Micron Technology Inc (MU) — Q2 2019 Earnings Call Transcript

Thank you. And welcome to Micron Technology's second fiscal quarter 2019 financial conference call. On the call with me today are Sanjay Mehrotra, President and CEO; and Dave Zinsner, Chief Financial Officer. Today's call will be approximately 60 minutes in length. This call including the audio and slides, is also being webcast from our Investor Relations website at investors.micron.com. In addition, our website contains the earnings press release filed a short while ago. Today's discussion of financial results will be presented on a non-GAAP financial basis, unless otherwise specified. A reconciliation of GAAP to non-GAAP financial measures may be found on our website along with convertible debt and capped call dilution table. As a reminder, the prepared remarks from this call and webcast replay will be available on our website later today. We encourage you to monitor our website 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 follow us on Twitter, @MicronTech. As a reminder, the matters we will be discussing today include forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from statements made today. We refer you to the documents we file with the SEC, specifically, our most recent Form 10-K and Form 10-Q for a discussion of risks that may affect our future results. Although, we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. We are under no duty to update any of the forward-looking statements after today's date to conform these statements to actual results. I'll now turn the call over to Sanjay.

Thank you, Farhan. Good afternoon, everyone. Micron executed well in the second quarter, delivering solid results and healthy levels of profitability and free cash flow, despite a challenging industry environment. We continued to strengthen our balance sheet in the quarter by increasing our cash position and total liquidity. Although we expect industry headwinds in the near-term, we continue to grow and diversify our product portfolio, improve our cost competitiveness and lay the foundation to emerge stronger, both financially and operationally, from this environment. I would like to start with a review of two important pillars of Micron’s strategy, improving cost competitiveness and increasing high-value solutions in our portfolio. Our strategy positions us for the tremendous opportunities ahead while also enabling us to better navigate near-term headwinds. Strong execution against this strategy has improved our annualized profitability by over $6 billion from fiscal 2016 to fiscal 2018. This has improved our EBITDA margin by more than 15 percentage points relative to our competitors over the same period. We expect further progress on cost reduction this fiscal year, including healthy year-over-year cost declines in both DRAM and NAND. In DRAM, our 1Y nanometer is yielding well, and we expect to increase conversion to 1Y nanometer in the second half of fiscal 2019. We are also making excellent progress on 1Z nanometer and have started sampling products utilizing this technology. As we have said in the past, future DRAM node transitions require additional process steps and more fab cleanroom space. Consequently, in addition to the previously announced expansion of our Hiroshima facility, we are starting site preparation for the cleanroom expansion at our Taichung facility to enable the transition of existing DRAM wafer capacity to future nodes. We are still finalizing the timing but expect production output sometime in calendar 2021. In NAND, we achieved meaningful production on 96-layer 3D NAND in fiscal Q2 with the fastest yield ramp of any NAND product in our history. We are also making good progress on the development of our fourth-generation 3D NAND, which uses our replacement gate technology. Given the high initial capital requirements of floating gate to replacement gate conversion, we expect that our first replacement gate node will provide limited cost reduction, and hence we are planning to deploy this node across select NAND products, with the rest of the portfolio converting later to the second node of replacement gate. This approach will optimize the ROI of our NAND capital investments as we convert our capacity. As a reminder, our replacement gate architecture will allow us to deliver performance improvements and provide us an efficient path toward scaling multiple future generations of 3D NAND. Given the limited initial deployment at the first node of replacement gate, we expect that our NAND bit supply growth in calendar 2020 will be below industry demand levels, and we plan to utilize our cost-effective floating gate inventory position to meet customer requirements. Turning to high-value solutions, more than two-thirds of NAND revenues in the first half of fiscal 2019 were from high-value solutions, up from 55% in the first half of 2018. This increased mix of high-value solutions, combined with our competitive cost structure, enabled us to deliver fiscal Q2 NAND gross margin in the high 30s despite steep price declines in the industry. In SSDs, we are making progress on transitioning to NVMe while continuing to improve our cost profile in SATA. In fiscal Q2, we began revenue shipments to a large PC OEM for our first NVMe client SSD, which features our internally designed controller, and are in active qualifications with other customers. We intend to introduce cloud and enterprise NVMe SSDs later this calendar year. In SATA, we introduced consumer and client SSDs based on 96-layer 3D NAND in fiscal Q2. In the cloud market, our custom persistent memory solution, which combines DRAM and NAND, is now fully ramped and contributed meaningfully to our cloud revenues. 3D XPoint development remains on track with customer samples planned before calendar year-end. We believe 3D XPoint technology will be a key enabler for numerous new applications, particularly artificial intelligence and data analytics. As announced previously, in January of this year we exercised our option to acquire Intel’s interest in the IMFT facility in Lehi, Utah. This acquisition provides us with the manufacturing capability and highly skilled talent to drive 3D XPoint development and innovation. Now turning to end markets. I’ll start with mobile. During fiscal Q2 we grew revenues and expanded gross margins year-over-year despite adverse memory and storage pricing and weakness in high-end smartphone unit sales. Our performance in mobile was propelled by growth in our managed NAND portfolio, where NAND bit shipments grew more than 5x year-over-year. We are also seeing strong demand for our 1Y-nanometer LPDRAM due to its industry-leading capacity and best-in-class power consumption. Memory and storage content growth in smartphones continues, driven by features such as multiple cameras, machine learning, computational photography and 4K video. Last month, Samsung announced its premium Galaxy S10 Plus smartphone, featuring 12 gigabytes of DRAM and 1 terabyte of NAND. At Mobile World Congress, several companies announced exciting new phones featuring 5G connectivity and foldable screens. These next-generation premium smartphones will typically feature 8 to 12 gigabytes of DRAM and 256 to 512 gigabytes of NAND versus 4 to 6 gigabytes of DRAM and 64 to 128 gigabytes of NAND in current-generation premium smartphones. These trends will likely cascade to lower-tier phones as well. We believe that 5G, foldable phones and upcoming innovations in augmented and virtual reality will drive sustained content growth for years to come and should reignite smartphone unit sales beginning in calendar 2020. We are also excited by the opportunity that 5G is likely to create beyond mobile, as it will enable true machine-to-machine communication and accelerate data creation and analysis, which are fundamental drivers for our business. We expect 5G adoption to create increased demand for memory and storage in IoT devices, wireless infrastructure and data centers. Our embedded and networking businesses are already starting to see benefits from early 5G infrastructure investments. In the data center market, the demand for memory has moderated this year following exceptional growth in the last two years. The slowdown in demand is a result of ongoing customer inventory adjustments, as well as software optimizations at some cloud customers. We expect growth to resume in the second half of calendar 2019 as we see improvement in our customers’ inventory position. The new server processors that support higher memory densities are expected to be introduced in a few months, which should drive additional demand growth in the second half of calendar 2019. In fiscal Q2, we shipped high-density 1Y-nanometer DDR4 server module samples to customers ahead of plan, which will position us well to benefit from this new CPU platform ramp. In graphics, we grew sales of our high-performance GDDR6 DRAM and expanded our customer base, which positions us for stronger growth in the second half of calendar 2019. We are seeing steep customer inventory adjustments in GDDR5 and expect them to be largely completed by the middle of this calendar year. We had another strong quarter in automotive with year-over-year revenue growth driven by increasing demand for ADAS and advanced in-vehicle infotainment systems. In fiscal Q2, we announced several new automotive products, including a collaboration with Qualcomm for next-gen in-vehicle infotainment and 5G communications modules. We also announced a new strategic collaboration with a leading supplier of ADAS platforms using our full portfolio of memory and storage products. Lackluster automobile unit sales are a short-term challenge; however, we see the auto market generating robust growth for Micron over the next decade as memory and storage content continues to increase in autos, driven by advanced infotainment systems and the adoption of autonomous vehicles. In the industrial and consumer markets, we saw a decline in sales due to seasonal, macroeconomic and pricing weaknesses, as well as inventory adjustments. We had important design wins in video surveillance, point of sales and factory automation applications. At Mobile World Congress, we announced the industry’s first 1 terabyte microSD card using QLC NAND. In the PC market, sales declined more than 25% sequentially driven by weaker pricing and the inventory drawdown seen in other segments, as well as client CPU shortages. We remain focused on our cost competitiveness in this market, and over two-thirds of our PC DRAM bit shipments are now coming from our advanced 1X and 1Y-nanometer technology nodes. Now turning to our DRAM industry outlook. Since our last earnings call, DRAM pricing weakened more than expected. Our demand outlook for calendar 2019 has moderated, led by somewhat greater levels of customer inventory, weakening server demand at several enterprise OEM customers and worse-than-expected CPU shortages. We believe macroeconomic uncertainty is also contributing to hesitation in buying behavior at some customers. However, as we discussed on our last earnings call, we still expect DRAM bit shipments to begin increasing in our fiscal Q3, with demand growth strengthening in the second half of calendar 2019 as most customer inventories are likely to normalize by mid-year. Based on our current view, we now estimate calendar 2019 DRAM bit demand growth from our customers to be in the low-to-mid teens, with their end demand a few points above that. Further, we estimate industry supply bit growth is tracking to mid-to-high teens. Given the lower DRAM demand outlook from our customers, we have decided to idle approximately 5% of our DRAM wafer starts. This action will bring our production levels close to our view of DRAM industry bit demand growth for calendar 2019. We will continue to monitor the market and take appropriate actions to ensure that our bit supply growth in calendar 2019 remains closely aligned with demand. Looking beyond our fiscal 2019, we expect bit demand growth to accelerate as mobile and server demand improves. In particular, we expect robust DRAM bit demand growth in fiscal 2020, bouncing back from a weak fiscal 2019. NAND markets remain oversupplied from the acceleration in bit growth driven by the industry transition to 64-layer 3D NAND. Although fiscal Q2 pricing came in below our expectations, we are optimistic that demand elasticity and seasonal trends will support improving demand growth in the second half of the calendar year. We expect that calendar 2019 NAND bit demand growth is likely to be in the mid-30s% range, with industry supply growing in the high-30s, and we are targeting our bit shipments to grow close to the growth rate of industry bit demand. We have been managing our NAND bit supply growth prudently, including adjusting our capital planning and wafer volumes. We are reducing our total NAND wafer starts by approximately 5%, mostly through reductions on our legacy nodes. Given these changes in DRAM and NAND industry conditions, we have reduced our CapEx for fiscal 2019 and are evaluating our CapEx for fiscal 2020. We are taking prudent actions to address the current market conditions, while executing well on our long-term strategic objectives. I will now turn it over to Dave to provide financial results of our fiscal second quarter and guidance for the third quarter.

Thanks, Sanjay. Micron’s fiscal second quarter results were within our guidance as we executed well in a period of somewhat weaker-than-expected market conditions. In the quarter, we returned capital to shareholders, continued to improve our cost structure and strengthened our balance sheet through our first issuance of investment-grade debt. Most of the proceeds from this offering were used to redeem a large portion of our outstanding convertible notes, reducing our fully diluted share count. Total fiscal second quarter revenue was $5.8 billion, down 21% from the prior year and down 26% from the fiscal first quarter. Revenue reflected worse-than-expected pricing trends in DRAM and NAND. DRAM revenue was down 28% year-over-year and 30% sequentially from the fiscal first quarter and represented 64% of total Company revenue in the fiscal Q2. DRAM ASPs declined in the low 20% range compared to the prior quarter, while shipment quantities were down in the low double-digits. Year-over-year, DRAM bit shipments were down mid-single digits. NAND revenue declined 2% year-over-year and 18% from the prior quarter. NAND revenue represented 30% of total Company revenue in the fiscal Q2. Our overall NAND ASP declined in the mid-20% range, while shipment quantities increased in the upper single-digit percent range compared to the prior quarter. NAND bit shipments came in stronger than our expectation due to the timing of demand from a large customer. Now turning to our revenue trends by business unit. Revenue for the Compute And Networking Business Unit was $2.4 billion, down 35% year-over-year and 34% from the prior quarter. The sequential decline was driven by pricing across major market segments, as well as volume reductions, particularly in graphics, cloud and PCs. Revenue for the Mobile Business Unit was $1.6 billion, up 3% year-over-year and down 27% from the record fiscal first quarter. Lower volume due to weak seasonality and pricing contributed to the quarter-over-quarter revenue decline. Despite the current market conditions, Mobile Business Unit revenue grew year-over-year due to strong growth in our managed NAND products. The Embedded Business Unit revenue of $800 million was down 4% compared to the prior year and down 14% from the record fiscal first quarter. The automotive business was only down slightly from record fiscal first quarter, despite weakness in automobile sales. Other embedded revenue declined quarter-over-quarter due to weaker pricing and lower DRAM volumes. Finally, the Storage Business Unit fiscal second quarter revenue was $1 billion, down 19% year-over-year and down 11% quarter-over-quarter. The sequential decline was driven by lower SSD revenue, partially offset by increased component revenue. The consolidated gross margin for the fiscal second quarter was 50% compared to 58% in the prior year and 59% in the fiscal first quarter. Fiscal second quarter results included ongoing impact from 3D XPoint underutilization costs, which approximated 160 basis points. Pricing came in weaker than expected in both DRAM and NAND, but strong execution on cost reductions resulted in gross margins within our guidance range. Fiscal second quarter operating expenses of $818 million came in at the high end of our guided range. OpEx included $37 million in one-time tool impairment costs that were not anticipated in our guidance. Excluding this impairment, OpEx would have come in at the low end of our guidance. We remain focused on controlling our expenses while investing in future products and technologies. We delivered solid profitability in the fiscal second quarter with operating income of $2.1 billion, representing 36% of revenue. This margin is down 13 percentage points year-over-year and also down 13 percentage points from the fiscal first quarter. The tax rate for the fiscal second quarter was approximately 8.3%. And we now expect our fiscal 2019 tax rate to be approximately 10.5%. Non-GAAP earnings per share in the fiscal Q2 were $1.71, down from $2.82 in the year-ago quarter and down from $2.97 in the prior quarter. Turning to cash flows and capital spending. In the fiscal second quarter, we generated $3.4 billion in cash from operations, representing 59% of revenue. Capital spending, net of third-party contributions, was approximately $2.4 billion, relatively flat compared with the prior quarter. We have lowered our CapEx target for fiscal 2019 to approximately $9 billion from our prior guidance range of $9 billion to $9.5 billion, as we manage through the current environment while maintaining investment in our strategic priorities. As we mentioned before, a significant portion of our CapEx this year is going towards cleanroom construction and assembly and test operations, which do not contribute to our bit supply growth. Fab equipment spend in fiscal 2019 is down from last year and is mostly targeted towards migrating 20-nanometer DRAM and 32-layer 3D NAND to more advanced nodes, with no new wafer capacity additions. The investment in these technology transitions provides compelling cost reduction and a very attractive ROI. As we have demonstrated over the past two quarters, we remain nimble on CapEx based on business conditions. In the fiscal second quarter, our adjusted free cash flow, defined as cash flow from operations less net CapEx was approximately $1 billion, compared to $2.2 billion in the year-ago quarter and $2.3 billion in the fiscal first quarter. We deployed approximately 70% of the quarter’s free cash flow towards our share repurchase program. We bought back approximately $700 million of stock in fiscal Q2, representing 21 million shares. Through the first half of fiscal 2019, we repurchased 63 million shares for $2.5 billion, utilizing 76% of our free cash flow in the fiscal first half. We continue to view share repurchases as an attractive use of capital and remain committed to deploying at least 50% of our free cash flow on an annual basis towards repurchases under our current $10 billion authorization. In addition to the buybacks, we also eliminated our 2043 converts subsequent to the quarter close, which at current share prices effectively lowered our fully diluted share count by approximately 9 million shares. Note that the underlying share count for these converts was 35 million shares, which could have resulted in greater dilution with increases in our share price. Inventory ended the quarter at $4.4 billion, increasing from $3.9 billion at the end of the fiscal first quarter. Our fiscal second quarter days of inventory were 134 days compared to 107 days in the fiscal first quarter. The actions that we have announced today regarding supply reductions, combined with improving customer demand will begin to address our higher inventory levels. We ended fiscal Q2 in a strong liquidity position with net cash of $3 billion and total liquidity of nearly $12 billion. Total cash increased to $9.2 billion, largely as a result of our $1.8 billion debt issuance. Our debt position increased by $2.1 billion to $6.2 billion in the quarter, primarily due to the debt offering and recognition of a premium associated with the Series G convertible note redemption. Subsequent to quarter-end, we used $1.4 billion of cash to complete the convertible note redemption, which reduced our outstanding GAAP debt balance by approximately $1.1 billion. On January 14th, we exercised our call option to acquire IMFT, our joint venture with Intel. We expect to close the transaction in either late fiscal 2019 or in the first half of fiscal 2020. This near $1.5 billion transaction will also retire the $1 billion of joint-venture-related debt on Micron’s balance sheet. Since we already consolidate IMFT’s results in our financial statements, we do not expect a material impact to our near-term results. Now, turning to our market outlook. DRAM and NAND markets are working through supply and demand imbalances. Our visibility remains low and the near-term environment remains challenging. While there have been CapEx reductions across the industry, they haven’t yet impacted output growth due to lead times. We expect our DRAM bit shipments to grow sequentially during the fiscal third quarter and at much higher rates in the fiscal fourth quarter. In NAND, we expect a modest sequential decline in our bit shipments in the fiscal third quarter due to timing of shipments and expect growth to resume in the fiscal fourth quarter. The output reductions that we announced today for DRAM and NAND, plus the $1.5 billion of CapEx reductions that we have announced year-to-date will also help reduce our supply of DRAM and NAND in the second half of this calendar year. With that in mind, our non-GAAP guidance for the fiscal third quarter is as follows: We expect revenue to be in the range of $4.80 billion, plus or minus $200 million; gross margin to be in the range of 37% to 40%; and operating expenses at approximately $785 million, plus or minus $25 million. Based on a share count of approximately 1.14 billion fully diluted shares, we expect EPS to be $0.85, plus or minus $0.10. In closing, Micron continues to execute on our key initiatives, increasing our mix of high-value solutions, improving our cost profile and investing in new and innovative products. Our solid financial footing, strong liquidity and substantially reduced leverage means that we are well-positioned to invest in our future despite near-term market conditions. I’ll now turn the call over to Sanjay for some concluding remarks.

Thank you, Dave. In response to near-term industry conditions, we are taking decisive action to reduce our supply growth to be consistent with industry demand. At the same time, we continue to invest and execute against our strategic priorities to reduce costs and increase the mix of high-value solutions in our portfolio. The long-term demand trends for Micron remain very healthy, with tremendous growth opportunities across multiple markets. We continue to believe that the memory industry is structurally stronger with more diversified demand drivers and moderating supply growth capability. With our strong balance sheet and improved product portfolio and operating model, Micron is better positioned than ever before to win and deliver long-term value for shareholders. We will now open for questions.

Hi. Thank you. I wanted to discuss the inventory situation. Sanjay mentioned hyperscale inventory several times, and Dave was also looking at how the balance sheet inventory would change. So, can you provide an update on our weeks of inventory? Additionally, Dave, what is the remaining flexible capital expenditure that you could reduce if conditions worsen? Thank you.

Okay. First, let me discuss our inventory. Our inventories are currently at 134 days, and there are a couple of dynamics at play. In DRAM, we anticipated a higher inventory level in the first half of the calendar year as our customers digest their built-up inventory. We also reduced our CapEx, which should start to impact bit growth in the latter half of the year and help manage inventory. Additionally, we announced further CapEx reductions to about $9 billion for this quarter and are taking about 5% underutilization to further lessen output. This should help align DRAM inventories more appropriately, and we expect an improvement in the second half of the calendar year. On the NAND side, we are also at elevated inventory levels, which is somewhat intentional. As mentioned, we are undergoing a transition from floating gate to replacement gate in NAND this calendar year, and the bit output will not be very strong. Therefore, we aimed to maintain higher inventory levels to support customer demand. The CapEx reduction also affects NAND, and we adjusted our wafer output by 5% to manage inventory. We believe you will see inventory improvements in the latter half of this year and into 2020 as we work through the NAND inventory. Regarding CapEx, we are managing it according to what we discussed at our Analyst Day. We remain committed to our model of low-30s as a percentage of sales for CapEx. Naturally, there will be years above and below this average. In the last two years, 2017 and 2018, we operated below this low-30s model, so it's not surprising to be above that level for these years. We also had some pent-up demand to prepare clean room space for node transitions, leading to various cleanroom initiatives this year, which might elevate our spending slightly from our normal levels. Over the long term, we expect to be in the low-30s percent range, and as Sanjay and I mentioned, we are flexible on CapEx and will adjust it based on economic conditions.

And the hyperscale?

Regarding hyperscale, we anticipate that inventory will be processed by our customers during the first half of the year, and we are already observing signs of inventory reduction. We expect this process to be largely finished by mid-year. In terms of DRAM, we foresee growth accelerating, both sequentially and year-over-year, throughout the remainder of the calendar year. Demand is expected to improve in the second half of the year compared to the first half. Additionally, the ongoing CPU shortages are projected to ease over the course of the year, which we believe will further enhance demand in the latter half of the year relative to the first half.

Yes. Good afternoon. Thanks for letting me ask a question. Sanjay, I guess, I just wanted a little bit more detail behind the decision to actually shutter some DRAM capacity in the current quarter. Last quarter, you talked about how a flattening cost curve actually increased the useful life of holding inventory, which seemed to make sense to me. This seems to be a little bit of a reversion from that. And just given that you're not a big enough piece of the DRAM market to I think impact overall supply-demand, it really kind of depends upon what the guys in Korea are doing. I'm just kind of curious as to why you came to this decision to shutter some capacity.

So, I think, as Dave had previously mentioned in one of the earnings calls, that about 150 days of inventory is something that we are comfortable with. And when we really look at our demand at this time and look at our production output, we think it is important for us to bring our supply to be in line with the expected demand for the year. And it provides us obvious benefits in terms of managing our inventories more effectively, managing our cash flow effectively as well and really managing our business in a healthy fashion. Of course, our inventory is at good cost; there is no obsolescence issue with this inventory at all. But we really consider it prudent management of our business to bring our supply growth in line with our demand expectations.

The underutilization costs that will arise will not contribute positively to our cost per unit. Therefore, they will be recorded as period costs within the quarter and are reflected in our gross margin guidance of 37% to 40% for the third fiscal quarter. Sorry to interrupt, John.

So, Sanjay, you explained why in fiscal 2020 you’ll under grow the industry in NAND bits as you move to fourth generation. I'm wondering if you could help us understand what the cost implication of that is. Will your cost curve in NAND be negatively impacted or should you be able to benefit in 2020 from continued mix towards 96-layer on the technology side and just product mix to more managed NAND? How do we think about cost in fiscal year 2020?

Our cost position will remain strong in fiscal year 2020 because we are currently outperforming the industry in terms of die-level costs on a per gigabyte basis with our 64-layer and 96-layer technologies. The advantages we gain stem from the CMOS under array architecture that Micron has pioneered, and we are now in the third generation of this technology. This offers us a significant cost edge that will enable us to maintain a competitive mix of NAND production in fiscal year 2020 to meet market demands. Additionally, the upcoming fourth generation of our 3D NAND, which will utilize the first node of replacement gate technology, will involve greater capital intensity due to the transition from floating gate to replacement gate. This shift necessitates unique tools, prompting us to convert a portion of our portfolio to this first-generation replacement gate technology. The rest of our portfolio will follow, transitioning from the third generation floating gate to the second node of replacement gate at a later stage. This strategy will yield greater cost benefits and ROI, especially when compared to the first node. In summary, despite the increase in layers in the first generation of replacement gate technology, we are confident about our cost competitiveness with the combination of floating gate and replacement gate technologies that we plan to implement next year.

Good afternoon. Thank you for taking my question. I guess, a two-part question. You used the word idling regarding 5% for DRAM and then reducing your NAND, wafer starts by 5%. I guess, two questions to that. Are you trying to send us a different signal in terms of what you're doing for both? And then, could you provide a little clarity on how we should think about the impact to your cost structure, as you slow down wafers? And then, when you start to turn back on, how we should think about the impact? Thank you.

We are decreasing our production of DRAM and NAND. The effect of reduced supply growth in DRAM due to idling capacity and fewer wafer starts is more significant. In NAND, the reduction in wafer starts, especially for legacy nodes, has a smaller impact on supply bit growth. Our goal is to align our supply growth with our demand estimates for both DRAM and NAND for 2019 and 2020. Regarding costs, we have consistently achieved year-over-year cost reductions in DRAM and are confident in our ability to remain competitive despite the slowdown in this sector over the next few quarters. Similarly, in NAND, we will benefit from our transition from 64-layer to 96-layer technology next year, which will aid in cost management. Our costs in both DRAM and NAND will remain competitive. Additionally, the advantages of reducing output extend beyond cost, as they also encompass inventory management and cash flow management.

Great. Thank you for letting me ask the question here. So, back to a question on inventory. So, when you first started seeing your customer demand inventory related weakness, it always takes time for the actual supply growth output of your manufacturing infrastructure to kind of trend towards your target. So, initially, you augment that manufacturing ramp down with some inventory accumulation. It appears that you executed to that in fiscal Q2. But, now that you're moderating output lower again, again, that's going to appear that it's going to take some more time. So, do you anticipate inventories actually moving higher here in the May quarter before it starts to down shift in the back half of the calendar year?

Yes. I think, inventory might be a little bit elevated in the May quarter relative to where we are today. Obviously, as you point out, it does take some time, most of the CapEx reductions we took in the first fiscal quarter. So, those take a couple of quarters, but we should start experiencing that in the back half of the calendar year. And the underutilization, you get probably a quarter before it starts impacting you. So, I think, we’ll be in pretty good shape on DRAM, as I said, as we kind of exit the calendar year. NAND will take a little bit longer because of the reasons we cited about keeping elevated levels of inventory into 2020.

Great. My follow-up question is that much of your industry outlook is based on an expectation of improvements in the second half across almost all your target markets, including PC, client cloud, and mobile. Considering the value chain and lead times, should we expect that your customers' recovery in the second half will start to influence your NAND and DRAM business in fiscal Q4?

We are not providing guidance for fiscal Q4 at this time. However, we expect bit growth in DRAM to persist in the second half of this calendar year, both sequentially and year-over-year. We are currently forecasting bit growth in DRAM for fiscal Q3, which should carry on into fiscal Q4 and beyond. In NAND, there is typically seasonal variation in the second half of the year, and we anticipate that elasticity will also support improved demand. The trend of increasing average capacities in smartphones for both DRAM and NAND remains strong. The recent results from various cloud service providers highlight solid performance, indicating ongoing demand and growth in cloud services. Memory and storage are crucial for the future computing paradigms, which are increasingly reliant on AI and machine learning. This all points to favorable long-term demand trends. We are observing a general improvement in demand across all of our end markets in the second half compared to the first half, but this outlook is contingent on macroeconomic factors. If there are further shifts in the microeconomic environment, it could alter this outlook. Based on the information we have today, this is our assessment of demand expectations.

Sanjay, I wanted to go back just to the question that got asked before. So, in DRAM, you are still well above cash costs, yet you're idling capacity. So, obviously, demand is a lot worse than you expected. But, you sound pretty optimistic that it's going to come back in the back half of the year. So, why would you reduce starts now if you’re so optimistic about demand coming back in the back half of the year? I get that it has to do with inventory. But, I'm just trying to reconcile those two comments because it seems like you're leaving money on the table. Thanks.

Demand has been weak so far this year, and we anticipate that the demand environment will remain weak in the first half. When we discuss our overall DRAM demand growth expectations, we are referring to the entire year. Therefore, we need to consider our supply growth on an annual basis as well. Our goal is to align our supply with our demand expectations. We believe that by the second half of the year, the improving demand environment will allow us to benefit from our supply reductions. This will also help us continue to improve our inventory position.

Okay. And then, just a quick follow-up, Dave. I just wanted to go back to the question on costs. You've been bringing DRAM costs down kind of like low to mid-teens year-over-year and NAND has been kind of in the mid-20s year-over-year. So, it seems like some of these actions have to ultimately impact your abilities of cost down vis-à-vis that level? Am I missing something there because it sounds like you're saying that there's no impact? So, can you just again reconcile those for me? Thanks.

We do expect healthy cost declines in both DRAM and NAND this year. We are still making technology transitions next year. And so, we would obviously expect, particularly in DRAM the cost will be good. As we said, replacement gate might not be where we want it to be in the very first generation. But one of the advantages of carrying the inventory we're carrying, 64-layer and 96-layer inventory in the next year is that has a very good cost structure. And so, we should have a good cost structure in 2020 on NAND as well. The other thing on utilization, I just want to make sure it's clear. What period cost means is, we'll take that expense kind of as it comes in the quarters in which we take the underutilization. It won't roll up in the inventory; it won't be counted as part of the cost. So, obviously, we'll have an impact on margins. And as I said, it's implied in the guidance of the margins we gave for the fiscal third quarter.

And on NAND, I just wanted to point out again that, 96-layer is still early in our production ramp, and it will continue to ramp during the course of next year as we bring out our first node of replacement gate. So, 96-layer will also continue to be a strong driver of our cost reduction capability in 2020.

Hi. Good afternoon. I wanted to just kind of go back to bit growth. I understand that idling your wafer starts slows your bit supply. But, do you expect any shifts in your portfolio mix toward certain end markets or shifts toward new technology nodes that should impact your second half bit supply?

So, obviously, we pay a lot of attention to this in terms of managing the mix of our production. We do that on an ongoing basis anyhow in production. And, when we implement this output cut, both in NAND as well as DRAM, obviously we make sure that we are not impacting any aspect of our ability to fulfill our demand. So, as we said, I mean, we have high levels of inventory currently, both in NAND and DRAM. And it gives us an opportunity to bring our production to be in line with demand. And when we say that, we mean that we will be able to address the demand in all of our end markets. We are not going to compromise our production cuts so that we run low in terms of meeting our customers' requirements in any of the end market segments. So, we believe this is a very prudent way for us to manage our business.

I appreciate that. I guess, perhaps a clarification on that question, then. The outlook would say that NAND demand elasticity has not yet kicked in. So, could you just perhaps shed some light on design wins, maybe not just in NAND but also in DRAM that you've seen across your product portfolio that would anchor your view of a second half recovery? Thank you.

Regarding NAND elasticity, the average capacities in notebooks and PCs, along with the SSD attach rates to notebooks, continue to increase. This indicates a price elastic market. The appealing price points of NAND facilitate greater HDD replacement in both the data center and client markets. Mobile technology also shows signs of elasticity concerning NAND. At Mobile World Congress, various smartphones, including foldable and 5G models, were announced featuring 512-gigabyte and terabyte storage capacities. Additionally, applications are increasingly demanding more storage; for instance, 5G advancements offer greater connectivity and lower latency, necessitating more DRAM and NAND. End market applications are performing well. At Micron, we are dedicated to expanding our product offerings. On the SSD front, we are enhancing our portfolio with NVMe solutions. We have launched our first NVMe client drive and plan to introduce NVMe for enterprise and cloud applications later this year. We have also secured a qualification win and begun shipping to a customer for our first-generation NVMe client product. These initiatives are integral to our roadmap for expanding our opportunities. We have made significant improvements to these solutions over the past few years, but much execution lies ahead to grow our SSD and mobile opportunities in NAND, where we have gained substantial market share in recent quarters. There is still considerable opportunity and execution required ahead of us.

Hey, guys. Thanks for my taking question. I was curious on the customer timing if you can elaborate. Was that just the timing between quarters or was that more of a strategic buy that was multi-quarters in nature? And then, I was just curious if you can elaborate on the data center you set back in the second half, but it seems like you're not seeing a pickup in orders yet, and kind of what gives you confidence that you're going to see that start in Q3?

Regarding the timing of demand in the second quarter, it was influenced by a large customer's specific fulfillment timing related to NAND. As I mentioned earlier, we are seeing signs of inventory consumption by our customers, which gives us confidence that this inventory will mostly be cleared out in the first half, with demand expected to improve in the second half. In recent weeks, we have also received new orders from certain customers who had previously maintained high inventory levels. However, it is still too early to make any definitive conclusions about demand trends moving forward. Ultimately, the fundamental demand drivers in the end market remain strong. If our customers, especially in the cloud market, continue to consume DRAM, it indicates they are utilizing their inventory to meet that demand. Over the next few months, by mid-year, we expect that inventory levels will return to normal, creating opportunities for increased demand in the second half compared to the first half of the year.

Great, thank you. I'm just curious on the inventory side for the May quarter. To the extent that you built 27 days of inventory this last quarter, a fair amount of your introduction went on to the balance sheet. Thanks.

We’ve got most of that, but okay, let’s take a crack at that, Joe. There was some background noise. So, yes, as you mentioned, inventories were up. We do expect DRAM to grow sequentially in the third fiscal quarter. That, combined with some benefits we are starting to see, should be attributed to the reduction in utilization and the CapEx activities, or CapEx reductions that we've already implemented, which will start to adjust output growth. So, we expect to see some benefits from that in the fiscal third quarter. As I mentioned, we do anticipate inventories will be up again next quarter. However, as Sanjay noted, many customers who have built up inventory will begin to normalize their orders. They will start to place heavier orders with us again in the third and fourth calendar year, and we will begin to see reductions in DRAM inventory levels.