After experiencing the worst period, semiconductor industry may see a glimmer of hope (Micron FY23Q2 Earnings Call)

Micron (MU.O) released its Q2 2023 financial report (ending in February 2023, Beijing time) after the US stock market closed on March 29, 2023. The following are the main points:

1. Core data vs. market expectations:

1) Revenue end: Micron Technology.US revenue was 3.693 billion US dollars (QoQ-9.6%, YoY-52.6%), with a guidance median of 3.8 billion US dollars, and the market consensus expectation was 3.714 billion US dollars.

2) Gross profit margin: GAAP gross profit margin was -32.7% (QoQ-54.6pcts, YoY-79.9pcts), with a guidance median of 7.5%, Non-GAAP gross profit margin was -31.4% (QoQ-54.3pcts, YoY-79.2pcts), with a guidance median of 8.5%.

3) Net profit: GAAP net profit was negative 2.312 billion US dollars, and the market consensus expectation was negative 853 million US dollars. Non-GAAP net profit was negative 2.081 billion US dollars, and the market consensus expectation was negative 722 million US dollars.

4) Sub-business situation:

(1) DRAM: Revenue was 2.722 billion US dollars (QoQ-3.8%, YoY-52.4%), accounting for 74%, the market consensus expectation was 2.54 billion US dollars. The shipment volume (in bit) increased by mid-teen compared to the previous quarter, and the price decreased by 20% compared to the previous quarter.

(2) NAND: Revenue was 0.885 billion US dollars (QoQ-19.8%, YoY-54.8%), accounting for 24%, the market consensus expectation was 0.962 billion US dollars. The shipment volume (in bit) increased by mid-high single digit compared to the previous quarter, and the price decreased by mid-20% compared to the previous quarter.

(3) Others: Revenue was 0.086 billion US dollars (QoQ-43.8%, YoY-21.8%), accounting for 2%, and the market consensus expectation was 0.164 billion US dollars.

For more detailed financial information, please refer to Long Bridge Dolphin's comments《Micron's "Great Bleeding", Maybe Not a Bad Thing》(https://longportapp.cn/zh-CN/topics/4540623?channel=t4540623&invite-code=294324&source_app=longbridge)》

2. Teleconference incremental information summary:

1) Situation of inventory reduction: The inventory was reduced by 1.4 billion US dollars, and the tailwind contributed to 38.7% gross profit margin. The reason for the write-down was that the expected selling price was lower than the inventory cost. The quarterly inventory days were 153 days, and without write-down, it would be 235 days. NAND inventory days were higher than DRAM.

2) Outlook for downstream industries: Data center (expected to reach bottom in 2Q, and by the end of 2023, the data center inventory will reach a relatively healthy level); PC (expected to decline mid-single digit YoY in CY23, falling back to the pre-epidemic level. Although customer inventory is still high, But there has been significant improvement, and it is expected that the storage demand (in bits) of FY23H2 PC will increase and DDR5 market share will improve. In mobile communication, it is expected that the shipment volume of smart phones in CY23 will slightly decrease YoY, and some OEM inventories are still at high levels. However, it is expected that the shipments of mobile DRAM and NAND in FY23H2 will be better than that in FY23H1.

Company outlook: Regarding inventory, a write-down of 500 million US dollars in 3Q was achieved, benefiting from inventory write-downs, and the turnover days will return from its peak in 2Q. In terms of personnel, the company's layoff target for CY23 has been increased from 10% to 15%. On capital expenditures, the FY23 capital expenditure plan will be reduced, with an expected investment of 7 billion US dollars, a YoY decline of more than 40%.

Phone Conference Transcript

Management Remarks

(I) Operating Conditions

1. DRAM: Significant progress has been made in the transition from 1-alpha to 1-beta.

2. NAND: The proportions of 176-layer and 232-layer yield (in bits) are over 90%, and the proportion of QLC production and shipments exceeds 20%.

3. Yield rate: The target yield rates for 1-beta and 232-layer have been achieved ahead of schedule, and the development progress is faster than in the past.

4. R&D direction: Based on EUV technology, 1-gamma is expected to be launched in 2025.

5. Inventory: A write-down of 1.4 billion US dollars in inventory resulted in a gross margin reversal of 38.7%, and the write-down was due to an expected selling price lower than the inventory cost. The inventory turnover days for the quarter were 153 days, while it would have been 235 days without the write-down. The inventory turnover days for NAND were higher than that for DRAM.

6. CAPEX: Quarterly CAPEX was 2.2 billion US dollars.

(II) By End-Market

1. Data center: It is expected to bottom out in 2Q, and the inventory of data centers will reach a relatively healthy level at the end of 23. On the technical side, the focus is on opportunities for AI servers, CXL, HBM, and DDR5. Among them, the DRAM and NAND capacity required for AI servers is 8 times and 3 times that of conventional servers, respectively. The company's CXL samples have been delivered to enterprise/cloud/HPC related OEM customers in 2Q, and the 24GB 1-alpha DDR5 product has obtained its first customer certification. The new generation data center CPUs of AMD and Intel will drive up the penetration rate of DDR5 products.

2. PC: It is expected that the PC shipments in CY23 will decrease YoY in mid-single digits, down to the level before the epidemic. Although customer inventories are still at high levels, there has been significant improvement, and it is expected that the storage demand (in bits) of FY23H2 PC will increase and DDR5 market share will improve. The company's QLC shipments have grown for the second consecutive quarter, benefiting from the growth of client and consumer SSDs, and the company has obtained the industry's only 176-layer QLC SSD certification. 3. Graphics: TAM CAGR is higher than PC and data center, customer inventory adjustment is smooth, and demand for FY23H2 is expected to be better than FY23H1. NVIDIA's RTX 4070Ti is equipped with the company's 16GB G6X product.

4. Mobile Communication: It is expected that the shipment volume of smartphones will decrease slightly in CY23 compared to the previous year, and the inventory of some OEMs is still high. It is expected that the shipment volumes of mobile DRAM and NAND in FY23H2 will be better than FY23H1. As for products, the company expects to acquire 1-β revenue at the end of FY23.

5. Industrial and Automotive: The revenue and profit performance of the industrial and automotive business is stable, accounting for over 20% of the total revenue, and the company is the leader in this market. The automotive revenue in 2Q increased by 5% year-on-year. The company obtained the first 176-layer eMMC 5.1 and the first 176-layer UFS 3.1 automotive solutions. The industrial sector was under pressure in 2Q, mainly due to channel inventory backlog and weak demand from some terminal customers, but is expected to improve in FY23H2.

(III) Outlook

[1] Industry Outlook for FY3Q23

1. There are still challenges in the market. It is expected that the shipment volumes of DRAM and NAND (in bits) will continue to increase during the remaining time of CY23, and the supply-demand relationship will improve.

2. The growth rates of DRAM and NAND demand (in bits) in CY23 are expected to be 5% and low-teens, respectively, lower than the mid-teens and low-20% long-term CAGR.

3. The original expectation was that the shipment volume would decline for the whole of CY23, but the expected improvement is due to the progress of customer inventory adjustment and the recovery of the Chinese market.

4. Industry CAPEX has been significantly reduced, capacity utilization is declining, and it is expected that the supply growth rate in CY23 will be lower than the demand growth rate, which will help inventory repair.

[2] Business Outlook for FY3Q23

1. The company expects to reduce inventory by $500 million in 3Q, and the turnover days will return to the peak value of 2Q due to inventory reduction.

The staff reduction target for CY23 has been increased from 10% to 15%.

1. The FY23 capital expenditure plan will be reduced, and it is expected to invest $7 billion, a decrease of more than 40% year-on-year, with WFE down more than 50% year-on-year. FY24 will be further reduced, mainly because the capital efficiency of 1-β and 232-layer is higher.

2. The number of wafer starts will be further reduced, with a year-on-year decrease of approximately 25%.

3. It is expected that the supply growth rate of DRAM in CY23 will slow down, and NAND will experience negative growth year-on-year.

4. The company will lower prices but will not engage in price wars for market share.

[3] Performance Outlook for FY3Q23

1. Revenue: $3.5-3.9 billion (median QoQ is flat, YoY -57.2%), and market expectations are consistent at $3.715 billion. 2. GAAP Gross Margin: -25.5% to -20.5%, Non-GAAP Gross Margin: -23.5% to -18.5%;

3. GAAP Diluted EPS: -1.86 to -1.72 US dollars, market consensus is -1.07 US dollars, Non-GAAP Diluted EPS: -1.65 to -1.51 US dollars, market consensus is -1.15 US dollars.

3.2 Analyst Q&A

Q: Expectations for demand recovery and measures to address it; With industry capital expenditures reduced, there may be a shortage of supply, and expectations and actions of major customers-especially in the data center field.

A: (1) Supply and demand

- Demand: Although customer inventory is still increasing, it is improving overall. It is expected that DRAM and NAND shipments will increase sequentially.

- Supply: Industry capital expenditures and utilization rates have declined, and supply will decline significantly. Therefore, the supply trend will basically start to improve and gradually reach supply-demand balance this year.

Overall, in terms of inventory, Micron inventory days reached their peak in 2Q, and inventory days are expected to improve if inventory adjustments are not considered; in terms of business, revenue will transition to sequential growth. The overall industry environment and supply-demand relationship are gradually improving, and it is expected that Micron's shipping prices will also improve accordingly. That is, although profitability and free cash flow still face challenges, the industry fundamentals are positive, and there will be a shortage of overall industry supply in CY24. Micron is managing capital expenditures, utilization rates, operating costs, and focusing on improving supply.

(2) Market trends and customers

- Data center: Inventory has improved significantly and this trend will continue for the next several quarters;

- Smartphones: Some customers' inventory is still high, but inventory will continue to improve over the next few quarters;

- Cloud: Revenue has hit bottom in 2Q; although data center inventory is still at a relatively high level, it is expected to improve this year and return to normal levels by the end of this year. New CPUs have promoted the deployment of new DDR5, and Micron's DDR5 is at the forefront of the industry. DDR5 is the wind vane of cloud computing demand, and it will drive the increase of memory in each server.

Although the future business environment is extremely challenging, Micron is responsibly managing supply and continuously focusing on improving the supply-demand environment. If DRAM and NAND supply decreases year-on-year, the industry recovery will accelerate, so Micron has taken action to make DRAM and NAND supply decrease year-on-year.

Q: What long-term measures will the industry take to emerge from the bottom of the cycle, and what are the expectations for the future?

A: In the past three years, under the macro influences of epidemics, the Russian-Ukrainian war, and high inflation, demand soared, leading to inventory adjustments, which caused substantive dislocation of customer behavior. Currently, the industry is promoting market recovery by slowing down the growth of supply, but because the external impact in the past three years is accidental, it is expected that investments that guarantee healthy profit levels, profitability and supply will return in the future. CY24 and CY25 are expected to have very strong revenue, and 2025 will be a record year for industry revenue, provided that the industry is normalized in the next few quarters.

In addition, AI and AIGC are in the early stages and will drive demand for memory and storage in the future, and the company has advantages in its products and technology.

Q: If the company expects to write down inventory in 3Q, why continue production, and what is the minimum acceptable capacity range for the company?

A: The company has been actively reducing supply, and the utilization rate has reached historically low levels. However, at the same time, the company will take into account the continued improvement of the month-over-month shipments of future shipments. Currently, market prices are still challenging, and NAND faces even greater price challenges. But at the same time, NAND's shipments (in bits) are also growing, which is a sign of supply and demand balance.

Q: Considering the recovery rhythm of data centers and smartphones, how will the utilization rate change?

A: The company will continue to track market dynamics to adjust the utilization rate, and continuously reducing the number of days of inventory and the utilization rate is still very important, and this will continue until FY24.

Regarding smartphones, although the shipment volume is still not optimistic, the amount of memory in smartphones will also increase due to the increasing proportion of flagship models, which should be seen this year.

Q: In the last earnings call, the company expected that the cost of underutilization in 3Q and 4Q would be approximately USD 460 million, with 3Q guidance accounting for the proportion. Considering the continued decline in utilization rates in CY2H23, how to evaluate the utilization level in CY4Q23 and CY24?

A: Last quarter, the company believed that underutilization expenses were USD 900 million in FY23, of which COGS was USD 460 million. As the utilization rate continues to be downward adjusted, the company expects that underutilization expenses will be USD 1.1 billion this quarter, and the assessment of this expense comprehensively considers factors such as holding cost, expected selling price, inventory write-down, utilization rate, inventory scale, and the effect of relevant leverage on period expenses.

At lower profit levels, profit margin forecasts and results are more sensitive to small changes in assumptions. The company wrote down inventory of USD 1.4 billion in 2Q and is expected to write down USD 500 million in 3Q, thereby reducing the book value of existing inventory. As these lower-cost inventories are gradually sold, the future profit margin will also be reflected. It is expected that the gross margin in FY2H23 will bottom out, and 4Q will be better than 3Q, and FY24 will improve.

Q: Is the company's more aggressive capacity adjustment than its peers damaging its long-term competitiveness?

A: The company is ahead of its competitors in technology and product combinations, with high shares of 176 and 232 layers, which is also part of its competitiveness. Regarding production capacity, if the market recovery accelerates, the company will adjust the utilization rate accordingly.

Q: Further explanation on inventory and inventory write-downs.

A: The inventory is not outdated, and the write-down is mainly due to the market's expected selling price being lower than the inventory cost. Before, the underutilized expenses generated by the company in FY23 were approximately 900 million US dollars. As the utilization rate continues to decline, the company now believes that underutilized expenses will reach 1.1 billion US dollars, of which FY23H2 accounts for 900 million US dollars.

Q: What is the price anchor for company inventory write-downs?

A: The company will evaluate based on the expected sales time and sales price range of inventory, as well as the recoverability of inventory each quarter, and carry out inventory write-downs accordingly. Currently, the inventory days are 235 days, corresponding to 3 quarters. The company will write-down based on expected sales price and inventory holding cost. Please refer to the relevant public documents for specific details.

Q: The company believes that the iteration time of DDR4 and DDR5 is in the early to mid 24 years, which seems better than the previous expectations. Considering that there is still a lot of DDR4 inventory, what is the basis for this expectation?

A: The company has not adjusted its expectations for the development time of DDR4 and DDR5. This view is based on the new CPU cycle, which will be widely deployed and see growth in market share in 23 and 24 years. Additionally, the company still has technological advantages and favorable positioning in DDR5.

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