06/28/22
Press Release and Investor Presentation Commentary
Here are the points from the press release, outside the financial statements, that I found notable:
• The sub-headline is wafer starts are being reduced by another 5% of total capacity on both DRAM and NAND, to a total reduction of 30%. Further down the release they state the reduced wafer starts will continue “well into calendar 2024.” This says their internal forecast for demand and production says they will continue to have excess inventory for at least the next eight to nine months, into the early spring of 2024.
• Quarterly revenue, gross margin, and EPS were all above the midpoint of guidance.
• The company believes the memory industry has passed the trough for revenue in this cycle.
• Pricing trends are improving. This doesn’t necessarily mean pricing is getting better. It could just be saying the rate of pricing declines is slowing.
• The company expects the memory TAM to set a record in calendar 2025, along with a return to more normalized levels of profitability.
• The Cyberspace Administration of China restriction on purchases of Micron products by some entities in China is a “significant headwind that is impacting our outlook and slowing our recovery.” They estimate half of this is at risk of being impacted.
• Micron’s long-term goal is to retain its worldwide DRAM and NAND share. They are saying here, as much to their competitors as to anybody, that they intend to replace any lost share in China with higher share elsewhere. It is a signal/warning to other memory companies that they should not expect to gain net market share as a benefit from Micron being restricted from selling into China.
• Micron revenue with companies headquartered in China and Hong Kong, including direct and indirect sales, is approximately a quarter of Micron’s total revenue.
• The company will build aa new assembly and test facility in Gujarat, India that will be online in the second half of the 2020s.
• Micron will reach DDR5 crossover with DDR4 in the first calendar quarter of 2024, ahead of the rest of the industry by about one quarter.
• CY23 PC unit volumes will decline low double-digit % YoY with total unit volume at levels similar to 2019.
• CY23 smartphone unit volume will be down mid-single digit % YoY.
• Automotive revenue reached another quarterly record, growing high-single-digit % YoY.
• The industrial market saw early signs of recovery in fiscal Q3.
• Calendar 2023 industry bit demand growth have reduced to low-to-mid single digits percent in DRAM and high-single digits percent in NAND. The company’s long-term CAGR expectations are mid-teens percentage for DRAM and low 20s percentage for NAND.
• Industry bit shipments for both DRAM and NAND are expected to be higher in the second half of calendar 2023.
• Total industry supply growth of both DRAM and NAND in calendar 2023 is expected to be negative as utilization and capex cuts have their effects.
• Micron’s calendar 2023 supply growth will be “meaningfully negative” for DRAM compared to 2022. They will produce fewer NAND bits in 2023 than in 2022. I think this is a creative way to say NAND supply growth will be slightly negative while DRAM supply growth will be more negative, between the two calendar years.
• Fiscal Q3 results were impacted by a further $400M of inventory write-downs, which lowered EPS by $0.37 per diluted share.
• GAAP guidance for FQ4-23 is revenue of $3.90B +/-$200M, gross margin of (12.5%) +/- 2.5%, operating expenses of $946M +/-$15M, and diluted EPS of ($1.34) +/- $0.07.
Financial Statements
Statements of Operations
Between the guidance and this quarter’s results, revenue bottomed in the second quarter of fiscal year 2023 at $3.693B. This quarter, revenue increased to $3.752B, well above the midpoint of guidance. Gross margin saw the benefit of inventory write-downs in the second and third quarter. Including those, gross margin was negative 17.8%. The midpoint of guidance in the coming quarter is $3.90B. While pricing continues to drop, there is enough demand to absorb an increasing number of bits. Layoffs, suspension of bonuses, and other cost-cutting measures took operating expenses down by $42M, or 4.1%. Management forecasted another reduction in Q4 and then an increase in the first fiscal quarter of 2024 as they bring back some employee compensation. Interest income and interest expense were both higher in the quarter, because of more debt and higher interest rates. The share count, with buybacks suspended, rose by 3 million shares. Total loss for the quarter was $1.896B, an improvement from the $2.3B loss last quarter. On a per-share basis, that is $1.73 to the negative.
Cash Flows
For the first nine months of the company’s fiscal 2023, operating cash flow was positive. In the midst of a terrible downturn, this is possible because of the capital intensity of the business. Depreciation and amortization over this period was $5.82B. Inventories grew by $3.4B while working capital contributed a billion in cash flow. $248M worth of government incentives came in so far this year. Capital expenditures so far were $6.2B, with another billion to go in the fourth quarter. Even liquidating half a billion in available-for-sale securities, the situation is just too bad and capital expenditures are too high. Investing activities consumed $5.4B of cash. The company has increased their cash position by a billion dollars in the last nine months, by adding $6B in debt. The coming upturn had better be really, really good to pay back all this debt and return enough cash to make it worthwhile to own shares in this company. The company ended the third fiscal quarter with $9.4B in cash.
The Balance Sheet
Total current assets are the same as they were three quarters ago at $21.7B. PP&E is also the same. What a capital-intensive business. Micron has $38.7B in property, plant, and equipment on their balance sheet. There is another $8.2B worth of inventory. Total liabilities are $20.3B with $13B of that being long-term debt. It’s been awhile since management could talk, as they used to so proudly, about how their balance sheet had a net positive cash position. Book value is $45.4B. Their equity trades at 1.55x book.
Conference Call
Numbers given during the conference call are non-GAAP.
Sanjay Mehrotra (President and CEO)
• Micron will invest another $600M over the next several years in their Xi’an, China assembly and test facility. This includes buying out PTI from their portion of the capacity there as well as adding a new building. This is a relatively low level of investment and is likely being done as a gesture to China to gain favor with the CCP.
• Data center customer inventories will likely normalize by the end of calendar 2023 or early 2024.
• Generative AI is driving higher-than-expected data center demand, but traditional data center demand is “lackluster.” The company gave an example of an AI server having 6x to 8x the DRAM and 3x the NAND content of a regular server.
• Mehrotra’s prepared comments took up one-third of the total call. This is a waste of time as all he did was read the prepared slides out loud. The company already sends out this text ahead of the call. They should take out this redundancy and instead expand the time used for Q&A.
• Industry demand is improving. The company believes the industry has passed the bottom for quarterly revenue and year-on-year growth.
• Pricing trends are improving.
• Micron intends to regain and maintain their worldwide share post adjustments from the sales restrictions in China.
• “Good progress” is being made to introduce EUV-based 1-gamma node in 2025 in Taiwan. Micron will also be the first company to bring EUV to Japan. This is an obvious statement as Micron is the only company with advanced non-NAND fabs in Japan, but the company likes to make empty but nice-sounding statements in the press.
Mark Murphy (CFO)
• $72M from an insurance settlement was included in FQ3 revenue. This was previously announced with guidance for the quarter.
• Business unit revenue increased sequentially in CNBU (1%), EBU (5%), and SBU (24%). It was down 13% sequentially in MBU. They expect MBU revenue to grow in FQ4.
• $400M of inventory value was written down in the quarter, on inventory produced during FQ3. This impacted EPS by $0.37 per diluted share.
• Non-GAAP operating margin in the quarter was negative 39%, an improvement from the negative 56% seen last quarter.
• Their payment of taxes in the quarter was driven by one-time discrete items. They owe taxes in certain geographies despite overall company losses.
• Capital expenditures were $1.4B in FQ3. They continue to expect total FY-23 capex to be $7B, thus there will be $1B of capital expenditures in FQ4.
• Free cash flow in the quarter was negative $1.4B. This is a terrible result but not as bad as the previous two quarters.
• Total inventory ended the quarter at $8.2B, or 168 days. Because of increased process and product complexity, the company now targets 120 days of inventory, equivalent to $6B.
• $1.5B of new long-term debt was issued in the quarter, of which $600M was used to pay off a term loan.
• They will exit FY-23 with less than $850M of opex. This will rise $50M in FQ1-24 because of new product timing and the end of employee compensation reductions.
• DRAM revenue was down 2% QoQ (down 4% prior) and represented 74% of total sales. Bit shipments increased around 10% sequentially QoQ (increased in the mid-teens percent range prior). ASPs declined approximately 10% QoQ (declined 20% in the prior quarter.)
• NAND revenue was up 14% QoQ (was down 20% in the prior quarter) and made up 27% of sales in the quarter. Bit shipments increased in the upper 30-percent ragne QoQ (up mid-to-high single-digit percent range in the prior quarter). NAND ASPs were down mid-teens percentage range QoQ (was down mid-20% range in the prior quarter.)
• Guidance for FQ3-23 (non-GAAP) is revenue of $3.9B +/- $200M, gross margin of (10.5%) +/- 2.5%, operating expenses of $845M, and a loss of ($1.19) per share, +/-$0.07 per share. They are not expecting any inventory write-downs in the fourth quarter.
Analyst Q&A
• Excepting data center, customer inventories in other segments (PC, mobile, etc.) are nearing or at normal levels. This is surprising to me given how much inventory was in the total supply chain just a few months prior.
• Mehrotra gave a typically long-winded answer to a question on LTAs that gave little useful information. In fact, he talked about how useful LTAs are to Micron to plan supply, yet LTAs were in place prior to this downturn and Micron badly missed matching their production to demand, leading to the historically oversupplied market.
• Inventory effects and the one-time insurance settlement roughly offset each other, leading to a negative 16% gross margin is roughly reflective of the current pricing and cost environment. Gross margin will bottom in the “next few quarters” and will improve throughout FY-24.
• The additional 5% cut in wafer starts is not in response to the China restrictions.
• Micron estimates their DRAM market share is 23% and their NAND market share is 12%.
Post Earnings Q&A call with Mark Murphy (CFO), Sumit Sadana (CBO) and Manish Bhatia (VP of Global Operations)
• The effects of restrictions on sales to some China customers will be highest in the fiscal fourth quarter of this year and in fiscal Q1 of FY-24.
• Free cash flow is expected to be negative for a “good part, if not all of FY-24.” Given the cuts in capital expenditures announced already (they will be lower than the $7B forecasted for all of FY-23,) this means their internal forecasts for pricing recovery is not steep. They seem to believe FY-25 will be the strong upturn year. A lesson I’ve learned in this cycle is that memory company executives aren’t able to predict future pricing trends much better than everyone else. These executives didn’t see this downturn coming, even though it is the most severe to hit the industry in fifteen years. It is unlikely they will predict the timing, and especially the strength, of the coming upturn. Almost everyone is surprised every single time by how fast the memory market recovery happens, when it finally does come. Also, there are ample incentives internally for the Micron forecasting team and executives to model the recovery conservatively. They would rather be surprised to the upside than predict a stronger recovery than what actually comes to pass.
• They signaled to other memory makers that more action is needed on the supply side to reduce inventories from where they are today. Micron’s cuts are a public signal to Hynix and Samsung that they should also cut their output further. With three companies left, they should be able to coordinate a gentlemen’s agreement – through public statements, not back-channel collusion – to reduce output such that nobody loses market share over the long term.
• They expect a $500M benefit to gross margin in the fourth quarter because of prior inventory write-downs. $500M in the first and second quarters of FY-24 is also expected. Murphy didn’t make it clear if that is total, or in each quarter.
• Underutilization charges, in their current plan, will persist in FY-24.
• Reported gross margin is expected to gradually improve in FY-24 and become positive in the second half of FY-24.
• The company is forecasting price declines to continue in the near term and then to improve in the second half of calendar 2023. Nobody knows anything.
• Company record bit shipments are expected in FQ4-23 for both DRAM and NAND.
• Pricing in DRAM is better than NAND now.
• PC unit sales now are well below total unit sales in 2019.
• Total industry production in both DRAM and NAND are now below demand, so inventory across the supply chain – from suppliers to distributors to customers – are now declining.
Summary
The worst of the downturn is behind Micron. They took more inventory write-downs this quarter and didn’t preclude the possibility of more to come, but revenue was up from last quarter and pricing declines are moderating. Management now believes total memory industry production is below total demand, so total inventory is declining. The company must still be concerned as they took wafer starts down from 25% below capacity to 30% below capacity. The VP of operations said they won’t start putting more wafers into their fabs until pricing is significantly better. They restated again that capital expenditures in FY-24 will be lower than the $7B planned for FY-23. Everything is set up for pricing to bottom and start heading up in the next few months. When that happens, it usually comes faster than people expect. In this case, so much money has been lost that the three DRAM players at least should hold back increasing their wafer starts until pricing is a lot better. Hopefully they all hold their fire on raising capital expenditures for longer than normal, to let this upturn run higher and farther. They have a lot of cash to make back. Generative AI could be a major new source of memory demand. A perfect storm for the memory business would be the collision of reduced capacity and capex, inventories running out, a large new demand source from generative AI, and an economic soft landing. Since the downturn started with PC and mobile, those two should start to see memory shortages first. Datacenter will be last to recovery. A potential positive risk for Micron is if the US and Chinese government work out an agreement that includes removing the restrictions China has put in place on some memory purchases. Potential negative risks include: a recession, Samsung and/or Hynix raising their output before the recovery is clearly underway, an unforeseeable event like COVID, or a major accident at a Micron site leading to lost production. While the last one would be good for pricing in the near term, it would cost Micron market share over the longer horizon. The one I am looking out for is a resolution to the China purchase restrictions, though I handicap it at well under a 50% probability. I’m looking for it because it would be an instant positive catalyst for the stock and could come at any time. More likely, we will see the pricing inflection point in Micron’s fiscal first quarter of 2024, between September and November. From there, the stock will probably run up quickly, if the last upturn is a model for what will happen this time. In that last run-up, the stock reached full upturn value within five months of the cycle bottoming.
-Smooth Hughes (cyclical long MU)