Good day, welcome to the Lam Research Corporation December 2016 conference call. At this time, I would like to turn the conference over to Mr. Satya Kumar, Vice President of Investor Relations. Please go ahead, sir.
Thank you, good afternoon, everyone, and welcome to the Lam Research quarterly earnings conference call. With me today are Martin Anstice, President and Chief Executive Officer, and Doug Bettinger, Executive Vice President and Chief Financial Officer. During today's call, we will share our outlook on the business environment, review our financial results for the December 2016 quarter, our outlook for the March 2017 quarter. The press release detailing our financial results was distributed a little after 1:00 P.M. Pacific Time this afternoon. It can also be found on the investor relations section of the company's website, along with the presentation slides that accompany today's call. Today's presentation and Q&A includes forward-looking statements that are subject to risks and uncertainties reflected in the risk factor disclosures of our SEC public filings. Please see accompanying slide in the presentation for additional information.
During discussion of our financial results, we'll be presented on a non-GAAP financial basis unless otherwise specified. A detailed reconciliation between GAAP and non-GAAP results can be found today in today's earnings press release. This call is scheduled to last until 3:00 P.M. Pacific Time, as always, we ask that you limit your questions to one per firm with a brief follow-up so we can accommodate as many questions as possible. As a reminder, the replay of this call will be available later this afternoon on our website. With that, let me hand the call over to Martin.
Thank you, Satya. Good afternoon, everyone, thank you for joining us today. We'll first start with an overview of our December quarter results, followed by comments on our 2016 performance milestones and their relevance to sustainable growth opportunities for the company. Lastly, we'll speak to the industry updates and their assumptions relative to wafer fab equipment spending in 2017. In December 2016, Lam delivered another record quarter, reporting all-time high shipments, revenues, profit dollars and EPS, all of which also exceeded the midpoints of our guidance range. That foundation and momentum reflects itself in our March quarter guidance, where shipments and revenue both exceed $2 billion for the first time in our history. We are inspired by the opportunity to support the success of our customers and for Lam to continue its trajectory of multi-year outperformance again in 2017.
First, let me take a moment to reflect on 2016, the fifth consecutive year of growth and outperformance for Lam, with a shipments CAGR of almost 20% over that period. In the year, we grew our shipments to a record $6.7 billion, two times faster than the 5% increase in WFE that we estimate occurred. We consider this relative outperformance as well as a further solidifying of our share of WFE as noteworthy, especially in the context of a meaningful decline in DRAM investments last year. Customer segment mix will be better for us in 2017 than was true in 2016, we believe. As we establish new record results, it is important to recognize the demonstrated quality of our earnings because our focus remains on delivering sustainable, profitable growth.
This is particularly true in the context of the balance we described at our Analyst Day between the various business segments of multi-patterning, 3D non-volatile memory, packaging, and installed base service. Lam has strengthened its momentum in foundry and logic, with significant application share gains from the 2016 nodes to the 10 and 7 nanometer nodes. As an example, during the quarter, we more than doubled our installed base for our production-proven atomic layer etch system for logic self-aligned contact application with our dielectric etch product and mixed-mode pulsing technology. Application share wins such as this helped us grow our foundry shipments 15 percentage points faster than foundry WFE growth of 25% last year. Said differently, the foundry business segment for Lam Research grew 40% in 2016 year-over-year.
Turning to 3D NAND, which has emerged as one of the strongest growth opportunities for the semiconductor industry, we grew our NAND shipments by over 80% in 2016, almost twice the rate of growth in NAND's WFE. This record growth was made possible because Lam's product portfolio addresses a variety of critical applications in the manufacture of this device architecture. We shared with you previously that our revenue opportunity increases by approximately 50% per incremental bit of capacity added for 3D NAND compared to planar technology. Perhaps unique to Lam, our opportunity is relatively agnostic to whether the incremental bit capacity is added by new greenfield wafer capacity or through conversions and upgrades, which means that in a conversion-driven world, our opportunity to outperform remains significant.
Most importantly, we continued our market share momentum in 3D NAND and other non-volatile memory derivatives by defending 100% of critical applications and by adding additional applications for staircase etch and atomic layer deposition for advanced memory and 64-layer selections, which will ramp in 2017. Specifically, in atomic layer deposition, we continue to expand the number of applications with several key penetrations at multiple memory and logic customers. While we're very happy with what we accomplished and delivered in 2016, we are committed to the success of our customers long-term and are enthusiastic about the multi-year growth opportunity ahead. As we said at our Analyst Day, the industry is clearly now more than more as powerful demand drivers in the form of cloud, mobility, and connected devices create new challenges that we are well-positioned to help our customers address.
Important to capitalizing on the opportunities ahead is the fact that we have the right products at the right time to help our customers enable this industry transformation. This multi-year product positioning by Lam creates sustained outperformance opportunities, central to which is our technical competency and capability and the trust our customers place in delivery of technology in a form that contributes to their success. Complementing the customer engagement momentum achieved through technology innovation is the capability of Lam manufacturing, supply chain, and customer support organizations. Our largely U.S.-based manufacturing organization once again delivered record factory output for the December quarter, managing and ramping a complex global supply chain and our own manufacturing capacity both.
The flexible business model of Lam and the commitments to invest in our future has enabled, consistent with our guidance today, scaling of the company by more than 40% in the March 2017 quarter from the average shipments level in calendar 2016 of slightly less than $1.7 billion. Record systems shipped means record systems installed and supported, and here, once again, our global customer organization affected accelerated production ramps across multiple sites throughout the world. Our focus is on supporting the time-to-market needs of our customers. Rounding out the overall value proposition to our customers is the service capability provided by our customer support business group, a value proposition that has increasing emphasis, particularly in the context of IoT. This component of our business reported the fifth consecutive year of growth and has more than doubled in revenues over the last five years.
Simply stated, our focus is on improving the technology and productivity of our 40,000-plus process modules in the installed base through innovative product, upgrade, and service offerings. In turn, increasing the competitiveness of our underlying etch, deposition, and clean systems capabilities. Turning to the overall equipment spending trends of 2016 and our expectations for 2017. WFE investments in 2016 ended a little over $34 billion, essentially unchanged from our prior views. We are in a data-centric world characterized by the cloud and connected devices, which we believe is driving a multi-year growth trajectory for semiconductor content across a number of electronic devices. As a result, we are seeing our customers increase their WFE investments to capture these opportunities. We remain optimistic on the potential for global economic stability and growth. Without exception, our key indicators are models more positive in calendar 2017 than for calendar 2016.
In 2017, we expect the following trends. DRAM supply and demand balance has tightened significantly in the second half of 2016 due to strong end demand and a depletion of inventories generally. We expect continued tight supply and demand in 2017 as investment recovers from the extremely low levels of 2016. We continue to see multiple demand drivers for DRAM. On the consumer side, the migration to eight gigabit die densities enabled by the transition to 20 and 1X nanometer DRAM, combined with increasing use of advanced processes, is enabling exciting new applications such as VR and 4K gaming, also sustaining healthy DRAM content growth in mobile and the PC. On the enterprise side, the migration to 14 nanometer server processes with new architectures, including increasing attach rate of hardware accelerators and new high-bandwidth memory interfaces, are driving significant DRAM content.
As a result of these favorable supply and demand dynamics, we expect to see a double-digit recovery in DRAM spending in 2017. Still largely focused on conversions, with approximately a quarter of the industry capacity converted to 1X node by the end of calendar 2017. This is a commentary on increased investment with continued discipline relative to our expectations for supply and demand balance. We expect NAND CapEx to once again grow double digits in 2017, with more than 700,000 wafer starts per month of 3D NAND shipped capacity expected by the end of 2017, representing less than half of the total NAND wafer capacity for the industry we expect at that time. While there is continued focus on where we are in the conversion from 2D to 3D, we believe the industry is in a much earlier stage on the broader transition to solid-state storage.
As an example, the average NAND content in a smartphone was only about 25 gigabytes in 2016, a tenth of the levels for high-end flagship models. The transition from 128 to 256 gigabytes for PC SSDs with line of sight to 512 gigabytes reaching cost parity with hard drives is increasingly a consensus view. In the data center, high-density SSDs are playing a pivotal role to usher in new architectures. Consistent with the headlines of our recent analyst meeting, this is a world of increasing content. Combined, these trends are on track to drive significant growth in revenues for our memory customers. We expect memory industry WFE in the high teen billion dollars, with growth representing stable capital intensity in 2017 year-over-year.
We expect foundry and logic investments to be flattish in 2017, characterized by investments primarily in new 10 and 7 nanometer capacity for leading-edge processes for both mobile and compute applications. Approximately a quarter of the foundry industry capacity we anticipate will be at the 20 nanometer and below nodes by end of 2017, matching capacity in aggregate that is equivalent to the 28 nanometer node. Coincidence with this leading-edge spending, we see meaningful investments at the 28 and 40 nanometer nodes for various types of sensor and communications chips for mobile and IoT applications again this year. Overall, we think WFE is likely to grow mid- to high single digits in 2017 to the mid-$37 billion level, ±$2 billion. Consistent with our prior commentary, at this time, we expect investments by domestic China memory companies more a 2018 story than 2017.
We remain optimistic about the focus on global supply and demand and disciplined investments by all. In closing, let me take a moment to acknowledge the hard work and contributions of our global employees and the support of our customers, without which our past, present, and future would not be possible. We are positive on long-term semiconductor growth and for 2017 specifically. From our comments again today, I hope it is clear that we believe Lam is unmatched in its positioning and opportunity relative to markets and technology transitions. With that, let me turn the call over to Doug.
Thank you, Martin. Good afternoon, everyone, and thank you for joining our call today on what I know is a busy earnings day. We ended the calendar year with strong performance for the December quarter, exceeding the midpoint of our guidance on all financial metrics. We delivered record levels for shipments, revenue, operating income dollars, and earnings per share, both through the December quarter as well as for the calendar year 2016. Again, demonstrating the company's ability to grow the business at a pace that is materially faster than WFE as a whole. Let me dive more deeply into the December quarter. Momentum in our shipments continued, totaling $1,923,000,000, which was up approximately 13% compared to the September quarter and was at the high end of our guided range.
Shipments for the combined memory segment came in at 61% of system shipments, which was up from 56% in the September quarter. Non-volatile memory shipments made up 37% of the system shipments, which was down a little bit from 43% in the prior quarter. Customers are committed to their technology roadmaps, investing in their vision of economically scaling the technology in step with increasing product performance. As we shared during our Analyst Day in November, this is an exciting time for this segment of the market, with 3D NAND possibly the largest growth driver in the industry. We are pleased with our leadership in 3D NAND, and in particular, with our strong position in the most critical applications like the channel hole etch, the mold stack, and the word line fill. DRAM shipments grew 24% of total system shipments compared to 13% in the prior quarter.
With the tightening of the supply-demand balance in the DRAM segment, customers increased their investments in the December quarter. Content growth in areas such as servers and smartphones have contributed to a burn-down of inventory and a corresponding upward movement in DRAM prices. The foundry segment remained strong at 31% of system shipments in the December quarter, which was down slightly in absolute dollars from the record level we saw in the September quarter. Foundry spend was focused primarily on 10 nanometer. As Martin mentioned, we have made some significant market share gains in the foundry and logic space as our customers are migrating to smaller geometries and implementing more challenging architectures. Finally, the logic and other segment contributed 8% of system shipments, which was flat with the September quarter. December quarter revenues were $1,882,000,000, which is up 15% compared to the prior quarter.
Gross margin improved to 46.4%, which was up 120 basis points from the 45.2% in the September quarter. This was primarily due to business volumes, product, and customer mix. As I always mention, you should expect to see some quarter-to-quarter variability in gross margin due to multiple factors such as product mix, customer concentration, and overall business volumes. I remind you that our financial model continues to be the right tool for you to use to build your own models and to think about our ongoing financial performance. Operating expenses came in at $384 million for the quarter, which was up from $372 million in the September quarter. OpEx decreased to about 20% of revenue in the quarter compared to 23% in the prior quarter. Spending allocated to R&D was about 64% of total spending in the December quarter, up from 63% in September.
You should expect to see more variability in our quarterly spending in 2017 than historically, as we've changed our methodology in how we record variable compensation to better align the expense with the quarterly profitability. Operating profitability was very strong in the quarter. We generated operating income of $490 million, which was an increase of 34% compared to the $366 million that we generated in the September quarter. Operating margin increased to 26%, which was up from 22.4% in the prior quarter, driven by the higher revenue and an improvement in gross margin. The December quarter tax rate came in at about 15%, which was higher than the roughly 12% rate last quarter and in line with our expectations. A rate in the middle teens would be a reasonable number for you to use in your modeling for the March quarter, as well as 2017.
Based on a share count of approximately 181 million shares, earnings per share for the December quarter were $2.24. The share count includes dilution from both the 2018 and 2041 convertible notes, with a total dilutive impact of about 16 million shares on a non-GAAP basis. I'll just remind you, dilution schedules for the remaining convertible notes are available on our investor relations website for your reference. We returned $0.30 per share for a total of $48 million in dividend distributions to our shareholders in the quarter. At our analyst meeting in November, we announced an increase in the dividend level to $0.45 per share. The first distribution at the new level was paid out earlier in the month of January. In addition, we initiated purchases under our billion-dollar board-authorized share repurchase program, which was also announced at our analyst event.
In the December quarter, we spent $65 million and took delivery of approximately 619,000 shares at an average share price of $105 per share. Let me now take you to the balance sheet. We ended the quarter with $6,089,000,000 in cash and cash equivalents on the balance sheet. The cash remains approximately 40% onshore and 60% offshore. During the quarter, we redeemed the $600 million 2023 senior notes and the $1 billion 2026 senior notes under the special mandatory redemption provision of those notes. Cash generation for the company continues to be healthy. In the December quarter, we generated $404 million in cash from operations. In the December quarter, day sales outstanding improved to 69 days from 72 days. Inventory turns also improved from 3.9 to 4.1 times.
We exited the December quarter with a deferred revenue balance of $673 million, down a little bit from $704 million in the September quarter. That number excludes approximately $129 million from shipments to customers in Japan. This number is up from $65 million last quarter. I'd like to remind you that those Japanese shipments remain as inventory carried at cost on the balance sheet and will convert to revenue in future quarters. I do expect to see deferred revenue grow again in the March quarter. Company non-cash expenses during the quarter included the following: $32 million for equity compensation, $39 million for amortization, and $39 million for depreciation. Capital expenditures were $37 million, which is down a little bit from the $42 million that we spent in the September quarter. We exited the quarter with approximately 8,200 regular full-time employees.
Headcount additions were targeted at supporting increased business levels and customer ramps. Let me now turn to our outlook for the March quarter. I'd like to provide you with our non-GAAP guidance. We're expecting record shipments of $2.35 billion, ±$75 million. We expect record revenues of $2.125 billion, ±$75 million. We expect gross margin of 45.5%, ±one percentage point. Gross margin is down somewhat from the previous quarter due to business mix. We're forecasting operating margins of 25.5%, ±one percentage point. Spending is up in the forecast due to profit-dependent expenses and payroll-related taxes, in addition to new R&D investments. Finally, we forecast record earnings per share of $2.55, ±$0.10, based on a share count of approximately 180 million shares.
In closing, we're very pleased with our performance in the December quarter as well as calendar year 2016 and the milestones we achieved throughout the year. Looking ahead, we remain committed to our objective of creating value for shareholders and to successfully executing on the growth opportunities ahead of us. We continue to expect 2017 will be a first-half-weighted year, with shipments more first-half-weighted than revenue. Also, as we sit here today relative to the June quarter, we're expecting June shipments that are roughly in line with what we're seeing for March. That concludes my prepared remarks. Operator, Martin and I would now like to open up the call for questions.
At this time, if you'd like to ask a question, please press the star and one on your touch-tone phone. If you find your question has been answered and you'd like to remove yourself from the question queue, you can do so by pressing the pound key. Once again, that is star and one on your touch-tone phone to ask a question. We'll pause a brief moment to allow questions to queue. Now we'll take our first question from Timothy Arcuri with Cowen and Company. Please go ahead. Your line is open.
Thank you very much. I guess, Doug, the first question I have is, as you look, obviously you have some concentration issues in March, do you think that the concentration's going to get a little better or a bit more favorable as you look out to June and the shipments are basically flat?
Yeah, it might, Tim. As I always remind you, keep in mind the financial model when you model things. We're right in the sweet spot of where we should be relative to that financial model, relative to operating income percentage and gross margin and spending, obviously, both go into that number. We're kind of where we should be, is how I think about it. There'll always be puts and takes around it, as you've seen over the last couple of years.
Okay. I guess just a question, you guys are doing a great job. There's no question about that. Everybody can get that. I guess as you think strategically, Martin, as you're looking out a couple of years, KLA-Tencor would've been great, but it didn't happen. As you think about sort of making hay when the sun shines right now, and how you want to remake the company for the next couple of years, is display something that's interesting to you, given that we seem very early in that cycle? Is there any technology you can bring to bear maybe in that vertical? Thank you.
Well, probably the most important thing to say in response to that question, Tim, and I appreciate your comments about the performance of the company, thank you, is that actually there's no need to kind of remake the company. We're not sitting here as a leadership team feeling encumbered with that responsibility, for several reasons. The first reason is the company is performing very well. The second reason is in the context of how we expect the market to evolve in the next several years, in the context of these secular demand drivers for the semiconductor industry more broadly, the KLA-Tencor conversation for the company was leveraging a position of strength, and that's a position of strength that we expect to continue for a number of years. I feel like we've got a tremendous opportunity with the product portfolio in the markets that we currently occupy.
As we touched upon, albeit briefly, in the analyst meeting, we have attention always to capital redistribution conversations, we have attention always to adjacent market growth opportunities, and that strategic dialogue has always been active and will continue to be active. I feel like, even if we took no action relative to product and markets, the story of the company in the next several years is going to be a story of outperformance, if we continue to execute in the way that we have.
Thanks, Tim.
Thank you. We'll take our next question from C.J. Muse with Evercore. Please go ahead. Your line is open.
Yeah, good afternoon. Thank you for taking my question. I guess first question is sustainability and longer, stronger cycle kind of question. I guess within that, perhaps we could just focus on the NAND side. Curious, how do you think about, I know you put up the $50 billion number, but how do you think about perhaps a world where there's more conversions next year as opposed to greenfield, and your exposure to both, and whether or not the strong level of spend in NAND that we're seeing today can continue into calendar 2018, and beyond?
Yeah. CJ, very good question. Thank you. A couple of things to say, maybe I'll kind of step up a little bit from the NAND dialogue here, just to give a little bit of context. In our prepared comments today, Doug specifically called out an expectation that shipments in the June quarter would be somewhat similar to shipments in the March quarter. We've talked about a couple of times now an expectation that this is a WFE year that has a bias more to the first half, than the second half. We'll see where the year ends out, but if you ask me today what I expect the balance to be in terms of shipments and WFE, it's hard for us to see today at an industry level and a company level, a better balance in shipments and WFE than 55/45 first half/second half.
The NAND flash segment is one of the segments that's a little bit more acute from that in terms of first-half bias, in large part, simply a byproduct of the timing of customer investment decisions. Not every NAND flash customer in the world is biased to first-half investments, but the sum of all of the market, as best we understand it today, is slightly more first-half concentrated than the overall 55/45 reference I just gave you for the industry.
In answer more specifically to your question, we clearly take a position that the secular trends, the multitude of demand drivers, the SSD roadmap that our customers are invested in, is a multi-year and a long-term reality, and we've articulated, I hope, the substance of the positioning of Lam Research in the mix of enabling that and the etch and the deposition portfolios of the company get stronger, and they are as relevant, if not more relevant today than they were a month or two ago relative to the future of our customers. As we think about the question, I would say 3D NAND is clearly a very strategic investment, number one. Number two, there's a multitude of demand drivers that are very well established and legitimate, I think, for our customers.
We do see discipline, the timing is really just a byproduct of individual choices for investment for our customers. We expect to end the year with less capacity in qualification than when we started the year, which maybe is another commentary on discipline. Maybe most important than all, the capital intensity conversation is really unchanged year-over-year, which I think is a positive for the industry. In addition, last comment, the investment plans of the industry to transition to 3D in our models would cause us to end this year with less than half the installed base 3D capable. Multiple year investment for demand and technology roadmap drivers.
That's very helpful. If I could just ask a quick follow-up. I guess, Doug, as we look at deferred revs, including Japan growing again, and shipments being more first-half oriented, is there sort of a $ figure we should be thinking about where revenues will surpass shipments for all of calendar 2017?
I'm not going to give you a dollar number, C.J., but I'll remind you, the way to think about it is when you've got an accelerating shipment profile like we've had, you always get revenue lags as it just takes time to get things into the fab and they get accepted. You're seeing a guide in March where revenue again is lagging shipments. I expect deferred revenue will build in March. What happens when shipments level off or if they, in one quarter might go down a little bit, then revenue will catch up. Over time, it all normalizes, and it's going to be the same numbers, right? It's just a matter of the rate of change, a second derivative, if you will, of what's going on there.
Maybe last point to add on that. If you take a long-term model, which Doug's already said is the guidance we can give you always for modeling the financials of the company. If you look at the stated revenue model for the company in the 2017-18 timeframe at a $35 billion WFE. Implied by that model and our statements today around WFE expectations for 2017, which cause you to conclude that a revenue level for the company in the $8 billion range is a reasonable stake in the ground. That is obviously not a forecast, it's not guidance, it's kind of triangulating around the disclosure of the company, and if WFE turns out in the way that we've articulated today, we would expect an $8 billion reference for revenues as a legitimate framework for modeling the company.
For calendar 2017.
Thank you. We'll take our next question from Stephen Chin with UBS. Please go ahead, your line is open.
Thanks. Hi, Martin and Doug. Nice results and guidance as well.
Thanks, Stephen.
Thank you.
I wanted to just follow up on the DRAM view for 2017. Can you remind us of how much Lam historically outperformed DRAM spend during these WFE upturns? Last year, I think you said Lam's NAND shipments outgrew the industry by 2X. Is DRAM something along the same lines as NAND outperformance?
I have to profess, I don't know the exact number off the top of my head. If we can get it by the end of this call, we'll provide it. Needless to say, we're in great shape in terms of kind of DRAM position. It has a dominant profile to it in terms of conversion, spending, and the segments of etch particularly is in the kind of top end of the investments of the customer that are typically upgraded from one node to the other. There was a noticeable headwind for us last year because of a reduced spending, and that situation is very different this year.
All that said, in spite of the fact that we expect more investments in calendar 2017 in DRAM than 2016, we still expect the level of investment in DRAM in 2017 to be lower than the levels of 2015 and 2014, just as a proxy.
Yeah.
I think everybody understands, pricing tells the story, and it tells the story really well right now in DRAM relative to supply and demand balance or even maybe constraint.
Okay. No, thanks for sharing that, Martin. Just a follow-up question on your view about domestic China being a 2018 opportunity as opposed to a 2027 opportunity. Is your view that developing intellectual property is kind of the key hurdle rate for domestic China before they spend?
I think maybe what's true for all of us in the supply chain is two things need to come together, maybe at least two things need to come together to be successful. You have to have the money to fund investment, and you have to have the knowhow, the competency, and the capability to execute. The reality is for all of us, getting access to knowhow, competency, and capability includes a broad range of initiatives, and technology licensing and acquisition can be one of them, but it's not the only one. So I would maybe say our view relative to China, and to be very clear, I specifically called out China domestic memory as my message today. Clearly, there's a history and a reality and a future of well-established domestic foundry investment in China, as well as the participation of the global semiconductor companies.
My comment was really focused on domestic China memory, more 2018 than 2017, and money and know-how, competence, and capability is what it takes for all of us in any part of the world to go execute.
Thanks, Stephen.
Thank you. We'll take our next question from Farhan Ahmad with Credit Suisse. Please go ahead. Your line is open.
Thanks for letting me ask a question, and congrats on the great results. My first question, Doug, is on the potential tax reform. You guys have a significant amount of your cash offshore. How should we think about your capital return if there is a tax reform? Have you given any thought to it?
Yeah, you think about it all the time, Farhan. The practical reality of it is, until there's a definitive law out there that you can understand exactly what it requires and what it allows you to do, it's hard to specifically answer the question. Obviously, if we get accessibility to worldwide cash without a heavy tax penalty, that creates a whole lot more flexibility for us to access the cash to do a variety of different things, some of which might be capital return, investment in the business, as Martin talked about, adjacent M&A. We haven't had any definitive conversations because it's just too early right now and too much uncertainty. Stay tuned. We're paying very close attention to it.
Thank you. As a follow-up, I just had a question on the linearity of the year. You talked about March quarter and June quarter being significantly higher than December. Can you provide us some color on what's driving the incremental growth from December quarter to first half of the year? Is it primarily NAND, or are you seeing more growth in other areas as well? Is the linearity between first half and second half any different between different segments?
Farhan, you heard Martin describe more first half-weighted overall, both WFE and shipments, and also describe NAND is maybe more first half-weighted than the other stuff. That's a data point for you. When we look at March as well as June, everything is pretty strong. Investments are occurring at leading edge. It's NAND, it's DRAM, it's foundry logic. It's hitting on all cylinders from my perspective. I don't know, Martin, if you-
Yeah, I would say maybe, just to be very direct, our shipments guidance today from March quarter assumes that there will be sequential growth across foundry, DRAM, and NAND. Next question, please.
There you go. You got a follow-up, Farhan?
We'll take our next question from Harlan Sur with J.P. Morgan. Please go ahead. Your line is open.
Good afternoon, great job on the quarterly execution and outlook. At Analyst Day, I think you guys showed a slide that China WFE spend would be up this year, I think the biggest component of that was the incremental growth coming from the domestic China programs. First of all, do you still see the spending landscape playing out this way for 2017? I assume most of the domestic China spend is more 28 and 20 nanometer foundry and logic. Any insights here would be appreciated.
Yeah. Actually, our China perspective today, I feel, is actually unchanged from the commentary of the analyst meeting. Clearly, there's an ambitious agenda. Our assumption is there is a greater investment in calendar 2017 in China, and the largest single component of that expansion year-over-year, we've assumed, is domestic, not international, and it's logic foundry in focus.
Great. Thanks for the insights there.
Thank you.
Given your advanced equipment tool sets and process modules, I'm assuming that it's becoming more difficult for your customers not to be engaged in some sort of service and productivity engagement. As it relates to your installed base business, and I think last you gave us an update, it's about 25% of your business. You've been growing that at a stable double-digits CAGR, very accretive to the cash flow generation. For calendar 2016, how much did your services business grow, both revenues and operating profitability? Do you guys expect it to grow double digits this calendar year?
Yeah, Harlan, it grew consistent with our expectations. I can't remember off the top of my head whether it grew a little bit more than the equipment business or not, but it was roughly in line. It's still roughly a quarter of the company's overall business. You've got it right. It's very cash generative, very profitable business, very broad-based in terms of the number of engagements and number of customers. Generally speaking, that chart that Tim Archer showed you at the Analyst Day, we're very much on track to deliver that growth that we had targeted and are targeting.
I think one of the reasons why we answer the question the way we do, Harlan, is because there are two value propositions of the Customer Service Business Group, and one of them is the contribution to the company of profitable growth, which is the essence of your question. The second is the contribution to the company through the delivery of installed base performance that makes the underlying systems businesses of etch and deposition clean more competitive and more valuable to the customer and to the company. That's how I think about the totality of value that's possible for the customer and the company, the specificity of income statements by segment is not so relevant for us.
Thanks, Harlan.
We'll take our next question from Krish Sankar with Bank of America. Please go ahead. Your line is open.
Hi. Thanks for taking my question and congrats again on the good execution, guys. Two quick questions. First one, I just want to ask the DRAM CapEx question a different way. If you look at the DRAM WFE spending last year and possibly this year, it's going to be roughly half of the NAND WFE spend. Do you see that increasing for DRAM to go back to the 2014, 2015 levels, or do you think conversions are going to be the norm this year and into next year, that what you're going to see in DRAM WFE is more a bounce off the bottom or bounce off the really low levels of 2016? I had a follow-up.
Thank you for your comments there at the beginning. I think, as I said a few minutes ago, our expectation is, I wouldn't describe it as a bounce. I'd describe it as a demand-driven investment by our customers. The expectation is that the level of investment continues to be sustainable, continues to be disciplined, and we're certainly modeling a level of investment for 2017 that is lower than the levels of investment that occurred in 2015 and 2014, but to your point, higher than 2016. It's probably a little early for us to get specific on segments at the WFE level, given we're only in the first months of the year. You should expect us to put more substance on that maybe in the next earnings call.
Got it. Thanks for the margin. A follow-up, when do you expect the 3D NAND customers to move to 96-layer? If you think that's going to happen next year and NAND WFE holds up at these levels, you add in China memory CapEx coming in from the domestics, do you think a $40-plus billion WFE is not way out of the range for next year? Thank you.
Maybe I'll break your question into two parts. One of them is the kind of technology roadmap of the customer. I think, we don't actually have a tremendous amount of data points in terms of the pacing of 3D device architecture kind of scaling. As you know, the end of last year and this year is really the first year where we have a broad participation by every semiconductor company in this space, in 3D device architecture. There is a roadmap that's a multiple-node roadmap. I think we presented that in analyst meeting. I think our customers talk about having multiple steps beyond the 64-layer device. We currently have a stake in the ground at kind of 18 months as a reasonable proxy. Obviously, our R&D engagements run all the way through the roadmap of the customer for the next five years.
I think the answer to your economic question, investment levels, is all a byproduct of momentum in the marketplace around this broad set of drivers and kind of momentum in terms of Solid-State Drive technology. I've read a bunch of questions around yields of customers in this technology, and I think ironically, the investment is a commentary on confidence around yield. I think ironically, the creation of demand in this space is somehow related to economics. There is a momentum around creating legitimacy in the vision of the entire ecosystem, and economics and scaling the device is central to that. We're here to do the best we can to support the vision of our customers.
Thanks, Krish.
Thank you. We'll take our next question from Sidney Ho with Deutsche Bank. Please go ahead, your line is open.
Thanks for taking my questions, and congratulations on the results and guide. I want to go back to DRAM for a second. You talked about you expect DRAM WFE to go up double-digits in 2017, but your customers suggest wafer capacity will be relatively unchanged from 2016. First of all, do you agree with that? Second, from your conversation with your customers, how much does capital intensity increases at 18 nanometers or 1X nanometer, and do you think Lam will do better than that?
I think we have an opinion, and it's always plus or minus, but we have an opinion that actual wafer starts capacity for DRAM is relatively constant through the year. Our view right now is no material change in capacity end of year 2017 compared to beginning of year 2017. The best color I can give you right now on capital intensity is that it's dominated by conversion-based investments in DRAM, and we're not seeing a material positive or negative in the next several technology nodes around capital intensity. The position of the company is very strong. We have good share, and to the earlier question, good SAM presence in the context of WFE. I feel like we've positioned very nicely, but certainly no expectations of capacity addition. If capacity addition does occur, I have every confidence it will be demand-driven.
Okay, great. My follow-up is similarly on the NAND side. You guys talked about 3D NAND shipped or installed capacity going up to 700,000 or more by the end of this year. One of your biggest customers is only guiding full year for the industry and themselves to be around 30% range. Is that because capital intensity is a lot higher for 64-layer, or are yields a lot worse than what we expected? When do you expect an inflection point where this relationship may reverse itself?
Maybe I'm not quite understanding your question. I'll take a shot at giving you some color on it. I think the commitment of every customer to the technology is a statement on either actual yields or planned and realizable yields in the eyes and minds of the customer. I think there's enough discipline around all of us that we make investments when we have confidence, and we don't make them when we're not. That would be a kind of generic answer to your question. Obviously, the investment levels at least of a 64-layer device are more than a 48, and the investment levels of 96-layer are more than 64-layer. The answer to your question in terms of capital intensity is going to be a byproduct of the pricing on the die when it comes off a wafer.
I think the customer is much better equipped to answer that than we are.
Thank you. We'll take our next question from Toshiya Hari with Goldman Sachs. Please go ahead. Your line is open.
Great. Thanks for taking my question, congrats on the solid execution. My first question is on EUV. I realize it's only been a couple of months since your Analyst Day, ASML, they continue to be pretty vocal about potential EUV deployment at the leading edge in a couple of years. When you sit down with customers and discuss N+1, N+2 technologies, do you sense any change in your opportunity over the next couple of years, or not so much?
The disclosure from everybody, privately and publicly, that we have access to causes me to say no change in the message of the Analyst Meeting. To refresh, we articulated a SAM expansion for Lam of 40% from the 2015, 2016 timeframe through to 2020. We are definitely an advocate of technology innovation like EUV as a contribution to extending the value of the entire semi ecosystem. We're invested in contributing to the enablement of that to the extent that we can. No real change. The set of assumptions that we articulated in terms of number of passes and the economics of that implementation for us, I think importantly, the market characterization between space-based multi-patterning and litho etch schemes, we would communicate, I think, exactly the same headlines and messages today as we did in the Analyst Meeting.
Great. Thank you. As my follow-up, I had a question on OpEx into the June quarter, if I may. Doug, you talked about your OpEx number becoming more variable and dependent on profitability, I suppose, in the quarter. If we assume revenue in June is kind of flattish relative to March and gross margin's pretty stable, is it fair to assume that your total OpEx number is also flattish relative to March, or is it not that simple?
That's probably a reasonable assumption, Toshiya. Yeah, that's not unreasonable.
Thank you. We'll take our next question from Atif Malik with Citigroup. Please go ahead. Your line is open.
Hi, thanks for taking my question, and congratulations. Martin, your outlook of a $37 billion WFE is a lot more bullish than what Street is thinking. Can you just talk about what will it take to get to the high end of that range and the low end, basically, what's the swing factor?
Well, I guess we have a $4 billion range on this, which is customary for us. What does it take to be at the high end of any range? It takes legitimate demand for semiconductor devices, and the need to add capacity. I go back to one of the core themes of the analyst meeting. This is no longer the world of a killer app, nor one dominant device. Even that one dominant device that we talked about five years ago, I think by most people's view, is seeing a stabilizing, a decline, or maybe even potential for growth this year. This is a world of secular demands and a very diverse set of demand drivers.
I think our customers, when I sit down with a customer today, the entire conversation is focused on time to market for them, and enabling their business strategies and competitiveness ambition to prevail. The simple answer is demand. If the vision of the customer and the industry and the performance of the entire ecosystem delivers what's possible, then we're in a multiple year period of expansion, and we've called out specifically what we think that means for our company.
Okay. As a follow-up for Doug, you had product rationalization charges in the COGS line. Can you just talk about what those products or areas were?
I'm not going to give you specificity. It's just investments we were making with an eye towards a penetration two nodes from now that didn't end up coming to fruition. We ended up with some assets that didn't have a forward useful life. That's what that was. It was an investment that we decided we were no longer investing in.
Thank you. We'll take our next question from Patrick Ho with Stifel Nicolaus. Please go ahead. Your line is open.
Thank you, and I'd like to extend my congrats as well. Martin, first off, in terms of 3D NAND, a couple of years ago, before this market really took off like it has today, you talked about some of the capital intensity trends, but you've revised them higher over the last few Analyst Days. As the industry moves potentially to 96 and 128 layers in future years, is there the potential for increases in that capital intensity as well, or do you still feel very comfortable with the numbers you laid out at the most recent Analyst Day?
I guess the amusing interpretation of that is we're not so good at analytics, because it takes us a while to get it right. I feel like actually, maybe it's all about Satya joining the company, that the analytics of the company are now perfect. I actually think that we now have much more experience under our belts, right? To give us a little bit of credit, if you go back three to five years, this was a concept, and there was really only one customer in the world that was singularly committed to that device architecture. Collectively, we've gone through an incredible learning about what it takes to manufacture that device architecture, and we've gone through an incredible learning relative to how the customers individually implement considering greenfield opportunities, conversion from planar to 3D, and plain simple scaling of 3D capacity.
I feel like, knock on wood, that the analytics presented at the analyst meeting are good for the next several years. I'm sure you will ask a question in a year's time if I say something different.
I just want to make it clear, I didn't criticize your analytics.
It's okay, Patrick.
A follow-up question for you, Doug. In terms of the services business, you talked about the growth aspects both on this call as well at the Analyst Day. Can you give some tangible areas where you've improved the profitability? Is it what you're offering? Is it just internal cost reductions? What's made services a more profitable business for you guys?
I don't know if it's necessarily more profitable year-on-year, Patrick. It's always been quite profitable. It's a great business, right? All the investment occurs in new equipment. It gets leveraged in installed base. It doesn't require a whole lot of investment. It's a very profitable part of the business. On a year-on-year basis, I don't think it's really more profitable necessarily.
I think there is a kind of macro trend that is very important to us as we think about the strategy for this business. The macro trend is a trend for us at least, of targeting by investments, the most valuable products and services for the customer. There are 2 types of businesses you can have in the installed base space. You can sell spare parts and maintain equipment at one extreme. At another extreme, you can be all of that and also a provider of advanced services around installed base optimization, for example, or taking productivity improvements that you've embedded in latest generation leading-edge equipment and putting them back into a 28-nanometer space, for example.
Advanced services and value-creating products and services is our focus, and if we're successful developing that capability, if we're successful having it competitive over time, I think there's a trend to higher profit opportunities. That would be maybe another characterization for you.
Thanks, Patrick.
Thank you. We'll take our next question from Amit Daryanani with RBC. Please go ahead. Your line is open.
Hey, thanks for taking my question. It sounds like generally you guys expect the first half strength in WFE and shipments. Do you see any sub-segments of pockets of strength manifesting in the second half of 2017, or do you see decline across all sub-segments?
No, we don't see decline across all segments. Maybe I go back to my earlier statements. It is only January. We have a tremendous amount of adds and subtracts ahead of us by virtue of push and pull and changes in the investment strategies of our customers. Please recognize that we're giving you the best we can, but I guarantee it will change. The best we can say today relative to first half and second half is exactly what I noted earlier. We don't expect a more balanced shipments and WFE year than 55/45. As I added as a supplement, the concentration to the first half shipments in WFE for NAND, we believe is above that average. Now, everything I just said could change, but that's the best we got for you today in terms of first half and second half balance.
The second thing that I tried to provide some context to for analytical purposes was a reference to revenues. What I wanted to do there was to make sure that everybody interpreted the long-term stated financial models as we had intended. There was a long-term model that referenced revenues, not shipments, referenced revenues in the 2017 and 2018 calendar year timeframe with an assumption of $35 billion of WFE, with revenues $7.25 billion to $8 billion. What I said today is, we had intended that with that information, you would derive approximately an $8 billion revenue reference to the assumptions of SAM concentration and WFE and share that we've communicated in the last several months, including this earnings call.
Thank you so much. As a follow-up, when China begins to ramp in the 2018-2019 timeframe, what % of revenue do you think you could see China achieving? Is it something like 20%, 30%? How long could that sustain for?
Wow. I really don't know that I have a basis to answer that question. There's so many moving parts. There's clearly a very strong ambition for investments. There are kind of stated numbers, I think, available to us all, and whether those numbers are investment dollars or those numbers are kind of wafer start references. I think I've read references to 300,000 to 400,000 wafer starts for NAND. I think I've read 100,000 wafer starts for DRAM. I have no idea how this will kind of play out. We continue to engage in every region of the world, with every customer in the world, to support to the best of our abilities.
Thank you. We'll take our next question from Mehdi Hosseini with SIG. Please go ahead. Your line is open.
Good afternoon, guys. This is Bill Grinstead in for Mehdi. Just a quick question here on internal manufacturing capacity. Obviously, you guys are looking for pretty strong shipments in the first half. What is your capacity? How high is your utilization, or do you guys think you'll need to flex that up?
Well, we're constantly investing in flexing. That's the nature of this industry. Less today from traditional cyclicality and disconnects on an industry level between supply and demand, more today because of the variability that any one customer can bring to us as a supplier to the semiconductor industry. We have no public disclosure for you on utilization or capacity, but I would reinforce the point that I made a little earlier. We are focused on proactively investing in the business of our company, and that means proactively investing in technology and also operational capabilities from manufacturing and supply chain and service to execute and support the success of our customers. We did a lot of that already, right? We've invested in creating the potential to increase the output of this company by 40% in a really short period of time.
Our average shipments in calendar 2016 were $1.6 billion, I think, maybe $1.6 billion-$1.7 billion. We just gave guidance materially in excess of that. The investment is proactive, and we're obviously focused on the flexibility of our business model as much as ever.
Okay, operator, that's going to be our last question.
Okay.
Operator, conclude the call. Thank you.
This does conclude today's conference. Thank you for your participation. You may disconnect your line at any time, and have a wonderful day.