Clean units in the quarter. When could we expect to see those come to revenue? Related to that, when you announced the Clean product a year ago, you also announced a strip product, but I don't see it in any of the materials or I didn't hear anything related to it in your comments. Are we to take from that that perhaps that is a little slow in coming or is that on track or if you could give us an update on the Strip product as well?

Steve Newberry

Okay. Robert, what I talked about was that we expect to ship four to six eval systems this quarter, not last quarter. We're on track to do that. As I previously commented, we expect to take revenue on Clean systems later in the year. Whether that actually occurs in the September quarter will be a function of eval, completion, timing with some of the customers, and so I think it is better to think in terms of that most of the Clean revenues are going to be associated with the December quarter.

As it relates to Strip, we actually released a new strip chamber that targets a number of some advanced integrated Etch and Strip capability as well as some standalone Strip capability last year. It is relatively low levels of product shipments, and so we really haven't spent a lot of time really talking about the Strip market.

We build Strip revenues into the Etch revenues because fundamentally, while you do have a standalone Strip segment that's serviced by the companies that have those significant dedicated products, the vast majority of our Strip revenue comes as a function of being integrated onto a platform with Etch chambers and so we've just built that in there. You're correct to point out that we haven't talked about it, but fundamentally it is in the midst of what we're doing right now, and it has been for a couple quarters.

Operator

Our next question comes from C.J. Muse - Lehman Brothers.

C.J. Muse - Lehman Brothers

Steve, on the January call you cited one DRAM, one logic, and one foundry for the delay in shipments. Can you talk about what's driving the smoothing now? Is it only memory and if so can you comment on the mix between DRAM and NAND?

Steve Newberry

I want to be careful how I characterize it. I would say to you that in every single quarter that exists in any period of time, there is always movement of shipments, schedules, whether you're in the midst of a huge upturn or the biggest downturn you ever saw. There is always instability of in and out.

So I think the best way rather than think about company specific activity is to kind of look at it and say if you look at the fact that instead of being first half shipping up 5 to 10, we're going to first-half ship up 2 to 4, so we're 25 million to 50 million short of being in that 5% or 6% up. You can characterize that the majority of what that is is memory companies who back in the January timeframe indicated to us that they were wanting us to plan and slot for them deliveries in the May/June timeframe. Since that time they have come to us and said, a number of them, we actually wanted it in July and August instead. There was enough of that that it resulted in $50 million or $60 million moving out.

Operator

Your next question comes from Chris Blansett – JP Morgan.

Chris Blansett - JP Morgan

My question is related to an earlier one about foundry shipments picking up and I wasn't sure how the other logic makers were picking up for their 65-nanometer build outs. When you exit into the second half of the year how do you expect the shipment mix to be in the second half versus the first with a logic versus memory breakout?

Steve Newberry

Well, that's an interesting question these days, Chris, because the advanced logic space as it relates to non-microprocessor advanced logic is really in a state of significant change. As you know, a lot of those advanced logic manufacturers, whether you're talking about the old Freescale or NXP, ST, TI, Fujitsu, TI has announced that they're fundamentally moving to a foundry-based supply model. Freescale and NXP as a function of being acquired by private equity are focusing more on an orientation of shipping, let's say, current generation to trailing-generation type of devices and going to the foundries for advanced logic type activities.

So we're kind of in the middle of a situation where part of the pickup for what's going on in the foundries is that with this movement of major logic IDM companies away from their own manufacturing models, we're going to see more and more of that manifest itself in foundry.

I think that when we said that microprocessor, logic and analog was going to be plus or minus 5% for the year, we're probably starting to see with some of the microprocessor activity and some of the major logic guys that it is probably starting to trend toward the middle to the lower end of that activity for 2007. The question will be when you look at the totality of foundry and logic, will it just move from one space to the other space, which is what I expect will happen.

Operator

Our next question is from Mark Fitzgerald - Banc of America Securities.

Mark Fitzgerald - Banc of America Securities

Steve, on the explanation for the memory shipments facility issues in DRAM/NAND mix here, I assume that's coming from your customers. Do you actually buy that given that at the same time we've seen memory prices really collapse here?

A follow-onto that would be what level of confidence do you have that these delays don't get pushed out further? That's kind of the history of the business, we see these things once they slip really is the beginning of something far worse?

Steve Newberry

I think that if you talk to the customers, the first thing they would say to you is, well, we never formally committed relative to the hard copy purchase orders for deliveries in May/June that companies may now be talking about, we're asking for deliveries in July/August. So they wouldn't characterize that this shipment environment that I am describing to you is them pushing anything. What they would characterize it as -- and I am not disagreeing with them at all -- is that given the fact that lead times in this industry are short, customers who want deliveries in that May/June time frame, they didn't deliver their purchase orders until late in the March quarter. It's not unusual at all now that you don't get purchase orders until three or four months before shipments. So by the time you actually get the purchase order, many times it will reflect a much more accurate view that the customers have in terms of the exact timing that they want.

So I don't view that it is surprising that a lot of these memory orders have kind of smoothed out from a earlier communication that it would be more front end loaded, and in fact last year the same thing happened that at the beginning of the year it was expected that a lot of memory shipments would be very much front-end loaded and as it turned out they spread themselves out over the year. I think we're seeing the same thing.

So relative to the pricing environment, I think that pricing is very much occurring as we would expect it to given the seasonality that's associated with the memory market these days and the pricing is consistent with those expectations. As I said in my commentary, I think that the pricing environment will stabilize, and I think that what we'll find is that the actual additions of capacity and the actual outputting of supply will be reasonably well aligned to the expected demand environment that they're going to be shipping into. So I view their behavior as rational, and I do expect them to take the deliveries that they're scheduling as we go forward.

Operator

Your next question comes from Mark Bachman - Pacific Crest.

Mark Bachman - Pacific Crest

Martin, I thought that given your cash balances here that you would have a bias to be holding some debt here. Why did debt decline by $50 million in the quarter?

Why did you under spend on SG&A? I believe your guidance from last quarter was for about a 28% operating margin, but you came in about 100 basis points better.

Lastly in your share count what is your share count associated with your calendar year '07 EPS guidance?

Martin Anstice

The share count assumption in the scenario that Steve articulated at the outset here was the same as the guidance we gave for G&A, it was 139 million shares. We haven't taken any speculative attempt to anticipating how the next nine months or so rolls out here.

In terms of the operating expense part of your question, generally that's a good thing. I think if we spend a little less than we originally anticipated and don't undermine the progress of the growth initiatives of the company, and clearly we gave guidance implicitly at least as a function of the operating income guidance we gave, we gave guidance at or around the $141 million level, and I was saying pretty consistently through the quarter plus or minus $1 million or $2 million. So again I don't think there is a fundamental message for you there in terms of operating expenses.

As far as your debt question was concerned, obviously there is a cost to having debt, and if we had a strategy in place to have debt for the sake of leverage, then clearly it would be the wrong thing to go do. We don't have that strategy today, and if we get to that point, we'll cross that bridge when we get to it. So to the extent that there is a cost to have debt that exceeds the other uses of cash, it makes perfect sense to systematically process through repayments of that arrangement.

Operator

Your next question comes from Patrick Ho - Stifel Nicolaus.

Patrick Ho - Stifel Nicolaus

In terms of your 45-nanometer wins that you detailed on your prepared remarks, were they a new market share win with new customers or were they just a win on in terms of the next generation technology node from the 65-nanometer?

Steve Newberry

Two were new application wins, and three were defenses.

Operator

Your next question comes from Steven Paleo - HSBC.

Steven Paleo - HSBC Capital

Actually two clarifications and one question. First one, you didn't answer O'Rourke's question on the deferred revenues. If revenues were up about 1% or 3%, shipments are up 10% to 15%, you are going to see an increase in deferred revenues for June. That's the first clarification I need.

On the full year guidance you're now saying revenue is up 15% to 20% versus 10% to 15% and EPS of 4.50 to 4.70. I am curious what are the assumptions in the middle there for gross margins, operating margins and probably most important share count?

My last question, my official question here, your full year guidance for shipments are about 5% to 10% EPS at a mid-point of about $4.60. To make the shipment work that means in Q3 and Q4 you are down about 10% in each one of those yet you're assuming flat EPS, roughly $1.15 per quarter in Q3, Q4. Can you do flat EPS on down shipments in the second half?

Steve Newberry

We said we were biasing the shipments guidance to the high-end of the 5% to 10%, and I think that if you look at what our 10% to 15% shipments up for June is, and then you look at extrapolating that out to the second half, we might have a slight decline in shipments, but because we're a revenue on acceptance, we will have a situation where we will revenue slightly more than what some of our shipment output would be in the second half.

I think your question about the adjustment to the EPS range comes as a function of as we now sit here three months later in the year and we look at customer behavior and we look at our expectations for gross margin, OpEx spending controls, and our confidence in our ability to deliver a very strong operating margin performance, the movement from the $4.10 to the $4.30 scenario that I described in January to the $4.50 to $4.70 scenario really is a function of our confidence that the shipping environment will be there, our confidence that the revenue environment will be there, and most importantly our confidence that our operational execution capability as it relates to operating profit will be there. So it reflects our increased confidence in how the year will play out and how we will execute.

Martin Anstice

On the deferred revenue question, Steve, I thought I gave it a pretty good shot actually, but I will try again. Obviously some of this gets lost in rounding. Deferred revenue balance last quarter was 284. It is now 277. It is down a bit. When we give guidance and counsel for revenues in a range, 655 to 675 this time and shipments range 10% to 15% sequentially, clearly depending on how you choose to model either one of those high or low or mid-range, you are going to get a different answer to the question.

Hopefully the three data points that we've given you, the deferred balance at the end of the quarter, 277, the revenue guide, and the ship guide allows you to triangulate and answer the question in the way that you see fit.

Operator

Your next question is from Zhao Ping – Caris.

Zhao Ping - Caris & Co.

A quick question on all shipment bases. Do you still believe that Etch will grow faster or slower than overall WFE for 2007? What's your specific outlook for foundry on the same basis, the shipment basis for Etch 2007 over 2006?

Steve Newberry

What I had commented on last quarter was I felt that typically as the rate of wafer fab equipment spending growth slows down, which it is in '07 versus the 30% some it was up in '06 over '05, Etch typically will contract slightly as a percentage of wafer fab equipment.

In 2006 Etch was about 13% of wafer fab equipment, and we expect that in 2007 it is more likely to be 12.2%, 12.3%, something like that, maybe up to 12.5%, but it will be slightly less. Therefore on about 5% wafer fab equipment growth we think Etch is going to be essentially flat '06 to '07.

For Lam we will still grow because the make-up of what the shipments are that are going in for Etch applications is going to be dominated by 65-nanometer, and because our market share at 65-nanometer is significantly higher than it was at 90-nanometer, we will actually grow our Etch shipments as a function of market share growth.

Operator

Your next question is from Brett Hodess - Merrill Lynch.

Brett Hodess - Merrill Lynch

Martin, earlier you commented that the new products were being booked, the costs were all being booked in R&D now, and obviously while they've been released, I guess you haven't started recognizing revenues. As you get later in the year and start recognizing revenues, will most of the costs be already recognized so you will be getting some increased margin at that point off the new products?

Maybe you can give us an update also on the three new releases of the expectations for when they might book revenues and how meaningful that might be?

Martin Anstice

I think I'd echo Steve's earlier answer relative to the timing generally of revenues and it is echoing the commentary we gave in January which is biased towards the second half of the calendar year. As far as the accounting is concerned, your hypothesis is a correct one, certainly to the extent that we have previously expensed into R&D evaluations shipped to the customer, when that becomes a revenue event the normal cost of goods sold get associated with that hence normal gross margins, but we then get a credit through R&D. So from an operating income perspective those early eval turn shipments are actually pretty highly leveraged. Your hypothesis is indeed correct.

Operator

Your next question is from Stephen Chin - UBS.

Stephen Chin - UBS

On the new full year 2007 revenue guidance, Steve, how much market share do you now think you can gain in 2007? I think you said last time 3 to 4 market share percentage points.

And then on the June gross margin guidance, do you get the sense that the June quarter could be the trough quarter for gross margins given all these spare part initiatives that you've taken recently? Can this acquisition help the gross margin expansion during the second half of the year? Thanks.

Steve Newberry

Relative to market share, our assumption is consistent with what we talked about before. We are assuming in that it will be a 3% to 4% market share gain in 2007, again primarily driven by the fact that it is 65-nanometer shipment, those decisions have already been made, that market share is essentially already locked down. It is an execution of one market share type of year as this is the 65-nanometer ramp year.

Relative to the gross margin guidance question, I think that if you look at what we have performed at over the last couple of quarters and what we have guided to for the June quarter, that we would expect that as long as we are in a similar revenue range that we would expect to see our gross margins maintain at that 50% level. I think that we won't see margin degradation unless there is a drop-off in revenue that would, let's say, maybe approximate $50 million and then we'll have some factory absorption, inefficiencies that we'll have to account for, and some other period expense related activities that would begin to impact margin.

But as we look at the shipment in revenue scenario that we've laid out for the year, I think we would expect that our margins will stay consistent around 50%.

Martin Anstice

As far as the Blouin piece of your question is concerned, clearly we're optimistic about the opportunity to continue to define value with that particular transaction. It is still kind of early days. I think I characterized at the outset an expectation for neutral impact to earnings in the fiscal year, so to the extent there is upside it is not super material, at least in this calendar year horizon, but clearly part of our road map.

Operator

Our next question is a follow-up from Tim Arcuri.

Tim Arcuri - CItigroup

I am just going back over my model and I'm looking at what you guided shipments the last couple quarters. It looks to me like if I include what you guided June it looks like shipments have missed your expectation now for five quarters in a row. I am wondering, is there something going on there with respect to your shipments forecasting? I am just wondering why it has missed now five quarters in a row?

Steve Newberry

If it is five quarters in a row -- I think when you go back three quarters, I think we missed by some little rounding errors, so not sure what you're talking about, but here is the issue. I am giving you guys some flavor that's out beyond the current quarter, nobody else does that. Know why they don't do it? Because all I am doing is I'm telling you what the customers are asking for in terms of delivery today relative to that next quarter. We should all know that as we move forward in time that what may occur in terms of shipments can change. That's what's going on.

So if it would be more helpful that there is no discussion about anything related to shipments other than in the current quarter that we're talking about, that's fine.

I personally think that it is more helpful to provide visibility as to what is the state of what the customers are thinking today about what's going on in the next couple quarters, and then updating you all on how is it playing out? Is it strengthening, is it smoothing, what is it doing? If, as a function of that then I am incorrect, like instead of being up 5% to 10% in the first half we're up 2% to 4%, you're right. We've not been able to accurately have the customers actually take delivery consistent with what they have been requesting, and that's all I can tell you, Tim.

Martin Anstice

I think you know actually the answer to your question, Tim, I think if it were a Lam specific-item, the comments that we're articulating relative to volatility and shipment scheduling would only be showing up with us, and I think we all recognize that it isn't, and it is very consistent with the commentary from the customers themselves, and so it really isn't a statement of forecast process. It is an environment statement in the industry.

Operator

Our next question is a follow-up from Satya Kumar.

Satya Kumar - Credit Suisse

I know that you typically tend to provide al lot of detail on the memory market and I find your commentary to be extremely useful. To the extent that you use that analysis to base your full year expectations, I looked at your DM ASP outlook of down 30 to 35% for the year, if I take DM prices average last year and take that down to about 32.5%, I get DM prices to be about $3.60 on average for calendar '07. If I flat line DRAM prices from where they are today, I would get an average price of $3.30.

Is it fair to say that in your outlook you're sort of thinking implicitly you've seen the bottom in DRAM pricing? That's one question. Secondly, in your full year EPS guidance of $4.60, what are you baking in for the increased EPS from a lower share count? Thanks.

Steve Newberry

Relative to your question on DRAM pricing, everybody has their own set of numbers and data, and I would say that what we're thinking is that if you look at that 30% to 35% average year-over-year decline, that for it to be 30% you would pretty much have to have things kind of basically flatten out. If it declines 35%, then there is room for the pricing to decline about another 10% from where we are today.

That's why I am giving a range because we think that the rate of decline is going to flatten out, and the question is, is it going to go dead flat or is it going to drift slightly down? But even within the range of 30% to 35% price declines, we think the profitability capability for the companies in the industry remains intact. We think that they the elasticity of demand capability at those price points would create a situation where you would have that supply that's generating that kind of pricing still sucked up on the demand side of the equation.

Relative to the $4.60, we commented earlier that it is consistent with the 139 million shares that we articulated we were using for our EPS calculation for June. We have just maintained that assumption for the $4.50 to $4.70 guidance or scenario numbers that we laid out for '07.

Operator

Our last question is a follow-up from Chris Blansett.

Chris Blansett - JP Morgan

Guys, just two quick things. One, when you look out to some of the systems that you talked about in the memory world that were smoothed out, we had been hearing that some of the Taiwanese DRAM makers were looking to change configurations to more of a 70-nanometer config. I wasn't sure if that was part of it.

The second thing is, just when you look at overall orders year-over-year first half to second half, just clarify what that was? I know we have been talking about memory orders but what about overall orders year-over-year since we're going to have a pickup in logic in the second half?

Steve Newberry

Chris, one, we don't make any comment about orders.

Chris Blansett - JP Morgan

We can talk about shipments, then. Sorry.

Steve Newberry

We really didn't talk about second half shipments versus first half. What we said was first half shipments 2% to 4% up over the second half of '06, and shipments for the year in '07 up 5% to 10% biased toward the high-end of that range, and so that was the comment that I made about shipments.

In terms of why memory companies are smoothing out their deliveries, there are 15 different reasons all of which have validity as they relate to what that customer's circumstances are, and again to be fair to those customers, in their mind and I understand why they are saying this, until they deliver the hard copy PO, and until they lock down and firm commit to that delivery date, they don't view that if they say to us, hey, I am thinking about wanting delivery in June, we reserve those slots for them, we have material plan for that. And then when they actually deliver the order in March they come in and say, well, actually we've looked at everything, we looked at all our schedules, we look at it all the time, and we want it in July.

I mean, that happens all the time, and I think that the reality is because we're in the part of the cycle where the rate of wafer fab equipment investment for capacity expansion has slowed down from the dramatic rate that we saw last year. All of this stuff tends to be a little more visible, and people are paying maybe a lot more attention to it. Trust me, in the course of any given quarter the amount of movement in requested ship dates in and out is always high.

Julie Cimino

Thank you, operator. That's all the time we have this afternoon. We would like to thank everyone again for dialing in to today's call. We appreciate your interest and look forward to speaking with you on our next quarterly call that's scheduled for Tuesday, July 17.

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