Samsung Electro-Mechanics Co., Ltd. (A009150) Earnings Call Transcript & Summary

[Interpreted] Good afternoon. Thank you very much for joining today's conference call. We will now start the third quarter earnings conference call of Samsung Electro-Mechanics. The conference call will begin with a presentation by the company, followed by a Q&A session. [Operator Instructions] Now we will start the presentation by Samsung Electro-Mechanics.

[Interpreted] Good afternoon. This is KwangWook Bae, Head of Planning Team and IR at Samsung Electro-Mechanics. Thank you for joining our third quarter earnings conference call. On today's call, I am joined by EVP, Bongyong Kang of the Business Support Team; SVP, Kook-hwan Cho, Head of Strategic Marketing; Jung-hoon Ahn (sic) [ Ahn Jung-hoon ], Head of Support Team, Component Solution Division; [ Jang Won Lee ], Head of Support Team, Module Solution Division; and [ Kwon Choi ], Head of Support Team, Substrate Solution Division. We will start with a presentation on our third quarter company level and divisional business results, followed by market trends and outlook by product before taking your questions. First, our third quarter results. In Q3 2020, our revenue was KRW 2,287.9 trillion, which is about 26% growth Q-on-Q, and approximately, 3% growth year-on-year. The details regarding the business -- revenue increase/decrease factors by divisions will be explained later on during the divisional results. Third quarter operating profit was KRW 302.5 billion, which is approximately 215% Q-o-Q and 60% increase Y-o-Y. Pretax profit in Q3 was KRW 300.7 billion, driven by factors including increase in operating profit. Net profit after corporate tax was KRW 230.2 billion. Next, in terms of financials. As of end of September 2020, total assets was KRW 9,245.5 trillion, which is about 1% increase from the end of the previous quarter. For the major financial indicators, debt-to-equity was 60%; net debt-to-equity, 9%, both slightly decreasing Q-on-Q. Equity to assets was 63%, a slight increase Q-on-Q. Next are the results and future outlook for each division. First, the Component Solution division. The Component Solution division's third quarter revenue was KRW 983.2 billion, a roughly 7% (sic) [ 17% ] increase Q-o-Q and 20% increase Y-o-Y. In Q3, the main driver for the division's revenue growth was the increased supply of high-end MLCC, thanks to increased sales of small-sized, high-capacitance MLCCs for mobile applications of key customers combined with the increased supply of automotive MLCC from the recovery of the automotive demand. We also achieved further enhancement in profitability through gains in yield and equipment efficiencies by improving our yields in overseas plants and unlocking profitability around key bottleneck processes. In terms of the MLCC market outlook, IT-related demand for applications such as mobile, PC and game devices is expected to continue, and we will focus on further expanding the supply of high-end MLCCs for IT applications. For automotive MLCCs, demand is expected to increase as automotive demand starts to recover, and we will focus on increasing supply by adding new products to our high-reliability lineup. Next is the Module Solution division. The Module Solution division's third quarter revenue was KRW 852.7 billion, a roughly 41% increase Q-o-Q, but a 9% decrease Y-o-Y. Major factors for the revenue growth were the increase in high-end camera module supply, such as folded zoom for the new flagships launched by Korean and overseas customers and the start of mass production for the 5G communication modules for the supply of 5G millimeter wave high-end antenna modules. The camera module market is expected to continue to evolve around a better optical zoom functionality and adoption of higher pixels. Accordingly, we will focus on supplying new high-end camera modules for flagship smartphones as well as the increasing supply of camera modules for the upper mass tier smartphones. Also given the expected growth of 5G communication module market, we will focus on diversifying our 5G-millimeter wave antenna module customer base. Last, the Substrate Solution division. Third quarter revenue was KRW 452 billion, which is roughly 23% increase Q-o-Q but a 1% decrease Y-o-Y. In package substrates, the supply of BGA for the APs on a strategic customer's new flagship increased, and there was also an increase in supply of Flip Chip BGAs for the thin CPUs driven by the increased demand for laptop PCs. Also in the case of circuit boards, we started supply of the RFPCBs for the OLEDs on the new flagship smartphone, which helped increase the overall division revenue. However, on a year-on-year basis, revenue slightly decreased mainly because RFPCB, which shows strong demand seasonality. And this year, the demand was pushed back from third quarter to the fourth quarter. The profitability of the substrate division improved as a result of increased sales of high-end products. Package substrates continued to operate at full utilization as the share of high multilayer substrates, including 5G antenna substrates, increased and with the increased sales of RFPCBs for the new OLEDs. We expect that the market demand for high-end package substrates will continue to remain solid going forward. In response, we will focus on actively responding to market demand by increasing production of high-end package substrates for applications such as 5G, automotive and thin CPUs and also leading the market by securing next-generation technology such as multilayer and micro circuit. Now that ends my presentation on our third quarter results, and the Head of Strategic Marketing will now go over market trends and outlook by each major product group.

[Interpreted] Good afternoon. This is Kook-hwan Cho, Head of Strategic Marketing at SEMCO. I would like to share the update and outlook for MLCC, camera module and substrate markets, respectively. First, for MLCC. During the first half, overall, economic sentiment was negative due to the unprecedented pandemic, social distancing, lockdown and rising unemployment. However, various applications relating with a new trend of remote working and learning, such as laptop PCs, servers and tablets, monitors and base stations, drove up demand for MLCC, which helped us achieve solid results compared to initial concerns. In Q3, we saw demand increase across all applications as demand for applications returned for smartphones, TVs and game devices. Even automotive MLCC demand started recovery from the bottom in Q2 as automotive plants increased their utilization levels. Our production lines are in normal operation without any COVID-19-related disruptions. And while overall market supply is on an upward trend as other MLCC suppliers also see better utilization in Q3, channel inventory appears to remain at normal levels, given the increase in market demand. In terms of outlook for fourth quarter and next year, we expect demand improvement to accelerate in Q4, given the continued solid demand for applications such as smartphones, other mobile devices, PCs and game devices, which together, account for about 2/3 of the IT MLCC market, combined with the recovery of the automotive MLCC demand as indicated of how in September, North American auto market recorded growth on a year-on-year basis. In particular, we have been continuously receiving upside volume requests from customers driven by 5G expansion and increased demand by Chinese smartphone customers and given the effects of the new smartphone launches in North America and new product launches by game device companies, change in demand due to seasonal year-end inventory adjustments is not expected to be significant. For next year, even though a lot of uncertainty remains about economic outlook and sellout by application, the size of the overall MLCC market is expected to grow versus this year, driven by demand growth in 5G smartphones and automotive products. We will focus on maximizing customer satisfaction with on time, optimal supply, in line with solid demand expected in the fourth quarter and also increase our revenue with growth in the share of high-end products. Also, given the high possibility of market volatility, depending on whether COVID-19 ends and the level of stimulus policies by each country, we will continue to carefully monitor the market and prepare strategies for each scenario to ensure growth of our MLCC business even in 2021. Next about the camera module market and our strategies. In Q3, the level of global demand recovery and the launch of new flagship smartphones and the wider adoption of folded zoom cameras were all major drivers behind the increase of demand around high-end camera modules. In the market, there is an ongoing trend around implementation of 100x digital zoom, supported by increased demand for 108 meg modules for flagship smartphones and adoption of 5x optical zoom. This approach of adopting high-end camera modules as a differentiation feature has been gradually spreading even down to mass tier smartphones, resulting in a wider adoption of 48 meg and 64 meg high-pixel modules. In response, our technology advantages, such as the 6p and 7p multi-element, large-aperture lenses and the internal sourcing of key components, such as ball grid actuators, place SEMCO in the optimal position to capture not only opportunities in the premium camera module market but also in the upper mass tier market. Already in Q3, we have achieved higher revenues by supplying high-end camera modules that incorporate differentiating technology, such as precision lens technology and high-performance actuators in the new flagship models launched by strategic customers. Even though flagship smartphone-related camera module demand is expected to decrease in Q4 due to seasonality, we will focus on leading design activities for the new module scheduled for launch in Q1 and also expand the supply to the upper mass tier smartphones. For 2021, we will prepare to fully capture the opportunities presented by the wider adoption of high-end camera modules to drive our business growth. Last, for the substrate business. In Q3, our package substrate business, including BGA and Flip Chip BGAs remained strong, maintaining full utilization, especially around the high-end thin substrates. The demand for RFPCB products also improved as seasonality kicked in and the revenue in Q3 increased with the start of new product sales for the overseas customers, which is a major part of our volume. In Q4, for BGA, we expect demand growth around 5G antenna and AP substrates, driven by wider adoption of 5G smartphones. Also because the demand for smartphone RF front-end SiP is also expected to be solid, we're expecting BGA product revenue to continue growth, especially around the high-end products. For the Flip Chip BGA market while the launch of the new CPU will help drive market growth, the increase in layers and the size of the substrate to support the higher-spec PCPU will further erode the Flip Chip BGA capacity, likely leading to an even tighter supply situation. Demand for these thin Flip Chip BGA and BGA products that we are currently supplying is expected to remain solid even next year as demand for laptop continues due to remote working and learning trends and a wider penetration of 5G. For RFPCBs, we are expecting a significant increase in revenue during Q4 as we supply our new products for the new flagship smartphone launched by the overseas customer. That ends my market update and outlook. Thank you.

[Foreign Language] Now Q&A session will begin. [Operator Instructions] The first question will be presented by Wonjae Park from Mirae Asset Daewoo.

[Interpreted] I have 2 questions. The first question is about your third quarter results, very strong and above market expectations. Can you give us a bit more detail on the main reasons, the causes of the strong results in the third quarter? Second question is about an MLCC update. Can you give us some details of where MLCC was in terms of ASP and shipments in third quarter and your guidance for MLCC in the fourth quarter?

[Interpreted] To answer your first question about the major reasons why we were able to overachieve -- over-deliver on the market consensus. As you know, in the third quarter, all of our business divisions have been able to achieve improvements overall. First of all, for the MLCC, while the demand for MLCC for both IT MLCC and automotive MLCC continue to expand, for the IT MLCC, it was because of the major demands related with the remote working and steady trends such as MLCC demand related with PCs and smartphones. Also for automotive MLCCs, there was an improvement in demand because of the improvement in the auto market. While this was happening on the demand side, we were able to maintain stable mass production of our production by strengthening our measures to prevent disease in our global plants. And also, we were able to further enhance our cost competitiveness by enhancing our yield and equipment efficiency. I think on top of that, the higher utilization that we were able to achieve further amplify the effects of profitability improvements, and we were able to deliver above-the-market expectation. If we look at the substrate division, there was -- that is explained, number one, by the increase in the higher-end package substrate supply, such as the substrates for the 5G millimeter wave antenna as well as the substrates for mobile AP and the thin CPU substrates. On the other hand, we were able to increase the revenue of the RFPCB for the new OLED, which also boosted up profitability. Camera modules were also able to deliver solid results because of increase in the sales of especially folded zoom and the high pixel camera modules.

[Interpreted] To answer your question -- second question about the MLCC third quarter ASP shipments and the fourth quarter outlook. In third quarter, there was increase in sales of both IT high-end and automotive MLCCs, driven by the recovery in demand for smartphones as well as automotive MLCC itself, and this is why our shipments in third quarter increased in the mid-teens versus the previous quarter. Also the prices remained stable in the market, and so our blended ASP in third quarter was similar to the previous quarter. Looking forward to the fourth quarter, we do expect that our shipments in Q4 would increase slightly versus Q3, given the fact that major new flagship models and the new game console is scheduled for launch and the fact that the automotive MLCC demand is also continuing to show signs of recovery. In terms of ASP, we think that fourth quarter ASP will remain similar to what we saw in third quarter.

[Foreign Language] The next question will be presented by Ji-San Kim from Kiwoom Securities.

[Interpreted] I have 2 questions. First question is a follow-up to the MLCC. Can you also give us your detailed MLCC utilization and inventory levels for third quarter? And the outlook of these indicators for the fourth quarter? The second question is about the RFPCB. I think many are expecting your RFPCB performance to improve in the second half, given the launch of the new flagship model by the overseas customers. Can you give us the impact that you've seen in the third quarter and your expectations for the fourth quarter?

[Interpreted] To answer your question about the MLCC utilization and inventory, as demand recovered from the third quarter, we have also improved our utilization to full utilization level. Also in order to meet the stronger market demand for our IT and automotive products, we have been expanding our sales. And as a result, our third quarter inventory has decreased slightly versus the second quarter. Looking towards the fourth quarter, we expect our utilization to remain at full utilization level, given that demand for mobile, TVs and other IT applications are increasing. And also, the automotive recovery is likely to remain. In terms of inventory, we expect our inventory levels to remain at sound levels.

[Interpreted] To answer your second question which was about the RFPCB and the impact to the overall Substrate division's business. As you mentioned, during the third quarter, we started the mass production of our new RFPCB for the flagship of the customer, the flagship smartphone of our customer. On top of that, we also increased the supply of substrates for thin PCs, for laptops as well as mobile APs, and this has helped overall divisional revenue and profitability to increase. Looking towards the fourth quarter, while our supply of the RFPCB for the OLED will reach full scale, the package substrates would also, I think, continue to see tight supply situations as the demand for 5G-related products increase and as the substrates become higher multilayered as a result of -- for the PCs. And so due to these factors, we think that we will be able to achieve business performance improvement in fourth quarter versus the third quarter.

[Foreign Language] The next question will be presented by Harry Kim from CLSA.

[Interpreted] Questions are about MLCC. The third question is about the Substrate business. The first question regarding MLCC is, you said that the automotive demand recovered in third quarter. Can you give us the share of automotive MLCC within your overall MLCC revenue in third quarter? And does the company have a target of that MLCC revenue -- automotive MLCC revenue share for next year, full year 2021? How much of your overall MLCC revenue do you think will be accounted for by automotive MLCC? The second question is that, I think, after the end of second quarter, the company suggested the possibility that some of the capacity in the Tianjin plant could be allocated for high-end IT applications rather than automotive applications. Can you just confirm whether the company still finds that possibility open? So do you still consider allocating some of your Tianjin capacity for high-end IT applications? The third question is about talk in the market of the company possibly exiting or selling off its Wi-Fi business or its RFPCB business. Can you give us some color regarding this talk that's going around in the market? And maybe as part of a bigger picture, can the company give us any information or color about what it thinks in terms of financial plans or investment plans or M&A strategies going forward?

[Interpreted] To answer your first question about the share of automotive MLCC, yes, even though the first half automotive MLCC demand was weak, it started to recover in third quarter. And I think in third quarter, it accounted for about a little less than 10% of our MLCC revenue. We do expect automotive MLCC demand to continue to grow in fourth quarter, and our target for fourth quarter is to increase the share of automotive MLCC to above 10% of our MLCC revenue. You also asked about the Tianjin new MLCC plant and how we plan to allocate that capacity. We already started pilot mass production in Tianjin starting from September to meet the demand from the IT high end as well as industrial MLCC customers. We will continue to pace the increase of capacity in Tianjin, in line with what we see in the market.

[Interpreted] You've also asked about some of the media reports regarding our businesses. As a company policy, we always consider various ways in order to maximize the efficiency and the value of our individual businesses. Currently, we have not made any final decision or detailed decision. Once we have details finalized, we will communicate that with the market in the future.

[Foreign Language] The next question will be presented by Giuni Lee from Goldman Sachs.

Congratulations on the strong performance. I have one question on camera module. So you've mentioned that you plan to increase supply for the upper mass tier smartphones. I wanted to know how much this could contribute to the top line growth of your camera module business. And also given the lower ASP compared to flagship smartphones, is there any concern on margin dilution? [Foreign Language]

[Interpreted] To answer your question about the smartphone camera module supply and expanding that to the upper mass tier. As you know, we have been the leader in supply of high-end camera modules, the high-spec, high-feature camera modules for the flagship smartphones of both Korean as well as overseas OEMs. Recently, we're seeing that in the market, even the mass tier smartphones are demanding, asking for camera modules with specifications similar to what goes into the flagship models in terms of, for example, optical zoom and other needs. And therefore, the need for adoption of high-performance, high-end camera modules is coming from the market, from the upper mass tier. And that is why from third quarter, we have started to supply optical 3x OIS products to the mass tier. And we are planning to further increase the revenue that comes from the high end, the upper part of the mass tier smartphones segment. We believe that this will increase the revenue of the camera modules, and that by next year, the revenue share of these products could increase to double digit or more in terms of our revenue share. You've also asked about the implications this may have to our margins. But we think that considering the additional factors, such as the cost saving effects that comes from larger scale, we would be able to increase our top line while maintaining appropriate levels of margins.

[Foreign Language] The next question will be presented by Jay Kwon from JPMorgan.

I have one for Substrate division. We've been hearing increasing the investment in capacity addition activities from your competitors, Japan and Taiwan. How would you assess the competitive landscape for your Flip Chip BGA business? [Foreign Language]

[Interpreted] You've asked about the competition implications in the Flip Chip BGA given, for example, the investments in capacity made by Japanese and Taiwanese competitors. In the Flip Chip BGA market, while demand is growing driven by applications such as servers, 5G and automotive, due to the increase in the layers required in the substrate as well as the increase in size of the substrate itself, there is more capacity that is eaten by these increases in layer and sizes, and that is why there has been a continuous supply shortage compared to the increasing demand. Competitors have been investing in capacity, as you mentioned during your question, but we have also been expanding our capacity in line with the market situation. And our basic approach going forward is that we will carefully monitor the market situation and plan to increase market or increase product -- production capacity, if that is what is called for by the market situation. And given about what the competitive outlook, as you know, in this high-end Flip Chip BGA market, it's only a handful of very few companies that can actually supply that have the technology to supply. So even though competitors are investing, we think that the possibility of competition becoming intensive is not very high in the near future.

[Foreign Language]. The next question will be presented by Hyung Wou Park from Shinhan Investment.

[Interpreted] I have one question about the communication module, the millimeter wave for -- module for the 5G. Many people are expecting higher 5G penetration? Can you give us your current status update on the millimeter wave product and your expectations for the future?

[Interpreted] You've asked about the 5G millimeter wave antenna module business. And in third quarter, we started supply of the 5G millimeter wave, high-end antenna module that uses the 28 gigahertz band. Even though the 5G millimeter wave is still in a very early phase as a market, we do expect that as new services and applications are launched, it will be adopted wider going forward. And so we will be focusing on building our business, especially by diversifying our customer base.

[Foreign Language] The next question will be presented by Taewoo Lee from UBS.

Congratulations again on a great set of results. I got 2 questions, first, on camera modules. So it seems like the customers' interest and demand for folded zoom cameras are quite high and still increasing. So I was wondering how much is the folded zoom revenue contribution currently. And could you share some color on what you expect in terms of the outlook? And my second question is for the overall firm line. So could you share any comments on the impact from Huawei restrictions for your overall business, especially on the indirect impact side given SEMCO's higher exposure to the Huawei competitors? [Foreign Language]

[Interpreted] To answer your first question about the folded zoom, we started the folded zoom supply in 2019. And currently, we are supplying the product to many major companies in both Korea and overseas. The folded zoom revenue has been growing as more and more OEMs adopt optical zoom features onto their handsets in order to differentiate the smartphone. And we expect that this year, the revenue contribution of folded zoom will be double digits, reporting significant growth versus the previous year. Regarding our future business strategy for folded zoom, given the very positive response from the market for folded zoom, we will continue to focus on winning markets and also expanding our business by gaining technology differentiation in folded zoom, given the fact that the market is expected to move on to a higher magnification power for optical zoom and also adopt new technologies such as variable zoom.

[Interpreted] Regarding your question -- second question about the impact of the Huawei sanction, we don't think it's appropriate for us to mention or to answer that question. But we can say that we will continue to focus on responding and satisfying the customers' demand and also focus on continuously building our differentiating competitiveness in the key businesses that we have.

[Foreign Language] The next question will be presented by S. K. Kim from Daiwa Capital Market.

[Interpreted] I have 2 questions. First question is about the millimeter wave, the 5G millimeter wave antenna substrate. There is increasing demand for that product. But given the fact that this product does eat up, erode more capacity than the existing products, some are concerned that this may lead to a capacity shortage. And so can you give us your outlook of market demand for next year? And how you plan to make up for any capacity shortage or erosion that may happen because of the 5G millimeter wave antenna substrate product, the antenna module product? The second question is about your performance guidance -- the results for fourth quarter as well as next year. Can you give us some guidance on your business results you're expecting? We do know that fourth quarter is usually the slow season in terms of seasonality of SEMCO's business. But this year, the MLCC is doing very strong. And there are even some expectations that the customer may launch new products earlier than their original calendar schedule. So can you give us a bit more detailed guidance for fourth quarter as well as future?

[Interpreted] To answer your first question about the 5G millimeter wave antenna substrate, its market demand outlook next year as well as how we are planning to respond to the capacity limitations, as you know, the 5G antenna substrate is a very sophisticated product that requires a high multilayer substrate, and it does erode, eat into the capacity quite significantly. And those are the reasons why only a very few number of companies are actually in this space supplying that product. Fortunately, we've been able to prepare the necessary capacity in advance by making the supplementary investments and also improving our product mix earlier in this year. Now going forward, we do continue to plan to actively respond to increasing market demand for these multilayer 5G substrates by further enhancing our productivity and also expanding our capacity in appropriate manner.

[Interpreted] Yes, this is EVP, Bongyong Kang, of the Business Support Team to answer your question about the fourth quarter and future guidance. Looking towards to the fourth quarter, we do expect the IT demand to continue to remain strong, driven by applications such as smartphones, PCs and game devices. And also with the expected effect of new models being launched by the overseas customers, we believe that fourth quarter this year, we will be able to achieve more solid results compared to previous the previous year. So in terms of division, we think that the Component business division and the Substrate business division will be able to continue its revenue growth trend in the fourth quarter. The module business division is expected to decrease in terms of revenue versus the third quarter, but that the amount of decrease, the degree of decrease in revenue for the Module division would be less compared to previous years, given the fact that it will not only supply high-end camera modules for flagship smartphones but also expand its addressable market down to the higher part of the mass tier. Looking to the market for next year, there is still quite a lot of uncertainty in the business environment due to possibilities of a second wave of COVID-19 and possible tensions between U.S. and China. But when we look towards the downstream demand, the demand in our key downstream industries, such as smartphones and automotives is expected to recover at least compared to 2020 as these industries go through major technical turning points such as 5G and electrification. Our approach, number one, is to further increase our technology competitiveness as a differentiating factor for our key products by securing the key source technologies and materials, the equipment as well as manufacturing processes in order to actively satisfy the customers' demand while, at the same time, focusing on maximizing our productivity by enhancing our equipment efficiencies as well as manufacturing know-how further. So given that market outlook and our focus on further technology and manufacturing excellence, we will focus next year on further enhancing our enterprise value by achieving above-market growth rates by increasing our revenue and also further enhancing our profitability. At the same time, given the market situation and the uncertainty, we will continue to maintain a flexible business operation system that strengthens our market sensing capabilities and also establishes contingency plans, so that we will be able to minimize any volatility in our business performance regardless of what happens in the external environment by continuously maintaining sound free cash flow and managing the risks. Thank you.

[Interpreted] Well, that completes our conference call. If you have any further questions, please forward them to our IR team. Thank you very much. [Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]