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Micron Technology, Inc. (MU)

F4Q06 Earnings Call

October 5, 2006 5:30 pm ET

Executives

Kipp Bedard - Vice President, Investor Relations

Bill Stover - Chief Financial Officer, Vice President of Finance

Mike Sadler - Vice President of Worldwide Sales

Mark Durcan - Chief Operating Officer

Steven Appleton - Chairman of the Board, President, Chief Executive Officer

Analysts

Glen Yeung - Citigroup

Mike Masdea - Credit Suisse

Shawn Webster - JP Morgan

Joseph Osha - Merrill Lynch

Tim Luke - Lehman Brothers

Gus Richard - First Albany Capital

Titus Menzies - Jefferies & Co.

Bill Dezellem - Tieton Capital Management

David Wong - A.G. Edwards & Sons

Jim Covello - Goldman Sachs

David Wu - Global Crown Capital

Doug Freedman - Amtech Research

Presentation

Operator

Good afternoon. My name is Lindsay and I will be your conference operator today. At this time, I would like to welcome everyone to the fourth quarter fiscal year and financial release conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer period.

(Operator Instructions)

It is now my pleasure to turn the floor over to your host, Mr. Kipp Bedard, Vice President of Investor Relations. Sir, you may begin your conference.

Kipp Bedard

Thank you, Lindsay. I would like to welcome everyone to Micron Technology’s fiscal fourth quarter and fiscal year-end 2006 financial release conference call.

On the call today remotely is Mr. Steve Appleton, Chairman, CEO, and President. With me here in Boise is Mr. Mark Durcan, Chief Operating Officer; Bill Stover, Vice President of Finance and Chief Financial Officer; and Mike Sadler, Vice President of Worldwide Sales.

This conference call, including audio and slides, is also available on Micron’s website at micron.com. If you have not had an opportunity to review the fourth quarter 2006 financial press release, it is also available on our website at micron.com.

Our call will be approximately 60 minutes in length. There will be a taped audio replay of this call available later this evening at 5:30 p.m. Mountain time. You may reach that by dialing 973-341-3080, with a confirmation code of 7930225. This replay will run through Thursday, October 12, 2006, at 5:30 p.m. Mountain time. A webcast replay will be available on the company’s website until October 5, 2007. 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.

During the course of this call, 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 on the company’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 achievement. We are under no duty to update any of the forward-looking statements after the day of the presentation to conform these statements to actual results.

With that, I would now like to turn the call over to Mr. Bill Stover.

Bill Stover

Thanks, Kipp. The results we will be going over, just for confirmation, are the consolidated results, including our IM Flash technologies joint venture with Intel, our TECH Semiconductor joint venture wafer fab in Singapore, and Lexar Media for the nine-week period subsequent to our acquisition of Lexar.

For those listeners who may not yet have access to our press release, let me go over summary financial results for the fiscal year and fourth quarter, which ended August 31st. For the fiscal year, net sales totaled $5.3 billion. That is the second-highest total in our company history, and the company recorded net income of $408 million, or $0.57 per diluted share. We are certainly pleased with the third consecutive year of increasing net income.

The major themes benefiting this year’s results are:

  1. A strategic shift in product mix to take advantage of our CMOS image sensor business, which became the number one supplier in 2006;
  2. Acceleration of our NAND flash efforts through partnering with Intel and our acquisition of Lexar Media, which positioned us with scale and expertise to be a significant competitor in the NAND market; and
  3. The strengthening of our overall financial condition and balance sheet, which in part is reflected in the net interest income reported for the year of $76 million.

As was mentioned on our second quarter conference call, operating income in 2006 benefited from the technology sale to Intel, which realized $230 million for the company.

For the fourth quarter, net sales totaled $1.37 billion and net income was $64 million, or $0.08 per diluted share. You will notice that the fourth quarter results reflect a $24 million amount, or $0.03 per diluted share, with a non-controlling interest in TECH Semiconductor. The product mix, which TECH runs, has been primarily PC DRAM devices, which have enjoyed favourable market conditions recently. The non-controlling interest line reflects 57% of TECH’s profitability for the quarter.

Gross margin for the year came in at 23%. As we noted in our press release, the fourth quarter gross margin was impacted by legal settlement costs. Absent the effects of the settlements, gross margin would have been approximately 3 percentage points higher for the fourth quarter, a slightly higher level than the third quarter, primarily on improved PC DRAM margins.

With regard to the legal settlements, I want to acknowledge that the $45 million amount includes our previously announced Tessera agreement, and the remainder all relate to contingency matters previously disclosed within the company’s filings. As these are active matters, there is no further detail that we can provide.

Selling, general and administrative expenses in most regards have increased proportional to the activities associated with IM Flash, TECH Semiconductor, and Lexar. Lexar itself is a step function increase of about $20 million per quarter.

Additionally, the fourth quarter of 2006 incurred a heavier-than-normal legal cost. We expect the quarterly run-rate in ’07 to approximate $140 million.

Stock related non-cash expenses totalled $26 million in 2006, of which approximately $11 million are reflected in SG&A. Total stock related non-cash expenses in 2007 are expected to approximately double the 2006 amount.

Unlike SG&A, which grew consistent with an increasing scale of operations, R&D expense stayed quite flat, even while the scope of R&D activities increased quite significantly. The strategic move to partner with Intel for NAND development has been noticeably beneficial in containing R&D expense. We expect R&D to run at approximately $175 million per quarter in 2007.

It was a very strong year for the company in generating cash flow from operations in excess of $2 billion. The improvement over 2005 reflects our successful diversification into specialty DRAM and CMOS image sensors, and the alliance’s we struck in the year.

Capital spending for 2006 came in at about $1.6 billion. Our forecast for capital spending in 2007 is $4 billion. That appears to be an increase from our last forecast for 2007, but merely reflects that 2006 came in under our last estimate. Approximately $1.5 billion of that 2007 capital spending total is expected to come from partner contributions.

The second half of fiscal 2007 will really be the first period to see the noticeable benefits of increased volume coming from Manassas and Lehi ramps associated with our capital spend.

The size and scope of our operations expanded greatly in 2006 as we positioned the company for market opportunities in NAND and capitalized on our industry-leading position in CMOS image sensors.

Cash and investment balances increased $1.8 billion to $3.1 billion at year-end. Total debt declined to less than $600 million.

The growth across the balance sheet is reflective of the consolidation of IM Flash, TECH Semiconductor, and Lexar. The approximate $890 million purchase price for Lexar was allocated over the net assets acquired and liabilities assumed, and resulted in the recognition of approximately $490 million of good will.

I will close there and turn our commentary over to Mike.

Mike Sadler

Thanks, Bill. We could not ask for much more with respect to the strength of demand in the mobile communications, consumer electronics, and computing markets. These markets account for the vast majority of demand for Micron semiconductor memory and imaging products. As our customers roll into their peak selling season for cellular phones, digital TV’s and personal computers, we are braced for even stronger demand as we move through our fiscal Q1.

We have spoken extensively about our strategy to continue broadening the product portfolio and create exposure in a variety of markets. This strategy is playing out nicely as we make further in-roads into these newer markets.

We have made a conscious effort to reduce exposure in the desktop and notebook markets with our commodity DRAM offering. This journey continues, but by no means are we withdrawing from these markets, as they continue to be the single largest consumers of DRAM. At this point in time, it is gratifying to see the market performing so well in terms of DRAM consumption, particularly when many industry experts were predicting a sluggish environment due to Vista operating system rollout delays from this year to next.

DDR2 is now entrenched as the mainstream memory solution for the PC market. With strong demand, we have seen average selling prices increase over 20% from the low- to mid-summer. Prices are continuing to rise in the near-term and we are optimistic that this environment will sustain right into what is expected to be one of next year’s major demand catalysts, the Vista operating system.

The minimum effective DRAM configuration for Vista will be 1-gigabyte, with optimal performance in most applications achieved at 2- to 4-gigabytes. This represents a significant step up in memory content, with typical PCs today configured with about 800-megabytes.

The server market is at the heart of our DRAM strategy, and we are holding a leadership position with a full line of high-density chips and modules. We are not sitting still here, as evidenced by our continued early enablement of fully buffered DIMs and the recent introduction of the world’s first 1-gigabit DDR3 component.

In the current quarter, we are commencing volume production of our mainstream 1-gigabit DDR2 components on 78-nanometer technology in the Virginia plant. This is the DRAM industry’s smallest 1-gigabit die and the best cost performance solution in the market for high density applications.

We have seen an acceleration in NAND flash demand over the past 60 days. Portable audio players are a primary driver, and as we all know, there is a seasonal aspect to the timing of consumer electronic demand in any given calendar year. NAND pricing has been on a rollercoaster this year and the recent trend has resulted in about a 30% average selling price bounce off the bottom as seen earlier this summer. Beyond Christmas season, I would not be surprised to see things slow down and we may see price pressure again in the early part of next year.

Over the intermediate to long-term, we are bullish on the demand for NAND, particularly for the mobile phone and personal computer segments. These markets are negligible drivers of today’s demand, and markets in which Micron is deeply entrenched with our complementary products in our portfolio. To that end, we are aggressively deploying new capital and advanced technology to extend our NAND flash market presence over the course of the next couple of years.

The mobile phone space has been the primary demand driver for our explosive image sensor business over the past couple of years. Our mobile phone imaging business had another quarter of growth, with high pixel density imagers of 1-megapixel and greater now accounting for well over one-half of our imager revenues. We believe this is a good indicator validating Micron’s position as the recognized leader in image quality and in CMOS imaging technology.

In addition to imagers, the current offering of low-powered DRAM and cellular RAM are vital pieces of our mobile phone success. With these products, we believe that today’s mobile memory architecture has legs well into the future, with the markets eventually migrating to a NAND plus low-powered DRAM architecture. As one of only a few manufacturers with the capability to develop and manufacture these fully integrated solutions, our value proposition to the handset makers increases as this evolution continues. We are helping our customers succeed as opposed to competing with them and believe that this is a significant differentiator for the company.

We could not be more pleased with our position in the mobile phone value chain, given Micron’s technology and product portfolio.

I will also point out that our fiscal Q1 will be the first opportunity to fully incorporate Lexar’s products and markets into the mix. With over 70,000 retail outlets, top performing products and leading controller technology and intellectual property, we are excited for the prospects of this new segment in both the retail space as well as placement with our OEM customer base.

To wrap things up, from my perspective, everywhere I look in the market I see robust demand for Micron products in all end markets. Our near-term efforts are focused on balancing product mix supply and allocations to optimize customer satisfaction and profitability.

Our intermediate to longer-term efforts are focused on technology development and capacity expansion to bring even more value to the customer base. As always, we appreciate your continued support and interest in the company.

I will turn it back over to Kipp.

Kipp Bedard

Thank you, Mike. With that, we would like to take questions from callers. Just a reminder, if you are using a speakerphone, please pick up the handset when asking a question so that we can hear you clearly.

With that, please open up the phone line.

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question is coming from Glen Yeung from Citigroup. You may go ahead.

Glen Yeung - Citigroup

Thank you. Just a couple of questions. First one is if you look at gross margins in the quarter, up slightly from the previous quarter, particularly if we take out the charges. Can you talk about, as we look into the November quarter, how that gross margin may trend? What I am specifically looking for is, are there changes in how you are going to break down your wafer starts to optimize gross margins for the next quarter?

Kipp Bedard

Let me break that up into a couple of questions, Glen. I think we will start with Mark and he can address some of the costs programs we have in play for next quarter and throughout the year, and then we will hand over the second part of that over to Mike to address perhaps what his expectations are for pricing. Mark.

Mark Durcan

Thanks, Glen. On the cost front, for DRAM, we see relatively flat bit growth over the next couple of quarters, but should see that accelerate towards the second half of the year, driving some significant cost reductions in the core DRAM arena, maybe in the 30% to 40% regime.

As we look at NAND, obviously we are pretty early into our NAND ramp, and while we are pretty pleased with the way the technology is levelling out, we expect that it is going to take another few quarters before we really start to see the benefit of the capacity we are putting in place. So strong bit growth throughout the year, leading to significant cost reductions throughout the year, that we will realize a much better position as we roll late into the fiscal year.

Mike Sadler

On the product mix front, Glen, if you look at our DRAM portfolio, we have a pretty stable platform of business in the synchronous DRAM area and in the mobile DRAM and cellular RAM products for mobile phones, industrial equipment, networking products and so forth, and that business is highly predictable, so generally speaking, that business is going to be stable to slightly up as we roll into Q1 and into Q2.

The real challenge for us from a mix standpoint in the short-term is on what we call the commodity DRAM front, and that is targeting the proper mix of DDR versus DDR2. There are a variety of transitions going on in the marketplace in the computing area that are driving DDR to DDR2 to transitions from a demand standpoint, and of course the pricing is bouncing around. It has been quite active, actually, in the last month or so, and it looks like it is probably going to continue to be, certainly for the rest of the calendar year.

So what we are trying to do there is optimize both customer satisfaction and probability, and the bias at this point is probably towards a richer mix of DDR2 versus DDR, which is a little bit different than has been the case looking backward over the past couple of quarters.

Glen Yeung - Citigroup

Maybe just a follow-up to your comment. Could you comment a little bit on what you see in the next quarter for image sensors, and also what you think PC demand is going to look like in the fourth quarter, largely because we are in front of Vista, do you see any air pockets in the fourth quarter?

Kipp Bedard

Glen, we are having a little bit of a problem hearing you. Are you asking for Mike’s interpretation of the image sensor business in Q1?

Glen Yeung - Citigroup

Yes, and then also, any thoughts on PC demand trends for the November quarter, given we are one quarter ahead of Vista.

Mike Sadler

First of all, on the image sensor front, we are continuing to have a richer mix of -- I will call them high pixel density imagers in the mobile phone space. I mentioned that over half our business in Q4, in our Q4, was for 1-megapixel and greater sensors. Actually, what we are heading towards, the 2-megapixel sensor really being the sweet spot sensor for -- I will call it the mid-range mobile phones, and we are continuing to grow our high pixel density chips as a percentage of our overall revenue.

The EGA for us is still pretty substantial, but now it is in the neighbourhood of a quarter of our business, and most of the growth for us really is occurring in 2- and 3- and even 5-megapixels area.

On the PC DRAM demand front, things are on fire right now. We cannot even come close to meeting the needs of our customers. The real hot product today is DDR2 and I presume that is primarily tied towards consumer demand for both desktop and notebook PCs, so if there was any concern or worry about a lull or a lag in PC demand leading into the Vista introductions next year, it is not happening -- at least, it is not happening from our view.

Things are really looking positive on the PC front for us. When we get beyond the hot seasonal season, in the January-February timeframe, our expectations and our customer’s expectations are that the Vista intro is going to be a real good demand kicker for them, for system shipments for us, both for system demand as well as a big boost in terms of memory content, so we are quite bullish on the prospects for our DRAM business in the computing environment.

Operator

Your next question is coming from Mike Masdea from Credit Suisse. You may go ahead.

Mike Masdea - Credit Suisse

Thanks a lot. You gave some commentary on the profitability in the DRAM side. Could you help us out a little bit, at least directionally, what is going on in the CMOS and NAND side?

Kipp Bedard

Mike, is that again from a cost perspective, market perspective?

Mike Masdea - Credit Suisse

Gross margin perspective, kind of overall. So were you able to, given the mix comments that you had and also given that you are covering more of your fixed costs on the NAND side, are you able to improve your profitability in both those, or were you able to improve your profitability in both those segments?

Mark Durcan

Let me take the NAND piece of that. Clearly we are still building out our NAND product portfolio, so if you look at where we are today profitability wise, we are underwater. Now, as we move throughout the year and richen up the product mix, move more and more of our products into SLC, from SLC into MLC, we will see some significant improvement there.

We are also putting a lot of new capital in place, and generally there is a lag as you bring that new capital online and then try and get it fully utilized. We are anticipating, as I said earlier, we are anticipating 50% bit growth quarter over quarter as we move through the year, and we should see significant cost reductions associated with that growing bit production.

Mike Sadler

With regard to the imaging business, we have been very pleased with that performance in the fourth quarter. ASPs on average were actually up slightly and margins up slightly, so we are very pleased with that position.

Mike Masdea - Credit Suisse

Just to follow-up on the comments for the NAND side, my understanding is that it has gotten a little bit worse first and then it is going to start to get better, now that you have the mix starting to get a little bit better and you have the volumes starting to get better?

Mark Durcan

It is definitely true we are not where we want to be, cost-wise, on NAND today and that is going to get better as we move through the year.

Mike Masdea - Credit Suisse

Then, your commentary on inventory, both from what you guys are doing with your own inventories, which I think were up a little bit this quarter and then what you are seeing out there in the industry.

Mike Sadler

Our inventory balance, quarter over quarter, we were up in terms of total megabits in finished goods inventory. That was really isolated to our cellular RAM products, which are our mobile phone memory products, and I would attribute that to some inventory accumulation on the part of our customers. We were up on Flash megabits as well, in terms of what you would think of as our traditional DRAM product portfolio, pretty flat quarter over quarter, and it is basically hand-to-mouth today.

We still do have some inventory on the cellular RAM and we are working through the inventory on the Flash. Anyway, I do not think nothing too much to be concerned about.

Based on the -- I will call it the emotion in some of the phone calls that we are having with customers today, particularly on the PC DRAM front, I think it is pretty safe to say that there is no inventory out there at all.

Mike Masdea - Credit Suisse

Just to follow-up that one real quick, given the money out there on the table potentially, given that market is pretty healthy right now, any kind of change in view? I know you said you were going to hold bits flattish, but any opportunistic potential out there to make the customers happy and take a little bit of money in the short-term?

Mike Sadler

With respect to our strategy, which is to strengthen our position in the high-end competing space, specifically servers, we are not deviating from that at all. We are not deviating at all in terms of continuing our Flash ramp and so forth.

Now, with respect to what we do with some of those commodity DRAM chips, they are suitable for desktop and notebook applications to try and take advantage of the opportunities we have -- absolutely no question we are trying to push things as hard as we possibly can to increase prices and still support the same customers that we are working with.

We can be as opportunistic as anybody else, and we are trying to do the best we can with that commodity DRAM portfolio.

Mike Masdea - Credit Suisse

Got it, very helpful, thanks, guys.

Kipp Bedard

Thanks, Michael. Next question, please.

Operator

Your next question is coming from Shawn Webster from JP Morgan. You may go ahead.

Shawn Webster - JP Morgan

Good afternoon. Could you talk a little bit on the gross margins and the $45 million impact? I could not quite tell from your commentary, is that a one-time event or are you expecting other things in the future? Then I have a follow-up, please.

Bill Stover

Yes, the item that we are speaking to there in the fourth quarter included $28 million Tessera agreement that we reached and we previously announced. The other items, as we have indicated, settlement of legal matters, as a general rule, we do not anticipate those to be recurring. We deal with them case by case.

Shawn Webster - JP Morgan

Thank you. Turning to the demand environment, can you give us your bit consumption expectations for the end market for PCs in Q4, calendar Q4?

Mike Sadler

Sure, I would be happy to. A cross section of our big consumers, which you can imagine are pretty good proxies for the overall industry, bit consumption up about 12% to 15% quarter over quarter, calendar Q4 versus calendar Q3. On a year-over-year basis, Q4 versus Q4 of ’05, up about 60%.

Shawn Webster - JP Morgan

Is that normal seasonal for you guys in terms of bit demand?

Mike Sadler

Normal seasonal in Q4 would probably be on the lower end of that, maybe 10% to 12%, so it is slightly higher than normal seasonal.

Shawn Webster - JP Morgan

Can you tell us what your DRAM bit shipments and ASPs did quarter over quarter in August?

Kipp Bedard

We can tell you that the bit shipments were up low-single digits, and for ASPs, I believe we were -- go ahead, Mike.

Mike Sadler

ASPs I believe quarter over quarter were relatively flat on the DRAM.

Shawn Webster - JP Morgan

Flat quarter over quarter?

Mike Sadler

Yes, yes.

Shawn Webster - JP Morgan

If pricing stays flat where it is now, where do you think your average pricing could land in November for DRAM?

Mike Sadler

They will be up for sure, and I would just have to say single digits at this point, based on our visibility.

Shawn Webster - JP Morgan

Thank you very much.

Operator

Your next question is coming from Joseph Osha from Merrill Lynch. You may go ahead.

Joseph Osha - Merrill Lynch

As I understand it, if we back out the NAND Flash and we back out Lexar, the DRAM gross margins, on an apples-to-apples basis, would have been up slightly, is that what you said?

Kipp Bedard

That is correct, Joe.

Joseph Osha - Merrill Lynch

Is that -- again, if I go back, this is, I think for most of us, the best DRAM operating environment we have seen in several years. Is that, by my estimation, very small improvement in gross margins driven by the fact that you are sort of mix limited and you are limited in terms of what you can do out of your 200 mil facilities because you are supporting IMFT, or what is the story here?

Kipp Bedard

Keep in mind two things, Joe. One is that the price increases we actually saw that benefited us in the quarter came substantially in the last month, and so at most, a third of the sales. Secondly, do not forget the $45 million that Bill referenced as a cost of goods sold cost that came in during the quarter.

Joseph Osha - Merrill Lynch

I can see that, but if you go back, the last time you had a DRAM business that was generating at one point 40% gross margins, and even in the November ’04 quarter, 34% gross margins, so I guess I am a little flummoxed as to how the DRAM margins seems stalled here in the mid- to high-20s, despite this extraordinarily good operating environment.

Kipp Bedard

I think again one other piece that Mark mentioned earlier, just to reiterate, is that we have put a lot of costs in place to date in building our businesses and we are on the early phase of wafer output. As you can appreciate, pretty substantial wafer increases helps drive the fixed portion of that overhead cost that gets allocated on a wafer basis lower quite quickly. As Mark mentioned earlier, we have a pretty good cost reduction profile heading in front of us here.

Joseph Osha - Merrill Lynch

So let me ask you then, and I am not going to -- obviously I know you are not going to call pricing, so I will do it for you. If pricing were to stay where it is now for the remainder of the quarter, which I believe implied a mid-single-digit sequential increase per your previous comment, can you get your DRAM gross margins to improve?

Kipp Bedard

Definitely. As Mike mentioned, we have ASPs would be up high-single digits if they were flat from here, and as Mark mentioned, we are going to get increasingly positive cost reduction, so that equates to margin expansion, you bet.

Operator

Your next question is coming from Tim Luke from Lehman Brothers. You may go ahead.

Tim Luke - Lehman Brothers

I was wondering if you could give us a feel for how big a piece of the revenue the NAND portion may have been in the August period, and then going forward, it sounded from your commentary that we would wait until the middle of calendar ’07 before we move into profitability in the NAND arena, or how should we view that kind of time as the transition?

Bill Stover

With regard to the first part of the question, the NAND represented 9% of revenues in the fourth quarter. We also indicated that there is a quite limited amount of Lexar NAND revenue that was able to be recognized as the product that was in the channel, by way of the purchase accounting, did not allow us to pick up the revenue associated with those final sales.

If you look at Q1 and estimate approximately $160 million of NAND Lexar related sales, that is a fairly significant increase for the quarter.

Tim Luke - Lehman Brothers

Would the incremental ramp also boast non-Lexar related NAND?

Kipp Bedard

I am sorry, could you repeat that for me?

Tim Luke - Lehman Brothers

You will get a boost of $160 million associated with Lexar, and then you will have a further mix increase in NAND on top of that?

Bill Stover

Without trying to call the ASPs, the bits grew over 50% last quarter. They are going to grow 50% quarter over quarter this quarter.

Tim Luke - Lehman Brothers

With respect to your expense structure, how should we think about that developing, going forward? It looked like your SG&A was somewhat higher than one might have modeled this quarter in August.

Kipp Bedard

I think as Bill mentioned in his comments, you should model SG&A 170 to 175 range, or excuse me, R&D 170 to 175 range and the SG&A I believed he mentioned the 140 to 150 range.

Bill Stover

But the 140 looks like where it is going to run for quarters in ’07.

Tim Luke - Lehman Brothers

Do you think this other income level of around the 15 level, down from sort of 50 in the prior quarter, is where it is likely to be through count fiscal ’07, or how should we think about that?

Bill Stover

I am sorry. If your reference is to net interest income --

Tim Luke - Lehman Brothers

Yes, right, sorry.

Bill Stover

It will range between $15 million and $30 million for quarter over ’07, with it being at the higher end during the early quarters by way of the cash balances which we are maintaining right now, and with our capital spending profile, that will come down over the year.

I would also acknowledge that $140 million estimate on the SG&A, until we have the opportunity, which is really a six- to nine-month period of integrating Lexar, we really do not have an opportunity to strip much cost out of where there may be some duplications, but about six months from now, we will get on Micron systems and we will have an opportunity to do some reduction of costs.

Tim Luke - Lehman Brothers

Let me just get back to the question with respect to the timeline for the transition towards profitability in NAND, if there is any flavour or color there about what sort of timeline we should be thinking about.

Kipp Bedard

Not really, Tim. One of the reasons we are doing that is we are going to stay away from trying to predict ASPs for you. We know, as Mark stated, we have a very substantial second half fiscal ’07 continuing through second half calendar ’07 cost reduction profile. We have talked in prior analysts meetings of we expect nothing short of 60% to 80% cost reductions throughout the fiscal year. We are going to leave it to you to determine what you believe the ASPs will be, and when you think those two lines intersect, that is when we will get there.

Tim Luke - Lehman Brothers

But your status is really the second half of the fiscal year in terms of seeing the cost reductions?

Kipp Bedard

Well, the more significant ones, but obviously if we are increasing bits quarter to quarter 50%, you are seeing pretty substantial cost reductions right now, especially when layered on the fact that the fixed overhead cost of adding additional wafers and equipment is there, and the wafers are just now starting to come out of fabs in an increasing way.

Operator

Your next question is coming from Gus Richards from First Albany Capital. You may go ahead.

Gus Richard - First Albany Capital

When you mentioned that the sequential bit consumptions will be up 12% to 15%, a little bit above normal seasonal trends, is the increase coming from box loading or strong unit demand?

Mike Sadler

I do not know, to be honest with you. I would speculate it is probably coming more from unit demand than box loading, given where we are in the season, but we have not dissected granularity of the demand, to be honest with you.

Gus Richard - First Albany Capital

Essentially, you are looking at 60% year over year growth Q4 to Q4, isn’t that an acceleration of bit consumption?

Mike Sadler

60% year over year Q4 versus Q4 would be an acceleration of bit consumption. That is correct. What we model in, and I believe what in general the industry has modeled in for DRAM demand growth from the computing environment, it is somewhere in the range of 40% to 50%, so yes, things are -- the numbers would suggest that things are hotter than what had been expected, and I can tell you that the environment feels that way as well.

Operator

Your next question is coming from Titus Menzies from Jefferies and Company. You may go ahead.

Titus Menzies - Jefferies & Co.

If I can ask maybe just two questions. Firstly, you guys seem very upbeat about your CMOS sensor business. Can you give some visibility as to where you see the overall handset markets panning out over the next three to six months?

Mike Sadler

I will give you my view on that, with the caveat that we are a semiconductor maker, not a handset maker, so I can only tell you through what we are seeing from our customers. I will have to turn the clock back a couple months ago. I mentioned that we had accumulated some cellular RAM inventory, which is really a component that almost goes exclusively into cell phones. We had also accumulated some VGA sensor inventory at about the same time. Subsequently, in the past 30 days or so, we have seen a resurgence in demand for those components, which has resulted in some liquidation of the inventory that we had accumulated on both the cellular ram, but in particular on the VGA sensors. I interpret that as though our customers have worked off some of the inventory that they were sitting on.

Now, so my take is essentially with respect to our component feeds into the cell phone market were relatively flush in terms of inventory. I do not know what really that means for the future. If we take our customers’ forecasts for the next couple of months, which we always take with a grain of salt, it would suggest a pretty robust environment running all the way through the first part of next year.

To summarize and boil things down, I think things have strengthened substantially in the past couple of months from where they were say in the August timeframe. At least from an inventory standpoint, I would think that a lot of the inventory that was in the channel has been digested.

Titus Menzies - Jefferies & Co.

The second one is about the cap-ex. Of the $2.5 billion which is coming from Micron itself, where do we split out between in ’07?

Bill Stover

If your question is -- we gave an indication of $4 billion cap-ex for 2007. You can look at that as a bit more than half of that going into the IMFT operations, and if you take the balance and split it about 50-50 between the TECH Semiconductor Singapore joint venture and the balance of the Micron historical operations.

Titus Menzies - Jefferies & Co.

Last question, in terms of the contract price. I know you mentioned about how robust pricing has been to date, but in terms of contract pricing going forward, can you give us some feel as to what you are seeing from your customers right now?

Mike Sadler

I presume you are talking about DRAM pricing in the computing environment?

Titus Menzies - Jefferies & Co.

Exactly.

Mike Sadler

We just went through the first half of October pricing and we were successful in a 3% to 5% average selling price increase on DDR2. I cannot imagine we are looking at anything other than price increases, certainly next time around, just based on how strong the demand is. It is a multiple of our ability to supply right now, so the environment is such that price increases are pretty much locked in, certainly for next time around, anyway.

Operator

Your next question is coming from Bill Dezellem from Tieton Capital Management. You may go ahead.

Bill Dezellem - Tieton Capital Management

Thank you. We had a couple of questions. First of all, coming back to the Flash business, and if we simply assume that prices are flat, given that it does affect profitability, would it be reasonable to assume that the losses in that business on a dollar basis, not margins, but absolute dollars, would decline in Q1, and then, versus Q4, it would decline further in Q2 versus Q1, et cetera as you roll through the fiscal year?

Mike Sadler

I think, Bill, you need to be looking at it as a bit more flat early in the year and a greater change throughout the second half.

Bill Dezellem - Tieton Capital Management

Thank you. That is helpful. Then, relative to Lexar, you had mentioned that there will be an incremental $160 million of revenues in the Q1 versus the Q4. Would it be fair to say that $160 million of it was the sales level in the fourth quarter that was not recognized, or are you adding on at some number to what was not recognized in the Q1 for the normal seasonal pick-up?

Mike Sadler

Lexar has been able to re-engage with a number of customers by way of them being quite receptive to the broad portfolio that Micron offers, but we are not taking a particularly optimistic view yet of first quarter growth. That level is really reflective of what they have been able to do in recent periods.

Bill Dezellem - Tieton Capital Management

So, said another way, in the fourth quarter, there were roughly $160 million of sales that Lexar, or the old Lexar, experienced but, due to the way the accounting works, simply were not recognized on the sales line?

Mike Sadler

Bill, I did not go back and specifically check what they had done prior to our acquisition. This period is a little bit of a seasonal up-tick, so I would expect that they had slightly less than that in that prior period.

Bill Dezellem - Tieton Capital Management

Thank you. That is helpful. One final question, relative to the Toshiba $288 million settlement. Would you walk us through number one, how the cash is anticipated to come in, and then number two, how the accounting will work for that, if it is any different than the recognition in line with the cash being received?

Kipp Bedard

Bill, I can take the first part of that on how we expect the cash received. We were very specific in the press release to say over multiple years. We just cannot go into anymore detail. I will let Bill handle the accounting approach to it.

Bill Stover

The $288 million, the vast majority of that is actually recognized in the purchase accounting for Lexar, so when we get the 10-Q on file, you will see an increase in receivables, which is reflective of the vast majority of that amount. As that transaction settled a number of matters that Lexar had pre-existing to our acquisition, the accounting dictates that treatment. Certainly we are very, very pleased with the negotiations there and it is reflective of the combination of Micron and Lexar and the strength that we brought to those negotiations. Steve may want to comment to that.

Steven Appleton

Let me just say that there was a lot of anticipation, I think, in the Lexar litigation as they were going through it, but we really have a lot different relationship with Toshiba. I think the agreement that we struck we thought was pretty good. It is, as Bill mentioned, whether it is fortunate or unfortunate, I do not know, but it ends up, because of the proximity to the acquisition of Lexar and because of some of it being attributable to something that was historical, it all got wrapped up and simply flows to purchase accounting. It will not flow through the P&L. We still, of course, get the cash but it will not flow through the P&L.

Bill Dezellem - Tieton Capital Management

That is helpful, and I apologize for taking so much time, but as you look back on the negotiations, were there additional benefits above and beyond simply the settlement of the litigation in terms of future collaboration in any way, shape or form, the two companies, that is noteworthy?

Steven Appleton

As you might imagine, there is a lot of strict confidentiality around the agreement, so I cannot really comment on that, other than to say we had a pretty good relationship with Toshiba historically and expect to have a good one going forward.

Bill Dezellem - Tieton Capital Management

Thank you all.

Kipp Bedard

Thanks, Bill. Next question, please.

Operator

Your next question is coming from David Wong from A.G. Edwards. You may go ahead.

David Wong - A.G. Edwards & Sons

Thank you very much. Can you give us some idea of the relative gross margins of your different product lines -- DRAM, sensors, and then the NAND flash itself by Micron, not the half that is sold to Intel at half cost.

Mike Sadler

Sure. The rating has not changed much. We still -- gross margins are still the highest on image sensors, which you will see when we report our financials on the 10-K, that we are about 42%. Specialty DRAM was closely behind that. Core DRAM as we call it, was fairly close to the printed averages, and of course, if you did the calculations, as Mark said earlier, NAND Flash, we are underwater on today.

David Wong - A.G. Edwards & Sons

That includes NAND Flash that Micron sells, not the blended NAND Flash together with what goes to Intel, is that correct?

Mike Sadler

That is blended together. That is the way we are going to talk about these going forward, so we will report our flash business as combined.

David Wong - A.G. Edwards & Sons

Thank you.

Operator

Your next question is coming from Jim Covello from Goldman Sachs. You may go ahead.

Jim Covello - Goldman Sachs

Good evening, guys, thanks so much. I have a strategy question. How do you guys think about the fact that some of the other players in the industry who are kind of further along in their diversification strategy, and I am really thinking about Samsung now, are now starting to move a little bit of capacity back from NAND to DRAM because the DRAM margins are higher than the NAND margins? So the real question is, by the time you guys get to where I am sure you are ultimately going to get to on the cost side of what you are trying to do in NAND, are there going to be any profits to be had, because there are so many competitors adding so much capacity in this thing?

Steven Appleton

First of all, I assume when you said other competitors, you mean other competitor which has the kind of portfolio that we do. I suppose you could say that Hinex has done a pretty good job too.

There tends to be an assumption out there that we have no ability to adjust our NAND capacity by virtue of a joint venture, and it is true that we do have a partner for NAND Flash and we have an obligation to ramp that product in concert with Intel, and we are doing that.

In terms of the ability to change the mix of the product, clearly we have the capability to do that, and in fact, it is probably not as widely known that we have adjusted memory wafers including NAND already to some degree to try to meet additional demands on the imaging, or things like [specialty] RAM, et cetera, so we have some flexibility but we just have to make sure that we have the cooperation of our partner.

Now, I think there is a natural mechanism that will occur when our NAND capacity gets larger, because remember, we are not producing that much NAND yet. As Mark mentioned, the Virginia facility is starting to ramp as we speak, and the Utah facility will start to ramp in the first part of the year. Those are really the first two big thrusts in terms of capacity and product portfolio that we have outside of the production that we had in the Boise facility that was previously running.

We need to get to a critical mass first before we truly start thinking about making these tradeoffs, but I wanted to point out that we will be able to make those tradeoffs, we believe, because first of all, we will have the ability to do that. There is no question that the facilities can cross over and you have something like a 90%, 95% equipment crossover. The second thing that is worth noting is when the NAND market is poor, obviously our partner will have less interest in getting a lot of it, and when the NAND market is very strong, they will have an interest in getting more of it. So there is a natural mechanism that leads us both in the right direction to utilize this significant capacity that we are putting in place. It is just that right now, we do not have that much capacity allocated around because we are in the early stages of the ramp.

Jim Covello - Goldman Sachs

I understand the quarter to quarter nuances, and I understand the fact that we are in a ramp, and ultimately you are doing the ramp because you think NAND is going to be more profitable one day, but what happens to the extent it is not? What happens to the extent the real winners in this are the folks who are modernizing their DRAM facilities now because there is just too much competition in NAND, regardless of the great demand drivers of NAND? There is just a hell of a lot of supply out there.

Steven Appleton

Keep in mind that we are also modernizing our DRAM facility. In fact, we think we are the first one to really ramp 78-nanometer DRAM technology right now as we speak in Virginia, and that is on 300-millimeter. TECH is starting its conversion to 300-millimeter.

Essentially, we do not really produce any -- think of it as computing DRAM or what you would think of as the high density DRAM on 200-millimeter anymore. That capacity is essentially all consumed by either specialty or imaging today, so we do not have a lot of capacity on DRAM that runs on older technology anyhow, and we too are what you call modernizing or advancing the process on 300-millimeter for the product that we do build DRAM on.

There is always this question about when should Micron build the next DRAM fab, and we consistently look at that, so I wouldn’t negate that but -- and we are not ready to announce anything today, but the other thing I would point out is that the Virginia facility runs half DRAM and is ramping on now to be half and half, so that would actually be a relatively easy conversion, because it is really just in the same facility.

Jim Covello - Goldman Sachs

Perfect, that is helpful. Some other real quick questions, if I could. What should we think about depreciation being for this year, for this coming year?

Steven Appleton

Should come in about $1.6 billion.

Jim Covello - Goldman Sachs

Final question, on the Vista, you referenced it earlier as a driver, and what I was not clear on is, is that going to be a driver you think of incremental box loading or incremental box sales, if you will? I guess the -- in the industry, we have already seen the boxes pre-loaded with DRAM with the necessary DRAM considering the OEMs thought they were going to have to be Vista-enabled already?

Mike Sadler

I think the significance in terms of demand creation from Vista is probably going to be more weighted towards box-loading than system demand, and our own internal studies would indicate that the real benefits of the operating system are observed with loading of 2- to 4-gigabytes. That is a huge jump from where we are today. The industry today is at an average of about 800-megabytes.

I am not suggesting we are going to go from 800 to 2-gigabytes in the first quarter of 2007, but my point is that there are huge benefits to be derived from significant box-loading from a memory standpoint.

I think from our view, the majority of the impacts is going to be as a result of increased box-loading. Certainly there is some pent-up system demand in anticipation of the release of the OS as well.

Jim Covello - Goldman Sachs

That generated one last question for me, then I promise I will go away. Do you think there is a change in the rule of what DRAM can represent as a total cost, as a percent of the total cost? That kind of box-loading of 2- to 4-gigs would certainly violate that rule, given how much PCs are coming now, but maybe that rule is going to change.

Mike Sadler

I believe so, and I certainly hope so. With the prices of other components in PCs, particularly CPUs and hard disk drives under a lot of pressure and coming down, one could argue that it certainly leaves some more bill of material costs that should be, in fact, should have been allocated towards memory for the past 20 years, in my opinion, but there is room for that -- it seems as though there is room for that to occur here as we move forward.

Operator

Your next question is coming from David Wu from Global Crown Capital.

David Wu - Global Crown Capital

Thank you for taking my call. Two quick questions, first on the CMOS side. As I look at your revenue, it looks like it has been flat, roughly quarter on quarter. You mentioned that ASP has been rising slightly. Does that mean that unit volume is kind of flat on a unit basis? I assume when you talk about VGA a quarter of the business, you are talking about units or are you talking about dollars?

Then I have a question on memory, which is NAND. At this point, everybody is gung-ho on expanding capacity and you have a rich friend at Intel, so you are not going to blink. Do you think we might have a bloodbath sometime in ’07?

Mike Sadler

I will address the image sensor questions, and I will let Steve address the NAND question, if that is okay.

On the image sensor front, our revenues in Q4 grew slightly over Q3 and our unit volume grew slightly as well. It is true that the growth rate certainly levelled Q4 versus Q3. I would attribute that to a couple of things. Number one, I mentioned earlier that we had accumulated some VGA sensor inventory that we were not sure to interpret that as a slowdown in phone sales or perhaps just some indigestion of inventory, if you will. In fact, things have picked up significantly since we accumulated that inventory, so I think we are back on a growth track again.

Secondly, kind of from a macro view, we have been riding a growing penetration rate of cameras in mobile phones for the past three years. Once we reach close to 100%, obviously that has to level off somewhere, and the growth we are going to see, the result of two camera phones and replacement phones, and I do not think we are there yet at 100% penetration, but certainly we are at a point where three-quarters or so of the world’s mobile phones have cameras in them, and naturally, that business is going to slow down somewhat. We do not believe it is going to decrease, but we certainly believe the growth rate is going to slow down.

We also firmly believe that there are several other markets that are going to drive strong growth for us. Video conferencing in notebook PCs would probably be the first one on the docket in terms of driving big growth for us in fiscal 2007. Do-it-yourself security systems is another. Digital still cameras is another, and automotive would probably be the next.

So there are several other markets we believe are going to be big demand drivers for us. It just so happens that at this point in time, they have not really become that significant in terms of driving big demand for us.

Now, on the NAND front, Steve, do you want to -- Steve, do you want to take that?

Steven Appleton

Let me first throw out there that there are a number of reasons that we are doing NAND, so despite the fact that there is capacity coming on NAND and we are a part of that, getting into that market because of the growth rate of that market is clearly one piece of it. We have a couple of others, and I will come back to those in a second.

In terms of whether we think there is too much NAND capacity or not enough NAND capacity for ’07, I guess I would add the comment that I do not know if anyone can predict it, frankly, because we are in such a high-priced elasticity correlation on NAND right now for growing density and lowering cost, it would be tough for anyone to predict.

Clearly there is going to be more capacity that comes into the market, but frankly, we have never said, and if you have listened to us for a while now, we have never said that we thought NAND would not be volatile, or it would not have either great expansions or periods of time where you have pretty heavy price declines because of over-supply. We think in fact that will occur.

Having said that though, we do not think it is going to be any worse than DRAM, and in fact, we believe that the opportunity for NAND is better than DRAM because we think that NAND really looks more like DRAM did in the up to 1995, so pre ’95, in which net net it was a pretty good business overall. In other words, the up cycles were longer than the down cycles, and those of us that were good at it made money in the DRAM business, up to the period of time where the price elasticity was pretty good. Although even then, it was into a relatively narrow market with a narrow customer base, NAND actually is a much broader customer base and a lot broader number of applications, so the potential for margin pressure, if you will, I think is not eliminated but reduced by virtue of this variety of channels it goes through, where you actually have opportunity to have more value add.

To think about how long it took the DRAM market to get to a differentiated portfolio, effectively it took 25 years for that to occur. Right now, there is a lot of discussion around NAND being high density, et cetera, and that is where you see a lot of the commoditization, but the fact of the matter is there is already a lot of opportunities for differentiation in the NAND space when you start combining it with controllers and interface and software, et cetera, that we think it will have a lessening effect on the volatility.

Having said all of that, NAND for us will clearly help drive a lower R&D cost per wafer and help drive, if you will, a scale gain for us where a lot of the other costs get shared as well, because for two reasons. One, not only do we have more wafers to spread the R&D over, but we also now have a partner sharing that cost. Obviously, as our total business grows, we get the benefit there because if you think about what was happening to us in the DRAM business, we had less and less product that needed an advance process, and that is just by virtue of the market bifurcating and splitting between specialty and what you would think of as PC DRAM, but it did not cost us any less to develop that advanced process. It cost us the same. So we had a rising R&D charge per wafer internally. It did not look like it externally because our silicon production was the same or growing.

We are actually reversing that trend now. In fact, we internally, in all of our numbers, will show a decreasing R&D cost per wafer by virtue of the scaling of our total silicon business and by virtue of the crossover of development, which is essentially about 70% the same between NAND and DRAM.

We are not really focused on just the supply side in ’07. I cannot predict whether what you said is a bloodbath will occur or not, but that does not change our course, not because we have a rich partner, but because of the other benefits that it brings to our business.

Operator

Your next question is coming from Douglas Freedman from AMTECH Research. You may go ahead.

Doug Freedman - Amtech Research

Thanks for taking my question. Steve, if you could, we just missed on basically execution of spending the cap-ex and removing $500 million from ’06 into ’07, if I heard you correctly. When are you expecting that catch-up to occur? We should be entering the peak, if I remember your slide that you presented recently.

Steven Appleton

On the cap-ex side, I think we need to be careful to differentiate three things. One is when does the equipment get installed. The second is when do you actually pay for it, and the third is when does it show up on the books. Oddly enough, all three of those are slightly different.

It was interesting, because when we came out and our cap-ex was lower by this number that you just mentioned, half a billion or so, I think a lot of people thought that we were -- in fact, there were articles that we were deferring or pushing cap-ex. We have done nothing of the such, nothing even remotely close. All of that is being driven by when this stuff gets either on the books or when it gets cash flowed.

In terms of schedules of capital implementation, I suppose it is always possible they are off a few weeks here and there, but the fact of the matter is the big capital projects are on schedule within a pretty tight band.

In terms of producing product based on the capital that we have been forecasting to spend, all of that is happening. The rest of it, frankly, is just an accounting nuance as to when the timing hits and cash flow and assets.

By the way, to answer your question more specifically, it probably gets almost all caught up by the end of ‘07 or the first part of ‘08.

Doug Freedman - Amtech Research

Okay, so it is actually -- we are still in a peak spending period as we exit ’07.

Steven Appleton

It is fair to say for us, I think, fiscal ’07 will be a peak for us in terms of what we report as capital expenditures.

Doug Freedman - Amtech Research

Then if I could just move on to, you have given us some targets on wafer loading as a percent of wafer loading by product. Any change to those numbers for the end of ’07?

Kipp Bedard

We had previously talked about core DRAM around 40% toward the end of ’06, Flash being 10% to 15%, or mid-teens, CMOS image sensors, 20% to 25%, and specialty DRAM 20% to 25%. Those are still appropriate.

For the end of ’07 timeframe, expect core DRAM to be 20% to 30%, Flash 30%-ish, plus or minus, CMOS image sensors, 20% to 25%, and specialty DRAM 20% to 25%.

Doug Freedman - Amtech Research

My last question for you, Lexar Bits, what percentage of Lexar sales are being supported by IMFT fabs presently and what do you think that will do in Q1?

Steven Appleton

I do not think it is going to change much, by the way, for the next couple of quarters. We have customer commitments for the current output, so Lexar right now, as you may know, they had good supply relationships in place. Prior to the acquisition, those supplier relationships had remained in place. We actually do not have much, if anything, to allocate to Lexar in the next couple of quarters. Even if we did, by the way, I think our strategy is to have downstream, external and internal supply to meet their needs.

In particular, when you look at their product portfolio and our product portfolio, they do not necessarily match up exactly right now for part of their products because they had historical practices of buying things from these other suppliers, and there are some differences. I think it will take quite a bit of time for those all to sort their way out.

Doug Freedman - Amtech Research

Any clue on what we should think about gross margins for their business next quarter, given the fact that spot NAND prices seem to be declining?

Steven Appleton

We are still sorting through that ourselves. I think suffice it to say that if you looked at their historical results, they had pretty poor margins. We are weekly, if not daily, working on fixing all of that. So the guy that runs that business for us, Mark Adams -- who was a new COO at Lexar, he had only been there a couple of months when we engaged to acquire them -- is really focused on that and I think doing a pretty good job.

I think the answer is they will improve from where they were. How much progress is made in the next quarter, I do not know. I cannot really respond to that yet because they are still working on it.

Doug Freedman - Amtech Research

Thank you.

Kipp Bedard

Thank you, Doug, and with that, we would actually like to wrap up the call now. We would like to thank everyone for participating 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 this 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 10-Q and 10-K. Thank you for joining us.

Operator

This concludes today’s conference call. You may now disconnect.

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Source: Micron Technology F4Q06 (Qtr End 8/31/06) Earnings Call Transcript (SeekingAlpha)
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