Micron Technology's (MU 1.00%) second-quarter earnings report wasn't pretty, with falling prices of DRAM memory chips overwhelming the company's ability to cut costs. A 30% decline in revenue was paired with a quarterly loss, and guidance calls for continued pain in the third quarter.
Beyond the numbers, management had some important things to say during the company's conference call. Here are five quotes from management, taken from the transcript provided by Thomson Reuters, that investors need to see.
Mobile market slump
While the PC market has been weak for quite some time, pressuring demand for PC memory chips, the mobile market has picked up some of the slack for Micron. That ended during the fiscal second quarter, when mobile revenue plummeted by 40% compared with the previous quarter. The company blamed the timing of product qualifications for the steep decline, and CEO Mark Durcan assured investors that things will start to look better as the year goes on:
"We do expect to finalize 20-nanometer low-power DDR4 qualifications with most customers by the end of this quarter. And this, coupled with our expectation that memory demand across the smartphone categories will continue to expand, leaves us confident that our mobile business is well-positioned for substantial growth by the fourth fiscal quarter of this year."
In addition to a severe revenue decline, the mobile segment turned unprofitable for Micron during the second quarter, with a negative segment operating margin of 4.2%. A recovery is expected in the fourth quarter, assuming that demand for smartphone memory keeps growing, but that's certainly not guaranteed. Smartphone unit growth has slowed dramatically, with IDC expecting single-digit growth this year, and falling DRAM and NAND prices could continue to pressure revenue.
Despite slowing smartphone unit growth, an increase in the quantity of DRAM per device can still drive substantial bit growth for Micron. Whether that will be enough to offset any further price declines is an open question.
Micron didn't attempt to predict what DRAM prices are going to do going forward, but its guidance for the third quarter assumes some continued pricing pressure. The company expects its per-bit costs to be cut significantly over the next few quarters as it ramps up its 20nm technology, but pricing will be a major factor, according to CFO Ernie Maddock:
And as I said earlier, we all have an assumption set around what's going to happen in the pricing environment. And so, depending on your assumption about that -- and we certainly have taken a view that suggests that you're going to continue to see some of the pressure that we've seen over the recent quarters. So the gross margin guide is very, very centered around an ASP assumption, versus any doubt about our ability to achieve our cost reductions.
Micron's non-GAAP gross margin fell to 20% during the second quarter, and the company guided for a range of 16.5% to 19% for the third quarter. This suggests that Micron expects weak prices to overwhelm cost cuts, at least in the short term. Micron's financial performance going forward is going to depend heavily on DRAM pricing, and it will take a stabilization of prices before Micron is able return to earnings growth. Unfortunately for the company, there's not much reason to believe that DRAM prices will improve anytime soon.
Production cuts are unlikely
One of the most important quotes from management during Micron's conference call was in response to a question about the likelihood of the company cutting production to ease supply. Both Durcan and Maddock chimed in, and their answers demonstrate exactly why a downturn in any commodity market can drag on for a long time.
- Durcan: "Well, first of all, we're not going to do it unless we see negative cash margins, because we haven't added any incremental capacity. And we think we would be foolish to be the first ones to take capacity off, given that fact set."
- Maddock: "Yes. It's important to remember how much of our cost structure is fixed. And so, to Mark's point, as long as we're getting a contribution to that cost structure, that fixed cost structure, it's a really ill-advised move to be unilaterally cutting production."
A big chunk of Micron's costs are fixed and can't easily be reduced. This means Micron has a limited ability to cut costs during times of falling revenue, which can lead to a collapse in profitability, as we've seen over the past few quarters. What's more, because semiconductor manufacturing is so capital intensive, non-cash depreciation is a major component of Micron's per-bit costs.
As long as manufacturing DRAM is generating cash, even if it's unprofitable factoring in non-cash costs, Micron isn't going to cut production. This mind-set is probably shared at all of the major DRAM manufacturers, and that makes a reduction in supply unlikely, at least until prices fall far enough for cash margins to turn negative.
Inotera benefits lower than expected
Toward the end of last year, Micron announced that it planned to acquire Inotera, a DRAM manufacturer that currently sells all of its output to Micron. The deal was expected to generate about $600 million per year in incremental free cash flow for Micron, but with falling DRAM prices, Maddock now expects the benefits to be reduced:
So obviously, with the change in the market, since the time we've talked about the acquisition, the benefits, whether you assume it's the new arrangement or the full consolidation, are actually more muted. We still believe that they are positive, but significantly more muted than the time when we originally announced things. And we would expect from a handicapping point of view, FQ1 would be the first time you'd see the big uplift, and the impacts that we have previously talked about, relative to margin accretion starting in the third quarter, have obviously changed as a result of the change in the market environment.
A few analysts downgraded Micron before earnings, and one reason was that Micron will probably need to raise debt to complete its Inotera acquisition. With the benefits of the deal now reduced, it's unclear whether the transaction will be a net positive for the company.
Automotive was a bright spot
The only profitable segment for Micron during the second quarter was the embedded segment, and this was driven in part by strong demand from the automotive industry. Revenue did slump slightly compared with the first quarter, and margins did contract a bit, but an operating margin of 18.9% appears healthy. Durcan explains why the automotive market is attractive for Micron:
The automotive business has been pretty strong for us. And it's also, we view it as an attractive business, because the sockets are pretty sticky, the lifetimes of the products are longer. And so, from a total return, it's a very positive market for us.
Cars are becoming smarter and more connected, and demand for memory will probably remain strong for quite some time. Embedded is a relatively small part of Micron's business, so it's unable to counteract weakness elsewhere, but I would expect the segment, or at least the automotive portion of the segment, to have a long growth runway.