科林研發 (LRCX) 2006 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to Lam Research fourth-quarter and 2006 financial results conference call. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded today, Wednesday, April 12, 2006.

I would now like to turn the conference over to Kathleen Bela, Director of Investor Relations and Corporate Communications for Lam Research.

Please go ahead, ma'am.

Thank you, Rob.

Good afternoon and thank you for joining us to discuss the financial results for the quarter ending March 25, 2006 and the business outlook for the June 2006 quarter.

By now you should have received a copy of today's press release which was distributed by business wire at approximately 1 p.m.

We are webcasting a slide presentation in conjunction with today's commentary.

The presentation can be accessed through the Investor Relations section of our website at WWW.Lamresearch.com.

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

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

These statements are subject to various risks, uncertainties, and changes in conditions, significance, value, and effect that could cause results to differ materially and in ways not readily foreseeable and which are detailed in the Company's SEC reports.

We encourage you to read those reports in their entirety.

Lam would also like to disclaim any obligation to correct or update any of the information we are about to provide.

Note that this presentation includes certain non-GAAP financial measures which the Company believes are useful in analyzing ongoing business trends, reconciliations to the most directly comparable GAAP financial measures are presented in the Investor Relations portion of our website.

This call is scheduled to last until 3 p.m.

We ask that you limit questions to one per firm.

I will now turn the call to Martin for a review of the financial results.

Thank you, Kathleen.

This afternoon, we will discuss our March 2006 quarter financial results.

Highlights for the quarter include orders growth of 29% sequentially at 520 million, higher operating expenses as planned targeted at enabling our long-term revenue growth objectives, leverage through operating income at 25.2% of revenues, representing an incremental flow through of 42% on the sequential revenue growth of 22%.

Profitability levels and operational asset performance driving cash from operations of 110 million, in line with our targeted performance of greater than 25% of revenues in the calendar year.

Sequential EPS progression from $0.55 in December to $0.65 ongoing this quarter which was impacted by the quarterly ongoing effective tax rates of 9.8% and 20.6% in the December and March quarters respectively.

300 millimeter applications represented approximately 73% of total systems new orders, 79% of orders were for applications at less than or equal to the 90 nanometer technology node.

As we expected, the customer activity through the quarter was positive and broad based.

New orders, market segmentation for the quarter was memory at 53% of systems new orders, IDM logic 26%, and foundry other at 21% of the total.

Dedicated NAND application systems new orders represented approximately one quarter of the memory orders.

Geographically, Asia represented 57% of total new orders.

Revenue of 437 million, slightly exceeded the high points of our guidance range and is generally consistent with previous comments regarding the trend to faster acceptance timelines now down to the one-to-four-month horizon.

On increasing customer demand, shipments at 511 million ramped by more than 30% sequentially.

Practically, we have again approximately doubled the output of our supply chain within a six-month period.

A repeat demonstration of the operational capability intended by our business model transition.

The ending unshipped backlog remained constant at 404 million.

For more complete details on the geographic breakdown of orders and revenues, please see today's press release and our website for a reconciliation of new orders, shipments, revenues, deferred revenues, and backlog.

As presented in our March investors and analyst meeting, we target operating income levels between 22.5% at 400 million in revenue and 25.4% at 450 million.

Accordingly, we see today's reported results as consistent with those stated objectives.

Profitable market share growth remains a priority.

We continue to be focused on our target to deliver operating income exceeding 30% in at least one quarter this calendar year.

We report gross margins of 50.2% today, approximately half of the difference to our 50.5% guidance is seasonal and due to the March quarter FICA payroll tax effect that was perpetuated this year by higher-than-anticipated employee stock options exercise.

The remainder is product mix largely in our spare parts business.

Increasing R&D investments focused on growth opportunities, new products, and available market expansion continue to be a prominent theme of our message today.

In addition, you'll remember that in the last several quarters, we signaled an expectation of 8 to 9 million equity compensation expense and consistently incurred less at approximately 6 million each quarter.

In the March quarter, our Board of Directors finalized a long-term executive compensation program and stock ownership guidelines for certain executives.

The program rewards long-term profitable growth, combined with long-term share price performance and was designed to optimize the variability of our expense structure going forward.

As a result, total company long-term compensation expense recorded in operating expenses this quarter includes 5 million equity and 3 million cash-based expense, combined, these represent a sequential increase of 3 million from the 5 million equity-only expense incurred in the December 2005 quarter.

In addition as stated in our press release today, equity compensation recorded in cost of goods sold was approximately 1 million in the March quarter, essentially unchanged from the December level.

In our press release today, we announced the Company's decision to repatriate up to 150 million of foreign earnings in the June quarter under the provisions of the American Jobs Creation Act, the ongoing tax expense consequence of that decision was approximately 7 million as stated in our reconciliation of U.S.

GAAP net income to ongoing net income.

Concurrent with funding the ramp in our business and investing in new products, we delivered cash from operations of 110 million this quarter.

Inventory performance continues to set a standard for the industry at six turns.

Our accounts receivable days outstanding was 66 days at the end of the period.

We are particularly pleased at the timeliness of customer dues.

At the end of March, our balance of accounts receivable more than 60 days past due was less than 5 million or approximately 1% of total receivables.

In the quarter, we received 66 million from the exercise of employee equity plans, and we used 74 million to repurchase 1.7 million shares at an average price of $43.36.

Our total cash balance, including restricted cash, was 1.1 billion at the end of March.

Deferred revenue essentially matches our high watermark since implementing SAB101 at 195 million with deferred profit balance at 119 million.

These balances exclude approximately 90 million of anticipated future revenue value for shipments made to Japanese customers where title has not yet transferred.

These shipments are currently recorded at cost in inventory.

In the quarter, adjustments from backlog were a net negative 2 million.

Order cancellations were 7 million.

Capital expenditures were 8 million.

Depreciation and amortization was 5 million.

Employment levels increased by 70 to approximately 2300 at the end of March, reflecting our commitment to supporting our customers and investing in our growth opportunities.

Now to Steve's comments.

Thank you, Martin, and thank you all for joining us this afternoon to discuss the March financial results.

This was another solid quarter.

I am pleased that we continue to execute well to our business model.

Our model is focused on profitable market share growth, leveraged growth in operating income as we ramp, and cash generation of 25% of revenue in the upcycle.

Our ability this quarter to deliver operating income at a rate nearly two times faster than the rate of revenue growth demonstrates the leverage in our P&L.

Our cash generation remains strong, producing cash from operations in March of 25% of revenue, and we continue to gain share with four new application wins in the quarter.

I believe our March quarter results demonstrate our commitment to achieving our business model targets.

Today, I'll recap some of the information we presented at our analyst and investor meeting, provide an update on our industry outlook, and close with guidance for the June quarter.

Three weeks ago, we hosted an analyst and investor event in Shanghai, China, at Semicon China and presented several new three-to-five-year strategic initiatives for the Company.

Specifically we stated we intend to sustain and grow our market share in Etch, become a multiproduct company by entering the clean and resist strip market segments, execute the next phase of our manufacturing outsourcing strategy by aggressively pursuing global sourcing opportunities and maintain our focus on achieving leadership financial performance in our sector.

In 2005, we exited the year with booked market share of approximately 39% to 40%.

We expect this number to increase by 3 to 4 points in calendar year 2006.

And we expect to accomplish these first-year objectives of our three-to-five-year plan by cost effectively solving yield and device integration issues at 90 and 65 nanometers, and early positioning for 45-nanometer applications.

We will target new application wins at customers where our current position and customer trust levels are strong.

Last quarter, I noted that we are targeting 10 to 12 new application wins in the first half of 2006.

We are on track to meet that target, and as I mentioned earlier have secured four of those wins to date.

I will now comment on the industry before closing with guidance for the March quarter.

Our outlook for the wafer fab equipment market remains consistent with our view presented at the investor and analyst meeting in March 2006.

Based on our analysis, and our customers' current plans, we expect growth of 20 to 25% in Wafer fab, expenditures in 2006 over 2005, and with that assumption, Etch could grow 25 to 30% in 2006 versus 2005.

Our outlook for memory remains solid.

Recent price declines in NAND Flash are to be expected given the premium pricing this segment has had over the last several quarters.

In addition, the impact of the change in the forecast for iPods has been well managed by our customers and demand for NAND Flash devices outside of the iPod remain strong and represents approximately 85% of of the total market.

NAND Flash bit growth is expected to remain close to 200% year-over-year, and for DRAM, bit growth appears to be a little stronger than expected at 55 to 60%; therefore, we expect continued steady investment in both Flash and DRAM as we go forward.

The foundry and logic market segments are also tracking in a positive manner.

Foundry customers are beginning to qualify 65-nanometer devices and foundries will need to begin investing in that capacity soon.

Investment activity across the foundry companies is expected to be more active in 2006 with spending planned to be up approximately 20% over 2005.

These spending plans by foundries for 2006, while improving, are still expected to be approximately 25% less than what was spent in 2004.

Now I will turn to guidance for the June quarter.

Orders up 5% to 15%.

Revenue 490 to 510 million.

Shipments expected to be up 10 to 12%.

Operating expenses at $114 million.

Gross margin at 51%.

And operating margin at 28% at midpoint of the revenue range.

EPS of $0.80 to $0.85 per share at an assumed share count of 144.8 million and an assumed tax rate of approximately 21%.

This guidance is on target to our P&L model for operating income at a 500 million-per-quarter revenue level.

It is a half a margin point shy of our model for gross margin due to an acceleration of planned spare parts pricing reductions into this quarter and going forward.

We had planned to roll the spares price reduction out over the next four to six quarters consistent with our global sourcing cost reduction initiative.

This accelerated action has been taken in response to customer requests for us to speed up our activities related to their cost reduction programs targeted at reducing fab operating expenses and to preserve and grow spare's market share in the presence of third-party spares provider competition.

We believe it is important that we respond to our customers' requests, and also to ensure that we are providing them a consistent supply of Lam-certified high-quality spare parts which are essential to maximizing the performance capability of the Lam-product installed base.

This action will result in a potential 0.5 to 1 margin point impact to our P&L model for gross margin throughout calendar year '06.

It is expected there will be no impact to our operating income performance to model in calendar year '06.

We plan to return to our gross margin model, consistent with the speed of execution to our global sourcing cost reduction activities.

In closing, I want to thank our suppliers, and most importantly our employees for their continued outstanding efforts on behalf of our customers and the Company.

I believe it is truly a job well done.

With that I will turn the call over to Kathleen for the Q&A.

Thank you.

Operator, we can begin polling for Q&A.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Satya Kumar from Credit Suisse First Boston.

Please go ahead.

Yes, hi, thank you.

Steve, can you perhaps allude a little bit to what is happening in the second half of the year.

If I take your guidance for Etch to grow about 25 to 30%, plug in your market share numbers, should we expect some kind of a decline in the September or December time frame for shipments and bookings and do you care to comment on how the second half is shaping up?

Okay.

I'll provide some color for activities that we can see that the customers are planning to do in September, but in our business today, looking out beyond really four or five months is kind of an exercise in crystal ball reading because while our customers' thoughts may at times be communicated, they really sometimes represent maybe more dreams than reality, but I think certainly in the June quarter we have good visibility as normal.

So when I look at September, we would expect that if the customers execute to the plans that they are sharing with us now that the bookings environment would be higher than what is scheduled to book in June.

I think from a shipment standpoint, essentially what we have been doing is shipping at about a one-to-one ratio to what we book in a quarter, and so I would expect for us to continue to have shipments that are essentially equal to bookings.

I think revenue, if you look at where we are now, essentially what is booked in one quarter, essentially the revenue level is what occurs one quarter further out.

And I think that that is a reasonable expectation as it relates to what is likely to occur in September if the customers actually go forward and maintain the plans that they are sharing with us today.

Okay.

That's very helpful, Steve.

Can I have a quick follow-up.

You mentioned a little bit about NAND Flash orders being 25% of the memory orders.

It looks like that has declined and the DRAM portion has gone up.

Given that NAND is so seasonal, do you see any change in the buying patterns from the chip companies, i.e. are the chip companies looking to build more flexible products -- flexible fab in the form of -- fabs that can build both NAND and DRAM?

Are you seeing any trends in that front?

Some of the fabs out there have the flexibility to do product switch between NAND and DRAM.

The trend over the last couple quarters has really to be building dedicated fabs that are essentially set up to optimize the efficient production of NAND and DRAM.

I think what we are seeing is that the vast majority of customers that are targeting to add capacity and wafer start outs for NAND are going forward.

I think that like in any market where customers are doing both that you will typically see depending upon their market share, depending upon what business levels they are winning in a given time frame that they possess the ability to perhaps switch a plan that was designed for NAND and then convert it and actually buy it for DRAM.

That's not a very difficult thing for them to be able to do.

And with the lead times as short in the industry as they are today, I would expect that we will see that from time to time, but for the most part, the planning that occurs is going forward as they originally planned.

Our next question comes from Gary Hsueh from CIBC World Markets.

Thanks for taking my question.

Steve, I would just like to follow-up and maybe play the order bucket game in Q3.

What's sort of driving orders to be up sequentially in September if orders are falling off for maybe NAND Flash.

But -- and maybe -- maybe DRAM and maybe foundries can kind of pick up.

Can you help me out here?

I am struggling with this.

Well, I think that -- I am not sure that the assumption that orders for NAND Flash are necessarily going to fall off.

As Martin outlined in the March quarter, our orders as they relate to NAND versus DRAM were actually stronger in the March quarter for DRAM than they were for NAND.

When I look at the June quarter, we will actually see that where the NAND orders in June will be 55 or 60% of the memory orders.

And memory will be about 61% of our order book in June.

And as I look at what the customers are planning to do in the June time frame and what they are talking to us about what they are planning to do in the September quarter, NAND is going to be a consistent, steady investment plan in the next two quarters if they execute to their plans.

And so I don't -- I don't see at this time that there is a fall off in order rates for NAND.

Our next question comes from Jay Deahna with J.P. Morgan.

Good afternoon.

Two questions here.

The first one is, looking a little bit longer out from memory, and I think you alluded to this a little bit in your prepared comments.

How do you see the overall memory environment right now compared to say what we saw in the mid-90s when we had three solid years of growth driven primarily by Windows 95 and PCs, sustainability and tool demand for memory for the next year or so?

And then secondly, it looks like the spending ratio outside of NAND Flash for the rest of the industry is somewhere in the 17% range this year.

Pretty low by historical standards, and I am just wondering what you see looming out there for DRAM in particular as Vista comes and then foundries and IDM as we look into perhaps later this year and into next year.

Thank you.

Jay, I think your questions are really excellent questions, because I think that when I look at what's going on in the business today and in the industry, to me, it's not really what's going on on a quarter-by-quarter basis that's really important.

It is what is going on from a fundamental basis in terms of device, design, and end consumer product use.

And when you look at that, certainly the demand profile for NAND Flash is awfully positive and awfully encouraging over a multiyear perspective.

When I look at comparing the memory market today versus the memory market in those explosive growth years of '94, '95.

The thing that struck me is that this is a much more measured investment activity.

Back in those days, we had the semiconductor industry largely driven by memory, and largely driven by the fact that a lot of second and third tier players were really investing.

Were investing 25 to 27% of semiconductor revenues in capital expenditures, and we also saw that in '99 and 2000 not driven by memory of course, but driven by fundamentally the logic business for networking and the whole dot com boom, but what I have been really pleased to see is that while we've had a significant increase in the output of the NAND Flash devices and the NAND Flash market, when we look at the total investment, I expect that we are going to be at about 20% of semiconductor revenue for CapEx this year.

And so I -- I've -- I think that the industry in the 2003 and 2004 behaved in a very measured way for the most part.

The foundries got a little bit ahead of themselves in 2004, and when I look at how the industry is behaving through this particular cycle, it's a far more measured response, and clearly, there is an acceleration of order activity and capacity additions, but it is commensurate with the acceleration in the demand for units and the end markets there.

And I think your question about the spending ratio at 17%, based on our calculations, that's exactly -- or very similar to the number that we've come up because if you take the investment in NAND Flash that looks to be about 10 or 11 million and if you end up somewhere around 18 to 20 million in revenues, you take that out of the equation, the investment on the remaining 230 at about 38, 39 billion is 17%.

And that is a historically on the very low end of investment.

And I think that while the industry collectively is more efficient, 17% to me is not a sustainable level of investment.

I think that investment level will have to come up sometime as we go forward in the future.

Exactly when that is going to occur, I can't predict, but I think that is a good indicator of the long-term health of the current investment levels that we are seeing.

Thank you, sir.

Ladies and gentlemen, our next question comes from Suresh Balaraman with ThinkEquity Partners.

Yes.

Can you give us some thoughts on your plans for resist strip and historically those segments have been pretty low margin and how do they tie in with your goal of growing with profits -- profitable growth?

Thanks.

Okay.

So your question was what is our plans are for the resist strip business?

Yes, how do you manage the challenge of keeping the profitability levels up while still trying to grow the resistor business?

Because it is a pretty commoditized business and historically the margins have not been that great in the segment.

Sure.

I think, one, it is important for us to note that we are not intending to enter into the stand-alone high-volume strip market that the current companies that you're talking about play in.

We are focusing on bringing enhanced capability to our customers primarily with integrated Etch and Strip and expanding the number of applications where that economically is present both in a capital cost per wafer on a multichamber X system but also more importantly, that as we get into some of the really advanced 45 and 65 nanometer structures, yield issues become much more difficult to achieve and the process windows have narrowed.

And so the benefits to the customers of using onboard, integrated strip, whether it is in situ in the Etch chamber or with a dedicated strip chamber I think are going to grow in applications.

There are -- there is one primary stand-alone dedicated strip that is a very difficult process on a going forward basis, which is the post implant strip, and as you get to 45-nanometer, it is going to require a different capability be present in the strip chambers that are being utilized today.

The capability is present in the kinds of Etch chambers that we make, and, so, therefore, that market is moving our direction as a function of the technical requirements and the hardware configurations that have to be present in order to achieve it.

So as a result of that, our margins are targeted in the first year or so to be in that 45% range as we introduce the products and work with our customers to qualify them, and then I would expect as a function of the differentiation that may occur with the particular capability that those margins can move up and be similar to the margins that we see in the Etch business today.

Okay.

Great, thanks.

Our next question comes from Timothy Arcuri with Citigroup.

Hi, actually I had two things.

Number one, Steve, if I just take the shipment numbers for 2005 and if I grow them by even 30% this year and I take your shipment number for the first half of this year, it implied that shipments are going to decline by something like 30 or 40% in the second half versus the first half.

I guess, number one, is that the wrong math?

Yes.

I would -- if you take our first half shipment numbers, which are at the -- are you talking about shipment numbers now or revenue?

Shipments.

So I am just basically trying to take the full-year market projection and I am trying to take what has been guided for the first half of the year and just trying to figure out what has to happen in the back half of the year and it looks like there has to be a pretty big decline in the back half of the year to get to that.

To kind of keep the four-year number that low.

Well, I think that -- well, as low as what you are talking about.

And so, see, if you take that our shipments are going to grow 10 to 12% in the June quarter from the 511.

So let's take 10% because it makes the math easy.

That says you are going to ship about 560 million in June, and if we have targeted that our bookings will grow 5 to 15%, then our September shipments are going to essentially mirror that.

So our September shipments are going to be very similar in terms of their level of shipment activity, and then if our September bookings are up from June, then I would expect that that will drive a shipment level in December that will mirror the September bookings.

So if you kind of extrapolate that, you end up where we think that the first half shipments and the second-half shipments are going to essentially be about equal.

Okay.

Great.

I guess that would mean then that the -- so the full-year wafer fab equipment number would have to be a heck of a lot higher than your 25 to 30% year-over-year number.

It would have to be something more like 50 to 60% based on those numbers.

I guess that's where I am going

I hear what you are saying.

Here is the thing.

If you have wafer fab equipment up 20 to 25, because in an upturn, the Etch component of that moves from about 12.2% of wafer fab equipment to about 12.8 to 13%.

So what happens is if you have 25% wafer fab equipment growth, you are going to get 30 -- maybe even 32% Etch growth.

If you then combine that with the fact we are going to pick up 4 margin points.

If you end up where the Etch market is somewhere around 3.7 to 3.9 billion depending upon whoever's numbers you want to use for what 2005's Etch market was, if you then take and look at that as being something that we will ship at a 40, 41% market share, then you are going to end up where our growth rate in Etch is that 30% plus the 4 margin points.

And the 4 margin points is going to be another 150 million in revenue for the year.

So the leverage gets to be pretty strong and the numbers move up very strongly right along the lines of what you are talking about.

Does that make sense?

No, it does.

It does.

If I can ask just one more quick one.

If you compare the sequential tool shipments, and you look at how much the industry is shipping in the first half of this year relative to the back half of last year it looks like the shipment rates and if shipments equate to capacity addition, it looks like the sequentials are roughly the same as they were '95 and '98 and 2000 and 2004.

So, I guess, what's the view on whether we are going to have a little capacity digestion here in the back half of the year before it gets better again?

Well, I think that what you have is -- if you take kind of the first two or three quarters, I think the ramp rate that you described are, in fact, at that accelerated level .

I think the difference is, is that what happened in '95, '96, '99, 2000 is it just kept going that way that you had three, four, five quarters of this 20%, 30% on top of each other, and I think that when you get into that kind of situation, then you really run into the risk that you are adding capacity at a rate that is much faster than one, the demand can in essence stay equal to.

If we look at where we are today with all that is shipped in the second half of '05, and what has now shipped in March, which really has not obviously come online in terms of adding to capacity, the utilization rates in the industry are very healthy.

They are very strong.

When you look at the projected demand growth, and then you take the March shipments and you say, okay, that's going to add to capacity output capability in the June time period, again, those things seem to be pretty much in sync.

The one thing that I think is very important is we are coming off of a relatively low investment period in 2005.

Where the semiconductor players revenue actually grew very strongly.

And back in those time frames, capital investment as a percent of semi revenue was 25, 27%.

Back in '99 and 2000 I think it was even 28% or 29%.

I mean, it was very high.

And here we are, we are sitting here with -- we have this acceleration, but it's on an investment level of only 20% of semiconductor revenue.

So those things are in very good balance with each other, and I think they are very important elements to look at.

Thank you, our next question comes from Steve O'Rourke from Deutsche Bank.

Thank you.

Just a follow-on to a lot of this discussion on sort of investment levels here.

There have been some comments from people in the industry as well as elsewhere that the foundries simply have to invest more based upon how they have invested over the past few years.

One, do you believe that?

Do you think they are under investing or are they investing rather wisely at this point and we shouldn't expect that kind of a pickup.

I think that is a good question because I think a lot of people have been thinking about what the foundry invested in 2004 which I think was about 9.7 billion, and there is no question that that level of investment for the foundries was getting out in front of themselves, and I think that they had anticipated that the upturn in that '04 time frame was going to sustain itself but it didn't.

So foundries then significantly pulled back investment in 2005 to about 5.7, 5.8 billion, and as a function of that, they really kind of let this whole activity in unit demand growth grow into their install base.

And the foundries exited 2005 in a really good state overall, and there's obviously some companies on some technology nodes that have different utilization challenges, but overall, the foundry utilization, particularly on the leading edge is very strong, and even at 130 and 180-nanometer nodes, there is a very strong foundry demand environment going on.

I think that in my view the foundry investment coming up about 20% in '06 over '05.

The interesting thing is that even at that level, that probably takes their investment up to approximately 7 billion.

At 7 billion, they are still 25% below the amount of money that they invested in 2004.

And so when I look at the foundries, I think it is very logical that with the demand that they are seeing, that they are going to be investing at that 20, maybe 25% increase over '05, and I think that the one thing that the foundries have learned is they don't need to buy in large 10 to 15,000 wafer start chunks.

They tend to buy today in 3 to 5,000 wafer start chunks.

The cycle times are so fast their ability to get those pieces of equipment qualified and ramping and output is so fast that we really operate now to a much less speculative environment in terms of capacity ads.

It is much more synched to the end demand that they're getting from their customers.

Just a quick follow-on to that.

Do you think it is fair to say that all that said, what we have really been seeing is a capacity digestion period for the foundries for the past year or two?

And if we are going to see a capacity digestion period, it is probably going to be driven by memory?

Well, what you said -- for the first part about the foundries was true, what they were doing with the capacity digestion period where they were really working off whatever the excess capacity they had and letting their wafers starts grow into that.

In terms of memory, I don't understand the context about memory.

Well, if we are at risk of any kind of a capacity digestion later in '06 going into '07, for example, the most likely scenario would be that it would be memory induced.

Okay.

If you think that the investment since about 50% of the overall investment is going into memory, if memory gets ahead of itself, then that will be where the problems are in the industry.

That is what your question is?

Right.

I look at sheer wafer starts going in for memory.

I think that if you end up where there is a falloff in demand or a significant slowing of the growth rate relative to demand for either DRAM or NAND Flash, then you obviously have the potential that they would have to slow down their rate of investment and allow that unit output demand to catch up.

I think that there's always the potential that in any given period, whether it is a three-month period or a six-month period, that something like that could occur.

But, again, I think that the rate of investment in memory, while it seems aggressive, is actually being put in in response to the fact that they have a unit output demand that is running 14, 15% per year which is much higher than the typical 9 to 11% that memory was seeing and obviously NAND Flash is a big part of that but DRAM bit growth is very strong at about 55 to 60%.

It is even stronger than what people had been forecasting which is probably around 50.

So we will have to watch it, and I think people are looking at it pretty carefully, and we'll just have to see what happens, but as it states right now with where we are right now, things are pretty balanced right now.

Thank you, our next question comes from Mark Fitzgerald with Banc of America Securities.

Two quick questions on the memory side.

In previous quarters, Steve, you have commented that you couldn't sort out the NAND and DRAM purchases out there.

So I am curious at this point why you can decipher with such accuracy the split at this point.

Then I have a quick follow-on.

Well, I think actually for the last couple of conference calls, we have broken it out because what's happened now is that in the memory business, when NAND was first starting to ramp, they were basically utilizing their existing DRAM lines, and then they were adding various pieces of equipment to kind of create the ability to run NAND down an existing DRAM line.

But as the industry and the unit demand grew, customers started ordering for dedicated NAND Flash lines and dedicated DRAM lines, and they communicate that to us, and we know what the configurations are that are different between a NAND line and a DRAM line.

That is what has changed in the last six to nine months and we are able to break that out pretty readily.

And then just a follow-on.

The cancelations -- 7 million in cancelations, where did they come from?

To your question.

We had 2 million of adjustments which are essentially kind of price adjustments.

The cancelations were both as it turned out foundry cancelations.

In and of itself that's not very meaningful.

Neither were competitive losses.

One of them was a cancelation from a customer and then the customer reordered a very different specification.

If they do that simply as a change order we never record it as a cancelation.

It is just an adjustment.

In this particular situation they canceled and then replaced the order with the new specification.

One was just a trade out the other one was again, a foundry customer one system where they concluded they had ordered one too many.

Neither were competitive situations, very, very simple message, two systems.

Thank you.

Our next question comes from Timm Schulze-Melander with Morgan Stanley.

Good afternoon.

Two very quick questions, if I may.

You referenced price cuts in the service and spares business.

Can you just give us some sense as to -- you know those spares where you were cutting price.

At what technology node are they sort of most focused?

And can you just give us a sense what service revenues.

What proportion of your revenues service accounts for?

And then I have a quick follow-up.

Okay, Timm, one, we are not doing it on service per se, we are doing it on spare parts only, not service labor in any specific way.

The area where we are focused is really on our 2300 product which really makes up a significant part of our customers 130 nanometer and below production.

And fundamentally for quite a while now, what has really started in the downturn of 2001 to 2003.

Customers business models started to change because as the growth rate was kind of slowing down and going up and down, customers got very focused on what's happening to their fab operating costs.

And a process started then where we would work with them on cost reductions, whether it was via pricing or parts lifetime or looking at alternative materials, and that continued for a while, and then we went into the '03, '04 ramp.

And once again now I think what you have is a situation where the semiconductor businesses is very competitive.

A lot of what goes on out there is more commodity related, and so, therefore, the focus on cost in the fabs across a whole variety of product lines and applications is very strong.

So what's different today is in the last couple of years, a so-called third-party spare parts, pretty much a localized business has sprung up because in the industry, there is probably a 2.5 to $3 billion parts business that's out there for the industry as a whole.

And so the customers working with us, working with them have really, I think, started to take a stronger look at spare parts and the impact to their business.

We got together at the end of the quarter.

We had looked at the actions that we had taken.

We looked at the actions that we were planning to take as it relates to responding to our customer request and responding to the competitive situation.

And we just fundamentally decided that we wanted to really be a lot more aggressive and, one, build on the customer trust that we have by demonstrating to our customers that we were really going to be a supportive partner in their efforts to get their fab operating costs lower, and we wanted to basically make it much more difficult for these third-party suppliers to compete for that spare parts business, and essentially really ensure that our customers would be able to continue to have a source of high-quality and reliable delivery from Lam.

I think that we also fully expect, and we have in the cases where we did some of the early rollout of this, is we have won back market share.

We have gained customer commitments that will get all of their spares business when they may have outsourced 10 or 20% of it as a function of the actions that we have said we would be willing to take.

And so when I look at the opportunity for incremental revenue and incremental operating profit dollars and the resultant increase in EPS, I think it is a good thing to do financially.

I think it is a good thing for the customers.

And I think it is a good thing for us overall in terms of EPS growth.

And just on that, I mean, I guess, with the production being sort of 130-nanometer and below, these are relatively new products.

Wouldn't somebody be infringing your patents or your IP if they were reverse engineering spare parts for your equipment?

Timm, that's an interesting and very complicated subject.

There are cases and there are situations at times when our patents or IP have been violated.

And, in fact, we have instigated some legal actions and it had in fact has been successful in protecting some of our I.P. as it relates to the parts business.

Many parts are not -- it is not necessarily against the law if I understand the legal aspects of this to go and take a part and reverse engineer it and redraw it and go and have the part made.

I think that one of the issues here is that sometimes a part gets made.

It appears and may physically look like it's the same part, but actually there may be some trade secrets embedded in how that part is manufactured or what the actual properties of that part are.

So in the semiconductor business which has many, many very high purity materials, it is a difficult process to get a spare part qualified, but it obviously is possible to do.

Most of that competitive risk has really occurred in more a commodity parts areas because some of the suppliers that maybe 2, 3 years ago tried to get into some of the more high value-added proprietary parts found that one, they couldn't make them or two the violation of the IP wasn't something they wanted to enter into and so a lot of what is going on now is kind of outside that space for all the reasons I noted.

Thank you, our next question comes from Jim Covello with Goldman Sachs.

Good afternoon.

Thanks so much for taking the question.

Steve, can I probe a little bit on the rationality of the spending.

If we think about it this way, we had kind of unprecedented declines in pricing in two of the key markets in the first quarter being NAND Flash and microprocessors and those customers continue to be very, very aggressive.

Even accelerating the spending from pretty healthy levels to begin with.

Is that rational?

I don't know.

You are going to have to ask them if in the face of some of those price declines is it rational.

All I can tell you some things that they tell us when we have these discussions, one is, that yes, there has been a significant price decline in NAND Flash, but it is still more profitable than DRAM and some would even say much more profitable than DRAM.

Two, the reality is that they were making very high margins because they were over the last six, nine months in an environment where demand was greatly outstripping supply, and whenever that happens, prices are pretty high, and so what we've seen is that clearly the supply has ramped up, and it's still short of the demand, but that -- and you have more players that are in the market now.

There was only two or three about a year ago and now there is going to be five or six so all of that competition is a logical expected decline as it relates to NAND Flash.

And microprocessor, I really can't speak to much of that because we don't really focus too much on the economics because it is really two players.

We kind of just look at what's going on overall in that market, and clearly with one of them we have a good position the other one we don't have a position so we don't spend too much time on microprocessors so I really couldn't comment on that for you.

Steve, if I could follow-up on the pricing on the NAND side and the margins.

If you look at it on a pretty realtime basis.

Certainly the excess margins were true last quarter.

You look at our realtime basis and actually some of these companies are losing money.

You look at a Micron report from this week.

That's where I get into the questions about the rationality -- yet they continue to accelerate the CapEx.

That's where I get into the questions on the rationality.

It's one thing when they were making such profits, now some of them are losing money.

Micron right now from a revenue standpoint, if my information is correct probably has less than 10% of their revenue is coming from NAND.

Because they just recently took some of their DRAM capacity in their Virginia facility and started to convert it over to NAND and Micron has largely been a DRAM and other specialty memory product.

I can't speak to that other than to say that I think that Micron which just recently announced as everybody read, believes that the economics in the NAND market where there is over 100 different customers that you can sell directly into, and that's kind of what exists today and is expected to be much larger over the next couple of years that the pricing power for the players in the NAND Flash market is going to be much better than in the DRAM market where you really only have about five major consumers of all the volume DRAMs, and those guys have the pricing power and the elasticity of what they put into their products that makes the DRAM market very difficult at least from the perspective of Micron.

I think that, again, in my discussions with the NAND players, I specifically have asked the question, is 200% bit growth really what is occurring.

If so, why.

The answers that we get are embedded in the comments that we have made in the investor and analyst meeting and in today's conference call.

They believe that the growth rate that is occurring is still significantly greater than the amount of investment that's been put into adding capacity for output.

That's all I can tell you.

Our next question comes from Brett Hodess with Merrill Lynch.

Thank you.

Just two quick ones.

First, given the very short acceptance times of one to four months you mentioned earlier, is there really any difference between booked and shipped market share and Etch anymore?

Yes, there is, because you book it, and you will ship it two, three, four months later, and then you'll accept it another one to four months later.

So from booking to revenue acceptance, you still have six, seven months of lag.

So, yes, there is still a big difference between book and revenue.

There is less difference between shipped market share and revenue market share, but it still exists in the two-to-three-month average lag time.

And then the second one just quickly.

It looks like with matching sort of your shipment rate with your bookings rate roughly that your backlog is going to stay -- it looks like it will stay fairly stable around this level over the next few quarters.

Is that accurate and if not -- or should I say -- wouldn't you want to start to be building some backlog, I think at this point given the higher revenue run rates?

I will have Martin talk about the specifics of the backlog but as it relates to building backlog.

Those were maybe the good ol' days, although, let me tell you what happened.

Whenever you built up backlog that generally was what you ended up getting canceled on you because back in those days when you had six and seven months of backlog and customers were ordering for delivery nine months out, et cetera, that's how we all got in trouble because they were ordering all based on speculation, not real demand that they were getting from their customers.

So I think that actually the fact that we have very short backlogs, in our case probably around 10 or 11 weeks is a reflection of the fact that the supply chains are fast.

The turns are fast.

But their order decisions are really now much more based on a reality of what they see and not nearly so much about speculation.

With that I will have Martin address the rest of that.

I think that may be the best answer to the question quite honestly.

I think the convention that we all got used to is, when we as an equipment company offer a three-month lead time, our customers tent to take advantage of that.

And so my take is with that in mind, which is a statement of customer behavior and one of our kind of principal operational objectives which is to balance our business and try and target as close to a one-to-one ratio on shipments book-to-bill you should expect the backlog of the Company to continue to be in the two-to-three-month range and you should continue to see us target a shipments book-to-bill of close to 1.

When I look at the forecast that Timm placed on the Company it looks pretty stable.

But the basic answer to the question is the backlog is going to move with the bookings environment with a one-quarter lag.

So hopefully that helps.

Our next question comes from Patrick Ho with Stifel Nicolaus.

Thanks a lot.

A quick question for you Steve.

In terms of the 5 to 15% orders outlook that you gave.

Now that we are getting into these bigger numbers and on the 15% side is starting to push, I believe, $600 million of booking.

What's, I guess, the swing factor that can lead you from, I guess the low end or the high end when you get -- when the June quarter is complete.

I think that -- one of the reasons that I gave guidance of 5 to 15 is that customers are ordering in some respects in some areas 50 million, sometimes more, but a 30 to $50 million order is not uncommon.

And all it takes is one of those that was supposed to come in at the end of the quarter and it doesn't.

And all of a sudden now instead of being at your midpoint at 10%, a $30 million order is 3 or 4% -- I am sorry about 5 or 6% and if it's a $30 million order actually comes in earlier, then you can see how easily you can swing plus or minus 5%.

I think that is really the reason for providing some flexibility there and where we are going to actually come out is just not predictable when one order slides one way or the other.

Okay.

That's really helpful.

And a second question.

And maybe Martin can give a little color on this.

In terms of the gross margin, we are continuing to obviously see gross margins progress upward, but you did mention that the spare parts.

You are going to I guess take a little more aggressive pricing in that.

What is offsetting it that allows you to continue to grow margins over the next few quarters?

I think the answer to that question is kind of defined by two things.

One of them is there is some economy of scale, a consequence of having a bigger business.

Clearly these levels that benefit is a reducing economy of scale which is why when I shared the gross margin scenarios in Shanghai a few weeks ago, I was very deliberate about the choices that I made, and so we had 51.5% and the 52 at the 550 revenue level.

So as Steve kind of talked about a little earlier, there are kind of two parts to this decision.

One of them is the decision to work with customers aggressively, proactively, and work to reinforce and gain share positions which is the ASP and the revenue side of the equation.

As you might remember in Shanghai, Ernie Maddock our Vice President of Operations discussed our local cost sourcing initiative where we are pursuing a 1 to 2 percentage point revenue cost reduction play in the next couple of years and our ability to accelerate that is clearly a focus and a propriety as we proceed in the next coming quarters.

Okay, operator we have time for one more question.

The final question from David Duley from Merriman.

Thank you for the opportunity to ask a question.

I was wondering, you gave us your book to market share in the Etch market at 39 or 40%.

Can you give us a little bit more granularity as what you think your share is in the Dielectric side.

One other follow-on question to that is the current order guidance that you have, I believe that exceeds your peak order number in 2000.

Can you give us some commentary of whether you think the overall industry is going to see its peak or is this unique to Lam with its market share growth?

We will work on the data for the second one and I'll answer the first one while we do that.

Yes, for 2005, our book to market share we believe 39 to 40.

And since recently a number of market research firms have come out with their revenue-based market shares, both of those firms indicated that we grew our market share 15% from 2004 to 2005, which essentially puts you in the 36% type of range for revenue.

I think that the situation for us in Dielectric is that our market share is right around 30, 31% at the end of '05.

When I talk about our targeted 10 to 12 new application wins in the first half, some of those are clearly targeted at winning additional market share in Dielectric because our market share in silicon and metals is in the mid to high 40s, and so clearly there's a larger target market opportunity in Dielectric and we are clearly pursuing that.

As it relates to bookings peaks from the prior 2000 time frame, we had a new orders peak of 563 million in December of 2000.

And so if you take the midpoint of our guidance at 10% over 520, that will get you to 572, so clearly we have an opportunity to have the bookings in the June quarter be a new order peak for Lam.

As it relates to the rest of the industry, I really can't speak to that for other people, because I think as we talked about earlier, what a company ends up booking is a function of the markets you serve and the growth rates of those markets it is a function of your market share growth.

And certainly for us, Etch is a market that is growing faster than the overall investment.

Our market share we believe continues to grow at a good clip, so those two things combined I think give us an opportunity to have a higher level of bookings in this cycle than perhaps some might have.

Okay.

We would like to thank everyone for joining us for today's conference call.

We look forward to speaking with you again next quarter.

Thank you, ladies and gentlemen, this does conclude Lam Research March quarter 2006 financial results conference call.

Thank you again for your participation in today's conference and you may now disconnect.