SK Hynix, Inc. (OTC:HXSCL) Q1 2017 Earnings Conference Call April 24, 2017 8:00 PM ET

Executives

Cha Seong-Geun – Head of Investor Relations

Kim Jun-Ho – President, Head of Corporate Support

Analysts

Peter Lee – NH Investment and Securities

Ricky Seo – HSBC Securities

Min-sung Hwang – Samsung Securities

Simon Woo – Merrill Lynch

JJ Park – JP Morgan

Mark Newman – Bernstein

Operator

[Interpreted] 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 2017 First Quarter Earnings Results by SK Hynix. This conference will start with a presentation followed by the Q&A session. [Operator Instructions] Now we shall comment the presentation on the fiscal year 2017 first quarter earnings results by SK Hynix.

Cha Seong-Geun

[Interpreted] Good morning and good afternoon and evening to those calling in from abroad. This is Cha Seong-Geun Head of IR at SK Hynix. Welcome to the SK Hynix 2017 first quarter earnings release conference call.

Before starting the conference call allow me to introduce the executive presence here with me today. First, President, Kim Jun-Ho, Head Of Corporate Support; Senior Vice President and CFO, Lee Myeong-Yeong; Vice President, Kim Sok, in charge of the DRAM Marketing Group; and Vice President, Kim Yeong-Nae, in charge of the NAND Marketing Group.

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 2017 first quarter earnings release conference call. Let me now turn over to President Kim Jun-Ho to present the first quarter earnings and the Company’s plan and market outlook.

Kim Jun-Ho

[Interpreted] Good morning, this is Kim Jun-Ho in charge of SK Hynix corporate support. Let me begin with a review of our financial performance in the first quarter of 2017.

First quarter consolidated sales totaled KRW6.29 trillion a 17% increase from the previous quarter and the highest ever in a quarter recorded by the company. Although a bit shipments fell for both DRAM and NAND prices rose sharply as market improvement continued from the second half of last year.

DRAM bit shipment fell by 5% quarter-on-quarter. DRAM supply shortage continued in the first quarter despite the seasonality. There was a particularly strong demand for server DRAM as the cloud computing market began to take off. The company responded accordingly increasing the portion of server DRAM in our bit shipment, but overall there was low inventory level early in the ear and supply growth was limited.

ASP rose by 24% quarter-on-quarter, it rose across all DRAM products particularly led by PC and server DRAM.

NAND flash bit shipment fell by 3% quarter-on-quarter, but ASP rose by 15% from the previous quarter, thanks to strong prices across all NAND products. Demand was driven by growth in NAND contents in Chinese smartphones as well as the growth in the SSD adoption in PCs. From the supply side similarly to the DRAM the volume available for sale was limited due to the low inventory level early in the year and fewer production days compared to the previous quarter.

For MCP both volume and price continue to grow in the first quarter with sales once again reaching the highest ever in a quarter. Despite the seasonality there was strong demand to build up inventory from customers concerned about possible supply shortage.

In terms of profitability our operating profit in the fourth quarter was KRW2.468 trillion, an increase of 61% quarter-on-quarter with operating profit margin of 39%. It is the highest operating profit in a quarter in the Company’s history.

Depreciation and amortization expense for the quarter was KRW1.164 trillion a slight increase from the previous quarter. EBITDA was KRW3.631 trillion representing an EBITDA margin of 58%.

There was a net non-operating expense of KRW97 billion mostly coming from the currency related loss of KRW72 billion. Appreciation in the Korean won that to KRW83 billion in translation gain in the valuation of our foreign currency debt such as long term borrowings. But it was more than offset by the KRW156 billion in transaction loss coming from the recovery of accounts receivables.

There was recognition of KRW471 billion in corporate tax for the first quarter. Our net profit after corporate tax for the quarter was KRW1.899 trillion with a net profit margin of 30%.

Consolidated cash balance at the end of the quarter was KRW4.872 trillion, an increase by approximately KRW737 billion from the end of 2016. Our interest bearing debt stood at KRW4.343 trillion an increase by KRW7 billion which brought us to a net cash position of KRW529 billion.

Next I’d like to discuss the Company’s market outlook and plan for the next quarter.

For DRAM demand will be driven by increasing content per system rather than growth in 80 device unit shipments as we have already witnessed last year.

For mobile DRAM the content for box is expected to increase despite recent concerns of slowdown in smartphone demand in China. To transfer the rise in component prices smartphone makers are focusing more on offering high end models that have higher profitability rather than trying to drive sales volume. Particularly since the new smartphone models to be launched this year will adopt the dual camera and improved AI, adoption of higher speed mobile products such as LPDDR4X is likely to increase to support the higher functionality.

For server there is rapidly growing demand from data centers as cloud services are beginning to grow. Many providers are building data centers to be the first mover in the fast growing cloud service market. There is also the trend to adopt higher capacity server DRAM modules to ensure low latency and high processing power.

For PCs, the drop in PC shipment as slowed compared to the previous quarter – a previous year, thanks to strong demand for corporate PCs. And sales are increasing for a high specification ultra books and gaming PCs that will drive increase in that DRAM content per box.

For graphics products demand is growing fast for a high bandwidth product with strong gaming PC sales and increasing adoption of graphic processors and servers to handle big data such trends have maintained the upward momentum in GDDR5 demand and expected to lead to similar demand for next generation GDDR6 next year.

Even this back drop DRAM demand growth is expected to be a little over 20% this year, which is expected to outpace supply growth. There is not enough cleanroom space to significantly increase DRAM capacity and the pressing need to invest in 3D NAND will leave less financial room to invest in DRAM.

Meanwhile in the NAND market demand growth will be driven by adoption of higher density NAND products in smartphones as well as growth in SSD adoption.

For mobile NANAD there is a trend of adopting higher storage NAND across smartphone models despite the higher price as 256 gigabyte began to be used in major flagship smartphones last year. The most to higher density NAND is expected to continue this year in eMCP and eMMC for example. Adoption of UFS and 3D NAND is likely to increase in high-end products.

And for enterprise SSD, which began to take off last year is expected to grow in data centers as a cloud services keep growing. Demand for enterprise SSD is expected to be generated elsewhere as well to support new services based on generating, storing and using data such as AI, Big Data and IoT.

As for a client SSD growth in the content for box is expected to slow down a little due to the recent price hike. However, adoption in PC’s is likely to keep increasing as ultra books and high performance PCs are growing in sales.

In the NAND market this year, there is likely to be a shift transition to 3D across the different end markets as suppliers are working hard to ramp-up 3D production, it is likely to be adopted first in enterprise SSD, high density client SSD and flagship smartphones as by its nature 3D is more suitable for a high density products and its production volume is still less than 2D. At the same time, those end markets that continue to use to the products they experience ongoing supply shortage as to the production continues to decrease.

Given such outlook NAND demand growth for this year is projected at low to mid 30% level. Demand growth is likely to slightly outpace supply growth.

Under such market environment, SK Hynix will focus on technological development and mass production as planned to keep strengthening our profile as a leading technology company while preparing for the new demand for high performance products.

First in DRAM, the company will keep ramping up 2Z-nano production and start mass production of the next generation product 1X-nano in the second half of this year. We’re also preparing for volume production of 2Z-nano based LPDDR4X and sales of HBM2 in response to growing demand for high performance products.

For NAND, we started mass production of the 48-layer TLC product late last year following the 36-layer MLC. We successfully developed the 72-layer product in the first quarter of this year. As such this year we plan to supply the 36-layer to the mobile market requiring MLC and the 48 and 72 layer for high density mobile and SSD markets.

For DRAM, the company is planning for a shipment growth that is in line with the market growth this year. NAND bit shipment growth is planned to slightly under grow then the market. In the second quarter, DRAM bit shipment growth is planned at mid single-digit increase to recover from the drop in the first quarter while NAND bit shipment growth is planned to be flat sequentially.

The company was able to achieve record performance in the first quarter and missed a favorable memory market environment that started in the second half of last year. The fact that such market growth and the Company’s performance were made possible despite the weak seasonality is indicative of the sustainability of growth in the memory market. SK Hynix will not remain content with the recent performance and keep focusing on preparing for the future, so let’s ensure sustainable growth and stability no matter the market conditions.

This concludes my report. Thank you.

Cha Seong-Geun

[Interpreted] And with that, we are ready to take your questions.

Question-and-Answer Session

Operator

[Interpreted] Now Q&A session will begin. [Operator Instructions] The first question will be provided by Peter Lee from NH Investment and Securities. Please go ahead, sir.

Peter Lee

[Interpreted] First of all congratulations on the excellent performance, and I have two questions. First is about the market outlook for the second half, because there seemed to be diverging views on how the market is going to develop in the second half. So I would like to ask for your outlook in terms of the second hand market, the memory market in terms of the overall market condition as well as the prices?

Kim Jun-Ho

[Interpreted] Now first about the DRAM market outlook in short, we believe that the supply shortage will continue into the end of this year. The reason is that now in the second half although there after the technology migration there would be increase supply, we believe that there is going to be even bigger growth coming from the demand side.

So our outlook is that in the second half the extent of the supply shortage would be eased somewhat, so in the second half the extent of the supply shortage will not be as much as in the first half and as a result, we believe that pricing will also be stabilizing.

And then about the NAND market as well, we believe that the supply shortage will also continue. And that’s mostly because of the continued migration to 3D across the NAND industry, which actually is not an easy quite challenging. But then I believe that a lot depends on the success of the V4, the 64 layer and the 72 layer development, so depending on the success of the technological developments on these products, we believe that it will determine whether the NAND supply and demand in the second half will reach balance or not.

Peter Lee

[Interpreted] Now then my follow-up question is about the 3D NAND, so you also mentioned the 72 layer, but what is your schedule for the production in volume of the 72 layer and what would be the specific applications of this product?

Kim Jun-Ho

[Interpreted] Now as was announced in the first quarter, we have already completed these developments of the discrete product for the 72 layer 3D NAND.

And at this moment the company is undergoing qualifications for the 72 layer solution product, meaning that the mobile and SSD.

Now, of course for the customer qualifications depending on the specific application, the qualification would take differences in terms of the timeline. But then the overall the general outlook is that we will be able to launch the CSST or mobile products sometime in the second half of this year.

Operator

[Interpreted] The following question will be provided by Ricky Seo from HSBC Securities. Please go ahead sir.

Ricky Seo

[Interpreted] Thank you for taking my questions, which is also a two part question. Now, first about the mobile DRAM, although overall there is a tight supply and many of the smartphone makers are actually reducing their target shipments for this year, and also seem to be adjusting their inventory wouldn’t this have an impact on the overall DRAM market if you could provide more detail explanation please?

Kim Jun-Ho

[Interpreted] Now then if the question is about the smartphone set shipment, then I would like – then I believe that this is mostly pertaining to the Chinese markets, so I’d like to focus by response as well to the Chinese smartphone makers.

Now it is true that in the first quarter the Chinese smartphone makers seem to have a higher level of DRAM inventory, but then this is largely in line with the traditional patterns of building up inventory in the first half and then reducing it in the second half. And in fact, when we look at inventory level today then it’s actually not that much higher compare to the similar period last year.

Now it is true that there were some moves by some of the smartphone makers in China who have learned their lessons in the second half of last year as they have to experience some difficulties in securing the sufficient DRAM volume. And then as a result of that there were some moves for among them to increase inventory level in the early part of this year. But we do believe that by May and June when new products are launched and the inventory will very quickly go down.

And in terms of the memory content, now the Chinese smartphone makers are also segmentizing their set meaning that they are reducing the low margin, low-end smartphone sales well trying to increase the higher margin mid to high-end smartphone sales and as a result of this actually the overall memory capacity is increasing.

Kim Jun-Ho

[Interpreted] And then in the second half of this year not only from the Chinese smartphone makers but then also there would be new products to be launched from the global makers as well. So we believe that the mobile DRAM demand will continue to remain robust into the second half of this year.

Ricky Seo

[Interpreted] The next question is about the portion of server. It seems as if can from the previous quarter in the first quarter of this year there has been a big increase in the portion of server. So can you give us more details in terms of the numbers so in terms of how much percentage it has gone up and also you did explain a bit more, you did explain about the server demand, but then is this about the content growth or more about the shipment growth. So could you also share with us some of your outlook on this?

Kim Jun-Ho

[Interpreted] Yes. It is true that among the DRAM applications the portion of server has gone up, but then please understand that we are not have liberty to give you the numbers. What I can tell you is that mobile has the highest portion followed by servers.

And about the second part of the question so between these servers set shipment and mobile memory content per box, so which one is a bigger demand driver I would say that it is the content per box.

Now the reason is because of the growth in cloud computing and cloud services as well as demand coming from the data centers for high performance and also the advantage of new technologies such as hyperscale and virtualization which also require higher content memory.

And we believe that such demand for server will remain the main driver of the overall DRAM demand not just into this year, but also well into next year.

Operator

[Interpreted] The following question will be provided by Min-sung Hwang from Samsung Securities. Please go ahead, sir.

Min-sung Hwang

[Interpreted] Now this is also a two part question. First, now in the first half, do you believe that there was more demand growth than expected or less supply growth to an expected. And then now you also mentioned that you expected the demand to continue to outpace supply growth into the second half. And so there is also going to be a very strong demand coming from the service side and then you also added that from the DRAM suppliers there is not enough cleanroom to ramp up production. And it seems as if Hynix also does not have plan to invest in addition a cleanroom space, I wonder whether this is the case?

Kim Jun-Ho

[Interpreted] Now, regarding your first question, I would say that it was less supply than expected probably because of some technological challenges from the supply side and also because of the relocation of the equipment.

Now about the cleanroom and you would know the half of the second floor of M14 will be used for the production of NAND Flash, the construction has been completed and we are relocating the equipment for NAND production to prepare for the production there.

And then about the DRAM cleanroom, the first floor, so most of the first floor of the M14 is already being used for DRAM production and we have some space left for migration in the future.

And then about the remaining half of the second floor of M14, we will start construction for this in the second half scheduled to be completed by the end of December. So once that is completed and once this is opened for DRAM production then we will have more room for DRAM.

But then as to the actual usage of the other half of the second floor of M14 to be completed by the end of December this year whether this will be used for NAND Flash or DRAM, we will have to make that decision later on while reviewing the market conditions in the second half.

Operator

[Interpreted] The following question will be presented by Simon Woo from Merrill Lynch. Please go ahead, sir.

Simon Woo

[Interpreted] Now continuing with questions about the cleanroom, so you’ve just talked about the M14 cleanroom to the newly be ready in the second half of this year. You also talked about a longer term plan to build a new cleanroom in Cheongju a few months back, and then also a plan to upgrade the OC a cleanroom, so could you just share some light into your trend and future for the next two to three years?

Kim Jun-Ho

[Interpreted] So regarding the second four of the M14 the cleanroom that will be available there, we will be able to use the new cleanroom starting from this year until next year, meaning that by 2019 there would be no more cleanroom space left, and that is why we will start preparing for more next year.

[Interpreted] The cleanroom plant in Cheongju this will be used for 3D NAND and then the one plant in Wuxi now this will be used for additional migration for DRAM in the future.

Now for both Wuxi and Cheongju construction has started already with the plan to complete this by the first half of 2019, so by then the cleanroom in both facilities would be completed. But then in both cases of course, the shell will be completed, but then in terms of the actual cleanroom space we are going to increase this on a face by face basis depending on the status of migration at that time.

Simon Woo

[Interpreted] And next question is about the bit crossover from the new technology, so for both the 3D NAND and for the DRAM, particularly for the DRAM going from 20-nano to 18-nano in the near future, so when do you think that they will take up more than 50% of the bit production meaning that the bit crossover, so when do you foresee in terms of the timing of the bit crossover, so for 3D NAND do you believe that it is certain to happen in the second half of this year then also for the DRAM as well, when will it go from 20-nano to 18-nano.

Kim Jun-Ho

[Interpreted] Now for 3D NAND we believe that once we increase the capacity with the new cleanroom in M124, we believe that we will have be able to have the bit crossover from 2D NAND to 3D NAND by the end of this year.

[Interpreted] And then for DRAM once we completed technological development for 1X-nano and start volume production in the second half by the end of this year it will still not go over the 10% level.

So in DRAM for the 1X lever to go over 50%, I would say that it would be late next year at the earliest or the first half of the year afterwards.

Operator

[Interpreted] The following question will be presented JJ Park from JP Morgan. Please go ahead sir.

JJ Park

[Interpreted] My question is about your CapEx particularly related to NAND, because your guidance in the last quarter was that the overall CapEx would be KRW7 trillion with a lot of it going to NAND. I wonder whether that guidance remains the same or have there been any changes to that. And obviously the reason why I’m asking is about the talks in the market and particularly about your intent to take over the shipment NAND business, so does that mean depending on the outcome of your attend will this also change your plans for NAND investment or do you believe that the NAND investment will go ahead independent of your Toshiba acquisition or not. So I wonder whether the Toshiba acquisition will have an impact on your overall CapEx plan as well as your NAND investment plan in particular.

Kim Jun-Ho

[Interpreted] The guidance that we provided in the early part of this year remains unchanged, meaning the KRW7 trillion in CapEx remains the same. And first of all we do not know what the outcome will be coming from our intent to acquire the Toshiba NAND business, and no matter the outcome or short term plan for the 3D short term plan for the CapEx especially the NAND investment for the migration into 3D NAND will continue.

Operator

[Interpreted] Your last question will be presented by Mark Newman from Bernstein. Please go ahead sir.

Mark Newman

Hi guys thanks for taking my question, congratulations on fantastic results this quarter. I have two questions, one on because in secondhand technology on the DRAM bit growth, I believe you’re saying in line with the market about 20% because this year, I’m just wondering with all the comments you made about cleanroom space being very limited understand that, but is there any possibility to go higher than that 20% mark, for example, if you use some of that cleanroom space, you got a bit of cleanroom left the migration, if this could be used more efficiently to get more output to get above that 20% this year, that’s my first question and I have the follow-up on technology. Thanks.

Kim Jun-Ho

[Interpreted] Well, of course, the 20% level that we are projecting this is based on our expected yield as well as the expected pace of ramp up, but then of course, if the yield is much more improved and we had initially expected or if the technological migration takes place at a faster pace than expected, then of course there is room for this to go up a bit more, but then the current projection for about 20% level growth is also based on our assessment of the – all of the factors.

Mark Newman

Thank you.

Kim Jun-Ho

Your second question please.

Mark Newman

Yeah, sure, thanks. So on the technology roadmap you’ve commented about DRAM of 1X starting production second half of this year and I think you said crossover late next year, and I’m just wondering how do we think about this technology migration difficulty now and going forward, because we have both Samsung and Micron having some issues on their next generation DRAM and we all know that you know SK Hynix as well as Micron had quite a few issues on the last migration. So you know or we is this going to be normal should we expect that there’s going to be more and more issues with ramping the next technology, because it’s more difficult or it was that a onetime hiccups for SK Hynix on 20-nanaomter node?

Kim Jun-Ho

[Interpreted] Well as you would be aware going from 20-nano from to 10-nano, now of course this is more challenging in terms of the technological development, and that is lot of the players are struggling with it, and that is why we’ve also had some difficulties going on to the 20-nano mode.

Now having said that for the 1X nanotechnology that we plan to go into volume production in the second half of this year. We have been sure that there would be fewer uncertainties and instability in terms of the technological development based on our past experience and also benchmarking the others experience and that is what I believe that the pace of migration for 1X-nano would be different from the past.

But then in general as you have commented, I believe that the technological migration going forward will become more and more challenging with a ramp up taking longer time and the duration for the migration would also take longer, and I believe that this is just an indication of the overall difficulties involved with technological development.

Operator

Thank you very much. And this concludes the SK Hynix 2017 quarter one earnings release conference call. Thank you to all the participants.

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