Micron: My Q1 Takeaways Are Not Necessarily Financial
Summary Everyone’s aware of the spectacular quarter @Micron had after looking at the income statement and balance sheet. There are several takeaways that are arguably more important which show the direction and focus the company has taken on. Combining these takeaways with the anticipation of hearing more about #3DXPoint in the coming weeks means Micron is setting up for a strong 2018. It’s clear to many at this point Micron (MU) had a by-all-means blowout quarter. Earnings were 25 cents above Street estimates (3 cents above my mid-point estimate) while revenue blew the doors off. Gross margins were extraordinary at 55% while operating and free cash flow were as strong as we’ve seen in recent memory. Guidance was even more satisfying as it made Street estimates look like analysts forgot to take their 101 class. Even the high estimate – the one analyst all the other analysts peer over at with condescension wondering what bar he stumbled out of last night – was looking like the man with one eye in the land of the blind. ￼ (Source: Micron) This is really great stuff – financially. But there are some even more important items which say Micron is not just a wall of bullish numbers. It appears Micron is running on all cylinders in the business model and business acumen department as well. There are three areas where management has brought the business from an old era to a new, vibrant one. Offerings and Dilution This takeaway is the closest to being financial, but it has its roots in the overall direction of the company and its foundation. That being said, the focus on debt repayment while business is booming is not as clear cut as you would think. There’s a mixed bag of investors who believe taking on debt while it’s cheap in order to build out infrastructure and fund R&D is how to bring a company to the front of the pack. The other camp is of the belief that now is the time to pay off debt – while the going is good. You can look no further than offshore oil drillers as an example to reinforce the latter camp’s thesis. There were some pretty rigid opinions on this move when Micron announced its equity offering in the beginning of October. What made this more interesting was even the payoff-debt-now camp was divided – was it the right debt to pay off and at the most optimal time? I was on the divided camp side which said, yes, this is a pretty decent move; the stock is at 16-year highs and cash necessary to pay off this debt is overseas, therefore, generate some in the location it’s required. I was surprised CFO Ernie Maddock took a section of his prepared remarks to give more insight about the equity offering, but I’m glad he did. It essentially said if you look out long term (end of the fiscal year), you will see the decrease in interest expenses, the removing of otherwise convertible debt which would have created dilution anyway, and the added benefit of interest income on greater cash balances materially offsets the dilution from the recent offering. Advertisement ￼ We expect the interest savings from these de-leveraging actions, combined with higher interest income from larger cash balances and the anti-dilutive effects of settling converts for cash, to materially offset the dilutive impacts associated with the equity offering. While most readers let management “have it” two months ago, it seems management was thinking long term – and that means knowing the business would perform exceptionally well into 2018 and the stock would still be on the rise well after this offering. Translating to: if the company does this now, the lesser interest expenses and the repurchased convertible debt would be more beneficial than waiting for the offering to be marginally less dilutive. 3D XPoint Yeah, that’s not a typo – management talked about it, of its own volition! Not one but two paragraphs of roadmap talk. Since this is one of the more major topics to come about, I’m going to place both paragraphs here because it’s just worth reading. We continued to make good progress with our 3D XPoint technology. Historically, Micron’s efforts on 3D XPoint have been largely focused on technology development and early manufacturing ramp, but given our increased focus on high-value product solutions, we have recently resourced a product development team to address the opportunity ahead of us. Simultaneously, we are working with various players in the ecosystem to assess market and enablement opportunities, and we will provide further details of our views regarding these opportunities during our upcoming analyst event. We will also continue to have the opportunity to sell our 3D XPoint output to our partner as this market develops. The last time we had this much of an update on 3D XPoint was the company’s Analyst Day back in February. ￼ (Source: Micron’s 2017 Analyst Day Side Deck) And so it seems we’ll gain even further details about XPoint at this upcoming Analyst Day as the recent comments suggest. The key I wish to point out in bringing this up is the “increased focus on high-value product solutions” and how XPoint has become more interesting to management. I blame this re-ignition of focus on CEO Sanjay Mehrotra and how he plans on leading the company further into this new era of Micron market leadership. This means 3D XPoint is still viable as a technology to bring about further value for the company both in revenue and in leadership of the memory industry. Now, this isn’t the best news we could have heard on the tech – naturally a meaningful revenue announcement would be – but it is bubbling up to the surface once again after nearly a year. So while 2018 is still not set in stone by any means for DRAM and NAND market pricing, XPoint could be a card up the sleeve in terms of buoying any weakness seen later in the year, knowing it’s at the forefront of management’s roadmap. Closing The Tech Gap Micron appears to be increasingly focused on closing its technology gap with its competitors, especially now with Sanjay at the helm. While we don’t have hard specifics of where Samsung (OTC:SSNLF) (OTC:SSNNF) is versus where Micron is in the 1X and 1Y DRAM manufacturing process, we do have some information especially as we see a ramp with the technology to customers. Micron: Our 1X nanometer designs have been well received by cloud customers, with more than a quarter of our cloud revenue in Q1 coming from our 1X technology. Fast qualification and production ramp by our cloud customers of new technology node products is a significant benefit, as it diversifies and accelerates our customer traction and market reach during early stages of production deployment of these advanced nodes. We do know Samsung is just starting to ramp its 1Y technology as it heads in 2018. Samsung Electronics, the world leader in advanced memory technology, announced today [12/20/17] that it has begun mass producing the industry’s first 2nd-generation of 10-nanometer class* (1y-nm), 8-gigabit (Gb) DDR4 DRAM. Micron, on the other hand, is expecting to ramp its 1Y tech in the second half of 2018: Both 1Y DRAM and third-generation 3D NAND development are progressing well, and we remain on track for initial output of both in the second half of calendar 2018. This appears to be about a 6-9 month lag for Micron which still translates to disadvantage in node transition. However, this is a drastic improvement from the 1X node transition. Samsung was first outputting 1X in April of 2016 while Micron is just now transitioning to meaningful 1X output. As Sanjay noted in his prepared remarks, we are making strong progress on the roll-out of our 1X DRAM and 64-layer 3D NAND deployment. This means the gap has come down from about 17-19 months for 1X to the current expectations for 6-8 months with 1Y – cutting the catch up time in half or better. I expect the DRAM generation to follow to be half of the current 6-8 month based on this drastic improvement on Micron’s part. Who knows, 3D XPoint may have already set Micron ahead in that race, especially if it can produce a variation of the technology which displaces traditional DRAM or pushes the industry in a quicker success of follow up generations. Notable Mentions Some notable mentions which are important but not critical or are closer to financial takeaways include the tax bill not having an impact on Micron’s tax carry forwards as well as the in line expectation for Micron to be ahead in NAND bit output, due in large part because of its CMOS under the array technology. The tax bill impact is noteworthy because much of tech fell this month due to concerns the tax bill may hurt tech or at least not benefit them meaningfully. The worry with Micron was due to its tax loss carry forwards as they may have been written down due to the effective tax rate being meaningfully lower. Finally, a word about tax reform, as drafted, the legislation would have no significant impact to our FY18 tax rate, which we continue to expect to be in the mid-single-digit range. Much of this is likely due to the profits and tax losses Micron carries are from foreign countries and are under different tax regulations. The tax bill signed into law this past week would obviously affect any US profits as well as cash needing to be brought onshore, but at this point, a major portion of Micron’s cash flow is overseas. ‘The’ Takeaway Micron is being managed wisely and with intentional direction. There is plenty of money to be made in the current memory environment, but it could be squandered if the company doesn’t focus on the right things at the right time. Closing the technology gap and moving new technologies to the manufacturing floor are key initiatives in order to continue financial outperformance. It’s clear at this point Micron is setting up to be stronger than it ever has been on its balance sheet as well as in its portfolio of products. I look forward to management’s comments on 3D XPoint in the coming weeks and understanding how it will drive the company in the latter half of the calendar year. If you’d like to be made aware of my opinion and analysis in the future on Micron and other tech companies, then I encourage you to follow me by clicking the “Follow” link at the top of this page next to my name.