SK Hynix, Inc. (OTC:HXSCF) Q2 2020 Earnings Conference Call July 22, 2020 8:00 PM ET
Park SeongHwan – Head, IR
Cha Jin-seok – CFO
Conference Call Participants
Giuni Lee – Goldman Sachs Group
Marcus Shin – Mizuho Securities
Do-Yeon Choi – Shinhan Investment
Peter Lee – Citigroup
Jong Woo Yoo – Korea Investment & Securities
Hyunwoo Doh – NH Investment & Securities
Nicolas Gaudois – UBS Investment Bank
Good morning, and good evening. First of all, thank you all for joining this conference call. And now we will begin the conference of the fiscal Year 2020 second quarter earnings results by SK hynix. This conference will start with a presentation followed by a divisional Q&A session. [Operator Instructions].
Now we shall commence the presentation on the fiscal year 2020 second quarter earnings results by SK hynix.
Good morning, and good afternoon and evening to those calling in from abroad. This is Park SeongHwan, the Head of IR at SK hynix. Welcome to the SK hynix 2020 Second Quarter Earnings Release Conference Call. Before starting the conference call, allow me to introduce the executives present here with me today. First, Cha Jin-seok, CFO of SK hynix; Park Myoungsoo, in charge of the DRAM Marketing; and Kim JeungTae, in charge of NAND Marketing.
Let me issue a disclaimer that all outlooks presented by the company are subject to change, depending on macroeconomic and market circumstances.
With that, we will present our quarterly earnings, future plans and market outlook.
Good morning. This is the CFO, Cha Jin-seok. I will first report on the company’s financial performance in second quarter 2020. Consolidated sales in the second quarter was KRW8.607 trillion, up 20% from the previous quarter. Despite the persistent COVID-19-related uncertainties in the business environment, demand stayed strong for server memory, and the overall price environment remained favorable in the memory market. SK hynix actively responded to demand for products, which showed robust price conditions.
DRAM bit shipment increased 2% quarter-on-quarter, slightly outperforming the guidance. Weakness in demand for mobile products continued from the previous quarter but was offset by increased sales of server and graphics products where both demand and price remained relatively strong. ASP rose 15% quarter-on-quarter with prices rising across all applications.
NAND Flash reported a 5% increase in bit shipments from the previous quarter, which was below the original target. Although active response to solid SSD demand led to SSD sales mix close to 50% for the first time ever, the company engaged limitedly towards channel and certain mobile markets, which showed relatively weak demand and pricing conditions. ASP rose 8% quarter-on-quarter due to favorable price trends, especially from SSDs, of which we increased shipment.
For MCP, revenue fell 1% Q-o-Q, and revenue portion was 16%. Although the MCP prices also increased, there was decrease in shipment due to overall smartphone demand slowdown.
The company’s profitability improved across all applications as result of ASP increase and continued cost reduction per unit from increased portion of 1Y nano DRAM and 96-layer 3D NAND products, which have both reached mature yield levels. As a result, operating profit in second quarter was KRW1.947 trillion, increasing 143% from the previous quarter, with operating profit margin of 23%.
Depreciation and amortization expenses in the second quarter increased slightly from the previous quarter to KRW2.405 trillion. EBITDA was KRW4.352 trillion with EBITDA margin of 51%.
There was net nonoperating expenses of KRW220 billion in loss recognition from foreign currency-related items following appreciation of the Korean won at the end of the quarter.
Corporate tax for the second quarter was KRW463 billion, an increase by KRW183 billion from the previous quarter due to increase in net profit before corporate tax. Our net profit after corporate tax for the quarter was KRW1.264 trillion with a net profit margin of 15%.
Consolidated cash balance at the end of the second quarter was KRW5.265 trillion, up KRW522 billion from the previous quarter, while interest-bearing debt was KRW12.69 trillion, up by KRW275 billion. Debt-to-equity ratio was 26%, and net debt-to-equity ratio was 15%.
Next is the company’s market outlook and plan. In the first half of the year, while demand for mobile memory fell short of expectations due to COVID-19, demand for server and PC memory exceeded expectations, thanks to increased requirement for remote work and education, et cetera. Combined with growing anxiety over the IT supply chain in general, the overall memory price environment remained favorable.
As we enter into the second half, economic activities are partially being resumed in major countries, and some economic indicators appear to be over the trough. In addition, with supply chain beginning to stabilize for smartphones and new product launches planned for game consoles, we expect improvement of component demand, especially from mobile and consumer-related goods.
Under this situation where the global pandemic persists, it is too early to be confident about rapid and continuous economic recovery, and uncertainties still remain over trade conflicts among major countries. But as supply of 5G smartphones grows, especially in the China region, and demand for server products and support — and demand for server products to support remote work and online education continues to grow, we expect some customers’ inventory levels to become lower again by the year-end.
Although there are many variables regarding the pace of economic recovery, smartphone shipments are expected to grow by more than double digits next year due to lower base shipment of this year, along with a more rapid uptake of 5G smartphones. In addition, the launch of new server CPUs is expected to drive significant growth in server DRAM adoption, and the speed-up of cloud system deployment from governments and enterprises is also projected to boost demand growth for server SSD.
And newly launching game consoles during the second half are expected to drive solid growth through next year in graphic DRAM and NAND demand. It’s known to have an average 40% higher DRAM content than previous models, up to 16 gigabytes per box, and also to adopt SSD over HDD for the first time, up to 1 terabyte.
Memory demand next year is anticipated to show more firm and steady growth trend than this year, but supply is not likely to chase up as a result of the industry’s investment reduction over the past couple of years.
The company has been flexibly responding to demand changes even under a challenging business environment in the first half of the year, and we plan to focus on optimizing the product mix for profitability in the second half, based on the company’s quality competitiveness.
For DRAM, the company will actively respond to growing mobile demand driven by 5G smartphones and demand for new game console launches. We will continue to improve profitability by expanding sales of 1Y nanometer 8-gigabit mobile DRAM and ensure timely supply to the 12-gigabit and LPDDR market where adoption has begun in earnest. In addition, we will further accelerate sales of HBM and GDDR6 in the third quarter, and a portion of these products will exceed 60% of our graphics DRAM.
On the other hand, in the computing market where customers’ inventory is expected to be tighter, we will focus on expanding sales of 1Y nanometer 16-gigabit-based high-density modules, which have the best-in-class quality competitiveness and focus on enhancing technological competitiveness with smooth ramp-up of 1Z nanometer.
For NAND, alongside demand support for newly launching smartphones and game consoles in the second half, we plan to operate a flexible product mix in reaction to a product portfolio change for a major mobile customer. Thus, sales portion of mobile NAND, including MCPs and client SSDs, will increase compared to the first half. However, we will also strengthen our business capability for server products to diversify our customer portfolio. We will ensure that customer qualifications for 128-layer products are completed on time in the second half, so the profitability improvement can continue for mobile NAND and client SSD.
DRAM bit growth in third quarter is planned to be flattish, and NAND bit growth is planned to grow at a high single-digit percentage. Given the higher-than-expected shipments in the first half with customers’ effort to secure inventory, the company’s annual shipment is expected to meet mid- to high-teen percent for DRAM and above 40% for NAND, which was suggested earlier this year before COVID-19.
The company’s conservative CapEx and capacity plan remains unchanged from what we have already communicated. However, it is possible to consider more prudent responses depending on future market conditions. In addition, as our DRAM and NAND inventories both reached normal levels at the end of the first half, we will actively utilize this to cope with demand changes in the second half.
Still, demand visibility into the second half remains limited with a mixture of both concerns over re-proliferation of COVID-19 and expectations of resuming of economic activities. However, over the mid- to long term, as digital transformation accelerates in every part of our lives post-COVID-19, the importance and value of memory semiconductors will also be appreciated even more. SK hynix will stay flexible to changes in the external environment in the remaining half of the year as we continue to lay the basis for sustainable growth. Thank you.
With that, we will now begin to take your questions.
[Operator Instructions]. The first question will be provided by Giuni Lee from Goldman Sachs.
Congratulations on the good performance. And now I have 2 questions. First is about the inventory level. I believe that the continued good performance from the first quarter to the second quarter is largely due to the inventory buildup by the customers. So what is the current inventory level among your major customers? And do you also believe that there’s a possibility of the customers going into inventory adjustment in the second half of this year? And combined with that, how do you foresee the demand in the second half, along with the seasonality?
And the second question is about the 5G smartphone and also the related memory increase. So because of the increase in the 5G smartphone sales, now some in the industry expect that this is also going to increase memory content, while on the other hand, because of the rising BOM cost, they also point out that this is actually going to limit the increase in the memory content. So what is the SK hynix’s outlook on the 5G smartphones’ overall impact on the mobile demand?
Now first question was about the customers’ inventory. And since I believe that this is similar to the NAND situations, I would like to respond to this question, along with the NAND as well. So then in the first half, as was reported earlier, now there were some — it appears that there were some issues in the supply chain. But then now earlier, starting in the — early this year, the customers went into inventory buildup because of the positive outlook that they still had at the time.
And then now moving into the second quarter as the COVID — as there was the COVID outbreak, now the customers continued with the inventory build up because there were some concerns about the supply chain risks. But then now more recently, because the supply chain is a concern, not only for the company but also to the industry overall, there have been a review and monitoring of the supply chain through various channels. And because of this, we believe that now, since then, the build has been consistently done. So we believe that in the second half of this year, the inventory will begin to be lowered. So by the end of the second half of this year compared to the end of the second quarter of this year, we believe that the customers’ inventory will go back to a healthier level.
And then your second question was about the 5G smartphone, both the outlook as well as some concerns. Now yes, we see that the 5G smartphone is briskly increasing throughout the world, and that is mostly led by the flagship smartphones by the major companies as well as the mid- to low-end smartphones. And for this, we see that there is growing requirement for app-based integrated chipsets, and we also see that they are being developed and also being adopted at a faster pace. And because of this, we believe that for the 5G smartphone, this is going to be favorable for the cost competitiveness as well.
And in terms of the memory, now compared to last year and also even compared to the early part of this year, we believe that the price has stabilized quite a lot. So this is not going to be an important factor in terms of the demand. And also looking at the demand itself, then now for the mid-range segment, the mobile — the memory content is continuing to grow. And also because of the value considerations coming from the industry as well as the customers, the memory content and the growth of the memory content is becoming even more important, especially because for the 5G smartphones, the important features are camera, video and processing speed. So these are what the 5G smartphone users are looking for. And because of this, the DRAM content is continuing to grow, and we believe that this is going to be quite positive for the company — for the demand as well.
The next question will be provided by Marcus Shin from Mizuho Securities.
I have one question each for DRAM and NAND. First about the DRAM. Now some are predicting a drop in the DRAM price starting in the second half of this year. So if that does happen, then how do you foresee the duration and the extent of the DRAM price adjustment? So if you cannot give specific numbers, then perhaps a comparison with previous cycles would also work.
And the second question about NAND. And I see that the recent — in your recent performance, what stands out is the cost saving on the NAND product side. And what is your current progress on the 96- and the 128-layer products? And also in the market, it seems as if there are growing expectations over the 128-layer products. And how do you foresee the 128-layer product contributing to the company’s growth in the SSD market share?
Regarding your first question about the price outlook for DRAM in the second half of this year, yes, as it stands now, it appears almost unavoidable that there will be some price adjustment or some adjustment to the ASP in the second half of this year. But what is going to be different from the immediate past is that now when we look at the period between 2016 to 2019, so for about 3 to 4 years, there have been some up and down adjustments in the demand and supply dynamics. But then now we see that, that has been just about completed by the end of last year. And because of that, and also at the same time, we believe that for the mid- to long term, the growth in the memory demand is going to be quite solid and robust. So unless there are some large external factors like, for example, re-proliferation of COVID-19, we believe that the adjustments in the DRAM ASP this time is going to be quite short-lived. And of course, the — I cannot specify the extent of the price adjustment, but it’s quite likely that it is going to bottom out in the second half of this year.
Then for NAND, the 96-layer product is currently the company’s flagship product, and we are trying to secure competitiveness in all applications. And combined with both the 96- and the 128-layer products, so these 2 products combined, we believe, will go over 60% in the third quarter and, in the fourth quarter, over 70%.
And particularly for the 20 — 128-layer products, now the customer qualification is currently underway for major applications in major customers. And we are also stabilizing the mass production process for the 128 stack product. So we — so by the end of the third quarter or the early part of the fourth quarter, we will be able to drive sales of the 128-layer product. And we believe that it is going to be quite helpful in responding to the SSD, especially the mobile high content demand. So this is always going to be quite helpful in improving the profitability.
The next question will be provided by Do-Yeon Choi from Shinhan Investment.
Now I also have two questions. First is about the inventory but this time about the company. So we have discussed the inventory level among the customers, but then I wonder what the company’s inventory level is going to be by the end of the third quarter. So you have also presented the bit growth outlook for the third quarter for both DRAM and NAND. So in light of the bit growth outlook, then where do you foresee your inventory level being at the end of the third quarter?
And the second question is about the inventory valuation reversal. So there was some reversal in the second quarter of the NAND inventory valuation. So then what is the expectation in the third quarter? Do you believe that there’s also going to be additional reversal?
In response to your first question about the inventory level, so let me first explain about the DRAM. Now as it stands today, now when we look toward the second half of this year, especially into the third quarter, then we expect no major changes in the inventory level compared to the first half. Now for DRAM, we would have to respond to the actual demand coming from the customers in each application market, so depending on the pace of demand recovery and also launch of new products. And so we are going to make sure that there is going to be minimum changes or volatility in our product inventory level so that we will be able to respond flexibly to the environment as well as the changes.
And as for NAND, now in terms of the sheer inventory level, then because of the lower shipments than planned, the inventory level at the end of the second quarter rose slightly compared to the first quarter. But then when we look at the days of inventory, then it has slightly gone down in the — at the end of the second quarter. So likewise, when we consider the bit growth outlook for the third quarter, then we believe that by the end of the third quarter, there is going to be additional slight decrease in the NAND inventory level. Now having said that, the inventory level remains quite stable, and we intend to maintain it this way. So we are going to make sure that we maintain the inventory level according to the profitability and the growth prospect of NAND, and so that we will also be able to flexibly respond to the changing demand.
And about the inventory valuation reversal in the second quarter, now in the second quarter, there was almost none. Now in terms of NAND, because of the rising ASP and also because of the improved yield coming from the 96-layer products, there was some reversal for 96-layer product. But then because of the mass production beginning for the 128-layer product and because of the initial production cost, now in this case, there was some inventory valuation loss. And also there were some raw materials that had to be discarded. So overall, there were some pluses here and minuses there. So overall, the inventory valuation was almost net 0.
And then looking toward the third quarter, now as we kickstart the sales and mass production of the 128-layer products, so as we move on to the mass production by the end of the third quarter or the early part of the fourth quarter, then we expect that there can be some reversal coming from the inventory valuation.
The next question will be provided by Peter Lee from Citigroup.
Now I have two questions, one for next year and another for the longer term. Now what is the company’s outlook for DRAM and NAND demand growth for next year, especially compared to this year?
And then the second question is about the mid- to longer-term demand for servers, so the server memory, because more recently, we see the spread of the multi-access edge computing, the MEC, and which is characterized by ultra-low latency and high efficiency. So how do you foresee the uptake of the MEC affecting the server memory demand for the longer term?
Now regarding your first question about the demand outlook for next year, now allow me to respond regarding the DRAM first. Now we expect that there is going to be some base effect coming from this year and especially looking at the major markets, the server and the mobile side. And for the server side, we believe that there is going to be the new CPUs or 8-channel-based new CPUs to be launched. So the CPU solutions are going to become more important as they become the basis for competition, and we believe that this is going to further drive demand.
And some other factors include the hyper cloud companies building up new data centers, so this is also going to be a positive factor. And another is the major countries continuing to build up their IT infrastructure, which we believe will further drive demand for server.
And also for the smartphone shipment next year, it is expected to grow by double-digit because of the decrease this year. And with the increased use of 5G smartphones, the memory content in the smartphones is also going to grow, so this is also going to further drive up the content growth in smartphones. And also, there is expectations of new game console launches to come. So along with the 5G smartphones, we believe that this is also going to be a driving factor for DRAM.
So overall, the DRAM bit growth next year is expected to be over 20% compared to this year. And similarly, for the NAND demand, so the positive factors include the smartphone and server, game consoles as well as the base effect. So after the high 20% bit growth expected this year, we expect that there is going to be a low 30% growth next year.
Moving on to your second question about edge computing. Now what we are seeing today is an overall shift toward the 5G environment. And along with that, there is going to be a growth in connected devices. And also for the edge server, now there’s going to be growth in the edge server as well as the micro data center servers. And they say — some say that the average growth to come for some time is going to be over 50% per annum.
And also, they say that compared to the volume of data that is currently being generated in the IT environment, what is actually being processed and used by the business sector and the product sector is quite small. So down the road, there is going to be growing demand and actual use of more data processing and also more use of high-performance computing, especially for, for example, deep learning. So because of this, we believe that there is going to be growing importance and growth of edge computing.
The next question will be provided by Jong Woo Yoo from Korea Investment & Securities.
Jong Woo Yoo
So my first question is, now we see that the U.S. sanctions against Huawei have become stricter coming to this year. And I see that we are — the company is also being affected by this. So what is the company doing in response to the sanctions against Huawei so that we will be able to minimize the negative impact?
And the second question is, I see that the company has steadily increased the portion of its server DRAM business, and on one hand, of course, this has served the company well. But then also, on the other hand, now what we are seeing is there is much higher volatility in both the demand and pricing of server DRAM compared to other applications. And of course, this volatility then translates into the volatility in the company’s performance. So such high volatility is not always a good thing. So I wonder how the company sees this volatility. And is there any plan by the company to try to minimize or address the volatility coming from the server DRAM side?
Now first in response to your question about the — about Huawei. Please bear in mind that we cannot be specific about the situation, but what I can tell you is that with the COVID outbreak in the early part of this year, the company has come up with a contingency plan, which also reflects such risks. And what we can tell you is that the risks are currently being managed quite stably without any major problems. And we will continue to manage the risks, but if the risks are to be prolonged, then of course, we would have to make sure that they will not become — turn into a major risk. So we — for the second half of this year, we will be operating a product mix that is well related to the launch of new products by the major customers and also make sure that we remain flexible in supply.
And regarding the question about the volatility in server demand, now the company has grown the server demand business portion, but then that was in line with market growth. So our strategy as the market kept growing was to have a mid- to long-term agreement as much as possible. And thanks to this strategy, I would say that the impact coming from demand volatility for server has been minimum.
And I also did mention earlier that the adjustment cycle this year is not expected to be long. So over the past cycles when the adjustment would last 3 to 4 years and also in terms of the demand and supply dynamics, where the adjustment is lasting quite a long — for a long time with steep extent, I think that through these cycles, both the buyers and the suppliers have realized that what is very important for all of us is to make sure that there is stability and reliability in the supply and demand dynamics so that we can also maintain the pricing at a stable level.
And in terms of how the company is responding to the volatility, well, we believe that fundamentally, having quality competitiveness would be the best solution against that. So the company is already recognized by the customers as having the best-in-class quality. And also in terms of the high content products, the company maintains global leadership. So we will make sure that we maintain such quality competitiveness down the road.
The next question will be provided by Hyunwoo Doh from NH Investment & Securities.
Now I also have two questions. First is, as was reported earlier, yes, there will be launches of new game consoles, including the Sony PlayStation 5 in the second half of this year. So how do you see such new game consoles affecting the memory supply and demand in the second quarter?
And the second question is, recently at JEDEC, the DDR5 standard has been adopted. So then we — so they say that the memory companies will now be starting to use this and the DDR5 by the end of the year. So what is the company’s outlook about the DDR5?
Let me briefly respond to your first question about the game consoles impact in the second half. Now for — in terms of the DRAM, now in the new game consoles, the content is going to grow by around 8 gigabytes to as high as 16 gigabytes at most. So this obviously is going to be a boon for the demand growth. So compared to the first half of this year in the graphics market, in the second half, the EBIT growth is expected to be about 50%.
We believe that with the growing sales and also in the — because of the characteristics of the different application markets, so considering this, we will be running the optimum product mix in the second half.
Now for demand for the new game consoles in terms of the SSD adoption, the — it is going to be as high as 1 terabyte. And also the average content of the SSD in the second half for the new game consoles is going to be 800 gigabytes. And given that the — this is going to account for about 5% of the overall NAND demand in the second half, we believe this trend will be a driving factor in not only the demand for memory in SSD but also in the overall NAND market.
And your next question was about the current — the outlook for DDR5 market and the company’s progress. And of course, we already had the press release as well, but then overall, the DDR5’s biggest value would be, compared to DDR4, the double-the-bandwidth effectiveness as well as the double-the-capacity support. And given that the smart functionalities in both the related devices as well as infrastructure will only continue to grow, there is going to be a growing need for on-site computation to support that as well as growing need for lower latency. So we believe that these are going to be a very strong driving factor for the DDR5 market growth.
And related to the market growth, the — it also depends on the CPU supply. So by the second half of next year, when there is going to be increase in the supply of CPU to support DDR5, we believe that the DDR5 market growth is really going to take off, sometime around next year, especially in the second half. And also, based on this growth, there is likely to be a crossover sometime in 2023 when the DDR5 goes over the 50% mark over the entire computation memory market.
The last question will be provided by Nicolas Gaudois from UBS.
First one would be on CapEx. So you basically said that your overall guidance for this year is unchanged, but you did refer to potentially keeping some flexibility going forward. Does this imply any delays at all in the ramp-up of capacity this year, in particular for DRAM? And how do you think about 2021 so far, in particular for the timing of starting to put in equipment for production for M16 on the DRAM side?
And secondly, you provided some useful comments on DRAM pricing in the second half of the year and compared to prior cycles. Could you perhaps do some exercise for NAND Flash in terms of whether you see any probability of any price decline later in the second half of the year? And if so, how do you relate to that versus prior cycles?
In response to your first question about CapEx, now as was reported earlier and as you have rightly observed, yes, there are no major changes to our conservative CapEx policy for this year. But having said that, yes, we also intend to be flexible depending on the changes in the market environment. And now looking at the schedule today, then looking at the market circumstances, it is likely or it is probable that our CapEx operation might become a bit more conservative than was the guidance. But what I can tell you and what — which is probably going to be helpful is, compared to the infrastructure investment, the equipment investment has become lower. And as for the CapEx plan for next year, of course, it is too early to tell at this point. But then the — so the CapEx plan for this year was reduced compared to next year. But next year — compared to last year. But next year, there is likely to be increase compared to this year, but the extent of the increase is not going to be large.
And about the NAND price outlook in the second half, now as we move into the second half, there has been some adjustment already, and we are seeing weaker pricing for NAND compared to the first half. Still, over the mid- to long term, as the technology becomes more sophisticated and as the product becomes higher content, we believe that the price per gigabyte is going to gradually fall. But for the short term, we do not expect there to be any large fluctuations in the pricing coming from fluctuations in the supply and demand dynamics.
That concludes the SK hynix 2020 Second Quarter Earnings Release Conference Call. Thank you very much for your participation.