Lam Research Corp (LRCX) — Q1 2023 Earnings Call Transcript

Thank you, operator, and good afternoon everyone. Welcome to the Lam Research quarterly earnings conference call. With me today are Tim Archer, President and Chief Executive Officer, and Doug Bettinger, Executive Vice President and Chief Financial Officer. During today’s call, we will share our overview on the business environment and we will review our financial results for the September 2022 quarter and our outlook for the December 2022 quarter. The press release detailing our financial results was distributed a little after 1:00 PM Pacific Time this afternoon. The release can also be found on the Investor Relations section of the company's website, along with the presentation slides that accompany today’s call. Today's presentation and Q&A include forward-looking statements that are subject to risks and uncertainties reflected in the risk factors disclosed in our SEC public filings. Please see accompanying slides in the presentation for additional information. Today's discussion of our financial results will be presented on a non-GAAP financial basis, unless otherwise specified. A detailed reconciliation between GAAP and non-GAAP results can be found in the accompanying slides in the presentation. This call is scheduled to last until 3:00 PM Pacific Time. A replay of this call will be made available later this afternoon on our website. And with that, I will hand the call over to Tim.

Thank you, Tina, and thank you to everyone joining the call today. Our September quarter results reflect continued strong execution by Lam, with revenues topping $5 billion for the first time in the company's history. Gross margins came in at the higher end of guidance and operating margin and earnings per share both exceeded the guidance range. As you can see from our press release today, we also expect solid performance in the December quarter despite the challenging environment. Recently, the United States government announced new export regulations for U.S. semiconductor technology sold in China, including wafer fabrication equipment and related parts and services. We have taken the necessary steps to ensure full compliance with the rules and have ceased shipments and support as required. Our financial guidance issued today for the December quarter includes the impact of these changes. For calendar year 2023, we estimate the total revenue impact from these restrictions to be in the range of $2 billion to $2.5 billion. Turning to the broader demand picture, we see wafer fabrication equipment spending in calendar year 2022 in the low $90 billion range. This outlook includes the impact of new China-related restrictions and lower demand, partially offset by improving supply chain conditions. As some of our customers have indicated recently, there has been a rapid deterioration in demand fundamentals, particularly within the memory segments. Customers are adjusting investment plans into next year to bring channel inventories down to more normalized levels. As a result, we see memory bit shipments tracking below end demand for the next few quarters. In our normal cadence, we would provide our first view of 2023 WFE on our January earnings call. However, given the current environment, today, we are providing our preliminary estimate for calendar year 2023. Inclusive of the China restrictions, we expect next year's WFE to be down more than 20%, with memory investments accounting for a large portion of that decline. We will provide more detailed color on our outlook in our next earnings call. But for now, we believe that customer actions to reduce memory bit supply growth will create a favorable setup for memory mix to increase as a percent of overall WFE beyond 2023. As cyclical adjustments play out, the structural factors supporting long-term WFE growth remain unchanged. These include expanding semiconductor content in end devices, rising device complexity, and larger die sizes. These factors create tremendous opportunity for Lam, as they require greater etch and deposition intensity to enable higher performance and more scalable device architectures, including the transition to 3D structures. To ensure we are best positioned to win long-term, we are focused on three key strategies: First, continue to demonstrate our commitment to customer success by ensuring that the rapidly growing installed base of Lam tools at our customers is operating at maximum efficiency. Second, be a trusted R&D partner for our customers by sustaining our investment in the technology development that is most critical to their long-term device scaling road maps. And third, accelerate innovation and deepen our customer and supply chain partnerships by fully leveraging Lam's recently expanded global R&D and manufacturing infrastructure. Our installed base is now approaching 80,000 chambers in the field. This is over 30% higher than in the 2019 memory-related pullback in WFE. Lam's growing installed base continues to drive strong performance in our CSBG business, which hit another record in the September quarter with approximately $1.9 billion in revenue. While we won't hit new records every quarter, our installed base has become ever more important to our business model, particularly in WFE spending downturns. During such times, customers can continue to advance their technology, while optimizing capital efficiency through upgrades to their existing tools. We are also engaging with customers to find other efficiencies, including yield enhancement. An example of the opportunity this creates can be seen in our Coronus product line. Lam's Coronus double-etched process is employed by customers to help prevent process-related defects, which can impair cost per bit scaling. As a result, we have seen a steady increase in the number of double-etched passes used at each successive NAND technology node. Another opportunity to help drive efficiency can be found in the enormous volume of equipment and process data being generated from our large and growing installed base. Together with customers, we are using key learnings to deliver services and upgrades that positively impact our customers' operations. For example, we recently deployed Equipment Intelligence Services to support new equipment installation at a large memory manufacturer. Using these capabilities, we were able to shorten the time to release tools to production by more than 20%. While the near-term demand dynamics warrant an increased focus on operational efficiencies, the strong pull for technology advancement from our customers and the growth opportunity it creates for Lam continues. We made solid progress in the September quarter with key technology wins across multiple customers. For example, our ability to deposit critical films to lower device capacities and improved lithography overlay performance led to wins for these layers at a leading DRAM customer. For both applications, we leverage learning from our 3D NAND leadership position as well as ecosystem partnerships to bring innovative and cost-effective solutions to our DRAM customers. In foundry logic, we secured multiple new ALD application wins at a key customer by delivering purpose modifications and film characteristics required for building and integrating gate all-around structures. Whether it is our focus on operational efficiency or our collaboration on advanced technology, we believe our long-term success will be rooted in an R&D and manufacturing infrastructure close to our customers, close to our ecosystem partners, and with access to world-class talent. Consequently, over the past two years, we have made strategic investments to expand our global footprint, including the addition of a manufacturing facility in Malaysia, an R&D lab in Korea, and just last month, the opening of Lam's India Center for Engineering in Bengaluru. This center is a valuable addition to our global Lam network, specializing in the design and testing of hardware and software used across our product lines. So, overall, I am pleased with how we are continuing to strengthen our foundation in technology, manufacturing, and service. This foundation puts us in a very good position to navigate the current cyclical dynamics and emerge stronger as we look to capture the exciting opportunities we see over time in the semiconductor industry. Thank you again for joining today. And I'll now turn the call over to Doug.

Excellent. Thanks, Tim. Good afternoon everyone and thank you for joining our call today. Lam delivered solid results in the September quarter with record levels of performance across multiple metrics, including revenue, operating income, and earnings per share. The September financials reflect our focus on operational excellence and our ability to deliver and meet the needs of our customers in a dynamic industry environment. Revenue in the September quarter crossed the $5 billion mark for the first time in our history, coming in at approximately $5.1 billion. We continue to ramp output levels, delivering nearly 10% revenue growth over the prior quarter. Supply chain issues have begun to ease somewhat. They have not gone away completely, however. We continue to deal with certain inflationary pressures as well as output constraints. Deferred revenue was $2.8 billion and grew in the September quarter by approximately $550 million. This growth was primarily due to customer cash and advanced deposits followed by the timing of shipments on outstanding orders. With macro conditions weakening and wafer fab equipment spending declining, I expect deferred revenue and backlog levels will come down as we exit the December quarter. I'll provide more information regarding our December guidance and focus for calendar year 2023 later in my scripted remarks. Let me now turn to the segment details for the September quarter. Memory represented 52% of systems revenue, which was slightly down from the prior quarter level of 54%. Included in Memory, the NAND segment represented 39% of systems revenue compared to 40% in the prior quarter. We see capacity adds and conversions occurring by NAND customers mainly for 192-layer class devices. The DRAM segment concentration was consistent with the prior quarter coming in at 13% of system revenues, compared to 14% in the June quarter. The DRAM investments were primarily for 1z and 1-alpha node conversions. Foundry investments were respectable in the September quarter, comprising 34% of our system revenues, reaching a record level from a dollar standpoint. The increase in the quarter from the June quarter concentration of 26% was a result of the continued strength in investments for both the leading and mature node devices across a myriad of customers. These investments are supporting areas such as AI, IoT, cloud, automotive, and 5G. The Logic and Other segment contributed 14% of systems revenue in the September quarter compared with 20% in the prior quarter. I'll remind you that we had record results in this segment in the June quarter, and we continue to have positive momentum in the Logic segment. Our customer base here is investing in microprocessors, image sensors as well as advanced packaging solutions. I'll now turn to the regional composition of our total revenue. The China region came in at 30% of the total, relatively flat with the prior quarter level of 31%. The China September revenue was more concentrated toward the domestic Chinese customer base, and as Tim discussed, we now have additional restrictions for certain domestic Chinese customers and expect the revenue in this region will be significantly lower as we go into next year. The Taiwan region increased to a concentration of 22% in September versus 19% in the June quarter. Korea decreased to 17% of our total revenue from 24% in the prior quarter. I expect these two regions to continue to be strong for us based on the plans of our customers in those regions. The Customer Support Business Group results were strong in the September quarter. Revenue here reached a record of nearly $1.9 billion, which was up 16% from the June quarter and 37% higher than the September quarter in calendar 2021. All parts of the CSBG business delivered good performance in the quarter. Notably, the Reliant and spare product line revenues were at record levels. Reliant was the biggest contributor to the sequential growth in September. As we have noted in the past, CSBG revenues will fluctuate on a quarterly basis, while the macro set up creates the likelihood of a decline in trailing edge demand, the strength of our installed base and value-added services provide a platform to offset potentially softer specialty WFE spending. We do believe, nonetheless, that the specialty segment will weather next year relatively better than WFE in total. Moving to gross margin, the September quarter came in at 46% at the high-end of our guided range and increased from June's gross margin of 45.2%. We benefited from higher output levels as well as favorable customer and product mix. We do continue to have cost pressures in freight logistics as well as in certain raw material areas like semiconductors. I see headwinds coming in our December quarter related to customer mix, which I'll talk to when I address our guidance. Operating expenses for the September quarter were $647 million, up from the prior quarter amount of $635 million. The increase in spending was in R&D, which comprised nearly 68% of our spending, which was a high water concentration level for the company. We're focused on supporting our customers' manufacturing plans for both the short and long-term and investing with those objectives in mind. We're committed to managing spending next year as we see a decline in calendar year 2023 wafer fab equipment spending, which will obviously negatively impact our revenue levels. The September operating margin was 33.3% and was over the guidance range due to the higher levels of revenue and improved gross margin. Our non-GAAP tax rate for the quarter was 13.8%, slightly higher than expected due to geographic mix of income, coupled with the impact of the required U.S. R&D capitalization rules. Our estimate for the December 2022 quarter and for 2023 is for the tax rate to be in the low to mid-teens level. Please note, this estimate does not reflect the impact of any potential U.S. and global tax policy changes being considered. The minimum tax provisions of the Inflation Reduction Act are not effective for us until the second half of calendar year 2023, which is our 2024 fiscal year. We do not expect any meaningful impact to our tax rate related to this policy change, however. And also, as a reminder, as we've discussed in the past, you should expect the tax rate to fluctuate from quarter to quarter. Other income and expense came in for the quarter at $30 million in expense. This was an expected decrease compared with the $87 million of expense in the June quarter. I'll just remind you that we incurred a loss related to market declines in one of our venture investments last quarter, and we have now liquidated that position. Other expense in the September quarter was a bit better than we expected, mainly because of higher interest rates and an increasing cash balance and slightly favorable foreign exchange impacts. The OI&E P&L line item is subject to market-related fluctuations that will cause some level of volatility due to items such as foreign exchange, as well as impacts from the equity markets. From a capital return perspective, we allocated approximately $105 million to share repurchases during the September quarter. The cash was deployed in open market repurchases. The ASR from the June quarter also continued to execute in the September quarter. We paid $206 million in dividends during the quarter. And just to remind you, we continue to target returning 75% to 100% of free cash flow as our long-term capital return plan. September quarter diluted earnings per share came in at $10.42, which was above our guided range because of the strong revenue and improved profitability performance that I spoke about. The diluted share count was 137 million shares, which was lower than the June quarter and was in line with September quarter expectations. Let me now pivot to the balance sheet. Cash and short-term investments, including restricted cash totaled $4.6 billion, which was up from the prior quarter level of $3.9 billion. We generated solid cash from operations in the September quarter of $1.2 billion, which was partially offset by the share repurchases and dividend payments. Inventory turns were consistent with the prior quarter level, coming in at 2.5 times. Days sales outstanding was 82 days, which was a slight decrease from the 85 days in the June quarter. Non-cash expenses for the September quarter included approximately $71 million for equity compensation, $64 million for depreciation, and $12 million for amortization. Capital expenditures for the September quarter were $140 million, a little bit higher than June, which was $126 million. Capital expenditures are supporting growth in manufacturing facilities in the United States and Malaysia. Additionally, we're investing in research and development infrastructure in California and Oregon as well as our new technology centers in Korea and India. We ended the September quarter with approximately 18,700 regular full-time employees, which is an increase of approximately 1,000 people from the prior quarter. We had headcount growth primarily in the factory and field organizations, and some in R&D to address higher output levels, manage the supply chain constraints, and support customer deliveries and installations. We've decided to slow down hiring to only critical positions as we assess the business trajectory going into 2023. Overall, we're executing well in the short term. While we plan to prudently manage the business for a down WFE year in calendar year 2023. I'll remind you that we know how to manage this business during a down cycle. Our operating model has been constructed and tested for many years in different business environments. With that backdrop, I'll provide our non-GAAP guidance for the December 2022 quarter. We are expecting revenue of $5.1 billion, plus or minus $300 million. This includes our current estimate of the impact of new regulations on our ability to supply products and services to certain customers in China. This revenue guidance would have been decently higher if not for these new regulations. Gross margin of 44.5%, plus or minus one percentage point, this is down from the September quarter, primarily due to customer mix. We have lost more profitable business from the China region. Operating margins of 31.5%, plus or minus one percentage point; and finally, earnings per share of $10 even plus or minus $0.75 based on a share count of approximately 136 million shares. So let me just wrap it up. Throughout 2022, we've demonstrated the ability to deliver record financial performance and profitable growth. It's been a year of volatile supply chain constraints, inflationary pressures, and regulatory changes. We're confident we're prepared for the challenges we see in the industry in calendar 2023, and we've built a solid foundation for continued success evidenced in our technology leadership and robust installed base.

Hi. Thanks a lot. This is Jason on for Tim from UBS. I just have a couple of questions. So my first question is on your December guidance. You just guided to deferred revenue to come down. So I was just curious whether you can quantify for us how much of excess deferred revenue you're realizing and contemplating into your December guide. Then I have a follow-up. Thanks.

Yes, I'm not sure I completely heard you. I think you asked what we think deferred revenue in December is going to do. And all I'm going to tell you is I expect it to go down. I'm not going to quantify it for you.

Got it. Thanks a lot. Yes, so my second question is on the gross margin for the December quarter. Could you please quantify how much of a headwind you're still facing in December for things like elevated freight costs in the Malaysia facility there? When can we expect the gross margin to normalize eventually? Thank you.

Yes. No, I'm not going to quantify that for you either. It's still a headwind, otherwise, I wouldn't have put it in the scripted remarks. As we go into next year, and I think supply gets caught up with demand in terms of some of the supply challenges we're having, I expect some of the inflationary headwinds there to mitigate. I expect the same thing in freight and whatnot. So I'm not going to put a number on it, but I do expect that that will get better as we go into next year.

Yes. Hi. Good afternoon. Thanks for taking my question. Given your commentary on a $2 billion, $2.5 billion impact next year from the export controls in China, it looks like near-term you are offsetting some of that with your significant deferred revenue and order backlog with some of your non-China customers. But, I guess, my question is, could you quantify of the $2 billion, $2.5 billion impact, what percentage is systems and what percentage is services? And then, I have a follow-up question.

Yes.

You go ahead.

Yes, Harlan. I guess, we wanted to give some sizing for that in 2023, since we knew there would be questions that we're not going to break out the difference right now. That's inclusive of both systems and spares and service for those customers in China that are impacted by the restrictions. I think that we talked a little bit about improving supply chain conditions. And so, where possible, we talked about December, including some impact of, of course, China restrictions, offset partially by supply chain easing, offset as well by some decreases in other customers due to the demand elements that we talked about. So we're not prepared to break each of those items out, but we're doing best we can to essentially meet customer demand requirements where we can as early as we can.

I appreciate that. For my follow-up, the team has recently begun to break out services or your CSBG business, which is evolving into a more stable, multi-year service contract-focused business that offers enhanced value-added services and solutions. As indicated in your presentation, chamber shipments have significantly increased over the past three years. Considering a potential weaker WFE environment next year, I am curious about the historical performance of the Lam services business during previous downturns. Has it generally remained stable or grown during those times, and do you anticipate a similar trend in a weaker WFE environment next year?

Well, Harlan, in my comments, I specifically said it's a very important part of our business model, especially during WFE downturns. It's also been a very deliberate strategy of Lam. I think if you attended the last couple of investor conferences, we've talked about an intention to increase revenue capture per chamber. And so I mentioned that just in the time from the last WFE downturn in 2019 from now we've managed to grow the installed base in chamber count by more than 30%. At the same time, we've also increased the breadth of our portfolio and the services that both in terms of the types of equipment intelligence services, the spares, the upgrades that have also meaningfully improved our opportunity for each of those chambers that's in the installed base. So each element of the spares of CSBG, whether it's spares, upgrade services, Reliant probably moves a little bit differently through each of the kind of WFE up cycles or down cycles. But generally, spares, as we've said, holds up pretty well as most customers continue to run all of the tools that they've got installed. Upgrades sometimes can actually do a little bit better as customers have a little bit more time in a downturn to make the improvements that they want to make so that they come out of those downturns stronger with their installed base. And then services, especially with our expanding offerings around equipment intelligence sources I talked about efficiency, productivity, those are all things that are important to customers at all times. But they're really important to customers as they're thinking about squeezing everything they can out of the installed base they have and being able to then maybe delay additional capital purchases or expenditures for just a bit longer. So I would say that we see CSBG as a very important part of stabilizing the company's performance through cycles.

Harlan, the only thing I would point out incrementally. Yes, the only incremental thing I'd point out incremental to what Tim said is, I've been talking about how strong Reliant has been the last several quarters. And in fact, last quarter it was the biggest sequential grower in CSBG. And as we look into 2023, we're not going to parse all the different components of WFE, but I know there's some people out there that think specialty segment of WFE will soften next year, and that would impact Reliant along with that offset by the things that Tim talked about.

Yes. Thank you for taking the question. I guess first question relates to deferred revenues. So when you gave us your early view for 2023 WFE, how are you kind of reflecting deferred revenues for you as well as the rest of the industry in that more than down 20%? And as part of that, should we be thinking about your deferred revenues getting close to zero exiting calendar 2023?

Yes. Let me address that first, and then Doug can add his thoughts. We have considered what we believe the industry can achieve from a shipping and revenue standpoint. So, when looking at those numbers for next year, it's somewhat analogous to this year's figures. I believe the year will unfold in a way that allows deferred revenues to decrease as the supply chain improves. There is certainly a normal level of deferred revenue we expect, which I will let them clarify. It won't drop to zero, but we will see a significant portion of the deferred revenue that reflects the systems we were unable to deliver this year, as we ramp up our capacity and the supply chain catches up, allowing us to fulfill deliveries and recognize revenue.

Yes, I mean, C.J., you know that, deferred revenue is never a zero number because we always have these cash-in-advanced payments, volume purchase agreement credits, a whole bunch of different things, spares and service credits that are there. If you look for the supply chain challenges we had, a normalized level of deferred revenue would be somewhere between $500 and $1 billion. It bounces around, it's lumpy sometimes, but that is kind of the normalized level that I think about. And it's elevated right now because of the backorder stuff and the incomplete tools that we're shipping. It will come down in December and then it will come down more as we go through 2023, is our outlook right now.

Very helpful. And as my follow-up, you've grown your headcount by 30 plus percent over the last five quarters. And I'm just curious, as you contemplate the coming kind of correction, how are you thinking about headcount? How are you thinking about OpEx and operating leverage?

Well, I think that obviously, as Doug mentioned in his comments, it's not our first downturn. And the reality is we really had no choice but to expand the company as we tried to meet what was really unprecedented, the gamble of the last couple of years and no choice in doing that. And as you see, not only did we add headcount, we also expanded our facilities. Obviously, as you move through cycles, we then look at the resources that are required to meet the business level in the year and going forward and beyond. But I made a couple of comments. One, we think it's incredibly important that we sustain technology development through any cycle. Our customers expect for us to be continuing to advance the products and technology they're going to need on the other side of the demand cycle. And two, I talked about some very strategic investments that we've made to expand our global footprint, to put us closer to where some of our key customers are, to create capabilities closer to ecosystem partners and our supply chain. And we think those investments are incredibly important to the long-term business model of the company. And so, we'll be sure that however, we're thinking about the resources in the company that we sustain those types of investments as well because it's not only how you act to the downturn, it's how prepared you are for the next upturn and what performance you can deliver in that cycle as well. So those things are all under consideration now. And it's also why we gave you some look ahead to 2023 to give you a sense of how we're thinking about how this business can run through the near term.

Thanks, C.J.

For my first question, you obviously have backlog and deferred orders supporting you through December. For calendar 2023, you are projecting a decline in WFE; based on my calculations, it seems to be around $70 billion. How should I think about the transition from your current performance to that future environment? Can you provide any insights, even qualitatively, about the March quarter? Are you currently at the run rate where you expect WFE to be next quarter? What does that transition look like?

Yes, Stacy, I mean we gave you color beyond what we would normally do at this point in the year, and I'm not going to do any more than we've already provided. That's the best we're going to be able to do for you right now.

Sure, I'll address that follow-up. If I examine the WFE guidance for the upcoming year, it's projected to decline by 20% or more from the low 90s, bringing it to around $70 billion. You mentioned that this forecast accounts for the China sanctions. Would the figure have been higher without those sanctions? Are you considering that some of the capacity in China may be shifted to other companies? What does that situation look like?

No, that assumes that most of the China WFE comes from a specific source, and I don't believe that could happen. If your question is whether someone else could spend what those customers were planning to spend to install the same equipment or capacity, our current perspective is that this is unlikely to occur in 2023.

Yes. I guess what I'm asking is if it wasn't for the transactions, would you be looking for WFE like $80 billion or $75 billion instead of the $70 billion where it seems to be coming out?

Yes. It would have been a little bit higher, Stacy. Yes. Yes, it would have been a little bit higher.

Yes, hi. Thanks for taking my question. I have two of them. So, the first one, thanks for the color on CSBG. I'm just kind of curious, you shipped a lot of tools this year. Most of them are under one-year warranty. So they won't necessarily contribute CSBG revenues. WC down 2% or higher and the customer utilization rates come down, is there a way to think about what utilization rate below which actually CSBG revenues don't grow?

It's a challenging question because there are actually four components of CSBG, and not all of them depend entirely on utilization. Regarding the tools we've shipped, we've seen a 30% increase in chamber count since 2019, indicating significant growth in our opportunities. Some parts of CSPG, including spare space and consumables, do begin with customer usage. Therefore, that one-year delay doesn't apply uniformly across all CSBG spending. I haven't calculated the specific utilization rates at which certain elements would not grow, but we expect customers to continue using the tools extensively, especially those already installed. There is likely to be more interest in upgrades rather than adding new capacity, which will benefit both our CSBG business and Lam's investment capture rate. Overall, CSBG remains a vital segment of our business.

Pointing out Doug also commented some elements like Reliant are subject to kind of overall macro environment, and we just have to watch that as we go through next year.

Got it. Got it. Tim, that's very helpful. And then as a follow-up, it seems like the first time your foundry revenues crossed $1 billion in a quarter. And you mentioned about some ALD wins for gate all around, etc. So I'm curious how much of the foundry strength is share gains versus just underlying cyclical strength from the foundry purchasing?

Over to you, Krish. I believe you and everyone on the call recognize that foundry investment is quite robust this year. That plays a significant role. Additionally, we have made some incremental gains. Tim usually highlights some of these at every earnings call, and you just mentioned a few now.

Yes, Krish, I usually focus on our performance alongside some of the longer-term trends we've highlighted. When you consider foundry logic, our emphasis has been on ALD, where we've made significant strides. There are areas like the EUV patterning module that encompass hard masks and the capability to etch very fine pitch features with remarkable uniformity across the wafer and between different tools and chambers. Although I generally discuss longer-term projections, this illustrates the company's momentum that is not tied to the current cycle. These are areas where we're gaining ground, and when customers decide to purchase, it leads to substantial opportunities for the company.

Thank you. Regarding the business affected by the export controls, you mentioned an estimate of $2 billion to $2.5 billion for the next year. Could you explain how that figures on a run rate basis? I'm trying to grasp whether this projected amount indicates growth compared to previous figures. I want to understand the extent of the negative impact in relation to the past numbers.

Yes, that's a good question. I mean, obviously, we're giving a 2023 a little earlier than we probably have a great look at 2023, but in that number, $2 billion to $2.5 billion, we did anticipate some growth in 2023 over 2022. So we won't say how much, but it's incorporated some growth from the run rate we see today.

Okay. Thank you. And then within the service spares in particular, part of that business, I assume you'll be impacted in your ability to ship spares going forward as well. Should we think about those customers being similar in size to their overall capital spending? Or have they been sort of purchasing spares ahead of this? And could they be outsized exposure within your services business because of that?

Yes. No, Joe, there's not an enormous amount of it. There's been a little bit of inventory. I think the entire customer base built up with some of the supply chain constraints this year, including the local Chinese customers, but it's not like a crazy amount.

Great. Thank you so much. I was hoping, Doug, you could help us think about your systems revenue into 2023 vis-à-vis how you're thinking about WFE? Obviously, you're over-indexed to memory where you guys expect the bulk of the decline to come in 2023. You've been really successful in China and chunk of that is coming out on the positive side, you seem to have really strong momentum in both logic and foundry. So, net-net, is it fair to assume you guys can kind of perform in line with WFE? Or do you think '23 is going to be a relatively challenging year, just given your mix?

Yes, I think in many ways you answered your own question. We're somewhat over-indexed in memory and have a strong market share there. However, we expect a decline in the overall WFE next year, which will be offset by the strength of our CSPG business, which I consider to have the highest quality installed bases in the industry. This will benefit us. If you want to get an idea of what this might look like, look back at 2019, when memory was quite soft but foundry logic was strong. We navigated that period successfully.

That's helpful. Thank you. And then as my follow-up, a question on gross margin. So you're guiding December down 150 basis points, and Doug, you spoke to customer mix. One of your competitors, they've talked about inventory write-downs and costs associated with repurposing tools. Curious if anything like that is negatively impacting your December quarter guide? And I guess, more importantly, how should we think about margin beyond with volume declining? Could gross margins decline further from here? Or do you think there are enough offsets in pricing and hopefully, freight and semiconductor pricing that could help you on the upside? Thank you.

Yes, let me unpack it a little bit. I don't really think we're going to have a meaningful inventory exposure. So no, there isn't anything from that. We believe we're going to be able to meaningfully rework any inventory we had that might have been targeted for those specific customers we can no longer ship to. And I don't think, as I sit here today, that's a material number. So the softness, sequential softness in December gross margin is because we lost some very profitable customers in the China region, and that's going to persist, obviously. So that was kind of the first question. Unpacking next year, I mean, the way I think about it, first, I think, as everybody on the call does, this isn't really a fixed cost business. It's highly variable. And so as volumes vary, a lot of cost of goods sold varies. You've seen that from us over the years. So that hasn't changed. The model here hasn't changed. As we go into next year, the benefit, I think we'll see in gross margin is. I believe we'll see the mitigation on some of these inflation pressures. I think supply gets back caught up with demand in terms of our supply base in areas like semiconductors. I believe freight gets better next year to what magnitude. I'm not positive, but I think that gets better. And then we ramp supply chain in Malaysia, so we're flying things shorter distances and whatnot. And so, we're going to see the benefit of that offset then by we've just lost some very profitable customers. And yes, volume will be down. There is a little bit of fixed cost in the factory and field that we're going to have to deal with. So, I'm not going to quantify it for you, but those are the puts and takes.

The only thing I would add is there's been a lot of our actions. Again, I spoke to some of the repositioning. I mean effectively, your question is about next year, but we're really thinking about, again, long-term trajectory for profitability in the company, which both Doug and I have said over time, we want to drive it meaningfully higher. And so, Doug mentioned and I mentioned the investment in Malaysia. We talked about the engineering activities in India, talk about the technology lab in Korea. All of these things are designed to make us faster and more efficient in our operations over the long term. And so how much of that shows up next year and kind of how the effect is going to see how next year plays out. We're going to be focused on it. As I said, we go back to look in 2019, we do pretty well in these periods. But really, what we're trying to message is that the investments we've made over the last couple of years, taking advantage of this very strong growth period in the company really sets us up for the remainder of this decade to really drive the strategy of the company towards, again, speed of mission and efficiency and delivery of our products and services.

Thanks for taking my question. For the first one, I'm curious, Tim, when do you see your ex-China memory customers getting to some level of supply-demand equilibrium? Is it sometime in Q1, Q2, Q3, just what's your sense of how much inventory do they have? And how much time would it take for them to clear it out, so that your orders can resume?

Yes, we are beginning to focus more on 2023, and we've included our perspective in the guidance for that year. We would prefer to wait until we are closer to the year to provide further details. Customers are taking action, and you may have heard about some significant efforts from them to align inventories with supply and demand. While I won't speak on their behalf, I believe that as we finish 2023, we will be in a favorable position for memory spending as a percentage of total WFE to increase from that point. We'll keep you updated as the year progresses.

And Vivek, maybe just an observation for me. I mean, these cycles have similar timeframes associated with them, almost just walk back in history and look at it. With the caveat, though, I think as we came through all the supply chain challenges this time, maybe a little more inventory gotten built up, when I look at things in the industry, so it might be a little bit longer than typical, but these things are pretty consistent on a historical basis. So you just go look at history, you'll have to answer your question.

Hey, guys. Thanks for taking my question. I just want to ask you all the restrictions. I mean, I guess just optically looking at it, it seems like you're taking out the domestic memory vendors. And I know there's very little leading-edge logic. I'm just curious, at least some debate as to whether the multinationals, whether you could still ship to their Chinese facilities. I know there were some licenses, maybe for services, but just kind of curious if you could just quantify your understanding of the restrictions and what you're taking out, and whether it includes multinationals and if you can still ship to facilities that may make leading-edge foundry processes even if the equipment is not being used for?

Bunch of questions there. First of all, maybe the simplest is we've taken out, obviously, the shipments that were destined for applications or customers that are restricted, which primarily means right now domestic Chinese customers that are manufacturing restricted technologies, which in NAND and DRAM have certain specifications and in foundry logic and others. The multinationals, as you noted, were given an authorization to receive shipments and service and so our business there effectively remains unchanged as a result of that. And so we are continuing to include that in our outlook for 2023. To your point about a facility, it's our understanding that a facility that would have mixed use would likely fall under the restricted category. And so, therefore, if a customer were to want to manufacture and take shipments and receive support for unrestricted technology, you would have to be in a facility that was clearly not also doing restricted activities. And I think that that's something that's being worked through by our customers. We've contemplated all of those, as well as what we believe will happen in China, and to that $2.5 billion estimate. And so that's our view right now of the restrictions on how they affect customers and our business.

Thanks. In December, I was a bit confused. You mentioned an impact of over 500 million per quarter that you can't ship to, and that your sales are flat. I'm curious if you're compensating with other customers. How adaptable is the equipment you initially intended for Chinese memory? Can it be repurposed this quarter, and is that why you're not seeing an impact, or do you anticipate shipping at a higher level, which we weren't aware of, leading to the flat sales?

I believe that, as Doug mentioned, the December projection would have been significantly higher if the restrictions in China had not been implemented. That clarifies the matter. We noted that we may have compensated somewhat due to improved supply chain conditions, but that would have occurred regardless. Therefore, December's figures would have been greater had the Chinese restrictions not been in place.

Yes, thanks for taking the question. I just wanted to go back on the expectation that deferred revenue declines in the December quarter. Is there any part of that that's related to the export restrictions where customers that are now restricted had tools that were incomplete, that are now, I don't know, more or less stranded?

No, Joe, there's not. We cannot ship anything to those restricted customers.

But tools, I guess, that were previously shipped that are just incomplete like they were shipped last quarter or two quarters ago?

If that situation existed, and I'm not saying it did or didn't. We can't ship anything to them.

Got it. Okay. And then just trying to think about bit shipments in the cycle, relative to prior cycles, how do you think about your customers' willingness to hold more inventory on their own balance sheets this cycle relative to prior cycles? Does that change the way you think about maybe the snapback in terms of like bit supply growth?

Yes. It's a good question. It's definitely one that's better relative to their tolerance of holding that inventory. I think everybody's view of inventory probably changed a little bit as a result of shortages and the ability to respond to what—over the last two years, we've seen a relatively sharp changes in demand. But I really can't answer for them about their willingness to hold more inventory. I think we're going back and as Doug said, looking at kind of historical behavior and these kinds of downturns, what we're experienced with, and that's how we kind of like project out what we think will likely happen.

Operator, we have time for one more question, please?

Thanks for fitting me in. Tim, there seems to be some confusion regarding the market's interpretation of the license requirements for US citizens in China. Could you clarify if the support license requirements affect the same group of customers as the equipment license, or if there is a wider impact on US citizens operating in China?

On US citizens operating in China, there is a restriction as defined by the government regarding support for the development of restricted technologies.

Right. But is that just sort of the same set of customers that require export licenses on the equipment side. So, the advanced NAND, the DRAM, and 16-nanometer and below? Or is there a broader set of customers you cannot support under the export control?

No, I believe it is the same step that spelled out. Fundamentally, customers that are either on a restricted list or producing restricted technologies for those that are affecting.

Okay. Operator, that will conclude our call. I’d like to thank everyone for joining us today. Have a good day.