MICRON TECHNOLOGY INC quarterly report, Q2 FY2014

Business Context and Reporting Period

Micron Technology, Inc. filed this unaudited Form 10-Q for the fiscal quarter ended February 27, 2014, and six months ended February 27, 2014. Micron manufactures and sells DRAM, NAND Flash, NOR Flash and related semiconductor products serving computing, mobile, consumer, networking, automotive, industrial and embedded markets. Results include the acquired Elpida and MMT operations, acquired July 31, 2013.

Key Financial Metrics

Metric	Q2 FY2014	Q2 FY2013	Six Months FY2014	Six Months FY2013
Net sales	$4,107 million	$2,078 million	$8,149 million	$3,912 million
Gross margin	$1,403 million; 34%	$366 million; 18%	$2,684 million; 33%	$583 million; 15%
Operating income	$869 million; 21% of sales	$(23) million	$1,420 million; 17%	$(120) million
Net income attributable to Micron	$731 million	$(286) million	$1,089 million	$(561) million
Diluted EPS	$0.61	$(0.28)	$0.91	$(0.55)
Operating cash flow	Not separately provided for the quarter	Not separately provided	$2,897 million	$470 million

• Q2 sales increased 98% year over year, while six-month sales increased 108%, primarily from the Elpida acquisition, higher DRAM and NAND Flash volumes, and improved manufacturing output.
• DRAM generated Q2 sales of $2,785 million, or 68% of total sales; NAND Flash generated $1,154 million, or 28%.
• Q2 segment operating income was $520 million for DSG, $185 million for WSG, $77 million for NSG and $59 million for ESG.
• Cash and equivalents were $4,305 million at February 27, 2014, compared with $2,880 million at August 29, 2013. Short-term and long-term marketable investments totaled $751 million.
• Total debt was $6,547 million, consisting of $2,230 million current debt and $4,317 million long-term debt. Contractual obligations totaled $8,589 million, including debt, capital leases and operating leases.
• Capital expenditures were $1,031 million in the first six months. Management estimated 2014 capital spending of approximately $2.6 billion to $3.2 billion, with approximately $950 million of related purchase commitments outstanding.
• Net cash used in financing activities was $1,006 million, reflecting $1,987 million of debt repayments, partly offset by $1,062 million of new debt issuance and $224 million from equity plans.

Material Changes Versus Prior Comparable Period

• Profitability improved substantially as DRAM pricing, manufacturing cost reductions, Elpida contributions and higher production volumes more than offset increased operating expenses.
• Gross margin expanded to 34% from 18% in the prior-year quarter, while operating results improved from a $23 million loss to $869 million of income.
• DSG sales increased 150% year over year in Q2 and WSG sales increased 327%, primarily due to Elpida. NSG sales increased 27%, while ESG sales increased 29%.
• DRAM average selling prices increased 22% year over year in Q2, while DRAM cost per gigabit declined 19%. Trade NAND Flash average selling prices declined 24%, but gigabits sold increased 77%.
• Elpida inventory fair-value step-ups increased cost of goods sold by approximately $42 million in Q2 and $153 million cumulatively since the acquisition.
• Q2 SG&A increased 44% year over year to $177 million, and R&D increased 61% to $344 million, primarily due to Elpida-related costs, higher payroll costs and lower partner reimbursements.
• Equity income from investees improved to $134 million from a $58 million loss, including $131 million from Inotera, compared with a $55 million loss in the prior-year quarter.

Guidance, Outlook, Commentary and Unusual Items

• Management expected Q3 FY2014 SG&A of approximately $170 million to $180 million and net R&D expense of approximately $345 million to $355 million.
• The Singapore DRAM facility was being transitioned to NAND Flash production, with substantial completion expected by the end of 2014. The transition was expected to cause a marginal temporary reduction in wafer production.
• Management expected DRAM production and sales volumes to increase significantly in 2014 as a result of Elpida. Elpida facilities represented approximately one-third of Micron's wafer capacity and produced 53% of aggregate DRAM gigabits in Q2.
• Micron expected cash, investments, operating cash flow and available financing to meet requirements for at least the next 12 months. Credit facilities provided up to $408 million of additional financing, subject to conditions.
• Micron completed significant debt restructuring, including cash settlements of convertible notes, a $407 million repurchase of $164 million principal amount of convertible notes, issuance of $600 million of 5.875% senior notes due 2022, and issuance of 2019 secured notes.
• The company recorded a $233 million Rambus settlement liability in Q1 and agreed to pay Rambus up to $10 million per quarter for seven years, totaling $280 million.
• Other unusual Q2 items included an $80 million debt-restructuring loss, a $33 million adjustment to the Elpida acquisition gain, and $63 million of income tax expense. Tax arrangements reduced Q2 tax expense by $68 million.
• Micron extended its Inotera supply agreement through December 2016 and purchased $714 million of DRAM products from Inotera in Q2. Inotera represented 37% of Micron's DRAM gigabit production.

Risks, Contingencies and Liquidity Considerations

• Memory pricing is cyclical and highly competitive. Future declines in DRAM, NAND Flash or NOR Flash average selling prices could outpace manufacturing cost reductions and compress margins.
• Elpida remains subject to Japanese court and trustee oversight. Its assets, including approximately $2,025 million of cash and investments, were generally restricted from funding Micron's other operations.
• Micron had remaining Elpida creditor obligations of 142 billion yen, approximately $1,392 million at the reporting-date exchange rate, payable from 2014 through 2019. Unfixed claims could increase total payments.
• Inotera had a $129 million working-capital deficit at December 31, 2013 and was not in compliance with certain loan covenants. A waiver had been requested, creating potential risk to Micron's investment and supply relationship.
• The Qimonda litigation could result in loss of Inotera shares, monetary damages or termination of a patent cross-license. The Inotera shares had a $312 million carrying value and approximately $1,002 million market value at February 27, 2014.
• Outstanding patent, antitrust, securities and other legal matters could result in material liabilities, although the filing states that the range of possible loss generally cannot be estimated.
• Foreign-exchange exposure, particularly to the yen and New Taiwan dollar, could affect operating costs and the dollar value of Elpida creditor payments. A 10% adverse currency movement was estimated to produce approximately $9 million of losses on monetary exposures.
• Cash availability was constrained by restricted funds held by Elpida and IMFT. The company also faced substantial capital spending, debt service and equipment purchase commitments.

Most Important Facts to Verify

• Whether DRAM pricing and cost-per-gigabit improvements remain sufficient to sustain the 34% gross margin.
• The pace and execution of Elpida integration, including the use of Elpida cash, court oversight and annual creditor payments.
• Actual 2014 capital expenditures versus the $2.6 billion to $3.2 billion estimate and the effect on free cash flow.
• Debt maturities, cash conversion obligations and the impact of further convertible-note settlements on liquidity and dilution.
• Inotera covenant compliance, liquidity, supply reliability and the outcome of the Qimonda litigation.
• Changes in NAND Flash pricing, the Singapore fab conversion and competitive industry capacity.
• Resolution and potential financial impact of outstanding patent, antitrust and securities proceedings.