Good afternoon. My name is Saeed, and I will be your conference facilitator today. At this time, I would like to welcome everyone to Micron Technology's third quarter 2013 financial release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you'd like to ask a question during this time, please press star followed by the number one on your telephone keypad. If you'd like to withdraw your question, press the pound key. Thank you. It is now my pleasure to turn the floor over to your host, Kipp Bedard. Sir, you may begin your conference.
Thank you. I'd like to welcome everyone to Micron Technology's third quarter 2013 financial release conference call. On the call today is Mark Durcan, CEO and Director; Mark Adams, President; and Ronald Foster, Chief Financial Officer and Vice President of Finance. This conference call, including audio and slides, is also available on our website at micron.com. If you have not had an opportunity to review the third quarter 2013 financial press release, again, it is available on our website at micron.com. Our call will be approximately 60 minutes in length. There will be an audio replay of the call, accessed by dialing 404-537-3406 with a confirmation code of 91862727. This replay will run through Wednesday, June 26th, 2013, at 5:30 P.M. Mountain Time. A webcast replay will be available on the company's website until June 2014.
We encourage you to monitor our website at micron.com throughout the quarter for the most current information on the company, including information on the various financial conferences that we will be attending. Please note the following safe harbor statement.
During the course of this meeting, we may make projections or other forward-looking statements regarding future events or the future financial performance of the company and the industry. We wish to caution you that such statements are predictions and that actual events or results may differ materially. We refer you to the documents the company files on a consolidated basis from time to time with the Securities and Exchange Commission, specifically the company's most recent Form 10-K and Form 10-Q. These documents contain and identify important factors that could cause the actual results for the company, on a consolidated basis, to differ materially from those contained in our projections or forward-looking statements. These certain factors can be found in the investor relations section of Micron's website. 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 the date of the presentation to conform these statements to actual results.
I'll now turn the call over to Mr. Mark Durcan. Mark?
Thanks, Kip. I'd like to start today with an overview of the key developments during the quarter and a few strategic and industry updates. I'll turn it over to Ron for a financial summary, and before turning to Q&A, we'll close with Mark Adams covering more details of our business units and operations performance and market conditions. Our third fiscal quarter was highlighted by continued improvement in memory market fundamentals and Micron's financial position. The DRAM business had significant revenue and margin expansion in the personal system segment, which achieved the highest revenue in almost 3 years. In NAND, we had another quarter of strong unit growth in the SSD segment and took advantage of improved market ASPs generally. We remain focused on making capital and segmentation decisions to optimize margin and free cash flow over time.
As you will have noticed in the release, revenue in the quarter was up about 12%, with strong growth in both DRAM and NAND. Gross margins were also up significantly from 18%-24%, highlighted by DRAM, which was up over 16 percentage points for the quarter. Trade NAND margins improved by about five percentage points and still represent our highest-margin product category, followed by DRAM, then NOR. Operating cash flow of $624 million exceeded our disciplined and measured capital expenditures of $235 million. I previously mentioned that we were taking steps to enable some capacity fungibility between different memory technologies. We're moving forward with plans to convert a significant majority of our DRAM capacity in Singapore to NAND.
We believe that customer demand and margin opportunity in NAND over the next 12 months, coupled with a highly attenuated capital investment relative to greenfield capacity, make this a sound financial decision. A measured transition will likely occur over the course of the next year or so, depending on market conditions, as we continue to monitor the demand and margin profile of our various products and segments. The impact of this conversion will be included in the guidance we provide. During the quarter, we closed on the previously announced sale of our 200-millimeter image sensor fab in Avezzano and took another step to streamline our operations through restructuring our R&D relationship with STMicroelectronics, Italy, and also discontinued operations of our LED pilot line in Boise.
We will continue to look for opportunities to improve our operational structure and performance, including the wind-down of some remaining 200-millimeter capacity as we migrate more products to 300-millimeter. We made good progress towards closing the acquisition of Elpida and believe the principal hurdles to closing are mostly resolved. We've obtained regulatory clearances, bondholder challenges of the plan of reorganization in Japan have been denied, and the waiting period for challenges to the recognition motion in the U.S. Bankruptcy Court has expired. As a result, we're optimistic that closing will occur during our fiscal Q4. Elpida's financial performance has been strong in recent periods and continues to improve, reflecting a strengthening DRAM market as well as Elpida's strong mobile DRAM presence and operational improvements.
During the last quarter, Micron and Elpida entered into a joint development agreement that has enabled more seamless integration of our technology roadmaps. We're encouraged by the early productivity of the cooperation. Following the close, our overall trade memory wafer capacity will increase by about 45% from today's level without impacting industry supply. This deal will provide significant revenue and margin leverage for Micron as we are positioned to benefit from low-cost scale, enhanced product and customer breadth, and improved operational efficiency. We believe conditions remain positive for continued improvement in the memory industry. We're forecasting DRAM industry supply up in the mid-20% range this year and low to mid-20s in calendar 2014. For NAND, we're forecasting supply up in the mid-30% range this year, followed by the low 40s in 2014.
We believe this historically slow supply growth, coupled with memory demand growth in mobile and infrastructure-related markets such as smartphones, storage, and servers, creates a favorable balance. We're well-positioned to capitalize and look forward to driving profitable growth in the coming quarters. I'll stop here and turn it over to Ron and Mark before turning for Q&A.
Thanks, Mark. Our third quarter of fiscal 2013 ended on May 30th. Our website has a schedule containing certain key results for the third quarter, as well as guidance for the fourth quarter. That information is also presented on the following slides. For the third quarter, we reported net income of $43 million, or $0.04 per diluted share on net sales of $2.3 billion. These results compare to the previous quarter's net loss of $286 million or $0.28 per diluted share on net sales of $2.1 billion. The consolidated revenue growth and improved operating results reflect the significant improvement in the memory markets, particularly for DRAM products. The effect of this improvement can also be seen on the equity and net income of equity method investments line shown on the slide, which largely reflects our share of the net loss from Inotera with a two-month lag.
In their two most recent monthly reports, Inotera has reported positive net income, which will be reflected in the next quarter's results for Micron. Related to Mark's earlier comments on our continuing efforts to optimize our operational footprint, these actions have resulted in restructuring charges. This quarter, we separately presented those charges as a restructure and asset impairment expense on the face of the income statement. Expenses and asset impairment charges associated with restructure activities from prior quarters have been reclassified to present the operating results on a consistent basis. To simplify the presentation of noteworthy items and those items that are not representative of the company's trended economic performance, we are presenting a schedule of net income for the period as reported, reconciled to net income excluding these certain items.
Note that the amounts in the reconciliation do not include all their related income tax effects, as the amounts are generally de minimis due to our net operating loss carryforward and our global tax structure. The restructure activities over the past two quarters include the following. Approximately $60 million charge that we accrued in the second quarter associated with the estimated loss on the sale of our 200-millimeter imaging fabrication facility in Avezzano, Italy, to LFoundry. This transaction closed in the third quarter. For the first three quarters of the fiscal year, the imaging business reported approximately $60 million of operating loss in our Micron results on sales of approximately $220 million, in addition to the restructure charge. Going forward, there'll be no future revenue or losses from sales of imaging products.
Approximately $26 million in the third quarter for the loss on the transfer of certain assets and approximately 500 employees in Agrate, Italy, to STMicroelectronics is also included in the schedule. Approximately $25 million in the third quarter to write down certain production assets used in the LED technology development, which was terminated in the third quarter. Other recurring items presented in the reconciliation include the amortization of debt discount and other costs. This adjustment, which flows into interest expense on our financial statement, is substantially comprised of the imputed interest to value the debt component of our convertible notes at fair value. This item will be ongoing as long as we have these convertible notes and discounted debt, such as the Elpida installment payments. Foreign currency activity, including the impact from our hedging programs, is also included.
The largest impact in this area is from the hedge of the Elpida Rexchip acquisition, which has been heavily impacted by volatility in the JPY exchange rates. Other items called out in the second quarter include a non-cash loss of $31 million from the early redemption of a portion of our outstanding 2014 convertible notes and two favorable items in the tax provision resulting from the resolution of an uncertainty and a tax rate change, both occurring outside the U.S. Adjusting for these items, non-GAAP EPS improved from a $0.06 loss in our GAAP results in the second quarter to an income of $0.15 per share in the third quarter. As we have mentioned previously, we may undertake additional restructure activities as we continue to optimize our manufacturing and other operations. Let's turn now to operating results and outlook.
Note that none of the guidance we are providing today includes any direct effect from the Elpida Rexchip acquisition. DRAM revenue in the third quarter increased 23% compared to the previous quarter as a result of a 16% increase in bit average selling prices and a 6% increase in bit sales. The increased selling prices for DRAM products was favorably affected by more Inotera volume sold into higher-value segments, along with general improvements in the market. DRAM bit costs decreased 5% quarter-to-quarter, driven primarily by the higher concentration of lower-cost products from Inotera. The cost of DRAM products purchased from Inotera increased in the third quarter compared to the second quarter, but was still slightly lower than the cost of the rest of the company's DRAM production on a per-bit basis. Guidance for Q4 DRAM is as follows.
Using quarter-to-date selling prices and projected product mix for the quarter, ASPs would be up mid to high single digits compared to the Q3 average. Projected bit costs are expected to be flat relative to Q3. Projected production volume is up high single digits. Key themes influencing this guidance for DRAM are, first, 4-gig DDR3 volume continues to ramp in our system, comprising over one-half of the DRAM bit sales in the third quarter and increasing into the fourth quarter. This transition from two gigabit to four gigabit has the effect of lowering ASPs and costs with some margin improvement. We're seeing a somewhat higher percentage of our total bit production from Inotera, with improving product mix and costs that move directionally with prices. As a reminder, the cost of products purchased from Inotera is based on a moving average market minus model with a one-month lag.
While we account for the change in our equity investment with a two-month lag. The higher output in the fourth quarter is a result of higher output from Inotera, partially offset by lower output from our Singapore DRAM fab as we transition existing DRAM capacity there to NAND. This transition will continue through the next year or so based also on market conditions. Turning now to trade NAND, bit sales in the third quarter increased 8% compared to the prior quarter, primarily as a result of higher per-bit average selling prices. We continue to see growth in SSD sales, and we built some WIP inventory to support strong demand over the coming quarters. Trade NAND bit costs in the third quarter were relatively flat compared to the second quarter due to higher SSD production and some costs related to the start of NAND production in the Singapore DRAM fab.
guidance for Q4 trade NAND is as follows. Using quarter-to-date selling prices and the projected mix for the quarter, trade NAND ASPs would be down mid-single digits. Bit costs are expected to be down high single digits, while bit production is expected to be up high single digits. Key trends affecting for Q4 guidance are, we expect a higher-density product mix in NAND, lowering both the ASP and cost per gigabyte while increasing volumes. We expect also to sell more NAND into SSDs with greater capacity per drive, which slightly lowers the average ASP and cost per gigabyte. We continue the migration to 20-nanometer process technology, resulting in lower costs and increasing bit output into both component discrete sales and SSDs. NOR sales were relatively flat comparing the third quarter to the second quarter, in line with our prior guidance.
NOR revenue, which has been fairly stable over the past few quarters, is expected to decrease by about a third in the fourth quarter as the wireless business accelerates its transition to more NAND-based solutions. With positive net income, certain stock options and convertible notes start to become dilutive in our financials. These dilutive items added approximately 23 million shares to the denominator in the EPS calculation for the quarter. Going forward, because the dilutive effect of the convertible notes and employee stock options is determined using the treasury stock method, the amount of dilution will vary primarily based on the average traded share price for the period. For example, the average traded share price for the third quarter was approximately $9.85, which resulted in 23 million shares being added to the denominator of our diluted shares.
Had the share price been $14 average for this last quarter, approximately 105 million shares would've been added to the denominator. SG&A expense in the third quarter was just below our guided range. We expect SG&A expense in the fourth quarter to be between $135 million and $145 million. R&D expense was $226 million in the third quarter and is expected to be between $230 million and $240 million in the fourth quarter. There was no DRAM development cost-sharing with Nanya in the third quarter, as the joint development program with Nanya was discontinued earlier in the year. The level of R&D expense in any given quarter can vary based on the timing of product qualifications and the volume of development wafers processed. The company generated $624 million in cash flow from operating activities in the third quarter, as Mark mentioned, reflecting improvement in the operating results compared to the prior quarter.
The third quarter ended with cash and investments, including non-current investments of just over $2.9 billion. As Mark summarized, expenditures for property, plant, and equipment in the third quarter were $235 million, and we expect expenditures for the fourth quarter to be between $300 million and $500 million, which will result in fiscal 2013 total spending below the low end of our guided range for the year. We are deferring some capital spending in the second half of our fiscal year as we anticipate changes from the Elpida transaction. We expect to pick up this spending in 2014 as we integrate the two companies. As previously indicated, we expect the capital intensity of the combined company to be similar to Micron's standalone historical level on a per-wafer basis.
Activities in the third quarter includes the cash payments on currency hedges of approximately $200 million, which includes settlement of the previous hedges associated with the Elpida Rexchip acquisition. Similar to the discussion in our conference call last quarter, at an exchange rate of ¥95 per US dollar, the US dollar equivalent price for the Elpida acquisition, including the installment payments to creditors, would be approximately $400 million lower relative to the price when we signed the sponsor agreement last summer. In addition, at the expiration of the initial hedges earlier in the third quarter, we entered into a series of new hedging transactions to mitigate the effect of currency rate changes on JPY 80 billion. This JPY 80 billion is the initial payment of JPY 60 billion due at closing, plus the first JPY 20 billion installment payment to the creditors in the reorganization process due in December 2014.
The total hedging cost for this structure is capped at approximately $30 million, of which approximately $24 million was accrued in the third quarter. Post-closing, we currently plan to implement a natural hedging strategy to offset the foreign exchange exposure on the longer-dated installment debt by utilizing yen-denominated assets such as cash. In May of this year, Nanya made an additional investment in Inotera, which reduced our ownership from approximately 40% to approximately 35%. Because the price of the shares sold to Nanya was above our carrying value per share, Micron will recognize a non-operating, non-cash gain of approximately $49 million as a result of the transaction. With the two-month lag in equity accounting for Inotera, this gain will be recognized in operating results in our fourth quarter. With that, I will turn over to Mark Adams for his comments.
Thanks, Ron. I'm going to provide some more detail on our third-quarter operating performance, as well as share some comments about the current state of the memory market. Our NAND Solutions Group recorded revenue of $730 million, up 2% when compared to our second quarter. Total trade NAND gross margins were up five percentage points quarter-over-quarter, reflecting improved ASPs and stronger penetration into enterprise SSDs. Our branded SSD business was $178 million in Q3, an 11% quarter-over-quarter increase. When you combine sales of our Micron-branded SSD drives with flash memory we ship to our strategic third-party SSD customers, shipments to the SSD segment represented over 60% of our trade NAND capacity. We continue to migrate the SSD product family to our 20-nanometer flash memory technology with the announcement of our M500, currently targeted at client and Web 2.0 applications.
In addition, we launched the industry's first MLC-based PCIe accelerator drive with the Micron P420m, initially targeted at database applications. We have hit big crossover on our 20-nanometer process technology. 20-nanometer production will continue to expand over the next couple of quarters. We plan to commence the ramp-up of our 16-nanometer technology early in calendar year 2014 and anticipate a faster ramp than occurred at the 20-nanometer node, given solid SSD and other socket enablement. In addition, we are pleased with our progress on 3D NAND development, and we remain focused on driving support for higher-end storage applications. From a pricing perspective, as we shift our SSD portfolio from SLC to higher-density MLC, we will see a lower ASP per gigabyte due to density growth per unit and lower costs associated with the technology.
The effect is a slight downward movement on ASPs offset by improved costs with a net positive benefit to our gross margins. Due to this mix effect, our quarter-to-date mix-adjusted trade-in ASPs are forecasted down mid-single digits based on quarter-to-date pricing, with expected continued improvement in margins. In short, we remain optimistic for a strong second half of the calendar 2013 for flash memory. Sales for our DRAM Solutions Group came in at $924 million, up 23% quarter-over-quarter. The increase in sales were driven by a 16% increase in overall DRAM pricing, coupled with a 6% increase in DRAM shipments when compared to Q2. Our overall DRAM gross margins came in just above the 24% corporate average, up over 16% from our second quarter. We achieved outstanding results in all of our premium DRAM segments, with the non-PC business representing about half of our gigabit shipments.
Our server business recorded record shipments with a total sales of over 260 million gigabit equivalents, driven by increased densities at key OEMs and cloud service providers. We had a record quarter in our networking business for both revenue and bit shipments. DRAM bit shipments in networking were up 19% compared to our second quarter and now represent 16% of our DRAM revenue. We had another strong quarter and made progress to expand beyond the large OEM business to smaller customers and distributors in the sale of our networking portfolio. Sales of our networking products through distribution are up 139% year-over-year. We also had a strong quarter in our consumer graphics segment, which continues to be an attractive premium market, in particular looking forward with the upcoming launch of next-generation gaming consoles.
DDR3 volume represented 75% of our overall DRAM production, as DDR2 is addressing more of a legacy market requirement. We are optimistic we will begin shipment of our 25-nanometer DDR3 technology in early fiscal year 2014 and start sampling our 20-nanometer DDR3 product by the end of calendar year 2013. We are getting positive market feedback from Micron's DDR4 samples at our key OEM customers. Our LPDRAM continues to gain momentum, and we had strong design-in activity with enablers and OEMs for Hybrid Memory Cube. From a market standpoint, U.S. carrier CapEx for LTE deployment is strong, and data center networking remains a bright spot for investment by key OEMs. DRAM pricing continued to be favorable. We have seen good progress in narrowing the gap between spot market sales and our OEM customers who negotiate contract pricing.
As we mentioned on the last call, the PC segment is a lower percentage of our DRAM business at about 40% of revenue. Our specialty business typically lags in market in terms of price movement in either direction and thus had a limiting effect on our combined DRAM pricing. As such, the current spot market price increase in pricing, while still positive, have less of an impact on our overall DRAM ASPs. Channel inventory stayed tight throughout the quarter. We currently are on allocation on a number of DRAM products and have not seen any signs of a letdown in demand heading into the summer months. The DRAM supply and demand remains in favorable balance, and we think this situation will remain for the second half of calendar year 2013.
Sales by the Wireless Solutions Group were up roughly 30% quarter-over-quarter, as we saw increased demand in both our major OEM customers and the tier 2 China mobile market. Supply for mobile DRAM and NAND products remained tight due to strong demand for tablets and smartphones. Our low-power DDR3 16 gigabit product is in the design phase at the top smartphone manufacturers. Our NAND-based MCPs have gained strong traction in the overall market, with growing share in the China smartphone market. Our portfolio of eMMC and EMCP products is expanding with strong presence across all of our customer base. From a market perspective, we saw improved pricing trends in the tier 2 China market and then expanding to our larger OEM customers.
As I've mentioned on prior calls, we are in the turnaround mode in our wireless business but are making progress as we reduced our operating losses by about $25 million when compared to Q2. We're very excited about the future combined mobile offering of the combined Micron Elpida wireless group and continue to receive strong support from top mobile customers. Our Embedded Solutions Group had another record revenue quarter, eclipsing the $300 million mark. The embedded business maintained strong gross margins in Q3. We continue to invest in growing our presence within this category. ESG's automotive segment increased market share, highlighted by our automotive eMMC product portfolio and setting a record shipment to automotive in the quarter. We are seeing a rapid transition from NOR to low-density NAND in the embedded market. In fact, our embedded NAND business roughly doubled quarter-over-quarter from Q2 to Q3.
Despite this, we see pockets of solid NOR margins and are on track for qualification of our 300-millimeter 45-nanometer NOR technology in early calendar 2014. Overall, demand for ESG product is increasing, and we are optimistic for a strong Q4. Our Q4 results reflect an improving memory market and good execution in key operating areas. We continue to manage our expense line, as reflected by our SG&A and R&D staying in alignment with last quarter's spending and our guidance for Q3. We continue to drive inventory turn performance down. Inventory stays flat despite higher cost of goods in the quarter. We successfully concluded the sale of our Avezzano imaging fab and are continuing to explore ways to optimize our manufacturing footprint to align with future capacity needs. Despite the current market conditions improving, we have managed also to reduce our overall headcount by 7% compared to second quarter.
As we look to invest in high-value, differentiated memory solutions, we also remain committed to driving maximum efficiency in our operations. Our management team has been working diligently on integration plans with Elpida. The teams have worked well together, and we are excited about the opportunity for the consolidated business going forward. After the close of our Elpida transaction, we will have increased our trade memory capacity over 90% compared to early last year, all with existing industry capacity. Our customers are supportive and encouraged about the prospects of a scaled Micron with Elpida and are seeking a new level of strategic alignment for advanced memory solutions. Micron's customers understand memory is evolving to new applications and form factors, moving to a more solutions orientation. We are measured in our approach to capital spending as we transition technology nodes over the next 12 to 18 months.
The market for both DRAM and NAND remains in good balance, and we are optimistic for a strong Q4. With that, I will hand it back over to Kip.
Thanks, Mark. We will now take questions from callers, and just a reminder, if you are using a speakerphone, please pick up the handset when asking your questions so we can hear you clearly. With that, please open up the phone lines.
Thank you. Ladies and gentlemen on the phone line, if you have a question at this time, please press star then one on your touch-tone telephone. If you wish to remove yourself from the queue, please press the pound key. Again, if you'd like to ask a question, please press star then one. Our first question comes from Glen Yeung from Citi.
Just a question about the demand opportunity from gaming. We've seen those game consoles go from quite a low amount of DRAM to quite a high number now. To what extent do you think this is a meaningful demand driver for DRAM in the next few quarters?
Glen, this is Mark Adams. I think it's all pretty positive for us. When we look at the gaming sector and compare it to other segments, it's still a pretty positive segment for us. Looking at the densities, on average about 8 gigabytes. Of course, going into the holiday season, we're pretty excited.
Can I ask another question about cost, then? Just thinking about Inotera, I recognize Inotera costs are below yours and over time, it's a bit of a drag on the net cost down of the two companies. Is there a point at which the costs come together, and at that point, do we then revert back to more normal cost declines in DRAM?
Glen, this is Mark Durcan. It's not likely to happen in the short term, and that's primarily because there's a pretty significant difference in the mix that runs at Inotera today versus the mix that runs other places. You look at Micron DRAM today, there's a lot of networking, server, consumer, gaming products that aren't necessarily found in Inotera, that typically drive pretty good ASPs, but also may be not advancing to the leading edge node as quickly. We're not particularly concerned that the cost profiles don't marry up. The other thing to keep in mind, obviously, is that going forward, Inotera costs to Micron are going to track with the end markets and those are going to move over time.
As we bring Elpida into the fold, we will have wholly owned DRAM capacity that'll be much more leading edge and cost efficient to service some of those more high-volume markets.
Perfect. Thanks very much.
Thank you. Our next question comes from Joseph Moore from Morgan Stanley.
Great. Thank you. You said that NAND was the most profitable category, but it doesn't look like they're that far apart if you look at DSG being a little higher than NSG, and I know that doesn't map exactly to the chips, but they're pretty close. Now you've got DRAM prices going up and NAND going down. Going forward, how do you think about the relative profitability of the two, and how do you think about moving capacity over to NAND? Is it possible that DRAM will be more profitable?
I think the clarification I'd like to make is that the pricing trend you identified in NAND, I should clarify, is really driven by a shift in a mix from SLC and MLC and some other applications. We think it's gross margin positive, and we think the relative profitability is about the same. Let me jump in here. We're not going to be moving capacity around on a high-frequency basis. The changes we're making are over the long haul, and if we look at the market going forward for NAND, there's just insatiable demand. It looks like there's pretty strong demand growth out there into the future, and that's why we're making the adjustments.
Okay, great. Thank you. At the beginning of the quarter, you had talked about NAND bits being up sequentially, they ended up flat and pricing being down and then ended up quite a bit higher. What was the change over the course of the quarter versus when you gave guidance at now?
Sure. Ron had mentioned in his comments that the nature of the SSD business will provide some variance in terms of inventory levels and how we stage products for our strategic customers around SSDs. When you get to a category that, as I mentioned in my comments, are up around 60% of our trade NAND capacity, that will have an effect on the timing of the shipments.
Great. Thank you very much.
Thank you. Our next question comes from James Schneider from Goldman Sachs.
Good afternoon. Thanks for taking my question. I was wondering if you could talk about the DRAM capacity situation for a second. Many of your competitors have talked about transitioning from PC DRAM to mobile. I was wondering if you still see that continuing in the industry at large for the foreseeable future, or if you see that reaching equilibrium at some point soon.
We still are pretty positive on that trend. James, it's Mark Adams again. We still are pretty positive and watching it. At this point, we don't see a shift away from that trend.
Okay, fair enough. Just as a follow-up on the NAND side, in terms of capacity, there's been quite a bit of controversy about how much capacity is going to get added this year on the NAND side. Can you maybe give us your feeling about roughly your estimate of how many wafer starts get added in NAND by the end of 2013?
I think we all read the same thing in the press and hear similar things from various suppliers that are out there talking these numbers. I can't tell you that I have better insight than that. I think some of the numbers that have been previously reported were potentially jumping the gun on what Micron might do. You should factor that into any thinking you have as to what's happening with NAND supply. Obviously, as I've just told you, we're going to watch what's going on in the marketplace and meter that in a measured way, given supply and demand. I'm not aware of any big new fabs coming in the NAND arena other than the one that Samsung actually has under construction in Xi'an, and I wouldn't anticipate that having a significant impact on the marketplace in 2014.
That's very helpful. Thanks so much.
Thank you. Our next question comes from Vijay Rakesh from
Yeah. Hi, guys. On the gross margins, looks like it came up pretty nicely on the quarter. Just looking out, given the improving profitability on DRAM and NAND, and historically, you guys have hit 30% back in the 2010 timeframe, how do you see that going out?
Hey, Vijay, as you know from following us for a long time, we just stay away steadfastly from trying to predict gross margins. We're going to let you guys do that. Would you like to ask a follow-up question, or should we move on?
On Inotera Memories, I was wondering, looks like you guys, that hitting profitability in the last two months, how do you see that contribution going forward?
Vijay Rakesh, this is Ronald Foster. If you look at the Inotera Memories structure, as I mentioned in my comments, we are on an ASP-minus arrangement structure. It's a moving average formula. As Mark already commented, there'll be a tendency for the cost to move with the market pricing. What it gives is stability of a major segment of our DRAM capacity with pretty good margin structure, you're going to see the cost move with the price moves in the market, the ASP moves in the market in general.
Got it. Thanks.
Thank you. Our next question comes from Mark Newman from Sanford C. Bernstein.
Hi. Thanks a lot. Could you give a brief update on the technology side? You mentioned 3D NAND progress was pretty good, if you've got any further update on that. I'd like to understand a little bit more about, on the NAND side, what you have in terms of controller and system expertise. You mentioned that your SSD sales were up quite a bit. I think you said 11% increase to $178 million. I'd like to get a sense of your controller expertise and how that's helping you, and how you're kind of working on that to improve it. Thanks.
This is Mark Durcan. Let me jump in on the technology question first, then I'll let Mark address the controller firmware software capability piece of that question. From a non-volatile advanced memory perspective, we feel like we're very well-positioned relative to those we compete against, not only in the NAND arena, but also in some of the emerging memory spaces. Let me address NAND first. Mark commented earlier in the call on the 16-nanometer rollout. There's been a lot of different terminologies out there about 2X, 2Y, 1X, 1Y. I don't know how that maps to somebody else's nomenclature. I don't think there's anybody else out there with 16-nanometer half-pitch product. I'm pretty confident that that's going to be the smallest cell size planar NAND in the marketplace here over the next couple of quarters.
Feel pretty good about how we're positioned on planar NAND. Moving to 3D NAND, we're very happy with the progress we're making on our 3D NAND programs. We believe everyone's taking a slightly different approach. Obviously, we like our approach the best. We don't have complete visibility into what everyone else is doing. I would say that you're going to see samples in the marketplace from a number of different competitors over the next few quarters. You're not going to see any significant production occurring until the second half of 2014. You really won't see anything that has any impact on the marketplace probably until the 2015 timeframe. I'm not saying that because I think I'm behind anybody else. I'm just trying to give you a sense of what the impact on the marketplace might be.
Relative to some of the other emerging technologies that are out there, whether they're storage class memories or pure NAND replacements, et cetera, we've got a number of different programs going with a number of different partners, as well as some purely internal ones. We really like the way we positioned our company in terms of being able to work on anything that we think is fruitful and do it in a cost-effective way as possible with the partnerships we've created. If you're thinking about who's going to be positioned for any memory technology transitions that are coming down the pipe, we feel very good about how we've positioned the company. Mark, you want to talk about controls?
Sure. I think I've mentioned in the past couple of calls, our strategy on controller development around SSDs and around NAND solutions in general has kind of philosophically been, we're going to partner externally for entry-level client type devices, consumer devices. For some of the higher value-add differentiated products, we're going to invest in our own controller development. That's pretty much played out, at least to date. For example, I referenced a PCIe accelerator drive earlier in my comments, and that's a controller that Micron developed in-house with their own controller team as well as firmware organization. Over the long run, I think you'll see us add to those efforts and teams as we see more opportunities for differentiated solutions on the high end of the storage market.
In addition to that, we see pretty good value in doing so more on firmware and on eMMC solutions for both the embedded and mobile market. Again, the way to think about it is kind of your differentiated higher-end value-add solutions, we're going to try to do in-house.
With our controller and firmware teams, and on the entry-level solutions, be more along the lines of third-party partnerships, maybe with their controller and our firmware or totally outsourced.
Okay, thank you so much. That's very helpful.
Thank you. Our next question comes from John Pitzer from Credit Suisse.
Good afternoon, guys. Thanks for letting me ask the question. Apologies if I missed this. Can you guys talk about industry supply growth expected over the next 12 months and your ability to outgrow that given the Elpida acquisition?
Sure, John. We're looking at DRAM in the low to mid 20 range for this year, low 20 range for 2014. As you pointed out with the Elpida acquisition, we'll probably be above that. On the NAND side, we're looking at mid-30s for this year and probably low 40s for next year. Again, we'll probably be slightly ahead, depending on the pace at which Mark decides to move the tech fab.
Maybe a question for Mark Durcan. Mark, just given that when you look at the DRAM side of the equation, for the first time in perhaps over a decade, we seem to have some pretty good demand drivers out there, whether it's the gaming console in the back half of the year or the fact that as you move to multi-core chips in handsets, you're just seeing DRAM density go up. At what point would it make sense to actually grow that DRAM asset base more quickly, just given how strong the demand signals are? What would you need to see to really take a meaningful step up in your capital spending plans?
Well, as we look at those kind of decisions, it's a multi-year investment payback decision, right? We have to be sure that we don't see any significant oversupply being created as a result of that activity in the horizon over which we're going to recoup the capital expenditure. We're going to be pretty careful about adding additional DRAM capacity as opposed to optimizing the existing capacity we have. Now, we've talked about fungibility between the various types of capacity, and these transitions we're making currently moving from DRAM to NAND are reversible. We typically choose to do that as we transition a technology node. That's the most cost-effective time to do it. We could see some of that actually reverse at some point in the future if necessary.
We also do have some clean room space available so we can probably react a little bit more quickly than some of our competitors if we decided we wanted to move in that direction. We don't have any plans at all to do that. We're going to have a little bit of digestion here with Elpida and optimizing that operation. We're going to also be pretty focused on realigning our balance sheet where we'd like it to be for the long haul, taking obviously a pretty close look at capital spending before we engage in any.
Mark, maybe if I could sneak one in just on that balance sheet. Given that the model's now generating significant free cash flow and you're starting to see some dilution from the conversion, I'm just kind of curious as to how we should think about fixing the balance sheet over what time frame, what kind of looks interesting, and is there anything you can do to help keep the share count down?
Well, yeah, let me hit that at a high level, and then maybe Ron's got a few additional comments. Obviously, we've done a little bit of convert repurchase here over the last few quarters, we'll have more appetite to do that, obviously, as we de-leverage the balance sheet and have available cash to do so. We'll have to trade that off against the other options of how we return value for the shareholders, that's something we'll be looking at. Ron?
Sure. On the share count side, John, we've got in terms of our convertible debt instruments, we've actually targeted those to be light as possible on the equity. A lot of them created to be pretty debt-like, but yet still leverage the volatility of our stock in the pricing of the instrument. We're using the treasury stock method on all of our dilution calculations, and basically, that slows the rate of dilution, and that's why I gave you an example of how it'll actually work as you flow that through the divisor on the EPS calculation. Going forward, obviously, we've been careful and continue to be careful about equity positioning, but the dilution effects will play through our stock prices.
May I just give you a quick formula so you get an idea how it works, and we can certainly give you more information offline if you want. If you take the average share price of the stock in the period we're reporting and subtract out the strike price on the instrument, and our strike prices tend to be in the eight, nine kind of range on pricing on the stock. You take that average price minus the strike price, divided by the average market price, so you get a percentage, multiply it times your share count on that instrument, that gives you the dilution effect. It's a muted dilution effect unless you really get high up in the stock price. That's how that works and why we constructed them that way.
In addition, we also have exercised cap calls on virtually every one of our instruments, and we've got several hundred million dollars, for example, at a $14 strike price that will come in the benefit of cap calls raising that strike price up. That's an economic benefit, but obviously, it could accrue to us in cash, and we could repurchase shares or whatever. Mathematically, we get the economic benefit, and we decide what we want to do with it. We've done cap calls as well as the treasury stock method to make it minimized.
Helpful, Ron. Thank you.
Yep.
Thank you. Our next question comes from Monika Garg from Pacific Crest Securities.
Hi. Thanks for taking my question. First question is, I'm trying to understand, I'm comparing the NAND cost declines in 2012 quarterly over 2013. In 2012, you had a very nice NAND cost declines. In Q1 2012, it's -16%, then -18% in Q2, -9% in Q3. If I compare that with 2013, Q1 was cost was up 2%. The second quarter was -5%, and third quarter is again +1%. We understand that the benefits of shrinks is declining, but just trying to understand what else could be the reason.
Yeah, Monika. A big variable in all this obviously is mix. There's lots of flavors of NAND. There's SLC NAND, MLC NAND, TLC NAND. That pendulum has kind of swung a couple of times as we've moved through different technology node generations and different applications with the NAND that it's going into. If you go back in the timeframe you were alluding to, there was a fairly significant swing into the MLC and even at Micron, some relatively small amount of TLC, which drives a significant bit cost reduction.
As we've moved through more recent quarters, we've actually seen a slowdown in some of the technology transitions driven by more highly reliable and non-changing bits going into high-reliability SSDs, as well as the 20 nanometer conversion that I alluded to earlier, Mark alluded to, actually, driving potentially higher ramp cost initially as that went in and then going a little bit slower at the 20 nanometer node than it did at the 34 nanometer node. A lot of different things that play into that. Generally speaking, we feel like we're doing what we need to do in the NAND business.
Yeah. The last question is on the mobile DRAM side. We are seeing PC DRAM pricing significantly up quarter-over-quarter. Could you talk about the trends in the mobile DRAM pricing, especially given that some publicly available data shows that in Q2, mobile DRAM pricing was actually down quarter-over-quarter?
Yeah, I'll let Mark address the specifics of more recent moves in the marketplace. What I would say relative to PC and mobile DRAM pricing dynamic is that obviously, there was a pretty significant price advantage for mobile DRAM earlier in the year. As more bits have converted from PC DRAM to mobile DRAM to meet that rapidly growing demand, we've seen PC DRAM start to catch up. Eventually, these things are likely, if the market's efficient, for us to equilibrate at an ASP that's about equivalent to the difference in cost, so the gross margins are neutralized between the two. That's probably where it'll oscillate around here over the next couple of quarters as demand and supply, people consuming the bits and people producing the bits work out that equilibrium.
I'd also say that's sort of a process we went through on the NAND, the discussion we just had. As we think about SLC, MLC, TLC, 20 nanometer, 34 nanometer, what we're doing is we're optimizing gross margin. Whether it's mobile to PC DRAM or MLC to SLC to 20 nanometer, 34 nanometer, 25 nanometer, we're just optimizing gross margin based on customer demand.
Thank you so much.
Thank you. Our next question comes from Hans Mosesmann from Raymond James.
Hi, this is Brian Peterson in for Hans. Just a quick question on the NAND side. You indicated that gross margins were up five points sequentially, looking at the operating margins, they were actually down. I know the consolidated OpEx numbers were in line to a little bit lower than you were expecting. Could you just give some color on the disconnect there?
I think the difference is that NAND goes into a number of different business units at Micron. The numbers you're referring to are NSG numbers, obviously there's NAND that goes into ESG, that in many cases carries a pretty significant premium. There's also NAND going into mobile products and MCPs, sometimes it's tough to even figure out exactly what the gross margin is in those products, that can be either higher or lower. It's a BU effect versus a NAND technology effect.
Okay. Just lastly, on the supply side for NAND, I thought that the previous forecast was kind of in the mid-30s, it looks like you're talking about low 40s now. Just to clarify, is that a little bit of an increase, and what's driving that there?
Actually, I gave you both years. For 2013, we now think it's a little bit lower than our last cost. We're now in the mid-30s with the rest of the market, and it's for 2014, we're looking at low 40s.
Okay. Thank you.
You bet.
Thank you. Our next question comes from Doug Freedman from RBC Capital Markets.
Thanks for taking my question, guys. If you could talk a little bit about, you just mentioned you're looking at moving DRAM to NAND, what can we expect that to have an impact on your bit output growth, and in which quarter should we expect that?
It's all included, Doug, in the guides that we give you. If you go back to the last quarter conference call, we did mention we were starting to prep the fab, so it would have an impact of lowering our DRAM bit growth in Q3. It's in our guide as we give it to you.
The transition will be completed by the end of the fourth quarter that you've just guided?
No, not at all. Over probably the next four quarters or so, with adjustments for market.
Okay. I guess what I'm trying to get at is the transition, I imagine it has some sort of a negative impact on your total potential production output. What type of a handicap are you operating under as you migrate DRAM to NAND?
Oh, that piece is pretty transitional, you've seen some of the impact, as Ron alluded to earlier on. It had an impact on both probably DRAM and NAND costs in the quarter that just finished, that'll probably continue for another quarter, then we'll be through the overall manufacturing input pack, the actual transition will occur over a four-quarter period, something like that.
Okay.
The reason there, Doug, is you got to create some white space to get the tools in, then once you reach sort of an equilibrium, you're not suffering any more downside.
Okay. In the past, we did get a filing when you did some of your debt restructuring with some numbers around Elpida. Can you give us an update on their financial performance?
Doug, this is Ron. Mark already made a comment in his script about Elpida, the strength of performance and moving in line with the DRAM business. We don't have information at this time that's available to update beyond what he already said.
All right. If I could then, just to follow up on the inventory, you made a comment that your NAND inventory was up in the SSD segment, but yet your overall inventory of the company was only up $11 million. Does that mean that DRAM was actually down to offset the NAND that you built?
The comment I made was just around some SSD and the WIP pipeline. Obviously, there's a whole lot of moving parts in the broad mix of our portfolio. I wouldn't draw that conclusion between DRAM and NAND. It's just moving parts in total. We are continuing to manage cycle times in our inventory and try to improve all of those activities quarter by quarter, so some of that effect helps as well.
I guess I'll leave you alone after one last one, if you could. What are you seeing the inventory in the marketplace, given the fact that pricing has been rising in both NAND and DRAM? Can you give us an update on what you're seeing in the marketplace inventories? Thank you.
Yeah. Sure, Doug, this is Mark Adams. Overall inventory looks pretty tight right now on both NAND and DRAM. Sometimes, when we head into the summer, you see a bit of a lull on the buying behavior of our customers. Quite honestly, at this point in our quarter, we have not seen that, and the demand signals seem pretty strong. There's rumors about accumulation and all that stuff, but we have not felt that at this point.
Great. Thank you so much.
Thank you. Our next question is from Ryan Goodman from CLSA.
Hi. Thanks for taking my question. One of your peers recently discussed how some of the remaining empty clean room space was going to have to end up being used up to enable the 1Y transitions in NAND. I was curious if you're seeing a similar dynamic to that and how we should be thinking about, in IMFT, how much open clean room space there is and how much of that you will have to use to get to 16 nanometers.
16 nanometers for us is a very easy capital and equipment transition because it's a planar node to a planar node, and you'll recall that we made the transition to a different kind of planar, but a planar NAND cell, when we moved to 20 nanometers. If you look at Micron's 20-nanometer storage element, it's very different than the other folks'. It's a high-k dielectric, and the cell itself is planar. That technology extends for us, and it's a relatively easy transition. Don't think in terms of big clean room requirements for us to move to 16 nanometer. What is true for all of us, I think, or likely to be true for all of us, is moving to 3D is going to consume a significant amount of incremental clean room capacity to maintain the same wafer output.
The productivity of that transition is very high, so it makes sense to go ahead and do that. Relative to that question, for Micron in our fab in Singapore, our wholly-owned NAND fab in Singapore, we have a lot of clean room space there, and we can get well down a transition to 3D NAND without having to add any incremental clean room space.
Great. Just different area. Hynix and Rambus recently came out with a settlement announcement, so I think it's down to just you as the remaining participant in litigation with Rambus. Is there any update on there in terms of timing or expectations or anything you can help us with there?
There's an appeal that's on file now that I believe is heard again in about a year.
Okay, thank you.
With that, we would like to thank everyone for participating on the call today. If you will please bear with me, I need to repeat the safe harbor protection language. During the course of this call, we may have made forward-looking statements regarding the company and the industry. These particular forward-looking statements and all other statements that may have been made on the call that are not historical facts are subject to a number of risks and uncertainties, and actual results may differ materially. For information on the important factors that may cause actual results to differ materially, please refer to our filings with the SEC, including the company's most recent Q and 10-Ks. Thank you for joining us.
Thank you. This concludes today's Micron Technology third quarter 2013 financial release conference call. You may all disconnect.