Gross margin expected to continue to improve (Micron Tech 1QFY24 conference call minutes)

Micron Tech (MU.O) released its fiscal first quarter earnings report for the 2024 fiscal year (ending in November 2023) after the US stock market on December 21, 2023. The key points from the conference call are as follows:

1. Incremental Information from the Micron Tech Conference Call

1) Increase in Gross Margin for the Quarter: The gross margin increased by 10 percentage points compared to the previous quarter, with half of the increase attributed to price recovery and the other half to the increase in DRAM share. We also cleared $600 million of low-cost inventory.

2) Gross Margin for the Next Quarter: We do not expect sales growth in the second quarter, but we anticipate a 12 percentage point increase in gross margin. So, all of this is driven by price, or primarily by price. In addition, there will be a $400 million benefit from the clearance of low-cost inventory in the second quarter.

3) Industry Demand Outlook: We expect the compound annual growth rate of bit demand for DRAM to be around 15%, while the compound annual growth rate of bit demand for NAND will be slightly over 20%. We predict that the industry's bit demand growth in 2024 will be close to the long-term compound annual growth rate of DRAM, slightly lower than that of NAND.

2. $ Micron Tech(MU.US) Conference Call Transcript

2.1 Management Remarks

In the first quarter, Micron Tech's revenue, gross margin, and earnings per share were all above the upper end of the guidance range we provided during the last earnings conference call, reflecting Micron Tech's strong execution and pricing power.

We drove a significant shift in industry pricing during this quarter, which will allow us to benefit from higher prices earlier in this fiscal year than previously planned. We intend to maintain strict discipline in our supply and capacity investments, as our pricing has not yet reached levels associated with the necessary return on investment.

We expect improved profitability and financial performance for the full year 2024, and the storage industry TAM (Total Addressable Market) is also expected to improve in 2025.

We have made significant progress with our industry-leading technology roadmap. Micron Tech is at the forefront of the industry in terms of advanced technology nodes in the DRAM and NAND fields. The majority of our bids are focused on leading-edge nodes, such as 1-alpha and 1-beta for DRAM, and 176-layer and 232-layer for NAND.As mentioned earlier, the 1-beta DRAM and 232-layer NAND nodes have achieved mature yields faster than previous nodes.

We expect front-end cost reductions by the fiscal year 2024 to align with our long-term expectations of high single-digit reductions for DRAM and low double-digit reductions for NAND.

We anticipate mass production of 1-gamma DRAM using EUV technology by 2025.

In terms of end markets—

For most customers in the PC, mobile, automotive, and industrial end markets, memory and storage inventories are at or near normal levels. Therefore, the demand we see from these market segments is closer to their final market demand. Memory and storage inventories for data center customers are improving, and we continue to expect customer inventories to approach normal levels in the first half of 2024. In our data center and PC markets, we are at the forefront of the industry transition to DDR5, and we expect our DDR5 volume to surpass DDR4 by early 2024. AI use cases are expanding from data centers to the edge, with recently released AI-enabled PCs, smartphones with on-device AI capabilities, and embedded AI in the automotive and industrial end markets. The proliferation of AI at the edge brings many benefits, such as enhanced privacy, reduced latency, improved performance, greater personalization, and competitive cost structures, applicable to a wide range of use cases from content creation to productivity. We see rapid development in our customers' product roadmaps, enabling and leveraging the expansion of the AI market, which in turn drives higher capacity, lower power, and higher performance requirements for memory and storage.

Our HBM3E has received very positive customer feedback, with approximately 10% performance improvement and 30% power reduction compared to competing products. In the first quarter, we shipped HBM3E samples to several key partners and made good progress in qualification. Micron Tech is currently in the final stages of validating industry-leading HBM3E for NVIDIA's next-generation Grace Hopper, GH200, and H200 platforms.

Furthermore, our LP5S is being used in the Grace CPU, driving new use cases for LP memory in data centers to achieve accelerated computing.

We expect to begin HBM3E mass production in early 2024 and generate hundreds of millions of dollars in HBM revenue in the fiscal year 2024.

We anticipate continued growth in HBM revenue in 2025, and we continue to expect our HBM market share to align with our overall DRAM share at some point in 2025. Last month, we launched the industry's fastest and lowest latency 128GB high-capacity module on our industry-leading 1-beta node, using a single chip without the need for 3D stacking, resulting in a simpler assembly process.Our solution offers top-notch performance and will support current and future memory-intensive workloads in data centers.

We anticipate that smartphone OEM manufacturers will start increasing support for AI-enabled smartphones in 2024, with each device adding an additional 4 to 8 GB of DRAM capacity. Looking ahead, many popular generative AI applications will emerge on smartphones, and our leading product portfolio is ready to seize this opportunity in memory and storage.

We have also begun sampling the next-generation 232-layer NAND UFS 3.1 and 1-beta DRAM, as well as 24 GB LP5x, to support the memory requirements of emerging AI base models. Lastly, I will discuss the automotive and industrial sectors, which are key end markets that we value as part of our portfolio, as they offer relatively predictable revenue and profitability and long-term growth opportunities. The diffusion of AI in memory at the edge continues to increase in the industrial and automotive markets, translating into content growth for many AI-supporting edge devices.

Market Outlook

We expect the bit demand for DRAM to grow at a high single-digit percentage in 2023, surpassing previous expectations of mid-single-digit growth. In NAND, we continue to anticipate high double-digit growth in bit demand for 2023.

Looking ahead, we project a compound annual growth rate of around 15% for DRAM bit demand and just over 20% for NAND bit demand. We predict that the bit demand growth for the industry in 2024 will be close to the long-term CAGR of DRAM and slightly lower than that of NAND.

Turning to supply, the significant reduction in industry supply has contributed to the ongoing recovery. The recovery pace will be accelerated by supply growth that remains below demand growth in the long term. Micron Tech will continue to adhere to supply and capital expenditure discipline, consistent with our strategy to maintain long-term market share in DRAM and NAND. Micron Tech's capital expenditure for fiscal year 2024 is expected to be between $7.5 billion and $8 billion, slightly higher than last year's level, with the majority of the investment planned to support the increase in HBM3E production.

We continue to expect a year-on-year decline in WFE capital expenditure for fiscal year 2024.

We anticipate that industry supply for DRAM and NAND in 2024 will be lower than demand, resulting in a contraction of industry inventory levels.

We remain engaged with the U.S. government, and chip subsidies have been included in our capital expenditure plan for fiscal year 2024. The competitiveness of our Idaho and New York projects and our global competitiveness depend on Micron Tech's ability to secure chip subsidies to address cost differentials compared to overseas expansion. To better support our global customers, we have established state-of-the-art assembly and testing facilities in Malaysia and Taiwan.We are continuing with the previously announced expansion plan for our Xi'an factory, which has been approved by the Chinese authorities. In the first quarter, the LPDRAM assembled at our Xi'an factory obtained its first mobile customer qualification, further driving our strong commitment to serving Chinese mobile customers.

Our widely diversified global operational network remains a key element of our strategy to meet customer demands reliably and flexibly.

Financials -

Improvements in the supply-demand environment and our team's strong execution have led to price increases in DRAM and NAND. The current pricing trajectory has improved our financial outlook for the second quarter and the entire fiscal year. Total revenue for the first quarter was approximately $4.7 billion, representing an 18% MoM increase and a 16% YoY increase. DRAM revenue for the first quarter was $3.4 billion, accounting for 73% of total revenue. DRAM revenue increased by 24% MoM, with bit shipments growing by over 20% and prices increasing in the low single-digit percentage range. Despite strong pricing in the fourth quarter, Micron Tech's strong bookings entering this quarter, including strategic purchases by customers for the first quarter shipments of the previous few quarters, limited the reported price increases for DRAM in the first quarter.

Last year, our world-class technology, business, and manufacturing teams ensured our continued leadership in foundational memory technology and expanded our industry-leading product portfolio.

We are encouraged by the progress in pricing and expect to regain profitability, which aligns with the significant value our solutions provide to customers.

We anticipate 2024 to be a year of recovery, with a clear path to a healthy supply-demand environment and strong growth in key new technologies such as HBM3E. From data centers to the edge, artificial intelligence has become a critical long-term driver that will further propel the industry to achieve record TAM revenue in 2025 and drive growth in the coming years. Micron Tech's extensive and growing portfolio of leading products positions us to fully capitalize on the tremendous opportunities ahead. Thank you for joining us today.

2.2 Q&A

Q1: Pricing for DRAM and NAND in 2024? Any way to quantify the capital expenditure for HBM next year? What prompted you to start investing in NAND?

A1: In terms of pricing, we certainly expect pricing to continue to strengthen in 2024 as supply growth has been significantly curtailed. Customer inventories have normalized, supplier inventories are improving, and our own inventories as well. Of course, with the improvement in customer inventories, overall demand trends are seen in personal computers, smartphones, automotive, and industrial. The demand trends are expected to continue, and at some point in the first half of 2024, we expect customer data center inventories to normalize as well. Additionally, we expect data centers to be another growth driver for demand in 2024.

Therefore, we expect prices for NAND and DRAM to continue to rise. We anticipate a healthy supply-demand environment to emerge in 2025, and our leading-edge nodes are tight.They are already in high demand, and our inventory will continue to improve. All of this will contribute to overall healthy dynamics of pricing improvement, profitability improvement, and revenue growth driven by demand factors. Artificial intelligence will become the ultimate dominant demand driver in the market.

Therefore, we will not separate the capital expenditure between HBM and other parts of the business, but we note that our WFE has declined. Of course, we are very focused on supporting the growth of the HBM business.

We are very excited about our leading product, HBM3E, and we will start increasing production in early 24. We will certainly make the necessary investments to support the demand for HBM in 24. As for NAND and capital expenditure, the most important thing is for profitability to recover to the level that truly requires increased capital expenditure investment.

Q2: How does the company obtain NVIDIA HBM3E certification? How much visibility is there?

A2: Our products have passed qualification certification, and the qualification certification is progressing smoothly. After obtaining the qualification, we expect to increase production and deliver to customers, which will bring us hundreds of millions of dollars in revenue in the 24 fiscal year. Similarly, this revenue will increase in the second half of our fiscal year. But as we enter 25, sales growth and revenue opportunities will continue to increase. At some point in 25, we expect to reach the same level of market share in HBM as we have in DRAM.

As for strategic inventory, we have formulated certain strategies, and some customers have made strategic purchases within our fourth quarter timeframe, which will be completed in the fourth quarter. Looking ahead, we are very focused on managing our supply and managing our demand.

Q3: How is gross margin considered and calculated? Can the cross-cycle model from May be maintained?

A3: The gross margin for the first quarter increased by 10% MoM, with half of it coming from price recovery and the other half from the increase in the proportion of DRAM. We also cleared $600 million of low-cost inventory. Then we discussed the reduction of some idle costs.

We will not see sales growth in the second quarter, but we see that the gross margin is still up 12 percentage points. So all of this is driven by price or mainly price-driven. In addition, there will be $400 million in low-cost inventory clearance gains in the second quarter. There are some mixed changes within customers and some seasonal effects. But again, this is largely price-driven growth.

The low-cost inventory gains in the second quarter are lower than in the first quarter, but pricing improvement is the main factor for gross margin improvement.

Therefore, we expect gross margin to continue to improve from the second quarter to the third quarter. The volume-price relationship in the fourth quarter will also improve.

This model is very relevant. Once we get through this downturn and recover from it, I think we just need to recognize that this recession is severe. It is driven by a once-in-a-century pandemic and all other related factors. We have discussed customer inventory, followed by demand pull and demand normalization, as well as all other factors that have had a serious impact on the industry environment last year.In 2024, we will experience a recovery, which we call the "Year of Recovery". We have already discussed how we expect pricing to continue to rise during this year, and of course, profitability will also continue to improve.

Q4: Can you talk about the limitation on Bitcoin shipments?

A4: Advanced process supply has been tight. Therefore, this will definitely impact our shipment volume in the second quarter. Of course, the second quarter is also affected by seasonal factors. When managing the allocation of supply to customers, we want to ensure careful management of shipments to customers.

Q5: Historically, the memory industry tends to favor products with higher profit margins. This has historically led to a decline in profit margins. What makes HBM different?

A5: I believe that artificial intelligence is still in its early stages. The era of artificial intelligence has just begun, and it is the biggest revolution in the future of the internet, presenting tremendous growth opportunities. As our data center AI accelerators, including HBM, continue to grow, the rest of the infrastructure will also continue to grow.

Therefore, we expect the compound annual growth rate of HBM to exceed 50% in the coming years. This is more than three times the compound annual growth rate of the DRAM industry that we talk about. 2023 will be the first meaningful year for HBM shipments in the industry, which corresponds to low single-digit percentage shipments this year, but with much higher pricing and revenue opportunities.

Looking ahead, we see strong growth for HBM in the industry, and its demand will also increase. It will become a key driver for the next generation of artificial intelligence applications in training and inference, as the need for more data increases with the growing size of large language models and more training. This will only drive more demand for high-bandwidth, high-performance, low-power memory.

So, this is just the beginning. It still has a long way to go. Another important factor for HBM is that it does require more than twice the number of wafers to produce the same amount of bits as DDR5. So, it is indeed a headwind for the supply growth of the DRAM industry, and it also helps us contribute to the supply-demand balance of the industry.

So, I think these are some important aspects, and of course, it is important to see it as a long-term opportunity, a long-term growth opportunity. We are pleased to be able to align our HBM share with our DRAM share at some point in 2025. Of course, as we see any significant opportunities, over time, there will certainly be some fluctuations in demand and supply. We will manage this cautiously, maintaining flexibility and managing it is absolutely crucial. As you have seen, over time, we have managed this well throughout the entire DRAM industry and in Micron Tech's DRAM segment, and we will continue to manage it in this way. It is an exciting opportunity.

Q6: Should we consider normalizing capital intensity, especially as we move away from the memory nuclear winter? If there is no standardized capital intensity, what else can help us better predict free cash flow?A6: I believe the best way to consider capital expenditure is to view it as a percentage of revenue over time, and we have provided a percentage of around 30% over time.

Q7: Have you considered your capital expenditure plans and the capacity transition from mature nodes to leading nodes? When do you see yourselves fully capable of meeting customer demands? Is it more likely to be in 25 years now? In this fiscal year, which terminal markets or application areas have the largest supply-demand gap?

You have a strong lineup of data center SSD products. What is the biggest difference in the team here? How do you continue to expand your market share?

A7: As we enter this fiscal year, there is tight supply of leading nodes, which are the driving force behind demand for personal computers, smartphones, and data center applications. We have a strong product portfolio and are well-positioned in these nodes.

Our team has performed exceptionally well in the data center SSD product portfolio this year. We now offer a strong portfolio of products for data center SSDs and NVMe SSDs. We have achieved record-high market share in the data center SSD market for two consecutive quarters. For the third quarter of the calendar year, our data center SSD share now aligns with our NAND share in the industry. You will see the full benefits and strength of vertical integration, as our team works closely with customers on device, design, firmware, system implementation, and understanding customer applications, collaborating closely on qualification and certification. In fact, over time, our broad customer base has indeed developed very strong industry-leading product portfolios, and there are even greater opportunities in the future.

Therefore, this indicates that we are starting to drive the transformation within the company, shifting from selling components in the past to value-added solutions, and we are very pleased that our customers have provided our team with recognition in terms of revenue opportunities for data center SSDs, which is certainly reflected in the share gains we have achieved in this market. Of course, you may also recall that another important factor contributing to our success here is the recent transition from floating gate technology to replacement gate technology in NAND, which is absolutely crucial and has played a significant role in the strength of our data center SSDs through successful and timely execution.

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