LAM Research Corp.(NASDAQ:LRCX)
F3Q08 (Qtr End 03/30/08) Earnings Call
April 23, 2008 5:00 pm ET
Steve Newberry - President and CEO
Martin Anstice - CFO
Carol Raeburn - Senior Director Investor Relations
Satya Kumar - Credit Suisse.
Gary Hsueh - Oppenheimer & Co
Bill Ong - American Technology Research
Timothy Arcuri - Citigroup
Jim Covello - Goldman Sachs
Steve O'Rourke - Deutsche Bank
Jay Deahna - JP Morgan
C.J. Muse - Lehman Brothers
Edwin Mok - Needham and Company
Harlan Sur - Morgan Stanley
Brett Hodess - Merrill Lynch
Stephen Chin - UBS
Welcome to March 2008 quarterly financial results conference. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions) This conference is being recorded today April 23, 2008.
I would now like to turn the conference call over to Carol Raeburn, Senior Director Investor Relations. Please go ahead.
Thank you, operator. Good afternoon, and welcome to Lam Research Corporation's quarterly conference call. Here today are Steve Newberry, President and Chief Executive Officer, and Martin Anstice, Chief Financial Officer. Today we will discuss the financial results for the quarter ended March 30, 2008, and share our business outlook for the June 2008 quarter. A press release detailing our financial results for the March 2008 quarter was distributed by BusinessWire at approximately 2:00 O' clock this afternoon and is available on our Web site at www.LamResearch.com.
Today's call contains forward-looking statements, including those related to revenue, shipment, margin and yearly forecasts, customer demand and industry conditions, as well as statements that express the company's expectations, beliefs, plans, and forecasts. There are important factors that could cause our actual results to differ materially from those discussed in these forward-looking statements. Additional information concerning factors that could cause results to differ can be found on our annual report form 10-K for the year ended June 24, 2007 and as filed with the SEC. This call is scheduled to last until 3:00 p.m. and we ask that you please limit questions to one per firm.
With that, I'll turn the call over to Martin for a review of the March quarter results.
Thank you, Carol. This afternoon, we have a lot to discuss as we are giving more comprehensive financial disclosure of the company. It's been a difficult time for all of us working with only limited, preliminary statements. I would like to thank you all for your patience.
As we review the financial statements today, we have a significant number of unusual items including the completion of the voluntary stock options review and the SEZ group acquisition. We have presented what we consider the key headlines in our earnings release; I will supplement that with additional comment shortly.
Before we begin, I wanted to communicate our intensions related to financial statement disclosure for the SEZ business. We are planning to aggregate the SEZ group now known as the Spin Clean Division into the existing Lam financial and accordingly we will not be routinely separating out their numbers.
Our presentation of the March 2008 quarter includes full consolidation of the SEZ group, although they reflect that they were slightly less than 2% minority interest. Because we provided guidance for the March quarter without this Spin Clean Division and the actual results we reported today have consolidated is performance since March 11, 2008 and include certain one-time and non-ongoing items, we will be more extensive in our commentary today.
Highlights of reported ongoing earnings for the March 2008 quarter include, revenues slightly above our mid-range guidance at $614 million or $612 million excluding Spin Clean Division.
Consolidated ongoing gross margin of 47.8% of revenues marginally stronger than expected but down sequentially due to challenging customer and product mix or 47.9% excluding the Spin Clean Division.
Consolidated ongoing operating income performance of 23.6% of revenues or 24.5% excluding the Spin Clean Division. Gross cash and short term investments including restricted cash in excess of $1 billion. Shipments momentum in the upcoming quarter was positive representing approximately 6% growth sequentially, a little stronger than our earlier expectations.
Consistent with prior quarters our applications and segment shipments disclosure is limited to the Etch business, accordingly 300 millimeter applications represented approximately 93% of the total shipment, and applications at less than or equal to the 90 nanometer technology node represented 92%.
Memory segment customers in the quarter represented about 76% of total, with the NAND components accounting for approximately 51% of total memory. Logic/other was 8% and foundry was 16% of the total.
As just noted, revenue was slightly stronger than the mid-points of our guidance range, facilitated in part by strong same quarter shipments to revenue churns in Etch system of more than 50%. Our customers are working with us to qualify and utilize our equipment as fast as ever.
For more complete details on the geographic breakdown of shipments and revenues, please see today's press release and website for a reconciliation of shipments, revenues, deferred revenues and cash. Generally consistent with our guidance our March quarter gross margin of 47.8%, decreased 2.6% sequentially as a result of unfavorable customer mix.
As discussed in January the concentration around the large memory customers was significant.
Product mix also placed pressure on our gross margins, notably in the Etch business. This was the first quarter that our 4X Series products represented the majority of our system revenue.
These products are the foundation of our recent market share expansion. They provide the basis for our expectations going forward and so we are really pleased with the revenue momentum.
As we have articulated in the most recent couple of quarters, we have continued to invest in building customer trust by supporting where appropriate, the current economic needs of our customers. Our reported profitability level reflects those pricing decisions and also the relative immaturity of the same products as far as we've implemented the targeted cost reduction.
Ongoing operating expenses for the company were $148.9 million in the March quarter, which includes $5.6 million incurred by the Spin Clean Division. In view of that the pre-acquisition operating expense levels is exactly as we projected.
As you will remember, one of the primary drivers for a sequential operating expense increase in the March quarter is the seasonal impact of high payroll packages. It is also the quarter where LAM processes its annual merit pay increases.
Normally, we would have approved the annual all employee equity grant in the quarter. Also, the date of the stock options review; that was postponed and is now planned for the June 2008 quarter.
Ongoing operating income was a healthy 23.6% of revenues or 24.5% on a pre-acquisition basis. Again in line with the guidance we provided in January.
Before moving to the balance sheet, our non-ongoing P&L items are as follows; as reported in our recently filled financial statements, the company accrued 50.2 million of future cash confrontation charges associated with anticipated employee Internal Revenue Code 409A tax liabilities on certain gains from so called misdated stock options. This expense is the result of determination by the company in completing its independent stock option review.
As shown on the pages of the P&L, $6.4 million of these compensation charges is classified in cost of goods sold, the remainder in operating expense. We incurred an additional $6 million in expense associated with the stock option review in the March quarter bringing the total cost in professional fees and other costs to $16 million. The costs are reported as general and administrative. Currently we only anticipate nominal costs going forward.
We incurred a one-time $2.1 million charge related to the write-off of in-process R&D following our acquisition of the SEZ group. This reflects the present value estimates of prior R&D investments made with no standalone expectation of future revenue and is reported in operating expenses.
Included in other income we realized a non-operating gain of $49 million, related to our currency hedging and Swiss franc strengthening associated with the purchase price of the SEZ group.
Finally the income tax effect related to the aggregates non-ongoing items is a benefit of $2.9 million. The financial consolidation of the SEZ group into LAM Research in essence involves two significant process steps.
First, the conversion from international accounting standards to US GAAP, including alignment with Liam’s corporate accounting policy and secondly, the completion of the purchase price accounting to determine the fair value of existing tangible and intangible assets, the new fair value assigned to separately identifiable intangible assets as a result of our acquisition, and finally the consequential goodwill.
Both of these processes and their effects are ongoing. The transition from international standard for US GAAP per se was largely insignificant.
Although only a short time has passed since the acquisition; our integration activities are becoming more meaningful. Since the deal closed we've implemented actions promoting a single phase for the customer by integrating a third organization into our existing global account structure.
In addition, we have developed a roadmap for business process streamlining, including in the area of customer terms and conditions. In that regards specifically, it became clear in recent weeks that it is appropriate to standardize the Spin Clean Division business under our preexisting revenue on acceptance model, because you had GAAP purchase price accounting rules precluding us from creating and opening balance sheet position for revenues, previously reported on the shipment base revenue model of the SEZ group this decision to adopt an acceptance model has the effect of deferring revenues and cost of sales for an estimated one to three months period from the date of shipments to the process acceptance timeline.
During this initial period of deferring more than as recognized, we continue to record all operating expense as a period expense consistent with US GAAP. As a result of this accounting policy change and the very limited 19-day windows since we closed the acquisition the Spin Clean Division shows an operating loss that in our view significantly exaggerate negatively the economic reality of the Spin Clean Division in the quarter.
We would expect this condition to repeat in the June quarter and largely be normalized by the September quarter as customer acceptances are anticipated to catch up, so to speak with the level of shipments.
Finally, the allocations of purchase price and equity consideration transaction costs and assumed liability are preliminary. But the March quarter ending balance sheet allocation includes $65 million of intangible assets and $204 million of goodwill.
Our total consolidated growth cash balance including restricted cash is slightly more than $1 billion at the end of March. This represents an approximate $100 million increase in our gross cash balance after the net tax used to purchase the SEZ group and as planned we reposition our $250 offshore debt to the US.
The consolidated deferred revenue balance was $270 million including $29 million for the Spin Clean Division at the end of March. In addition there was approximately $43 million of anticipated future revenue value of our previously made shipments to Japanese customers.
In the quarter there was no stock repurchase activity by the company and as a reminder we currently have no Board authorized repurchase program insight.
Consolidated capital expenditures were $19 million, depreciation and amortization was $13 million. As a result of the voluntary stock option review, LAM suspended its employee equity plans and so we received no cash from the exercise of those plans during the March quarter.
Headcounts were more or less constant and slightly more than 3000 employees at the end of March for LAM. The company added approximately 900 employees with the acquisition of the SEZ group.
Now, I'd like to provide a few words on the tax rate. Our US GAAP income tax rate for the March 2008 quarter was 23.8%, in large part this reduction from the level of 28.1% in the two quarters ended December 2007, is attributed to the tax reduction for the previously announced 409, A related employee compensation liability.
As Steve will capture in our guidance for the June quarter, the company assumes a 28% tax rate for the 2008 fiscal year, which requires us to assume a 34% rate for the June 2008 quarter. Most of the rates volatility quarter-to-quarter is a function of the timing of the non-ongoing items. Most of the fiscal year rate differentials to our previously announced target of 25% long-term effective tax rate is a consequence of this fiscal year being the most disadvantage tax holiday year in our last five. Further, the absence of the RD tax credit beyond December 2007 is a loss of one percentage points in the fiscal year.
In fiscal year 2009, and therefore the second half of calendar 2008, we would anticipate the rates fall on or below the 25% level again, due to the redemption of improved tax holiday benefits, which apply through fiscal 2013. Excluding the Spin Clean Division, operating assets performance remain strong. Accounts receivables collection performance had a DSO of 71 days. Inventory performance was 5.4 turns.
As a status comment on the SEZ group acquisition, we have at this point reached the 98% ownership threshold to qualify us for the more simplified administrative process to acquire the remaining shares of SEZ that we do not currently own. We are targeting to realize our goal of 100% ownership within the calendar year.
Finally, to recap the important headlines. We are pleased that through a period of significant adjustments in the industry we delivered ongoing operating performance that match or slightly exceeded our previously announced guidance in the March 2008 quarter.
We consolidated 19 days of SEZ Group performance into the financials and during large parts through our decision providing acceptance-based revenue recognition model, result was slightly diluted to earnings.
As previously highlighted, we have significant non-ongoing items this quarter including our voluntary stock options review $56 million pre-tax, and a gain related currency of $49 million as part of the SEZ acquisition. Our tax rate is generally in line with our expectations, although more volatile than normal mainly due to the non-ongoing items or discreet events.
And finally, our cash momentum is strong. We closed the quarter with $1 billion in gross cash balances. Now to Steve's comments.
Thank you Martin and good afternoon everyone. LAM produced a successful quarter in a challenging environment with our March shipments revenues, gross margins and operating income all meeting or exceeding our previously stated expectations.
In addition to these solid financial results, we completed our acquisition of the SEZ Group, a very important milestone in our strategy to expand in the market adjacent to etch.
The independent committee of the Broad of Directors completed its review of our historical stock auction practices for accounting purposes in the quarter, and now our 10-K and 10-Qs for past period are now current. We look forward to resuming our normal levels of disclosure transparency.
Since our last conference call when we shared our outlook, the macro environment has deteriorated significantly. We enjoyed a strong shipment environment in the March quarter, but increasing uncertainty in the consumer electronics environment had negative implications for previously planned capacity additions by semi manufactures over the next few quarters.
Our previous commentary around wafer fib equipment spending hasn’t focused on the supply, demand, and balances in memory and the results of negative impacts to memory manufactures profitability.
Increasingly, the economy must be factored into our view as well, and as a result of increased uncertainty around the demand side of the equation, we now believe that memory units, supply and demand and balances may take longer to resolve than we previously thought.
We think the impact of these conditions will be felt through the next two quarters with supply and demand for memory likely reaching equilibrium sometime in the fourth quarter of 2008. The level and timing of any resumption in increased capacity additions for memory is a function of improved profitability, cash flows, and the impact of the contraction in the credit markets that could affect access to capital.
Foundries for the most part continue to run at a very high utilization rates delaying as long as possible what looked to be required investments going forward for additional capacity. While foundries strive to improve profitability by keeping utilization rates high, foundry investment in leading edge technology continues, but at a slower adoption rate than previously expected. Foundries are shipping wafers at the 65 nanometer node, but the adoption rates are slower than the rates achieved for the 90 nanometer node. Additional factors impacting investments in added capacity are the short delivery and installation lead times available for equipment and the current strategy by foundries to add small amounts of incremental capacity, while waiting for demand signals from their customers.
As a result of the collective factors of memory unit supply and demand and balances, and customer profitability issues, and the macro economic issues potentially impacting consumer spending. Our overall view of the semiconductor equipment industry is that CapEx for 2008 will now be down around 20% to 25% relative to the spending in 2007.
4X specifically, we believe the reduction in equipment spending maybe down 20% to the 27% on a shipment stand basis relative to 2007. Our analysis suggests that even a down 25% scenario requires a strong acceleration of shipments in the last three to four months of the year.
With the current view of customer spending for equipment, I'd like to discuss how LAM is managing through this challenging near term environment. Our longer term thesis for underlying IC unit demand growth and the related capital spending requirements remains unchanged. And our strategy to target that opportunity through continued market share growth in etch and expansion into adjacent markets remains the key focus in the company.
And, we have stated on several occasions in the past few months, we are committed to investing in the long-term profitable growth of the company throughout the cycle and we plan to maintain spending to meet our long-term strategic goals while still generating acceptable operating income performance.
Despite the near-term decline in wafer fib equipment spending, we continue to perform well in etch, winning and defending applications at the leading etch. We are encouraged by customer decisions and we believe to validate our expectations to gain an additional couple points of market share in the transition from 6X to 5X to 4X technology nodes.
Our analysis suggest that most of the 4X tool selections decisions have been made for NAND Flash and we expect that NAND production wise going forward will be for the 4X node throughout 2008 and the first half of 2009. DRAM is introduction on 7X and 6X technology and decisions for tool selections at 5X are ongoing throughout the year. Microprocessor is complete for 4X decisions and advanced logic foundry decisions for 4X are ongoing throughout the year. We further advanced our adjacent market strategy.
We completed the acquisition of the SEZ group on March 11 of this year. This acquisition is the key achievement for our company and we have turned immediately to the task of assuring a successful integration.
First and foremost since the deal date, our addition discovery and strong collaboration have reinforced our belief in the value of our strategy in acquisition decision. A combination of the companies creates a broad set of highly competitive capabilities of the opportunity to leverage the leading installed base of single wafer clean and the established customer relationships of both companies into an accelerated penetration of the rapidly emerging transition in single-wafer clean, particularly in the front end of the line.
Integration activities are well underway and are progressing to plan. We are accelerating the collaboration activities between the companies particularly in the areas of technology exchange and we have reorganized the field organization around our existing global customer accounts to achieve a strong single phase to the customer capability.
Comprehensive discussions with the top semi-companies are occurring and I'm expecting accelerating, joint development projects and activity for both the new Spin Clean Divisions, Ad Vinci Prime and Isanti product line as well as Lames C3 linear cleaner.
In adjacent to our strategic commentary today, with the acquisition closed and integration well underway, we're aggressively focused on applying LAms strong operating discipline to the SEZ business. Opportunities for cost and operating asset improvements have been identified, as well as other synergies. We will provide addition commentary on this topic over the next several quarters.
We remain committed to both spin and linear clean technologies and our near-term technology focus is to leverage the advanced process technology and integration knowledge existing LAMs etch and clean business with the engineering and productivity expertise existing in a Spin Clean Division to strengthen our overall differentiation across the product portfolio. We expect this to result in a powerful capability, which when able strong share gains in the total wafer clean market going forward.
Turning to our guidance for the June quarter, this guidance reflects full integration of the new Spin Clean Division into the LAM research corporate P&L on a revenue on acceptance basis. We expect shipments to decrease to 490 million from 530 million down approximately 20 to 25% form the prior quarter. Revenues are expected to be in the range of $535 million to $565 million, down 7.5% to 12.5% from the prior quarter.
Gross margins are forecast at 43% plus or minus one percentage point. Operating margin guidance is in the range of 12.5% plus or minus one percentage point. GAAP EPS is expected to be in the range of $0.32 to $0.42 per share for the quarter.
Wrapping up, the current customer spending environment creates challenges for us in the near term. However, our commitment to a long-term strategy for growing LAM at a significantly higher rate and the wafer fab equipment industry is still supported by a favorable IC units demand outlook over the next several years.
Our strong balance sheet and profitability allows us to continue our investment in positioning products in multiple wafer fab equipment segments for the next generation of yield enabling solutions providing a strong spring board for the company's next leg of growth.
Thank you for your attention and we'll now open the call to questions.
Thank you. (Operator Instructions). First question comes from the line of Satya Kumar with Credit Suisse. Please go ahead.
Satya Kumar - Credit Suisse.
Yes hello. Thanks for taking my question, Steve. Just because this is the first quarter that you are getting with impact of Spin Clean Division I was wondering if you can help us understand how much that is contributing your shipments revenue in the June quarter and what we should think about it for the rest of the year?
We will talk -- Martin will talk about that and we will try to help you through that but we realize it’s confusing.
So I'm going to start relative to the June quarter. As Steve mentioned if you take the mid point of that guidance range. So to recap Steve guided EPS $0.32 to $0.42. So take the $0.37, of the middle of that range. I think the underlying business of LAM, by underlying I mean without SEZ is in excess of $0.50 and to a meaningful extent as I had indicated the revenue recognition decision model, decision that we took, drives an SEZ EPS loss of in the range of $0.10 to $0.15.
So when you think about $0.37 mid point you should be thinking $0.50 or so underlying for the existing LAM business and then to a meaningfully sense impacted by the revenue acceptance decision, the $0.10 to $0.15 negative for the SEZ business.
That kind of attributes, as I said relative to acceptance is something that I expect to see much more normalized in September and so the only comment that I really kind a put on the table at this point in time is that if you look at that level of impact that you see, this is probably the worst of our outlook from a quarters perspective in terms of impact on a company from an EPS point of view.
Satya Kumar - Credit Suisse
And Steve, looking at what you know from your memory customers at this point, shipments for memory was almost flattened the quarter. It didn’t seem like there was a lot of adjustments from these customers to adjust for the oversupply. Looking at the forecast you have for memory, this was a core etch business, can you give us a sense of how much you think memory shipment can be down the calendar year year-over-year?
Well, I think that from a calendar year perspective, if we break it down into what we think the impact will be for DRAM I think we can expect that DRAM will be down 45%, maybe even 50% on a shipment basis. I think that NAND flash will be up 10%. So, when you look at memory as a whole, kind of comes out about down 30% for the year, and we'll see that offset by some level of maybe slight increase in foundry.
I think, it all depends on one of the foundries really decide that they want to do in the second half of the year, but overall with memory down about 30 something percent that will take the total down about 20% for the year.
Satya Kumar - Credit Suisse
Steve, if I do a quick math on that, it appears that perhaps September you could actually see a sequential decline in shipments and revenue, would you kind of comment on that?
Now, I mean, the comment I would have is that with the volatility that's going on right now, it's hard enough to really add a tremendous amount of confidence that what's in the shipment guidance for the quarter will actually be what it is and interestingly, it's not all negative momentum.
In any given quarter there is a number of customers that are well publicized to push out to the number of customers that pulled in. I mean, we certainly saw that in March. When we look at the makeup for June, we've got a number of customers that pushed out. We had a number of customers that came back in. And, so when you think about September, in my view September is likely to be in the vicinity of June, and I think that were clearly dropping down to a level of shipments that for us is down 20% to 25%.
My expectation would be that I would expect that we'll kind of bump along at that level for another quarter or so. Potentially if you want to think about that instead of being down 20% that the industry is down 25, 25 to 30, if you kind of bumped along at the bottom at a similar level between the June quarter, the September quarter, the December quarter, that's kind of how you get into a down 25% to 30% scenario.
And, I honestly couldn't tell you right now because I think that with this industry being so much more consumer dependant and certainly the macroeconomic signs relative to consumer confidence, and what the consumer is going to do, given that the prices of oil are driving gasoline up to significant level.
While this is maybe mostly dominated by the issues in the United States, we all know the effect of the US consumer on worldwide GDP in consumer electronics can be significant. So, I think that we just going to have to wait to see how this place itself out.
Satya Kumar - Credit Suisse
(Operator Instructions) Our next question comes from the line of Gary Hsueh with Oppenheimer & Co. Please go ahead.
Gary Hsueh - Oppenheimer & Co
Yeah, hi. Thanks for taking my question. Just another further question here on SEZ, can you explain whether or not there is any significant differences to SEZ's end market exposure relative to Lam Core Etch business?
What do you mean by that?
Gary Hsueh - Oppenheimer & Co
Just in terms of DRAM, NAND, Logic and foundry breakdown, is there any significant sort of Delta and any one of those percentages that you reported in the March quarter for SEZ?
I haven't really studied the specifics of their breakdown. We do know that they tend to be strong. They have a very good position in foundry, but what we are really focused on is capturing lot of the opportunities that are going to be decided over the next 9 to 18 months, particularly the front end in the line and that is going to the opportunities that are in both NAND, Flash, DRAM, foundry, advanced logic etc cetera, but I do think that probably they have a little stronger percentage of their business that's foundry related today.
Gary Hsueh - Oppenheimer & Co
Okay. If I could think of one more question, just you kind of keep my interest your CV talked about, potentially an uptick in shipments in the September quarter on the premise that the etch total market in terms of shipments was down 22% to 27% year-over-year. Is that what you said?
What I said was that even if you look at a 25% down scenario, that if you are going to require a strong uptick in shipments in the last three or months of the year. And so, I didn’t say anything specific about the September, but I've been understanding where your question is coming from. But what I want people to understand is that, shipments are coming down pretty sharply I think. You are getting that kind of indication from all the companies in the industry.
And I think that even if we end up the year, whether we are down 20% or 25%, that includes a need for there to be a strong uptick in shipments sometimes in the last three or four months, and if we don’t get good demand coming through the product stream from consumer then we all run the risk that instead of just being 20% down, it's going to closer to 25%, and if things really don’t go well, I mean that’s how you can get to a 25% or even 30% down scenario. So, I realize that it’s a pretty large gap between 20% down and 30%, but the reality is that there's that level of uncertainty in the marketplace today.
And I think just to add to that, I think there's an important segue from the commentary around the last three to months of this year in terms of shipments, because as I think everybody understands with an acceptance modeling revenue, if that does take place the potential that will impact the revenue stream of the company is something that is kind of prolonged and you got to kind of model, if that does take place three months or so delay from that curve happening in shipment to the same curve happening in revenue. So, that’s important thing from a modeling point of view.
Thank you. My next question is from the line of Bill Ong with American Technology Research. Go ahead.
Bill Ong - American Technology Research
Yes I've got a foreign currency question. So the SEZ Group, it was obviously sold in Euro dollars, any plans for changing it to US dollars? And also my question is really about what's your foreign currency mix impacting revenue and cost. And then I assume what's the manufacturing for SEZ would stay in Europe and then how would R&D kind of be spread up between the two countries.
That's one very big question.
Bill Ong - American Technology Research
As I think the headline on foreign currency from the best hedging strategy in the world which is you have cost and revenue that match up and that's the best way to manage currency exposure. The addition of SEZ to the company has given us more of a challenge, but I would still say the currency exposure to the company to be a natural hedging it's pretty good actually.
Obviously today's news with the Euro at an all time high, it's something that we are going to have to pay a lot of attention to how big and unhedged the closures are the Euro and the Taiwan dollar, and we will be spending a [bunch] of time in the next couple of months getting our arms around that. Relative to the question on manufacturing for SEZ there are currently no plans to change the manufacturing locations for the SEZ business there. So your assumption there is correct, and I think that was the core of your question and if I missed anything then somehow we'll get in a follow up ahead.
Thank you. Our next question is from the line of Timothy Arcuri with Citigroup. Please go ahead.
Timothy Arcuri - Citigroup
Hi a quick [question]. I guess first of all Martin are there any charges in the guidance, and second of all would it be fair to say that the shipments if you are going to strip out these shipments for the core business in June or kind of in a 460 to 470 range?
No special charges in guidance.
Relative to shipment, the shipment profile for SEZ is not as strong as what you've said. So for a Lam-only business it's higher than that.
Thank you. Our next question is from the line Jim Covello with Goldman Sachs. Please go ahead.
Jim Covello - Goldman Sachs
Great, thanks very much guys for taking my question. Steve question for you, our models agree with what you said about the supply-demand balance in the commodities and memory in the fourth quarter. Based on your experience, how many quarters do you think the customers would need to see an up tick in profitability before they would start to order again? Would it be, right away would it be one quarter, two quarters, what has history told us about that?
Well, history at least from my perspective has told us is that, the first thing customers do when they get into this kind of environment is they try to anticipate and create a soft landing. And I think what we have seen is that, the amount of spending in DRAM has been declining consistently quarter-over-quarter, and the effort to try to create a soft landing around the middle of 2008 has clearly not been successful, and so now I think what you see is a realization that the rate of capacity additions for DRAM is going to have to come down more and that's largely what we see.
And I think that what happens is that, you get into a situation where the market will respond ultimately due to the fact that as supply is coming down and demand is rising, that you'll get a cross-over point and I think that what you end up having is, probably about -- and my guess would be about a three month effect before they see it, they know it's there. And I think what happens in this environment now is, they stop anticipating and they wait for the supply and demand to occur.
In the past it would take six months it would take six months, even nine months to respond to that. With the lead time and the installation cycle time and a speedy yield in terms of what the collective supply chain can do, I think once the real supply and demand gets balanced, you'll SEZ the adjusted too and respond to it in about three to four months timeframe.
Thank you. Our next question is from the line of Steve O'Rourke with Deutsche Bank. Please go ahead.
Steve O'Rourke - Deutsche Bank
Thank you good afternoon. Steve just a follow on to that last answer, that should we you suppose that we start to see shipments coming back in the first half of '09, Q1 of '09 maybe?
Well I think that -- I mean one of the question becomes, when do the semiconductor guys start to see the signs and signals that with pricing that already on one gig is firmed up that then starts to climb up. And I think that once it starts to climb up, that everybody in the industry is well aware that the rate of shipments has come down pretty dramatically and is schedule to come down pretty dramatically in this quarter.
So I think that, that's where you get this last three or four months of the year. You're going to see if the scenario plays up, even likely see shipments improve. If the demand environment is softer and the pricing environment doesn't improve, then you wouldn't see the shipment environment improve till and after the first -- the start of 2009.
Our next question is from line of Jay Deahna with JP Morgan. Please go ahead.
Jay Deahna - JP Morgan
Thanks very much. Steve or Martin assuming SEZ normalizes in the September quarter. Do you expect that to normalize at a profitable level, that's number one. And number two Steve can you characterize the differences between the SEZ cleaning products and the internally developed LAM cleaning products. Is it biased more towards transistor level one versus interconnect and can those kind synergize overtime?
And then lastly you reiterated in your press release your concept of $4 billion for LAM in 2010. Can you give us a little more detail as to what has to happen to get there? Thank you
Well, I’ll take the first part of that which deals with the expectations and the outlook for profitability for the SEZ business. I think the essence of answering that, it's still to say neutral to marginally accretive is an expectation when you kind of back out the effect of the acceptance model decision that we made. The one exception that is obviously the size of the business. If you back up sometime here and think that SEZ as a family company, it was perhaps a $275 million revenue company in 2007 at today's rates. It made a small amount of money at that time our expectations for wafer fab $30 billion or so.
Expectations to wafer fab today are, let's say 26 - 25 something like that. So -- sorry 25, 24 and so with that change impacting their business; we transitioned from making the significant operating income levels that we have been reporting to some less they transition from making small amount of money to breakeven or slightly loosing money. So I think at today's expectation for wafer fab, we would expect slightly, slightly negative to our earnings but not as much in the second half of the year compared to the levels that I spoke about in the June quarter with the revenue acceptance decision.
Jay Deahna - JP Morgan
I think I would amplify on that, is that clearly for the industry as a whole if the shipments have come down. They don't have the same ability that Lam does to mitigate it with deferred revenues with which we came into the year. They don't have necessarily the new markets and the new products that we have, and they don’t have a customer service business that has any similar degree or size, scale and scope all of which we use to mute the affects of having a revenue that is going to be probably 10 plus point less reduction than the market as a whole.
The other thing is that we have an outsource model factory that even though our shipment output from peak to trough is within the 30% down arena and the total amount of impact to margin from what goes on with factory absorption is only two margin points, and clearly when their revenue drop or their shipments drop to that level, they don't have the same variability to deal with factory cost as we did. So, one other thing that we are going to work on obviously is that as we go forward is how we implement some of the operating efficiencies and processes that we run LAM with and how do we get those implemented as appropriate with SEZ.
Relative to synergy, a kind of a simple answer if I could is that SEZ has historically being a company where it had had a market share leadership in the backend of the line claims, and most of that volume has a function of a number of levels associated with logic. That’s one of the reasons why the foundry in the logic segment is a bigger percentage of their business because of the number of levels requiring backend of the line clean in logic.
The opportunity in front end of the line is both in logic and in memory. And, while in some respect there are less layers, there are still many process steps that the transition level, transistor level that require critical clean applications. And, so relative to the harmony of the products, LAMs C3 linear cleaner was targeted at those applications where short contact time cleaning with robust chemicals would enable the ability to get a unique result in terms of profile control, line width control and very strong uniformity across the wafer.
SEZ with their front end of the line products, both the Da Vinci prime and the Esanti they address different parts of the high volume front end of the line cleaning applications and they do it with very high throughputs, very high levels of productivity. And one of the things that SEZ has been doing for the last year-to-year and a half is developing the Da Vinci prime, developing new Esanti, and one of the things that we have been very pleased with is as we increased our discovery and we're able to engage in comprehensive discussions with the customer that when we look at the competitive capability that's out there, these two product lines from SEZ really looked to be very well positioned to compete very effectively in some of the volume applications.
And, our C3 linear product continues to, while it addresses a smaller segment of the market, gain acceptance at the customer interface. And kind of enclosing then there is one other additional element is that we have technology that we developed in the C3 Group that we believe is very transferable and beneficial to enhance the competitiveness of the SEZ product line and we will expect to do some of that technology transferring here over the next few quarters and end up with a very technically broad and comprehensive set of solutions for the customers.
I just want to use your question Jay, if I may to just give a little bit more specificity. I said a few moments ago that the impact of SEZ performance on the EPS outlook for the June Quarter was in the, was up to the $0.15 number I gave. Based on the current outlook for the year which had a lot of moving parts not least the industry but also all of the assumptions that are still preliminary relative to the purchase accounting.
My expectation is that those up to about a $0.40 impact negatively on the company for the full calendar year. That’s a $0.40 EPS impact negative SEZ. My best estimate is that some where in the range of two thirds of that simply relates to the revenue decision that we made. And so when you kind of back out the revenue decision kind of normalize it, your, a third of $0.40 dilutive which when you take into the context, the change in the industry in reduction in wafer fab kind of plays out and makes sense.
We have got a lot to learn, there are lot to learn in the next kind of number of weeks and months relative to the synergy and cost reduction opportunities and we are certainly aggressively pursuing that. But that’s the best I can articulate at this point. And we being deliberate about the guidance range, you will notice a little bit of wider range on the guidance for that very reason.
Thank you. Our next question is from the line of C.J. Muse with Lehman Brothers. Please go ahead.
C.J. Muse - Lehman Brothers
Yeah good afternoon. Thank you for taking my question. I was hoping to ask, I guess a couple of questions here. First of I wanted to get to that only slightly dilutive SEZ in September, does that presuppose revenue rate of getting to north of $55 million?
I didn't, I did you, I must say if you listen CJ, just prospect layer to the commentary, I just gave. I just gave some specifics relative to the full calendar year. Well I try to convey in my general response to Jay's question was that, I didn’t see, I did not see the September and December quarters being as bad as the 15 or so that we articulated for the impacts on the June quarter. So, my neutral despite the diluted comment was really kind of more of a general kind of philosophical position. That was our kind of plan coming in. we have not made too many decisions that are fundamentally different from those decisions at the outset but the $0.40 number is my best estimate for impacts on the company's performance in calendar ’08. That’s a $0.40 dilutive impact and about two thirds of that is revenue and of course some elements of revenue expansion as a components of that.
Thank you. Our next question is from the line of Edwin Mok with Needham and Company
Edwin Mok - Needham and Company
Hi, just following SEZ, is it fair to say that based on accounting change that you are only going to recognize recognized revenues in the June quarter, maybe like 20?
No there is, yes that a fair assumption. You should expect as a by product of getting profits in the June quarter that we turn many of the shipments that are currently deferred and I mentioned that deferred revenue level for the SEZ within the $29 million range. So, turning that would get us the 29, turning any of the shipments that happened in the June quarter would take it above that, not turning would be less, but that’s the fact.
And one other thing that I think that, we are certainly operating with and it certainly a challenge for the people in SEZ is, when you are revenue on a shipment company, the focus around processes and procedures and activity in the installation arena tend to be different. Both, we and they do not know really what the speed at which the cycle time from shipment to acceptance can be accomplished, because they have never had to deal with it.
And, while we are very good at that, we have got many years of learning behind us, and while we expect that, we are going to be able to bring a beneficial perspective to them and ultimately some of the elements of the conservatism that exist in trying to forecast what's going to happen are a function of, we're changing a fair amount of what they're going to have do operationally and we don’t really yet know exactly, how that’s going to play out.
Our next question is from the line of Harlan Sur with Morgan Stanley. Please go ahead.
Harlan Sur - Morgan Stanley
Thank you, Steve. As it relates to your view on memory supply, demand fundamentals, I think you mentioned in the last call on DRAM that industry exited '07 was about 50,000 to 70,000 wafer starts per month of excess supply. Where are we now on that and then just a quick question for Martin on the June quarter guidance? Martin if you back out the impact from SEZ what are Lam core gross margins in June?
It will all work on the excess supply. You are right I mean, we've looked at and we felt like it was 60,000, 70,000 maybe even 80,000 wafer starts per month access. And we've just kind of we look that analysis again and update it, and I think I am a little bit surprise that it's really still fitting at about 70,000. And that's the delta between what we think is the real demand which is less than the actual selling that's going on because of the discounted price per bit is creating an additional elasticity of demand. And so part of getting this supply and demand back in sink is to get some of that extra demand out of the system which will occur as pricing rises.
And I think that when we look at the forecast that, we are still going to be in about a 70,000 wafer starts per month access demand through Q2, and then we see a move where that starts to narrow pretty aggressively as the capacity additions really slowdown and one other things that exists between DRAM and NAND is what you might call the Flex supply or there are some lines out there that can grow either way. We believe that the NAND seasonality affect is going to result in some DRAM demand or some DRAM supply coming out of DRAM and going into NAND and that will contribute to getting DRAM moving more aggressively in the right direction in the next four to five months at this thing [price] out.
So, a Flex demand or the Flex supply aspect of this thing is one of the tricky parts of really trying to understand what's happening to output. But I think that with the way shipments are dropping that we're going to see some real positive movements that we're going to be able to see the pricing environment reflect, and I think we should expect that that will be the case provided that the consumer demand plays out as forecasted and we all know how risky that is.
So Harlan to the second part of your question, you had a one-time deal answer here because normally I wouldn't kind of break this out. But I would expect the core Lam business to be a couple of margin points lower than what we recorded for the March quarter in June. And that couple of percentage points lower at the gross margin level reflects the fact that in essence we come off a $614 million revenue is something let's say if we put the midpoint at 550, if you just assume that the revenue of the SEZ business is plus or minus or different from what was deferred, which means you would be assuming a three month turn than the Lam revenue stream is in the kind of 515 range, consistent with that 550. So you've kind of come down a $100 million on an apples-to-apples basis in revenues and a couple of percentage points of gross margin reduction with the mix that we anticipate as well as the relative adjustment of efficiency in the factory is kind of the expectation that's embedded in my guidance.
Operator, we have time to take two more questions.
Okay. Our next question will then come from the line of Brett Hodess with Merrill Lynch. Please go ahead.
Brett Hodess - Merrill Lynch
Just to be clear on your comments on SEZ earlier. So SEZ would expect to be down more than Lam this year because of the reason you said about service and product etcetera on revenues?
Yeah I mean I think that, that's likely to be the case. Having said that though, there is a wild card in the equation, is that, single wafer is going to grow in 2008 to some degree and the reason for that is that wet bench supply that's dominated the front end to the line is beginning to start a conversion process. I think that my best guess is that, that's not going to manifest itself in a lot of shipments, but there will be a number of shipments and that provides the opportunity that depending upon how the customers play that out that could offset favorably for the SEZ group the amount of shipment and revenue decline for the year.
Thank you. Our next question is from the line of Stephen Chin with UBS. Please go ahead, sir.
Stephen Chin - UBS
Thank you. Martin or Steve could you be able to give us an idea of the quarterly break-in revenue level that you're preparing the company for engaging (inaudible) CapEx trend. And as a related question to that, I think in the past Lam has said that even if standalone revenue that drop to $500 million a quarter Lam could still have normalized operating margin of I think about 20% or 22%. Should we think of that as still being the target when SEZ is fully financially integrated later this year?
One of the things that we said was that if the industry was going to be down 10 to 15, then we would expect that we would expect that we could be flat because we could offset that with deferred revenue. We can offset it with both in the service business, new products etcetera. And so now that things are dropping 20 to 25 then I would expect that on a LAM normalize basis that we would be down maybe 10 points less than that. And part of that impacted by the factor if the shipments come back late in the year, how quickly can we can actually turn those to revenue. So we are still on track with that. Now one of the things that I have talked about in public forums is that if we ended up in a situation where revenues declined 10% to 15%, I felt that the Lam normalize performance could remain about 20%.
I said that if it grows greater than 20, which is part of the vicinity we are now that we would look to keep our profitability above 15% operating income and without breaking out all this specific I can tell you that the LAM performance with the revenues declining the way they are is north of that 15. It's somewhere between 15% and 20% exactly as we said. Now as we continue to incorporate SEZ. There is no question that taking a company that has operated to revenue on shipment and converting to revenue on acceptance, you create a hole in that three month period and then in the next quarter, you still have to kind a catch back up.
So the reality is that if the shipments dropped which they have and you have this acceptance hole, it actually take you two quarters to kind of work through that. And, then once the shipments go up you won't really see that for a quarter a later. So, that will result in and that's kind of what you see going on where the combined impacts of that were an operating income guidance of 12.5%, and I think that my expectation is that we can continue to operate north of 10% even in some of the difficult environments that are being played out, because my expectation is that while we could certainly see the demand for equipment kind of bump along at the levels that things are coming down too for June.
I think that the way you get to down 25 to down 30 is not that it drops significantly lower. That is just extends another quarter or so and that is what ultimately drives the total amount of spending down. So, I think that we are reasonably closed to bottom levels of shipments, and therefore revenues. So, what you see is the arena profitability that I think we can operate to with those shipments and revenue levels.
So, I think that's the last question. I want to thank everybody for joining the call and we certainly look forward to talking with you Paul and all the investors on how we intend to go forward and just one final reiteration would be - the near term is tough, there is no question about it, but we're very excited about the opportunities for growth in the company. And, we are very excited about the SEZ acquisitions and we look forward to talking you more about that in the coming months.
Thank you ladies and gentlemen this concludes today's conference. Thank you for your participation and you may now disconnect.
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