LRCX - Lam Research Corporation (LRCX) Evercore ISI 2023 Semiconductor & Semiconductor Equipment Conference - (Transcript)
2023-09-06 13:56:04 ET
Lam Research Corporation (LRCX)
Evercore ISI 2023 Semiconductor & Semiconductor Equipment Conference
September 06, 2023, 10:00 AM ET
Company Participants
Douglas Bettinger - Executive Vice President and Chief Financial Officer
Conference Call Participants
C.J. Muse - Evercore ISI
Joe McCormack - Evercore ISI
Presentation
C.J. Muse
There you go. Perfect. Good morning, everyone. Thanks all for your time. Really delighted to have with us Doug Bettinger, Chief Financial Officer of Lam Research, for our next keynote. Joe McCormack and I kind of cover the tech space here at Evercore. We're going to keep the session to about 44, 45 minutes. Halfway through, we're going to stop for some Q&A. So if you have any questions, please feel free to kind of jump in at that point. Our hope is this will be a fairly interactive session. I guess, Doug, first off, thank you very much for your time. Really appreciate it. Hopefully, everyone read the Safe Harbor statement that was up there.
Douglas Bettinger
Put it up real quick. I got to be on the record with it or my attorneys get mad at me real quick. I don't plan to say anything new that you haven't heard me say before. So I don't think you need to look at the Safe Harbor, but please do anyway. To the extent that I make any forward-looking statements, the Safe Harbor is relevant for anything that I decided to go rogue and say it today.
C.J. Muse
Obviously, it'll be fine if you actually put something material in the Safe Harbor to see how many people actually read it and find the nugget of information. That will be kind of fascinating.
Douglas Bettinger
Yes, it's actually kind of funny. We actually look at this every quarter and modify the wording. It's kind of funny. But anyway that's not what we're going to talk about.
Question-and-Answer Session
Q - C.J. Muse
Perfect. Well, thanks a lot for your time. I guess maybe just to kick things off and we have a bunch of questions to go through. I'm sure the folks will have questions to go through. I feel, Doug, long-term, everyone is really excited about semiconductors and the growth that's going to happen in the space, and you presumably need a lot of tools, semicap equipment tools to drive this growth?
Douglas Bettinger
Semiconductors don't build themselves. You got to have the equipment to support whatever the output of the industry. So, yes, that's absolutely true statement.
C.J. Muse
So I guess maybe touch on two parts. What does that mean for the longer-term growth framework for Lam Research as you go forward? And maybe also touch on what do you see is happening near term to WFE trends? I think you talked about this number being around $70 billion for '23. But within that, you had some, I would say, very dire assumptions on the memory side. Just talk about how that's stacking up, longer-term stuff and then near-term stuff as well.
Douglas Bettinger
Yes. Well, I can ramble on for 10 minutes on that. So I'll just say a few things. First, listen, it's a down year. If you've followed semis and I'm looking around the room, I see a lot of familiar faces. You know this industry. This is a growth cyclical industry with an emphasis on growth and an emphasis on the cyclical. Both are relevant to understand if you're an investor in this space. We're in the middle of a pretty significant kind of downtick, especially in memory this year. And so when we came into the year, my recollection, we started the year thinking the industry was going to spend low mid-70s. We're now looking at the industry and believe it's in the mid-70s this year. That's down 20% plus from last year. So that's your cycle comment actually. So what's going on? I'll talk about the near term and then I'll come back for the optimism on the longer term. Yes, I mean, there's a lot of inventory in memory out there, memory and storage. And when we parse the level of investment this year, NAND is really quite dire, frankly, right? I have never seen a downturn this significant in memory in my entire career. I've been in the industry for a while. Memory, in total, down north of 40% kind of sequentially year-on-year from an investment standpoint. NAND is down 75%. It is substantial. And when you look at what my customers are doing, utilization is dialed back more than I've ever seen. That's what you need to do when we're in the down cycle, I guess. But I've never seen it dialed this far back. It is what it is. At the end of the day, the industry will invest whatever it will invest. So NAND is pretty dark. DRAM a little bit better. But when you put memory in total down, like I said, north of 40%. Foundry and logic is doing relatively good amount better. And frankly and I know you're going to ask me some about foundry and logic, so I'll park that for a minute. But everybody thinks of Lam as the memory company, right, the memory equipment company. But frankly, if you look at the composition of our business right now, that's not true. 70% plus of my business is foundry and logic right now. And frankly business holding in pretty well. So that's one thing that kind of get in your mind that we are not just a memory company. We are actually quite strong in foundry and logic. So that's the near-term stuff. I'm sure you'll ask me more about it as we go forward here. But that's not why people get excited about what's going on in the industry. I know you had NVIDIA in here just before us. Everybody is super excited about AI and what's going on there and I am too and we can talk about what I think that means for equipment investment. But it's going to be significant. It's going to be substantial. It's not hard to go find your favourite $1 trillion semiconductor industry report. There's a half a dozen of them out there. I'm a believer in that. I am a firm believer in that. And frankly that's the reason to be excited about what's going on in the industry. Industrial automotive is going to drive long-term secular growth. AI is too. So if you want to kind of look forward and be excited about something, that's what's to be excited about. This is a growth industry. It's a growth cyclical industry. And if the industry is going to print a $1 trillion revenue, you need a good deal more equipment than is out there right now, and you need investment across the total spectrum of leading-edge foundry and logic, trailing-edge foundry and logic and memory. All this stuff goes together in a system configuration at the end of the day. So our optimism when we look at that trajectory is completely intact, independent of the fact that, yeah, things a little, are a little bit soft this year. Also stepping back to tell a little bit or foreshadow a little bit of the Lam story, when I look at a very kind of macro level, you have these changes in architectures that are inflecting in the third dimension, right? NAND did it years ago. The industry is looking forward, still pretty far away, but DRAM is eventually going to adopt a 3D structure. You're beginning to see it in foundry and logic with gate-all-around. When things go 3D, Lam does well. We are an etch and deposition company. We've put film down on the wafer, and we remove it with our etch bills. That is the definition of 3D. Everybody is super excited about advanced packaging today. Well, guess what, to make advanced packaging happen, you need to deposit conductive material and you need to create space to deposit that. That's etch and deposition. So when you think about the evolution of the industry heading in the third dimension, we, in my humble opinion, are the best positioned company in the industry for that broadly speaking.
C.J. Muse
Perfect. I always feel like investors markets have misconception about stocks or conceptions about stock sometimes. And I think for Lam, it's always been, it's a memory-centric company for the most part. And you touched on this a little bit, but you really don't have a lot of memory business today.
Douglas Bettinger
Nobody does.
C.J. Muse
And you're still doing 20 -- you're on track to do like $27, $28 of earnings this year, right? I guess maybe two parts on this, right? A) just talk a little bit more about the diversity, the reoccurring business to your build that's enabling you to do that or so that misconception of Lam is memory? And B) how do you think about recovery across both NAND and DRAM over time?
Douglas Bettinger
Yes. There's a couple of questions packed in there or buried down in there. Let me start a little bit. You're right. If you go back a year-plus ago, you would have seen two-thirds of our business was memory-oriented. If you fast forward to this year, it's completely flipped. Two-thirds of our business, actually a little bit more than that right now is foundry and logic-related. We are not just a memory company at the end of the day. Listen, I love my memory customers. We love where that's going. At the end of the day, you don't have a logic device without memory and storage system configuration. So you need all of it together. And we enable a lot of the memory architectures. But frankly, we are not just a memory company. Fully understand that. We have printed, in the last several quarters, record foundry, record logic. We've talked about with a large logic customer doubling our share in node-over-node as they go forward. There are some really good stuff going on with our business and our tool capability in foundry and logic. So understand that. We are not just a memory company.
And when we look forward, we see that continuing. Like I said, one of the things we're excited about right now is the evolution of foundry going to gate-all-around. The first true 3D structure in my opinion, in foundry and logic, by the way, both are obviously going to adopt a very similar architecture. To create that structure, it's very etch and deposition-intensive, right? To create the sheets, you need to lay material down and to shape those sheets, you need a whole different approach to how you etch things. It's selective etch and surface preparation.
And so when we look at this, this is a very large opportunity as we look into the future for our business. We've described an opportunity of close to an incremental $1 billion for every 100,000 starts that gets put in place. Not that we're going to win all that, but we will aspire to win at least as much as we hold across the rest of the industry. It's a big opportunity. We've been talking, I think, for three years or actually a little bit longer, about a new dry resist approach to putting material down as we look forward to the adoption of high NA EUV in foundry and logic. Brand new business for us, something we have not done in the past. And we've described that as an incremental $1.5 billion opportunity cumulatively over a five-year time frame, growing towards the latter part of that five-year horizon. So I'm super excited about what we have going on in foundry and logic. And when you think about the future, the future looks good.
C.J. Muse
Got it. So you've talked a little bit on the 2024 WFE expectations on memory and everything else, but maybe just flesh that a little bit. How are you thinking about the different parts, foundry and logic more specifically, but also you touched on memory already? But importantly, what does recovery look like? And I think that's a question everyone has, what does NAND recovery look like?
Douglas Bettinger
Yes, I'm staying away from like what shape is the recovery going to be? When is it coming? I don't know for sure, frankly. I don't. It feels to me right now that we're kind of bouncing along the bottom. But I do not see things right now getting better. And what you need to pay attention to is how much inventory is out there, what pricing looks like and all of that kind of stuff. It's classic memory cycle stuff. And like I said, looking in the room, I see a lot of familiar faces. You guys all know what I'm talking about. The metrics are out there. You can kind of go modulate this on your own and figure out kind of when it's going to begin to happen. It's not happening right now, though, I want to be very clear about it. But like I said, utilization dialed so far back, I have a hard time envisioning it getting worse than it is right now, but I don't see it getting better right now either. And I'm not going to give you a shape of recovery in the next year.
C.J. Muse
In your seat, what are sort of the leading indicators you look at to say, this is when it happens? Like historically you reflect on it, what do those indicators look like and what are they?
Douglas Bettinger
Yes, I have the benefit of having somebody at my company talk to every one of my customers every single day. So that's what --
C.J. Muse
That helps.
Douglas Bettinger
That helps. You guys can't do that. You'd come to conferences and listen to them talk and help parse it that way. Maybe what would be helpful though is we described how this is going to show up in our business. So maybe that would be helpful to talk to everybody in the room a little bit about in Lam's business, how are you going to know if things are starting to get somewhat better. Well, the first thing that will happen is inventory will get more imbalanced. Hopefully, that's not too far down the road. Pricing will stabilize, profitability will improve.
The first thing that our customers will do on the memory side is they'll begin to bring utilization back up, right, because that's the logical thing to do. For our business, where that will show up is in the customer support business group. You've heard us talk about CSBG. CSBG is a composition of four different businesses, two of which will first show benefits when utilization comes back. The first area is spare parts. Spare parts right now is dealing with the headwind in that utilization has dialed pretty far back. So we'll see it show up. Our customers begin to need to consume more spare parts because they'll start running the tools more significantly. Similarly with service. Service will need to come back when the tools actually come back in line. So those two things, if you listen to our earnings calls, you'll hear Tim, our CEO, begin to talk about that. I think, Ram, you've probably write in his script, not mine. But that's what you'll hear us talking about is, okay, you're starting to see somewhat of an uptick in spares and service. The next thing that will happen in our business is customers will start to upgrade the tools that are in the installed base again. When utilization gets dialed back, generally speaking, the oldest tools are what gets dialed back. And so that will be the stuff that then we'll need to get upgraded. That's also in the CSBG business. So the upgrade business, by the way, it's a great part of the business. It's an awesome value proposition for our customers because they get new tool capability at a fraction of the cost about the new tool. So you'll start to hear us talk about recovery in the upgrade portion of the business. And then eventually, new wafer capacity will need to get put in place. So that will be the -- and by the way, that's kind of the new equipment stuff that everybody thinks about when they follow semi-cap. But anyway, I'm rambling on here a little bit. But that's how it's going to show up in our business.
C.J. Muse
It seems like talking to customers every day is a much easy way to figure this out than the second option, but --
Douglas Bettinger
Usually speaking, it is, although sometimes I wonder, they don't always know when things are going to get better either.
C.J. Muse
Fair enough. Maybe shifting gears a little bit on the AI opportunity. I think on the last earnings call, you folks have talked about each 1% penetration of AI servers is going to have some impact to WFE over time, right? Maybe just talk about that and how are you thinking about Lam very specifically, how your opportunity when it comes to AI deployments?
Douglas Bettinger
Yes. I mean everybody is getting really excited about AI. So we felt it was important to describe, hey, what is this going to mean on the equipment side? And so we did our best to sit down, spend some time talking to customers but also analyze the market and anybody can go do this. The data point that we gave you is for every 1% of server volume that shifts to an AI configuration versus an enterprise configuration, what is that going to mean for the investment in WFE? So first, if you parse -- if you look at true AI configurations, what do you see? First, it's most advanced microprocessors with the biggest AI. So there's capacity at a certain level there. There's nominally eight GPUs in that configuration versus one or two in the enterprise class server. There's eight times the DRAM content. Put together in high-bandwidth memory configuration using a TSV structure, which is awesome for us, by the way, I'll come back to that in a minute, and then you've got nominally three or four times the NAND content. So if you look at what I just described and analyzed that 1% pivoting from enterprise to AI, that's $1 billion incremental WFE required to support that configuration. Now I've had some people pushing back to say, yes, but that's just a reallocation of hyperscale budget from enterprise to AI. Maybe that's somewhat true in the near term. It's not true in the long-term. AI is going to be incremental in the medium and long-term for sure. And I can talk about why I confidently say that. It's just based on what I see happening in my own business and how we're looking at what AI is going to do for our own business. But that's kind of how you get to the math that we put out there.
C.J. Muse
Yes. I mean, to your point, I think IBM, for example, has talked about 30% savings in what you can get if you deploy AI properly in your cost structure. And so if you can start saving billions of dollars, I imagine these deployments will be incremental and not just cannibalistic over time, right?
Douglas Bettinger
Listen, that's what I think about it and maybe why I say that is, right now, when I look at, well, let me paint a picture of what we're doing at Lam. All of us are trying to figure out what does this mean to your business? And I know I'm just like every other large company in the world, which is, I'm not sure. So we're looking at all these proof-of-concept different areas where we've got pain points in terms of information sits over there, work is being done over there and how can you more effectively put these things together? I see hugely compelling opportunities in our own business. And I know I'm not unique in that regard in that every large company has these pain points and everybody's business is a little bit different. Everybody's got different things that challenge them from a productivity standpoint. But this is going to be a real thing. There's going to be real business value from this. And I don't exactly know where but I know it's there. And I know when you see stuff like this, it ends up being incremental investment over here to save over there. There's a big ROI there, I believe.
C.J. Muse
No, it's a little bit like I think when iPhones came out. No one knew you'd use apps on it, but eventually, as that happened, you saw massive spending happen around it. So I think AI and the equipment needed for that will go down the same path. I'll pause there maybe give it to Joe to ask the smarter questions now.
Joe McCormack
Doug, maybe to go back to CSBG for a little bit. You covered most of it, but maybe just to touch on the Reliant business as well there, lagging edge tools has been a bright spot this year. Maybe you want to just remind us on like the diversity, both from a number of customers as well as like a geographic location standpoint for that business to think about sustainability from here.
Douglas Bettinger
Yes. Maybe if you'll allow me because I'm sure there's some new people listening to me talk for the first time. Let me describe what is CSBG first and then I'll come to your direct question on Reliant. For us, CSBG, again, the Customer Support Business Group is the money we make from the installed base in the customer's fab for the most part. It tends to fall into four buckets, not tends to, it is in four buckets. Spare parts, service, equipment upgrades and then what you specifically asked about, Joe, is the Reliant product line, which is more of our specialty node or some people think of it as legacy node equipment sales. That all sits in one business unit at Lam because it is how we monetized equipment that we've designed in the past, right? It's not necessarily requiring a lot of new R&D, although there is some R&D in there. It's more kind of the dollars made from prior period investments. And so when you look at it today, actually, it's actually quite amazing. Before the down cycle, CSBG was roughly a third of the company's revenue. Last quarter, it was 47%. That's as much a statement around how much the investment in new equipment is down, but it also is a statement around the relatively resilient CSBG business. In particular to your point, that Reliant product line or the specialty known product line is actually doing pretty well this year. It's perhaps a bright spot in a more of a down market. And that's because you think about what's going on there. This is a broad footprint geographically. It's supporting customer bases like industrial, automotive, IoT, analog, power. It's very broad. There is certainly a component of it in China, which is something everybody has been asking a lot about, and you guys probably will ask me more about it as we keep talking here. But that is doing pretty well. If I would have been here two years ago talking to you, I would have said the largest component in CSBG is spare parts. And now when I describe CSBG, describe it as there's two big components in CSBG. Spare parts still, but Reliant has actually grown quite a lot over the years and is doing real well this year.
Joe McCormack
Makes sense. And maybe just touching on CSBG longer term, you kind of pointed to this typically grows every year. Do you want to touch on as we push through 2024 and beyond how to think about a more sustainable growth profile for this business going forward.
Douglas Bettinger
Listen, a couple of things. Yes, I used to say, hey, this is a business that grows every single year. It's not growing this year. But it's not down too much. And it's not growing this year because utilization is dialed so far back. I never envisioned utilization being pulled so far back. Obviously, that impacts spare parts, service and equipment upgrades. All that stuff is facing headwinds relative to utilization right now. And so that's why it's important also to listen to us. When we finish the calendar year, the December earnings call, we always give the market, here's the number of chambers in the field. If you compare this downturn to the previous one, the number of chambers in the field for Lam has grown by 40%. That's why generally speaking, and I describe this as a business that grows every year, I think people sometimes don't realize our equipment runs for decades. It's not something that you sell and then it goes away. It actually gets repurposed. It gets upgraded. It gets moved to sometimes a different customer, although right now, that's not happening any longer. But that's the Reliant product line, things that go into some of the legacy nodes. So that's an important thing to understand. Our equipment runs for decades. We've got stuff that's been in the field for 30 years. And so if you think about that, what does that mean? Well, the revenue generated for an average Lam tool in the field over the life of the tool generates more revenue than when the equipment is first sold. We spent most of the conversation you're talking about, hey, where's WFE? It's up, down or sideways. Yes, that's important. But understand, a key part of how we make money at this is from the annuity that comes off the fact that we've got 84,000 chambers in the field, up 40% from the last down cycle. That's why usually I describe this as a business that grows every year because all of those chambers consume spares. They need to be serviced. There's an opportunity for them to be upgraded, sometimes multiple times over the life of the tool. And then every once in a while, we actually will buy used equipment back, refurbish it and resell it. There isn't any used equipment available anymore, but that used to be part of the Reliant product line business model. We're now selling new old equipment if that makes any sense to anybody. It's a great part of the business, by the way. Like I said earlier, it doesn't require a huge amount of R&D. The R&D is basically a sub cost when the tools developed, right? And then the opportunity, like I said, upgraded spares and so forth, happens over time. Enormously free cash flow generative in CSBG, like I said, because it doesn't require a whole lot of R&D. So it's an awesome part of the business model that I believe is truly underappreciated by people. And maybe I don't talk enough about it. I need to do try to do a better job describing this part of the business. It's a great part of the business.
Joe McCormack
That's great. And then maybe one last one before we open up to questions is you've touched on a few of the kind of key opportunities moving forward, whether dry resist or AI. Anything else that you want to kind of just call out there as it relates to what investors might underappreciate from your competitive positioning, NAND moving forward as layers continue to increase? Just anything that you feel like is really misplaced as it relates to how investors look at you?
Douglas Bettinger
I think the most important thing to understand is every new node is somewhat more expensive than the one before it. And like I just tried to describe earlier, when I kind of abstract and look at the evolution of architectures, of our customer, generally speaking, they're inflecting in the third dimension to a greater or lesser extent, depending on the architecture. When things inflect in the third dimension, we do well because to create structures that are three-dimensional, it's materials-intensive, and it's -- you need to etch the material that you put down on the wafer. Maybe if you'll allow me, one of the things we're really excited about right now is advanced packaging. So I'm going to ramble on about that a little bit here because I want to make sure I get it out there. One of the ways things inflect in the third dimension is advanced packaging. You'll hear my customers describe chiplets, heterogeneous integration, advanced packaging, what have you. This is an opportunity when you think about it is you're putting multiple die in some kind of structure or a package or sometimes just silicon on silicon to create an interconnect to help manage cost, performance and then just putting different device types together. When you do things like that, you need to create a conductive pathway for the electrons to flow. Generally speaking, when you look at how that is deposited, it's a copper electroplating process. But frankly, we own nearly all of -- maybe all of. It's a tool we call SABRE 3D to create the space for the conductive material to get deposited into. It generally is a silicon etch, a deep silicon etch. It's a tool we call Syndion, which we had nearly 100% market share in that. So again, when you think 3D, think Lam Research, it's all we do, it's what we do. And maybe if you let me digress for just a minute, everybody is super excited about AI right now. One of the key enablers of AI to feed that parallel compute architecture, you need a lot of data flowing through to make that happen, low latency DRAM. Generally, when you look at how it is put together in these AI architectures, you've got high-bandwidth memory in there using DDR5. It's eight-die, eventually going to 12, put together using something called through silicon via process architecture. To make that happen, pretty much 100% market share for us in silicon etch and in that electroplating process. So you have memory is not spending a lot of money, but one of the areas actually where customers want tools quicker than we can get them to them right now and we're expediting things is in TSV for high-bandwidth memory because of AI. We make that happen, full stop.
C.J. Muse
We'll pause and see if there's any questions in the group? Let's get the mic over there.
Douglas Bettinger
You have a mic in the room?
C.J. Muse
Yep. To Onkar.
Douglas Bettinger
How are you Onkar?
Unidentified Analyst
I'm good, Doug. How are you?
Douglas Bettinger
I'm good.
Unidentified Analyst
Just a quick question on the math around the 1% AI penetration and the effect on wafer fab equipment. How many AI servers replace one enterprise server or 10 enterprise servers like?
Douglas Bettinger
It depends on the application. Like I said, in the near term, maybe this is a push from one to another. In the long-term, I think this is all incremental, Onkar. And I say that because when I look at where we're looking at these AI services, these are new activities. I still have to upgrade my enterprise infrastructure to go to the next instantiation of SAP S/4. So to me, it's not a, this replaces that. This is going to be incremental. Maybe not in the near term, but in the medium and long-term, it's going to be incremental.
C.J. Muse
All right. Well, if anyone has questions, feel free to raise your hand. We'll get the mic to you. If not, we'll keep going. I guess just shift away from revenues and what's happening to memory, gross margins last quarter were extremely impressive. They were good. It was -- I think mix was good. You also had better cost improvements than expected. Maybe just talk about what enabled that. And then importantly, how do you view the sustainability of this as you go forward?
Douglas Bettinger
Yes. Let me describe a little bit about, I don't know, strategically or operationally, what we're doing at Lam this year. Like I said, business is down. And so what we're doing as a leadership team, as a management team is taking the opportunity to make the company better, so that when business gets better, we're going to be better. And what that means is we're going through a reasonably sized restructuring activity, taking cost out, eventually setting the company up for when growth resumes to be able to do it more cost effectively. We described that, I don't know, back in the January call. What I would describe to you right now is we're ahead of schedule on that project or program. And so that is a component of, I think, we came into the year, and I set an expectation that we would improve gross margin by 100 bps. Frankly, we've well exceeded that already. I guided to 46.5% gross margin. Starting the year, we're at 44%. A key component of that is this program is ahead of schedule. And by the way, a portion of what we're doing in this restructuring is related to kind of figuring out how to make AI work at the company, right? We're undertaking a digital transformation project that's delivering some of this. Although a lot of it is just taking advantage of the manufacturing footprint we have in place. I've been talking for a few years about this large factory we've built in Malaysia. When business does resume, a lot of the incremental growth will be supported from that factory in Malaysia. It's beneficial because it's got good labor rate. But frankly, more importantly, it's closer to customers, right? Most of this industry, the fabs are in Asia, obviously. And so being closer to the customer enables you to take advantage of a supply chain that has a better cost footprint. But equally importantly and maybe more importantly, actually, is to get our tools from where we build them to where the fabs are, and we're flying them around in an aircraft. If the distance you need to move stuff around is shorter, and obviously, if the factory is in Asia and the customers are in Asia, you're saving up freight, that's going to be a key component of it, too. So a big part of what you're seeing from us relative to the gross margin performance is that program that we're working really hard on. And then, yes, I will acknowledge there's a favorable mix as we sit here going into the September quarter that is going to show up. So both of those are important right now when you look at where we're at on gross margin.
C.J. Muse
Got it. And you touched a little bit on China or mentioned China earlier at least. How much benefit are you seeing from higher-than-normal domestic China revenues, let's just say, that could potentially fall off in '24? Maybe just level set that dynamic a bit.
Douglas Bettinger
I guess the first thing I would describe to you is back in October last year, a new set of regulations came out from the US government. That was a big negative hit to our business. We described back then an impact of $2 billion to $2.5 billion in revenue that we would no longer be able to support. So that's important to understand. This isn't like in a multiyear context. This is a headwind, not necessarily an opportunity. Although what we talked about more recently is we did get clarification that there was some business we weren't sure we were going to be able to support that we're now able to support. And that was a component of -- when we described where's WFE this year, we moved it up from low mid-70s to mid-70s because there were some incremental business that came back in related to that. That's part of the, like I said, uptick, in our view, of WFE.
C.J. Muse
Got it. And I think longer term, you've sort of talked about gross margins eventually getting to like 47.5%, 48% kind of target. I think it was back at the Analyst Day you folks had. What do you think is the path to get there? Is that -- is it revenue dependent? Is it more on the cost takeout stuff continuing on? Like what are the levers that get you there?
Douglas Bettinger
If I go back, we put that model out, you got the numbers exactly right. I think it was March of 2020 just before COVID, and then a lot changed, obviously. We had some inflationary headwinds that came in that don't necessarily go away. So that was a bit of a negative component to gross margin that we had in that model. What we're going to do to offset that though is what I've already described to you, which is we're working on operationally, making the company better right now. And so when you think about those two things, you had a little bit of inflation come in, you now are doing more operationally, those are going to net out such that at the end of the day, we're still committed to get to that 47%, 48% gross margin that was in the financial model. We're just going to have to pull slightly different levers to get there.
C.J. Muse
Got it. And then I think this year '23 is supposed to be a really good strong free cash flow year as well for the company. But I think within that, you've also talked about, hey, inventory may not come down as quickly as expected as you would like to the pre-pandemic levels. Just talk about what's happening with working capital that's delaying that? And when do you see that kind of normalizing?
Douglas Bettinger
Yes, let me go through it a little bit. I mean, maybe somewhat counterintuitive, when business goes down, oftentimes, cash flow improves. Why does that happen? Generally, it's because working capital comes down. Accounts receivable comes down, inventory comes down and cash shows up, I guess, a simple way to describe it. And that is very much what you're seeing from us this year. Very strong cash flow last year or excuse me, last quarter, free cash flow last quarter was north of $1 billion. So that's great. Actually, on a run rate basis, it's higher than it was last year because last year, business was growing. This year it's coming down. Having said that, though, there's a little bit of a lag. I see us being able to deliver this year relative to inventory. Why is that? If you think about the rate at which business declined, right, if you go back to the December quarter last year, we printed $5.3 billion in revenue. Last quarter, it was down to $3.2 billion. And so when you have a business reduction that occurs that quickly, you're ending up buying less material than you previously told your suppliers you were going to buy, right? We canceled a lot of purchase orders. And so as you go through a process like that, inevitably, what you end up needing to do is make sure your suppliers are hanging in okay, and you end up taking sometimes more inventory than you need in the near term. At the end of the day, this is going to be good inventory. I'm not concerned at all about risk of obsolescence or anything like that. It's more the pace at which business declined meant that we were canceling a lot of stuff that we previously told our suppliers we needed. And so as, like I said, part of that, you end up taking some inventory that you don't need in the near term that you'll use later. And so when you look at previous cycles, we've been able to manage inventory down more quickly. The pace at which this one showed up meant that there's going to be a little bit of a lag to that, but it will still happen. We're still good operators. We still know how to manage the balance sheet. We're still focused on managing the balance sheet. But at the end of the day, you also need to be focused on the health of your supply chain, and that's part of what's going on here. Inventory is not coming down as much as I wish it was, but for good business reasons.
C.J. Muse
It always seems like demand came off a lot quicker, but your purchase commitments that were out there, you were kind of set to honor these and --
Douglas Bettinger
That's exactly right.
C.J. Muse
And you want to make sure suppliers are around the next time when you need them.
Douglas Bettinger
At the end of the day, this is a long-term relationship, right? We think of them as remote factories in a lot of ways. And so the resiliency and the ongoing health of our suppliers is important to us.
C.J. Muse
I want to draw some analogies to your prior company on that statement, but I won't do that.
Douglas Bettinger
Yes, don't do that.
Joe McCormack
Doug, we have a few minutes left. Maybe to swing back to some technology-oriented questions for a bit. You talked about advanced packaging. Do you want to just talk a little bit more about like the current status of demand? It seems like some of your peers are looking for upticks in DRAM-related revenues into the September quarter. So just maybe when you look at high-bandwidth memory and the generative AI-related demand, how quickly do you expect that couple of hundred million dollars to move to the $1 billion over time that you've talked to as it relates to advanced packaging?
Douglas Bettinger
Yes, I guess what I would describe is you're right, the way I get asked how big is this advanced packaging stuff you're talking about. And I've described it, I don't know, in the recent past about, at Lam today, it's hundreds of millions of dollars. I more recently said in the not-too-distant future, I have not a hard time envisioning it being a $1 billion business because of the evolution of things that are happening in the industry, not just high-bandwidth memory, although that's a key bright spot right now in a fairly dark memory-spending environment. Like I said, we're trying to pull things to be able to ship them sooner to the high-bandwidth memory component. So that's a part. But you hear everybody talk about chiplet architecture and all -- everybody is doing this stuff, [indiscernible] all of this stuff requires everything I've already described with the Syndion and SABRE tool.
Joe McCormack
Makes sense. And then maybe just to touch on gate-all-around a little bit further as well. Do you want to talk about whether it be metal or dielectric, how you guys are positioned to kind of win out there and how are you in new products in selective etch and otherwise aren't really going to kind of benefit as you think about that close to $1 billion per 100,000?
Douglas Bettinger
Yes. When you look at the composition of that incremental opportunity, it falls broadly into two categories. There are ALD applications in there and there are selective etch applications, and they're probably a few more selective etch than ALD, but both are critically important. We're well positioned. I feel really good about it. We wouldn't be putting numbers out there if we didn't feel good about it, and it's just around the corner.
Joe McCormack
Great. Maybe one last one. You talked about optimizing the cost model in the current downturn to look more attractive out here. But obviously, probably still spending to kind of support growth into $1 trillion for semis industry. So anything else you want to call out, whether it's the sense platform or otherwise as it relates to your R&D spend that you guys are focused on to really benefit into the back half of the decade?
Douglas Bettinger
Yes. I guess that's one thing that's important to understand. In this business, you don't cut R&D and depending on wherever the business cycle is, you really don't because these are multiyear investments and our customers today are making decisions that are three nodes from now. So independent of whatever the business cycle is doing, you have to stay, come into your long-term R&D programs and very much are. We've got a new etch platform. We call it Sense.i, that's out today, but requiring incremental investment for sure. And we're still investing in the older platform as well because customers are still buying new equipment there. There's a whole bunch of new ALD investment that's occurring. The dry resist is all incremental business for us and all incremental R&D. So those are examples of things that are driving the R&D profile.
Joe McCormack
And maybe just to remind on dry resist, as you said, $1.5 billion over the next five years starting this year and maybe a little bit back half loaded as it relates to?
Douglas Bettinger
More weighted to the back half of that time frame. In year six, seven and beyond, it will get even bigger. And like I said, it's hard in this business to find something brand new to go after, to go invest in, to go generate incremental revenue. But this is an example of that. We don't play in this part of the equipment space today. The customer pull for this is very strong. Every one of our customers that uses EUV has our hardware in the lab evaluating the capability. And what's important to understand is that lab space is extremely valuable. If the customer doesn't see a benefit to what you're bringing to them, they won't put your equipment in the lab to look at it and evaluate it. We've already announced three tool selections. Two DRAM customers have selected this. And more recently, we talked about a large foundry, logic customer also has selected this to ramp into production. So customer pull is quite strong. The value proposition, I think, is quite compelling. The momentum behind where this is going is continuing to build. So I'm very excited about it. From our point of view, this is a question of when, not if this ramps and we're making really solid progress.
C.J. Muse
Yes. It's good to hear. Perfect. There's a question up here.
Douglas Bettinger
Yep. Can we get the mic real quick so they can hear it on the webcast.
Unidentified Analyst
So just two questions on NAND. One is like we talk about like how the AI has positive impacts on logic, on DRAM. Like just if you think about the AI's impact on NAND over the mid to long-term, just wondering, what your thought on that? And number two is like, obviously, NAND is in a very bad cycle right now. And if you listen to the memory guys, like they're not only -- they're also kind of like talking down like the midterm outlook for the bit growth on NAND as well. Is that a typical mid of down cycle behavior like the near term so bad is it very hard to feel -- not feel a little bit worse about the long term as well? Or is like there is some truth behind like the long-term outlook for NAND as well? Thanks.
Douglas Bettinger
Yes. Listen, I never question my customer's perspective, point of view, and I'm not going to now, right. But they're closer to the marketplace than I am. I would share an observation I have with you, which is in this industry, we suffer from a recency bias. When things are good, we just draw a line up into right. When things are bad, we draw a line down into the right. I don't know if that's case here. I wonder if it might be a little bit. But, yes, I think my customers have down-ticked a little bit in terms of what they think long-term demand looks like. I don't know what's changed, except that we're in the down cycle. But I'm not saying they don't have this exactly right, they're closer to the market than I am. And then to the beginning of your question, today best I can give you is when we look at these AI server configurations, it's got about three times the NAND content as compared to an enterprise server. Whether that is what it sustainably looks at as this gets to be a bigger and bigger component of the market, I'm not entirely sure. That's what I see today.
C.J. Muse
Perfect. I think we're almost up on our time, but maybe to wrap this up, free cash flow generation. I mean, based on just how well you folks are doing over here, I'd love to understand your ability to stay within this targeted 75% to 100% free cash flow returns in '23. And then, any changes really broadly to capital allocation priorities as you go forward?
Douglas Bettinger
No change. Listen, like I said, it's going to be a very strong free cash flow year for us this year. We are planning to continue to return 75% to 100% of free cash flow. In fact, a week ago, we raised the dividend by 16%. We plan to grow the dividend on an annual basis. I know people like that. So no change.
C.J. Muse
Perfect. I think we're up on our time. Maybe I'll pause here. I'll turn it back to you if there's any closing comments, I think, Joe and I did not touch on that you want to make sure investors are aware about.
Douglas Bettinger
No, listen, I think you guys covered a lot of what I'm spending all my meetings talking about. We're in a downtick kind of is what it is. Customers will spend whatever the customers will spend. At the end of the day, I can't -- we can't control that at Lam. But what we can control, we're working on making this company better for when the business gets better, right? And you're seeing that show up in the P&L. I'm pleased with that. And in the long-term, I am as optimistic about this industry and our unique position in it as I ever have been, independent on wherever we're at in the cycle. Don't lose sight of the fact that this is a growth cyclical industry. And, yes, there's a cycle. I will never say there's not, but there's awesome growth in front of us.
C.J. Muse
Perfect. All right. Thank you very much for your time, Doug.
Douglas Bettinger
Thank you.
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Lam Research Corporation (LRCX) Evercore ISI 2023 Semiconductor & Semiconductor Equipment Conference - (Transcript)