Q2-22 Earnings Release and Analyst Call

3/29/21

Press Release Commentary

Here are the points from the press release, outside the financial statements, that I found notable:
• Results exceeded the high end of the guided range for both revenue and margin
• The company is the industry leader in both DRAM and NAND technology
• A dividend of $0.10 per share will be paid to shareholders of record on April 11th, to be paid on April 26th

Financial Statements

Statements of Operations

The results in the second fiscal quarter was similar to those in the first quarter. Since guidance was for a down quarter, this was a meaningful beat in financial performance. Revenue was $7.79B, a quarterly record, up by about 1% sequentially. COGS was down slightly, so gross margin expanded, coming in at $3.68B. This is 47.2% on a GAAP basis, up 80 bps from the previous quarter. R&D cost rose quite a bit, from $712M to $792M. There was also a $145M swing in “Other operating expenses,” which made this quarter appear worse than last quarter than it actually was. Non-GAAP operating margin was 35.3%, flat to the 35.4% operating margin in the previous quarter. Net income was $2.26B, or $2.00 per diluted share, slightly down from the previous quarter because of higher overhead and the swing in the “other” category. Share count was flat at 1.13B diluted shares.

Cash Flows

For the first six months of FY-22, my version of owner’s cash flow for Micron is $2.35B. In this calculation I take stock-based compensation back out and ignore the effects of working capital on cash flow. Annualizing this number and dividing by Micron’s market cap of $91.88B (at a per-share price of $82) gives an owner’s cash flow yield of 5.1%. If Micron’s through-cycle performance were similar to this first six months, the stock would be a good buy at this level. But the shape and duration of the cycles are what make or break any investment in Micron. Historically, the company gushes cash flow for the handful of quarters when memory prices are high, then produces little to no cash in the trough. It also matters what management does with this cash. In the first six months of the fiscal year, they have bought back $667M worth of stock and paid out $224M in dividends. The share count has declined by 8M in the last six months, which is a total value of $656M. This means almost all of that cash used for buy-backs has been reflected in the share count, so shareholders have received this value. The company continues to pour cash into capital expenditures at a rate much higher than depreciation. This is both for future growth and a consequence of the ever-increasing capital intensity of making semiconductors. CapEx in the first half of the year was $5.9B vs. D&A of $3.4B. Management said on the call that this is half of what they anticipated spending on CapEx in the fiscal year. About $300M of cash was shifted to available-for-sale securities so far this year. Micron’s cash balance has risen by almost $1.4B in the first two quarters, bringing their cash and equivalents to $9.2B. The nearly $900M they received from TI for the sale of their fab in Lehi, Utah helped here. Management has been good with share buybacks this year, following a dismal record before when they missed out during the down-cycle. I hope to see that they were active in the early-March swoon that saw their share price dip below $70 at one point.

The Balance Sheet

While reviewing this balance sheet it hit me how different Micron is as a company than it was a few years ago. The balance sheet today was fragile ten years ago. It is stout today. The new management team deserves much of the credit for this. The oligopoly in the DRAM market that started in 2013 with Micron’s purchase of Elpida is the other reason. Micron has over $10B in cash, equivalents, and short-term investments today, plus another $1.7B in long-term marketable investments. This is against $7B worth of debt, so the company has a net positive cash position of nearly $5B. In the quarter working capital increased across the board. Management said in the call they are preparing for higher demand in the rest of the year. PP&E rose by $1B to $36B as the company continues to invest in capacity and new technology at a much faster rate than depreciation. Book value increased another $2B, same as last quarter, to $47.8B, or 1.9x book. With all this financial strength there is no excuse for management to not be taking full advantage of the volatility in the company’s stock price when there is a large pull back. I hope to see that they bought back a lot of stock in March, when the Q3 results are released.

Conference Call

Numbers given during the conference call are non-GAAP.

Sanjay Mehrotra (President and CEO)

• SSD products revenue and automotive revenue were both quarterly records
• The company is standing by their forecast that FY-22 will be a record year for total revenue
• Their Xi’an, China site was affected by the COVID-19 lockdown there, but they still hit quarterly customer commitments
• The Russia-Ukraine war is not expected to negatively impact their production volumes for lack of noble gases, but they will be paying higher prices
• Data center revenue in the second quarter grew more than 60% year-over-year, which comes from both DRAM and NAND products
• Strength in enterprise PCs offset weakness in personal PCs and Chrome books. They expect PC unit volumes to be flat year-over-year, but memory content per unit will continue to increase. Client DDR5 DRAM demand continues to exceed supply.
• The 4G-to-5G transition increases DRAM content per phone by 50% and doubles NAND content per unit
• Industry bit demand growth in CY-22 is expected to be in the mid-to-high teens % for DRAM. NAND bit demand growth in CY-22 is expected to be approximately 30%. They see healthy supply-demand balance across both DRAM and NAND. Non-memory component shortages continue to improve, and that trend will continue throughout the year which should help increase memory demand of both types.
• Micron’s CY-22 bit supply growth for both DRAM and NAND are unchanged from prior expectations and will be in line with industry demand. They expect strong bit shipment growth in the second half of the year.
• The company expects their cost reductions to outpace the rest of the industry this year as they ramp their 1-alpha DRAM and 176-layer NAND nodes. This is a change from last quarter when they said their cost reductions would match their competition.

Sumit Sadana (Interim CFO)

• Revenues by business unit was mostly flat from the previous quarter, up 2% in CNBU and SBU, down 2% in MBU. EBU was the outlier with 5% growth in revenue
• Gross margins benefitted from improved product mix and manufacturing cost reductions
• Capex guidance for FY-22 will be in the range of $11B to $12B, roughly equal between the two halves. They expect significantly stronger free cash flow in the second half of the year compared to the first half
• They remain committed to returning more than 50% of cross-cycle free cash flow to shareholders
• Their inventory level was 113 days, because of an increase in raw materials and of wafers in process, to support higher demand in the second half
• Company financial performance is ahead of their plans one quarter ago. Demand is strong across most end markets and pricing trends are “constructive”
• In the quarter, DRAM was 73% of company revenue. DRAM bit shipments were up high single-digit-percent range Q/Q (was down mid-single-digits percent last quarter). ASPs were down mid-single-digit percent range Q/Q (was down low-single-digit percent range sequentially last quarter).
• NAND was 25% of company revenue in the quarter. Revenue was up 5% Q/Q. Bit shipments approximately flat Q/Q (were flat sequentially last quarter) and ASPs increased mid-single-digit percent Q/Q (were down mid-single-digit percent last quarter)
• The company bought back 4.8M shares in the quarter at a total cost of $408M ($85 per share average.) Last quarter they bought back 3.6M shares.
• FQ3-21 non-GAAP guidance: revenue of $8.7B +/- $200M, operating expenses of $1.05B +/- $25M, GM of 48.0% +/- 1%, diluted EPS of $2.46 +/- $0.10, based on 1.14B diluted shares. This would be a record quarter for revenue.

Analyst Q&A

• Both NAND and DRAM gross margins are expected to improve sequentially in FQ3. They have 100 bps hit to gross margin in FQ3 from two sources; higher accrual for employee bonuses because of profitability forecasts being higher, and NAND (which has lower gross margin) outgrowing DRAM in the quarter.
• They see an overall healthy environment for both DRAM and NAND supply and demand throughout the rest of the year
• In response to a question asking if mobile demand has plateaus, Sadana said that is not the case, with memory content increases being driven higher by the ongoing conversion to 5G mobile phones
• Much of the gross margin increases they saw in Q2 came from both DRAM and NAND pricing improvements. In Q3, their forecasted increases are primarily driven by CNBU and SBU.
• Inflationary pressures on inputs across their business are expected to persist for the next several quarters. Sadana cited wages, materials, power, commodities, and subcon services
• Like-for-like NAND pricing declined sequentially in the quarter, but improved mix made up for it

Post Earnings Q&A call with Sumit Sadana (CBO and interim CFO) and Manish Bhatia (EVP of Global Operations)

• Their current level of long-term agreements covers all their large customers and at the level of >75% of their revenue and this can’t go much higher, because some of their segments can’t have LTAs, such as their direct-to-consumer business
• Their customers are carrying more inventory, in general, to keep their revenue being gated by lack of components, including memory. Sadana doesn’t see that going back to pre-COVID levels soon, as COVID, supply chain, and geopolitical risks are top-of-mind for many customers.
• Inventory reductions at PC customers that were seen late in 2021 are now complete
• Server DRAM is now their largest DRAM segment. The Data Center TAM is now the largest segment in the market.
• Their long-term forecast for front end NAND cost/bit reductions continues to be mid-teens percent annually. Their change in cost reduction forecast from last quarter relative to competition is because of changes to Micron’s cost declines.
• NAND pricing in Q3 is better than DRAM, but DRAM is “also constructive.” They expect “modest” GM growth in DRAM in FQ3. Sequential GM improvement in NAND will be stronger.

Summary

Micron’s second quarter results were similar to those in the first quarter. Management had forecasted for a down quarter but memory pricing in both DRAM and NAND was better than expected. The CEO is sticking with his prediction that FY-22 will be a record revenue year for the company. The previous best year was FY-18 with total revenue of $30.39B. To match that they will need to average $7.46B per quarter for the third and fourth quarters. Since they guided for $8.7B in the third quarter things would really need to fall apart in Q4 for FY-22 to not be a record year. The opposite seems most likely. Pricing, the single most important factor for Micron the company and MU the stock, is favorable today and looks to stay that way for the rest of the year. The NAND supply loss at Kioxia recently has boosted NAND prices. Management said DRAM pricing is “constructive,” though not as good as NAND is. For the quarter, DRAM ASPs were down mid-single-digit percent after being up mid-single-digit percent last quarter. The story was reversed in NAND. Pricing there increased mid-single-digit percent this quarter following a mid-single-digit decline last quarter. The CEO said that supply chain constraints have improved some since last quarter and they expect that to continue as the year goes on, which should improve memory demand. They see the supply-demand environment continuing to be healthy for the rest of the year. This is a good time to remember that even with all the information available to the executives in the semiconductor industry, pricing is quite hard to predict. But I do think things are lined up for a good rest of calendar 2022. I have been worried about the NAND market for a couple quarters now because both Hynix and Samsung said they plan to outgrow the market. But the supply drop from the Kioxia incident has helped pricing there. DRAM spot prices were increasing for the last three to four months before starting to soften in early March. DRAM capacity additions have been controlled for several years so I continue to think that calendar 2022 is going to be a good-to-great year for the DRAM industry. NAND I am still concerned about, despite the recent strength. This cycle is defying history, probably because of the effects of COVID on demand and on the supply chain. In previous cycles, gross margin steadily rises for two years, then drops for six quarters or so. In this cycle, the recovery started for 2-3 quarters, then COVID hit and prices declined for six months. Since then, gross margins for Micron recovered sharply, rising from around 30% (GAAP and non-GAAP had different nadir quarters) to around 47% in six months. The recovery has been lumpy. Also, since reaching the mid-to-high 40% level, Micron’s gross margin has been stable for three quarters and guidance has it at the same level in the current quarter. This would mark a full year of flat gross margin for the company, something that I’ve never seen in an up-cycle in more than twenty years of following Micron. I am continuing to hold Micron on my thesis that the up cycle will last about two years, which would have it peaking in late 2022 or early 2023. But as I have said, COVID is a massive exogenous shock that may have altered the shape of this cycle so much that this thesis won’t hold.

-S. Hughes (long MU)

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