Samsung Electronics' (SSNGY) Q2 2014 Results - Earnings Call Transcript

Aug. 2.14 | About: Samsung Electronics (SSNGY)

Samsung Electronics Co., Ltd. (OTC:SSNGY) Q2 2014 Earnings Conference Call July 30, 2014 8:30 PM ET

Executives

Robert Yi – Vice President and Head of Investor Relations

Pak Ji Ho – Vice President, Memory Marketing

Lee Chow Hun – Vice President of Planning and Samsung Display

Kim Hyunjoon – Senior Vice President Mobile Communications Business

Simon Sung – Vice President of Picture Display Sales and Marketing Team

Doo Young Soo – Vice President of System LSI Strategy Group

Analysts

SC Bae – Barclays Capital Securities Ltd.

Hu Jin Kim – Citigroup

Nicolas Gaudois – UBS Securities

Nicolas Gaudois – UBS – Analyst

Matt Evans – CLSA Securities Korea Ltd.

Ricky Seo – HSBC

Jung-Joon Park – JPMorgan

Peter Yu – BNP Paribas

Won-Seok Seo – Korea Investment & Securities

Young Joo Park – Hyundai Securities

Simon Wu – Bank of America Merrill Lynch

Keon Han – Credit Suisse Securities

Min-Seong Hwang – Samsung Securities

Han-Joon Byun – KB Investment & Securities

Robert Yi

Good morning. This is Robert Yi. Thank you for joining us today. On the call with me representing business units are Mr. Baek Jeeho, is the VP of Memory Marketing; Doo Young Soo, VP of System LSI Strategy Group; Kim Hyunjoon, Senior VP of Mobile Communication Business; Simon Sung, is the VP of Visual Display; and Lee Chang-Hoon is the VP of Samsung Display; as well as Kim Myung Kun is VP of IR.

I need to make this statement that some of the statements we'll be making today are forward-looking based on the environment as we currently see it and all such statements are subject to certain risks and uncertainties that could cause our actual results to be materially different from these expressed in today's discussion.

Before we dive into financials and operational discussions, I know many of you have high interests in the interim dividend. Therefore I would like to make a few comments.

We have not finalized the mid-term shareholder return plan. As you know the decision on the allocation of the free cash flows for the shareholder returns has to be an integral part of the overall capital management plan, which involves reviewing various mid to long term investment plans, as well as the financing need for future growth. In particular, strategic investment decisions for Vertical NAND, flexible display and foundry business in the next several years is expected to play a pivotal role in mid to long term growth of the company's total business.

So we are being very careful in making the decision. As a result for now, the Board of directors have decided to keep the interim dividend at the same as that of 2013 which was KRW 500 per share. We will make the determination on year-end dividend towards the end of the year.

With that I want to get into discussing the financials and operational results. Let's begin with our second quarter results. As we provided, the key factors for the weaker than expected second quarter results when we released the preliminary guidance on the July 8, the Korean won appreciated against dollar during the second quarter which negatively impacted our operating profit by approximately KRW 500 billion.

Let me just make one correction that the appreciation was not just on U.S. dollars but most of the foreign currencies.

For the business sides we experienced increased competition in the overall smartphone market amid the traditionally weak seasonal period for the industry. The smartphone sales declined due to increased competitions from mid to low end segments which resulted in higher marketing and promotion expenses to reduce inventories in sales channels.

Tablet sales also declined due to weak global demand. In addition to sales and profitability from System LSI worsened as the demand from its main customers continued to decline. Although the OLED business improved quarter-on-quarter, the improvement was less than our expectation. As a result total revenue in the second quarter was down by 2% from the previous quarter. The total operating profit decreased by KRW 1.3 trillion quarter-on-quarter mainly due to declined gross profit.

SG&A expenses increased by KRW 400 billion from approximately KRW 1 trillion increase in advertising and promotion expenses, then offset by reduction in most of other expense categories. The non-operating profit for the quarter was KRW 0.6 trillion, reflecting about KRW 300 billion income from interest and other financial activities and KRW 100 billion of equity income.

For your reference, the second quarter non-operating profit decreased by KRW 0.6 trillion from the KRW 1.2 trillion that we recorded in the previous quarter. If you recall we have KRW 700 billion income from sale of Samsung Corning Precision stake in quarter one.

I want to make few comments on the outlook for the rest of 2014. We expect the memory business earnings growth momentum to continue with a strong demand coupled with limited supply growth, which will result in a tighter or tight market supply and demand condition.

For the System LSI we expect earnings to remain weak due to low application processor demand. For our display business we expect earnings to improve in LCD business driven by strong sales of premium LCD TV panel. However, in OLED business with its main customers' continuous reduction of panel inventory and product mix change to increase offerings of mid-end products, it would be challenging to improve profitability in the second-half.

For our high-end business we will try to expand sales of smartphones by releasing new high-end models including innovative flagship model and also by reinforcing mid- to low-end product line up with improved design, spec and price competitiveness. However, given the challenging market conditions due to intense product and price competitions we'll have to wait and see how our efforts will improve the overall profitability in the second-half.

For our consumer electronics business amid strong seasonality we expect earnings to improve driven by extended sales of premium TV.

Moving on to the third quarter outlook, we expect negative impact from the foreign currencies to decline in Q3 compared to the second quarter. As we mentioned, when we announced the preliminary guidance we expect the memory business to contribute higher earnings in Q3 driven by strong seasonal demand. However, System LSI business is expected to remain weak due to continued low demand from customers.

Although, we initially forecasted improved profitability for the high-end business we may not be able to improve the Q3 earnings due to products and price competitions despite increase in overall shipments. Similarly for the display business we expect earnings in Q3 to decline due to the factors I described earlier on OLED business.

Consumer electronic business is expected to slow down due to weak seasonality prior to fourth quarter peak season. As for our 2014 capital expenditure plan the total budgeted amount is KRW 24 trillion, similar to that of 2013. Of that we expect about KRW 14.5 trillion for semiconductor and close to KRW 5 trillion for display.

Investment in semiconductor will be increased compared to 2013 mainly due to the memory business. We plan to equip S3 line with the DRAM capacity. The increased 2014 CapEx for memory will be spent on building infrastructure for S3 with no impact on 2014 production. Our investment strategy for memory business remains the same as we plan to manage it flexibly based on the market demand and supplies.

In the second quarter we executed KRW 4.8 trillion in capital expenditure, KRW 3 trillion for semiconductors and KRW 700 billion for display. That brings the total first-half expenditure of capital expenditure at KRW 10.2 trillion which is about 43% of our annual plan.

Now, I would like to share some of the key data points for business areas for your reference. For DRAM, our bit growth in second quarter was approximately 20% q-on-q and we expect for the third quarter the market DRAM bit growth will come in at high single-digit and we will outgrow the market's bit growth. At this point, we expect the DRAM market bit growth for 2014 to be low 30s and we expect our bit growth for the year to be high 40s. The second quarter we experienced ASP decline of DRAM at low single-digit.

For NAND flash in second quarter, our bit growth was low 20% and for the third quarter, we expect market bit growth for NAND to be low teens, and again we will grow approximately that of the market growth. For 2014 for the year, we expect a NAND market bit growth to be high 30% and our bit growth for the year will be about mid 40%. And we experienced low teens of ASP decline percent-wise in second quarter.

For our large LCD panel business, the sales was about mid-50% range of that of the total display panel business. The large LCD panel sales for the second quarter decreased high single-digit in the second quarter, but we expect it to increase low teens in the third quarter. And for the year, sales of large LCD panel will decline about mid-single digit for the company. In second quarter, we experienced a high single-digit ASP increase in large LCD panel business.

For the handset business or the mobile business, the – in second quarter total handset sales was about 95 million units and the tablet sales was about 8 million. And in third quarter, we expect both handsets and tablet in volume unit-wise to increase about 10% quarter-on-quarter. Within those handset sales, the smartphone mix in the second quarter was high 70% and in third quarter, that percent will increase to about 80%.

We experienced ASP in second quarter of high $230 range and in the third quarter because of greater mix in the mid-to low-end, we expect the ASP to decline. And for TV business in second quarter, we sold about 12 million units of flat panel TV and in third quarter unit-wise, we expect to remain flat.

Now, I will turn the conference call over to our gentlemen from the business units to present their view. Thank you. Start with the semiconductor.

Pak Ji Ho

Good morning. This is Ji Ho Pak from the memory marketing team. I'm going to present our business results for second quarter and the memory market outlook for the second-half of 2014.

For DRAM, while overall demand remained stable through all segments, we carried out flexible product mix storage in response to increased demand in PC, server, graphics and consumer segments. We also met mobile demand from China, mainly to solution products such as eMCP.

In second quarter, we improved profitability by continuing the 20-nanometer class migration as well as increasing output through enhanced production efficiency. On NAND, we actively responded to demand increase in SSD and mobile solution in China, while expanding sales of current through product competitiveness. In addition, we maintained profitability through continuous process migration and expansion of surrogate MSE product.

Next, I will comment on the memory market outlook and our strategy for 2014. For DRAM market, we expect increased mobile DRAM demand driven by the release of new mobile products and demand growth in China and emerging markets. We expect solid overall market demand, as such, manufacturers are expected to maintain low inventory level and demand growths are expected in all applications under strong seasonality.

In the meantime, while supply growth during the first-half was higher than expected, we expect limited supply level during the second-half due to challenges in 20-nanometer class migration throughout industry. While we expect supply and demand conditions to vary by applications due to different product mix strategy by manufacturers, the overall market condition will remain tight.

For our business, we will continuously expand the 20-nanometer class migration to strengthen cost competitiveness and keep flexible product mix strategy and respond to demand changes by segments. In addition, we will maintain profitability and market leadership by offering next generation products such as DDR4 and LPDDR4 based on our cutting-edge process. With such efforts, we expect to improve our overall revenue and profit during second-half.

On NAND market, the market demand is expected to grow, driven by demand for higher density storage of new mobile products and the expansion of high density cards. Also, SSD demand is expected to increase by growing enterprise SSD market with the expansion of clouding services and by increasing adaption rate of PC SSD from new models in the second half.

On the supply side, while we expect stable growth led by continuous 10-nanometer class migration, supply is expected to be concentrated in new mobile products, which will result in limited growth for other applications. For our business, we will strengthen our market position by offering solution products based on our own NAND controller and software technology for each segment. We will also strive to secure profitability by improving cost competitiveness through accelerating 10-nanometer class migration.

In addition, as qualification and production of our V-NAND for enterprise segment remains on track, we are expanding applications of V-NAND by developing appropriate products from enterprise server to PC client, including Samsung brand SSD.

Now moving on to the System LSI business. In the second quarter, although LSI product sales increased driven by high mega pixel CIS, overall System LSI revenue slightly declined quarter-on-quarter due to weak demand for mobile AP.

In the second-half, we expect annual earnings improvement in the short-term will be difficult due to weak mobile AP demand in high-end mobile segment, despite the release of 20-nanometer mobile AP. Therefore, we will focus on improving profitability by expanding sales of LSI product and continuous cost reduction. Also, we plan to increase profitability by using an existing line for production of 14-nanometer and by improving total capacity utilization.

For your reference, as 14-nanometer product development is on track, we are securing customer base and begin mass production by the end of this year. With the 14-nanometer process, we will produce Exynos in the first-half and expand the foundry business from the second-half in 2015. Through pursuing balanced growth on ASIC, foundry and LSI such as CIS and DVI, we will strive to build solid foundations for our future growth and to lead the next generation technology and product development. Thank you for listening.

Lee Chow Hun

Good morning, this is Chow Hun Lee, Vice President of Planning and Samsung Display. I would like to present our result for the second quarter of 2014, and our core strategies for the second-half. As for LCD panel business, earnings improved compared to the previous quarter, led by demand growth based on World Cup event and increase in shipment of large-size panels and UHD TVs.

For the second-half, we expect business result to improve continuously. Thanks to higher shipment of mainly TV panels impacted by year-end peak season. In particular, we expect possible ASP increase in some products due to demand growth of large-sized TV panels over 40-inch UHD TV and limited supply from increase in production of ultra large-sized panels over 60-inch and UHD TV.

For Samsung display, we will strive to increase sales and improve profitability through expansion of mass market lineups, as well as premium products such as curved panels and ultra large-sized panels over 60-inch. For OLED panels, overall earnings for the second quarter were slightly increased q-on-q due to higher shipment of new high-end smartphone panels such as Galaxy S5.

However, during the second-half, we cautiously forecast possible decrease of earnings growth due to increasing competition in the smartphone market and decreasing panel demand from major customers. Under such market conditions for high-end product, we will solidify lineups with differentiated flexible display and ultra-high resolution product to maximize our competitiveness. We will also pursue product diversification and sales expansion to new customers by utilizing mid-end product lineups with enhanced cost competitiveness.

Furthermore, we will do our best to solidify business competitiveness and secure mid- to long-term growth engine. Thank you for listening.

Kim Hyunjoon

Good morning, everyone. My name is Hyunjoon Kim from the Mobile Communications business. I would like to present the IM mobile communications division's second quarter business result and the outlook for the second-half of 2014. In the second quarter, slow seasonal market circumstances continued and market demand for smartphones is estimated to have demand at a similar level from the previous quarter.

For tablets, demand is estimated to have slightly decreased q-o-q. The IM division's revenue and profit decreased from the previous quarter due to weak business performances in the mobile communications business. Our smartphone shipments decreased q-o-q due to increased channel inventory of mid- to low-end models, mainly in China and Europe. Particularly in China, we were negatively impacted by the challenging market circumstances, including intensified competition among vendors and weaker demand for 3G phones in anticipation of our extensive 4G LTE rollout.

We experienced challenging inventory issues in Europe as well, caused by continued weak demand in the second quarter. In this (inaudible) we carried out our (inaudible) promotions in order to reduce channel inventories in preparation for the release of our upcoming new models and strong seasonal demand during the third quarter.

However, such effort resulted in increase of marketing expenses, which has significantly impacted our second quarter earnings. Meanwhile, for our tablets, weak replacement demand there to weak overall market demand which caused our tablet shipment to decrease q-o-q.

Now turning to the future outlook of our business. In the second-half of 2014, we expect that market demand will grow for both smartphones and tablets due to seasonality. However, product and price competition is also expected to intensify, driven by an increased number of new model launches in the market. For Samsung, we aim to increase our shipments by continuing to introduce new competitive models while maintaining healthy channel inventory levels. Regarding smartphones, we plan to launch a new Flash model in the large-screen category and a new premium model, along with new mid- to low-end models with more advanced features and more competitive price.

We will solidify our smartphone market leadership by further strengthening our product portfolio leveraging differentiated technologies and design. In China, we'll fully capitalize expected growth in the LTE market and actively respond to market growth in the second-half of the year by enhancing the competitiveness of not only our high-end smartphones, but also best market smartphones.

As for our tablets, we aim to increase the sales of Galaxy Tab 4 series launched in the second quarter and also increased the global sales of our new high-end tablet, the Galaxy Tab S. Galaxy Tab S provides the best visual experience with a super AMOLED display that produces incredibility and crisp imaging. The Galaxy Tab S is also powered with a greatly enhanced usability, including an ultra-slim design, fingerprint recognition, and remote PC functionality. In addition to our strong tablet portfolio, we have further strengthened channel capabilities, including UTEL and B2B in order to make the most out of growing demand in the second-half of this year.

Turning to our variable devices, which we believe offer great growth potential, we will introduce a more diverse products portfolio in order to continue leading the market and to develop the variable devices into our next growth momentum. For the network business, we will take advantage of the fast global expansion of LTE service to achieve sound business results. Thank you.

Simon Sung

Good morning. I'm Simon Sung, Vice President of Visual Display Sales and Marketing Team. Let me brief you on the second-half market condition and result.

For the plasma TV business in the second quarter, amid the competition among the manufacturers to the release of the new product overall market demand increased year-on-year and quarter-on-quarter, thanks to the increased UHD TV sales in the World Cup event especially in Latin America.

In particular, the UHD TV market grew almost double compared to first quarter, as UHD TV successfully rolled out in advanced market in China. In second quarter we achieved solid performance year-on-year and quarter-on-quarter, outperformed the market growth in terms of the post-sales volume and revenue by successfully launching the new product and actively responding to World Cup demand.

We also strengthened our number one position in the TV industry by extending the sales of our super-large size TVs over the 60 inches and UHD curved TV which defined new product category in the premium TV market. For the digital appliance business, while market demand increased in the second quarter, from the previous quarter led by advanced market our sales also grew driven by increased sales of the premium product and air conditioner under the strong seasonality.

Now, turning to the market outlook for the second-half of the year, during the second-half we expect over the flat panel TV market to grow year-on-year entering the peak season and continue growth momentum in emerging market including China and Asia. In these months, we aim to outperform the market growth in the second-half by expanding offering of mid-size UHD and retina-specific TV in addition to premium products to actively respond market demands from the emerging market, including China.

As the UHD TV competition is expected to intensify we will focus on improving sales of the products, profitability, by leveraging product differentiation, market leadership and strong distribution channels.

We will also continue to reinforce our leadership in the UHD TV market through the differentiated features including design for curved TV. The UHD video pack preloaded with UHD movies and documentaries and the Evolution Kit that's supports common UHD broadcasting standards.

As we enter the seasonally weak period in three quarter we will focus on the securing profitability through the deliveries of the limited edition TV models featuring unique design and alternate to plasma TV. Moving on to the digital appliance business, during the second-half the overall market demand is focused to grow year-on-year, driven by recovery of the U.S. and emerging market economies.

We will increase sales of our new product launching during the first-half as well as the premium product through the extending market activities. We will also focus on ensuring sustainable growth and improving profitability by enhancing our product competitiveness including system [ph] air cons. Thank you.

Robert Yi

Thank you. That completes our part of the presentation. As we have done in the last few conference calls, we will conduct the Q&A sessions with consecutive translation. We know that it may take longer than simultaneous translation, but I think that it will help us to have more clear communications between us and the market.

Let's start with the first questions, if you may.

Question-and-Answer Session

Operator

[Foreign Language] Now Q&A session will begin. (Operator instructions) The first question will be provided by SC Bae from Barclays. Please go ahead, sir.

SC Bae – Barclays Capital Securities Ltd.

[Foreign Language] I have a brief question regarding shareholder return. I think the interim dividend announced today is a bit below the expectation of the investors. And I think many investors would feel very disappointed in the fact that Samsung Electronics has not been able to yet fix its detailed vision in terms of shareholder return.

How should we read this? Is this because the company has shifted its direction towards being more conservative on shareholder returns than previously announced, or is it just because it needs more time to specify and decide its investment plans?

Robert Yi

[Foreign Language] As you will all know, the IT industry as well as the market itself is experiencing rapid growth in general, and on top of that, Samsung Electronics actually is looking upon various opportunities for its future business, including V-NAND, flexible display or 14-nano investments. That is given these two factors it's not an easy or simple decision in terms of deciding our investment plans.

And as you know from several years ago, Samsung Electronics, unlike other companies, have established and have been maintaining a relatively conservative capital management policy. And for these reasons, we need more time before we make a definitive decision. And as of the overall policy or position of the company regarding shareholder return, our commitment has not changed.

And as the top management of the company, we do need to consider various issues, in terms of making future decisions. And we believe that currently, since we are involved in a very intensive study of various programs that will guarantee the mid- to long-term growth for the company for the next five to 10 years.

We believe that we perhaps should place a bit more importance on such mid- to long-term growth opportunities. I believe that the mid- to long-term, the sustainable growth of the company, ultimately in the long-term will benefit the shareholders as well and we are very hardworking at guaranteeing this. And so we would like to ask the shareholders for a bit more time.

[Foreign Language]

Operator

[Foreign Language] The following question will be provided by Hu Jin Kim from Citigroup. Please go ahead, sir.

Hu Jin Kim – Citigroup

[Foreign Language] I have two questions regarding the IM division. I'll first ask the – my first question and then ask my second question after the answer. It seems that the excessive inventory was the main issue that brought down your performance in the second quarter. As of current time, in the third quarter, do you believe that all of the inventory issues have been resolved? I would like to hear the company's assessment as of the – regarding the current inventory levels.

Robert Yi

[Foreign Language] During the second quarter, we've controlled our sell-in volume as well as we've also launched various sell-out activities. And we believe that that has improved the situation regarding channel inventory. Now that we are going into the high season, we believe that the inventory has now come down to a manageable level. And going forward, we will continue our activities to promote our sell-out inventory.

Hu Jin Kim – Citigroup

[Foreign Language] The second question regards the high-end product strategy. Looking towards the second-half of this year, especially with the market anticipating the launch of the new large size iPhone, it seems Samsung would have to come up with a new high-end product that is dramatically differentiated in terms of its hardware features. I would like to hear in more detail what kind of changes can we expect from Samsung in its smartphones in the second-half in terms of these dramatically different hardware features. And going – looking more towards the future in mid- to long-term, what is Samsung's strategy in terms of differentiating its high-end handsets?

Kim Hyunjoon

[Foreign Language] It's difficult for me to go into the detailed features, but we are planning a very innovative new product in the large-screen space and also are preparing a very attractive new model that uses new materials and new displays in the high-end space.

Our mid- to long-term strategy is to leverage our current very solid and strong customer base in the high-end segment and to continue to introduce new products that not only incorporates new materials, new displays, and designs in UX, but also that incorporates new technology that actually provides more convenience and practical value to the customers in their everyday lives.

Also, we believe that there will be more demand focused around the LTE market, both LTE-A as well as Cat 6. And given the fact that we already have a very strong technology leadership in the LTE space, we would leverage this capability in order to continue our growth in the high-end segment.

[Foreign Language]

Operator

[Foreign Language] The following question will be provided by Nicolas Gaudois from UBS. Please go ahead, sir.

Nicolas Gaudois – UBS Securities

Yes. Good morning. My first question is on semis, and I've got a follow up question on mobile. On the semi side, as you say, we now are getting fairly close to the ramp-up of 14-nanometer FinFET. At the same time on the memory side, you're running out some of the floor space, we think, for your current memory cluster, and obviously DRAM tech migration would require probably more of that as you move to 20-nanometer eventually.

So with that, where actually will 14-nanometer start ramping on the logic side between Austin and Korea? And related to that, have you made a more precise decision on how you're going to use the new fab in Hwaseong, i.e., line 17 S3, in terms of logic versus DRAM? And if you're doing any DRAM there could you provide us rush [ph] on a two-track [ph] if you do that? Thank you.

[Foreign Language]

Pak Ji Ho

[Foreign Language] Regarding our line 3, as we had mentioned during the presentation, this S3 or what we call line 17, we are currently thinking of using that for DRAM production. And as you know, in terms of new lines, they are not brought in all at once, but they are expanded over phases.

So initially, we are thinking of using that for DRAM, even though it's too early for us to tell you whether we will use it all for memory or all for logic or what the share or split of these two would be, because our basic policy is that our production will be flexibly determined depending on the market situation. And given the current market situation, we are leaning towards using S3 towards DRAM production. And we think that probably we would have some effective output by mid next year.

Regarding the 14-nano production, as we have mentioned during the presentation, our current position is to use actually the existing lines to produce our 14-nano; that we will convert our existing line capacity for the 14-nano production, which would also address some of the capacity shortages and also have the added benefit of added efficiency, because this would involve less fixed costs versus an alternative method.

Nicolas Gaudois – UBS – Analyst

Great. I've got a follow up question on the mobile side. So Corning Tortshak [ph just seem to have adopted a more aggressive pricing strategy in China for smartphones and that's I guess to avoid a 4G inventory issue following the market that you had in 3G and as to a sense of competition, could you tell us what are early results of this new pricing strategy? And are you going as low as not making profit in the mid- to low-end in China like your peers are doing? As so, could we see this price war, "contaminating to overmarket"?

[Foreign Language]

Kim Hyunjoon

[Foreign Language] As you mentioned, the mid- to low-end smartphone market segment in China is growing very rapidly. And our basic policy is to respond very actively in this growth in terms of both product specifications as well as price. I do see that the market may be concerned about margins given this response, but our basic business strategy is to focus more on a small number of strategic models to raise the efficiency of our resources, as well as leverage the economies of scale that we will get by doing this in order to secure profitability in the mid- to low-end segment in the Chinese smartphone market.

Regarding the second part of your question, it's difficult to say whether it would spread to other parts of the country, because as you know, even though it is the same mid- to low-end smartphone segment. There is different competitive situations, carrier situations, and price sensitivities between countries and regions. But we do see that mid- to low-end smartphones is a segment where the growth globally is coming from. And therefore, we will respond to this growth by having more competitive products with better specifications as well as price competitiveness.

[Foreign Language]

Operator

[Foreign Language] The following question will be presented by Matt Evans from CLSA. Please go ahead, sir.

Matt Evans – CLSA Securities Korea Ltd.

Thank you. On the DRAM bit growth estimate, your number or your plan for this year seems to have increased from low 30s to high 40s in the last six months. But the new capacity that's going into S3, you said would not come onto the market until the middle of 2015. So could you walk us through what is driving such a dramatic increase in your output for 2014? That's the first question.

The second question is on handsets. Maybe I will come back to that.

[Foreign Language]

Pak Ji Ho

[Foreign Language] I can answer that question by two main reasons. One being the fact that, we were able to leverage the synergistic effects as a semiconductor operator that has both memory and system LSI. And that synergistic effect was realized during the first half of this year. Also, the other is the fact that, we were the first to move onto the 20-nano, and that gave us the opportunity to go through the learning curve faster than the others. And this has resulted in efficiencies in terms of the equipment, as well as processes.

So while the market demand remains strong, the suppliers weren't able to bring on additional supply much more other than us, and therefore we were in a very good position to capture this opportunity. And that is resulting in the higher bit growth expectations that you have heard and also we've seen a decrease in the inventory as well. So to summarize, there is really two effects. One is the synergistic effect that we can leverage, as well as the overall improvement in the efficiency of the operation.

Matt Evans – CLSA Securities Korea Ltd.

Okay. Thank you. And second question relates to the smartphone portfolio. There's a general impression, it seems among many that your portfolio is very stale. I know you've made a reference on the call already about to introducing new models. But could you be a bit more specific about how many new models will be coming to the market in the next three months, especially at the lower mid-end in China?

[Foreign Language]

Kim Hyunjoon

[Foreign Language] It is a bit difficult for me to go into too much detail about new models or new smartphone launching plans. The main message is that, we are preparing a very innovative product in the large-screen segment, as well as a new high-end product that will use innovative materials as well as displays. And we are also preparing new line-ups in the mid- to low-end segment.

Matt Evans – CLSA Securities Korea Ltd.

Okay. Just one last quick question follow-up on that. You mentioned the two premium products there. Are both those products, the large-screen one and the other one, global products will be launched globally within the next six months?

[Foreign Language]

Kim Hyunjoon

[Foreign Language] Yes that's the plan.

Matt Evans – CLSA Securities Korea Ltd.

Okay. Thank you very much.

[Foreign Language]

Operator

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

Ricky Seo – HSBC

[Foreign Language] This is a question regarding System LSI. You've mentioned that System LSI, the 14-nano is signing on customers according to plan, that everything is moving on smoothly with a target of starting foundry operation in mid to second-half of next year. But my assumption is that in order for that to happen, you should already be in tape-up [ph] with some customers. I'm wondering if this is going on with some external customers, and if so, how many products are currently in tape-up [ph] with customers?

Doo Young Soo

[Foreign Language] Regarding our 14-nano time schedule to recap that, our current 14-nano schedule is that, we will launch mass production around the end of this year and going through a ramp up during 2015, first, with internal and then in the second-half using external customers for the foundry operation.

Given the very special nature of the business, it is difficult for us to go into details of how our customers and our contact – and the business relationship with the customers are progressing. But I can say with confidence that our 14-nano products are receiving very positive responses from the market for being the best competitive offering in terms of not only time to market, but also scaling, and that our business plans are moving very smoothly ahead. And we're actually expecting that we may be able to gain a further share of the foundry business in the – in next year.

Ricky Seo – HSBC

[Foreign Language] The second question is regarding the DRAM. I'm assuming that in order to differentiate in terms of your margins, you would have to move onto the 20-nano nodes and that migration is already underway. I'm wondering specifically in which quarter can we expect to see a meaningful ramp up on your 20-nano nodes?

Pak Ji Ho

[Foreign Language] To give you an update on our 20-nano program, actually 20-nanos went into mass production in April. And the sampling were – samples were delivered and many of them have already finished qualification with the customers. In the 20-nano, even though some of them are used as a replacement to existing products, a lot of them are used for next-generation products. I'm not sure what would qualify as meaningful for you, but I would – I guess, I could explain that, we've already started mass production and we would probably start to increase the ramp up from the second-half, so from now onward. But mainstreaming would be more closer to next year.

Ricky Seo – HSBC

[Foreign Language] I guess a good way of answering my question would be to give me an estimate of what the share of 20-nano would be as of end of this year in your overall DRAM?

Pak Ji Ho

I'm a bit careful giving you that number, because it's subject to various factors, including the market situation, the demand situation, the capacity situation, the bit growth overall. But even at the end of this year, it probably won't be a two-digit share of our total DRAM.

[Foreign Language]

Operator

[Foreign Language] The following question will be presented by JJ Park from JPMorgan. Please go ahead sir.

Jung-Joon Park – JPMorgan

[Foreign Language] I have two questions. My first question is on the semiconductor side. You said that the 14-nano is in mass production and you're planning to ramp that up next year. Could you give us an estimate on what sort of capacity we are looking at? And if it's difficult for you to give me an absolute number in terms of capacity expectations, would it be safe for us to expect that it would scale similar to your 20-nano products?

And also it seems that the company is leaning towards using the S3, the new line towards DRAM production. I'm wondering how much additional DRAM capacity this would mean, because my information is that if a System LSI line is converted to a DRAM line about a doubling of capacity can be expected. So how much additional DRAM capacity can we expect from the S3 line?

Doo Young Soo

[Foreign Language] This is in LSI, the 14-nano capacity of course will be subjected to the market situation next year, as well as the demand, how strong it is. But if we go through ramp up at the end of 2015, I think we could – we are expecting that it would account for about 30% of the total 12-inch capacity.

Regarding the DRAM capacity that would be created additional by using the S3 line for DRAM production, it's difficult to definitely say, because we will – we can flexibly adjust our DRAM capacity depending on the market situation. As we – as I said before, the new line will be brought in phases and we are more than capable of adjusting when, for example, we would open phase two or three, depending on the market situation and the demand situation.

So if the concern – if the question is coming out of concern that there may be a huge influx of capacity onto the market, I don't think you need to be concerned of that.

Jung-Joon Park – JPMorgan

[Foreign Language] The second question is regarding the A3 line for the OLED production. When can we expect ramp-up on the A3, and is this a line dedicated for the manufacturing of flexible displays only?

Lee Chow Hun

[Foreign Language] The A3 line is a line that was planned out for the manufacturing of our next generation flexible OLED displays. And our current target is to start operation of A3 during the first half of next year. The pace of the ramp up that will follow can be flexibly adjusted depending on the market situation, as well as our communication with our customers. Also, any additional investment plans regarding A3 will be flexibly adjusted depending on the market situation.

[Foreign Language]

Operator

[Foreign Language] The following question will be presented by Peter Yu from BNP Paribas. Please go ahead, sir.

Peter Yu – BNP Paribas

[Foreign Language] I have two questions. First, regarding V-NAND, it seems the V-NAND is actually progressing faster than what we had expected. But there seems still to be a cost penalty that exists against the 3D NAND versus the 2D NAND. When do you think this cost penalty would be removed and there will be a cost parity between 3D and 2D, and when there will be a crossover where the 3D would cost less versus the 2D? Also, once that crossover point is reached and actually V-NANDs start to cost less than a 2D NAND, what would be Samsung Electronics' strategy regarding its NAND flash business, is my first question.

The second question is regarding the SD micro licensing, would the SD SOI business, the licensing, would that take up an important part of your System LSI business?

Pak Ji Ho

[Foreign Language] To answer your first question regarding the V-NAND and the cost and our ongoing future strategy in terms of our NAND flash business, as you know, VNANDs involve a very high initial fixed cost, because we have to build out a new line. And given this high initial investment, it's difficult, I think it's a bit unfair to expect that V-NAND will become economically competitive versus planars. We think that the two NANDs actually have different spaces, address different end uses. And from our perspective, our business strategy is to operate an optimal mix and balance between these two products to create the optimal portfolio of our products.

As you've mentioned, our V-NAND during the past year has made a lot of progress. We have completed sampling and started delivery. And over this past year, we've also been able to acquire and accumulate a lot of technological know-how and be – and was able to develop additional products in addition to the enterprise usage.

And so in the brand SSD segment, we've already launched a premium segment for brand SSDs and we're looking forward to adding a mainstream product line to the brand SSD lineup. And so basically regarding V-NAND, given the high initial fixed costs, we believe the best strategy to address that is to scale up the volume, so that the fixed cost would relatively account for less in the overall product cost.

And so going forward, our strategy is to use the V-NAND to address the high reliability, the high capacity applications, whereas we would use the 2D NANDs to address mobile card usage and other consumer applications, and that we will carry forward both and devote our R&D attention to both sides so that both will be leaders technologically and product-wise in their individual segments.

Robert Yi

[Foreign Language] Regarding the second part of your question which was the SD SOI licensing with SD micro, that licensing is an effort – one of our efforts to improve our performance on the 20-nano products and currently, we are providing a process design kit. How much further this licensing business will expand, will depend on the response from the customers. So we will decide that going forward.

[Foreign Language]

Operator

[Foreign Language] The following question will be presented by Won-Seok Seo from Korea Investment & Securities. Please go ahead, sir.

Won-Seok Seo – Korea Investment & Securities

[Foreign Language] My question is regarding the DRAM business. I think already the market is expecting the supply to be tight in the second half of 2014, given the limited supply but growth in demand. And therefore, I think everyone is more interested in what will happen in 2015. And therefore, can you give us a bit growth, DRAM bit growth estimate for next year first-half and second-half?

And I think some people in the market are concerned or are expecting Samsung to use its S3 line for DRAM production very aggressively to capture market share. Could you give us a bit more color in terms of what we can expect from your DRAM business and the market next year?

Pak Ji Ho

[Foreign Language] That's a very difficult question, because it involves various different factors. Regarding our bit growth estimates for next year 2015, given the fact that we are going to probably grow significantly in terms of DRAM bit growth this year, because we've already increased bit growth versus the start of this year due to the base effect, I think it would be difficult for us to grow even more. Probably next year our bit growth may be lower than previous.

Given that we believe that with the other companies having – hitting difficulties in terms of technology as well as yield in the 20-nano space, as they scale down to the mid to low 20-nano, that is contributing to the limited supply in DRAMs, whereas there is continuous increase in DRAM demand from the mobile side and that is resulting in the current situation, which we would unfold. And so in the second half of this year, we're expecting the DRAM supply situation to continue to remain tight.

And we think that this will result in some delays by other companies in preparing their next year new products, the DDR4s and the LPDDR4s, which should already be in preparation this year in order to be available next year. So given this reality, our basic business plan for next year is to focus on our next generation products and to address the supply and demand situation for each product segment, because we believe regardless of the overall demand and supply situation of the overall DRAM market, there will be very much differences, divergence, between the supply and demand situation between each product segment.

Regarding the new line, we will be using that for DRAM manufacturing, but that will mainly be focused on the new products and the capacity from that will be adjusted flexibly depending on the demand and supply situation next year. But I think, what we can say for certain next year, one thing is that probably there will be a large difference in the demand and supply situation between DRAM product segments.

Won-Seok Seo – Korea Investment & Securities

[Foreign Language] yes, DDR4 will probably become an important segment next year. Could you give us an estimate of when do you think DDR4 will start to be used mainstream in servers, PCs, and graphic applications?

Pak Ji Ho

[Foreign Language] DDR4 and such interface issues are decided on an ecosystem basis. I think at least from servers – actually some new servers that will be launched in the second-half of this year will be DDR4 ready, and some of the CPU company roadmaps are saying DDR4 for second-half of next year, but that will be more of a mainstream. While we reach second-half of next year before that mid, there will be some game or other high-end applications that will be using DDR4. And so that is probably what we will be expecting.

[Foreign Language]

Operator

[Foreign Language] The following question will be presented by Young Joo Park from Hyundai Securities. Please go ahead, ma'am.

Young Joo Park – Hyundai Securities

[Foreign Language] I have two questions. First is a set of questions for semiconductor. My information is that, there is some floor space available in your fab 16 and given the plans of using fab 17 for DRAM production, I'm wondering what are you planning to use fab 16 for going forward?

And another question is, is it correct that the first product from the 14-nano FinFET will be an AP product?

Doo Young Soo

[Foreign Language] I'm surprised, because you seem to have better knowledge of our lines than I do. My – actually my response to the question would be, if I had space in fab 16, given the current tight supply, wouldn't we have already been using it? But even if we had the fab 16 and the fab 17, given the base effect, given the large bit growth this year, I think next year it will be difficult to expect bit growth year-on-year.

Robert Yi

And to addressing the second part of your question, yes, it is correct that the first FinFET 14-Nano product will be an AP product.

Young Joo Park – Hyundai Securities

[Foreign Language] My second question is regarding the display, the VD division recorded very good margins in the second quarter and that is why I would like to ask a question regarding your UHD TV business. I'm wondering what do you think is the size of the UHD TV market currently in 2014 as well as what do you expect the market to grow to next year? And within these markets, what is the market share target that Samsung Electronics has?

Lee Chow Hun

[Foreign Language] The data for the UHD TV market is that last year in 2013 it was about a 1.6 million unit market. In 2014, the market data has continuously updated. Currently, the most recent is saying it's about a 12 million unit market. As you can see, this year has been an opening of the gate for UHD TV demand growth and especially with all of the companies introducing new models in the end of the first-half we believe that demand for UHD TV will continue to grow.

In terms of our market share, in 2014 first half we were the number one in terms of market share in the UHD TV segment. The new products that we launched last March received very positive responses from the market and has helped us record very good performances. As you know, Samsung, we already have a very strong market share in the premium TV segment overall and our goal for our UHD TV is to meet at least or even surpass our market share that we have in the premium TV overall segment.

And I think our new innovative product such as the curved UHD TV which opened up a totally new segment within UHD TVs. These new products would also help us achieve these goals.

Specifically, in the first half we focused more on the premium side of the UHD TV, but in the second-half in addition to adding on the ultra-large size UHD TVs, we will also be adding the mid to large screen sizes, so that we have a full line-up in the UHD TV segment, which would reinforce our number one positioning in the industry.

I have just been informed that there is some misunderstanding of what I have announced as one of the key data points earlier in my presentation. The total number of our second quarter shipment of flat panel TV was 12 million. Someone told me that somehow market thinks that we said 20 million, it's 12 million.

[Foreign Language]

Operator

[Foreign Language] The following question will be presented by Simon Wu from Bank of America Merrill Lynch. Please go ahead, sir.

Simon Wu – Bank of America Merrill Lynch

[Foreign Language] My question is about the strategy for differentiating the mid to low end smartphone segment, especially in China, given the fact that already these mid to low end segments are accounting for over 50% of all smartphones in terms of volume – thinking about this question even I cannot decide what will be the right strategy because the options – the strategy options is either to sell our mid to low end cell-phones at a very low price to beat the local Chinese companies in terms of price or to upgrade the product so that we have larger screens or better components. But then that would probably impact the high-end segment of the market.

So I can see how differentiation is possible in the high-end segment. That would probably be through better features. But exactly what is Samsung's strategy in terms of differentiating its mid to low end smartphones so that it will be competitive even against the local Chinese companies?

Kim Hyunjoon

[Foreign Language] Our strategy in the mid to low end segment is to address both the product side of the competition as well as the price side of the competition. We are planning on incorporating some of the key features offered in the high-end segment of our products to the mid to low end products, and also have a very competitive price policy as well.

Also, we will be focusing our product line-up in the mid to low end segment around a small number of very strategic and key products which would help us improve not only the marketing effort but also enhance the profitability.

We think that also it would be important for us to focus our efforts, because we are expecting that even within the mid to low end segments the growth will be coming from the large screen, the LTE model. And so that is where we would be having a very competitive focus line-up in terms of both product features and pricing.

Also, we will be using the advantages that we have at Samsung, our brand awareness as well as our relationship with the channels, in order to grow our mid to low segments.

I do see that the market may be concerned of the margin impact as the mid to low end segment grows in the entire smartphone market. But we believe that we do have the room for additional efficiencies in terms of R&D, supply chain management, so that we would be able to – by these additional efficiencies, be able to be competitive in terms of both product and price in the mid to low end segment.

But I would like to correct that our revenue, our sales in terms of the mass smartphones, the mid to low end, is not as large as you had indicated.

Simon Wu – Bank of America Merrill Lynch

[Foreign Language] Now, my last question is about the 14-nano FinFET that has already been discussed so much during this conference call. I'm wondering, when do you think the 14-nano FinFET in terms of cost will become cheaper than the 20-nano products that the Taiwanese companies are mostly focusing on? It seems like – my impression is that Taiwanese companies are sort of taking their time migrating onto 14-nano.

And while the 14-nano needs time to catch up in terms of cost to the 20-nano counterparts, I'm assuming then the competition regarding the AP chips would become for Samsung's perspective a competition in terms of performance. But given that in the mobile handset market the high-end is being very squeezed in terms of growth. Wouldn't that mean that the high-end, the high performance AP chips will feel a cost burden going on to next year given the difficulties that we're expecting in the premium high-end handset markets.

Robert Yi

[Foreign Language] That's another difficult question, but what I can say is that our 14-nano FinFET, once it goes through ramp-up in the second-half of next year, will be experiencing a large improvement in its cost. It's a bit difficult to tell you exactly when that improvement would be realized, because that will be subject to various factors including production as well as the demand situation from the market.

But as we mentioned, because we are planning to ramp up the 14-nano FinFET on our existing lines, that will be able to produce additional benefit in terms of profitability. And on top of that, we promise to continue our efforts to have additional cost effectiveness by improving our yield as well as productivity.

We've been having the Q&A session for about an hour now. I have been informed that we still have three persons waiting in queue, so I would like to suggest that we take these three questions before ending today's conference call.

Operator

[Foreign Language] The following question will be presented by Keon Han from Credit Suisse. Please go ahead, sir.

Keon Han – Credit Suisse Securities

Yes, good morning. A quick question on the 14-nano FinFET, you mentioned that you'll be starting with your Exynos product. And I guess my understanding is that production will begin in the U.S. Austin fab. If that's correct, is there a specific reason why you're starting the 14-nanometer in the U.S. for example? And second part of that question is that, when we see the 14-nanometer equipment ordering trends, it looks like the GlobalFoundries is actually the most aggressive.

And there's some speculation in the market that in fact GlobalFoundries could produce 14-nano chip prior to Samsung. And as we know, Samsung is the technology provider for that, so is that even a possibility that GlobalFoundries could produce 14-nano before you?

[Foreign Language]

Robert Yi

[Foreign Language] To answer your second question first, as we had mentioned, our plan is to go into 14-nano FinFET mass production at the end of 2014, and we believe that will be the first in industry. Whether we will produce this in Austin or Giheung in Korea, that will be flexibly decided depending on the market situation on the volume as well as the demand situation. We think that the 14-nano FinFET can be produced in either line.

Keon Han – Credit Suisse Securities

And just one follow-up question.

Robert Yi

[Foreign Language] Yes.

Keon Han – Credit Suisse Securities

Okay. So on the handset margins, as we know first quarter you probably surprised the market on all the sell-in volume and good margin structure. Second quarter, obviously some correction, M&A [ph] correction, promotion expense went up, margins came down. Is the sustainable margin, at least in the near term, somewhere between say, looks like, first quarter was 22%, second quarter was 15%. Is it somewhere between there that we can expect or is it just going to be sustainable at our current rate in the near term?

[Foreign Language]

Kim Hyunjoon

[Foreign Language] Regarding the mobile business in the third quarter we are planning to launch new models in the premium segment as well as in the mass, the mid to low end segment. And so in terms of volume, we are expecting to see a quarter-on-quarter growth in terms of shipment volume. However, in the second-half of this year we're expecting competition from new model launches from our competitors as well as fierce competition on both the price end as well as the product feature, the specification-end. So it's difficult for us to expect an improvement in quarter-on-quarter performance and in terms of the direction of our margins, it's difficult for us to predict the direction of our margins currently.

[Foreign language]

Operator

[Foreign Language] The following question will be presented by Min-Seong Hwang from Samsung Securities. Please go ahead, sir.

Min-Seong Hwang – Samsung Securities

[Foreign Language] I have two questions. First question is about the tablet market or the tablet sales for Samsung. Tablet sales were very low in the second quarter, but even in China, whereas the handsets are selling well in terms of chipsets and through MID. It seems that tablet sales are showing a different nature. How do you think that the sales in the tablets, the low sales in the tablets, how do you see that that is different in terms of the nature from the smartphones sales?

Kim Hyunjoon

[Foreign Language] I think the main reason the tablet market's growth rates are leveling off is, one, is that the replacement cycle for tablets are longer than that of smartphones and so the main – first replacement cycle has not come yet.

And the second is that tablets are still a relatively young product segment in the emerging markets. But next year once the early adopters of tablets reach their replacement cycle, we think that there will be replacement demand from the existing tablet users, then also the emerging market will be adopting tablets in a larger scale, and that will be able to fuel growth in the tablet products going forward.

And so going forward we also think that with the mobile chipsets becoming higher – more capable that tablets will be able to function closer to a PC and also support the productivity tools such as Office better and that will be able to generate additional demand for tablets. In the second-half, Samsung plans to launch the Tab S which uses an OLED display and is differentiated from other products in terms of both design and functions. And in the mid to long term we will be focusing on launching tablets that function as if a PC and also develop our B2B and other synergy markets.

Min-Seong Hwang – Samsung Securities

[Foreign Language] I think one impression that I'm getting from today's conference call is that regarding DRAMs at least, whereas the market seems to be concerned that Samsung would aggressively increase its market share to all of the DRAM related questions, the response from Samsung today has been that it will be responding flexibly depending on the market and customer demand situation. Now, I think a way of addressing this parallel would be to provide some adjusted data, so could you – is it possible to give us, for example, the DRAM payback or what is the margins that you believe are sustainable going forward?

Robert Yi

[Foreign Language] I think a better way of answering that question would be to say that our strategy in terms of memory in the past at least in the recent three years has never been to sacrifice profit for the sake of sheer market share. I know that the questions are coming from the investors and the fact that they're worried, out of concern that perhaps Samsung would take this opportunity as an opportunity to just mainly grow market share at the cost of lower profitability. But I would like to say that that is not a concern, because we have not considered any such strategies of just growing market share just for the sake of it at the cost of our profitability.

Any revenue growth will have to be supported by justified profits in terms of the memory strategy and any resulting market share increase at the end of the day will be because we were able to supply more capacity to the market, at a profit compared to other suppliers. We are not going to take this as an opportunity to increase our market share just for the sake of it.

Now, and I think that leaves us one last question.

Operator

[Foreign Language] The last question will be presented by Han-Joon Byun from KB Investment & Securities. Please go ahead sir.

Han-Joon Byun – KB Investment & Securities

[Foreign Language] I have two questions regarding the semiconductor business. First is the current situation of the System LSI business. I think one of the reasons why the operating profits, the operating results of the System LSI business this quarter was poor was because the shipment of its Exynos, 20-nano Exynos has not recovered. I'm wondering, what is the current situation on the 20-nano Exynos, and overall what is the plan that you have to improve the competitiveness in the AP products?

The second question regards NAND and there was a previous discussion of a cost penalty between 3D versus 2D and I think your answer was that, the importance is in having the right balance and optimized portfolio between these two products which I guess you're implying that the two-track strategy will be maintained for the time being. And in that context my information is that you are currently preparing the 16-nano planar NAND – do you have any further steps down the road map in terms of process migration?

Doo Young Soo

[Foreign Language] To answer your first question regarding the AP competiveness for the System LSI, there will be – the two major reasons for the weak performance in the first half of the System LSI was that there was a weak demand from the mobile handsets especially the high-end side. And the second is that the carriers themselves seem to have preferred a one-chip solution and that is why our focus is to increase the supply of one-chip solutions by improving the connectivity with the modem. Also as you know at the end of last year the modem team became integrated into the System LSI team and we have been able to already secure a global LTE slim modem product.

Regarding our migration road map, regarding we plan (inaudible) yet, even beyond 16-nano we have plans going on next year and then further to migrate and scale at whatever the technology limit permits.

Robert Yi

[Foreign Language] Thank you very much for staying with us until the end of this long conference call. Thank you very much.

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