MediaTek Inc

TWSE:2454

Earnings Call Transcript 2022-Q2

[Operator]

Welcome, ladies and gentlemen, to the MediaTek 2022 Second Quarter Investors Conference Call. Financial results and presentations for today's call are available on the Investors section of the company website at www.mediatek.com.

And now I would like to turn the call over to Ms. Jessie Wang, Deputy Director of Investor Relations. Ms. Wang, please go ahead.

[Jessie Wang, Deputy Director, Investor Relations]

Good afternoon, everyone. Joining us today are Dr. Rick Tsai, MediaTek's CEO; and Mr. David Ku, MediaTek's CFO. Mr. Ku will report our second quarter results, and then Dr. Tsai will provide our prepared remarks. After that, we will open for Q&A.

As a reminder, today's presentation will provide forward-looking statements based on our current expectations. The statements are subject to various risks and factors, which may cause actual results materially different from the statements. The presentation material supplement non-TIFRS financial measures. Earnings distribution will be made in accordance with financial statements based on TIFRS. For details, please refer to the safe harbor statement in our presentation slides.

In addition, all contents provided in this teleconference are for your reference only, not intended for investment advice. Neither MediaTek nor any of independent providers is responsible for any actions taken in reliance on content provided in today's call.

Now I would like to turn the call to our CFO, Mr. David Ku, for the second quarter financial results.

[David Ku, Chief Financial Officer]

Okay. Thank you, Jesse. Let me start with a quick update for 2022 quarter financial results. The currency here is all in NT dollars. Revenue for the quarter was TWD 155.7 billion, up 9.1% sequentially and up 23.9% year-over-year. Gross margin for the quarter was 49.3%, down 1 percentage point sequentially and up 3.1 percentage points year-over-year. Operating expense for the quarter were TWD 37.6 billion compared with TWD 35.3 billion in the previous quarter and TWD 29.2 billion in the same period last year. Operating income for the quarter was TWD 39.2 billion, up 7.4% sequentially and up 35.9% year-over-year. Non-TIFRS operating income for the quarter was TWD 40.5 billion.

Operating margin for the quarter was 25.2%, decreased 0.4 percentage points from the previous quarter and increased 2.3 percentage points from the year-ago quarter. Non-TIFRS operating margin for the quarter was 26%.

Net income for the quarter was TWD 35.6 billion, up 6.6% sequentially and up 29.1% year-over-year. Non-TIFRS net income for the quarter was TWD 36.8 billion. Net profit margin for the quarter was 22.9%, decreased 0.5 percentage points from the previous quarter and increased 0.9 percentage points from the year-ago quarter. Non-TIFRS net profit margin for the quarter was 23.6%.

EPS for the quarter was TWD 22.39, up from TWD 21.02 in the previous quarter and up from TWD 17.44 in the same quarter last year. Non-TIFRS EPS for the quarter was TWD 23.1. A reconciliation table for our TIFRS and non-TIFRS financial measures is attached in our press release for your information. And that concludes my comments. Thank you.

[Jessie Wang, Deputy Director, Investor Relations]

Thank you, David. And now I would like to turn the call to our CEO, Dr. Rick Tsai, for prepared remarks.

[Rick Tsai, Chief Executive Officer]

Good afternoon, everyone. Second quarter was another solid quarter for MediaTek. Quarterly revenues grew 9.1% sequentially, reaching the high end of our guidelines -- our guidance, with mobile phone growing the strongest, driven by the ramp of our flagship and high-end solutions.

Before I give you an update of each of our three revenue groups, I would like to make a few comments on the recent market environment. In recent months, macroeconomic challenges and uncertainties to market demand. For example, inflation negatively affects consumer benefit, leading to reduction of IC demand. Accordingly, we have already observed our customers and their distribution channels start to adjust inventory aggressively. And we expect the inventory management to continue for two to three quarters.

In this environment, MediaTek will manage our inventory prudently and control our cost and expenses carefully. Over the past 25 years, we have gone through several cycles. Although each cycle was different, for the semiconductor industry's relentlessness, pursuit of better connectivity as well as high-performance and low-power computing remains the same. Responding to the long-lasting demand trend, MediaTek has been heavily cultivating and developing key technologies to grab enabled MediaTek launch 5G, WiFi 6 and WiFi 7 early in the product cycle with advanced technologies.

As a result, MediaTek today is in a much stronger global position as industry technology leader with a broad product portfolio across mobile, smart edge platform and power IC. Among which, we have built several sizable businesses that demonstrate steady growth with much lower volatility, even during market downturn. For example, our leading position in smartphones, wired and wireless connectivity and TV, are results of structured market share and profitability enhancement in the past few years. We believe we can maintain such market positions despite cycles.

We also have businesses such as power IC and connectivity solutions, which are employed with a wide range of applications with historically more label demand. Therefore, we believe MediaTek will be much more resilient to market volatilities than previous cycles.

Moreover, we will continue to make the short-term market uncertainties. We believe this effort will further strengthen our market position and pay dividend going forward.

Now let me move on to our three revenue group. In second quarter, our mobile phone business grew 17% year-over-year and 12% quarter-over-quarter, accounting for 54% of total revenue. The strength mainly came from the ramp of our flagship and high-end 5G products as well as very robust 4G demand.

MediaTek 5G products are highly welcomed by customers. According to market research report, during the 618 China shopping festival, 13 out of the 20 top-selling Android models are powered by MediaTek. Among which, WiFi using our flagship, a high-end Dimensity 9000, 8100 and 8000 solutions.

Our higher-end solutions continue to gain share. We will continue to launch best generation flagship products with our leading computing capability and optimal power efficiency to further expand our presence in the flagship market.

Considering market uncertainties, we now expect mobile smartphone shipment in 2022 to be 1.2 billion to 1.27 billion units. Global 5G shipment is expected to be around 600 million, representing a 20% year-over-year growth.

Meanwhile, 4G smartphones remained attractive to budget-conscious and to amidst high inflation concern. For MediaTek, our successful global expansion in both 4G and 5G as well as 5G flagship entry will enable us to deliver a solid growth this year.

Moving forward, we believe the 5G penetration will continue to grow from 50% this year to more than 80% in a few years. In addition, the functionality of future 5G phones will be richer than those of today. Consequently, MediaTek is well positioned to continue to capture the benefit of 5G transition.

Now let's move on to Smart Edge platform, which accounted for 38% of revenue in the second quarter. This group grew 33% from last year and 7% from last quarter, driven by continuous technology upgrade of several major products, including WiFi 6, 5G modem, TV and ASIC for gaming console reach. However, due to weaker consumer sentiment, the demand for TV and tablet has been negatively impacted. Nonetheless, demand for wired and wireless connectivity solutions, particularly WiFi 6, 5G modem and 10G phones remain robust.

Moving forward, we have planted several feeds for our future growth. For example, MediaTek industry is introducing WiFi 7 solutions, which enable us to address the needs of high-end market assessments with revenue starting in the first quarter of 2023. We have recently expanded our footprint into enterprise 5G infrastructure at ASIC. We also continue to enhance our capabilities in our efficient ARM-based processors to address a wide range of new applications. With a rich set of product portfolio, we are positioned to address the market needs.

We expect our Smart Edge group will be a successful growth driver for MediaTek in the coming years.

Now moving on to power IC, which accounted for 7% of total revenue in the second quarter and grew 33% from last year and flattish quarter-over-quarter. Recently, we have observed a weakening demand for power IC use in smartphone and notebook. However, the power IC used for automotive and industrial applications, which account for about 10% of our IC revenue, remains on track. Moving forward, active connectivity and more powerful computing require energy efficiency and reliable power IC solutions. We believe MediaTek, through our broad product portfolio and superior technology solutions, is well positioned to capture the structural growth of power IC.

Now for the third quarter. Given the ongoing customer inventory adjustments, we expect our third quarter revenue to be in the range of TWD 141.7 billion to TWD 154.2 billion, representing a decline of 1% to 9% sequentially and a growth of 8% to 18% year-over-year at a forecasted exchange rate of TWD 29.5 to US$1. Gross margin is forecasted at 49%, plus or minus 1.5 percentage points; quarterly operating expense ratio to be at 26%, plus or minus 2 percentage points. With our diversified product portfolio and industry-leading position, we believe MediaTek can manage a short-term demand headwinds well. We now expect MediaTek to deliver a high teen percentage revenue growth with a 48% to 50% gross margin for year 2022.

Despite short-term demand volatilities for semiconductors, the mid- to long-term growth trend, driven by accelerated digital transformation, remains intact. MediaTek is the leader in the industry. Our investment in key technologies allows us to participate in the technology migration cycle early. We firmly believe MediaTek will continue to capture the growth opportunities brought by the enriched silicon content as well as the expansion of our market globally.

This concludes my prepared comments. Thank you.

[Jessie Wang, Deputy Director, Investor Relations]

Thank you, Rick. Operator, we are now ready for Q&A. May we please have the first question? Thank you.

[Operator]

Yes. [Operator Instructions] The first one to ask questions, Randy Abrams from Credit Suisse.

[Randy Abrams, Credit Suisse]

And a good job in staying resilient given what's happening in the environment. If I could ask a follow-up just to the guidance for third quarter and full year. If you could give a view by segment for the 1% to 9% decline. And factoring the high teens growth, it looks like you're implying a decline in fourth quarter. So if you could give that view by segment. And is it largely the anticipation of what you commented inventory for fourth quarter or any other factors dampening sales into fourth quarter?

[Rick Tsai, Chief Executive Officer]

Well, the short answer is yes, the inventory adjustment period, I think we said will last 2 to 3 quarters. So we are expecting customers to continue adjusting their inventories. And of course, the demand picture for the end customer or the end consumers will remain uncertain. We believe China market demand is stabilizing. We are not sure about speed of the recovery, but we do expect China market to continue going down -- downward. While the U.S. market uncertainty remains, I think, higher many view -- different views. But I think we believe our customers remain quite cautious with such uncertainty in the next couple of quarters. Thank you.

[Randy Abrams, Credit Suisse]

Okay. If I could follow up, the mid-teens CAGR, that was set during good macro and before we're in really COVID lockdowns and inflation. Could you give a view on that? And I think initially, the way you're seeing macro? I know it's a CAGR. So is it your anticipation given the slowdown next? Or we should factor may be a bit more conservative? And then you take a bit more conservative view on OpEx increase through that.

[Rick Tsai, Chief Executive Officer]

You mean take ready [for '22] or...

[Randy Abrams, Credit Suisse]

Yes. I'm thinking how you're now looking at '23. Because I think you started the year with 20% this year and then really the target each year to achieve teams growth, but just factoring the market if we should kind of bake in a more conservative view into next year. Do you -- or do you see product trends that could be enough to maintain a good bit of outgrowth.

[Rick Tsai, Chief Executive Officer]

Randy, I think for 2023, with the current uncertainty in a very dynamic environment, we -- I don't think we are prepared to really comment on 2023 at this moment. We are in the process of doing the planning for next year. I hope we can give you more -- give you, guys, more of our thinking later on. But I think you mentioned also OpEx. Yes, it is, I think, critical that we're managing our CapEx and our inventory and trade also. We have -- we do not have a hire increase, but we have slowed down our hiring quite a bit. And we will -- we are now having a strict OpEx target for next year. We are also managing our wafer, our OpEx business very carefully so that we can at least manage our inventory for the next couple of quarters in a much more stable manner.

[Randy Abrams, Credit Suisse]

Okay. And the last question I wanted to ask on the pricing -- the view on pricing. And it's a 2 part. If you see 5G, the different price levels for the market, flagship, mainstream, mid- to high end, do you see those bands enough new features to keep those bands continue to be more stable? And then how do you see -- if you expect, given desire to bring down inventory and customers, how do you see the pricing a bit more rebating or factor in a bit of margin erosion through the coming inventory direction?

[Rick Tsai, Chief Executive Officer]

I think our position has not changed from our previous statements, our remarks last quarter. We do not see pricing reduction being able to induce new demand. And we -- I think we are exercising a disciplined pricing in the company. We do not -- for fee a pricing reduction in any significant degree at all. Thank you.

[Operator]

Next one to have questions, Gokul Hariharan, JPMorgan.

[Gokul Hariharan, JPMorgan]

My first question is could you talk a little bit more on the inventory levels, especially for mobile, both for MediaTek as well as for your entry customers level? I think last time, you did talk about inventory being in the one to 1.5-month run rate. How elevated are inventory levels for and finished product in the channel based on your evaluation? I just wanted to -- could you also give a little bit more color on how you expect this inventory cycle to work out? I think you've said probably two quarters or maybe three quarters. Just wanted to get a little bit more clarity on how you think that is likely to play out.

[David Ku, Chief Financial Officer]

Let me try to answer this. I think the long story short, based on our view right now, we do believe probably the whole market would take maybe two to three quarters to adjust or digest about inventory levels on the customer hand or maybe it's also including on the inventory on the channel side. And the last time we updated about the inventory is too much stabilize out there. We don't really see it increase significantly. Actually, it's quite on the opposite side because given the overall weak demand out there, the whole supply chain, including our customer and also the inventory and aggressively addressing the inventory level. So we do believe about the adjustment cycle maybe around two to three quarters. It will last probably around two to three quarters.

[Gokul Hariharan, JPMorgan]

Got it. Could you also talk a little bit more about the pricing trend? I think you did answer to Randy's question, but I just wanted to go a little bit more. Typically, most inventory down cycles. [indiscernible]

[David Ku, Chief Financial Officer]

You mean pricing? Again just like the CEO, Rick, talked about earlier, we do believe the weaker demand right now is mainly caused by macro economy situation. And any aggressive pricing movement, [indiscernible] or introduce any structural long-lasting demand, maybe just a short-term demand, but not going to change the macroeconomics for the long term. So we will not actually address our pricing aggressively. I think that's our policy and strategy right now.

[Operator]

I think Gokul has accidentally dropped this line. So we are going to move on to the next one. The next one to ask questions, Bruce Lu from Goldman Sachs.

[Bruce Lu, Goldman Sachs]

I want to follow up the question about the compound growth for the next few years. Rick, you just talked about that because of micro concerns. So we are no longer to maintain our like next two to three years, [about] 10% to 15% revenue CAGR? Or you need to revisit and come out with an updated numbers?

[Rick Tsai, Chief Executive Officer]

Yes. Yes, this -- in light of the current slowdown, I don't think there's any question about that for anybody in the industry. We certainly will have to relook at, and we -- our future several years of the CAGR. Again, as I said earlier, we are now working on 2023. And from that, going on, we will have a much better idea for our future CAGR. The important thing though is the major growth driving business investment and opportunities continue aggressively. We've been putting resources. We are actually reallocating resources from the more kind of -- shall we say a mature business segment into the future growth segments, especially for the next 3 to 5 years. And we certainly expect and look forward to having a strong growth in that period of time.

[Bruce Lu, Goldman Sachs]

Yes. But if you've just mentioned that the inventory collection most likely in 2 to 3 quarters, it just started from now, then the inventory correction should be finished by the end of this year or first quarter next year. That should not impact your market year growth trend too much, right?

[David Ku, Chief Financial Officer]

Yes. Bruce, actually, like Rick say, is right now is there's a lot of moving targets and moving information out there. When we were talking about when to review it, it doesn't mean we're going to revise it substantially. I think that's the one we're talking about. We're just talking about -- it's actually not a prudent way to give any detailed number right now given the market situation, okay? But I agree with you, just like what we talked about earlier, for the long-term growth opportunity, it's actually not changed because the whole digital transformation still continue. We don't really think the short-term cycle adjustment will change the directions of the long-term growth pace.

[Bruce Lu, Goldman Sachs]

Okay. So the next question would be at the inventory cycle. I mean you just mentioned that you do expect it to be finished within two to three quarters. But most of the investors which we talk to, I mean, the confidence level for that is actually fairly low. So can you help us understand why do you believe this is going to be finishing within two, three quarters. It won't last more than 3 quarters or longer. Or what is the possibility to get an even shorter inventory cycle?

[Rick Tsai, Chief Executive Officer]

We -- again, two to three quarters, what we are looking at, I think different customers and depending on their own situation, will have their view. We follow -- we actually -- we look into each issue of our major customers' inventory level very carefully each month. And that's how we come up with our estimates. But the -- whether -- but you have to also realize the macro economy picture certainly is the biggest factor. We believe inventory level will go down in two to three quarters. We also believe the China market will gradually recover. The U.S. market is something that we do not have really a good pictures right now. So that's why we need to move month to month, quarter to quarter. Thank you.

[Operator]

Next one, we have Gokul Hariharan, JPMorgan.

[Gokul Hariharan, JPMorgan]

So I'll just ask one question. So MediaTek announced the foundry deal within [the 16-nanometer]. Could you talk a little bit about the contours of this deal? Is this a regular foundry deal that you're expanding, the [indiscernible] ? Or are there any more product collaborations also that are planned with Intel on WiFi and connectivity given that you already have a 5G modem relationship with them?

[David Ku, Chief Financial Officer]

Okay. I think we kind of made that announcement already, but let me just take this opportunity to explain in detail again. The major reason or major rationale is we -- MediaTek always been a multiples foundries strategy on the mature technology. So for this time around, I think we are using Intel 16, which is this roughly [22 nanometers] on the T like process. For that process, we do believe globally right now is still kind of in shortage. So it's actually one of our policy or strategy, trying to find more vendors and more capacity for two to three years down the road.

In terms of the product, we need to take out there, I think most likely it will be either digital TV or a mature WiFi analogy. But with all that, I guess, on a leading edge node, we still work very closely as a very close partner with TSMC. I understand out there, there's a lot of speculation or estimation of guesstimation talking about a data link with some kind of business deal. I just want to reemphasize actually, that's mainly from a capacity planning perspective.

[Operator]

Right now, we have Laura Chen from Citigroup to ask questions.

[Laura Chen, Citigroup]

We appreciate your sharing your recent market dynamics. Just wondering that for the 5G market you just discussed, we kind of lower our for the global 5G market. But I'm just wondering that from your perspective, MediaTek, in terms of the market share or share for the 4G and the 5G SoC market, what was it like for this year or maybe for the next year growth outlook, if you can provide that.

[Rick Tsai, Chief Executive Officer]

Laura, well, we have reported our estimate for the overall smartphone shipments, including 5G. Certainly, it's somewhat of a decline compared to last years. I'm thinking consistent with the other research organization or major players' view. The important thing to us really is to win our technologies and our flagship entries. And when we look at our portfolio, our offering or portfolio, we are quite confident that we will be able to maintain our market share, which we have earned over the last -- about 3 years.

We really are confident that this is a structured improvement that we have made will keep us with the strong market [indiscernible] we have now going forward into the [next] year. So the key here is that we will be able to keep our market share. And also, we will be able to manage our gross margin at the level we want, then things will gradually get better, we believe.

[David Ku, Chief Financial Officer]

Yes. Rick, if I may, I'm still trying to highlight one point because I understand right now is people looking at connectivity, but if we put in perspective, bear in mind, the 5G global shipment year-over-year still grew a very strong 20%. And even we're talking about for next year, given the relatively low penetration on 5G, we still believe 5G global shipment next year will continue to grow. So couple -- combined with actually Rick talked about earlier, our market share is not losing at all. In certain sense, actually, we still managed to grow the market share. That still represents a pretty good growth opportunity. So when we talk to different sale type -- sell side analysts, sometimes the buy-side investor, I think people worry about the short-term movement, but sometimes miss the big picture. Again, the year-over-year 5G shipments still grow a strong 20%. And when we get into this cycle, especially when we talk about 4G to 5G, product migration is a pretty good ASP impression, okay? And also in addition to smartphone, our Smart Edge and Power PC, the diversified and balanced business portfolio are all grown very nicely.

[Laura Chen, Citigroup]

Dr. Tsai and David, that's very clear. Just a follow-up on this. Because my understanding is like our 5G products used to -- has been enjoying better gross margin comparing to 5G. I'm not sure if its situation still maintained?

[David Ku, Chief Financial Officer]

I think that is still maintained. Again, because smartphone right now will account for roughly 50% to 55% of our overall revenue. So if we have any line of business have gross margin deviate too much from the corporate average, we will not be able to reach that gross margin. So basically, right now, all product line has been very similar, some higher, some lower, I would say, by and large, very close to the corporate average.

[Laura Chen, Citigroup]

Okay. And I got the second question if I may have. Just following a previous question of Intel's engagement. I'm just wondering that other than to diversify our foundry source, if there's any chance that we can leverage with Intel's resource to get into the PC-related or peripheral market with that engagement?

[Rick Tsai, Chief Executive Officer]

As you all know that we already have a 5G modem engagement with Intel into the notebook, PCs. Actually, we believe that the relationship between Intel and MediaTek will continue to grow. But right now, the arrangement between Intel and MediaTek, the foundry arrangement, is mainly still capacity long term -- I should say, a long-term mature technology capacity arrangement.

And I might add, we have strong confidence that the semicon industry will continue to grow at a very good rate. Despite the current slowdown, it will recover soon. And we definitely believe MediaTek will be part of that growth cycle when it happened. And you must realize, this is -- any time you take on a new foundry, the new process -- by the way, that process has been part in the process. So it does have some pretty good advantages.

We are preparing for the future growth of the company because we all know that the 22-nanometer node is a very good node for many applications. And so it's kind of a -- it's also more resilient capacity structure for us going forward. Thank you.

[Operator]

Next one, we have Charlie Chan from Morgan Stanley.

[Charlie Chan, Morgan Stanley]

So my first question is about your 5G strategy. So first of all, I know you will keep the pricing discipline, but your foundry partner costs may go further higher in [2023]. Can you pass through to customers? And can you maintain the 48% gross margin into 2023?

[David Ku, Chief Financial Officer]

Charlie, I think currently, the semiconductor supply chain is actually very dynamic. We have been proactively managing and dealing with it. But like you say, if necessary, we will definitely review our pricing strategy and also capacity location to reflect the industry dynamic and also, more importantly, our long-term capability to invest for the long-term capability. I think that's a quick answer.

In terms of the next year's gross margin target, I think like we talked about earlier this year, the guidance for the gross margin range -- earlier this year, the range was a 48 to 50. I think this year, we are well into this range more on the mid- to high end. I think next year, so far, it's not finalized yet, but we do believe that actually is a good target range to start with for next year.

[Charlie Chan, Morgan Stanley]

Got it. And also on 5G, I mean, I do believe that 5G is accretive to your blended ASP. But this year, we certainly have better flagship contribution. So next year, I'm not sure if the company wants to introduce some entry-level or lower-priced 5G? And if that's the case, do you think your plan in ASP for 5G can still go up in 2023?

[David Ku, Chief Financial Officer]

Charlie, I think it's maybe too early to talk about next year product mix. But in general, I think next year is one thing for sure, we will continue to introduce new products in all segments, which include the flagship and also the [internal] as well.

[Charlie Chan, Morgan Stanley]

Okay. Then my second question would be about your long-term investment. So Rick just mentioned that although you're kind of controlling the OpEx, you will continue to invest for the new technology for the coming 3 to 5 years. So can you elaborate a little bit on that? And for me, I'm particularly curious about your plan for Windows on ARM processor, because you already have a strong foundation there, but you compare to Qualcomm, just to point out, they will introduce the real project for Windows on ARM next year. So what's MediaTek progress on Windows on ARM?

[Rick Tsai, Chief Executive Officer]

We have been investing in the ARM-based processor for, of course, many years before, mainly for the mobile SoC and really, of course, a mobile flagship as to this application. But we also, as you probably know, leveraged those SoC into other applications. Windows on ARM represents, of course, a different fairly quite different segment. It's more in the compute segment moving from the low power to mid-power range. As a result, we are -- I cannot share with you the details of our engagement on development status. But what I can say is that we have putting the resources, both from the technical development of the apology, some software resources. And we are working with, I would say, really relevant going forward.

But I also want to remind you, for such a major endeavor, we always take time, lead time. There will be a lead time for such business to grow. So that's why I talk about all these things on for 3 to 5 years horizon, definitely not for, say, next year. That would be the case right now.

[Operator]

Next one, we have Sunny Lin from UBS.

[Sunny Lin, UBS]

So my first question is on the 5G pricing. So if we look at in the past, new generation of chips tend to have pretty meaningful premium in the first few years, but then the premium will come down to drive a higher penetration. Now that the 5G pricing is still a lot higher versus 4G, just wanted to get your thoughts on how the price gap may evolve going into next few years? And ultimately, how much do you think a 5G chip could deserve in terms of premium over 4G?

[David Ku, Chief Financial Officer]

Sunny, I think based on what we see right now, the gap probably going to stay here for quite some time is mainly due to the complexity of the 5G technology. Simply put, 5G transmission, also the functionality is actually much stronger to 4G, and we just need to spend more area of putting more transistors to our product. So that's why actually the size of the chipset will be much larger. And consequently, the pricing of the product will be higher. And take out what we see right now, there's no magic peel to against this. So in the near term, most likely, the gap will stay there.

But on the other hand, I think you're talking about the penetration. The good news is actually it's at least based on what we see this year. The 5G penetration already is reached to a good 50% globally already. And obviously, the pricing -- the capital pricing, to be precise, didn't really somehow slow down the 5G penetration or picking up. And so we do believe next year, the 5G penetration will continue to increase.

So it's in a way similar to 4G versus the 2G. Believe it or not, right now, we're still talking about 200 million, 300 million 2G every year, and the gap between 2G and 4G is still pretty wide out there. So it's just different product segmentation going forward. I think that's our view so far.

[Sunny Lin, UBS]

Yes. Got it. Maybe a very quick follow-up is if you look at the cost structure for 5G, do you still see a lot of room for cost reduction going to the next two to three years? Or are you seeing most of the cost improvement has already been done?

[David Ku, Chief Financial Officer]

I think there are still some cost improvement area, but probably is not quite a lot. Because, again, right now for 5G, most we're talking about the living edge process. Now flagship, even we talked about four or three. Even for mainstream, we're talking about seven or six. The pricing on the supply side and also the complexity on the supply side is actually not that easy to resolve.

And on our side, in terms of intellectual property, we can definitely do some improvement out there, but it's not going to be reduced substantially. So more like the cost structure will be similar.

[Sunny Lin, UBS]

Got it. Got it. My second question is on your flagship 5G. Could you help us think through the potential upside going to 2023? I think competitively, your peer supply issue is getting resolved, and they have also switched to [PSMC's] 4-nanometer. And so what's the for you to get a higher share into next two, three years? And do you see any upside outside of China?

[Rick Tsai, Chief Executive Officer]

Yes. Again, we are happy with what we have achieved with our first-generation flagship, Dimensity 9000, where we're actually about less than 18 months of development time, the performances and the acceptance from the market. I think it's quite good from our point of view. And during this period, we have really, I would say, learned to further improve our performance, especially from the user experience point of view. For the flagship phone, the user experiences is truly critical in order to be accepted by those high-end customers.

Now we have learned a great deal. And we are -- and these are not only in the hardware, IT and the process technology, but a lot of which also comes from the system software behind. So we are fairly -- we are quite confident that our second generation SoC, which now we have silicon had already, we have a pretty a significant improvement over the first generation. We just believe that the -- we will continue penetrating with our offering because we have good performance. We have also reasonable optic infrastructure for our customers. Thank you.

[Operator]

Next in line for questions, Frank Lee from HSBC.

[Frank Lee, HSBC]

Just I had a question, I guess, two questions. The first one is kind of the overall discussion people had on the inventory and your view of two to three quarters' digestion. But I guess just looking at the fact that we've come off kind of an unprecedented two-year upturn in inventory level seems quite elevated across the board for quite some time. I guess just trying to understand the rationale behind why two or three quarters, where seems to be a normal cycle inventory, is all we need? Or at least the expectation is that's about how long it takes.

[David Ku, Chief Financial Officer]

Frank, like we explained earlier, we actually take a hard look for all the customers and channels and level of inventory. And I think one key future highlights, actually, overall, we're still talking about 5G shipment year-over-year growth of 20%. So which means the end selling point is still pushing out a pretty good number of phones out there. So think about that way.

The digestion or the final channel is still [baking] out, but selling in, obviously, is actually coming down substantially, as you entail the whole supply chain, which including outside foundries and even on our customer side. So it's a basic math. When you -- a steady outflow by a much smaller inflow -- and right now, the channel inventory and the customer inventory were not going by 10 months or 20 months, with about maybe two plus three months. So plus with that patent, if that hasn't continue to two to three quarters, unless you believe next year, the demand will decline. Otherwise, I mean, if you're doing the math, most likely after two to three quarter, I think we should have some chance to see some picking up of stabilization.

I think just that's our view. So I still try to highlight. The key point is currently, even though people see lots of negative news, but bear in mind, there's still a pretty strong year-over-year growth. The final selling point is still pushing out for, I would say, steadily, okay? And next year, we're still looking for more 5G foundry to sell.

[Frank Lee, HSBC]

Okay. Okay. And I guess my second question is just overall on pricing. I understand the duopoly situation you have on the smartphone side, which I think will help insulate or protect downward pricing pressure compared to past cycles. But how should we look at the other businesses where you don't have so much [indiscernible] duopoly, but potentially more competitors? As we look at this inventory cycle on the pricing point, how should we think about these other applications?

[Rick Tsai, Chief Executive Officer]

We are -- I think if you look at our other segments, either we have strong really strong -- very strong market position. For the competition, it's relatively new, I would say. Then for power IC, it is really a very broadly based segment of the pricing is, again, not so sensitive to the macro environment. So that's why we believe that we are confident that going forward, the key thing for us is to continue investing in our capability, our technology, our product portfolio. And we will be able to maintain our market position. And we certainly will maintain our gross profit margin. And when the market turns, MediaTek will come out stronger and healthier.

[Operator]

Thank you. Ladies and gentlemen, in the interest of time, we are going to take the last one question. The last one to ask question, Brett Simpson from Arete.

[Brett Simpson, Arete Research Services]

I wanted -- Rick, I wanted to ask about potential M&A with MediaTek. I guess when we look at some of your U.S. fabless peers, they've been highly active in large-scale or medium-scale M&A, and it's been relatively successful from a synergy point of view. I guess when we look at MediaTek, you have a very strong balance sheet. You're generating north of 5 billion of free cash this year. And now that we've seen valuations come back in semis, what's holding MediaTek back from being more active in the M&A side? And if you are looking at M&A, can you maybe share with us what areas might make sense in terms of complementing what you're doing today?

[Rick Tsai, Chief Executive Officer]

Well, we [formally] are looking at M&A target. But I also must say the overall environment is not very friendly. If you look at -- actually, if you look at the deals which have failed to go through the regulatory process in different areas, different regions, countries, the failure rate is very high. It's very high. So that's why we're being cautious that we don't want to fall into the trap of spending a lot of resources than just end up paying [ breakup ] fee. But thing on that, we understand that the -- for our future growth, again, for the next three to five years, it is advisable to look -- to have some synergy -- synergistic target. I cannot share with you which every we're looking at, unfortunately, of course. But what I can say is that we work in that respect. And we also need to work on to have a more friendly environment for the M&A also. Thank you.

[Brett Simpson, Arete Research Services]

Maybe just a second question, if I may. I wanted to get your perspective on how you see automotive as a potential meaningful market for MediaTek. I mean you have IP that's highly leverageable into autos. And we've seen some of your competitors talk about very large pipelines over the next sort of five years. And just sort of dovetailing into your long-term CAGR thought process, can you just maybe share with us your thoughts on how you see MTK and automotive markets, specifically in things like 5G, digital cockpit, where are you winning business? And I mean given 5G and orders looks like it's going to be a big market and this two-player capability, and you have a very strong modem portfolio. Just can you help us understand how you're thinking about this segment of the market?

[Rick Tsai, Chief Executive Officer]

Agree. This is a segment that MediaTek -- it's not that we don't have a presence. We do. We do, actually, yes, not big enough. I also agree. We understand the fact that we can leverage our IPs, I think, very -- so yes, it is part of our future growth -- in our future growth of MAP. We are -- of course, the automotive industry is quite different industry compared to, say, a consumer and a smartphone or a computing business segment. They're quite different. But because of the group into the digital [indiscernible] as you said, and the much higher connectivity requirements, it opens the door for us.

We certainly are in the process of moving into a growth mode for this event. We understand certainly full well that we have a very strong portfolio in the modem, then, of course, in the Wi-Fi area, too. We will leverage. We will -- I'm not even sure leverage is a good word, and we will definitely expand and expand those IP capability into different segments and automotive be a very important one.

[Operator]

Ladies and gentlemen, we thank you for all your questions. Now I'm going to hand it over to Ms. Jessie Wang for closing comments. Ms. Wang, please proceed.

[Jessie Wang, Deputy Director, Investor Relations]

Ladies and gentlemen, this concludes MediaTek's 2022 second quarter conference call. We would like to thank you for your participation, and you may now disconnect. Thank you.

[Operator]

Yes. Thank you again, ladies and gentlemen, for your participation in today's conference.