Press Release and Investor Presentation Commentary
Here are the points from the press release, outside the financial statements, that I found notable:
- $1.43B of inventory was written down in the quarter, resulting in an impact of $1.34 per diluted share. So, without the write-down, the loss per share in the quarter would have been ($0.78.) That would be a gross margin of $224M, or 6.1% of revenue. That is positive gross margin without the write down.
- GAAP guidance for FQ3-23 is revenue of $3.70B +/-$200M, gross margin of (23.0%) +/- 2.5%, operating expenses of $1.07B +/-$15M, and diluted EPS of ($1.79) +/- $0.07.
- On January 5, 2023, the company added more debt to the loan they initiated in November of 2022. This load put on another $600M in debt.
Statements of Operations
Revenue declined sequentially by almost $400M, about 10%, to $3.69B. The company took a huge inventory write-down that brought COGS to $4.90B. That write-down was $1.43B, so without it, COGS was $3.47B and gross margin was $224M positive, or 6.1%. The full results with the write-down produced gross margin of ($1.206B), or (32.7%). With negative gross margin, operating margin is doomed. Cost cutting is being taken seriously at Micron. They reduced R&D to $788M (from $849M last quarter) and SG&A to $231M (from $251M last quarter). They layoffs brought the cost of restructuring and other in the quarter up to $86M. Interest rates rose faster than their debt balance, again leading to positive cash flow from interest. With share buy-backs suspended, share count rose by around 1 million, to 1.091B. The inventory write down made a bad quarter terrible. The company posted a loss of $2.31B, or ($2.12) per share.
Micron’s free cash flow for the first six months of their fiscal 2023 was ($3.368B). That is an outflow of more than $3.3B in cash. Capital expenditures, even with the large cuts in WFE they have announced, were greater than depreciation, by $800M. Part of this is the delay in the time it takes between the intent to reduce wafer fab equipment deliveries and when those deliveries slow down. The WFE companies have a long cycle time to make their complex products. Micron called in receivables to generate $2.9B in cash in the first six months, though accounts payable grew by $1.8B over the same period. Still, this generated $1.1B in cash. The weak market for memory products caused inventory to grow by almost $2.9B so far this year. The company liquidated a net of $472B worth of available-for-sale securities to generate cash. In the first two quarters, the company has issued $5.22B worth of new debt. They pay about a billion dollars per year in dividends. Share buybacks have been suspended. A shame the company is so desperate for cash right now as they are missing a great time to buy their stock back. The massive increase in debt offset the large outflow of cash for capital expenditures and into growing inventory, leaving a $1.55B increase in the company’s cash balance so far this year.
The Balance Sheet
Total value of equity has declined by $2.65B so far this fiscal year, to $47.26B. That is $43.32 per share in book value. This loss of equity value is from added debt (to make up for outflows of cash) and the $1.43B write-down of inventory. Backing this inventory devaluation out, inventory in the first six months would have grown from $6.66B to $9.56B. At the guided rate of sales ($3.7B per quarter for FQ3), that is 236 days of inventory. This is more than double what the company considers a healthy level. They have $10.8B worth of cash and short-term investments on hand. This healthy liquidity has been maintained, in the face of massive outflows of cash, by almost doubling the company’s debt load, from $6.9B at the beginning of the fiscal year to $12.2B today.
More New Debt
In addition to the $3.35B in new debt the company added in October and November of 2022, Micron took on more debt in January of 2023. The company added another $600M in borrowing, split into three tranches. The tranches are $125M due 11/3/25, $250M due 11/3/26 and $225M due 11/3/27. The interest rates on these loans are SOFR plus 1.00% to 2.00%, depending on the tranche and Micron’s corporate credit rating.
Numbers given during the conference call are non-GAAP.
Sanjay Mehrotra (President and CEO)
- · They see gradually improving supply-demand balance in the coming months. Note that does not mean they see the market reaching a healthy level in that time, just that the derivative will turn positive. Their inventory peaked in the second fiscal quarter of FY-23. This is the leading indicator of the cycle. If Micron’s inventory is representative of the overall memory industry, and if they are correct about the just-completed quarter being the peak of inventory, then the nadir of this downcycle has been reached and an upturn is in the offing and will be fully underway in a quarter or two.
- · On schedule to introduce their first EUV node, 1-gamma, in 2025.
- · Revenue growth is expected in the data center space in Q3 with inventory with these customers reaching healthy levels by the end of calendar 2023.
- · PC unit shipments will decline mid-single digits in calendar 2023 (same forecast given last quarter.) Inventories with PC customers are still elevated but have improved “meaningfully.” Increased bit demand from these customers is expected in the second half of the year.
- · Calendar 2023 mobile unit volume will be down slightly. This is a lowering from what they said last quarter (flat to slightly up in calendar 2023.) Mobile customer memory inventories will improve through the rest of the calendar year. Bit shipment growth is expected in the second half of their fiscal year (March through August of 2023.)
- · Automotive revenues grew ~5% YoY in the quarter and demand growth is expected to continue in the second half of the year. This seems to refer to the fiscal year.
- · Industry bit demand growth is expected to be 5% in NAND and low-teens percent in NAND. This is down from what they thought three months ago. The change is a combination of their most recent assessment of customer inventories as well as some degradation in end market demand.
- · Fiscal 2023 capital expenditures are expected to be $7B with WFE down by more than 50% year-over-year.
- · They have reduced wafer starts by 25% in both DRAM and NAND. This is an increase from the 20% reductions announced in their Q1-23 call.
- · Their overall headcount reduction will approach 15%. The layoffs are largely complete and the remaining headcount reductions will occur through attrition.
- · The company is executing to a plan to keep their market share flat in both DRAM and NAND. This is a signal to the other memory makers that, despite the pricing they are putting into the market, they are not trying to gain market share.
- · The DRAM and NAND markets have not been this far oversupplied in thirteen years, since the downturn that coincided with the Great Recession.
- · Micron’s CY-23 year-over-year bit growth will be “meaningfully negative” for DRAM and slightly negative for NAND. This is a reduction from what they said a quarter ago. That is consistent with the further decrease in fab utilization that has been announced, from a 20% reduction to a 25% reduction.
Mark Murphy (CFO)
- · $1.43B of inventory value was written down in the quarter. This impacted EPS by $1.34 per diluted share.
- · Operating expenses are expected to decline sequentially in FQ3 and FQ4.
- · Construction spending in the second half of the fiscal year will be a higher percentage of the total than in the first half.
- · DOI was 153 days after the write-down and 235 days before. Inventory is higher in NAND than DRAM.
- · Market conditions remain “extremely challenging.” Bit shipments are expected to gradually increase through the rest of the year.
- · Share buybacks continue to be suspended. The dividend of $0.115 per share will be paid on April 25th.
- · Liquidity at the end of FQ2-23 was $14.6B.
- · Operating cash flow and free cash flow will be “significantly negative” for the remainder of the fiscal year (through the end of August.)
- · They believe they are close to a transition to quarterly revenue growth. This is a hedged way of saying they believe the bottom of the cycle is near.
- · DRAM revenue was down 4% Q/Q and represented 74% of total sales. Bit shipments increased in the mid-teens percent range Q/Q. ASPs declined approximately 20% Q/Q.
- · NAND revenue was down 20% Q/Q and made up 24% of sales in the quarter. Bit shipments increased in the mid-to-high single-digit percent range Q/Q. NAND ASPs were down mid-20% range Q/Q.
- · As was the case the last two quarters, all four business units were severely down. In this quarter, revenue declined sequentially between 32% (Embedded BU) and 60% (Compute and Networking BU).
- · Performance in FQ2-23 (non-GAAP) is revenue of $3.7B, gross margin of (31.4%), operating expenses of $916M, operating loss of ($2.1B), net loss of ($2.1B), and $343M of cash flow from operations.
- · Free cash flow in the quarter was negative $1.8B.
- · Guidance for FQ3-23 (non-GAAP) is revenue of $3.7B +/- $200M, gross margin of (21.0%) +/- 2.5%, operating expenses of $900M, and a loss of ($1.58) per share, +/-$0.07 per share. This includes another $500M of new write downs associated with new inventory produced during FQ3-23.
- · Customer inventories are improving. They expect shipments to increase sequentially in both DRAM and NAND from here. CapEx and capacity cuts are reducing supply growth as well. Both sides of the supply-demand equation are moving towards a healthier industry. While improvement is good for shareholders, they are still selling into a deeply oversupplied market with terrible pricing.
- · Cloud revenue has bottomed in FQ2 for Micron, though inventories are still high.
- · Mehrotra took the first question as a chance to signal to other suppliers that they have taken their bit growth negative and, if others do the same, the industry will reach a healthy balance sooner.
- · In the third quarter so far, DRAM bit shipments are up modestly, and NAND bit shipments are up sharply. Both are still under heavy price pressure, with NAND feeling it more than DRAM. Said another way, they are cutting prices steeply to move product today.
- · They expect a $300M benefit to earnings in FQ3 because of the write-down in Q2, as the product sold in that quarter has a lower cost basis. This type of benefit will continue in future quarters, at variable levels, depending on factors such as pricing and mix.
- · If the effects of inventory write-downs is taken out, the gross margin for the company would reach it’s bottom in 2H of fiscal 2023.
- · They don’t see a risk of inventory obsolescence.
- · FY-23 is expected to have $900M in cost hit from under-utilization of their fabs, as of last quarter. Now, they see $1.1B of underutilization cost in FY-23, with $900M of that also landing in FY-23.
- · They are expecting a $500M inventory write-down in the third fiscal quarter.
Post Earnings Q&A call with Mark Murphy (CFO), Sumit Sadana (CBO) and Manish Bhatia (VP of Global Operations)
- · Their inventory target is between 100 and 110 days.
- · The size of inventory write-downs in coming quarters is highly sensitive to pricing.
- · They gave a non-answer answer to where their cash cost is relative to current pricing and to competitors. They said they are above their cash cost vs. current pricing and they are in “good” position relative to competitors.
- · Their current pricing assumptions for the future will lead to either a small inventory write-down in the fourth fiscal quarter or no write off in that period.
- · If inventory write downs are taken out, gross margin in FQ2 was 7.3% and FQ3 will be (7.5%). This decline is a function of both weak pricing and underutilization.
- · Their current model has NAND pricing in the third fiscal quarter to be near their cash cost. This is not their variable cash cost because labor cost is effectively fixed and is mostly a cash expense.
- · The CBO reiterated that the company intends to keep their market share flat. They are not cutting pricing to try and gain share. This is again signaling to competitors not to react to their price cuts with their own cuts, to protect market share.
- · Gross margins are significantly lower on NAND now than on DRAM.
- · Bit crossover from DDR4 to DDR5 is expected in mid-calendar 2024.
- · Capital expenditures in FY-24 will be lower than FY-23. This is far enough out in time that management can change their mind if the market recovers earlier than what their forecasts have today.
- · They expect a record TAM in FY-25. This is effectively a prediction that the market will have fully recovered and will reach or be reaching the next cyclical peak in their fiscal year 2025 (September 2024 to August 2025.)
- · Free cash flow is expected to improve from here. That is to say, the rate of cash burn will slow from the rate seen up to FQ2-23. Bit shipments are expected to improve from here. Free cash flow is expected to become positive some time in their fiscal 2024. That is, before the end of August of 2024. Not a risky prediction, to say the memory market will have turned sometime in the next seventeen months.
Last quarter, they believe aggregate customer inventories of memory had started declining. This quarter, the company says they believe their own inventory has peaked and is now declining. These are the leading indicators of the downturn ending. First, customer inventories peak, then memory manufacturer inventories peak. Once these have come down to healthy levels, then pricing stops falling and turns up. Multiple times on both calls executives said that Micron is not attempting to gain market share. Their target is to keep the share they have. They also said multiple times that reductions in supply of memory are needed to bring the markets into balance sooner. By the end of the second call, it bordered on pleading with Hynix and Samsung to reduce their production. Micron’s management is sending a strong signal to the other suppliers that, even as they see Micron taking prices down for their products, they are not seeking to gain share. The market is, again, worse than it looked three months ago. The company added another $3.35B of new debt. That brings the total new debt has taken on to their balance sheet in the first half of fiscal 2023 to $5.3B. That is a lot of new debt. The management team is scared. They raised the size of their workforce reduction from 10% of total headcount to 15%. This will help costs in the short term but may be costly in the longer term, taking reductions that deep. These executives say “people” are one of their core values. When they say “people,” what they mean are “people who own shares of Micron.” This executive team manages the company with heavy weight on the current quarter and the share price. As a cyclical shareholder, that is alright with me. Between the difficulty of the memory business and short-term focus and thinking of this management team, Micron isn’t a buy-and-hold investment. With the deep production cuts and 15% headcount reduction, management has put more risk into their future market share and performance. But in the near term it will bring the cycle to an end sooner and will boost margins once the cycle turns. If they are right about inventory peaking now and bit shipments improving from here, the cycle will turn upward by the end of calendar 2023.
-S. Hughes (cyclical long MU)