Supply Growth Continues to Flood NAND and DRAM Markets, Making Price Stability Impossible: With NAND and DRAM prices showing no signs of bottoming out, memory makers went deep into the red DRAM in 3Q08. The many remedial actions taken by virtually all participants had yet to be reflected in price stability, so out of balance was the memory supply line, compared to demand. What was worse, an abrupt weakening of demand welcomed memory vendors as the fourth quarter and Christmas came into view, largely attributed to the economic uncertainties surrounding everything financial these days. We estimate that memory makers lost about $4B in 3Q, against about $3B in 2Q08. It is hard to imagine the financials not getting significantly worse in 4Q, and continuing out into 2009's first half.

Steady productivity improvements, as the proximate means of cost reduction, only served up more DRAMs and GB of NAND. Capital investments in capacity coming on line merely added fuel to the fires of excess supply.

As with OPEC and oil, it is not clear if production cutbacks can keep up with weakening demand, and chip industry pundits are forecasting both sharp slowdowns in growth for both supply and demand for 2009, compared with today’s run rates.

Trying to Stop DRAM and NAND GB Growth to Balance Both Markets! Methods of slowing DRAM and NAND supply growth were many and varied. Most 200mm NAND lines have now been taken down or will be soon, due to their lack of cost-competitiveness with 300mm lines (IMFT-Boise, Nanya, Hynix Eugene OR and Korea…for a total of five 200mm fabs, several others). Many fab expansion plans were paused (Samsung NAND Austin, Toshiba-SanDisk Flash Alliance, IMFT Singapore, Nanya-Micron’s MeiYa, others). CapEx for 2009 were all cut back, some as a result of the existing overcapacity, some due to creeping cash-flow problems, some due to the financial markets’ turmoil and uncertainties about 2009 overall economic outlook.

In DRAMs, Taiwan has been exceedingly hard hit, in addition to showing the worst financials for 3Q08. Talk of a government bailout or support is making its way into discussions, but there is no clear direction or action yet. Taiwan DRAM makers lost 75 cents on every dollar of sales in 3Q08, counting restructuring costs and write downs. Prices have dropped still further from average 3Q levels, indicating both that a balance point has not been reached and that the 4Q financials will be even worse.

“Cash is King.” Most DRAM makers are cash-flow negative, putting a rather strict time limit on how long some companies can survive without financial assistance. This cash need and inability to generate it internally, has run smack dab into the worldwide tightening of credit. What prudent banker will lend money to a DRAM maker or NAND maker in such an uncertain business climate as we have today, which is already losing a lot of money? This is certainly the most severe test of many memory makers' business hypotheses yet: (1) Do pure play memory makers have a chance against broad-line suppliers (who may have readier access to cash)? (2) Does the Taiwan “Licensed Technology and make PC DRAMs Only” business model have a future? (3) Will these Taiwanese production partners-foundries be pulled back into the Parent/Technology developer fold, one way or another? (4) Ultimately, what number of independent DRAM or NAND production entities will the industry support, with its huge capital demand and associated technology and scale economies? Will there be four players in each market in 2010? Three? Two? One?... No one knows, for sure. But both the NAND and DRAM industries seem to be well on their way to finding a new equilibrium in competition, investment in fabs and technology, and industry concentration. No one thinks things will stabilize before mid-2009, which might as well be an eternity for those companies with thin bank accounts and reluctant bankers.

3Q08 Financial Results for Memory Companies: Below are the collected financial results for the chipmakers in the memory market which we track. All these results need ample background to a full understanding, and we have appended some discussions of key interpretative factors that have come up in 3Q08.

"Others" include Sony, Matsushita, Renesas, Toshiba, Fujitsu, NEC, Elite Semi.,
G-Link, Alliance Semi., Sharp
'Profits' = divisional operating profits for Samsung, STMicro, Intel;
profits are after-tax profits for all others
Mosys, SanDisk, SST, Saifun and Rambus include substantial IP licensing revenues as % of sales;
Exch. Rates 1Q08: 105.8Yen/$; 962 Won/$, 0.659 Euro/$; 31.4NT$/US$Exch. Rates, 2Q08: 105.0=Yen/$US; 31.0NT$/US$, 1040Won/US$; 0.646Euro/$US
Exch. Rates 3Q08: 104.5 Yen/$US; 31.5 NT$/US$;1120Won/$US; 0.676Euro/US$
For 4Q, Won could be as high as 1350/$US; 1 Euro = 1.30 US$ at 3Q end (=0.77Euro/US$)

Three Memory Companies Still Profitable: Macronix, GSI Technology and IDT all remained in the black in 3Q08. Macronix had net profits of $67.3M on sales of $240M, remarkably good even in the best of times, more so in today's dark climate. They are the Number One maker of Mask ROMs.

GSI is nearly the sole survivor of the Network Memory Fantasy Game from the early part of this decade. They recently announced a 450MHz 18M SigmaRAM. GSI Technology earned $3.6M on sales of $17.1M in 3Q08.

IDT, whose specialty SRAM line is only a small fraction of total sales these days, earned $11.7M on $201M for the quarter.

Samsung Results: In their 3Q conference call, Samsung claimed that they were profitable in memories, but we’re skeptical. We believe that if they were, it was through the use of unorthodox fab depreciation and cost-assignment accounting which shifted costs from one accounting period to another, or from one product line to another, in ways not usual in the industry. We will be looking into this and writing more about it in future blogs, but for comparison purposes here, we have shown Samsung as NOT profitable in 3Q08. Once we dig further, it may be that the 3Q results were even worse than shown here. It is hard to imagine that Samsung's basic manufacturing cost structure, based on yields, die sizes, process ground rules, fraction of output run on 200mm lines, expense levels (SG&A and R&D), were that much better than Hynix, which lost nearly $0.90 on every $1.00 sales, and Elpida, which was uniformly running 70nm design rules for the entire 3Q, has a good mix of differentiated products, and still lost 30 cents on every dollar of sales. Samsung even said that their NAND price/GB achieved in 3Q dropped 30% from 2Q, which is quite a price reduction curve to stay ahead of by reducing costs.

Profits, GAAP and extensive nuancing of results: During 3Q08 and again to be expected in 4Q08, great care must be taken in reading and interpreting financial results. It is these times, with rapid price declines and industry uncertainty, that management goes to great lengths to ensure that the financial results accurately reflect the financial status of the company. They also aggressively write down or write-off assets which no longer have value, sell assets at a loss (compared to their book value) to improve cash balances, write-down inventories to the new Pricing Realities..."mark to market". Some assets sales have taken place, and more can be expected.

The incidence of these practices during 3Q08 is more than can be detailed here. Suffice it to say, fair interpretation of current financial results demands a lot of care.

Other Events and Issues:

Samsung-SanDisk: During 3Q08, Samsung made an unsolicited offer for SanDisk of $5.8B ($26 per share when the SanDisk street price was $14/share), but withdrew it after Toshiba bought an additional 30% share of SanDisk's JV Fab Flash Vision for $1B; this made SanDisk richer by $1B, but gave them fewer GB of NAND from their JV fab. With two quarters of losses and losing market share of total NAND GB sales, SanDisk probably needs the cash more than the NAND capacity. In addition, now that SanDisk's stock is trading at under $9, they may rue the day they turned their back on $26/share, no matter that the stock WAS ONCE $54 within the past year.

Exchange Rates Chaos: The South Korean Won was trading at under 950/US$ until a few months ago. The US$ was $1.60 to a Euro as recently as early July. Most recently, the Euro dropped to under 1.35US$ and the Won went up to more than 1400/US$. The NT$ was stable at 30NT$ = 1US$, but now trades at more than 32.5NT$/US$. The global financial chaos, where dollars are still the predominant reserve currency (estimated at more than 65%), and international invoices are billed in US$, tight credit put many of the world’s currencies at a severe disadvantage as businesses rushed to buy US$ to pay their bills...driving up the price of US$ and driving down the value of the Won, the Brazilian Real, and even the Euro. This plays havoc with setting ‘sales’ and financial performance against a stable and common backdrop. Chip prices are given in US$, but most internal accounting of depreciation, R and D, and SGA are in native currencies. We have just seen the beginning of this in 3Q08, but it will bloom fully beginning in 4Q, with the US$ sticky at a high value not seen for six or seven years.

Mind the GAAP: What is a meaningful financial exposition for investors, or what the SEC demands in terms of reporting financial results, may be quite different from what is most useful to corporate management. One recent ‘improvement’ for ‘transparency’ is the reporting of the value of stock option grants and exercises as a part of the expenses, as they are viewed as employee compensation. Deferred compensation takes another toll to reconcile GAAP accounting with whatever non-GAAP method is used by the company.

Cypress also needs five other adjustment line item categories of expense-cost-gains-losses to reconcile their GAAP earnings with those of their own non-GAAP, the latter of which is used internally to measure operating performance.

Write-downs of inventory and ‘asset impairment charges’: Periodically, but not continuously, manufacturers assets...inventory and capital stock...are written down (or less often, up), once it is realized, and recognized, that the value they are carried on the books are no longer valid, and there is no chance that the market price will ever again reflect the book value. Chip prices are volatile, and this write-off or write down step is not taken until it is pretty clear that the value is gone forever.

This is also done with capital equipment and other assets once realized that ‘the world has moved on’. This write-down of assets was done many times by many players in 3Q08, as it was realized that 200mm lines would never again be competitive with 300mm lines. At least a dozen 200mm lines were closed, or announced to be closed, during 3Q, constituting several hundred million dollars worth of write down. It is a tacit admission that they did not charge as much depreciation as they should have in earlier accounting periods...which would have reduced historical profits and earnings per share.

Once an asset is deemed unproductive to the point that its value is not as high as the value it is carried on the books, but it still useful, a company can take an ‘asset impairment charge’; indeed Intel took a $250M asset impairment charge for its stake in Numonyx and ST Micro likewise took a $344M charge for its share of Numonyx during 3Q08. A horse of a different color, is the 70%+ stake that Infineon now has in Qimonda, which is in danger of being delisted from the NYSE due to too-low a share price…the same problem Spansion has, and which AMD and Fujitsu face with their respective stakes in Spansion. We can expect a reverse split to be forthcoming for such companies to avoid delisting.

Finally: We have begun to upgrade our Samsung Financial results to reflect consolidated operations, which adds in the results from their semiconductor operations in Austin (DRAM and NAND flash). In the past, we have reported only the parent company results. In future edition of these results, all prior Samsung results will be restated to be on a consolidated basis; in these results, only 3Q08 is consolidated.

Samsung non-parent memory sales (Austin) and profits have been running about $500M/quarter of sales and mixed Operating Profits or loss of about 8-10% of sales. The older DRAM fab, dating from the late 1990s, runs 60K/mo. of 200mm wafers; the NAND flash fab was launched just a few years ago, now runs about 70K/mo. of 300mm wafers.