SK hynix Inc. (A000660) Earnings Call Transcript & Summary

[Foreign Language] 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 2021 third quarter earnings results by SK hynix. This conference call will start with a presentation followed by a divisional Q&A session. [Operator Instructions] Now we shall commence the presentation on the fiscal year 2021 third quarter earnings results by SK hynix.

[Interpreted] Good morning, and good afternoon and evening to those calling in from abroad. This is Park Seong Hwan, the Head of IR at SK hynix. Welcome to the SK hynix 2021 Third Quarter Earnings Release Conference Call. Before starting the conference call, allow me to introduce the executives present here with me today. First, Kevin Noh, CFO and Head of Corporate Center; Chang Hyuk Joon, Head of Finance; Park Myoung-Soo, in charge of DRAM Marketing; and Park Chan-dong, in charge of NAND Marketing. Let me issue a disclaimer that all outlooks presented by the company are subject to change, depending on the macroeconomic and market circumstances. With that, we will now begin SK hynix' 2021 third quarter earnings release conference call. Kevin will first present the earnings for the third quarter and the company's plan. It will then be followed by a Q&A session with the executives present here today.

[Interpreted] Good morning, everyone. This is Kevin Noh, CFO and Head of Corporate Center. I will first brief you on the company's financial performance in the third quarter of 2021. Favorable memory market environment continued throughout the year on the back of strong demand for IT products following the shift to nonface-to-face environment. But the recent global supply chain disruption raised concerns of slowdown in memory demand. Despite such market uncertainty, the company's third quarter revenue was KRW 11.81 trillion, up 14% from the previous quarter and up 45% Y-o-Y, the highest ever in the quarter for the company. The fact that it even surpassed the revenue of the record boom period in the third quarter of 2018 is meaningful, showing that although with some variability, the demand and value of memory products have continued to grow. In the third quarter, the company focused on securing profitability. First, in DRAM, despite sound demand in most applications, Demand for PC products softened and price negotiations have been prolonged due to some customers' plans to sell down their inventory. Thus, the company's DRAM bit shipment growth in the third quarter was somewhat lower than guidance with a single -- with a low single-digit decrease quarter-on-quarter, but ASP rose nearly 10% Q-o-Q. For NAND, bit shipment growth was low 20% level, higher than previous guidance of high 10% as the company actively responded to the strong demand for server and new mobile products. ASP rose by mid-single-digit percentage, which helped pull up the quarterly revenue to over KRW 3 trillion, reaching record high for 2 quarter in a row. For MCP, customers in the Greater China region continue to demand high specification driving sales of high-density products like 8 gigabyte DRAM and 256 gigabyte NAND. Along with the rise in memory price, it helped drive MCP revenue to a record high as well. In the third quarter, there were meaningful performances not only in revenue but also in costs. Although DRAM bit shipment fell Q-o-Q, there were yield improvement and portion increase of 1z nano, an improvement in unit cost as a rise in one-off labor expense in the second quarter was reduced in the third quarter. For NAND, a double digit improvement was achieved in unit cost, thanks to additional yield improvement and portion increase in 128 layer, base effect of higher labor cost and evening out of fixed cost due to high bit shipment growth. Particularly for the 128 layer, the efficient transition to mass production increased its portion in sales to over 75% at the end of the third quarter, 1 quarter ahead of plan. This helped the NAND business turn to profit and profitability margin also improved significantly. As a result, the company's third quarter operating profit was KRW 4.17 trillion, up 55% Q-o-Q and operating profit margin, 35%, up 9 percentage points Q-o-Q. Both figures are the highest since the fourth quarter of 2018. Depreciation and amortization in the third quarter was KRW 2.71 trillion, slightly higher than the previous quarter. EBITDA was KRW 6.88 trillion and EBITDA margin, 58%. There was a net nonoperating income of KRW 426.8 billion. There was net interest expense of KRW 60 billion and net foreign currency-related gain of KRW 400 billion. Net profit before tax was KRW 4.6 trillion, and corporate tax expense was KRW 1.28 trillion. Net profit was KRW 3.32 trillion with a net profit margin of 28%. Consolidated cash balance at the end of the third quarter was KRW 10.01 trillion, up by KRW 3.38 trillion from the previous quarter. Interest-bearing debt was KRW 14.29 trillion, increased by KRW 0.45 trillion Q-o-Q. The company's debt-to-equity ratio and net debt-to-equity ratio stood at 24% and 7%, respectively, showing an improvement from the previous quarter. Next is the company's market outlook and plan. The memory market this year saw demand grow faster than expected despite supply shortages of some components affecting set build demand. Demand growth for DRAM is now expected at low to mid-20% level compared to the 20% projection early this year, while NAND is expected to grow over 40% compared to the low-30% level projection. The continued upward adjustments in demand forecast this year is likely due to the cautious projection early this year due to various uncertainties following dramatic market changes in 2019 and 2020. Looking at demand environment by application, bit shipment growth in the PC market is expected to be over 10% for the year. There was demand slowdown in the third quarter led by the Chromebook and some component shortages affected demand for PC build. The global supply disruption is expected to continue for some time, but upstream demand is expected to remain solid with recovery in demand for enterprise PCs, increase in online and hybrid working environment and replacement demand for Windows 11 launched in October. In addition, deferred demand from this year is expected to ease the seasonality in the first half of next year. In the mobile market, where demand remained volatile due to another wave of COVID-19 and component supply situation, solid build demand continued, thanks to new product launches by major customers and demand for higher densities from the Greater China region. Smartphone sell-through in the Greater China region, which was weaker in the third quarter, is likely owed to demand in waiting for new product launches and year-end promotions in the fourth quarter. Thus, it is expected to improve as we move into the fourth quarter. The server market is showing a strong build demand following increased investment in new data centers this year. There are still uncertainties over the global supply chain disruption and inventory correction, but investments in cloud and data centers is projected to continue to next year with the growth of 5G network and MEC. Upstream demand is expected to remain solid as demand for server replacement accelerates following the adoption of new CPUs and enterprise demand recovery continues. For server NAND, component shortage is somewhat affecting eSSD supply, the effect of which is expected to continue to the fourth quarter. As demand for eSSD grows, the supply disruption will lead to customers' push to secure more inventory, which can affect eSSD supply and demand. Utilizing our expertise and network, the company will make the best effort to ensure stable supply of eSSD. Considering current market conditions, the company is planning for a mid- to high single-digit DRAM bit shipment growth in the fourth quarter. This is reflective of the base effect from the decrease in bit shipment in the third quarter. Should there be changes in demand in the fourth quarter, the company will focus on securing profitability with a flexible response following the third quarter. For NAND, a high bit shipment growth of double digits is expected again following the third quarter. It will enable strong cost reduction, based on which, we will maintain the surplus that we achieved in the third quarter and achieve profit for the year. When the fourth quarter plan is reflected, the company's DRAM bit shipment for the year is expected to be slightly lower than the market demand growth. NAND bit shipment growth is expected to far outgrow market growth, reaching nearly 60%. Meanwhile, we aim to close the acquisition of Intel's NAND business within the year as planned with only the Chinese authorities' approval remaining. The acquisition will lay a strong foothold for the company in the rapidly growing eSSD market. And by securing R&D capability based on extensive understanding and experience in computing architecture, the company will focus on path finding to break through the technological limitations of memory and strengthen cooperation with global mega IT companies. The consolidation will solidify the company's profile as the global memory chip leader by ensuring a mutually complementary product portfolio as well as achieving economy of scale in its NAND business and by broadening its R&D capability. Last is the company's ESG management activities in the previous quarter. In step with the Ministry of Environment integrated environment management system, the company early in the year has built an integrated system where we can review information and flow of all pollutants emitted from our sites. As a result, the company's Icheon site became the first semiconductor company in Korea to receive government certification for integrated environment management system and approval criteria. The company is also working to obtain technologies to reduce air pollutants emitted during semiconductor-producing processes. As part of which we have jointly developed with a domestic vendor a system to reduce nitrogen oxide and ammonia. We are now currently expanding its adoption. The nitrogen oxide reducing system simultaneously eliminates previously uncaptured nitrogen oxide and fine dust. It was first applied in some sites in October 2019 and is now expanded for a company-wide implementation. The ammonia reduction system uses new technology, one that eliminates ammonia without using sulfur, which was previously required. After being successfully systemized through effectiveness testing and demonstrations, the system started being applied at our sites from May 2020. These are some examples of the company's ceaseless technological innovations and R&D with the aim of reducing environmental impact. Ultimately, the company will strive to establish a fundamentally green manufacturing process and will do its utmost to create sustainable value. Thank you.

[Interpreted] With that, we will now take your questions.

[Foreign Language] Now Q&A session will begin. [Operator Instructions] The first question will be provided by Ricky Seo from HSBC.

[Interpreted] Congratulations on the good performance. Now my question is with regards to the memory demand. So I see that currently, largely, there are 3 issues in relation to the supply of parts and components. The system IC issue as well as the package issues in Southeast Asia and the power issue in China. And because of these issues, there have been some impact on the production in the IT and automotive sectors. So how much has these issues affected the memory demand? And from the company's perspective, how far along in the issues do you believe we are in? And when do you foresee that these problems will be resolved?

[Interpreted] Then let me respond to this question about the memory demand impact. Now regarding the global supply chain issues, now these are the extraneous issues that have been known for some time and that have also affected the automotive and the PC industry somewhat so far. But then on the other hand, it could also have an opposite effect. In other words, it could actually turn some of the demand into deferred demand into next year or turn them into pent-up demand, which, in turn, could actually serve to solidify the demand next year. And as we discuss with our customers regarding the fourth quarter and next year, it appears as if the current issues have already been reflected into their plan. And especially in implementing our long-term agreements, there are no variables, I would say, in terms of the fourth quarter of this year and the first quarter of next year. So the changes in demand are also largely due to the uncertainties in the global supply chain. And as to when these issues would be resolved, it's very difficult for us to make that prediction, but I believe that it is important for us to maintain a broader understanding regarding the overall supply and demand dynamics. What I mean is that the memory supply flexibility is different from what it used to be. So in the past, if there had been supply chain issues, then it would impact both the set builder as well as the memory providers. And then what the -- normally, what the memory providers would do is they would increase their capacity in order to drive down the cost and thereby increase demand. But then with the explosive growth in cloud demand more recently, there has been increase in the overall demand. And also, there was -- it was followed by some memory capacity correction in the industry. As a result, what we are seeing now is that the suppliers' capacity is largely moving in step with the demand. So the demand flexibility is not like what we used to see in the past.

[Foreign Language] The following question will be presented by Choi Do-Yeon from Shinhan Financial Investment.

[Interpreted] I would say that this is a follow-up to the previous question in order to gain more tips from the company. So this is mostly regarding the equipment investment and your supply strategy. Now regarding the investment strategy, I'm sure that they are also having some headaches in Yeouido because of many of these extraneous factors. And because of that, it is also very difficult to project the overall market demand or the market environment. So then given that the extraneous factors are going to prolong the uncertainties for some time into the future, then what is the company's CapEx plan and the supply strategy?

[Interpreted] Now as you have pointed out, it is true that there are layers and layers of uncertainties today, which make us very cautious in trying to plan for the future or project the future. But I would say that compared to other semiconductor products for the memory, for memory, there has been a sound supply. And also, we have been running our business in a fairly predictable manner, meaning that there have been no supply shortages, and we have continued with our usual support for the customers. Now regarding your question for the CapEx, yes, there are a lot of thoughts that -- there are a lot of things that we have to consider today. And given the fact that the lead time for equipment has become much longer than in the past, we are also making our business plan at least 2 months ahead of the usual timing. And also for the equipment when it comes to ordering them and also having a communication with the equipment vendors, we are also doing that much earlier than usual timing. Now we are planning for and trying to respond to the DRAM and the NAND market differently from each other. In other words, for DRAM, we -- for the third quarter as well as the fourth quarter of this year and into the first half of next year, we intend to remain conservative in our business forecast and also, likewise, conservative in our response. But for NAND, given that we have the best-among-peers competitiveness in both the 128-stack and 176-stack products, utilizing this cost advantage, we intend to more actively respond to the supply and demand dynamics. And regarding the CapEx, so it is based on these different thinking that we are currently reviewing various scenarios for the CapEx, but it has not been finalized yet. But we are aware of the increasing capital intensity in this industry, so we are currently planning to maintain our CapEx to revenue ratio at around mid-30% level.

[Foreign Language] The following question will be presented by Min Seong Hwang from Samsung Securities.

[Interpreted] Now it was mentioned earlier that you have focused on securing profitability in the third quarter. Now given the price increase in the third quarter, had the company decided to sell at a little cheaper price than you could have sold more but you did not, so I believe that in and of itself is quite a change. But then perhaps the stock prices don't see this continuing. In other words, don't see such trend continuing into the future. And you also -- the company also mentioned earlier that the company intends to remain flexible in the fourth quarter as well. So do you also believe that you -- the company can maintain this stance into the nonseasonality as well? And also given the current supply and demand dynamics and the current inventory level, for how long does the company believe that you can maintain this position? And now if the company were to maintain such position, then there could be also some worries about falling market share. So do you believe that the company can maintain such, let's say, profitability-oriented business at the expense of market share? And also, there were some mention of equipment contracting in the first quarter of next year, and can you just give us some explanation or give us a view into the, let's say, the color or the tone of the discussions regarding the equipment contracting?

[Interpreted] Well, that is a very important question. And likewise, it's a very important question for the company as well. And to be frank, we believe that for the DRAM business, we do need to secure profitability for some time because we need resources down the road because we need to break through many technological challenges, and we must also continue to provide the kind of customer support that we have done so. And -- but then given the fact that currently, the higher operating profit is not automatically translated into a higher cash flow, we see that there can be some such reasons why the stock prices have been reacting hyper sensitively to even the smallest changes. Now having said that, they also say that the memory is raised to the industries. So we are very much cautious about artificially adjusting supply by adjusting the pricing because given all that has gone on in the semiconductor industry, if we are also to enable to have stable supply of memory as well, then the impact on the other industries will simply be too excessive. And also at the same time, when it comes to DRAM, the customers' inventory remains relatively high. And for the suppliers, including Hynix, the inventory remains historically low. So we do believe that for the DRAM side, there is room for some inventory buildup on our side. But then for NAND, this is a different story because compared to the DRAM, NAND is still a growing market, and we believe that there is much room for further growth. And because of this -- now, of course, from -- especially coming from the data center service side, we see that there is going to be much growth in demand coming from the applications related to the data center server. So our supply strategy for NAND is in step with such growth theme. Now in the past, utilizing the funds from the operating profit, we would invest -- we would make a CapEx-centric investment. But now I believe that for the memory market, we need to invest more in the R&D for the future. So rather than competing on CapEx, we need to invest in the R&D for new memory or the next memory. And that is why it is very important for the company to secure profitability in both DRAM and NAND. But then such profitability, again, is for the sake of investing into the future, not simply to compete on CapEx or capacity but to better prepare for our future. So to answer your question, then yes, the company intends to remain profitability-centric for DRAM down the road. So the profitability centricity will remain regardless of the cyclicality.

[Interpreted] And now regarding the long-term agreement for the fourth quarter and the first quarter. Now it's not about the, let's say, the changes in the share within the year, but then more about the changes in the business mix that are more interesting to us. And so we see that there are increase in the DDR5. And also for next year, there are going to be increase in the high-specification products, like the graphics or HBM. So those are the changes in the mix that we expect to see into the second half as well.

[Foreign Language] The following question will be presented by Nicolas Gaudois from UBS.

The first one is going back to DRAM. You had a slight decrease in bit shipments in Q3. And then in Q4, you're guiding for bit growth Q-over-Q. We actually forecast both Samsung and Micron bit shipments to decline in the fourth quarter. So could you help us reconcile the difference, whereby, SK hynix seems to be outperforming peers. It took Q4 for bit shipments for DRAM. And then for server memory demand, Intel last week spoke about some softness in the segment coming from China as well as IC procurement supply constraints. They also mentioned a strong backlog. Are you seeing similar trends on your side? And if you are, when do you expect procurement for memory for servers to regain more strength?

[Interpreted] Now for the overall server market, we see that the upstream demand in this year as well as next year will remain solid and the investment into that will also continue. And also in the boom years of the server, for example, the data centers and the cloud, which was in 2017 and 2018. So many of the equipment that we're investing in around this boom year of 2017 and '18. Now this equipment, many of them will be up for replacement this year and next year. So we believe that, that will also drive demand. In addition to that, there will be a new CPU launches by -- again this year and next year. And there is also the move to higher specifications in memory like DDR5. So we believe that, overall, among all the applications, it actually remains the most solid in terms of demand. And regarding the comment about China. Now I would say that it actually depends on the different companies in China. But overall, the Chinese cloud market is moving along with the national plan to expand the IT infrastructure. So perhaps there can be some blips in the short term. But then over the mid to longer term, we believe that it will probably remain on a similar trajectory. And also, there can be additional improvement, thanks to COVID-19.

And regarding the bit growth plan for the fourth quarter, I did mention in my presentation earlier that we had initially planned for low single-digit bit growth in the third quarter for DRAM, but then it went in the negative territory. And for the fourth quarter, our initial business plan was to achieve low single digit. And now we are now expecting it to be mid to high single digits and not from any changes in our plan or operations, but simply due to the base effect of the third quarter where there was a drop in the bit shipment growth. So that is the number that can be achieved simply by us fulfilling our commitments to the customers. But then as we have seen in third quarter, there could be some, let's say, unexpected changes in the customers' inventory plan or also in the negotiations. So depending on the situation, we will -- we intend to remain flexible as we have done so in the third quarter.

[Foreign Language] The last question will be presented by Sung Kyu Kim from Daiwa Capital Markets.

[Interpreted] I have 2 questions regarding NAND flash. Now I see that in the third quarter, the company's performance far outperformed the guidance. And likewise, in the fourth quarter, you're expecting another double-digit growth. And also, the -- but then the CFO has also mentioned that the -- there are some parts issues on the supply side. And then on the demand side, there may be some inventory correction by the customers. So does the company believe that it is possible to carry on these 2 trajectories in parallel, in other words, the rapid increase in bit growth while securing profitability at the same time? And the second question is the Chinese approval for the acquisition of Intel's NAND business appears to be delayed. So is there any update that you can share with us? And also perhaps it is related to the China-U.S. trade dispute. And also, there are moves recently in different countries to have more domestic production of semiconductors. And does the company believe that this would also affect the company in any way? And do you have any backup plans to these different changes?

[Interpreted] Now regarding our NAND business, yes, in the third quarter and in the fourth quarter, there will be a big increase in the NAND bit growth. And that is mostly thanks to the rapid transition to the 128 layer and also improvement in the yield. And that is why we were able to achieve rapid bit growth in NAND in the third quarter and also likely during the fourth quarter. And the increase in the portion of the 128-layer products, it actually directly drives down the cost. So this is also directly related to improved profitability. And then on the question of supply in the market, now in the third quarter, in the MCP market, especially, there has been much growth in the high-density products, which have also led to increase in the overall NAND sales. And likewise, in the SSD side, the customers intend to build up their inventory. So we believe that demand for SSD will remain strong as well. And then for the 176 layer, we are also getting the qualifications. So we believe that after the 126 layer, the 176 will also find a soft landing, which will continue to contribute to the improved profitability.

Just one more comment about NAND. Now for NAND, we need to maintain a strategic thinking. Compared to DRAM, we see that there is still more room for tech migration and also as a result, cost reduction. So by having a rapid or more active tech migration and tech development, and also providing rapid supply to the customers, we believe that there is much value to be provided to the customers. And again, unlike DRAM for the tech migration, we believe that in the NAND market, there is room to change the competitive landscape to be more stable for the company through such tech migrations. And by creating the synergy effect with the acquisition of the Intel's NAND business, we believe that Hynix will be able to provide even better value to the customers. And regarding the Chinese approval for the acquisition of Intel's NAND business, it's true that out of the 8 countries from which we need to get the approval from, China is the only remaining country. And we had initially expected to get the approval by the end of the third quarter. But as you have just mentioned, there has been some delay. But then we are still looking forward to receiving the approval in the fourth quarter of the year, so they will be able to close the deal by -- within the year. And as can be seen by the unconditional approval received from the 7 out of the 8 countries, this consolidation, in no way, restricts competition in the memory market, especially in the NAND market. Rather, it actually strengthens the effective competition, which will serve to increase the value to be provided to the customers. And yes, there has been some delay, but we look forward to receiving the approval from the Chinese authorities within this year. And regarding the around 2 to 3 months of delay in the approval, the company does have some backup scenarios. But overall, we believe that we will be able to maintain our business plan without any major changes.

[Interpreted] Thank you. That concludes the SK hynix 2021 Third Quarter Earnings Release Conference Call. Thank you very much for your participation. [Statements in English on this transcript were spoken by an interpreter present on the live call.]