Lam Research's (LRCX) CEO Martin Anstice on Q2 2016 Results - Earnings Call Transcript

| About: Lam Research (LRCX)

Call Start: 17:00

Call End: 18:03

Lam Research Corp (NASDAQ:LRCX)

Q2 2016 Earnings Conference Call

January 27, 2016, 17:00 ET


Satya Kumar - VP, IR

Martin Anstice - President & CEO

Doug Bettinger - EVP & CFO


Harlan Sur - JPMorgan

Romit Shah - Nomura

Timothy Arcuri - Cowen and Company

Chris Shankar - Bank of America Merill Lynch

Farhan Ahmad - Credit Suisse

C.J. Muse - Evercore ISI

Patrick Ho - Stifel Nicolaus

Steven Chin - UBS

Weston Twigg - Pacific Crest Securities

Atif Malik - Citigroup

Jogiday Shier - Redsun Technology Research


Welcome to the Lam Research Corporation December 2015 Earnings Conference Call. At this time, I would like to turn the conference over to Satya Kumar, Vice President of Investor Relations. You may begin.

Satya Kumar

Okay, thank you, Aaron. 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, review our financial results for the December 2015 quarter, our outlook for the March 2016 quarter and provide an update on a planned business combination with KLA-Tencor. The press release detailing our financial results was distributed a little after 1 PM Pacific Time 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 the time and the parties' ability to close the proposed business combination with KLA-Tencor and achieve the anticipated benefits, technological advances and synergies to be realized as part of the proposed transaction and the anticipated structures of future combined operations.

A comprehensive list of forward-looking topics that we expect to cover is shown on the slide that's 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 your questions to one per phone, with a very brief follow up so 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 hand the call over to Martin.

Martin Anstice

Thank you, Satya and thank you all for joining us today. I will first begin with a review of our calendar 2015 accomplishments, including comments on their relevance to the growth outperformance opportunities for the Company, then offer a perspective on wafer fab equipment spending in 2016 as well as the trends driving our longer term favorable outlook, concluding my prepared comments with a progress update on our planned business combination with KLA-Tencor. Doug will then review our financial and operational performance as well as provide guidance for the March 2016 quarter.

2015 was another record year for Lam Research, augmented by our plan to combine with KLA-Tencor this year. A partnership that we believe will create an unmatched capability for the global semiconductor industry by uniting best-in-class process technologies with process control, creating a new paradigm in process enablement, accelerating innovation for the benefit of our customers.

Last year, for the first time in our history, we exceeded $6 in earnings per share, grew shipments by 25%, to nearly $6 billion, reported record revenues of $5.9 billion, with operating profits expanding at greater than 1.5 times revenues. Demonstrating, we believe, sustainable leverage in our business model.

In this context in 2015, we achieved record output from our factories, while improving our on-time delivery performance and shortening cycle time for installations, a very solid operational contribution. 2015 was the third consecutive calendar year in which we have significantly outgrown the industry. Over the last three years, we have grown our shipments at an annualized rate of more than 22%, well in excess of WFE CapEx growth of 6% in the same period.

Our success is always predicated on customer trust and the opportunity customers are willing to provide us. It is also the result of our vision, strategy and operational execution to bring a capability in leading-edge process technologies to bear on the most fundamental technology inflections that are driving an increasing proportion of wafer fab equipment spending.

In short, calendar 2015 was a year we're very proud of. Many worked extremely hard, but the increased strategic relevance of Lam and the demonstrative results make that effort rewarding. I would like to take this opportunity to express my sincere appreciation to all of our employees across every function and in every location, without whom as a collective group, these accomplishments would not have been possible.

The culture and values of Lam and a priority on continued learning and development remain a foundation of competitive differentiation. We recommit to that as even stronger aspiration in 2016. We estimate that the industry grew wafer fab equipment spending by approximately 4% to $33 billion in 2015.

Marginally stronger than earlier expectations, our SAM share of WFE expanded to slightly more than 30% in 2015, driven by the technology inflections including the industry conversion to 3D device architecture in non-volatile memory and also in logic, increased use of multi-patterning in DRAM and logic applications and increased adoption of advanced packaging integration schemes. Our demonstrated strength in these extremely complex technology and cost-sensitive process flows allowed us to grow Lam's share of our SAM to the mid-to-high 40% range in 2015.

Multiple patterning has become a key driver in enabling our customers' scaling plans. Our Vector ALD and our Hydra conductor etch technology have enabled scaling and proactively positioned reductions in the cost of multiple patterning through variability reduction and productivity improvements.

We solidified our number-one position in 3D NAND for deposition and etch with differentiated products such as the high-productivity Vector Strata and industry-leading ALTUS and Flex products which address the high aspect ratio challenges of advanced memory applications.

In the multi patterning segments we saw an unprecedented ramp for our Kiyo with Hydra technology for conductor etch, where we have increased our install base by more than a factor of 5 in the last 12 months. The Hydra conductor etch process control technology has delivered improved CD uniformity by approximately 50% from the prior baseline. We saw very strong momentum for our Vector ALD products, where we doubled our shipments for multi-patterning applications enabled by best-in-class within-wafer, wafer-to-wafer film thickness and CD variation control. The Vector ALD platform has improved system productivity by up to 50% in the year, delivering the lowest cost of ownership available in the industry currently.

All market segments combined, the headline for Lam deposition was an approximate 2 percentage point market share gain in the year on a very strong SAM expansion. In 2015, founded on the depth of etch technical competency and capability at Lam and supplemented by some positive customer mix, we achieved the largest expansion of market share in over five years in our etch business growing our total share by over 5 percentage points to the high-50% level.

We're well on track towards delivering the longer term goal that we communicated at our Analyst Day in July last year. In a perpetually competitive industry segment, we had a truly great year, maintaining our leading HVM position in co-vector etch and making substantial gains in dielectric etch. In the conductor segments, we saw of fast ramp of Kiyo F Series products at multiple DRAM and 3D NAND customers. We were particularly pleased with the substantial market share gains we had in dielectric etch in 2015, with our Flex-F and G-series product families at multiple memory customers with increased potential and momentum emerging also in logic.

We remain focused on delivering critical etch technologies for high aspect ratio etch as our customers scale the DRAM capacitor and the film-stacked height in 3D non-volatile memory structures. In our clean business, 2015 was a year of solid execution and some strategic repositioning.

We recorded our largest increase in single wafer clean market share in any prior year, with a mid-single-digit percentage gain. Our strategic planning process ratified again the increasing strategic relevance of clean within our product portfolio. It also provided a framework for the streamlining actions we reported to you late last year.

We enter 2016 energized about a future of sustainable profitable growth excited about the increasing breadth of the Lam wet and dry technology product portfolio, targeted at supporting traditional clean and increasingly complex surface preparation and other yield-enhancing applications.

Providing the foundation for the overall business momentum is the performance of our install base, a key focus of our customer service business group. Here, we set another record for revenues. This business group is focused on creating collaborative solutions to improve our customers' productivity, also asset utilization and reduce their risk through the equipment lifecycle with products including advanced predictive services and productivity upgrades.

We're also addressing the needs of leading-edge and trailing-edge customers across a variety of wafer sizes and markets through a broader and more capable refurbished tools offering. 2016 has begun with well-publicized volatility and some contraction in growth expectations for the global macro economy, with risks in some emerging markets, but balanced by steady if slow improvements in a number of developed markets.

Within this environment, Lam continues to be optimistic that the underlying technology drivers of mobility, cloud and the Internet of Things provide a foundation for an exciting multi-year opportunity for our products and services. We assume 3D non-volatile memory, a new memory technologies adoption, are at a tipping point this year, resulting in an accelerated demand for solid-state memory in 2016. We're particularly optimistic in this segment where we see many years of technology visibility and opportunities for Lam to improve the cost and performance roadmaps for our customers.

We expect to see double-digit growth in non-volatile memory CapEx in 2016, driven by the need for the industry to convert to 3D capable capacity. Based on our analytics, the equipment industry is scheduled to support the delivery of a 3D capable install base of between 350,000 to 400,000 wafer starts per month of total capacity by the end of this year, supporting NAND bit growth this year of mid-30%.

Rational industry spending is a common theme in a consolidated world. We anticipate meaningfully reduced year-over-year spending in DRAM with customers focusing on 20-nanometer and 1X nodes migrations to continue to improve their cost competitiveness supporting industry bit growth in the mid-20% range.

On a combined basis, we expect overall memory CapEx at the $15 billion level, plus or minus $1 billion. From a foundry and logic CapEx standpoint, we continue to see an increase in projected spending for 10-nanometer investments, as well as 28-nanometer and above investments, across a number of customers.

Since our updates in October, we have seen some reported weakness in end-market demand for high-end smart phones with content continuing to expand however and in that context we expect to see growth in 14-nanometer wafer demand as more companies ramp products of this node throughout the year. Taken together, we expect foundry and logic spending to be up slightly year over year at the $17 billion to $18 billion level in 2016.

As a result of these trends, we expect that 2016 WFE will track to approximately $33 billion, plus or minus $2 billion which is relatively unchanged from the initial views we provided you in October. We're off to a great start this year with broadly positive customer engagements and an anticipated book-to-bill in March comfortably exceeding 1.

Based on our current understanding of customer plans, we're very confident that our shipments in the first half of calendar year 2016 will exceed the second half of calendar 2015 and early indications suggest our shipments in the second half of 2016 will grow from this new first-half baseline. As a closing headline, December was our weakest shipments quarter in a record-setting calendar 2015 year. We anticipate the March quarter as our weakest in the 2016 year which overall is anticipated to be stronger for Lam than 2015.

I will now update our progress towards completing our planned combination with KLA-Tencor and provide an early glimpse of our integration planning. We're working closely with regulatory agencies across several global regions to obtain the necessary approvals for the closing of this transaction. We remain confident that we can secure approvals to complete the transaction in mid-2016. Any updates to the developments on the regulatory front will be made through relevant filings or press releases that will be broadly disseminated to investors. We will not comment further on this subject in this meeting today.

We're in the early stages of planning for the successful integration of Lam and KLA and the process that will enable us to realize the full strategic and financial potential of the combination while continuing to operate as two stand-alone companies with compelling products, technologies and people.

We formed an integration planning team and we plan to leverage our experience from successfully integrating Lam with Novellus. A team with strong representation from both companies is established and already quite active. With a primary focus to develop a comprehensive understanding of what we both do and exactly how we do it.

At a more personal level, I continue to be very pleased with the dialogue with customers around the world, who without exception, look to the value proposition available of enhanced innovation from this business combination. As has been clear from our public filings related to the merger, we intend to continue the existing KLA-Tencor supply and support relationship with the broad industry ecosystem of our customers and suppliers to our customers both.

We will be ready for day-one execution I have no doubts based on numerous interactions worldwide. I am delighted that we have an engineering and technology community in both companies who see more opportunity each and every day to deliver a more compelling value together than is possible separately. Excitement is definitely building our deal hypothesis being validated through our planning.

While 2015 was a record year for Lam Research, we believe that 2016 holds even more promise. With the current quarter momentum in our business, our opportunity for continued outperformance and the anticipated creation of an even stronger and more strategically relevant company in partnership with KLA, we're positioning Lam for significant performance improvements now and over the long term.

In closing, I would like to express my thanks again to our customers for their trust and partnership, employees for our differentiated culture and performance, suppliers for their support and commitments and investors for their confidence and continued interest in Lam. Let me now turn the call over to Doug who will provide a review of our financial performance and our March quarter outlook.

Doug Bettinger

Great. Thanks, Martin and thank you, everyone, for joining us today on what I know was a busy earnings day. We ended calendar year 2015 with strong performance. Meeting or exceeding the midpoint of our guidance for the December quarter on all financial metrics.

Earnings per share came in above the high end of our guidance range. In addition to the numerous milestones Martin mentioned during his prepared remarks, during calendar year 2015, we generated over $1.2 billion in cash from operations which was an increase of more than 45% compared to calendar year 2014.

And we returned more than $410 million to our shareholders through stock repurchases and dividends. We're very pleased with what we've achieved this quarter as well as this calendar year. Shipments continued at a healthy level in the December quarter, totaling $1.288 billion which was a little bit above the midpoint of our guidance. As we anticipated, memory shipments decreased in the quarter, with the combined memory segment representing 65% of total system shipments and that compares with 72% in the prior quarter.

DRAM shipments made up 42% of the system shipments which was up from 32% in the previous quarter. DRAM investments continue to be largely focused on 20-nanometer conversions. Customers continued to ramp NAND and other nonvolatile technologies which made up 23% of the system shipments and this was down from the 40% level that we saw in the September quarter. NAND investments were again primarily directed towards employment of 3D NAND capacity.

December quarter foundry shipments were 25% of system shipments and this was up from 18% in the previous quarter. Foundry spending was broad based, with the combination of 10-nanometer pilot capability, first-generation FinFET capacity, as well as trailing-edge investments. The logic and other segment accounted for 10% of system shipments which was about the same level as last quarter.

Revenue in the quarter came in at $1.426 billion which was a little bit above the midpoint of guidance and down 11% compared to the record-high level that we saw in the September quarter. Gross margin came in right at the midpoint of guidance at 45.5%

And as I always mention, you should expect to see some quarter-to quarter variability in gross margin due to multiple factors such as product mix, customer concentration, as well as overall business volumes. Our financial model continues to be the right tool for you to use to build your models and think about our ongoing financial performance.

Operating expenses in the December quarter declined to $352 million, coming in at 25% of revenue and this compared with 23% in the September quarter. About 62% of the OpEx spend in the quarter was allocated to R&D which was around the same ratio we held throughout the calendar year. Funding of strategic R&D programs to continue our technology and productivity leadership is critical to meeting our objectives of growing the Company at a faster pace than the industry. The market share success we're currently enjoying is a result of investments we have made in previous years. We aim to continue that outperformance.

Operating income in the December quarter was $296 million, down from $380 million in the prior quarter. Operating margin was 20.8% which was down from 23.8% in September and a little bit above the midpoint of the guided range. Operating income and operating margin declined sequentially as a result of the lower revenues in the period.

Our tax rate for the quarter was approximately 7%, down compared to 14% last quarter. The tax rate was lower primarily due to the permanent extension of the R&D tax credit in the United States. A tax rate of low- to mid-teens for the remainder of 2016 would be a reasonable number for you to include in your models.

Based on a share count of about 172 million shares, earnings per share for the December quarter were $1.57. This was above the high end of our guided range due to the favorable tax rate in the quarter as well as the higher revenue. The share count includes dilution from the 2016 and 2041 convertible notes, with a total dilutive impact of about 11 million shares on a non-GAAP basis. Dilution schedules for the 2016, 2018 and 2041 convertible notes are available on our investor relations website for your reference.

In the quarter, we returned $48 million in dividend distributions to our shareholders. We did not repurchase any shares in the December quarter as we have temporarily suspended share repurchases in anticipation of the business combination with KLA-Tencor. Let me now move to the balance sheet. Cash generation was strong again in the quarter with cash from operations coming in at $295 million. During the quarter cash and short term investments including restricted cash increased to $4.7 billion, up from $4.5 billion in September.

Day sales outstanding increased to 70 days versus 62 days last quarter. The increase in DSO was due to the timing of shipments within the quarter, with shipments being more biased towards the back half of the period. Inventory turns remained strong at 3.6 times. Deferred revenue at the end of quarter were $395 million which was down from last quarter. And I just point out this number excludes $109 million from shipments to customers in Japan which will revenue in future quarters. I would like to remind you that those Japan shipments remain as inventory carried at cost on our balance sheet.

Company non-cash expenses during the quarter included the following, $33 million for equity comp, $39 million for amortization and $33 million for depreciation. Capital expenditures were $28 million which was down from $49 million in the September quarter. CapEx can sometimes be a lumpy number as you saw in December. CapEx for the year came in at $173 million.

We ended the quarter with approximately 7,300 regular full-time employees. I point out that we have been relatively flat headcount wise for the last two quarters. Entering 2016, we continue to be pleased with the momentum in our business and the progress we're making towards our targeted financial model. For the March quarter, our non-GAAP guidance is as follows. We expect shipment growth to $1.43 billion, plus or minus $75 million. We expect revenue of $1.3 billion, plus or minus $75 million.

This lower revenue for March is largely consistent with our December shipments. We expect gross margin of 44%, plus or minus 1 percentage point. The margin decline in March is due to both customer as well as product mix. I expect margin to improve from this level as we go through 2016. We forecast operating margins of 17%, plus or minus 1 percentage point. And finally, we're forecasting earnings per share of $1.07, plus or minus $0.10, based on a share count of approximately 172.5 million shares.

In the outlook for the Company, we're optimistic in the trajectory of demand for our products and services. We expect shipments and revenue in the June quarter will be stronger than in the March quarter. With the anticipated strength in shipments, we expect to grow our deferred revenue balances in the first half of 2016. As we sit here today, I expect the second half of the year will have a stronger top line than the first half due to investments in leading-edge foundry and logic.

That concludes my prepared remarks. Operator, please open the call for questions.

Question-and-Answer Session


[Operator Instructions]. And we will take our first question from Harlan Sur, JPMorgan. Your line is open.

Harlan Sur

Within the team's flattish WFE outlook for 2016 and your view on the positive trajectory of your business this year maybe you can just give us a sense DRAM, NAND, logic and foundry what the bias on customer spending trends look like first half versus second half. I assume for example 3-D and 28 nanometer maybe strong first half with 10 nanometer and 1X DRAM maybe strong in the second half, but wanted to get your views.

Martin Anstice

Yes, thank you for your comments at the beginning there, Harlan. Obviously we're at the beginning of the year so lots to learn. But our analytics today would cause us to think that year over year, so 2015 to 2016, the memory investment level is maybe down by $1 billion and the foundry is up by about $1 billion and then logic and other are kind of flattish. So there's a plus or minus with each one of those, so that's a kind of segment composition.

Our sense of first half, second half WFE we're currently modeling a 47%, 48%, 53%, 52% type of profile. So, overall a stronger second half than first-half. DRAM foundry and micron microprocesses all second-half stronger than first half and NAND to your point, slightly stronger in the first half of the year. And I would say that the upside to the extent there's upside in the first half, second half split and I'll just characterize with NAND, is all defined around the performance of devices and then momentum in SAD markets and so on and so forth. So that's the summary of our modeling at this point in the year.

Harlan Sur

And as you mentioned, it seems like legacy 28 nanometer is a pretty resilient note. There's still a lot of design starts going on in this node. I think UMC just reported last night their doubling their CapEx spend this year primarily for 28 nanometer, hearing the same thing from some of the other China domestic manufacturers. How much of a driver of the foundry outlook this year is from some of these legacy nodes?

Martin Anstice

It's not insignificant for sure. There is a healthy investment at above 28 nanometer and I would say it is almost equal to the same level of wafer stocks that we saw added in 2015. It has a slightly different composition. It's relatively broad-based so there's two to three customers at almost every foundry node and there's a cap in intensity at the 14 nanometer, 16 nanometer and 10 nanometer technology nodes obviously that make those investments relatively more expensive. But certainly there is a decent chunk of foundry wafer fabrication equipment spending that is 28 nanometer and above.


And we can take our next question from Romit Shah with Nomura. Your line is open.

Romit Shah

Martin, you're under an environment that you characterized kind of flattish WFE for this year, based on your comments I'm sort of concluding that the company shipments can grow presumably revenues would grow, but as you think about operating expenses and some of the other below the line items, do you think it is reasonable to assume the company can grow earnings per share?

Martin Anstice

Yes, I think we've got a pretty clear statement of modeling on that. Our long term financial model that we used at Semicon West is a great reference point for you. It's almost replicated in the F4 filing. There's 22% operating income references, there's growth references, there's SAM expansion references and the headline is the inflection story which is the catalyst for SAM expansion continues to progress 2015 into 2016 and all the way through 2018. Just to remind you our estimate of inflection-based spending as a percentage of WFE in the year just completed was in the low 30% range and by the time we hit 2018 our estimate is 55% or slightly higher.

So, the SAM expansion story the targeted market share story certainly have us optimistic that we're continuing to grow the company in an environment of flat WFE and the economics that we're targeting are exactly as we've communicated in our long term financial model. So I think the answer to your question is yes.

Romit Shah

Okay that's terrific. And then as a follow-up, Doug, just on gross margins for Q1, you mentioned that customer and product mix were negatively impacted in gross margin. Can you just give us a little bit more color on the specific stuff?

Doug Bettinger

Probably not much more. You see variability if you go back in December we were 4% to 5.5%, in you back to the quarter before we were 46.4% and overseeing 44%. You get lots of puts and takes when different customer mix, customer concentration, tool mix. Not every tool we sell is the same profitability level and overall business volume is part of this, too. So all of it is contributing, Romin. And as I said in my scripted remarks I expect this to be the low mark in terms of gross margin percentage for the company in 2016

Martin Anstice

If I need to just build on that and take the question in the context of the totality of investments that we're making in the company. Let me deal with margin and OpEx together. You know the full process relative to the operating expenses in the company we have tremendous opportunity here to continue to outgrow the industry and our commitment to invest in R&D to support that initiative is a really important commitment for the company. So we're not jerking left and right, our commitment to customers around enabling technology.

We're committed and we have to work through these short term kind of variability that we see as a result, as a result of concentrated customers these days. But having said that, we talked a lot about R&D and SG&A percentages so Doug can talk more if you want to in the call, but I think you know what we're trying to do there.

We have essentially in the guidance provided today retained or constrained the operating expense investments to a level that is pretty similar to the March 2015 quarter. And just to remind you, in March 2015, we were just coming off the back of a $5 billion revenue year.

Now we're coming off the back of a $6 billion revenue year. So to have the operating expenses at the $350 million level is a testament to the business model and the commitment to the management team to be responsible in the context of long term and short term performance improvements.

Last thing to say, relative to gross margins, I don't think we're the first large equipment company to message December to March gross margin contraction in the scheme of things. The best council we have for you is the long term model and the 22% range of operating income is still the ambition of the company in the 2016 year.


And we'll take our next question from Timothy Arcuri with Cowen and Company. Your line is open.

Timothy Arcuri

I had two things. First of all Martin just the sort of a question about the environment today versus three or so months ago, you guys had been very clear about the first half of this year shipments being up versus the back half of last year. But now it sounds like you're a bit even more optimistic on June shipments and particularly now you're looking in the back half and also showing you're pretty bullish there too. So the question really is what has gotten better? What particular customer area are what particular region has gotten better in that time? Thanks.

Martin Anstice

I guess the context of what I'm about to say as I've said $33 billion which is exactly the same as what I said in October. What's different today obviously the passing of three months always provides a little bit more visibility, always provide a little bit more of a confirmation on technology roadmaps of customers and their ability to yield through very complex technology transitions. So it's the same numerical presentation and if my tone is a little bit more positive that's really a commentary on the passing of time and being able to validate plans and being able to see customers validate their plans a little bit more in January that we were able to do in October.

Timothy Arcuri

And then I guess Martin just following on that if you add up all the projects in China there's like $20 billion worth of WFE. Clearly there's a big fab not huge but a decent sized fab that's actually ordering right now in China, but there's a lot of other very, very big fabs. And so I'm wondering, what is your assessment on the timing of that? Is any of that going to come into the back half of your year or is that more of a 2017, 2018 thing? Thanks.

Martin Anstice

Yes, I'm going to reserve the right to not get specific to anyone fab. I think the headlines are clear from that customer what they're intending to do and as you know, we've got great position in the 3-D NAND transition -- so to remind everybody we're at about a 90% market share etch and depth-cortical applications and we made progress between planar and 3-D and so, we're a very active participant in the spending plans of the customer that you are referring to. And I should defer to their public confree on the timing.


And we can take our next question from Chris Shankar with Bank of America Merrill Lynch. Your line is open.

Chris Shankar

Two of them, Martin and I give Martin the congratulations on a good calendar 2015. The first question is on the 3-D NAND spending. It looks like everyone want to be bullish on this. I'm just wondering, is there a risk that if customers run into yield issues, could that slow the pace of adoption or do you think that demand is so strong that they're going to punch through and meet your yields. And then I also had a follow up.

Martin Anstice

I think it would be irresponsible to say that yield isn't relevant relative to cost isn't relevant to adoption. There is kind of a chicken and egg here. And I think one of the things that we're trying to do, we have obviously a tremendous opportunity to grow our company and outperform in the context of enabling many of the 3-D NAND architecture in partnership with our customers, but what goes with opportunity is a lot responsibility and we've got a lot of responsibility to help the customers yield to create an environment from a cost and performance point of view which is a catalyst for demand.

I'm not sure which comes first a lot of this and the customer is going to speak to their tolerance of risk. To your point, everybody is invested with plans in 3-D NAND this calendar year as best as we can tell. 95% of the nonvolatile spending is focused on 3-D device architecture. It seems like there's a universal commitment to this and we're certainly head down working hard to contribute in our small way to the success of the customer.

Chris Shankar

Just a follow-up for you also, for Doug, when you look at the next year or even later this year or next year it looks like the spending shift might move more from memory towards larger co-foundry. Is there a way to quantify how much of a margin tailwind would it be when the mixture's from memory to foundry?

Doug Bettinger

No, I don't think there's really any substantial differential due to any of the segments in the business. There's differentials, customer to customer sometimes, larger early adopting customers that help with development sometimes, get a little better pricing but I don't think segments is something you should think of that way Chris.

Martin Anstice

And I think is a basic headline what you've heard us talk about for many years is the philosophy relative to pricing what we sell to our customers. So our number one focus is to build customer trust. Our number one way of building customer trust is to position for fair compensation. And we're not the highest gross margin company in the industry by a long stretch.

But I think we're the fastest growing or one of the fastest-growing and there's always a balance between targeted profitability and growth. And we spend a lot of time thinking through the legitimacy of the gross margin objective for the company and the range that we talked about for the last several years, this mid-forty percent range, 45%, 46%.

And I think a very defendable place for us to be and it is in general, in a consolidated world it is pretty segments and customer agnostic, right? We don't want to play a role influencing the competitiveness of customers based on our pricing strategy. That would be a sure way to lose customer trust.


We'll take our next question from Farhan Ahmad with Credit Suisse. Your line is open.

Farhan Ahmad

My first question is on 3-D NAND. Martin, you mentioned that the overall NAND spending is going to be up double digit. I wanted to ask if you can provide a breakout between cleaner and 3-D and specific to 3-D, how much an increase in spending do you expect to see?

Martin Anstice

You know, we're at least in this goal going to keep our WFE disclosure for memory at the memory level as opposed to a DRAM number and a NAND number and the reason for that is because we see there are some pretty big decisions for a couple of customers to make around where their allocation of spending will be.

So I'm hoping that by the time we get to the next call that clarity is there. But to the first part of your question our assumption is 95% of the investments in 2016 in non-volatile memory NAND and other schemes is 3-D.

So it is dominating the investments. And it is a very complex mix of conversions and upgrades as well as some additions. I would say it is a very efficient spends plan and it has everybody participating.

Farhan Ahmad

And just a clarification, how much was the split between cleaner and 3-D in say 2015 spending?

Martin Anstice

I want to say 60/40.

Doug Bettinger

Yes, it was about 60%.

Farhan Ahmad

And then one longer term question, Martin. If I look at what happened over last three, four years, Lam has outgrown the industry massively and part of the reason was obviously like you guys have been following a strategy and investing heavily in the growth trends within the industry where some of your other competitors, EMAP and DOE, for a period of time kind of moved away their focus from semiconductor and were looking at other market and were kind of struggling, then this went into semis.

Now looking ahead it seems like both of these companies have seen the outperformance that you have been able to deliver and kind of changed their strategy to start investing more in the space. Is there a change when you look at the competition that you are seeing in the growth areas of the market is it any higher now than what you used to see like say three years ago?

Martin Anstice

I think I used perpetually competitive when I described the etch segment. It feels the same today as it ever has done. This is a tough industry, a tough segment and it isn't just about the big guys, it's sometimes the smaller competitors, the regional alternatives and so on and so forth.

We have been very disciplined making the investments in our future, long term future, a priority for the company. It's a multiyear commitment that extends way back. And it is a tough thing to get balance but I think the company did a nice job at identifying the opportunity to grow through technology inflections. The technology and engineering results, the company did a fantastic job delivering as competitive products and services. Our field organization nailed the interface with the customer in terms of positioning but more importantly supporting ramps and productivity agendas and install base performance. So it's a total team effort.

Our plan is to build upon that foundation and whether we can do exactly the same thing in the next three years that we did in the last three time will tell, but you've got a pretty committed company to a growth trajectory that is profitable.


We will take our next question from C.J. Muse with Evercore. Your line is open.

C.J. Muse

I guess first question, was hoping to drill a little bit deeper in terms of SAM expansion peer for calendar 2016. You grew 20% plus in 2015 versus the market's 3% to 5%, so great job there. Curious what the puts and takes are this year. How do we think about maybe a falloff in image sensors but a pickup and sharing logic the move to a greater NAND less DRAM differed revenues. What are the key drivers we should be thinking about plus and minus for this year?

Martin Anstice

So I'll deal with one part of that and maybe Doug will deal with the deferred revenue piece. At a segment level the story that I described for WFE is slightly stronger foundry year-over-year relative to a slightly weaker memory investment.

Historically that has meant something to us in terms of the degree of outperformance but one piece of really important context is we really positioned well in the image sensor transitions and I think when other folks were struggling a little bit with logic spend reductions we generally marched right through that because of that positioning and it is as strong today as a was then.

Our momentum in foundries and in microprocessor logic is now I hope well understood to be a positive trajectory for the company. And so we still believe that in an essentially flat WFE our SAM increases. One part of that is the inflections message, so something like a 33% reference point for 2015 the proportion of WFE that is inflection-based and that is walking its way to the 55% level.

We've just come off a stunning market share year for the company. We're going to keep working hard and the long term market share objectives I think are well within grasp at this point. So we're pretty pleased about that.

Doug Bettinger

Yes, so just to follow on the second part of your question, normally you will see when we have got shipments ramping up deferred revenue will grow and vice versa when shipment coming down deferred revenue will come down.

You kind of saw that in December. And in my scripted remarks I talked about an expectation that in the first half of 2016 we expect deferred revenue to grow. It's because we expect to be on a ramping profile of shipments.

C.J. Muse

I guess as my follow-up if I take your commentary around shipments more second-half weighted than first-half it looks like we're going to hit roughly $1.6 billion, $1.7 billion and I'm curious, A., do you agree with that assessment? And B., does that mean that we should be targeting 46.5% plus type of gross margin exiting 2016?

Doug Bettinger

Yes, C.J., I'm not ready to quantify anything yet. The fact that we're giving you color on the second-half we thought was important given March was a low level for the year. I'm not going to quantify it quite yet. And in terms of the profitability level I'll just take you back to the financial model we've put up back in July as the right way to think about the performance of the business on a medium term basis.


And we can take our next question from Patrick Ho with Stifel Nicolaus. Your line is open.

Patrick Ho

Doug, first off in terms of the revenue recognition versus the shipments and the deferred revenues that you're talking about, obviously Japan is a portion of it. Are there any other variables, like say as you mentioned the new Chinese fab, things of that nature that also cause a potential delay in terms of revenue recognition?

Doug Bettinger

Every customer is a little bit different in terms of how they accept tools that are shipped, so customer-to-customer there's variation, fab-to-fab there can be variation. Especially when there's a new fab you're shipping to sometimes it can take a little bit longer to clear customs as an example, so the differential between ship and revenue has several different variables.

Martin Anstice

But I think it's fair to say that the mix of customers this was a relatively slow term and we'll probably speed up a little bit over time.

Patrick Ho

And Martin, just I'm going to the ALD market for a second. You guys have made a big foothold to try and get into that market. You're starting to see some of the gains especially as multi-patterning on the logic and foundry side. Kind of a two-part question there, one, how do you see the capital intensity increasing for the ALD market for us as a whole and secondly how do you see your share gain potential particularly as you move from the 16 nanometer, 14 nanometer nodes to 10 nanometer?

Martin Anstice

The share gain sits in the context of the overall objectives for the company and depositions, so we've kind of given you a reference point of 5 to 10 percentage points in the calendar 2013 through 2018 timeframe. The ALD question is a really interesting one and I think there are actually a lot of unanswered questions relative to the choices of technology and integration schemes to address really complex challenges.

But our expectation is that ALD is a market that grows faster than any other that we participate in in the deposition segment. And we come from behind in many respects. In the last kind of five years and so in relative terms the market share momentum that we're seeking in ALD is higher than the average in depositions. So it is a faster-growing market with a faster market share growth ambition. Which doesn't mean it's easy, it's really hard and it's hard because everybody wants a piece of that.


And we can take our next question from Steven Chin with UBS. Your line is open.

Steven Chin

Just a follow-up question on market share, did you feel comfortable that Lam's overall share in NAND this year will stay the same or even grow now that we've got a new entrance. I'm just wondering if customer mix in NAND this year can have another positive impact to Lam's market share this year.

Martin Anstice

You know, at a level which is kind of relevant to a conversation between us, there's not that much difference between the market share positions of any one customer. We tend to have, when we want something we kind of want it at an application-specific level because we have a very competitive technology.

As you know there is one of the four players that has a different integration scheme and so I want to be a little bit careful and just hold back because their scheme is there's and I don't want to focus too much on that difference.

But the basic headline of a 90% market share curative applications, 60% market share all in which is a kind of double-digit gain for us from playing at the 3-D, that is what we have to build upon. And it is what others are trying to take from us. So that is our responsibility.

Steven Chin

Just a follow-up question on China, do you think, Martin, we're at the point yet where Lam will invest more in a local China infrastructure or services to support future customers in China? Just wondering of China is part of the other Lam investment this year, part of the bet you're making going forward.

Martin Anstice

For sure, but I wouldn't say that's a new reality. As a customer invests in building a fab, we have to invest consistent with supporting that. And as noted a couple times in this conversation there's a reasonable investment in China and it is increasing and we're making investments proactively to ensure that when we win positions, we build trust through a customer's ramp.

The worst thing to do is to win a development position and then fail to execute because you don't have enough field process or field service engineers to support a ramp. So absolutely we're investing in infrastructure to support growth of the China marketplace. But that's true in every region of the world.


And we'll take our next question from Weston Twigg with Pacific Crest Securities. Your line is open.

Weston Twigg

First, just wondering on the 10 nanometer logic and foundry expectations for stronger second half installations and then a ramp into 2017, can you give us an idea kind of like you do for 3-D NAND how many wafers starts might be shipped this year and next year?

Martin Anstice

Yes, so I'm going to do this with some kind of caution and hesitation. We have a range around it. We're still over a 300,000 wafer starts per month reference point for 28 nanometer technology nodes and the sum of below 20 nanometer, so 20 nanometer, 16 nanometer, 14 nanometer and 10 nanometer. We would expect by the end of this year to have a shipped capacity which is different than a qualified capacity, but a combined shipped capacity of about 260,000 wafer starts, plus or minus 20,000.

Weston Twigg

Okay. How much do you think that might expand in 2017?

Martin Anstice

Can I way to get to 16 before answering that?

Weston Twigg

I guess so. Wafer cleans you mentioned you're getting some good traction. Can you give us a better update maybe on the evaluation programs that were in place last year? And your overall market share position at this point?

Martin Anstice

Yes, well, it still obviously is the weaker link in the company in terms of market share performance. It's certainly relative to etch and deposition and we did some strategic repositioning as you might remember towards the end of last year and rationalized some cost structure and focused a little bit more on what we consider to be the most relevant opportunities to grow.

It's a mid-to high teens market share play for us today and the message we communicated today is strategically relevant. We're excited about of profitable growth opportunity coming into 2016 and we're broadening the product portfolio wet and dry and time will tell what we can accomplish as a result of that investment. But I think most of us would say we feel better about clean this year that we did last year and long may that continue.


We will take our next question from Atif Malik with Citigroup. Your line is open.

Atif Malik

Martin, you talked about in your prepared remarks that you received positive feedback from your customers on the merger with KLA. Can you talk about one or two key areas where you think you guys can add value to the user or some of the applications?

Martin Anstice

Yes, I think the basic message is going to be the same as the hypothesis we presented last time. The challenge for the industry is not just a challenge of physics it is a challenge of economics. At a strategic level we concluded that the most responsible action we can take, the most significant contribution we could make to the success of our customers, would come from the integration of process and process control.

A big part of that value proposition is associated with new engagements across the companies with customers, because the reality is as you all know, the KLA team is a little bit more entrenched and stronger relatively in foundry logic than we're and we're more than them in memory.

So there is absolutely an opportunity there. There are engineering exchange programs. We're building momentum, specifying the types of things we think are relevant to new collaborations and joint development activities with customers when we get to be one company.

And quite how far that goes, how quickly, your reference right now is now $600 million bogie we have in the proxy for revenue synergies. And I would say I feel better about that today than when I did when I talked to you about last time because I see excitement emerging in the engineering community around the substance of opportunity which is everything about delivering vision here. And I see a sustained willingness in the customer base to support our plans to support them. So, pretty excited at this point.

Atif Malik

And then a follow-up, Doug, the street has a tendency to miss model your revenues. And I think in the past you guys have talked about a formula for revenue 50% of shipments in the prior quarter and then 50% from shipments in the current quarter. Is that still the right rule of thumb moving forward?

Doug Bettinger

I would be cautious about doing that because I think it has proven to be a really hard thing to model. And the reason is, because we live in a consolidated customer world and the difference between a week one shipment and a 13 week shipment is huge relative to the term and it moves absolutely.

And so we cannot really give you a nice simple reference like we used to be able to. I remember vividly describing a relationship to you 10 years ago that would work for three years, five years. It doesn't work anymore, because it's consolidated. It is a much more variable play and every week counts and so we have a little bit slower turn in the March timeframe and we expect it to speed up.

The best we can give you in terms of counsel on modeling is the exact guidance for the next quarter, the tone of quantitative sentiments on direction and the long term model that Doug has talked about a number of times and triangulating on those three you might get a quarter wrong but hopefully you get the year right.


We will take our final question from Jogiday Shier with Redsun Technology Research. Your line is open.

Jogiday Shier

I wanted to dive in on two aspects. First Martin I just wanted to get your thoughts on that DRAM side. Given the technology challenges and the market challenges, what needs to happen to trigger an investment going forward? Can we have an upside in DRAM investment this year? And I have a follow-up.

Martin Anstice

I guess the answer to the question always has to be, yes there can be. Do I think there will be? Not clear to me today. And it would be a second half environment not a first half environment because I think the energy situation is getting better but it's probably not all the way there, but it's a lot better. There's tremendous discipline, it's a very efficient spend because it's all about conversions which is increased performance and lower cost which is more profitability, despite the fact that profitability levels have come down they're still reasonably able to support investment.

I just think it's like a lot of discipline in a year when bit density conversion is playing out in DRAM as well which creates a little more complexity to your question. So I would say we have models pretty conservatively our expectations, maybe there's a little bit of upside in the second half of the year. At the end of the day it is all going to be about end-user and end-unit's demand and you will probably see that before we will.

Jogiday Shier

Just as a follow up can you compare or contrast your growth in your etch and deposition segments holistically for the year, given the spending mix as we compare it to last year? Thanks.

Martin Anstice

I'm not sure a quick at the question. We had a really tremendous year in terms of share gain last year. And that was particularly true in the etch business. It was an extraordinary year for the etch team. And do you get to repeat that every year? No you don't. So we typically target one to two percentage points of share gain. That's a great result in a year or in a technology node conversion.

And so we just did something like that in deposition, we did a lot better and that in etch. I would expect the 1% to 2% reference to be a better long term modeling from what we just did. But again, time will tell.


And this does conclude the question and answer session. I would like to turn the program back to Satya a Kumar for any closing remarks.

Satya Kumar

Yes, thank you, operator. That is all the time we have for today. Thank you for your participation and we look forward to updating you again next quarter. Thank you.


Thank you for your participation. This does conclude today's program.

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