Check out the latest Lam Research earnings call transcript.

Computing is getting more complex. Big data and artificial intelligence are demanding a new wave of chips to keep up with the world's flood of data and increasing workloads.

Far upstream in the semiconductor industry, Lam Research (NASDAQ:LRCX) is a leader in wafer fabrication equipment (WFE). With only a handful of competitors, the WFE oligopoly provides the expensive equipment that is necessary to actually manufacture these chips.

An image of a silicon wafer undergoing probe testing

Image source: Getty Images.

Lam's financial results during the past fiscal year have shown signs of a weakening semiconductor industry, caused by lackluster demand for smartphones and evaporating demand for bitcoin mining chips. Revenue and profits fell again this quarter, though there could be signs of improvement on the horizon.

On Thursday, Lam's stock rose 16% after the release. Let's take a closer look at Lam Research's second-quarter results.

Lam Research results: The raw numbers

Metric Q2 2019 Q2 2018 Year-Over-Year Change
Revenue $2.52 billion $2.58 billion (2%)
Operating income $690 million $737 million (6%)
Earnings per share* $3.51 ($0.06) N/A

Data source: Lam Research. *On a fully diluted basis.

What happened with Lam Research this quarter?

Revenue and profits again fell in the second quarter, though CFO Doug Bettinger did note that all of the company's financial results exceeded the midpoint of its issued guidance.

  • Revenue of $2.52 billion was down 2% from last year. Memory continues to be a bright spot, accounting for 79% of the top line. Within memory, NAND/flash represented 55% of total revenue and DRAM represented 24%. Foundry revenue declined slightly to 13% of revenue, and logic/other accounted for 8%. 
  • Gross margin fell 130 basis points to 45.4%, down from 46.7% last year.
  • Operating income fell 6% from last year to $690 million. Many of Lam's costs are fixed, so reductions in revenue have an even greater impact on operating profits.
  • Lam's forward guidance is for $2.4 billion of revenue, 43.6% gross margin, and $3.21 EPS in the upcoming fiscal third quarter.

Perhaps the biggest event that took place during the quarter didn't even appear in the financial results. CEO Martin Anstice, who had been at the helm since 2012, resigned in early December amid allegations of workplace misconduct. While the allegations are short on details, Anstice joins Intel's Brian Krzanich and Texas Instruments' Brian Crutcher as the latest CEO of a multibillion-dollar semiconductor company to resign due to misconduct. Anstice left without any severance benefits and was immediately replaced by Lam COO Tim Archer.

Archer is a lifer in the industry, having started as a production engineer for a chipmaker, and has been with Lam since 2012. One of Archer's first orders of business was to take advantage of Lam's lagging stock price. The company issued a $5 billion share repurchase authorization, which would be enough to buy back more than 20% of the outstanding shares at today's market cap. 

What management had to say

In his first earnings call as CEO, Archer laid out his long-term plans, which hinted at capitalizing on the growing opportunity for big data and AI:

As we see in the current environment, I value having a flexible operating model that enables us to respond rapidly to market changes to ensure we deliver on our commitments to our customers as well as our shareholders. I believe we are still in the early stages of a long-term secular growth story for the industry and particularly for Lam.

What you can expect to see from my leadership as CEO is increased focus on leveraging our core strength to deliver technology and productivity solutions to the fastest growing segments of the semiconductor equipment market, which in the long term we believe are those tied to the enablement of the emerging data economy.

Looking forward

Investors will immediately notice that Lam's revenue and margins both slid during the quarter. And its guidance -- which is even lower than this quarter's -- would suggest that the industry's weak demand will continue.

Lam is already well aware of its industry's cyclicality and seems prepared to ride out the storm. It is sitting on $3.9 billion in cash and short-term investments, which is enough to fund all of its operating expenses for two full years. Even in this difficult environment, the company continues to invest 11% of revenue into research & development.

But there are also signs that the industry may be turning the corner. Market intelligence firm IDC predicts that global smartphone shipments fell 3% during 2018, as China's trade disputes with the U.S. made for a difficult year. But IDC also expects 5G deployments to begin picking up, which could help smartphone shipments grow 2.6% in 2019. If so, chipmakers could ramp their production back up, along with their demand for Lam's equipment. We'll keep an eye on the macro picture.

Lastly, Lam's capital return program has been a bright spot for investors. The company returned $3 billion in fiscal 2018 through buybacks and another $500 million through dividends, and it plans to continue to return at least 50% of free cash flow to stockholders. Even with the current industry lull, its annual free cash flow has quadrupled during the past five years, from $559 million in fiscal 2013 to $2.4 billion in fiscal 2018.