Micron Technology, Inc.

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Good day and welcome to Micron's first quarter 2023 financial call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 1 on your telephone. You will then hear an automated message advising that your hand is raised. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker, Farhan Ahmad, Head of Investor Relations. Please go ahead.

Thank you, and welcome to Micron Technologies' Fiscal First Quarter 2023 Financial Conference Call. On the call with me today are Sanjay Mehrotra, our President and CEO, and Mark Murphy, our CFO. Today's call is being webcast on our Investor Relations site at investors.micron.com. including audio and slides. In addition, the press release detailing our quarterly results has been posted on the website along with the prepared remarks for this call. Today's discussion of financial results is 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. We encourage you to visit our website at micron.com throughout the quarter for the most current information on the company, including information on the financial conferences that we may be attending. You can follow us on Twitter at MicronTech. As a reminder, the matters we are discussing today include forward-looking statements regarding market demand and supply, our expected results, and other matters. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from the statements made today. We refer you to the documents we filed with DSCC, including our most recent Form 10-K and 10-Q, for a discussion of the 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 to conform these statements to actual results. I'll now turn the call over to Sanjay.

Thank you, Farhan. Good afternoon, everyone. Micron delivered fiscal first quarter revenue and EPS within our guidance range despite the pricing environment, which deteriorated significantly from our prior call. The industry is experiencing the most severe imbalance between supply and demand in both DRAM and NAND in the last 13 years. Micron is exercising supply discipline by making significant cuts to our CapEx and wafer starts while maintaining our competitive position. We are also taking measures to cut costs and OpEx across the company. Customer inventory, which is impacting near-term demand, is expected to continue improving and we expect most customers to have reduced inventory to relatively healthy levels by mid-calendar 2023. Consequently, we expect the fiscal second half revenue to improve versus the first half of our fiscal year. We expect our days of inventory to peak in our current fiscal Q2 and gradually improve over the next few quarters as our bid shipments improve and our supply growth is significantly reduced. Despite this improving bid shipment and revenue trajectory, we expect industry profitability to remain challenged through calendar 2023. The combination of our technology leadership, manufacturing expertise, diverse product portfolio, strong balance sheet, and our decisive actions provide a solid footing to navigate this challenging near-term environment. I'll start today with an overview of our technology position. Micron continues to lead the industry in both DRAM and NAND technology. We are first to market with one beta DRAM and 232 layer NAND. While both 1 Beta DRAM and 232 Layer NAND offer strong cost reductions, we have slowed their ramps to better align our supply with market demand, as we previously indicated. Yield trajectory for these nodes is on track, and we are continuing to qualify these nodes across our product portfolio and will be well positioned to ramp these nodes when industry conditions improve. Our 1 Beta DRAM node, which we introduced in fiscal Q1, delivers around a 15% power efficiency improvement and more than 35% bit density improvement versus 1 alpha. 1 beta will be used across our product portfolio, including DDR5, LP5, HBM, and graphics. Now turning to our end markets. Across nearly all of our end markets, revenues declined sequentially in fiscal Q1 due to weaker demand and steep decline in pricing. Shipment volumes were impacted by our customers' inventory adjustments, the trajectory of their end demand, and macroeconomic uncertainty. We believe that aggregate customer inventory, while still high, is coming down in absolute volume as end market consumption outpaces ship-in. In data center, we expect cloud demand for memory in 2023 to grow well below the historical trend due to the significant impact of inventory reductions at key customers. End demand at cloud customers is not immune to macroeconomic challenges, but should strengthen once the economic environment improves. DDR5 is extremely important for data center customers as the industry begins its transition to this new technology and calendar Q1. As modern servers pack more processing cores into CPUs, the memory bandwidth per CPU core has been decreasing. Micron D5 alleviates this bottleneck by providing higher bandwidth compared to previous generations, enabling improved performance and scaling. Feedback from our customers across the x86 and ARM ecosystem suggests that Micron leads the industry with the best D5 products. We expect server D5 bit shipments to become more meaningful in the second half of calendar 2023, with crossover expected in mid-calendar 2024. Building on our existing DeFi products, in fiscal Q1, we began qualifying one alpha 24 gigabit DeFi, and we announced availability of DeFi memory for the data center that is validated for the new AMD EPYC 9004 series processors. In addition, we are also making progress on CXL And in fiscal Q1, we introduced our first CXL DRAM samples to data center customers. In data center SSDs, we are continuing to proliferate our 176-layer SSD. And in fiscal Q1, we nearly doubled the number of customers where we are qualified. We have also completed qualification of our 176-layer QLC with an important enterprise customer. In PCs, we now forecast calendar 2022 units to decline in the high teens percentage and expect 2023 PC unit volume to decline by low to mid single digits percentage to near 2019 levels. Client D5 adoption is expected to gradually increase through calendar 2023 with crossover in mid-calendar 2024, and we are well positioned for this transition

with leading DeFi products.

We also continue to lead the industry in QLC, and it is an important competitive advantage for us. In fiscal Q1, client and consumer QLC SSDs had very strong growth, which helped increase our NAND QLC Max to a new record. Earlier this month, Micron began shipping the world's most advanced client SSD featuring 232 layer NAND technology. As the world's first client SSD to shift using NAND over 200 layers, the Micron 2550 NVMe SSD demonstrates superior speed, density, and power savings enabled by our industry-leading NAND node. In graphics, we expect bit growth to outpace the broader market in calendar 2023. Micron continues to drive the industry's fastest graphics memory with 24 gigabit per second, 16 gigabit GDDR6X shipping in high volume production. In mobile, we now expect calendar 2022 smartphone unit volume to decline 10% year over year, versus our high single digit percentage decline projection last earnings call. We forecast calendar year 2023 smartphone unit volume to be flattish to slightly up year over year, driven by improvements in China following the reopening of its economy. Micron continues to build on its strong product momentum in mobile. As of fiscal Q1, 1 alpha comprised nearly 90% of mobile DRAM bits and 176 layer made up nearly all of our mobile NAND bit shipments. We are also well positioned for the LP5 transition, and in SQ1, the majority of our mobile DRAM bit shipments were LP5. In fiscal Q1, our LP5X was validated for Qualcomm's latest platform and integrated into Snapdragon 8 Gen 2 reference designs. In addition, we shipped the industry's first one beta DRAM qualification samples with our 16 gigabit LP5. Last, I'll cover the auto and industrial end markets. Electron is well positioned as the leader in automotive and industrial markets, which offer strong long-term growth and relatively stable margins. In fiscal Q1, auto revenues grew approximately 30% year over year, just slightly below our quarterly record in fiscal Q4 2022. The automotive industry is showing early signs of supply chain improvement, and auto unit production continues to increase. The macro environment does create some uncertainty for the auto market, but we see robust growth in auto memory demand in fiscal 2023. This is driven by the volume ramp of advanced next-generation in-vehicle infotainment systems, as well as the broader adoption of more advanced driver assistance systems. Over the next five years, we expect the bid growth category for DNAM and NAND in autos to be at approximately twice the rate of the overall DNAM and NAND markets. The industrial markets saw continued softening in Q1 as our distribution channel partners reduced their inventory levels and demand weakened for some customers. The fundamentals of industrial IoT, AI, ML, 5G, and Industry 4.0 all remain intact, and we expect volumes to improve in the second half of our fiscal year. In our fiscal first quarter, Micron continued to collaborate closely with customers and achieved advanced product sampling and design-in across automation, OEMs, ODMs, and integrators with our latest generation of D5, LP5, and 3D NAND solutions. Now turning to our market outlook. We expect calendar 2022 industry bid demand growth in the low to mid single digit percentage range for both DRAM and NAND. For calendar 2023, we expect industry demand growth of approximately 10% in DRAM and around 20% in NAND. For both years, demand in DRAM and NAND is well below historical trends and future expectations of growth, largely due to deductions in end demand in most markets, high inventories at customers, the impact of the macroeconomic environment, and the regional factors in Europe and China. Near term, over the next few months, we expect gradually improving demand trends for memory as customer inventory levels improve further, new CPU platforms are launched, and China demand starts to grow as its economy reopens.

Longer term, percentage range.

Our long-term demand-based growth expectations for both DRAM and NAND have declined from our expectation earlier this year, primarily due to lowered growth expectations from PC and smartphone markets and some moderation in the strong long-term growth in the cloud. Turning to industry supply growth, Industry supply growth in calendar 2022 for DRAM and NAND is closer to their respective long-term demand categories and well above the industry demand growth in calendar 2022. Given the current pricing and resulting industry margins, we expect a significant decline in industry capital investments, as well as a reduction in utilization rates for the industry. We expect that DRAM and NAND industry supply growth in calendar year 2023 will be well below their long-term CAGRs and also well below expected demand growth in 2023. Due to the significant supply-demand mismatch entering calendar 2023, we expect that profitability will remain challenged throughout 2023. The timing of the recovery in profitability will be driven by the rate and pace at which supply and demand are brought into balance and inventories are normalized across the supply chain. We believe that negative year-on-year calendar 2023 industry DRAM bid supply growth and flattish year-on-year calendar 2023 industry NAND bid supply growth would accelerate this recovery. Micron is taking a number of decisive actions in this environment to align supply with demand and to protect our balance sheet. First, we are reducing our capex investments to reduce bid supply growth in 2023 and 2024. Our fiscal 2023 capex is being lowered to a range between $7 billion to $7.5 billion from the earlier $8 billion target and the $12 billion level in fiscal year 22. This represents approximately a 40% reduction year-on-year and we expect fiscal 2023 WFE to be down more than 50% year on year. We are now significantly reducing our fiscal 2024 capex from earlier plans to align with the supply demand environment. We expect fiscal 2024 WFE to fall from fiscal 2023 levels, even as construction spending increases year on year. Second, we have reduced near-term bit supply through a sharp reduction in wafer starts. As we have previously announced, we reduced wafer starts for DRAM and NAND by approximately 20%. Through a combination of these actions, we expect our calendar 2023 production bit growth to be negative in DRAM and up only slightly in NAND. Given the manufacturing cycle times, The full impact of the wafer start reductions on supply will be realized starting in our fiscal Q3. Due to our reductions to our fiscal 2024 WFE capex, our bid supply levels in 2024 will be materially reduced from the prior trajectory. We continue to target a relatively flat share of industry bid supply. In response to the decline in expected long-term CAGR for DRAM and NAND bed growth, we are slowing the cadence of our process technology node transitions. This change will help us align our long-term bed supply CAGR with demand and help improve the ROI of our R&D and CAPEX investments. Given our decision to slow the one beta DRAM production ramp, we expect that our one gamma introduction will now be in 2025. Similarly, our next NAND node beyond 232 layer will be delayed to align to the new demand outlook and required supply growth. We expect these changes to the technology node cadence to be an industry-wide phenomenon. With our industry-leading technology capability, we expect to remain very well positioned. Fourth, we are taking significant steps to reduce our costs and operating expenses. We project our spending to decrease through the year, driven by reductions in external spending, productivity programs across the business, suspension of 2023 bonus company-wide, select product program reductions, and lower discretionary spend. Executive salaries are also being cut for the remainder of fiscal 2023, and over the course of calendar 2023, we are reducing our headcount by approximately 10%, through a combination of voluntary attrition and personnel reductions. We expect to exit fiscal 2023 with quarterly OPEX of around 850 million with additional savings in costs in our P&L. Although we have taken these aggressive steps, we are prepared to make further changes and remain flexible to exercise all levers to control our supply and manage our cost structure. I will now turn it over to Mark.

Thanks, Sanjay. Fiscal Q1 revenue and EPS came within our guidance ranges despite worsening market conditions over the course of the quarter. Total fiscal Q1 revenue is approximately $4.1 billion, down 39% sequentially and down 47% year-over-year. Fiscal Q1 DRAM revenue is $2.8 billion, representing 69% of total revenue. DRAM revenue declined 41% sequentially with BIT shipments decreasing in the mid-20% range and prices declining in the low 20% range. Fiscal Q1 NAND revenue was $1.1 billion, representing 27% of Micron's total revenue. NAND revenue declined 35% sequentially with BIT shipments declining in the mid-teens percent range and prices declining in the low 20 percentage range. Now turning to revenue by business unit. Compute and networking business unit revenue was $1.7 billion, with weakness across client, data center, graphics, and networking. Embedded business unit revenue was $1 billion, with automotive staying stronger than consumer and industrial markets. Storage business unit revenue was $680 million, while QLC mix increased to a new high. Mobile business unit revenue was $655 million, a low level partly due to the timing of shipments between fiscal Q1 and fiscal Q2. We expect mobile revenue to grow through the rest of the fiscal year. The consolidated gross margin for fiscal Q1 was 22.9%. down approximately 17 percentage points sequentially, primarily due to lower pricing. Operating expenses in fiscal Q1 were down roughly $15 million sequentially to under $1 billion. We are taking significant additional actions to reduce our operating expenses through the remainder of this fiscal year. We reported an operating loss of $65 million in fiscal Q1, resulting in an operating margin of negative 2%, down from operating margins of 25% in the prior quarter and 35% in the prior year. Fiscal Q1 adjusted EBITDA was $1.8 billion, resulting in an EBITDA margin of 45%, down 9 percentage points sequentially. Fiscal Q1 taxes were $1 million as a result of profit before tax being close to breakeven. Non-GAAP loss per share in fiscal Q1 was 4 cents, down from earnings per share of $1.45 in fiscal Q4 2022 and $2.16 in the year-ago quarter. Turning to cash flows and capital spending, We generated $943 million in cash from operations in fiscal Q1, representing approximately 23% of revenue. Capital expenditures were $2.5 billion during the quarter, and we see CapEx trending down from these levels through fiscal 23. Free cash flow was negative $1.5 billion in the quarter. Under a 10 plan in place during the quarter, we completed share repurchases of $425 million, or 8.6 million shares, at an average price of $49.57. Our ending fiscal Q1 inventory was $8.4 billion. An average DIO for the quarter was 214 days. The rapid decline in BIT shipments in fiscal Q4 and fiscal Q1 has driven inventories well above our target levels, and our actions reflect our intent to work these down. We expect our DIO to peak in our fiscal Q2 and then gradually improve. We ended the quarter with $12.1 billion of total cash and investments and $14.6 billion of total liquidity. Given macroeconomic uncertainty and the market environment, we bolstered our liquidity in the quarter through $3.4 billion of added debt, bringing our total fiscal Q1 ending debt to $10.3 billion. With this additional debt and net of income on our deposits, we project net interest income of approximately $15 million in the fiscal second quarter. We project and intend to maintain ample liquidity while maintaining leverage consistent with our investment grade rating. Now turning to our outlook for the fiscal second quarter. The near-term market environment remains challenging and negatively impacts our profitability outlook. For both DRAM and NAND, we expect big shipments to be up in fiscal Q2, but revenue to be down. Included in the fiscal second quarter guide is an insurance recovery of approximately $120 million, most of which will be recognized as revenue. This insurance recovery is related to an operational disruption in 2017 and settlement occurred in fiscal Q2. Beyond fiscal Q2, we expect revenue and free cash flow to improve in our fiscal second half as we anticipate a continued recovery in demand. Related to announced wafer start reductions, we forecast approximately $460 million of headwinds to our cost of goods sold in fiscal 23, most of which we expect to incur in the second half. Excluding these underutilization effects, We expect fiscal 2023 cost per bit reduction to be healthy in DRAM, but to be challenged in NAND, primarily due to inflation and energy costs unique to Singapore. As higher cost inventories sell through, we expect these underutilization impacts to continue into fiscal 2024. In this environment and considering the outlook, we continue to aggressively manage costs And as Sanjay mentioned, we see OPEX trending down from approximately $1 billion in fiscal Q1 to around $850 million by fiscal Q4. Below the operating line, we will have lower net interest income as previously mentioned. While there is still a fixed level of tax as we discussed last quarter, due to the geographic mix and level of income, we now see fiscal 2023 taxes coming in at less than $250 million. We are reducing our planned capital expenditures in fiscal 2023 to be in the range of $7 billion to $7.5 billion, with the spending weighted towards the first half of the fiscal year. Fiscal 2023 CapEx includes an increased level of construction for long-term capacity planning. WFE CapEx will be down more than 50% year over year. We are also significantly reducing CapEx in fiscal 2024 compared to prior plans. Until market conditions and our cash flows improve, we will focus our capital return on dividends and have suspended our share repurchases for now. With all these factors in mind, Our non-GAAP guidance for fiscal Q2 is as follows. We expect revenue to be $3.8 billion, plus or minus $200 million, gross margin to be in the range of 8.5%, plus or minus 250 basis points, and operating expenses to be approximately $945 million, plus or minus $15 million. we expect tax expense of approximately $60 million. Based on a share count of approximately 1.09 billion shares, we expect EPS to be a loss of 62 cents, plus or minus 10 cents. As you work through this period of challenging market conditions, Micron has the benefit of best-in-class technology a competitive product portfolio, strong operations, a solid balance sheet, and most critically, a tenacious team. Beyond this downturn and over the long term, we are confident that memory and storage revenue growth will outpace the broader semiconductor industry. This is supported by the combination of strong secular trends, memory content growth, and better supply-demand balance. Micron is focused on operating and investing in a responsible and disciplined manner to achieve profitable growth and free cash flow generation consistent with our long-term model. I will now turn it back to Sanjay.

Thank you, Mark. In the last several months, we have seen a dramatic drop in demand. Micron has responded quickly to reduce our capex and supply output and we are taking strong enterprise-wide actions to control our expenses. We have increased liquidity on our balance sheet and adjusted our operational plans. While the environment remains challenging, we currently expect second half fiscal 2023 revenue to improve from the first half. We are confident that the broad advantages enabled by data-centric technologies will create long-term growth for our industry. and expect the total available market to reach approximately $300 billion by 2030. Thank you for joining us today.

We will now open for questions.

Thank you. As a reminder, to ask a question, you will need to press star 1 1 on your telephone. Due to time restraints, we ask that you please limit yourself to one question. Please stand by while we compile the Q&A roster. Our first question will come from the line of Tim Arcuri with UBS. Please go ahead.

Thanks a lot. Sanjay, I had a question about the market outlook for DRAM. You have already said that your DRAM production will be down mid to high singles year over year in counter 23. And then you said in your remarks, you said that if the industry production was down, this would accelerate the recovery and profitability. But at this point, I guess I have two questions. One, do you think the industry will be down in terms of production for DRAM? There's some concern about what your big Korean competitor is going to do. So I'm just sort of curious, do you think that they are cutting such that the industry production in DRAM will be down just like yours is down year over year? Thanks.

So Tim, I would like to point out that what we said is that our DRAM supply growth would be slightly negative in fiscal year 23, so not mid to high single digits. Supply growth for micron would be negative. That's because we have taken the actions. We are taking the actions in terms of supply, wafer output reduction, reducing supply through underutilization, the FAB, and as you know, we have also CAPEX reduction. We have pushed out our one beta DRAM production in the fab so that we can bring our supply closer to demand. So the industry is oversupplied, and we do believe that actions need to be taken as reflected in Micron's actions with respect to supply reduction. And, of course, the rate and pace of the industry supply cuts would affect the recovery of the industry in terms of bringing supply and demand balance closer together. So look, I mean, we cannot specifically comment with respect to our competitors, but what we can tell you is that if the industry supply is, supply growth in calendar year 23 is negative for DRAM and flattish for NAND, it will accelerate the recovery in the industry.

Thanks a lot.

Thank you. One moment for our next question. And that will come from the line of CJ Muse with Evercore ISI. Your line is open.

Yeah, good afternoon. Thank you for taking the question. I guess the question is, you've, you know, in the last few years really taken the leadership role both in DRAM And so as you think about hitting the worst downturn in 13 years and taking the appropriate reductions in supply and cost, how can you at the same time make sure that you maintain your leadership? What are you doing on that front such that when we do go into the next upturn that you are in that lead position, lead role, and can really take advantage of technology again?

Thank you, CJ. Thank you. Of course, Micron is in a strong technology position. We feel very good about our technology capabilities and our roadmap. If you look at our 1 alpha DRAM, that compared to our prior 1Z node gave us a 40% bit efficiency gain per wafer. And now if you look at our 1 beta, industry you would expect less, but what you see in our 1 beta node is a 35% improvement in terms of beta efficiency per wafer versus our one alpha node. And our one beta DRAM node is well designed for D5, DDR5 deployment as well, with good performance and good power efficiency improvements over prior products. So it's really one beta is a very good node when you compare it to any other even EUV nodes that are out there in the industry. So it's an industry-leading node. We are well-positioned with our one beta node. And, of course, our one gamma node will be well-positioned as well. And we are timing the production of these nodes to maximize the ROI in our R&D and manufacturing, and, of course, to bring supply and demand in balance overall and keeping in mind the longer-term demand CAGR for DRAM growth and adjusting our technology cadence accordingly. So I think we are managing our technology node development and manufacturing plans, our supply plans in a highly responsible fashion, and we'll be well positioned with our technology. And same thing on NAND side. Our 232 NAND is in very good shape. Both one beta and 232 layer NAND in terms of cost, in terms of quality, and in terms of, of course, yields. We are well positioned with them and continuing to work with customers in qualifying those products. So not only just one beta and 232 layer, we feel good about our technology roadmap capabilities and position with our plans for one gamma and the node beyond the 232 layer in NAND. And just to point out that Micron, I was recently talking to a leading customer and executive there, and the customer was praising Micron's D5 as being the best in the industry. And same kind of accolades we get from customers on LP5, on GDDR6, on our QLC, NAND, and of course we are broadening our portfolio of products too. So not only with respect to technology, We are well positioned. I think we are well positioned with respect to our product momentum as well. Thank you.

Thank you. One moment for our next question. That will come from the line of Chris Caso with Credit Suisse. Your line is open.

Yes, thank you. Good afternoon. Question is on the pace of gross margins as you go through the year. And you spoke about revenue and free cash flow being better in the second half. Do you believe that's the case for gross margins as well? Do you think gross margins are bottoming here? And if you could comment about some of the impact of the unutilization charges and how they flow through the year and beyond Q2.

Chris, this is Mark. I'll take that. A few comments on the profile. We did say that Q1 would be the bottom for BITS, and we expect BITS to be up in the second quarter and revenue down, so that points to continued challenges around the market conditions. We also expect 2Q to be peak on DIO, but 3Q will be the peak on inventory dollars, so the industry remains in an oversupply situation, but customers are depleting inventories, and we expect them to be in a better position by the second quarter of the calendar year. But profit's going to be challenged through the year, and that will challenge gross margins. Now, the utilization effects specifically, you know, maybe I'll talk just cost generally first. You know, in FY22 and historically, you know, Micron has strived and achieved cost downs in line are better than the industry. Note advancements, manufacturing, productivity, and other factors. But fiscal year 23 is going to be challenging in the near term as, you know, these utilization effects and low volumes weigh on the cost per unit and weigh on margins. And there are three principal drivers that will help explain that. One is maybe an overlooked factor. It's just simply the effects of routine period costs that run through the business on a normal basis. You know, scrap, pre-production volumes, pre-qual volumes, you know, freight, royalties, these sort of things. And when you have this sharp a decline in volumes and revenue, those period cost effects are going to impact margins. And so we're seeing that. The second driver is the much lower volumes are creating underload issues in the back end. And of course, that creates higher cost inventories that, you know, some is period cost, but most of it still hangs up in inventory and creates higher inventory costs. And that also is a significant factor early in the year, especially weighing on our costs. And then third, you know, most visible has been our announcements to lower utilization on the front end. And, you know, that is a significant cost And, you know, we have most of those costs are going to be in inventories also versus period costs. And we said that $460 million, which is just over half of the total fixed costs that will need to be applied, will impact FY23. Now, the rest of those costs will flow through in FY24. Now, if our volumes are better than expected, those higher cost inventories will be pulled through earlier. If volumes are less than expected, then more of those costs will flow through in FY24. But right now, we're seeing about $460 million in FY23. So, in summary, we expect costs per bit to be up modestly in Q1. Again, that's mostly just the period cost effects that are normal, and then some back end effects. And that's related to just low volumes. That's going to be a bit more cost in the second quarter. Again, and this is more back end effects as those inventories clear. And then the third quarter, we're going to have the back end effects. of underutilization and the front end effects as that inventory starts to clear. But then in the third quarter, and then especially in the fourth, we have offsets. In fact, we resume costs down in the fourth quarter as volumes pick up and absorption occurs. It's not a permanent condition. This is just a function of volumes that are at unseen drops in volumes and actually the steps that we're actively taking to reduce supply. And I think it's worth noting that cost is certainly important. It's a great focus. We're managing the details. But the largest impact to the profitability and financial outlook for us is the supply-demand balance, and the rate and pace of this improvement is going to be a function of aligning supply with demand, and we're taking decisive actions on capex and utilization to address it.

Got it.

Thank you.

Thank you.

One moment for our next question.

That will come from the line of Tom O'Malley with Barclays. Your line is open.

Hey, guys. Thanks for taking my question. My question is really on the demand side. I think that you did a good job of calling out what you saw from an end market perspective into next year, but I just wanted to ask specifically on the data center. You've called out inventory in the past, but versus where you guys talked about the data center last quarter, do you think that inventory at customers was worse than you initially thought, or do you think that you're seeing a weakening in terms of data center and demand?

Thank you. So inventories with data center customers, including cloud, is higher than what we thought. So that inventory adjustment has begun, and it has some wood to chop in that area. And of course, the end demand for cloud operations that are driven by consumer-related activities, given the overall consumer environment, and the macro trends, some portions of cloud and demand may be weaker as a result of that as well. And also in the macro environment that exists today, given the higher interest rates and other macro trends, companies do become somewhat cautious in terms of managing their overall expenses and any long-term agreements, et cetera. So that can impact some of the current environment for end demand in cloud. But what I would like to point out is that digitization trends ultimately do remain positive. Cloud definitely helps drive that efficiency that businesses seek in an environment like this. We do absolutely expect that once we get past the current macroeconomic environment and macroeconomic weakening, Longer-term trends for cloud will remain strong. In terms of the current environment, yes, inventory adjustments and some impact of cloud and demand weakening as well. That's impacting our overall data center outlook. Thank you very much.

Thank you. One moment for our next question. That will come from the line. That's Chris Zankar. with Cowan. Please go ahead.

Yeah, hi. Thanks for taking my question. I just have a quick question for Mark. Mark, you said inventory days to peak in the second quarter and inventory dollars in S3Q. What kind of inventory days should we expect in S3Q, and what is the risk of an inventory write-down? I'm kind of wondering what is your inventory write-down methodology? Thank you.

Sure. I think I got the question. So as mentioned, the DIO peak, we expect to be in 2Q, the dollars in 3Q. And from both those peaks, we expect it to gradually improve, which is consistent with a profile that we've said before, though the conditions have worsened and volumes are a bit lower. We do expect customers to be in better shape by the second quarter calendar year, and that's encouraging. And then you've seen the steps you've taken on supply to get inventories down. But I did cover this recently at a conference. It bears repeating. Inventory is obviously a risk where we carefully and thoroughly monitor. And with the lower utilization we have and the higher costs associated with that per unit, And then the weak market conditions we have, the margin of safety we have has decreased from where it was. We did a thorough quarter-end analysis, as we always do, and, of course, that includes the outlook. And in that, we determined that there are no write-downs to the lower of cost or net realizable value warranted requirements. We perform extensive reviews of projected pricing. We analyze customer trends. And there are a number of other factors. If our estimates did change further, there could be risk of write-off in future quarters, but none in the November quarter. I do refer you to our inventory policy that's disclosed in our 10-K. We have a long-standing policy of evaluating inventory as a single pool, and we evaluate this policy regularly, and we apply it consistently.

Thank you, Mark, and I do apologize for the background noise.

Thank you. One moment for our next question. That will come from the line of Mehdi Hosani with Susquehanna. Please go ahead.

Yes, Seth. Thanks for taking my question. Sanjay, I want to go back to the color you provided on the demand trend by end customer or by end application. You highlighted that the PC unit are expected to be down 5% to 10%. If I just take the current bill rate in December and apply a seasonal decline in Q1, it suggests to me that PCs or the end market application would bottom by March, April time frame, let's say post-Chinese New Year. Could that be a catalyzed, could that actually catalyze a more improved visibility with pricing for DEDAM and NAND? And I ask you because it was the PCN market that rolled over, and I'm just trying to understand whether PCN market could help stabilize certain part of DEDAM and NAND segments. Thank you.

Well, of course, the markets for DRAM and NAND are well diversified. You know, PC is one of the markets. And we already talked about the decline in PC units. Actually, in calendar year 22, high teams declined in PC units. This is the sharpest decline in the history of the PCs. And smartphones, another area where unit sales of smartphones globally down 10% as well. And that too, you know, historically in terms of a decline is high. So these are, of course, impacting the end consumer demand and, you know, then inventory adjustments on top of it impacting the demand. And of course, as I spoke about earlier, that inventory adjustments are happening in other parts of the market as well. I think, you know, with respect to our outlook for next year in terms of demand, we expect about 10% demand growth for DRAM in calendar year 23. And when you look at, you know, mid-single digits, low to mid-single digit demand growth in 22 and approximately 10% in 23, you know, that over a two-year time period is really significantly lower growth rate compared to the years in the past, the CAGRs that have been, you know, prevalent over time. So I think what's important here is that the supply has to be reduced. The biggest factor here really would be the supply reduction. You know, of course, once inventory adjustments We are able to get past and the macroeconomic environment improves. You know, the long-term trends for demand driven by all the factors we have spoken about before, AI, 5G, industrial IoT, autonomous, all of those long-term factors will drive the demand along the lines of the CAGR that we have discussed today. But in the near term, the biggest factor to really address the demand supply is... reduction in supply in the industry. And, you know, of course, the rate and pace of the financial performance improvement will very much depend on how fast supply comes into balance. And as we have discussed, we have taken our actions in terms of capex reduction, in terms of underutilization, in terms of adjusting the technology node cadence. And we do believe that with the supply actions, the industry environment will improve. I do see that in fiscal year 24, the revenue, the profits, and the free cash flow profile would be much better than 23. And of course, again, will be a function of how quickly the supply adjusts to demand.

Thank you. One moment for our next question. That will come from the line of Toshi Yahari with Goldman Sachs. Your line is open.

Hi. Thank you so much for taking the question. I had one quick clarification and then a question. Clarification for Mark. You talked about the $460 million of headwind related to the underutilization of your fabs. When you throw out that estimate, what assumptions are you making for utilization rates for the next couple of quarters? You know, you obviously talked about the 20% cut as of today, but are you assuming you stay at that 20% rate for Feb, May, and perhaps August, or are you assuming production rates or utilization rates kind of step up as you progress through the remainder of the fiscal year? And then the question is on the demand side. Sanjay, in your prepared remarks, you talked about customer inventory normalization and new server CPU platforms in China reopening as some of the key drivers for big growth over the next couple of months or few months. How much visibility do you have into those three dynamics? You talked a little bit about inventory, but we're hearing customer inventory in some cases might be increasing given some of the deals, you know, not just you specifically, but the industry is striking. The server platforms could be a little bit more skewed to the second half of calendar 23, and China reopening still seems pretty gray. So curious what kind of visibility you have there. Thank you.

Yeah, Toshi, I'll just briefly touch on the first one. We're expecting these elevated underutilization levels through fiscal year 23. And beyond that, we're just going to always be evaluating the market conditions, and then we'll update you and the market accordingly.

And on your questions regarding customer inventory, What I would like to point out is that customer inventory in aggregate, that means in terms of volume in bits, we believe has come down, although still at high levels. And you can see that in Q2, we are guiding to increased bit shipments. And just keep in mind that we're Our demand used to be, in terms of all the industry shipments used to be, a few quarters ago versus now, they have come down substantially. And even though there may be some end market weakening in demand, that points to that some of the inventory is being consumed by the customers. Basically, some of the inventory that the customers are holding is being consumed by them to address their end demand. So basically, the ship out by customers is greater than the ship in in terms of purchases by customers from suppliers. And this trend of inventory improvement, gradual inventory improvement, we believe will continue. And by mid-calendar 23, we are projecting, even though we don't have perfect visibility, but based on all of our discussions with our customers, we are projecting that inventory at customers will be in relatively healthier position by that time. And that's where we say that our second half of fiscal year revenue will be greater than first half, and we would expect continued improvements beyond the second half as well. And regarding the question on China, of course, China reopening has to be monitored closely, and it may be choppy. In terms of the near term, we are assuming that China's reopening for the second half of the calendar year will result in benefit in terms of increased demand coming from the China markets. And of course, you know, China reopening is not just an issue to be monitored in terms of Chinese customer demand, but also any impact on global electronic system supply chains. And of course, we have assembly and test operations in China as well. And we are continuing to monitor those as well with respect to some of the recent COVID cases there. So I think China, COVID cases and reopening will have to be continued to be closely monitored.

And Sanjay, Sapphire Rapids and Genoa, the new server CPU platforms, visibility there in terms of the ramp?

So our products are well positioned and we expect that these will be ramping during the course of 23 and of course continue to ramp in 24 as well. And these are the ones that will drive the greater D5 attached with the servers. And as we said, you know, we expect that for servers D5 in 30 percentage range in terms of deployment by end of calendar 23, and somewhere around 50% by mid-Calendar 24. So our products are well positioned, and we are looking forward to deployment of those new CPU platforms, and that will drive healthier dynamic with respect to D5 deployment. These new processors, they work with more cores. They increase the attach rate for memory. because they are bandwidth-hungry, and that just points to greater adoption of DRAM, particularly D5 memory, with those processors. Thanks so much. So, of course, it has been pushed out. I mean, compared to the plans last year or over the last few months, some of those new processor deployments have been pushed out, but we look forward to them getting broadly adopted as the year progresses in 2023.

Thank you. And we do have time for one final question. And that will come from the line of Aaron Rakers with Wells Fargo. Your line is open.

Yeah, thanks, guys. I'll make this a quick question. I'm just curious, as you guys kind of thought about the guidance for this current quarter and given the pace of change that we saw in the pricing environment through the course of this last quarter, you know, I guess when you roll up your assumptions for DRAM and NAN, Is it simple to think that you guys are assuming kind of a similar pricing environment or pace of pricing declines this quarter as we saw last quarter, or are you kind of factoring in any kind of acceleration of price degradation? Thank you.

So, look, we don't comment specifically on pricing, but I can certainly tell you that both DRAM and NAND are experiencing challenging environment. And again, It is about the oversupply in the market and decisive actions that we have highlighted today are the kind of actions that are important to make progress toward bringing supply and demand into balance.

Thank you. Thank you all for participating. This concludes today's conference call.

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