SK Hynix Inc

KRX:000660

Earnings Call Transcript 2023-Q2

[Operator]

[Interpreted] Good morning and afternoon and evening. Thank you for participating today. We will now begin 2023 Quarter 2 SK hynix Conference Call. [Operator Instructions] The call will be interpreted simultaneously, while Q&A as consecutive.

With that, we will now begin SK hynix presentation.

[Seong Hwan Park, executive]

[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 2023 Second Quarter Earnings Release Conference Call. Before starting the conference call, allow me to introduce the executives present here with me today. First, Kim Woo-Hyun, CFO; Park Myoung-Soo, Head of DRAM Marketing; and Park Chan-Dong, Head 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' earnings release conference call. Mr. Kim will first present the earnings for the second quarter 2023, followed by the company's plan and market outlook. There will then be a Q&A session with the executives.

[Woo-Hyun Kim, executive]

[Interpreted] Good morning. Allow me to first report to you the company's performance for second quarter 2023. Despite prolonged economic uncertainty and a moderate than expected recovery, second quarter IT demand, size surge in demand for AI-related memory products due to intensified competition in the development and commercialization of generative AI. SK hynix' expanded sales of premium products such as high-density DDR5, high-performance LPDDR5 and HBM enabling the company to achieve shipment volumes above guidance and blended average selling prices higher than previous quarter. As a result, revenue in the second quarter was KRW 7.31 trillion, up 44% from the previous quarter.

DRAM bit shipment grew by mid-30% from the previous quarter due to strong demand for high-end servers as well as some inventory build demand from mobile and PC customers. Blended ASP rose by high single-digit percent sequentially despite the continued price decline of DDR4 driven by the greater sales of premium products.

In particular, our graphics DRAM sales, including HBM products has previously constituted only a single-digit percentage of our DRAM sales. But since reaching 10% of DRAM sales in fourth quarter last year, this portion has grown rapidly to exceed 20% in the second quarter. As such, the sales of our HBM and high-density DDR5 module used for AI servers expanded significantly, contributing to DRAM bit shipment and ASP growth in the second quarter.

NAND bit shipment grew by approximately 50% from the previous quarter due to the expansion of sales across all applications as well as the base effect of low shipment in the previous quarter. ASP fell about 10%.

Although the cost of goods sold increased in the second quarter with rising sales volume, sales and general administrative expense decreased due to cost reduction efforts. The company recorded operating loss of KRW 2.88 trillion and operating margin of negative 39% in the second quarter, reflecting lower inventory valuation losses due to the improvement in DRAM pricing environment.

Having passage through in the first quarter, the memory semiconductor market has started recovering as sales increased and operating losses and margin improved significantly compared to the previous quarter.

In the second quarter, depreciation and amortization was KRW 3.49 trillion, slightly lower than previous quarter due to reduced investments. And EBITDA was KRW 0.61 trillion with an EBITDA margin of 8%. There was net interest expense of KRW 0.33 trillion, and net foreign currency-related loss of KRW 0.52 trillion, including translation loss from investment on Kioxia due to weak yen. Combined, net operating loss was KRW 0.91 trillion.

Net loss before tax was KRW 3.79 trillion, and net loss for the quarter was KRW 2.99 trillion, with net profit margin of negative 41%.

Consolidated cash balance at the end of second quarter was KRW 7.49 trillion up KRW 1.35 trillion from the previous quarter. Interest-bearing debt was KRW 30.81 trillion, increasing by KRW 2.05 trillion from that of previous quarter. Debt-to-equity ratio and net debt-to-equity ratio at the end of quarter 2 was 54% and 41%, respectively, up from 47% and 37% of last quarter.

Next, I will talk about market outlook and company's plan. Amidst the ongoing uncertainties in the global economic environment, the recovery of memory demand is taking place at a slower pace. Shipments of PC, smartphone and traditional servers have already been corrected downward from the beginning of the year expectation. However, from the second quarter, the market saw strong demand for high-density, high-performance memory and AI servers in addition to higher content growth in IT devices due to price elasticity. AI servers use at least double to 8x more memory compared to traditional servers for faster computational processing and adopt high-performance memory products such as HBM which not only drives demand but also positively impacts profitability.

Customers' memory inventories continued to decline in the second quarter. Additionally, with impact of production cuts gradually materializing since the second quarter, there was a slowdown in the decline of memory prices compared to the first quarter.

In the latter half of the year, demand is expected to improve compared to the first half due to seasonality and release of new mobile products. With greater effects of production cuts to materialize, supply-demand conditions are expected to further improve.

Looking at the demand by application in the PC market, channel inventory decreased on back of promotional events in second quarter. And sales volume have improved compared to the first quarter. However, this was mainly driven by replacement demand of Chromebooks and low-end laptops, so impact on memory content was limited.

In the second half of the year, although macro uncertainties persist, demand is expected to increase compared to the first half, mainly driven by enterprise and gaming PCs. Improvements in mobile demand following Chinese reopening has been rather subdued falling short of expectations at the beginning of the year despite large-scale promotions in the second quarter. However, smartphone demand is expected to improve in the second half of the year following new mobile product launches by memory customers and strong content growth from lower memory prices.

Additionally, as demand growth is centered on flagship products, the demand for high-density and high-performance LPDDR5 is expected to expand meaningfully.

The server market is expected to be rather slow this year due to reduced corporate IT spending stemming from concerns on economic downturn and inventory adjustments by CSP companies. However, the generative AI-triggered demand for high end servers has increased rapidly since the second quarter. And accordingly, the demand for high-density DDR5 and HBM products is also growing rapidly.

This year, with reduced level of corporate investments, customers are focusing on investing in costly AI servers, and thus, the investment in traditional servers may decline temporarily. However, general purpose servers will still be widely used for the development, deployment and operation of AI service, and thus in the long run will stimulate demand growth for general purpose servers as well.

With AI server market growing at an average annual rate of 30% in the medium to long term, overall demand for servers, including general purpose servers, is expected to grow at an average annual rate of high single-digit percent level. Given such market outlooks by application, this year's demand is expected to grow by mid- to high single-digit percent for DRAM and mid-teen percent for NAND, similar to the forecast of last quarter. The company will actively support demand for high-performing premium products, leveraging our technological competitiveness.

In the third quarter, the company is planning for a low- to mid-teen percent bit shipment growth in DRAM and flat bit shipment growth for NAND sequentially due to high base effect. For DRAM, we will continue to support demand for high-density products and HBMs and expand sales of DDR5 and high-performance LPDDR5. For NAND, we will expand sales of 176-layer-based SSD products, thereby continuing the revenue growth trend.

Memory demand has been recovering since second quarter from its record low growth levels seen last year, but the recovery is still insufficient to normalize the industry-wide elevated inventory levels seen since second half of last year. In particular, due to high inventory levels and lower profitability of NAND compared to DRAM, the company has decided to further reduce NAND production and anticipate this to accelerate the normalization of inventory levels.

The company continues to invest as planned where this year's consolidated investment is to be reduced by at least 50% compared to 2022. Within significantly reduced level of CapEx this year, the company is striving to secure capacity as well as investment for high-density DDR5 and HBM3 through efforts such as productivity improvement, accelerating equipment delivery time and cutting investments in other areas.

The impact of the industry-wide supply cuts which started end of last year is gradually being materialized, and additional reductions are being made according to market demand. The effects of the reduction will become more pronounced in the second half of the year compared to the first half. And due to the reduced production capabilities of this year, balance of demand and supply is expected to become tight next year.

Use on our 1A nanometer DRAM and 176-layer NAND have reached mature yields for most of our products. And our next-generation 1B nanometer and 138-layer are ready for mass production. These products will begin production at small scale this year and have their shares expanded when demand improves next year.

In the second quarter, by transitioning our 1A nanometer competitiveness to 1B nanometer, the company provided Intel with market's fastest 1B nanometer-based server, DDR5, for validation. The 1B nanometer DDR5 applying high-k metal gate process consumes more than 20% lower power than 1A nanometer. In the first half of next year, the company will continue to strengthen technological leadership from 1B nanometer to LPDDR5T and HBM3E.

This year, DDR5 and HBM market, where the company has competitive advantage is seeing significant growth. The company offers a wide range portfolio of 1A nanometer-based DDR5 products being the sole company to have its 16-gigabit, 24-gigabit and high-density modules of 128 gigabytes and above validated. Furthermore, our HBM products are now offered up to 24 gigabytes HBM3, the highest density available with 12 layers stacked, a world-first achievement.

Drawing on this competitiveness this year, sales of high-density 128 gigabyte and above DDR5 server modules and HBM is anticipated to grow by over twofold from the previous year, and expect to grow further next year. Our strong full lineup of 1A nanometer-based DDR5 products, along with our high market share and competitiveness in HBM will help us continue to strengthen our leading position in the AI memory market.

Next, I will explain the company's ESG activities and performance. The company recently released its sustainability report 2023, which highlights our ESG activities, achievements of the past year of 2022 as well as future commitments. In 2022, SK hynix significantly increased its company-wide renewable electricity usage rates from 4% in 2021 to 29.6% in 2022. Additionally, the company achieved platinum 0 waste-to-landfill designation, the highest achievable level by diverting 100% of waste away from landfills for all domestic sites. Detailed information on SK hynix' ESG performance in 2022 can be found not only in the sustainability report, but also through the company's sustainability reporting system.

Furthermore, SK hynix has completed on-site evaluations of key high-risk suppliers across the supply chain which the company initiated in 2022. This is a follow-up from the ESG Online self-assessment results of the supply chain conducted last year. The task identified through this on-site assessment will be managed through regular monitoring for further improvement.

SK hynix plans to improve the bi-annual supply chain evaluation process, which involves supplier assessment and SK hynix' on-site evaluation in order to strengthen the ESG capabilities of the company's partners across the supply chain. Thank you.

With that, we are now ready to take your questions.

[Operator]

[Interpreted] [Operator Instructions] The first question will be provided by Subin Lee from CGS CIMB.

[Subin Lee, analyst]

[Interpreted] I have -- this is a 2-part question. Now the first part of my question is about the bit growth. So we see that the bit growth in the second quarter has outperformed the guidance. But given the fact that the IT demand recovery is yet to catch up, what do you believe -- what does the company believe were the factors that drove the customers' purchases? And does the company also believe that this trend is going to continue into the third quarter of the year? And the second part of my question is about the revenue mix for the HBM and DDR out of DRAM in the second quarter. And what does the company believe that they will be by the end of the year?

[Unknown Executive]

[Interpreted] Now let me first answer the first part of your question. Now in the second quarter, there was a big growth in the AI demand for the company's DRAM. And as a result, there was more than double growth in the shipment of the DDR5 and the HBM. So I would say that it comes down to the company's fundamental competitiveness in our products.

And also at the same time, there was some inventory build demand among the PC and mobile customers whose inventory level had dwindled in the first quarter. And we see that for the PCs, the channel inventory is improving. And also for the mobile consumers, there was a higher preference to purchase flagship products. And as a result, there was also some recovery in the demand for high content memory.

And now for NAND, it appears that the demand uncertainty is going to continue throughout the year. And also given the fact that we still need to improve the inventory soundness, we have tried to maximize sales across all applications.

And also for the -- and also in the third quarter, we believe that the server demand for AI is going to keep increasing, especially for high-density DDR module and the HBM. And also the demand for high -- among the mobile customers, demand for high-density memory is becoming more and more visible. So we believe that in the second quarter and so moving on from the second quarter into the half of -- into the second half of the year then, we believe that the demand is going to remain as healthy as the second quarter.

Then for NAND, there was a very high base effect. And as a result, the shipment remained almost flat from the second quarter. And then looking at the bit growth, then we believe that in the second quarter, there was also some adjustments from then but we believe that there is going to be some -- so we will continue to try to increase sales based on the real demand and better application mix.

Now for your question -- the second part of your question about the revenue share by the HBM and DDR5, now as was also explained during the presentation, for the graphic DRAM including HBM, the revenue share has grown precipitously since the fourth quarter of last year, so much so that it has now gone over 20% out of the total DRAM revenue.

Now for the DDR5, we see that the demand for DDR4 continues to soften. So we are very quickly switching to DDR5 production, although we cannot give you the specific number at this time. But I can say that compared to the market, I would say that our mix strategy is about 2 quarters ahead.

And then about the HBM and the high-density DDR, -- in other words, the products for AI. Now as I believe I have also mentioned this in the last earnings release conference call, but then again, we believe that the revenue for these 2 products are going to more than double. And we will continue to see growth in the revenue of these 2 products more so in the second half than the first half of the year. So for the year, it is likely that the 2 product share is going to top 20%.

[Operator]

[Interpreted] The next question will be presented by Minbok Wi from Daishin Securities.

[Minbok Wi, analyst]

[Interpreted] I also have 2 questions. First is about the demand. So for the DRAM demand, the company once again projects mid- to high single-digit growth. But then according to the other, let's say, analysis organizations, then they are downward adjusting the demand forecast. So I wonder why the company is a bit different from this trend? And does the company believe that there is going to be further adjustment in the demand projection? And also for the 2024 does the company believe that demand will begin to normalize? And the second part of the question is about the HBM. So is there any specific technical road map for the HBM following the HBM3? And what does the company believe are the differentiators for its HBM product to the other players?

[Unknown Executive]

[Interpreted] Thank you very much for the questions. First, about the demand. Now the macro uncertainties are persisting, and we see that the soft demand continues across all applications, which is likely to continue. So this has been -- so -- sorry, so let me repeat. So macro uncertainties are persisting. So we see that the demand remains softer across all applications than we had expected at the early part of the year. And as a result, the company has also downward adjusted its demand forecast, which we have already announced in the last earnings conference call. And we believe that this demand forecast, which has been downgraded is going to stay.

And you see that from the early part of the year, demand has remained weak for smartphones, PCs and servers. But then starting in the second quarter, demand for AI servers has risen sharply offsetting some of the loss in the demand in other products.

And moving into the second half of the year then, there is going to be a new launch of mobile products. So we believe that compared to the first half, the second half demand is going to recover. And then moving into next year, although macro uncertainties will remain, so the demand improvement is also going to depend on the circumstances. But given the fact that demand has remained soft for the past 2 years, there's likely that there's going to be stronger replacement demand for smartphones and PCs. And also for general purpose servers, because the purchases of these servers had also been sluggish in the past few years, it is highly likely that there is going to be a recovery next year.

Now let me respond to the second part of the question, which is about the HBM roadmap after HBM3, as well as the company's competitiveness and allow me to focus on what we are doing. Now for the HBM roadmap, what is important is for us to be in alignment with the graphic processor launch or the schedule by the companies that are leading the accelerator market. And looking at the past 3 years of trends, for example, the move from HBM2E to HBM3 and then also looking at the adoption planning for the HBM3E, then we see that the product life cycle is quite fast at an interval about 2 years. So given this, then this means that there is going to be a shift towards HBM Gen 4 sometime in 2026. And based on this assumption, the company is also making the appropriate preparation.

Now about the customer feedback, we see that in terms of the time to market as well as the product readiness and the quality of mass production as well as the field quality, so in all these categories, the customers believe that SK hynix has leadership and has advantages. And that, we believe, is owed to the experience and the technological competitiveness that we have been accumulating ever since we launched the first HBM quite early in market. So based on these advantages, the company intends to keep leading the market.

[Operator]

[Interpreted] The following question will be presented by Myung Sup Song from HI Investment & Securities.

[Myung Sup Song, analyst]

[Interpreted] I also have 2 questions about HBM. Now of course, for the long term, I believe that there is no disagreement that there is going to be a sharp increase in the demand for HBM. But then now when we look at some of the big tech movement, then in order to launch more LLM services, they are investing very quickly and very intensely into this field. But then after the investment is pretty much completed by the first quarter or the second quarter of next year, then there are some concerns that there might be some idle period in investments, meaning that there could be some dampening of the very fast-growing demand for HBM by that time. So there are some concerns that the HBM demand is going to somewhat slowdown in the second half of next year. So what does the company see, what does the company think about this projection?

And the second question is about, again, the HBM. Now of course, the company currently has a near monopoly on the HBM3, but then there are some news and press news about how another player, a competitor, is going to jump into this market in the second half of the year. And also, the rumor is that the competitor is offering a 2.5D package together with the HBM. Now given the fact that the competitor does have a shortage in TSV capacity at this time, it is likely that hynix is going to maintain the comparative advantage for the time being. But still, this probably means that the competition landscape is going to somewhat change starting in the first half of next year. So again, what does the company see about this news?

[Unknown Executive]

[Interpreted] Now, thank you very much for what is quite a complex and difficult set of questions, but I would like to respond faithfully to the best of my ability and my knowledge. Now, I believe that what was inside your question was about how the cloud companies or the platform companies are very fastly increasing their CapEx investment to be followed by an idle period in investment which could be something like a chasm for memory companies. And I must say that we cannot take the possibility off the table entirely. But then since you also asked about the projection into next year, now for the -- for our customers, we believe that we do have some visibility into their long-range planning. And that is because now, of course, for the platforms, what they are currently focusing on is about training of the -- for the AI. So in order to prepare the AI server and to launch the services in the market, this means that they also need to keep making improvements and strengthen their inference servers as well.

Now having said that now, if this were to take place across different platform companies at different time intervals, then we believe that this is going to be -- this is going to mean that even if there is a chasm, it is going to be short or very weak because if it's just a single company, then yes, there would be a period of investment followed by harvest and then reinvestment, but then given that there are several platform companies making such investment and going through these iterations, then that also means that, again, the chasm, if there is one, then it is likely to be quite short and weak.

Now another factor that we have to consider is about the technological development trend. Now of course, in terms of the background to the demand, then it is difficult to predict what the actual demand -- what the actual development pathway or the scope is going to be. But now on one hand, it is true that today, it's mostly LLM based -- led by, for example, ChatGPT. But then we believe that it is ultimately going to go the path of personalization, meaning that there are going to be customized services arising from the AI services. And also, when we look at specifically the enterprise services like MS Copilot, then they would come pretrained. But then this would also mean that in order to provide -- in order to keep providing the services, then they would have to have real time and almost ongoing training. So that means that even if there is going to be some breakage in the investment, again, that is not going to last long.

And another factor that we have to consider is not only the platform but also the applications or the APIs that would be placed on top of them, which are only in the beginning phase. And they also have the potential to be connected with commerce, meaning that they could also potentially lead to explosive growth. So they could serve as the base demand and also given the growing competition on the platform side, then again, I would say that all these factors lead to the conclusion that even if there is going to be a chasm, it is going to be short-lived.

And now so you asked about whether there is going to be some break in investment and that there are concerns about slowdown in demand, perhaps in the second half of next year. So I would like to respond to this. Of course, you also asked about competition movement, but then I must say that it's not appropriate for us to comment on the competitor. So again, looking ahead to the second half of next year, then according to our roadmap, then that is going to be the period of mass production of HBM3E and also expansion of supply of HBM3E.

So in our discussion with the main customers, that is the assumption. And also when we look at the capacity planning as well, then we believe that the growth in the HBM demand is going to stay quite healthy well into next year. But then 1 caveat is about the high-density module because this is an area where the CapEx investment might be a bit burdensome for the platform company. So I believe that for the high-density module CapEx, the platform companies would have to perhaps think through this further.

[Operator]

[Interpreted] The following question will be presented by J.J. Park from JPMorgan.

[J.J. Park, analyst]

[Interpreted] Since most of the questions have been about HBM, let me ask something else. Now in the second quarter, we see that the bit shipment growth was quite rapid for both DRAM and NAND, but especially for NAND. Then what was the level of inventory at the end of the second quarter? And then also for the inventory valuation loss in the second quarter, what was the extent of the loss? And for the DRAM price, it seems as if the -- there is now some recovery in the price as well. So what does the company believe is going to be the extent of the price recovery?

And the second question is about the news about consolidation between Western Digital and Kioxia. So what would be the company's view regarding this potential consolidation given that the company is also a shareholder? And a point of clarification. In terms of the share of the HBM, so was it 20% by HBM plus Graphic or was it over 20% for HBM plus high-density DDR5?

[Unknown Executive]

[Interpreted] Now then first about the clarification, so for the 20% in the second quarter, so that was HBM plus Graphic segment because the company segmentation is by PC, server, mobile, graphic. So then in this case, we meant the segment that includes HBM, which is the Graphics segment.

Then allow me to respond to your question about the inventory level. But first off, please understand that I cannot give you the specific numbers.

At the end of the second quarter, the company's inventory level fell slightly as a result of growing sales and the effects of production cut. But again, we see different trends by product category. So where the demand is strong, for example, DDR5 and HBM, then of course sales grew and the inventory level has gotten lower. But then where the demand remains soft, like DDR4 or LPDDR4, then we see that the downstream demand continues to remain weak, meaning that the recovery also has been quite slow. So for these products, the inventory level remains not low.

Now in the second half compared to the first half, we believe that as demand continues to strengthen and the effects of production cuts continue to spread, then by the end of the year, the inventory level is going to be lower than what it is now.

Now allow me to respond to another part of your question, which is about the inventory valuation loss, what was the extent of it, and are there any possibility of additional losses. As you would know, in the second quarter, NAND prices continue to fall. Despite this, the company recognized about KRW 500 billion in inventory valuation loss, which is considerably lower than what it was in the first quarter.

And then whether there is going to be additional recognition of inventory valuation loss, well currently the expectation is that inventory reduction is going to accelerate in the second half even as the prices continue to stabilize. So we believe that at this time, there is the likelihood of additional valuation loss is going to be low. And even if it does happen, meaning that even if there is additional recognition of the loss, the extent is going to be minimal.

And for certain products, there's also the possibility of reversal in the inventory valuation loss, in which case, it is going to, of course, be positive in the company's recovery of the profitability.

And now for your question on the potential consolidation between Kioxia and Western Digital. Now as we all know, the NAND business now is struggling in quite an adverse environment. And perhaps as a result of this, there have been some news reports about the potential consolidation between Western Digital and Kioxia, and about how the negotiations are now picking up pace. Now for the company, we are keeping an eye on the situation and keeping -- we are very closely monitoring the situation. But as far as we understand, there have been no specific terms of consolidation that have been agreed on.

And about what kind of impact the consolidation would have on Kioxia, if it does happen. The company is also very closely reviewing the different possibilities and scenarios and we will define our position after reviewing all the relevant information.

[Operator]

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

[Nicolas Gaudois, analyst]

The first 1 is considering the upside in DRAM higher-density DDR5 and HBM demand, how will you address requirements for more 1A nanometer and below capacity to support that? In particular, would you actually accelerate potentially technology migration in your capacity in Korea, such as M14 from here and into 2024, and possibly even considering some new capacity in M16 at some point next year. And could that, therefore, trigger an overall increase in capital spending next year as well for DR.

And then secondly, could you update us on your utilization rate reductions. I think you mentioned in the presentation that you took further steps for NAND flash in particular. So could you try to first to quantify this for both DRAM and NAND where we are now? And where would you expect to be by the end of the year as well for both DRAM and NAND Flash for capacity, for production reduction.

[Unknown Executive]

[Interpreted] First of all, thank you very much for your questions. Now then let me respond to the first part of your question, which is about the 1A-nanometer tech migration or tech development plan, as well as potential investment next year.

Now the company is already -- has already adjusted slightly the tech -- the capacity mix by technology from the year -- early part of the year planning. So again, I mean, we have already just made adjustments to the planning that we have made from the early part of the year regarding the capacity mix by technology so as to respond to the growing demand for high-density DDR5 and HBM.

For this year, what we are focusing on is increasing the portion of 1Z nanometer, which we need to increase the mass production of HBM. And then we are also preparing to increase the capacity for 1B nanometer and TSV capacity to prepare for the HBM3E that is to be supplied starting in the first half of next year.

Now to that end, we are reducing investment in other categories within the investment scope that is given for the year, again, to better respond to the growing demand for HBM.

But looking ahead to next year, then in order to maintain our technological competitiveness and to sufficiently respond to the continuous growth in demand, the minimum level of investment that we have for this year is probably not going to be sufficient next year. For now, the company's priority is on investing to increase mass production of HBM. And then across the company rather than capacity increase, we would focus more on tech migration, meaning that we would be focusing more on improving the efficiency of our CapEx.

And moving on to the second part of your question, which was about the plan for production cuts. The company has been undertaking production cuts from the fourth quarter of 2022, mostly for legacy products as well as low-margin products. Now for the year 2023, the production for both DRAM and NAND are going to be lower Y-o-Y. Especially for NAND, as was explained earlier, its inventory level remains higher than that for DRAM and its profitability margin is also quite sluggish. So as a result, we have decided on an additional production cut of between 5% to 10%.

[Operator]

[Interpreted] The following question will be presented by Giuni Lee from Goldman Sachs.

[Giuni Lee, analyst]

[Interpreted] I also have a question about investment. Now of course, the company must continue with the investment in order to maintain its leadership in the rapidly growing HBM and DDR5 markets. But also because of the free cash flow and the balance sheet having yet to recover, there are also some concerns that the company might potentially fall behind competition. So then in order to prepare for this, then are there any specific plans for funding or investment that the company currently is considering? And if there are, then if you could provide us with more details, then that would be appreciated.

[Unknown Executive]

[Interpreted] Again, thank you very much for the questions. Now allow me to respond to your question about investment and funding. Now as we all know, adverse market conditions are continuing. Now the external uncertainties persist and customers' demand as well as prices remain soft. And the company is making preparation and is trying to address the current situation by adjusting the mix around higher profitability and also reducing costs and reducing investment in facilities.

And also, I must emphasize that the investment necessary to respond to the customers' demand for DDR5 and HBM3 is underway as planned. So investment on that front, the DDR5 and HBM3, is underway. It's continuing. But then as I explained earlier, for the company on the whole, for the group on the whole, then investment scale is about 50% lower than last year's, which has already been announced, and this is going to stay. Now the company has already secured some resources from preemptive funding in the early part of the year. And given the fact that sales have been rising since the second quarter with a limited investment, as well as cash expenditure, we believe that the cash flow is going to continue to improve in the second half.

So because of this, in terms of financing, then in the second half, there is not going to be large-scale financing that we have had in the first half aside from part of the refinancing. Now having said that, of course, we would be responding flexibly to any changes in the macro environment as well as the market situation.

[Operator]

[Interpreted] The following question will be presented by Sung Kyu Kim from Daiwa Securities.

[S. K. Kim, analyst]

[Interpreted] Now, I also have 2 questions. First is about the company's production in China. Now with the U.S. Chips Act being enacted, it appears that there will be some constraints in increasing capacity in China and also investing in the Chinese facilities. Then in October, the 1-year grace period is going to be expired, then does the company believe that they can -- it can be extended. So overall, the question is about an update on the company's production in China.

And then the second question is now looking at the different businesses, then yes, it is true that the AI demand for DRAM remains quite strong. So the company is responding quite favorably to this, thanks to its technological competitiveness in such products as HBM3 and DDR5. So it appears as if the company is set to recover its profitability earlier than expected. But that's for DRAM. And looking at NAND, then it appears as if it is very difficult to narrow the losses, and it seems like the difficulties are continuing for NAND business. So then for the NAND business, how does the company plan to address this? And if you could just give us an overall update about the NAND business as well.

[Unknown Executive]

[Interpreted] Thank you for the questions. Let me first give you an update about the grace period about the restriction against export of equipment to China. Now the company is currently looking into the various aspects of our plan in Chinese operations looking at such factors as the long-term geographic risks, market demand and efficiency in fab operations. And to ensure stable business operations, the company is currently engaging in very close consultation with the different stakeholders, including the government of different companies in relation to the export of equipment as well as control thereof.

And allow me to respond to the question about NAND business. As your question has rightly observed, for NAND, the impact or the benefit from the upside in surging demand for AI servers is less so than in DRAM. And also across the industry, the investment level still remains relatively high. So again, the inventory level across the industry remains high for the NAND business. So as a result, how the company plans to address this is, now in addition to the production cuts that have been announced already, the company will undertake further production cuts in order to accelerate the normalization of inventory.

And another area where we will work on is enhancing efficiency as well as reducing costs. So across the group, we will strengthen the management of CapEx and OpEx and we will also try to reduce further redundant costs between our NAND business and Solidigm, for example consolidating some of the redundant individual capabilities and simplifying some of the cost structure as well.

So in the second half, we will focus on improving the profitability by trying to sell more in response to real demand and improving the application mix. And also for the high value-add products like the eSSD 16 channel, we would also try to improve -- increase their mix out of the total products so that once there is improvement in the market, then we will be able to quickly make improvement on our profit and loss status. And also, we will strengthen the competitiveness of SoC like controllers.

We will take 1 last question.

[Operator]

[Interpreted] The last question will be presented by Dong Hee Han from SK Securities.

[Dong Hee Han, analyst]

[Interpreted] I also have 2 questions. First is about the HBM. Now HBM itself appears to be somewhat like a contract-based business. So does the company believe that based on this business model, the company will have some bargaining power in terms of the pricing?

And the second question is about the HBM demand. With the demand for HBM rising very sharply, then it is likely that it could also smooth out the profit variability at different cycles. And does the company also believe that this would have an impact on the DRAM market share as well?

[Unknown Executive]

[Interpreted] I see that HBM is the focus of intense attention today. I believe that the question was about whether the company will be able to maintain its price bargaining power for the long term. Now for products like HBM, which is a system in package type, then from the very beginning of product planning, we would have close collaboration with the customers as well as the related companies for development cooperation. It would also require large-scale R&D resource input, meaning that it is the kind of business that would require dedicated investment. And then also in terms -- so we would then also look at the appropriate ROI across the life cycle, which I mentioned was around 2 years. So based on these factors, then we would also set the pricing. And this negotiation is conducted almost on a yearly basis.

Now in other device businesses, then there is a separate validation process, meaning that the process company would validate the memory ahead of time. But then for the HBM, that goes to the accelerators. And as I mentioned earlier, the planning is done with the customers, meaning that the planning, as well as the validation, pretty much occur at the same time. So the capacity is also -- so capacity within the value chain is also predetermined. So this is conducive for such long-range planning.

And down the road, as we move on to HBM4, the ecosystem is likely to become even more complex. So yes, the business model that is different from the off-the-shelf devices is likely to be maintained. And this also means that given its nature of that is similar to a contract-based business, then the question was whether it is going to smooth out the profit variability. And we believe that the answer would be yes, given its contract-based business nature as well as the pricing structure.

And about the second question on whether this will also have an impact on the overall DRAM market share. Now on one hand, growth inside the market is almost a given. And then -- so it depends on the company's product competitiveness as well as the supply competitiveness. So if we maintain our competitiveness on both fronts, then I believe, yes, it would also have a positive impact on the company's market share and even the bit share.

[Seong Hwan Park, executive]

[Interpreted] Thank you very much. That concludes the SK hynix 2023 Second Quarter Earnings Release Conference Call. Thank you very much for your participation.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]