Micron Technology’s (MU) CEO Mark Durcan on Q4 2014 Results – Earnings Call Transcript

A webcast replay will be available on the company’s Web site until September of 2015. We encourage you to monitor our Web site at micron.com throughout the quarter for the most current information on the company, including information on various financial conferences that we will be attending. You can also follow us on Twitter @microntech.

Now please note the following Safe Harbor statement.

Unidentified Company Representative

During the course of this meeting we may make projections or other forward-looking statements regarding future events or the future financial performance of the company and the industry. We wish to caution you that such statements are predictions and that actual events or results may differ materially. We refer you to the documents the company files on a consolidated basis from time to time with the Securities and Exchange Commission, specifically the company’s most recent form 10-K and form 10-Q.

These documents contain and identify important factors that could cause the actual results for the company on a consolidated basis to differ materially from those contained in our projections or forward-looking statements. These certain factors can be found in the Investor Relations section of micron’s Web site. Although, we believe that the expectations reflected in the forward-looking statement are reasonable, we cannot guarantee future results, levels of activity, performance or achievement. We are under no duty to update any of the forward-looking statements after the date of the presentation to conform these statements to actual results.

Kipp Bedard – VP, IR

I’ll now turn the call over to Mark Durcan. Mark?

Mark Durcan – CEO

Thanks, Kipp. We had another strong quarter benefiting from robust market demand as well as solid operational execution. We set a new record for revenue of over $4.2 billion for the quarter. Net income was $1.15 billion or $0.96 per diluted share. For the fiscal year 2014, we generated record revenue of $16.4 billion, record net income over $3 billion, and record free cash flow of $2.6 billion based on record operating cash flow of $5.7 billion less CapEx of $3.1 billion.

As we enter fiscal 2015, I’d like to touch on a few key areas of focus as well as provide a brief industry update. Ron Foster will follow with a financial summary and before turning to Q&A, we’ll close our prepared comments with Mark Adams covering additional details of our operational performance and market conditions.

Beyond ongoing advanced component and technology development, we have three main operational focus areas for fiscal 2015. The first is technology deployment and includes continued 25-nanometer DRAM conversion and 20-nanometer DRAM ramp, completion of 16-nanometer planar NAND conversion and introduction of 3D NAND, TLC NAND deployment for cost sensitive applications and building out our capability to deliver advanced packaging solutions and controllers.

The second is optimizing manufacturing capacity, which includes improving our manufacturing efficiency through line balancing, cycle time, yield, and metrology initiatives, and managing our product mix in order to generate the best possible long-term margins and returns for our business.

And finally in 2015, we will focus on growing our memory systems and subsystem solutions, including expanding the market penetration and our offering breadth of our advanced bit addressable memory solutions, building additional storage solutions such as enterprise SSDs, and designing new and innovative mobile memory systems solutions.

As we outlined at our Analyst Day last month, fiscal 2015 CapEx is expected to be in the range of $3.6 billion to $4 billion. Roughly 30% of this CapEx will go towards non-supply expanding investments, including manufacturing efficiency improvements, emerging memories, backend capability and additional system manufacturing and engineering tooling to support system and subsystem level products. This compares to about 25% of our $3.1 billion CapEx bill in fiscal 2014, and highlights our belief that these investments, which are designed among other things to enhance our value-added product portfolio will generate some of the highest returns going forward.

In terms of the more traditional investments in memory process technology, DRAM will represent about 50% and NAND will represent about 20% of our total CapEx in 2015. This compares to roughly 45% and 30% to 35% respectively in 2014. We expect the bit growth we generated from technology in calendar 2015 to be in line or below the market for both DRAM and NAND. Our big growth profile is reflective of the strategy to grow the mix of premium and value added products while maintaining and improving operational efficiency and costs. While this will lead to less pure supply growth, we expect we will generate more attractive and sustainable margins over time with this approach.

Our long-term outlook for the memory industry remains favorable. For DRAM, we are forecasting 2014 industry supply growth of around 30%. In 2015, we expect DRAM industry bit growth in the low to mid 20% range, and beyond 2015 we expect industry supply growth to slow somewhat ranging from the high teens to mid-20s. Part of this encouraging supply trend is due to the fact that 20-nanometer and sub 20-nanometer process technology ramps significantly reduce the wafer production for existing clean room space.

We believe the DRAM industry; supply demand balance will continue to be favorable for the foreseeable future. Demand elasticity has declined from historical levels, and cost per bit is no longer the major factor driving demand growth. For NAND, we are projecting industry supply growth in the high 30% to low 40% range for 2014. This includes an increase in industry wafer production of just over 10%, with the remaining supply growth coming from technology.

We expect 2015 industry supply growth to be in the high 30% to 40% — to mid-40% range, beyond 2015 when 3D becomes more prevalent in the market, supply growth will depend on new capacity investment. Although 3D technology drives a significant increase in bits per wafer, without capacity investment, this is offset by substantial decreases in wafer output per square foot of clean room space.

The demand profile matches up well with the existing supply growth rate and we also believe that due to elasticity of demand for NAND and client enterprise storage applications, the demand growth could be significantly higher over time. At Micron, we will continue to manage our NAND business, focused on long-term returns.

I want to congratulate the whole Micron team for a tremendous year. We look forward to building on the success in 2015. The memory industry continues to look very attractive. We’ve never been better positioned to deliver differentiated value for our customers and shareholders.

I’ll stop here and turn it over to Ron and Mark before turning for Q&A. Ron?

Ron Foster – CFO, VP, Finance

Thanks Mark. Our fourth quarter 2014 and fiscal year ended on August 28. We posted to our Web site a file containing the financial information I will cover including GAAP and non-GAAP results, certain key metrics for fiscal 2014, the fourth quarter, as well as guidance for the first quarter of fiscal 2015.

For fiscal 2014, we posted record revenue and net income, as Mark mentioned, with net income of $3 billion or $2.54 per diluted share on net sales of $16.4 billion. This compares to the fiscal 2013 results of net income of $1.2 billion on net sales of $9.1 billion. Recall that the 2013 results include the $1.5 billion non-cash gain in the fourth quarter from the purchase accounting for Elpida and Rexchip, which we now refer to as Micron Memory Japan or MMJ and Micron Memory Taiwan or MMT.

The results for fiscal 2014 reflect continued healthy market conditions, particularly for DRAM products and our focus on maximizing long-term returns in the business. Non-GAAP net income increased significantly comparing 2014 to 2013.

Now focusing on the fourth-quarter results, we posted net income of $1.150 billion or $0.96 per diluted share on net sales of $4.2 billion. The fourth quarter gross margin of 33% includes a $66 million charge associated with a patent license with Tessera. The go-forward license will have cost of goods sold charges that are not anticipated to have a material impact to any future quarterly period.

In addition, gross margin in the fourth quarter was adversely affected by $38 million from a last time sale of legacy architecture mobile PCM or phase change memory products which was mentioned last quarter as part of our guidance. Without these two items, gross margin for the fourth quarter would have been higher by approximately 2.5 percentage points.

On a non-GAAP basis, net income for the fourth quarter was $961 million, or $0.82 per share. Non-GAAP adjustments netted to a reduction of income of $189 million or $0.14 per share in the fourth quarter and included the following. The charge related to the Tessera license mentioned previously, restructured charges in the quarter of $22 million which were primarily related to employee termination benefits from a workforce reduction in Italy.

Amortization of debt discounts and other costs of $37 million in the fourth quarter includes imputed interest on our convertible notes and the discount on the MMJ installment debt. The loss on restructure of debt of $17 million related to primarily to the repurchase and conversion of convertible notes in the fourth quarter including mark-to-market adjustments of the 2031 B-notes to be settled in the first quarter of this year.

Non-cash taxes from the MMJ operations were $118 million benefit in the fourth quarter, which includes a benefit from a change in the estimated utilization of net operating loss carryforwards for MMJ and MMT. A couple of significant gains recognized in the fourth quarter also adjusted out of the non-GAAP results as follows. A $93 million gain was recognized as a result of Inotera’s equity GDR offering in May that was executed at a price above the carrying value of our investment.

This gain was recognized in the fourth quarter, since we account for our equity method results from Inotera with a two-month lag. And $190 million gain was recognized from the sale of our remaining interest in Aptina to ON Semiconductor. The transaction closed just shortly before the end of the fiscal year. And finally, there is a 27 million share anti-dilutive effect of capped calls based on the average stock price during the fourth quarter of $31.91.

In the first quarter of fiscal 2015, we expect the following non-GAAP adjustments. Between $40 million and $45 million for amortization of debt discounts on the convertible notes and the Elpida installment debt, we are anticipating a Q1 net loss on restructure of debt of approximately $25 million as the conversions of the 2031 B-notes are completed.

Non-cash taxes related to the Elpida acquisition are expected to be between $20 million and $30 million in the first quarter. Also, the anti-dilutive effect of our capped calls will be based on the average share price for the quarter. Please refer to the convertible debt dilution table included in the earnings call data file posted on our Web site.

Let’s turn now to our results by technology and other guidance for the first quarter. On a consolidated basis we are guiding total revenue for the first quarter in the range of $4.45 billion to $4.7 billion. Recalling our first quarter of fiscal 2015, we will include an extra week due to the periodic adjustment of our weekly fiscal calendar to coincide with the end of August year-end, which will have a direct impact on operating expenses; however, revenue may vary differently.

Turning now to DRAM, DRAM revenue increased nearly 5% compared to the third quarter, primarily due to an increase in bit sales volume and stable ASPs. DRAM gross margin remained in the high 30% range, with flat cost per bit. Cost per bit would have been down 2%, absent the effect of the Tessera license. Our reported income from equity method investments for the fourth quarter was $119 million substantially all of which is attributable to Inotera.

DRAM gross margins for the first quarter using quarter to date ASP and projected mix for the quarter should be up a couple of points compared to Q4 based on bit production up mid to high single digits, ASPs up low single-digits, and cost per bit down low single-digits which includes the effect from the Tessera license in Q4. Key items affecting our DRAM guidance for the first quarter are continued favorable market conditions, like for like pricing, generally flat to up for PC and server DRAM and trending up for mobile DRAM, which Mark will comment on in a few minutes.

On the Trade NAND side revenue increased 6% in the fourth quarter with a 13% increase in bit sales volume partially offset by 6% decrease in the average selling price. Trade NAND gross margin was in the mid-20% range down approximately 3 percentage points with ASP declines outpacing cost per bit reductions of 2%. However, absent the effect of the Tessera license agreement, cost per bit would have been down approximately 5%.

Trade NAND gross margins for first quarter using quarter to date ASP and projected mix for the quarter, are expected to be down 1 to 2 percentage points compared to Q4, based on bit production is expected to be up high teens, ASPs down low to mid-single digits, and cost per bit down low single digits compared to Q4, which includes the effect of the Tessera license.

Key trends for Q1 affecting this guidance are generally stable NAND market conditions, and also, strong growth in client and enterprise SSD volumes with more pronounced price competition and initially higher BOM costs that impact margins.

Looking at other P&L and cash flow results and guidance, SG&A expense in Q1 is expected to be up slightly from the normalized weekly run rate from the fourth quarter. R&D expense in the first quarter and fiscal 2015 is expected to increase compared to the fourth quarter, even when normalized for the 14th week in Q1, due to higher volumes of development wafers processed for new technologies and new solutions development.

The company generated $1.35 billion in operating cash flow in the fourth quarter and ended the quarter with $5.4 billion in cash and marketable investments approximately $1.8 billion increase over the fiscal year. Expenditures of property, plant and equipment in the fourth quarter of fiscal year were $1.3 billion and $3.1 billion respectively.

Our cash tax rate continues to be in the low single-digit range at current profit levels. While GAAP taxes are expected to run in mid-single digits this year. Throughout this past fiscal year we’ve been in the market in each open trading window revamping the capital structure of the company with the focus on reducing dilution associated with our convertible notes. We’ve been repurchasing or converting convertible notes with cash and replacing them with high-yield notes including the fourth quarter repurchase of the 2032 notes and issuance of $1.15 billion and 5.5% notes. Approximately 90% of the free cash flow generated during the year was used for these dilution management activities.

In addition, in the fourth quarter, we used $339 million of cash to prepay certain foreign loans and leases. We have indicated the pending conversion of the remaining 2031 B-notes will be for cash, resulting in an outflow in Q1 of approximately $390 million of cash.

Now, I’ll turn it over to Mark Adams for his comments.

Mark Adams – President

Thanks, Ron. I will begin, as usual, with a review of our Q4 operating performance by business units, as well as share commentary on market insights, key segment trends and memory industry dynamics.

Our Computing and Networking Business Unit referred to as CNBU, had another strong quarter, achieving $1.9 billion in revenues in Q4. DRAM pricing in CNBU was up quarter-on-quarter, highlighting a continued healthy demand supply balance in computing, server networking and enterprise market segments. On the client side, we continued to receive strong demand signals from our PC customer base. We locked our pricing through the end of our calendar Q3 and with our three largest OEM customers, and have received interest in locking prices again for Q4. We achieved record revenue and bit shipments in our server segment.

Server DRAM growth is being driven by customers adding more memory per system. In fiscal year 2014, we saw a 40% year-on-year growth in DRAM per server, while ASPs in the segment had strengthened over the same period. This growth in server based memory is based on increasing server workloads, continuing to require DRAM performance and density and is a great example of a high-growth segment with a demand profile that is not sensitive to price.

Networking revenues in DRAM were up 19%, quarter-over-quarter. Demand for our networking products remained strong driven by LTE build-out in China and other emerging markets. Next year, we expect to see significantly more 4G handset sold utilizing this capacity, which continues to drive higher memory content per phone. I will address this more in the mobile section. The U.S. will fully be engaged in a 4G LTE build-out throughout calendar 2015 and as a result, we anticipate seeing continued strong demand in this area.

Lastly, our Graphics business continues to flourish and increasingly contributes to an uplift in ASPs and margin. We’re starting to see strong gaming consoles demand ahead of the holidays and remain optimistic for a good quarter and graphics. We are pleased with the progress on the technology innovation front in DRAM. We commenced early DDR4 shipments in Q4 as Intel officially launched DDR4 enabled platforms in early September, and Micron is validated with their entire 4 gigabit based portfolio.

I want to recognize our R&D organization, our engineering teams and BU product development organization for positioning Micron as first to market and what we feel could be a strong value-added business. We are in qualification at major OEMs for both server and client opportunities for DDR4. We anticipate a significant price for those customers looking to differentiate their solutions.

We have also launched into the non-volatile DIMM category providing for DRAM content back-up with dramatically improved reliability. Our NVDIMM product launch initially based on DDR3 is going well as we’ve received production orders from Tier 1 customers. We’ve also signed a lead major OEM customer for the launch of our DDR4 based NVDIMM targeting shipments in calendar Q2.

Micron’s hybrid memory cube continues to gain significant traction at leading network and server customers. In addition, similar technology for Micron will be used in Intel’s Knights Landing platform for a high performance in low latency benefits in high-performance computing. Finally, our DDR5 product continues to gain wide adoption in gaming consoles and is also being sampled in high-performance networking applications.

Our Storage Business Unit or SBU, recorded $907 million in revenue in the fourth quarter, up 4% quarter-over-quarter. We continue to make progress in both the client and enterprise SSD market. We set records for total SSD revenue gigabyte shipped and overall units in our fourth quarter, while also achieving record revenue for both client and enterprise SSD’s individually. We increased client SSD shipments to Tier 1 OEMs by 23% quarter-on-quarter.

For our fiscal 2014, SBU revenue was up 23% when compared to 2013, coming in at $3.5 billion. Gross margin dollars were up 17% year-on-year reflecting the overall health of the NAND market. We remain focused on improving the fundamentals of our NAND business as we believe there is upside to our performance relative to our competition in the coming quarters.

I would like to discuss some of the elements which we feel can bolster our NAND business. First, we continue to invest in process innovation. We executed the fastest ramp in our company’s history for our 256 gigabit, 16-nanometer planar product. TechInsights recognized Micron with a semiconductor product of the year award and most innovative memory device award for this technology. We’re making progress in our 16-nanometer TLC product with engineering samples still on track for the end of this calendar year. We are targeting late spring shipments of TLC components to consumer applications and expect to be shipping a TLC client SSD drive into the market during our fiscal fourth quarter.

Micron will continue to increase our leadership in overall NAND scaling with our 256-gigabit, 3D NAND device, which we believe will have the highest density per square inch of silicon in the industry. We remain on track for calendar Q4 samples and currently forecasting volume production by the second half of calendar 2015. Beyond innovation at the technology level, we continued to add controller and firmware resources that are helping to accelerate product development, enhance the quality of our PCIe SaaS and SATA-based SSD products led by the launch of our M500 DC enterprise product, which targets data center applications, our enterprise SSD revenue was up 79% quarter-on-quarter. This investment in system-level solutions has led new customer wins in server, network security, cloud and video streaming segments in Q4.

In addition to chip and system-level investments, we continue to recruit strong level sales and marketing personnel to position our go-to-market engine for future success. We are investing and expanding our customer engagement support, it is increasingly becoming more of a design and custom solution type relationship with key accounts.

Finally, we are continuing to diversify our NAND business and do more attractive end market applications. As an example, revenue for NAND sold in the mobile segment was up 18% quarter-over-quarter. Coupling NAND with DRAM in the form of eMCPs is a high-growth opportunity. eMCPs are essentially low power DRAM packaged with a managed NAND product all behind the controller. We believe this is solution, is a great example of the value of Micron’s portfolio.

We continue to grow share in our consumer products segments with Lexar-branded memory cards and USB products, gaining share in the U.S. and international markets. We remain bullish on the long-term market opportunity in NAND both in terms of the market outlook, and our ability to improve our operating performance. Upside potential in our NAND business will be driven by the chip level innovation including TLC and 3D NAND, investment in system-level capabilities, additional organization capabilities and focused execution on growth and diversifying markets.

We are very pleased with the performance of our mobile business unit. MBU revenue came in at $909 million with a 22% operating margin. We continue to see strong demand in mobile. The iPhone 6 launch appears to be going quite well and reflective of consumer appetite for improving smartphone application features and performance. On the high-end, the Samsung Note 4 is now shipping with 3 gigabytes of low-power DRAM’s is the Xiaomi MI4 product line as well.

In NAND, the higher-end configurations have shifted from 32 gigabytes and 64 gigabytes now to 64 gigabytes and 128 gigabytes. We are currently forecasting NAND growth in the mobile segment of greater than 3X year-over-year for fiscal year 2015. The low to mid range price smartphone market is driven additional memory content as well, meeting the entry-level segment is evolving from phones with virtually no DRAM to new products such as the Android 1, which is 1 gigabyte of low-power DRAM. This is $100 smartphone targeting 5 billion users in emerging markets. We are focused on our diversified set of mobile customers and continue to balance our PC DRAM and mobile DRAM capacity to optimize for long-term profitability.

On the product front, we are growing our managed NAND business with increased shipments of eMCPs as I mentioned earlier. The rapid adoption of eMCPs for the low to mid end smartphones, which is the fastest-growing segment today represents a unique opportunity for Micron. Our known good die flow from our MMJ fab formerly Elpida, coupled with Micron’s industry-leading 16-nanometer NAND technology enables us to capture share due to the accelerating market shift from eMCP from eMMC.

Over the next year, we are forecasting that roughly 25% of our overall mobile revenue will come from memory combined with the controller. We believe that companies like Micron, who have the portfolio of NAND and DRAM will have a distinct advantage in the long run in the mobile segment.

In addition to managed NAND, we’re currently working with our chip partners to enable low-power DDR4 for future qualification in high-performance applications for mobile. I want to congratulate the mobile team for their successful turnaround of the business that within last two years was losing money on the bottom line. We feel that the combination of increasing memory content and mobile devices and the declining rate of mobile industry supply growth due to the attractiveness of other relatively higher margin segments, lead to a healthy overall supply and demand outlook for mobile. We look forward to the teams continued strong execution.

Our Embedded Business Unit or EBU set a record of $1.74 billion in fiscal year 2014 which represent 39% year-over-year growth. Our fourth quarter revenue of $476 million reflected a seventh straight quarter of record shipments for embedded.

Automotive revenues were 40% increase year-on-year. The automotive segment continues to benefit from memory content growth fueled by both infotainment and advanced driver assistance systems. Our commitment to the unique needs of this market in areas such as quality, reliability, longevity and service has enabled us to strengthen our market leadership in Q4.

The broad category of industrial and multi-market, otherwise referred to as IMM, achieved record revenue for both the quarter and the year. Year-on-year revenue growth was 10% to 20% driven by continued growth in factory automation, machine-to-machine systems and aerospace and defense. As we see strong demand growth in areas such as automotive entertainment consumer electronics, connected home devices and machine-to-machine systems, we remain bullish on our EBU performance for fiscal 2015.

Operationally, we had a tremendous year. In a year where we shift to more diversified set of products with more complex packaging and custom configurations to a broader set of end customers, we were able to reduce overall inventory and drive our churns 18% higher compared to the end of fiscal year 2013. This is all the more impressive given the significantly larger revenue scale of our business than which we left 2013.

Our DRAM and NAND front-end cycle times improved 25% and 18%, respectively, year-over-year. And our backend test and assembly facilities reduced their cycle times 33% and 34% for NAND and DRAM. We see additional room for improvement in our operations during fiscal year 2015. The pricing environment for our portfolio of products remains favorable. DC pricing has remained strong with more than 90% of our computing capacity tied to OEM contract pricing most of which with quarterly pricing agreements in place. This has been a positive effect on mobile pricing, as well, having balanced our production to take advantage of PC DRAM ASPs in margins which are currently above the mobile business.

On the NAND front, pricing dynamics are relatively stable heading into the holiday build season. We remain bullish on the long-term outlook for NAND with increasing attach rates in both client and enterprise drives with a strong content move from 128 gigabytes systems trending upwards to 512 gigabytes systems, as well, seeing a big increase in phones.

As the industry converged to 3D NAND, we think performance and cost will continue to improve driving accelerated adoption of NAND and client mobile and enterprise market segments. We see a bright future in NAND another emerging non-volatile memory technologies.

In closing, I also want to congratulate our team for a great quarter and an outstanding fiscal year 2014. We look forward to a strong Q1 and we feel there is opportunity for improved performance in fiscal year 2015 as we continue to drive our memory solutions to higher value-added customers and segments.

With that, I will hand it back over to Kipp.

Kipp Bedard – VP, IR

Thanks Mark. We will now take questions from callers. Just a reminder, if you are using a speakerphone please do pick up the handset when asking a question, so we can hear you clearly and please open up the lines.

Question-and-Answer Session

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