Lam Research Corporation (LRCX) Earnings Call Transcript & Summary

All right. Let's get started. Good afternoon. Welcome to this afternoon session. I'm Vivek Arya. I cover semiconductor, semi cap equipment at BofA. I'm really delighted to have the team from Lam Research join us, Doug Bettinger, the Chief Financial Officer. What we'll do is go through some of my Q&A, but please feel free to raise your hand if you'd like to bring up a question. But with that, warm welcome, Doug, and I know you have some exciting announcement.

Let me do an exciting, just real quick safe harbor to keep all of my attorneys happy. So let me read this real quick, and please take a look at what's up on the screen. Today's discussion may include forward-looking statements that are subject to risks and uncertainties, and actual results may differ materially. Additional information concerning factors that could cause actual results to differ materially from those forward-looking statements can be found in the risk factors disclosed in the public filings with the SEC on Form 10-Q. So with that, we can actually talk about the business.

So maybe let's just start with the State of the Union, Doug, I mean versus what you thought at the start of the year in terms of the planning assumptions of demand in your various end markets. How is -- if you do kind of a midyear check, how are they panning out versus your original assumption?

Yes. No, that's a great place to start. Not all that different, frankly, Vivek, when I think about it. We started the year -- it did change a little bit. So I'll unpack that slightly. So it is a down year, right? And that statement is especially germane in the memory side of our business. And I'll talk a little bit about that. But we began the year with a view that wafer fab equipment spending would be mid-70s, and we ticked that down just a little tiny bit after the last quarter's earnings. And so -- now we're saying low mid-70s. And we began the years thinking things were a little bit first half-weighted. As we sit here today, we now think it's a little bit second half-weighted. Subtle movements around in there. It's probably no surprise to people that follow the semiconductor industry to know that memory got a little bit softer. Foundry got a little softer, too, relative to 90-plus days ago or something, right? That was part of the downtick in total. Offsetting that to a certain extent, and part of the reason why it's a little bit second half-weighted is we got some clarification on the rule -- the regulations relative to what we can ship into China that provided a little bit of an upside that we believe we're going to ship in the second half. I described that for Lam as a few hundred million dollars that will show up in the second half. So when you unpack the whole thing, we see WFE down more than 20%, memory down more than 50%, within that, NAND down well more than overall memory, and DRAM a little bit less so. So it's kind of how we see things.

Got it. So we'd go through the different end markets, but I have to ask this obligatory question about AI.

I love this question. Yes.

Which I know you're very excited to answer.

I am the best company in the industry to ask an AI question. It's kind of tongue and cheek, but yes, please.

Yes. So what's your sense, right? There's a lot of excitement, right, in parts of the data center. How does -- how do we connect the dots from that excitement to what it means for Lam?

I think, listen, when I think about this, there are 2 incremental growth drivers as I think forward over the next several years, one of which is what's going to occur in the cloud and driven in a big way by AI. It's new stuff, new use cases, new compute architectures that are going to show up. And frankly, today, even though there's lots of excitement about it, it's still a fairly modest amount of real spending at the end of the day, right? If you think about total servers that are true AI servers, it's probably only 5-ish percent, something like that. But it's going to meaningfully grow over time. And when we look at that and like study the motherboards in there and the architectures that we see, you tend to have very big logic die just [ staying ] around microprocessors, accelerators like GPUs. It's obvious, right? FPGAs, other custom TPUs and things like that. Maybe equally importantly for Lam is the memory content that shows up in these servers. When we look at the DRAM footprint, it's nominally 8x as much as an enterprise server, and in NAND, it's 3 to 5x. And so today, there's tons of excitement about it, and I'm super excited about it, too. But the future is really going to be where it shows up and impacts our business. And frankly, right now, it's not really doing anything with equipment orders, not yet, right? And so you'll see it at -- leading its foundry and you'll see it in memory.

Got it. Is that because on the memory side, data center still has inventory [indiscernible]. That's really the...

That's part of it. And then when you think forward, okay, there's a new set of CPUs ramping [indiscernible]. It's going to pair itself in a bigger way with DDR5. That's going to begin to help the industry move through the cycle when that begins to be a bigger contributor to the total bit demand.

Got it. And then just 1 last thing there, Doug. Longer term, do you think that data center and AI is incremental to industry growth? Or is it merely going to offset, right, the maturation of the consumer part of the industry?

I think it's going to be incremental. I mean if you go read these studies that are out there about the $1 trillion semi industry, it's almost obligatory, and I sometimes like to stay from that number. But anyway, be there as it may, if you actually go read the stuff that people have done the work, there's 2 things that contribute to incremental growth. One is this in AI and very high-end compute architectures. And the other is the content growth in automotive. Both, I believe, are going to be incremental as we go forward.

Got it. One other kind of near term is we heard that TSMC might change their CapEx towards the lower end of the outlook. I was under the assumption that when you gave your outlook or others, that you've kind of contemplated some of that softness in the leading edge also, right? So was that news to you? Or was it kind of already sort of contemplated in how you were thinking about the year?

Generally speaking, when our customers make public announcements, usually, they've communicated with us beforehand, usually well in advance. Because we have to plan, we need to be positioned for whatever might be changing. So almost always, when our customers are making public statements, we've known about it ahead of time, and to the best of our ability, contemplated that and how we describe what's going on in the industry. This is no different. I'd also tell you, we have a pretty robust process. When we get on an earnings call, we've gone through a cycle of talking to all of our customers. What are your plans? Has anything changed? That's one. It's a bottoms-up process. But then my corporate analytics and IR team goes through and does a tops-down analysis of the market. And do these 2 things kind of hold together to the best of our ability to analyze it? And when we communicate something to you, I want to be as accurate as we can be. So we go at this in a pretty rigorous way.

Got it. Now if you take a step back, Doug, last year, the discussion was the industry would be at $100 billion, WFE, unconstrained number even higher. And here we are, right? I think what you suggested is, what, low to mid-70s.

Low, mid-70s is what I'm seeing, yes.

Right. So how much of that is the cycle, and how much of that could be the fact that maybe $100 billion was a very abnormal and -- I know it's all hindsight, but maybe that number was too high to begin with.

Listen, with hindsight, it's very clear to me what occurred when it was -- when we were in the middle of it, it wasn't apparent to me. And so when I think about where we sit today, often, the cycle in semis is more about supply than it is about demand. When I think about the last 1.5 years, it's been as much about demand and change in demand outlook as it is supply-related. And by that, I mean if you take yourself back in time to the beginning of last year, I think all of us believe there was going to be unit growth in PCs and unit growth in smartphones. And the industry configured itself according to that point of view. Well, that didn't turn out to be what happened, right? I think some aspect of it, we perhaps mistook secular growth a little bit for a demand pull forward that occurred because of COVID. Anyway, with hindsight, I can look at it and say, yes, that's probably what happened. So there was that aspect to it. It was confounded actually and made it a little bit worse, and this is maybe as much supply, we went through this crazy period of everything being completely constrained. And the entire industry rallied itself around the stuff you could get. Maybe let's get a little bit more, right, just in case, waiting for that mythical golden screw. We all did it. And when you put those 2 things together, it created a cycle that we're sitting in today. And I can look back on it, and intellectually, what I just described, I thought deeply about, and that's my conclusion. But when it was happening, it wasn't apparent to me anyway that, that's what was going on.

Got it. So as we start to think about, right, the next 2, 3 years, what is the right formulation if you are an RC to predict what WFE can be, right? So not like the specific number, but when you have to make your predictions about WFE, like do you start with semiconductor industry growth and say, look, if in the past, semis grew x, right, WFE grew 20%, 30% faster than that? Do you think that kind of formulation is -- so let's say [indiscernible] semiconductor industry growth is 10% next year. Does that inform you what WFE might be next year?

It helps. I mean the first thing I would say is, listen, I'm a firm believer in the growth aspect of this industry. This industry is going meaningfully bigger 5, 10 years from now than it is today. That's an important thing to believe. And if you don't believe that, you're in the wrong room, invested in the wrong sector. I think we all believe that or you wouldn't be here listening to me talk about this. So that's 1 thing, right? The future growth is important. But this is a growth cyclical industry. Every year does not grow. And as much as I wish it did, it just doesn't work that way, and it never has. And as things have consolidated, there was a kernel of hope I had at 1 point that it would have got somewhat better, and frankly, it hasn't. So it is what it is, a growth cyclical industry. But the growth piece is important because you have to be prepared for that future growth. And for Lam, as I think about, okay, we're in a down cycle right now, what are we doing? We're making sure we've got the best product road map we can possibly have. Even though we're trimming spending a little bit, we're keeping R&D full steam ahead because you must have the best products in the industry to win. And that is what we're intending to do and what we are doing. Our product lineup has never been stronger. You must be convicted in that, and we are, right? Don't sacrifice the long term to manage the short-term P&L. You can't do it. Then you also must construct the company and have an operating model that has a level of variability to it. We've done that extremely well over the 43-year history of the company, and we keep refining that. We're fine-tuning that. It's not fun to go through the downturn where you got to kind of trim the workforce and whatnot, but that's what we just did. And frankly, we are setting the company up. Here's something else I've been saying. At the end of the day, in the near term, I can't control what the customers are going to spend. Kind of it is what it is. But what we can control is make sure you get the best products coming out, we're doing that, new edge platform, new drivers here. We've got a whole bunch of different things that we're extremely focused on. And then try to make the operating model better, right? We are working extremely hard right now. Maybe restructuring is not quite the right word, but I'll use it anyway. To take advantage of the manufacturing footprint, we've grown in Asia over the last 3 or 4 years to pivot to it in a bigger way when growth does come back so that we're more efficient, more profitable company. That's very much what the leadership team at Lam Research is focused on this year is control the stuff you can control and be better when business gets better is how I've been describing it. I believe we're going to be extraordinarily well positioned when that growth does come back whenever it is.

A few more things back about the back half, and then we will talk about the longer term. The incremental approvals for China, is that a one-off business? Or do you think that is kind of then becomes a baseline and it will do then whatever overall China WFE does going forward?

Yes. The first thing I want to make sure people understand is the rules didn't change. There are no new rules. The rules that came out on October 7 are the rules. There was some level of uncertainty we had with a specific customer at a specific process node. We had a view that it was not crossing that technology line that was out there. And the industry actually working together, kind of we came together and went and had that conversation with the government and got that clarification. So the rules didn't change. I think there was -- maybe we didn't describe this well. There was some people that thought, hey, did something change? No, not really. We just got a clarification. And so as I think through that, that's part of that. It's a little bit second half-weighted year because we didn't ship any of that in the first half. It will show up in the second half.

Got it. But is that then the new baseline? So all else being equal, then it is part of the new baseline, right, or whatever China WFE does going forward.

Yes, it is. It is.

It's not like one-off that was from last year, that was semi, right?

No. But having said that, let me remind you. This was a big impact on our business, right? We described a $2 billion revenue that we believed would have shown up this year that we -- it's not there any longer because the rules restricted our ability to ship. So we had to respond to that, and we have. It's still a big impact, but a little bit less than we previously thought.

Right. Do you think these China restrictions have reduced how we think about WFE going forward? Because their intensity used to be higher. So even if, let's say, overall industry sales are the same, is it possible that we should be preparing for somewhat incrementally lower intensity given that the customer with higher intensity may not be there because of these restrictions?

Yes, I don't necessarily think so. At the end of the day, in the longer term, really, what matters is demand for semiconductors. Geographically, where it's supplied doesn't matter all that much. The demand for semiconductors is based on form factors. We're all buying digitization of everything going on in society. It's the consumption of that, that at the end of the day, matters. Geographically, if something moves from 1 place to another to another, we're just shipping to a different location.

Got it. And one last one, kind of more semantics than anything. If Lam's view is kind of low to mid-70s and your competitors are saying mid-70s, is that just an end market difference, right? Like what is that, just noise, and you're reading much into that?

I don't read too much into it. Frankly, there's -- none of us get this perfect. We generally know our markets pretty well. In fact, perfectly, it was too strong of a statement, but pretty well. And then we estimate the stuff that we don't participate in, like litho and CMP and [indiscernible] and whatnot. And we don't always get that as correct as we get our own market. So there's -- I think there's a little noise from that. And frankly, I think everybody would say the same thing. In this year, because there was some level of like deferred shipment that spilled into this year, it's maybe even a little bit more confusing what the hard number's going to be. The important thing to understand though, at the end of the day, the market is the market. It will be what it will be. And it's not going to be different from 1 company versus another. It's the same market.

Right. And then on the deferred revenue, kind of unchanged, that $2 billion, what was your original plan when the year started? Like where do you -- is this a new normal for deferred revenue now? And why is that? Why has the normal definitely changed for deferred?

It's probably a little bit higher than it used to be, but it no longer has anything to do with all of the like deferred shipments that we had going on. When we came through the supply chain, we had a phenomenon where we couldn't get everything we needed, and we were shipping somewhat incomplete systems to the customer so that we could begin installation and qualification. And then we would ship the final components to the customer fab and assemble it and then turn it over to the customer. So that created a level of deferred revenue because if the tool isn't complete, you can't recognize revenue. We always have a little bit of that, but it went well beyond what was normal in terms of how we generally like to be running the business. But it's what the customers wanted because we can start the installation process sooner. As we exited the March quarter, that phenomenon largely is back to normal, meaning there's not some kind of abnormal volume of these incomplete tool shipments out there any longer. We're caught up. We're back running the business in a normal fashion. However, what occurred also in the March quarter is deferred revenue stayed flat. What offset that reduction in these incomplete tool shipments was cash-in-advance payments, which oftentimes when we have a new set of customers that we haven't done business before -- with before, they pay us ahead before we deliver and ship the tool. So that offset it. So we have several relatively newer customers that are in that bucket. The way I've described that is, yes, that is where it is. I believe the majority of that revenue is by the end of the calendar year. So it's maybe still a little bit elevated. It will come down to a more normal level as we exit the calendar year.

Got it. Next, on memory. Would you agree that this is kind of the biggest x factor for when WFE really starts to recover? And if yes, then as we sit here today, what's -- what are the typical landmarks you're looking for to suggest when that investment comes back? So sure, it's 70% [ occupies ], but we said when it was 50% [ occupies ], it's down a lot.

Yes. Listen, here's [ you and I ] pay attention to, and you guys can pay attention to a lot of this stuff, too. First is inventory, right? You parse everybody's earnings call, look at their balance sheets. Is inventory coming down in the memory space? That's the first thing that has to happen. There's a lot of inventory out there, more maybe than I can remember seeing for the reasons we've already spoken about. As that begins coming down, that's essentially a reduction in supply, right? ECON 101, supply comes down, pricing gets better. So that's how -- that's another metric you should be paying attention to is where is memory pricing. It's still going down. Maybe the rate of decline is getting a little bit better. So those 2 things are important. That then shows up in my customers' P&L and their cash generation. And when that begins to happen, the way we're going to -- I believe the way it will show up in our business is utilizations. And the first thing that will happen is utilizations will come back to a more normalized level. We will see that in our spares and service business. And in the customer support business group, a component of it in spares and service will begin to get better. That's when -- if you listen to our description of what's happening, that's when you'll know it's starting to show up at Lam. First -- so utilization will come back up to a more normalized level. The next thing that will happen is there's a large installed base out there in memory that's not being upgraded right now. The node conversion -- the pace of the node conversions has slowed to a certain extent. That equipment we shipped in '21 and '22 is not being upgraded to -- when we get past the increase in utilization, the upgrades will begin to happen. That's also in our CSBG business. So that's the next thing you'll begin to hear us talking about, whenever this does begin to get better is, okay, the upgrades are happening again. And then eventually, you get to the point that new wafer capacity begins to get put in place again. I am very hesitant to communicate any time frame for any of this because I -- frankly, I don't really know. My phone is ringing. Sorry. But that's how I know it will show up because that's how it always shows it.

So have we seen any green shoots, any changes at all in behavior in those?

Nothing I'm seeing right now.

And how much of an early warning system is that, right? In that -- let's say if you're not seeing those green shoots today, does it mean like, effectively, you know what the situation is for the next 6 months? Or do you think that memory, when things change, they change very quickly, so things could change 3 months from now, right? Or do you think that's too optimistic?

Yes. I'm being super hesitant on time frame. I'm just not going to engage the conversation. But frankly, I don't know for sure. Here's what I do know, though. I've been in the industry 30 years. It's been a while. I'm kind of long in the tooth here in some ways. For every downturn, the upturn always comes. The pace and the shape, I don't know. But I do know it will happen because it always does.

Got it. One other behavior, right, we have seen that some of the memory customers have written inventory off, right? So before the increased utilization, is it possible to first sell that, right? Because it's -- [ you know cost ], right? Their shareholders have already paid for it. So they first sell that, and then they start increasing utilization, and then you start getting the orders.

I think that's what will happen. Yes.

Got it. Okay. Do you see any differences in behavior NAND versus DRAM or you think that's pretty much the same?

It's not all that different. Frankly, 3 of my customers do both.

Right. So it won't matter.

Not all that much. You're not in exactly the same timing cadence. Pricing and inventory is a little bit different between the 2, but it's not terribly, terribly different.

I see. Then on lagging edge, Doug, as you must have heard, that there is a concern that there is pull-in, there are overinvestments, right? If you could address that, both in terms of China versus non-China, what part of lagging and investments and growth that we are seeing this year is sustainable, and where is it kind of unsustainable?

Yes. Again, I kind of think about this very simplistically. The first thing you have to think about when you're trying to ask -- answer a question like that is, what is the secular demand growth driver? What's going on? And is there secular demand that is requiring the investment? And there is in this case, right? And it's -- if you think about what's going on in industrial, automotive, security, analog, IoT, is there secular growth in all that? There is. Is it a segment of the business that's probably been somewhat underinvested in over the last several years? Yes, probably is. And so that's important to get your head wrapped around. If you believe that, then it will make more sense when you start decomposing. Okay, who's investing and why are they investing? When I look at the mature node spending, it's pretty resilient this year. That shows up in our Reliant business. So I've described that. It's a global set of customers investing. It's not any one or another region because of a secular demand. So that's important to understand. Now there is an aspect of this that is -- yes, there's a set of customers in China investing. I would tell you that, that set of customers is relatively new to some of this stuff. And so if you think about the level of investment they're likely making relative to the amount of output they're generating, it's very likely less efficient than somebody that's been doing this for 40 years. And is that overinvestment? I don't know if that's overinvestment. It's just a state of where a newer customer finds themselves. And they will get better and more efficient over time. And so that's the way I think about this is, first, is there secular demand? Yes, I believe there is. Is it an area that needs the investment? Yes, there is. Are there unique demand drivers in here? Yes, there are. And that's the most important thing. And then you decompose who's investing and at what stage are they and where the edge of the fab? You've got to then go decompose it sort of customer by customer.

Got it. So is there a way to quantify what is Lam's lagging edge exposure? How much has it grown this year?

The Reliant product line has done very, very well and continues to do very well. I've now been describing it as there's like a #1 and #2 size of business, and CSBG spares and Reliant are kind of 1 and 2. But I haven't put hard numbers on it.

The CSBG business, very attractive part of the portfolio, very resilient. Why not start giving a backlog for that business? If it is resilient and if it needs to be valued as a subscription and software die business, then why not provide a backlog?

I don't provide backlog for anything. It's not a business that backlog is actually all that relevant for or all that important for. I mean, yes, this service stuff clearly has long-term contracts. But there's a lot of it that is -- just think about spares consumption. A lot of that is transactional based on where the fabs are and where the utilization is, and it's a very large part of the business. Backlog isn't really all that relevant to consumption of spares. Same with upgrades, really not all that relevant to backlog. So why would I provide backlog when it's not relevant for a significant portion of the business? I don't. That's why. But that doesn't underestimate the recurring nature of this section of the business, right? I've been reminding people today, and sometimes I forget to do this, our tools actually generate revenue for decades. On average, over an average tool sold at Lam, over the life of the tool, it generates more revenue than we sell the tool itself. We've spent the whole 30 minutes talking about WFE and where is that at and so forth, but this is an important component of what the business model here is and how we make money and how we generate free cash flow. It's a very recurring portion of the business. And before this year, I used to kind of run around shaking my head and saying, it's a business that grows every single year. Well, this year is not going to grow because utilization is down so much, and I didn't anticipate that when I used to say it grows every year. But it is only down a little bit, with utilization down as much as I've ever seen it. So it's an important statement on the quality of this business.

Got it. And look, even in kind of a trough scenario, Lam is still putting up almost $5, right, a quarter...

Just got into $5. Yes. Precisely.

[ That makes sense ]. Significantly above than the last. But if I were to look at margins, right, they're about the same as they were kind of on the trough, right, about 44% or 45%...

44% gross margin.

44%. Right. But your revenues are significantly higher than the last trough. So why shouldn't trough margins be higher given that your revenues are significantly higher than the last trough?

This is not a fixed cost business. And you know that. I'm just reminding, right? When revenue goes up and down, so goes cost of goods sold here. And that's part of the operating model and why we show resiliency in the down part of the cycle. Actually, I'm quite proud of where the profitability of the company is performing. And frankly, 1 thing I've been pointing out today, and we talked about on our earnings call not all that long ago, is, frankly, if you go to the last memory down cycle in 2019, our installed base is 40% higher than it was then. That's part of the reason why earnings and cash generation, frankly, are as resilient as they have been. Gross margin will ebb and flow with volume. It's just -- it's the way this business runs. But the earnings resiliency has a lot to do with CSBG, which people often, I believe, when they look at our business, under-appreciate the quality of that business. It's a great business.

Right. Got it. And just 1 last conceptual 1, Doug, which is if in the next several years, so WFE grows, but EUV and litho takes up a lot more of those WFE dollars, doesn't that reduce the SAM for dep and etch markets?

Why would you think that? I mean you don't buy a litho tool in isolation. You don't just put the print on the wafer and then not go create the features. You got to deposit the films and etch the films to create the transistor in the structure. If you're buying EUV, you're buying etch and deposition as well. EUV and etch define the patterning module. So if EUV is doing well, we're going to well also, right? You need it all together. And frankly, there's some new stuff we're doing, and we've been talking about this for a while, right, like dry resist through partnership with ASML. But we're going to do our best to actually make the full-time absorptions with the resist we're putting down more efficiently and better. So there are also incremental opportunities for us as EUV ramps. So you shouldn't think of it as it's a zero-sum game here. If you're buying a litho tool, you got to create the features, too. You need the process tools.

Got it. And the last 1 I guess just there's been some excitement about maybe CHIPS Act funding adding to fab investments, right, in U.S., and obviously, every country has their own version of that.

It seems like every region in the world is trying to do something. Yes. Exactly.

So have you seen any of those benefits come through or they're all overwhelmed by the cycle? Or are those management teams right? Because they need to partner with folks like yourself to make sure that those fabs come up in time. So have you seen any of those benefits or all that goodness is to come or it's not that big to begin with?

Not too much. And again, I'm often a little cautious when I describe this. Don't lose sight of the fact that the demand for semiconductors is what matters at the end of the day. If there's some government assistance, it will move the fabs around. And if you have more fabs than fewer, it's probably going to create some level of incremental investment in WFE, but it's not just pure upside. Demand for semiconductors is what matters. And frankly, that's why I'm so excited about the sensory, because demand for semiconductors in the longer term is going to be extremely strong, I believe.

That's the most important...

That's the most important thing. Don't lose sight of that.

Excellent. Thank you so much, Doug. Really appreciate your time.

Okay. Thanks for having us.

Thanks.