Lam Research Corporation (LRCX) Earnings Call Transcript & Summary

Good morning, everyone. It's Joe Moore. I'm here with Doug Bettinger, the CFO of Lam Research. Maybe before we start, I have to read a quick safe harbor, and I know Doug does as well. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley's sales rep. So Doug, how are you? Go ahead and read yours, if you need to.

Good, Joe. Yes, I'm not going to read it. I just need to remind everybody of our safe harbor language. You can have a look at all of our filings on both our website as well as sec.gov. I may make forward-looking statements, and that language is important relative to that. So Joe, with that, why don't we jump into things.

Great. Well, thanks a lot for joining us, sorry for a couple of minutes late start, everyone. So maybe, Doug, if we could just start bigger picture. 5 years ago, the expectation that most equipment companies had, that we had, was that wafer fab equipment would sort of have a modest upward bias. Over time, and we roughly doubled in that with 5 years. And this would have been a lot easier if I had just known that and believed that 5 years ago. But we've doubled the size of WFE. That's in the context of semiconductors growing about 50% over that time. So as you think about the future, how do you put that doubling into context? And what's your conviction that those sort of positive trends continue?

Yes, Joe, I think you got to lead into it the way you did, which is, first, understand that semiconductors are, I don't know, seeing a bit of a renaissance in terms of demand drivers, right? The demand for what this industry supplies to society is extremely strong. And so if you think about that as the beginning -- that is the beginning, right? Semiconductor revenue has gone from I don't know, mid-300s to -- I don't know what you think it's going to be this year, high 400s, approaching 500s. So that's one, too. When you look at the composition of that, you have actually, semiconductor industry profitability as strong as it's ever been. That's one thing I look at as much as I look at semiconductor industry revenue is operating income for the industry at all-time highs. That begins a conversation of affordability, right, whether there's growth in capital intensity that has driven WFE higher even than the growth you've seen in semi. Is it affordable and it is when we look at the profitability in the industry. So that's how I think about that piece. You got to think about the affordability aspect, and things look pretty good for the industry. The second thing I'd look at, Joe, is not the entire industry is at the leading edge, which is where a lot of the investment, not all, right? But the growth in the lagging edge is very strong. In fact, maybe growing stronger. But there's a concentration of growth in foundry and memory that needs the leading-edge manufacturing capability. And actually, if you look at the revenue growth there, it's a good deal stronger than the growth of overall semiconductors. And that's where the CapEx has grown as much as anything is that those leading-edge process nodes, in foundry, in Logic, in NAND, in DRAM, and growth there has been even stronger than overall semi. So it's a story of capital intensity growing because of manufacturing complexity. And I'm extremely happy about Lam's footprint in all of that, and we'll talk about that as we go through. But that's how I think about it. That's when I look at it, what's happened and what the future holds, I'm very, very optimistic about this industry right now because of all the demand drivers we're all seeing. And again, we'll talk about that as we go through some of your other questions, I'm sure.

Yes, certainly a lot of positive trends. I think, again, bigger picture, Lam as a company has really transformed itself in a number of ways. You've had always really good technology, but in the last few years, we've seen governance improve, accelerated cash return, you've really emphasized the services business and given us the tools to evaluate that. And I'll get into those things. But like all of that happened after your transformative M&A wasn't allowed to move forward. So what's driven those changes? And what's -- how has Lam become more focused on the investor over the last few years?

Yes. I mean we've always been focused on investor, at least I've always tried to be. But you're right. I think perhaps what I observed -- I actually say, Joe, our transformative M&A was when we acquired Novellus. Yes.

That's also true. Yes.

We tried to do one more and couldn't get through the regulatory process, and we've seen that in other places as well. So when I think about that piece, I think the M&A -- the big M&A in this industry kind of is behind us, right? There's 4 or 5 big equipment companies today. And in 10 years' time, it will be 4 or 5 big equipment companies. So I think that maybe is a little bit of what's changed a little bit. And so -- and you're right, the quality of our business, as we have grown so significantly, has continued to get stronger and stronger and stronger. I'd say that by the barriers to entry around just what we do, we get so much learning because of the incumbency of where we are. It's really hard to replicate that from a development standpoint if you don't have it, right? And so that's a statement of quality business, quality of what we're doing from a technology development. You're also right that the quality of the growth in the installed base has been phenomenal. That business has done extraordinarily well. So the first thing you just think about, the business is just growing so much. And the cash generation capability of the business has continued to grow. And so what I think you've seen us do, and maybe what has helped it to a certain extent is we had tax reform in 2017 in the United States that made access to cash easier from a global standpoint. And so when we look at the business back then, the realization that we're generating way more cash than we need to run the business, and M&A is probably largely behind us, we got a little bit more aggressive in terms of our statements and commitments on returning that to shareholders, paying a dividend, growing the dividend on an annual basis, talking about 75% to 100% of free cash flow going back to the equity holders. And we've done more than that over the last several years, which has helped drive earnings. So that's kind of the story, Joe. I mean it's just the quality of business has continued to grow. I really like what's going on there. And then we just -- we're doing the right thing with the balance sheet, I think it's what I would describe we're trying to do, anyway.

Yes. All right. And then just the last sort of bigger picture question. In terms of geography, China has become pretty big for the industry, about $10 billion of WFE, I think, by your numbers last year, and you've said you've seen that kind of rising slightly maybe. Like, can you just talk a little bit about that? Because it seems like some of the bigger customers are demonstrably down or at least could be down and yet China continues to grow, and just what are you seeing in that region?

Yes. I think the first thing I would remind you and remind everybody listening to the webcast is, when you look at our China business, I put it in 2 buckets of customers. The first are the Chinese customers, and that's kind of what you're asking about with the $10 billion WFE growing somewhat this year. So that's one category, and I'll talk about that. But then the other bucket is the global multinational customer base equipping their fabs in China. When I look back over the last, I don't know, 3 years of our business, it's been fairly balanced between those 2 groups of customers, the multinational customers in China and the Chinese customers. So don't forget about that. Then we look at the Chinese customers in that $10 billion WFE growing somewhat this year. It's a broad set of customers. There's one big band customer, one big DRAM customer or one big foundry customer, but a lot of other customers as well that are very broad. People doing lagging edge, foundry-type business, image sensors, power devices, analogue-y kind of stuff. So it's a broad set of customers is what I would describe, Joe. And then you asked about the geographic breakdown of the business. Generally speaking, what you see is when a fab is having equipment shipped to it, they're all over the world, right? They're in Korea. They're in Taiwan, they're in Japan. They're in the United States. There's some in Europe. There's a lot in China. You're right. But it really is where the fabs are. That's how the business breaks down.

Yes. Okay. Great. And then in terms of the bigger business environment, you guys characterized the wafer fab equipment market in the high 60s this year on the earnings call. It seems like semiconductor shortages have intensified since then. So my guess is that we're still feeling pretty good about the year. I guess, how do you put that number into context? And it seems like from a run rate perspective, you're kind of at that level maybe in the first half, which is why you're guiding the year where you did. But just any context you can give us on that high 60s WFE?

Yes, Joe, I guess, when we look at it, every segment of the business is growing in terms of its investments this year is our view of things, foundry, Logic, DRAM, NAND, it's broad. So that's one thing. We did describe high 60s, approaching 70, and we suggested a somewhat first half-witted spending profile in terms of that WFE spend, with the caveat that, obviously, we've got pretty good visibility in the first half. The second half, things could move around a little bit. I think one of our peers maybe has suggested that WFE might actually be even a little bit stronger than we said, and that could be what plays out. If it happens, it will be more in the second half of the year, I think. But it's a broad set of investment occurring. And when I think about it, Joe, what I see happening actually, and I've been saying this, as I've talked to investors after our earnings is, I'm more optimistic about the outlook for the semiconductor industry than I've been in my entire career, and I've been in semis for a long time. I've seen over the last year, a pull forward of what I would call digital transformation in almost every aspect of society, business, witness how we're doing this conference right now. COVID will be done at some point. But I still think we're going to be interacting the way we are today, maybe not entirely, but this won't go away. And I see that all over the place in our business, and I know it's happening in everybody else's business. And it's all enabled by our industry. So that's the exciting part about what's going on, quite honestly. All of these transformations that we've always known were coming have happened quicker. And that's exciting for me and exciting for us at Lam.

Okay. Great. Maybe we could talk a little bit about some of the segments. And I think my questions are a little NAND heavy, and that's because half the conversations I have about Lam tend to be about NAND because it's become a big business for you and for everyone. You've given kind of a helpful number on NAND, that sort of $70 billion of WFE over a 5- year period is kind of what's needed to stay on a high 30s bit growth trajectory. Is that still kind of the right number to think about sort of $14 billion WFE? And is there a risk that were kind of higher than that now?

Yes. The $70 billion over 5 years is still our view. There's probably a little bit of an upward bias over time as layer counts get taller and you need to invest a little bit more at those higher layer counts. But it's still the right number in terms of how we look at it and think about it, Joe. And when I looked at -- when we looked at kind of the year that ended 2020, that's kind of where the last 3 years have been, if you look at kind of '18, '19, '20, it's been fairly consistent with that spending profile. Now it's never going to be exactly $14 billion every single year. It just doesn't work that way. The industry doesn't work that way. But over a multiyear time frame, that's the right way to think about it. That generates, as you said, a high 30s supply growth, which -- that's about what we think industry demand in the longer term is. So I guess a long-winded way of saying, yes, that's still the right way to think about it.

Okay. And yes, it seems like last year, if I actually look through 9 months, there wasn't like spending over a couple of year window was actually below that level. And then we got a lot in Q4, obviously, and it feels like there's a lot in Q1. But it feels like there's actually a little bit of a period of kind of underspending, to your point that it's not linear. There's a period of underspending and maybe a little bit of catch-up. Is that a fair characterization, do you think?

Yes. I think that's a fair characterization, Joe, right? It's never going to be completely the same every -- it just doesn't work that way. No business works that way. And it will invest and then it will digest and then it will invest further, right? And you'll get a combination of no transitions occurring and some new wafers coming in periodically, and that will ebb and flow. Through that, when you think about NAND -- and yes, I'm sure you get a lot of questions about NAND with Lam because we're all over that process flow, right, in terms of depositing the film stack, doing the most difficult etches, depositing the metalization and a variety of other things. We get so much learning from owning those applications that we begin to see new things that come out, right? The VECTOR DT is something we brought out last year to help manage some of the stress. We do development like that because we see these things. And that's the unique position we sit in because of the incumbency factor of having such a strong position.

And then the other question I want to ask about NAND was, I want to talk about the installed base business later. But is -- does NAND pull through kind of a higher amount of installed base business? I mean, it seems like in our conversations, there's a lot of spares that chambers need to be replaced frequently and things like that. So I feel like people look at that NAND exposure as maybe enhancing your cyclicality, but it may actually even drive a little bit more of the annuity business as well.

Yes. I mean, Joe, there probably is a little bit. I think of it more that leading-edge tools, by and large, have a higher spares consumption rate because on average, the technical requirements are more exacting, which means maintenance needs to occur more frequently. There's higher RF power oftentimes. That just drives a need to keep the tool running at its peak performance, the periodic maintenance needs to occur, and that tends to mean spare parts need to be replaced, right? And that's probably -- not probably, that is more true at the leading edge. And certainly in NAND, but it's also true in DRAM. It's also true in foundry, Logic. The most technically advanced tools tend to be a little bit more spares intensive simply because of the way they're running.

Great. And then in terms of DRAM, it seems like DRAM, there's less controversy around it. It seems to be clearer that we've underspent recently and that there's a little bit of an upward bias to those numbers. How are you thinking about the DRAM business and Lam specifically, your ability to outgrow the WFE in that DRAM segment?

Yes. I mean, we've got over 50% etch market share in DRAM. So obviously, as DRAM invests, we do well, and we do well in that etch and deposition. Yes. We see investment in DRAM up this year. I mean, pricing looks very good, which means profitability is strong, which means there's demand there, and that tends to be when investment occurs. And so that's what we see happening. So, I'm very optimistic about where DRAM is headed. We've got some new things coming in as EUV begins to be introduced in process flows, the dry resist that we announced about a year ago, and talked about it at SPIE last week. The demand and the pull for that is very strong. We're very excited about that in DRAM and foundry and Logic. But yes, I mean DRAM looks pretty good. The industry is in a good spot.

Great. I want to interject a little bit questions from the webcast. I want to come back to the foundry, Logic side of your business. But so on the webcast people are asking, the sort of government support issue that sort of executive order that's being talked about. How do you guys see that? And then specifically, the geographic drive to sort of diversify geographically? It seems like it would create more spending, all else being equal. So just how are you guys thinking about U.S. government support and the sort of government focus that's now being associated with semiconductors and semi equipment?

Yes. I mean, clearly, it's happening in the U.S., you're seeing a little bit of it in the European Union as well, right? That may create a little bit of upside from an investment standpoint. But the way I think about that is, honestly, it doesn't change end demand probably, right? Demand is strong because demand is strong. And what it likely will mean over time is a broader geographic distribution of business. But it probably doesn't mean there's that many new incremental wafers put in place to incremental capacity because capacity gets put in place to satisfy demand. And if a wafer is put in the United States, it would have otherwise gone in Taiwan or somewhere else, right? Now having said that, if you're running multiple fabs, you're probably somewhat less efficient than just in one big fab. So maybe there is a little bit of upside, but I wouldn't want people thinking of this as a big upside to business necessarily. But it is, yes, something we're looking at, we're paying very close attention to. We've made incremental investments in our government affairs capabilities so that we're plugged into these things and have a seat at the table in the conversations. So it is certainly something we're looking at and paying attention to and setting up to enable the success of our customers, right? If there's new fabs that are going in Arizona or Texas or something, we have to invest ourselves to put resources there to support the customers, and we're absolutely looking at those things.

Yes, I was actually quite happy to see some of the investments you guys made in government relations and some of the hires you made there. Just because I feel like semiconductor companies have a pretty loud voice with the government, and I'd like for equipment companies to have a loud voice as well as sort of representing one of the big exporting industries that you guys do.

Yes. No, it's something we're kind of touching too, Joe.

On the foundry side, we've sort of -- I've been sort of concerned that foundry spending was getting high last year. And now we're sitting here dealing with sort of the once in a generation type shortage. So I guess those concerns were overblown. How are you guys viewing that? Like -- and are you seeing -- there's obviously a shortage cutting edge, there's also a shortage of trailing edge to some degree. How are you seeing the investment profile? Is it -- should we expect a burst of spending to try to catch up and then maybe it moderates? Or is it more linear? Just how are you thinking about this foundry environment being so tight now?

Yes. I mean, demand is strong. Demand for semiconductors is very strong. Like I said, this, in my mind, been an acceleration of the digital transformation of a lot of things in society. That's manifesting itself in the need for leading-edge wafers. It's also manifesting itself in the need for lagging-edge wafers, right? It's because semiconductors are pervasive. And it's driving required demand. Now demand is strong. I think it's sustainably strong. Now it doesn't mean it grows every single year. I don't know what several years down the road are going to look like necessarily. But I do know the demand for semiconductors is strong. And to satisfy that demand, you've got to invest in capacity. That's a statement of leading-edge foundry. It's also a statement of memory, right? These things are all symbiotic in terms of system-level architectures. You need Logic devices, you need low-latency memory, you need storage. Anyway, when I look at this and think about it, it's all about demand and demand is very strong for semiconductors.

Yes. Makes sense. All right. And then talking about the installed base business, you've given us, like I said, I actually like it a lot that you do the segment breakout now and give us the opportunity to evaluate that. I mean it's 1/3 of your business growing really nicely. You've made the statement that you can't envision it here. I think where it's down. I hope I'm not misquoting it. But it seems like a really good business. Can you talk about it? And is there any thought in your mind that, that's more linked to WFE than we think it is? Or just how do you think about those linkages?

Yes. Let me remind you what's in there. Yes, I have said, Joe, I can't envision a year where this business doesn't grow. It grows every single year because chambers grow every single year. Chamber count at the end of 2020 had grown to 66,000, up 5,000 I think, in the year. And that's why it grows every year because chambers really never go away. They run for decades. The way to think about this business, I'll just remind you, there's 4 things that are there. It's spare parts. And if fabs are running, maintenance is required, you need to replace parts, right? In that piece, when I think about spares and service actually is somewhat independent of WFE. If the fabs are running, service is needed, spare parts are needed. So that's an important component there. There's also a very healthy upgrade business, right? We can bring productivity upgrades to those chambers that are out in the field, make the tools run better. That's a high ROI for the customer base. And so you see that happening every single year. And then we also have in that business, the lagging-edge refurbished equipment is all running one business unit. We call it the customer support business group, CSBG. And we actually see demand there. That is direct in WFE. Demand for the lagging-edge stuff, actually, we call it specialty semiconductors is growing faster than the leading edge, quite honestly. We've described it as you should think of that as growing 2x to 3x faster than overall WFE. So when you put all of that stuff together, it's a very high quality, very recurring business, very healthy profitability, very cash-generative aspect of the business. And our tools will run for decades, like I said. So it's an awesome part of the business model that people oftentimes forget to talk about when they talk about Lam, but it's a great part of the business.

Yes. And that refurbished tools business? I know some companies don't classify that as services. And so it makes -- the basis for comparison is a little different. How big is that business? And you said it's strong now. I mean, I would think that there's also an issue of you don't have the tools to refurbish because nobody is retiring the older capacity, as well. So just how do we think about the size of that whole, the Reliant part of your business?

Yes, I haven't broken out or quantified it except it's all running one business unit. And you're rightly observed, it's about 1/3 of the business overall when you put the 4 components together. We have said the -- we call it Reliant. The refurbished tools business, I think it's 8 or 9 consecutive quarters of record level of business. So it is just coming along quite nicely because of the demand for those specialty semiconductors that I referenced early.

Great. And then I think we have time for one more question. The profitability, any ability to drive up gross margins over time. We've seen an upward bias at a couple of your competitors. It's certainly becoming clear with the regulatory environment, how much value-added there is here. And it would seem like -- I understand there's a consolidation of your customer base as well as a consolidation of equipment market. But is there the opportunity over time to drive leverage there? And then at the operating expense line, what's your sort of -- how much of that is going to be total relative to revenue growth?

Yes, there's some upside. We're -- I just guided the current quarter to 46% gross margin. If you go back to that financial model I put out about a year ago, we put out about a year ago, gross margin is higher in that model. And I believe will be higher as business grows and things like our Malaysia factory ramps to support increased volume. That's a good thing for gross margin. So yes, there's upside to gross margin, there's upside to operating income as well. That financial model suggested, I don't know, 32%, 33% operating income. We're running between 30% and 31% right now. So yes, if you look at the leverage that Lam has delivered and the team that's delivered it is the team that's running this company today. We know how to do this. We scaled gross margin. We'll scale spending as well. And we'd like to see revenue growing faster than the expense growth rate, and that's going to continue, and we will continue to be focused on it for sure, Joe.

Okay. Great. Well, I'm afraid we're out of time, but thank you so much for joining us, and have a great day.

Thanks. Good to see you, Joe. Thanks for hosting us.

Same. Thank you. Bye.