Thank you very much for joining our earnings conference call. We will now start the 2016 third quarter earnings conference call of Samsung Electro-Mechanics. The conference call will start with a presentation by the company before we take your questions. To ask questions, please press star one. We will start the earnings conference call. Good afternoon. This is [Hoik Lee], Vice President of Finance and Accounting of Samsung Electro-Mechanics. Thank you for joining our third quarter earnings conference call. We have CFO Kwang Young Chung, as well as key executive of each business division and executive of marketing joining us. Please note that the comments and data presented during this conference call contain forward-looking statements that could differ significantly based on changes in the macroeconomic environment and market conditions.
First, we will look at the third quarter results and financials before going into detailed results and future strategies of each business division. First, our Q3 revenue was KRW 1,467,300,000,000, which is a 9% QOQ and YOY difference, a decrease. The operating profit was KRW 12.8 billion, which is a decrease of KRW 2.4 billion, QOQ decrease, and KRW 8.7 billion YOY decrease. Main reasons for the QOQ decrease is fall in key component revenues such as camera module and MLCC because of decrease in demand of the strategic customer's flagship model. Even though the company expanded cost savings through yield improvements and cost cutting to make up for the lost profitability, fall in the Korean won to the U.S. dollar exchange rate, and fall in ASP, and some temporary costs for management efficiency caused operating profit to fall below market expectation.
Pre-tax profit was KRW 5.1 billion, net profit KRW 2.2 billion in Q3. Next, our financials. As of end of September 2016, SEMCO's total assets was KRW 7,325,600,000,000. Liability was KRW 2,980,600,000,000. Our financial structure remains strong with a debt equity ratio of 69% and capital adequacy ratio of 59%. Now we look at the results and strategy of each business division. First, the DM division. DM's Q3 revenue was KRW 658.5 billion, which is a 10% decrease quarter-over-quarter and 1% decrease year-over-year. In Q3, due to decrease in demand of strategic customers' flagship model, camera module revenues slightly dropped versus Q2, but our camera module was newly adapted into a new mass-market model as we pursue to diversify the product lineup.
Also, we have succeeded in pilot production of a dual camera module with differentiating performance and have started to supply this to a major Chinese maker. In the future, the camera module strategy is to first diversify the customer base for dual camera modules by developing differentiating features with low power technology and software development, and strengthening our manufacturing capabilities with new techniques and equipment exclusive for dual camera manufacturing, and by securing leading technologies such as high-precision alignment and calibration. We plan to lead the dual camera market from Q4 2017 when significant growth is expected and develop dual camera module into a new growth momentum for the company. Also, given the increase in demand from the Chinese market for high-end single-camera modules, we plan to actively expand the supply of 16 mega plus AF and OIS high-end modules targeting flagship models of Chinese customers.
Next, about the communication module business. In Q3, sales of wireless charging modules increased significantly quarter-on-quarter. The sales of Wi-Fi modules, which account for a larger part of overall sales, decreased, resulting in a slight drop in revenue of communication module as a whole. In terms of future strategy, we will continue to expand supply of Wi-Fi modules to the strategic customer by enhancing high performance, low power characteristics through design optimization and by designing high density, smaller sized new products on time using our differentiated packaging technologies to expand revenue. For wireless charging modules, we will increase supply of the receiving module where we have a competitive advantage with internal supply of magnetic sheets, high efficiency, and excellent heat dissipation.
We will secure leading technology for rapid charging and magnetic resonance to gain entry into new growth markets such as wearable and automotive, while at the same time actively develop the receiver side of the market that is expected to grow as charging infrastructure rolls out. Next, the LCR division. Q3 revenue was KRW 450.8 billion, which was an 11% decrease quarter-over-quarter and a 17% decrease year-over-year. First, MLCC revenue decreased due to foreign demands related with strategic customer flagship model and adjustment of said manufacturing by overseas customers. However, Chinese major smartphone makers, with increased headset volumes, needed more small size, high capacity MLCCs, and our revenue from Chinese mobile customers continues to grow.
Future MLCC strategy is first to continue to increase revenue from industrial and automotive applications. We will expand the lineup of high reliability products, such as high temperature and high voltage MLCC, and increase our supply capability with dedicated production infrastructure and quality system. We'll expand industrial and automotive revenue by developing global top-tier customers and pursuing new specs. The new plant in the Philippines will add a highly efficient innovative line to contribute in both quality and cost competitiveness. We will increase high value-added passive components and improve the product mix. Next is the EMC business. In Q3, due to decrease in demand for thin power inductors for the strategy customer flexing model, revenue decreased slightly quarter-on-quarter. In terms of future strategy, first, sales of new power inductors will be increased.
We will launch new products on time to meet the needs of the strategy customers for smaller and high efficiency products to increase new product sales. We gain cost advantage by increasing the working panel size and internalize material to win opportunities with overseas and Chinese customers. It is in order to actively develop new customers and sales opportunities outside the captive market. Second, the EMC product lineup will be further diversified. We will pursue increasing sales of new products such as high efficiency, high frequency inductors, and these that use differentiating manufacturing technology unique to SEMCO to diversify the product structure that is currently dependent on power inductors, which also help keep EMC revenue up. Lastly, the ACI division. Q3 revenue was KRW 327.8 billion, a quarter-on-quarter 5% decrease, year-on-year 17% decrease.
Revenue of a package substrates for mobile APs decreased due to decrease in Flip Chip CSP demand from falling sales to strategy customers flexing model and adoption of Fan-Out WLP technology by an overseas customer. Even though the sales of flip chip BGA substrates to overseas customers increased due to growth in demand of substrates for laptop PCs, overall revenue decreased compared to the previous quarter due to falling sales to global companies. The future strategy for package substrate is first, to expand market share in mobile AP boards. We are strengthening strategy cooperation with major customers and also increase design activity in AP solutions for Chinese customers by improving product lineup and securing low cost technologies, including better manufacturing efficiency. It is in order to offset as much as possible and decrease in revenue due to adoption of Fan-Out WLP.
For CPU package substrates, we will actively meet increasing demand for thin core boards for laptops and qualify for next generation new CPU products on time to increase share of high-value products in revenue and improve profitability. The HDI substrate increased in revenue compared to Q2, despite decrease in sales to strategy customers' main board, thanks to increased supply high-value flexible PCB to overseas customers. Future HDI strategy is to strengthen business competitiveness by increasing share of overseas production and to increase market share of the strategy customer. We will leverage the Vietnam plant to enhance cost competitiveness and continue innovative activities such as lead time and yield improvements to concentrate on increasing sales to the strategy customer. That ends our presentation. We ask for your continued support for SEMCO. Now, we will take your questions.
Now, question session will begin. The first question will be provided by Jisun Kim from KB Securities. Please go ahead, sir.
I have two questions. The first question is about the impact of the discontinuation of the Galaxy Note7. What is that impact? Also, can you give us your outlook on the business environment in Q4? The second question is about the dual camera. Can you give us some more detail about the revenue of the dual camera in Q3 and your outlook going forward?
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To answer your question about our dual camera. During the third quarter, we started pilot supply of our dual camera module to a major Chinese handset maker, and the supply is increasing. We are expecting this to continue to expand in the fourth quarter, especially given the fact that many global smartphone makers are now adopting dual cameras as a part of their features. This may actually become an explosive growth factor similar to what we saw when OIS was being rolled out. To prepare for such changes in the market, we are ready. Also we will continue to expand our supply to the Chinese makers at the same time.
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To answer your question about the impact of the Galaxy Note7 being discontinued, as we had previously mentioned during the presentation, it has had significant impact on our third quarter revenue, especially focused around the camera module and the MLCC. Given the fact that the cause is still in analysis, but the Note7 has been discontinued, we think that in terms of our business, the impact will be similar to as we saw last year that it will have some impact on the revenue as well as the earnings in the fourth quarter. The strategic customer today mentioned that actually in place of Note7, they're seeing actually Galaxy S7 and other models' sales staying strong. If this continues, this would also be a potential plus to us down the supply chain.
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The following question will be provided by Marcus Shin from Goldman Sachs. Please go ahead, sir.
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I have two questions. The first question is connected, is sort of a follow-up to your previous answer. The impact of the Note 7, I expect that that would have direct and indirect losses in loss impacts on the fourth quarter for SEMCO. How much does the company expect that to be during the fourth quarter? Also today, Samsung Electronics said that they have plans of compensating the suppliers related with the losses connected, for example, with inventory and so forth, due to the discontinuation of the Note 7. Do you think that could potentially be a plus or at least help you recover some of the operating profit losses that you have incurred? The second question is related with the PLP business. Many people have high expectations for it, but I don't think we get a lot of detail.
Could you give us some more details about your roadmap related with PLP development and the amount of revenue contribution you expect this to have in your business next year and year after?
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The outlook on our fourth quarter earnings, given the fact that the fourth quarter, the year-end, is traditionally a period where the customers go through a cycle of inventory adjustments and try to make up for the changes in the market condition. Given the fact that the flagship model of the strategic customer has been discontinued, we do expect revenue in the fourth quarter to be a decrease Q on Q. However, we will try to make up as much as possible, especially by increasing the supply of high-end camera modules to Chinese mobile handset makers that has now entered a full-scale supply stage. We will increase the market share of our components supply.
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To follow up on that answer, you did mention related with inventory-related costs as a result of Note 7 discontinuation. It has been announced that Samsung Electronics will be fully compensating the suppliers in terms of any inventory burden related with the Note 7 that has been reported by the press that way, and actually it is being carried out that way. In the fourth quarter, we do not expect to have any additional losses incurred related with any Note 7-related inventory. However, there will be some impact in terms of lost revenue opportunities.
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To answer your question about the PLP business, we are currently, as we have already disclosed, in the process of executing investments for equipment and infrastructure related with PLP. Our current target is to complete connection of the line within this year. If everything goes smoothly, we will be able to, in the earliest date, go into mass production Q2 of 2017 next year, but that would depend on talks with customers as well as the overall supply and demand situation in the market. We are expecting 2017 to be the first year of our PLP production, and we will carry out production stabilization and mass production as we internally plan. Especially given the fact that there is already a handset out on the market with a new next-generation packaging AP on board, we expect other customers to also have strong demand for next-generation packaging solutions.
that is why we will be leveraging our FO PLP technology to provide such alternative next-generation packaging technology that offers various advantages in features and requirements. We plan to offer this not only as a single standalone IC package, but also a multi-package solution, such as a system in package or System -in -module form. in terms of revenue contribution, even though it's too early to give you details, we expect that perhaps if everything goes smoothly, within a three-year period, we will be able to record a revenue that is equivalent or more than the current telecommunication module business, including our Wi-Fi modules.
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The following question will be provided by Wooyoung Cho from HSBC Securities. Please go ahead, sir.
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I have two questions. First question is, can you give me the share of revenue you reported from the Chinese customers during the third quarter? What do you think the share of Chinese customer revenue would be in the fourth quarter? Second question is related with a dual camera that's being supplied to the Chinese customer. Are you experiencing any yield-related issues at this point related with that production? Do you expect something like Tronics, would it be likely for them to also adopt dual cameras on their handsets? In preparation for that, is there a need to increase your dual camera capacity? </edited_transcript
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Actually, yes. Our revenue share towards Chinese customers has been increasing, especially as we are able to spec in on the high value-add components and especially the power inductors and other passive components. I think at the start of this year, we said that we expect Chinese revenue to account for 20% or more. Actually, as of the third quarter, we have already achieved that level, and we expect this trend to continue in Q4.
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Regarding the dual camera, we started our pilot supply in the third quarter, and we are continuing to produce smoothly and supply smoothly without any quality issues. I think this was possible because we had prepared very thoroughly for this supply. We have built up our internal manufacturing capabilities, also brought in dedicated manufacturing equipment, also developed dedicated manufacturing techniques for the dual camera. going forward, we will continue to improve our advantages, especially focusing on development of high-precision alignment and calibration technology. Regarding the second part of your second question, given that it's speculation about customers, I hope you will understand that we are not able to answer that.
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The following question will be provided by Jaeyoon Lee from Yuanta Securities. Please go ahead, sir. </edited_transcript
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My first question is about the Fan-Out technology. Recently, there were press reports that something like Tronics plans to produce a 10 nano mobile AP next year using Fan-Out technology. Is SEMCO ready and able to respond to that?
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To answer your question, even though we cannot answer details about customer and their plans, technically speaking from our perspective, we are ready technically to apply Fan-Out technology on 10 nano process.
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Regarding the camera, my second question is, you have hinted that you expect camera module revenue towards Chinese customers to increase significantly in the fourth quarter. Given that, assuming that, what would your utilization of the camera capacity stand at year-end?
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Regarding the camera module, we are currently supplying to a major Chinese customer. They supply dual camera as well as single module cameras. Dual camera wise, many other companies have approached us with interest. We are currently increasing not only capacity, but also increasing utilization. At this point, we are at full utilization.
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[Non-English content ] The following question will be provided by Kangho Park from Daishin Securities. Please go ahead, sir.
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In the third quarter, you had some human resource related costs. Do you think that there will be a repeat of this in the course of this year or next year? Second question is related with the HDI business. This year, your HDI business profitability has been rather lagging. There was a transfer to the Vietnamese plant, but in addition to what you've mentioned, for example, increasing the utilization and also increasing market share of your captive market, don't you see the need for some new initiatives to enhance or improve the profitability of the HDI business?
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Regarding the first question, yes, as you mentioned, we had some human resources related one off cost second quarter and third quarter, and we do expect some human resource costs to also be incurred in the third quarter to a certain extent. I think going forward, such human resources restructuring related costs would be incurred on a routine basis on small levels continuously. This year we had the ERP, the early retirement package offering, as was reported by the press in the first quarter. We don't expect to have the same program next year, but I think looking forward, there would be human resources related costs being incurred in small levels repeatedly.
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Regarding the HDI profitability, in terms of revenue in Q3, even though there was some impact due to the Note 7 situation, we were able to make up for that fall through the good performance in terms of revenue of the rigid flexible, the RFPCB. In terms of revenue, we didn't see much impact of the Note 7 discontinuation on HDI during third quarter, and we think that this will continue in the fourth quarter as well. Your question was more about profitability. Our approach towards improving the profitability of HDI has two prongs to it. The first is to change the production base or to transform the production base. In terms of enhancing the efficiency of the domestic production base, that efficiency improvement process is almost completed. Also, the setup on the Vietnam side is also almost completed.
We will be completing the second stage of setup as of end of October. With that finished, we will be able to put that up to full capacity or full levels, and that will also enhance the profitability of the business. The second prong of improving the profitability of HDI is improving the product mix. We plan to continuously expand RF PCBs, which offers much better ASPs than HDIs. We also believe that major handset makers, including Samsung or Apple, will look forward to adopting this RF technology as the next generation solution. That is why we are currently planning to expand the RF PCB and use this as a step to reaching BEP in the HDI business.
The final question will be provided by Sunok Lee from Hana Investment & Securities. Please go ahead, sir.
I have two questions.
The first question is about the automotive business or sales towards automotive. Automotive applications is being mentioned as a new growth opportunity by most component makers. In terms of SEMCO, what kind of components are making headroom there? Have you won any orders for your components from automotive applications? Specifically, are you seeing some achievements related with the automotive application from MLCC? Second question is about your earnings for the third quarter. Even considering the impact of Note 7 discontinuation, still, I think the earnings this quarter was weak. Were there any one-off expenses that we haven't heard of? In terms of the automotive opportunity, I think next year will be a very significant year for our camera module business supplying towards the automotive applications. We used to be in the rear view camera, but now we are starting to supply sensing cameras, which is a higher technology level.
With this business becoming more full scale next year, we expect that the revenue will double or more than double next year. Also, the picture quality of the cameras are moving from VGA to HD class, and we will be leading that transition and also try to diversify our customer base in terms of automotive camera supply. Also, we will try to expand our coverage in the camera-related space for automotive applications. Use our current footholds to expand into AVM or NVC and other areas within the car. Also for other automotive sides, the communication module, which is a key component in completing the ADAS solution, is now at a point of the market where it is expected to grow more than 30% each year. Global tier ones are looking for suppliers, and we're also looking to move into this space.
in addition to the camera, we will also expand our business opportunities in the automotive supply of our communication module. Also regarding MLCCs, we are trying to expand the tier one customer base with MLCCs this year. Our MLCC automotive sales increased by about 1.8 times year-on-year, and we expect this increasing trend to continue next year.
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Our third quarter operating profit was 12.8 billion Korean won, which was below market expectations. We think that could be attributed to three major reasons. First is the decrease in revenue, top line. Second is the impact of exchange rate, current foreign currency. In second quarter this year, the Korean won dollar exchange rate averaged at 1,162 won per dollar. In third quarter, that came down to 1,120 won per dollar on average. Roughly speaking, a 10 won decrease in the exchange rate for us is about one billion Korean won impact per month. Overall, the negative impact on our operating profit due to the exchange rate decrease is roughly about 15 billion Korean won. That's the second reason.
The third reason, as was previously mentioned, even though the absolute size was an amount was smaller than Q2, we also had some one-off costs in Q3 for future management efficiency.
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That completes our earnings conference call. If you have any other questions, please forward them to our IR team, and thank you very much for joining us.