Good morning and good evening. First of all, thank you all for joining this conference call. Now we will begin the conference of the fiscal year 2019, third quarter earnings results by SK hynix. This conference will start with the presentation, followed by a divisional Q&A session. If you have a question, please press star one, that is star and one on your phone during the Q&A. Now we shall commence the presentation on the fiscal year 2019, third quarter earnings results by SK hynix
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 2019 third quarter earnings release conference call. Before starting the conference call, allow me to introduce the executives present here with me today. First, SK hynix CFO, Cha Jin-seok.
Kim Seok, the head of the DRAM marketing group, and the head of NAND marketing group, Kim Jung-tae. 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 2019 third quarter earnings release conference call. We will first present the earnings for the third quarter, the company's plan, and the market outlook.
Good morning. This is the CFO, Cha Jin-seok. I will first report on the company's financial performance in third quarter 2019. Consolidated sales in the third quarter was KRW 6.839 trillion, up 6% from the previous quarter. Sales grew for both DRAM and NAND, driven by signs of demand recovery and slowdown in the price decline.
DRAM bit shipment grew by 23% quarter-on-quarter, far outperforming the plan, as the company actively responded to the mobile market that showed a seasonal upturn with new smartphone launches and increased sourcing by some internet data center customers. ASP fell by 16% from the previous quarter, the price decline softened in all product categories except mobile. The company actively responded to solution markets such as the high density mobile and SSD markets that continue price elastic recovery in demand. As sale of discrete products, which increased temporarily in the previous quarter, came back down to normal range, NAND flash bit shipment fell by 1% from the previous quarter. ASP rose by 4% quarter-on-quarter with moderated price condition in all applications and a considerable volume mix reduction of discrete products, which carried relatively lower price than others.
MCP bit shipment grew with rising smartphone demand in China, but price decline continued, which led to 2% sales decrease quarter-on-quarter. Its sales portion out of total revenue also fell slightly to 22%. Operating profit in the third quarter was KRW 473 billion, down 26% from the previous quarter. Although DRAM unit cost was reduced, it was not enough to offset the price decline. Operating profit margin was 7%.
Depreciation and amortization in the third quarter was KRW 2.159 trillion, slightly up from the previous quarter. EBITDA was KRW 2.631 trillion, with EBITDA margin of 38%. There was net non-operating profit of KRW 48 billion in recognition from foreign currency related gains as the Korean won depreciated at the quarter end. Net profit after tax was KRW 495 billion, with net profit margin of 7%. Consolidated cash balance at the end of the third quarter was KRW 3.256 trillion, up by KRW 146 billion from the previous quarter. Interest-bearing debt was KRW 9.703 trillion, up by KRW 956 billion, mainly due to issuance of $500 million of offshore corporate bonds.
Let me now turn to the company's market outlook and plans. DRAM market in the third quarter exhibited healthier demand than expected, with demand expansion coming from the PC and newly launched smartphones and increased sourcing from some server customers. After a period of stagnant demand, DRAM inventory level gradually normalized for internet data center customers, prompting to begin increasing their purchase. Server demand is also on the rise for the customers in the Greater China region, this trend of server demand recovery is expected to continue in the fourth quarter.
In the global mobile market entering into the second half, the sales remain brisk for new flagship models with high-density 8 to 12GB mobile DRAM adoption, including those that support 5G services. Next year, 5G smartphones are expected to enter a growth cycle in earnest, triggering the smartphone replacement demand that had been dormant for some time and help drive stable memory demand increase.
Meanwhile, with Windows 7 support about to terminate, demand is improving for enterprise PCs. Price competition for market share gain among SoC makers is easing the cost burden on PC OEMs and is expected to have a positive impact on demand for components such as PC DRAM and Graphics DRAM. In the NAND market as well, there is shipment growth in PC and smartphone, and elastic demand recovery is speeding up with lower NAND price. In particular, NAND demand for PC SSD in the third quarter grew nearly 50% year-on-year. As we saw mid 20% growth year-on-year in SSD shipment for PCs, an increase in the average NAND content in the SSD with a high 20% adoption of 500 GB or higher content.
NAND content in smartphones continue to increase, the average content per box is expected to reach 100 GB in the fourth quarter. This trend continues in the mid to low-end smartphones as well, with the average content of DRAM and NAND in the MCP already reaching beyond four gigabytes and 60 GB respectively. With suppliers' inventory level quickly coming down, NAND supply and demand dynamics is regaining balance.
Adding the gradually rising eSSD purchase demand from server customers, a favorable price environment is expected to continue for some time. While it is evident that the customer demand improvement is a positive trend, there still exist chances for sudden change in demand due to external uncertainties, including trade disputes. Since the customers that are more exposed to the trade issues may be willing to accumulate component inventory preemptively, we will keep executing our production and CapEx plans with a cautious stance. As was reported last quarter, we are converting part of the M10 DRAM capacity into CMOS image sensors for volume production and reducing 2D NAND wafer capacity. This will reduce wafer capacity for both DRAM and NAND next year, and total CapEx, including equipment spending that has a direct bearing on wafer production, is expected to be reduced considerably.
In addition, the company will keep trying to create stable profitability while flexibly responding to changes in demand in each application. We will focus on driving sales for high value add products that offer high density, low power consumption, and high speed enabled by our next generation process technology so that we can accelerate growth as the market improves. For DRAM, we started sales of computing products using 1y-nanometer technology and will increase the portion of 1y-nanometer to low 10% by this year end as the portion of 20nm shrinks. In addition, we will make preparation for stable mass production of the recently developed next generation 1z-nanometer technology. In addition, we plan to actively address the demand in LPDDR5 and HBM2E market that is expected to grow as customer adoption increases next year.
For NAND, we started sales of 96-layer products, and their respective bit proportion will be pulled up to more than mid 10% level by the end of the year. We will focus on the high-density NAND markets, such as high-end smartphones and PCIe SSDs, which is likely to raise our SSD revenue mix to 30% in the fourth quarter. We are also making preparation on schedule for volume production and sales of 128-layer products.
In light of the current environment where demand continues to grow, our DRAM bit shipment in the fourth quarter is expected to increase by mid-single digit%, and NAND bit shipment is expected to increase by around 10% level. For the company's full year, DRAM bit shipment is expected to grow by high 10% level, thanks to the higher-than-planned performance in the third quarter. NAND bit shipment growth is expected to reach around 50% level. This will significantly reduce our DRAM and NAND inventory level at the end of this year from the very high level in the first half of this year.
Volatility in the memory market has increased considerably this year due to a number of external factors and slow demand overall. Although memory technology has become far more complex over the years and demand has become more diversified, the magnitude of the change has been bigger than expected. The company has adjusted its production, sales, and CapEx strategies in a timely manner, ensuring effective response to changes in the market environment as they arise.
5G service that was commercially launched from this year is expected to start spreading more quickly next year, creating a momentum for new memory demand for a long time to come. SK hynix will utilize this downturn as a chance to minimize business volatility and ensure sustainable growth in the midst of structural changes in the demand environment. We ask, as always, for your continued support and encouragement. Thank you. With that, we are now ready to take your questions.
Now Q&A session will begin. Please press star 1, that is star and 1, if you have any questions. Questions will be taken according to the order you have pressed the number star 1. For cancellation, please press star 2, that is star and 2, on your phone. In order to allow as many Q&A chances as possible within the restricted time, we would appreciate only two questions per participant. The first question will be provided by Wonsik Lee from Korea Investment & Securities. Please go ahead with your question.
I have two questions. First is about the DRAM demand in the third quarter, which was much stronger than the company's guidance. Of course, you did explain a little bit about this in the presentation, but can you elaborate a bit more on the reasons why the actual demand for the DRAM in the third quarter outpaced the company's guidance so much? In relation to this, there are some concerns that perhaps the demand in the third quarter was driven by the moves to preemptively stock up the inventory ahead of the U.S.-China trade dispute. The concern is that perhaps the demand will not continue into the fourth quarter. What is the company's expectation? Do you believe that the stronger than expected demand in the third quarter will continue into the fourth quarter?
The second question is about the outlook for demand for the 5G smartphones next year. We see that many companies are upwardly adjusting their demand outlook for 5G smartphones. What is the company's outlook?
First of all, about the DRAM demand in the third quarter, there has been recovery in demand from the server clients in the Greater China region, as well as the IDC clients in the U.S. From the mobile side, yes, there have been some, let's say, a buy ahead or inventory buildup moves coming from the Greater China region, as you have mentioned, and also some such moves in the PC side as well. As regards to whether such move will continue into the fourth quarter. Perhaps not so much as the bit growth of 23% that we have seen in Q3, but we are still expecting about a mid-single-digit growth in Q4 as well. Bearing in mind the persisting macroeconomic uncertainties, we are also watching out for the possibility of the server customers taking a turn for a more conservative purchasing stance.
Regarding the second question about the outlook for 5G smartphones next year. Yes, we see that there is going to be a big jump in the demand for 5G smartphones, more so than this year. Whereas this year the numbers were about millions of units for smartphones, for next year, combining all the demand coming from the customers, we project this to be around 200 million units.
The reasons or the causes or the drivers of such a jump in the demand for the 5G smartphones, we believe are the increase by the subsidies from the Chinese government and also the dissemination of modem or the integrated modem, so the integrated chip, which is also driving the development of mid to low-end 5G smartphones.
The next question will be provided by Marcus Shin from Mizuho Securities. Please go ahead with your question.
I have some questions about your fab operations. The ones in C2F in Wuxi, which has newly opened, and then the M15 in Cheongju, the ramp-up, can you just give us the update on these fabs? For the M16 ramp-up plan by the end of next year, in the second half of next year, the fab in Icheon, when do you believe that you will also be able to start the operation of M16? You did mention that the CapEx for next year will be reduced. Can you just tell us about how much it is going to be?
First of all, about the fabs. Yes. The Wuxi C2F and the Cheongju M15, they have both opened and are operating on schedule. In terms of the ramp-up, now the pace of the ramp-up, we are trying to be flexible as we keep an eye out on the market changes. For the Icheon M16, again, as you have rightly pointed out, yes, this is scheduled to open in the second half of next year. Again, from then on, in terms of the further ramp-up, we will be watching out for changes coming from the market and will remain flexible in the pace of the ramp-up.
About the CapEx plan for next year. Please understand that the company's business plan for next year is still under work. We cannot tell you the exact number at this point. Looking at the activities of the company recently, I believe that the CapEx will be reduced considerably in line with the company's plan and activities so far. Likewise, there is going to be a significant reduction in the investment into equipment as well.
The next question will be provided by Doyeon Choi from Shinhan Investment. Please go ahead with your question.
I also have two questions. First is about the inventory level in the third quarter. I see that the inventory level in the third quarter has gone down. It seems like the first quarter this year that SK hynix's inventory did go down. When do you believe that the inventory level will go back to normal for both DRAM and NAND? The second question is about demand profitability. We see that demand price is recovering, and it's likely that the recovery in the pricing will continue into the fourth quarter. The market is wondering whether there is going to be a reversal in the inventory write-off for NAND. If so, then do you believe that there is going to be much improvement in demand profitability in the fourth quarter compared to the third quarter?
First about the DRAM inventory, which was explained in the presentation that it is going to go down considerably by the end of the year compared to the early part of the year. If I were to give you some specific numbers, at the end of the second quarter, it was at 7 week level, and at the end of the third quarter, it went down to 5 week level. This number is likely to roughly continue in the fourth quarter. Going into next year in the first quarter, the trend could change a little bit because of the seasonality, but then afterwards we believe that this will then start again to slightly go down. This means that the inventory level is more or less back to normal.
For the NAND inventory, at the end of the third quarter, it was at high 6 week level. This will also continue into the fourth quarter and all the way to the end of the year. We believe that by the end of the year, the NAND inventory level will also go back to normal. As for the NAND price and the profitability, yes, there have been some slight increase in the NAND price in the third quarter because of the additional demand coming from some channels as well as from some applications.
Since then, in the third quarter, there has been a slight fall in the price after the negotiation. In the fourth quarter, there is going to be some price increase for some applications. We believe that thanks to the improvement in price and reduction in cost, there will be some improvement in NAND profitability in the fourth quarter.
The next question will be provided by Ricky Seo from HSBC. Please go ahead with your question.
I also have two questions. First is about the company's capacity operation strategy. In the third quarter, can you just give us a rough idea about the share in the capacity between mobile and server? Also in terms of the inventory in the server, we see that the server inventory remains a bit high. Now, for next year, for the smartphones, if the strong demand for 5G smartphones is going to be a surefire thing, then can we take it that the company would be converting some of the capacity more to the mobile side? The second question is about the demand coming from the Taiwanese companies.
It seems as if there is growth in demand for server components, led by the Taiwanese companies. What is SK hynix's understanding of the data center company's inventory level today, and how strong do you see the demand is coming from them? When do you believe that there is going to be a full pickup in demand?
First about the share of capacity between mobile and server. In the first half, mobile was much higher. In the second half, the server's share has increased. This will continue into the fourth quarter. Still, when you look at the share numbers, the mobile share is still higher. Looking ahead to next year, because of the expected demand for the 5G smartphones, yes, the mobile share is likely to be higher next year than this year, which means that the server's share is likely to be lower than it was this year. Having said that, please bear in mind that this is dependent on the market circumstances. We will run our capacity in a strategic and flexible manner as we keep an eye out for the market.
The second question about the demand coming from these server companies of Taiwan, the supply chain channel. Yes, of course, we are monitoring them as well. Yes, we also see that there has been increase in component demand and ODM build.
As the set build increases from the server companies and the data center clients, we see that they are very quickly using up their inventory. By the end of the year, their inventory level is likely to be about half the level that it was in the beginning part of the year. As the inventory goes down, and as there is a possibility of a market upturn in 2020, it seems true that the server customers have done some buy ahead.
Looking ahead to the first quarter. The first quarter, there is a traditional seasonality in servers in the first quarter. Now if we are to look ahead into 2020, around the time of the new SoC launch, there is some volatility expected at that time. Considering all the factors and the circumstances, we believe that the pickup, the recovery in the server demand, is going to materialize perhaps by the end of the first quarter or early second quarter.
The next question will be provided by Soonhak Lee from Hanwha Investment & Securities. Please go ahead with your question.
First question is about your shareholder return policy. I see that the free cash flow for this year is going to be much worse than last year, and it's very likely to affect your shareholder policy such as dividend policy. Will there be changes to your shareholder policy this year? The second question is, I see that the NAND price, yes, it has been increasing. You did mention this earlier, but then what do you see as the actual drivers of the stronger price in NAND? Is it perhaps from the Toshiba side? Are there still problems lingering even after Toshiba came out of the power shutdown situation? Until when do you believe that this is going to continue? When do you believe that your NAND business will turn around to profitability.
The company began to provide cash dividends in 2014. Since then we have maintained the dividend per share policy at around 30%-50% of free cash flow. Now, as you have pointed out, the cash flow for this year has considerably worsened. It is going to be quite challenging for the company to apply the policy as it has been so far.
The company believes that there should be some adjustment to the dividend policy, and that is currently under review. At a time when the company profitability or cash flow are quite extremely volatile and changing, we believe that we need to try to find the right balance and also consider the acceptance level by the shareholders as well. We would be taking a look into the overall factors. We will be looking into the company's financial performance and the free cash flow and the market circumstances as we try to come up with the kind of policy that would work for the company and would also be acceptable to the shareholders.
Regarding your second question, the demand has continued to increase in the second half. In the first half, from the supply side, we see that there had been reduction in investment in the first half, whereas sales continued to increase. As a result, the suppliers inventory level began to stabilize. Coming from the demand side, then we also see that there has been bigger adoption content per box for SSD. Also there has been a bigger increase in content per box for mobile SSD as well.
We believe that it is this change in the supply-demand situation that has driven up price. Since there has been general improvement in supply and demand situation, we believe that the price increase will continue for some time. Now, having said that, because of the macroeconomic circumstances, there is always a risk of the market volatility increasing all of a sudden.
Thanks to the stronger price and also our continued efforts to reduce the cost. We have been able to improve profitability, but it's not likely that we will turn around to profit in the short term.
I have some questions about your technology roadmap. You did explain a bit about the roadmap for the second half. Can you also explain more about the roadmap for both DRAM and NAND for next year? In relation to that, the EUV for the company. The company has announced the completion of the development for 1z nano, and you also have announced the intent to start supplying this next year without having used the EUV. We see that starting this year, some foundries have started using EUV for their volume production, and it's likely to be applied to DRAM in the very near future. What is the SK hynix's update on the EUV preparation, and what is your plan for this?
About NAND for next year, it seems as if some of your peers, some of the other suppliers, there would be some supply difficulties from the other players next year. What is the company's ramp-up status for the 96-Layer and 128-Layer? What is your plan down the road? Do you believe that you will be able to further widen the technology gap with the other players?
First about the DRAM development roadmap. As has been reported through the media, yes, we did complete the development for 1Z nano, to be more specific, the 16 Gigabit DDR4.
Using this technology, the 1Z nanometer, there would be additional follow-up products to be developed by early and mid-next year. For example, LPDDR5. Then the follow-up to that would be 1a-nanometer level. The plan is to develop this by early 2021. Our plan for EUV is to start applying the EUV for volume production of 1a-nanometer. The next technology will be 1b-nanometer, planned for 2022. By this time, the application of the EUV will widen as we move ahead with the development. For NAND, in the second half of this year and the first half of 2020, we will first focus on increasing sales for the 96-layer. For the 128-layer products, we will be focusing more on the customer qualification and mass production in the first half of 2020 for a client SSD and some major clients on the mobile side. The full sales is likely to begin in the third quarter of next year.
G iven that the 96-Layer and 128-Layer share a lot in terms of the structure, we believe that there is going to be a very smooth conversion between the two products in terms of the production. For the investment, we will try to optimize the investment and also maintain the optimum capacity as we continue to strengthen our competitiveness in both the product and cost. Based on that, we will continue to drive business in these products.
We'll take two more questions.
The next question will be provided by Young-Keun Kim from Mirae Asset Daewoo. Please go ahead with your question.
I have two questions about demand. First, the stronger demand on the mobile DRAM side. Do you believe that it is coming from the increase in sets or increase in content? If it is coming from the increase in the sets, depending on the level of sell-through in China, I believe that the mood can change all of a sudden. If it is due to the increase in sell-through, perhaps there are some changes in the structural demand. Which do you believe is the main driver of the stronger demand for DRAM? The second question is about the CPU shortage that seems to persist to this day. With the CPU shortage not going away, do you believe that this is also going to weigh down on the demand recovery?
The first question about the mobile. For the smartphones, and your question was whether the mobile DRAM demand is driven by set increase or the content increase. Obviously it is very difficult to pinpoint where it is exactly coming from between the two. For the smartphone set, there has been negative growth from 2018 which also continued into this year. Next year, we believe that because of the 5G replacement demand, there is going to be set increase by around one percentage point.
For the content side, this year the average content was four gigabytes. Next year, it's expected to be five gigabytes. It's because of the increase in tier and also the high premium smartphones, for example, for the 5G. The increase on average is going to be about 20% for the content. We see the increase in sets by about 1% and content by about 20% level. All of this combined is likely to drive up the mobile demand, mobile DRAM demand next year by 20% level.
The second question about the PC CPU shortage. Now this appears to have been caused by the more concentrated demand on one side than expected out of the overall expected mix between the CPU tiers. It is likely to have an impact on the build or shipment of PC sets in the fourth quarter, meaning that the sudden jump in demand for one particular side, that probably is going to have an impact on the build. Looking ahead for the longer term into next year, we see that from the PC CPU side, in terms of the number, so looking at the numbers from the PC CPU companies, also looking at the capacity that the foundries have secured so far, we see that the CPU is going to increase considerably next year.
This means that in general, and also for the longer term, this is not going to affect the demand for PC DRAM. We'll take one last question.
The last question will be provided by JJ Park from JPMorgan . Please go ahead with your question.
My first question is about your performance in the third quarter and the margin. I see that in the third quarter, sales grew quarter-over-quarter. Margin actually fell. Of course, in the first quarter, there has been some impact from the inventory valuation loss and so forth. In the third quarter, why do you believe that the margin actually fell compared to the previous quarter? Also in the third quarter, I see almost no tax credits or tax breaks. Have there been any tax credits in the third quarter? The second question is, now next year it seems as if there is going to be some unit growth. Because of the increase in the content, also the 5G demand and the inventory normalizing.
Overall, it seems as if there is expectation of demand growing next year, the company is planning to reduce CapEx. Is this because you believe that you'll be able to support the incremental demand just with technological migration, or is there any other reason?
Regarding the financial performance in the third quarter. Throughout the first, second, and third quarters this year, aside from the changes on the profitability coming from the changes in the shipment in ASP, there are no other non-ordinary factors that we can mention. About the tax credit. Yes, you mentioned that in the third quarter, there seems to have been no tax credit or the overall corporate tax has gone down, and one part of it is because of our lower pre-tax profit. As a result, the corporate income tax has also gone down. Aside from that, there were some tax credits that were not reflected in our books, so this was captured the last time in the third quarter, and that is why this has decreased our corporate income tax.
To your question about CapEx. Now, basically, of course, we would have our Fab operations based on the business outlook and the market circumstances, and CapEx would, of course, follow such Fab operation strategy. As we had explained earlier, now the company will, of course, maintain the investment into the infrastructure for future growth. Other than that, let's say for the short-term investment into equipment, we would be flexible about such investment as we keep an eye out for the market circumstances. This stance will continue into next year. For both DRAM and NAND, it is true that there are some signs of change in demand to come. When it comes to CapEx, we still have to be mindful of the external uncertainties that are still persisting. Basically, we are taking a more conservative stance for CapEx next year.
That concludes the SK hynix 2019 third quarter earnings release conference call. Thank you very much for your participation.