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Lam Research Corporation (LRCX)

November 15, 2011 3:30 pm ET

Executives

Ernest E. Maddock - Chief Financial Officer, Chief Accounting Officer, Senior Vice President and Head of Silfex Incorporated

Analysts

Stephen Chin - UBS Investment Bank, Research Division

Unknown Analyst -

Stephen Chin - UBS Investment Bank, Research Division

All right. Good afternoon, everybody. Thank you very much for coming around this afternoon for our presentation here with Lam Research. I'm Stephen Chin from UBS. And it's my pleasure to welcome Ernie Maddock here from Lam Research. Ernie, thank you for joining us this afternoon.

Ernest E. Maddock

Thank you, Stephen.

Stephen Chin - UBS Investment Bank, Research Division

I thought we would just go through a brief fireside chat. I'll run a couple of questions by Ernie and we'll take it from there, and we'll leave a few minutes to see if there's any questions at the end from the audience members.

So I guess, to kick things off, Ernie, I thought it would be great if we could perhaps get your views on the trends that you're seeing in the semiconductor industry right now, especially as we head into 2012.

Ernest E. Maddock

Sure. So relative to 2011, 2012 is looking to be flat maybe down 10% to maybe as much as 15%, but we believe more oriented toward flat to sort of a down 10% scenario. We see relatively constant spending in the memory segment and the foundry segment. Obviously, there'll be some mix differences between those 2 segments, between NAND and DRAM, for example, as we look forward, and certainly, some customer mix trends within the foundry space.

But really, coming up in 2012, on the third fairly stable year of wafer fab investment on the part of the company's customers. From a technology perspective the next couple of years are extremely exciting as we think that across all segments, NAND, DRAM and the Foundry/Logic space, you're going to see a transition to 3D structures. That represents a very significant opportunity and technical challenge as we help our customers make that transition.

And I think as many of you know, the company is making the R&D investments that we need to make to ensure that as those transitions occur, the company is well positioned coming out of that period of time because we think it represents some significant opportunity. And then of course, longer-term, as we look out into the latter part of the decade, we're all going to be looking at and dealing with a potential transition to 450mm. And that will likely be sometime post 2015.

So very quick summary, Stephen, and we can address any specific questions you might have.

Question-and-Answer Session

Stephen Chin - UBS Investment Bank, Research Division

Okay. So Ernie, historically, the semiconductor industry has been highly cyclical. Some will say this current cycle that we're in looks reminiscent of the 2005 cycle. But you called out some of the new technology shifts that are occurring with 3D NANDs, FinFET technologies and quadruple patterning. What's kind of your view on how this cycle looks relative to prior cycles that you've been through?

Ernest E. Maddock

Sure. Well, one of the interesting things as we're talking about a cycle in the context of a year that, I think, most people think is $31 billion to $32 billion in overall wafer fab, which by all historical measures actually represents a pretty strong level of spend by the customers. And one of the things that we take some encouragement from is the fact that, that $31 billion or $32 billion in spend that's occurring this year is occurring in the context of a relatively muted macroeconomic environment, as well as a belief and a spending pattern that suggests you don't see the sort of supply-demand imbalances that you've seen in prior cycles, say, in 2007 and then back in the 2000 timeframe. So as we look at this year, we are incrementally encouraged by the fact that we have very rational spending on the part of our customers. We think that the level of spend is indicative of the fact that the cost to produce 10,000 wafer outs across almost all segments of our business is increasing, and we are seeing that manifest in overall investment level of the customer base. So while it's very clear that shipments in the back half of this year has been suppressed versus what we enjoyed in the front half of the year, it's still very challenging to talk about a cycle now having a context of maybe a couple of quarters.

Stephen Chin - UBS Investment Bank, Research Division

Okay. So in terms of the spending level of wafer fab equipment, you talked about how the industry is currently about $31 billion a year now. If we look out and we look at a super bullish case of, I think, it was a $40 billion number that Steve Newberry had mentioned at SEMICON West, how do you see that developing? Because there is a lot of concern that once this EUV technology, the enhanced ultraviolet technology, comes out from some of the lithography companies perhaps, etch could become a smaller percentage of WFE. How do you see that developing for Lam?

Ernest E. Maddock

Sure. So really, kind of 2 different parts to the question. So the first is the question of a $40 billion wafer fab spend and the likelihood of that. And I'll go back to the comment I just made about fact that we're dealing with $31 billion to $32 billion in a year where we are seeing a relatively muted macroeconomic environment, particularly in light of 2007 or 2000, when it was a much more vibrant environment. Also the fact that you have this good supply-demand balance exiting the year, I think it's also important in this context to understand that the level, for example, of new capacity additions in DRAM are de minimis this year compared to what they've been in the past. So as we start thinking about that $35 billion or north of $35 billion wafer fab environment, it certainly would be predicated on a more vibrant economic environment and that driving increased demand for electronics, which would result in higher levels of bit growth in the DRAM space, particularly and also in the NAND space, that would essentially reshift the balance between technology conversion and capacity addition. So you've really had a relatively muted environment for capacity additions in the memory space, stronger in NAND, certainly than DRAM. So I think if we see a combination of continued advancements in terms of performance that each of -- makes each of us want to go out and buy the next generation electronics device, some of the macro overhang going away a bit, it is not at all difficult to see an expansion in wafer fab spend. Specifically, relative to EUV, the interesting challenge there is that the longer EUV is delayed, the more it forces customers to come up with very creative ways of addressing a set of requirements that essentially aren't going away or aren't being delayed. And they are solving those challenges today with double patterning schemes, and in many cases, are finding as they establish those double patterning schemes, particularly those that are spacer-based, that those schemes remain cost-effective over any reasonable assumption about a cost sort of throughput ratio for EUV when it's introduced. The other double patterning scheme, which is litho-etch. Litho-etch scheme is more challenging economically. And I think it's pretty clear that EUV would likely be beneficial as a substitute for those sorts of double patterning schemes. But certainly I think by the time EUV is introduced, given even the most conservative estimates of -- or I'm sorry, the most aggressive estimates of when it would be introduced, our view is you'd likely need both double patterning and EUV. And so we are progressively less concerned about the impact of an EUV introduction as time goes by, relative to any significant detriment to the overall etch market.

Stephen Chin - UBS Investment Bank, Research Division

Okay. Maybe next, we can move to some of the spending trends that you're seeing at the different types of customers. In terms of the foundry customer capital spend, there seems to be 2 camps of views. The bearish camp is of the view that foundry CapEx to sales is at these very high levels and 2012 CapEx to sales level needs to climb for the foundries. But then there's a very bullish side of the foundry spend argument that there's new foundry players still in the market trying to push TSMC hard, such as Samsung, LSI and GLOBALFOUNDRIES. What's kind of your view on foundry CapEx spending trends, both near-term and longer-term?

Ernest E. Maddock

We are in the range this year of $11 billion to $13 billion in overall foundry spend. And as we look into 2012, we would estimate about roughly similar levels. So there might be $1 billion worth of variation, but it's really, really difficult to predict that level of change in a spend pattern that is in that range. So I'm not sure whether in a world that would put us in the bullish camp or the bearish camp. But we tend to look at very legitimate needs for 28-nanometer capacity across the board. The 28-nanometer node is a great node in terms of what it offers to chip manufacturers for power and performance. And certainly, that's the one thing that again keeps us interested in buying new personal devices is the idea of extended battery life or faster speed or other sorts of enhancements. And so we tend to believe that the requirement for that, which at least double the amount of capacity installed next year and potentially slightly more than double the amount of capacity installed at 28-nanometer, will drive significant foundry investment. And a good rule of thumb to use for that is about $1 billion. For 10,000 wafer starts, it might be a little bit more or a little bit less. But you're centering on a number that looks something like that. In addition, while there's been some real challenges at 45 and 65 this year in terms of utilization, that utilization seems to be bottoming and in some of the leading-edge customers, is actually on a path to improving. And so there's some likelihood that you would need incremental capacity at 45 certainly, potentially 65, although less of a probability there, which would only enhance that spend. And then as you said, you have some customers who are planning to spend beyond what would be normally indicated with a normal expansion of demand as they establish themselves in the business. You've named a couple of them who are the most likely to do that. And certainly, for at least one of those customers, there is absolutely no question about their ability from a technical or a financial point of view to move forward with those plans. So we tend to be more optimistic rather than less.

Stephen Chin - UBS Investment Bank, Research Division

Okay. Maybe we can talk a little bit more about some of the company-specific trends at Lam Research. There's a lot of discussion on Lam's continued investment in research and development. Despite quarterly sales declining, Lam continues to invest aggressively in R&D. Kind of share your thoughts on what Lam is looking for in terms of perhaps returns on investment or trends from these investments in R&D.

Ernest E. Maddock

Sure. I think with all due respect to the audience, who look at R&D as a percent of revenue, if there's one correlation inside the company that is least meaningful, it's R&D as a percent of revenue. Because the revenue that we're generating today is based on the R&D that was done in 2008, 2009 and 2010 and the R&D that we're spending today is actually forward-focused on 2012, '13 and '14. And so while it would be great if the comparison of R&D to revenue looked a little bit better, we believe, in fact, the most irresponsible thing that we could do is to reduce R&D or to artificially constrain R&D, thus guaranteeing that our share would be limited on a going-forward basis. So again, as we look at the technology transitions that are coming up over the course of the next 2 to 3 years and the opportunities that creates to get that incremental share, as well as a need, frankly, to defend a very, very high market share position already with north of 50% or so share in etch, we take very seriously the need to invest to protect both. We have always adopted the philosophy that if the investment is made properly and with the right orientation, if we're successful developing the products that meet our customers' needs, that the market share growth will come. That's been our experience over the course of the last, really, the last decade. And in fact, we continue to operate with that philosophy. So while we are mindful of our overall level of spend, we are nonetheless committed to making the R&D investments that we think will best position the company. And if we're successful, we'll look back and talk about how this was the right thing to do. If we fail to execute and we're unsuccessful, we'll -- you'll be provided with a chance to hold the company accountable at that time. But to cut off that opportunity today seems imprudent.

Stephen Chin - UBS Investment Bank, Research Division

Okay. Maybe we could elaborate a little bit more on the market share gains story since it's been a pretty strong success story there up to the mid-50% market share in etch. One of the key customers that Lam still doesn't have a strong position is certainly Intel, it's been well-discussed. Maybe you could share a generic discussion of what it takes to win at a new customer? Kind of what Lam is up against winning at new customers?

Ernest E. Maddock

Sure. One of the good things about the business is when you are engaged with the customer on a day-to-day basis, and this is really true of any customer, you have the ability to learn and to understand what their problems are and to understand how to help them solve their problems. So obviously, if you are not present in a customer, that adds to the complexity of trying to develop a solution that a customer would find a benefit to them. And so as you think about penetrating a new customer or really penetrating a new application at an existing customer that is not fundamentally based on the technologies that you know and understand, the first thing that you try to do is ensure the customer sees value, at least in the initial technical product offerings that you have. So perhaps, with the generic recipes that we would develop for a specific application or certain hardware features that may be of particular benefit. And once you've established that level of interest, that forms the basis for deepening the relationship on an ongoing basis. But we are very, very mindful of the fact that really what we're asking a customer to do is trust us with the most critical parts of their manufacturing process because certainly, I think there's no dispute about the fact that etch and increasingly clean become critical parts of the process. So it is a long collaborative process that is not very conducive to sort of spot-buying decision or spot change. And while that works in the company's favor in the vast majority of cases, it certainly is a bit of a detriment to the company in the particular customers' circumstances that you mentioned.

Stephen Chin - UBS Investment Bank, Research Division

Okay. And then maybe just elaborate a little bit more on Lam's financial model. I mean, you have shown us a case when industry spend on wafer fab equipment gets to about $35 billion. Lam can generate I think it was earnings power of close to $7 in EPS. As you look at the industry trends in that assumption, does that assume etch as a percentage of WFE is increasing? Or is that still a function of Lam's flexible operating model?

Ernest E. Maddock

It's -- really, etch in those models assumes operating in the range of 12% to 14%, which is the historical range as you know. And certainly, our assumption would be that as wafer fab spending begins to rise to the higher end of that range, that etch would also be at the higher end of its range. So while it doesn't presume sort of breaking through that 14% level, it does assume operating in the upper end of that range as opposed to the lower end of that range. It also recognizes the increasing importance of single-wafer clean and the fact that, that is actually growing as a percent of wafer fab and will likely continue to do so for the next couple of years before it reaches full saturation. And it presumes actually the kind of market share gains that we have demonstrated the ability to achieve here on a pretty consistent basis. So really, it's a function of all of those, and then certainly leveraging the company's operating model in terms of flexible manufacturing and a flexible cost structure.

Stephen Chin - UBS Investment Bank, Research Division

Okay. And then maybe the last question I've got is just on the balance sheet. The amount of cash that you think the management team feels comfortable managing the business with versus the amount of free cash flow that you could potentially generate, I think you showed if the industry's a $35 billion WFE environment, you could generate $1 billion of cash per year. I mean, thoughts on what to do with the excess cash?

Ernest E. Maddock

Well, first, let's get to a $35 billion wafer fab environment, and that will be a great problem to have there. But I think to reiterate sort of what we've talked about in the past. First and foremost, we continue to look for ways to responsibly grow the company. We have an adjacent market expansion strategy. And as we continue to participate and survey the market and try to understand how we might profitably execute that strategy on behalf of the shareholders, we certainly want to have the cash available to do that. It is also no secret that we have engaged in a share repurchase program, which allows the company to repurchase its shares at intrinsic valuations that the company finds attractive. Also there seems to be an increasing interest in dividends. And although from a technology perspective, that has been a relatively recent phenomena, certainly if that trend continues, it's certainly something that management would have to think about quite seriously, were investor sentiment and demonstrated differentiation of the performance of companies, who in our space, who pay dividends is present. It's certainly something we'd be willing to consider.

Stephen Chin - UBS Investment Bank, Research Division

Okay. And there's now the breakout session here, so we have about 5 minutes left, Ernie. So if there's any questions the folks in the audience wanted to ask.

Unknown Analyst -

Yes, 2 questions. One, longer-term, if one assumes that DRAM would be a declining percentage of total CapEx, what does this do to your etch percentage of wafer fab spending since DRAM is more etch-intensive than the average? And secondly, I guess, the conventional wisdom is the delay of EUV is good for etch because quad patterning, you mentioned, would be more etch-intensive. Then again if it is really that much more expensive, could we be in a situation where shrink size [ph] will be delayed in terms of implementation and then everybody gets impacted?

Ernest E. Maddock

So I clearly caught the first question. I'd ask you to repeat parts of the second if I may have misunderstood it. But relative to the first question, if you presume that DRAM declines but that NAND substitutes, right -- so I didn't hear you assume that basically the memory market itself is in decline, then NAND and DRAM are fundamentally relatively similar in terms of overall etch intensity. And certainly, relative to the cost of putting in 10,000 wafer starts of DRAM capacity versus NAND, there might be a 5% or 7% difference, but it isn't substantial. And both of those are far below the cost to put in 10,000 wafer starts of foundry capacity. So memory space is a pretty important space to the company. But in terms of dollar investment for 10,000 wafer starts, foundry is actually like a factor of 3 higher than any of the memory spaces. So presuming NAND substitutes for DRAM, I wouldn't presume any significant change in the company's fortunes. Now the second question relative to EUV was whether or not the delay of EUV could potentially cause a delay in customers' shrink plans?

Unknown Analyst -

Yes. I guess, on the plus side, quad patterning happening is good for etching, right, for logic, in particular. On the minus side, if 3D total wafer cost goes up by a factor of 40% to 50% because you start with quad patterning immersion and more etching, et cetera, then actually the pace of technology migration could be impacted negatively across your industry.

Ernest E. Maddock

That's potentially true. But bear in mind, there are 2 double patterning schemes. There's the spacer-based double patterning, which still only requires one immersion layer. So the cost of that double patterning scheme is very, very economical on a relative basis for customers. And at least based on some of the modeling work that we've done it, it would suggest that even quad patterning schemes that are spacer-based are very economical, even in light of any reasonable performance, it's a price criteria that you could have for EUV. Certainly, for litho-etch, litho-etch schemes, which are a part of the market, the advent of EUV or the introduction of EUV will be financially beneficial. I think it's really too soon to tell what the overall impact would be because as we think about a transition, particularly in the memory space and specifically in the NAND space to vertical structures, that sort of resets what is critical and what is noncritical across a very wide range of equipment providers, including lithography. So generally speaking, it probably has less critical lithography and slightly more noncritical. And so I think it's too soon to tell specifically what would happen if EUV continues to be a challenge from a schedule perspective.

Stephen Chin - UBS Investment Bank, Research Division

Okay. Well, I guess, if there's no other questions, I thank you all for attending this afternoon. Thank you, Ernie, for joining us this afternoon.

Ernest E. Maddock

Thanks very much.

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Source: Lam Research Corporation Presents at UBS Global Technology and Services Conference 2011, Nov-15-2011 03:30 PM
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