Ladies and gentlemen, thank you for standing by, and welcome to Hua Hong Semiconductor's Fourth Quarter 2017 Earnings Conference Call. Today's call is hosted by Mr. William Wang, President and Executive Director, and Mr. Daniel Wang, Executive Vice President and Chief Financial Officer. Please be advised that you are dialed in, and in listen-only mode. However, at the conclusion of this management presentation, there will be a question and answer session, at which time you will receive instructions on how to participate. The earnings press release and fourth quarter 2017 summary slides are available to download at our company's website, www.huahonggrace.com. Without further ado, I would like to introduce you to Mr. William Wang, President and Executive Director. Thank you.
Good afternoon, everyone. Thank you for participating in our conference call. We ended the year on a very strong note. The fourth quarter performance was nothing if not stellar. The $808.1 million revenues came from virtually all segments, especially bank card, ID cards, Super Junction, IGBT, and analog and power management ICs. Gross margin and the net profit margin grew substantially over 2016, thanks to the commitment and engagement of all customers and the employees. Once again, our company reconfirmed the success of our strategy and clearly demonstrated our relentless commitment to growth and profitability. As discussed in previous earnings releases, the consistent strong demand for the company's 8-in wafer business far exceeds our capacity, leading to the need for substantially more capacity, a need that can be satisfied best with a new 12-in fab.
In addition, several of our customers also have requirements that can be met with 12-in technologies and potential new customers needing significantly 12-in capacity within the wings. For these reasons, we are going to establish a joint venture to build a 12-in wafer fab in Wuxi in conjunction with the National Integrated Circuit Industry Investment Fund and the Wuxi government. We are convinced that augmenting our 8-in business with 12-in production is the next best step, both to obtain needed capacity and to enable innovation down to 65 nanometers. Our embedded non-volatile memory, RF power management, and related IPs, just to name a few of our highly successful technologies, all can be transferred to and implemented on 12-in equipment rapidly and with reasonable effort.
In summary, our Wuxi project will provide much needed capacity and the technologies to fulfill the demand coming from all segments of our customer base, fixing our capacity bottleneck for the foreseeable future. Furthermore, equally importantly, Wuxi will also enable a significant expansion of that customer base. Now I would like to hand the call over to our CFO, Mr. Daniel Wang, for his comments.
Thank you, William. Hi, everyone. Thank you for joining us today. I will begin with a summary of our financial performance for the fourth quarter and a recap of the whole year 2017, followed by an outlook on revenue and the margin for the first quarter 2018. We will then move on to the question and answer session. First, let me summarize financial performance as of the fourth quarter. Revenue was $216.9 million, 3.3% over Q3 2017, and 11.8% higher than Q4 2016. Cost of sales was $143.8 million, 5.8% higher than Q3 2017, primarily due to increased wafer shipments, and 7.4% above Q4 2016, mainly due to increased wafer shipments and depreciation expenses.
Gross margin was 33.7%, 1.5 percentage points lower than Q3 2017, primarily due to accrual of year-end bonus, and 2.7 percentage points above Q4 2016, largely due to improved average selling price and product mix, partially offset by increased depreciation expenses. Operating expenses were $36.8 million, 25.4% over Q3 2017, primarily due to, one, the accrual of year-end bonus, and two, an impairment provision for certain tools, and 23.7% above Q4 2016, mainly due to increased labor, R&D expenses, and a foreign exchange impact as a result of RMB appreciation. Other income net was $12.2 million, 174.9% higher than Q3 2017, primarily due to increased share of profits from an associate. And 15.5% lower than Q4 2016, mainly due to a foreign exchange loss, partially offset by increased share of profits from associate.
Income tax expense decreased to $7 million, 48.8% lower than Q3 2017, primarily due to an end-of-year adjustment of income tax deductibles. Profit for the period was $41.5 million, 17.4% over Q3 2017, and 8.7% above Q4 2016. Net profit margin was 19.1%, 2.3 percentage points over Q3 2017, and 0.6 percentage point lower than Q4 2016. Earnings per share was $0.04, up by $0.01 from Q3 2017, and flat to Q4 2016. Annualized return on equity was 10%, 1.2 percentage points better than Q3 2017. Now let me provide you with more details on our revenue from Q4 2017. From geographical perspective, revenue from China reached $122.4 million, contributing 56.3% of our total revenue, and an increase of 5% compared to Q3 2017, chiefly driven by increased demand for smart card IC.
Revenue from the United States was $41.1 million, an increase of 8.6% compared to Q3 2017, predominantly due to increased demand for MCU and super junction products, partially offset by decreased demand for logic products. Revenue from Asia was $22.2 million, a decrease of 15.4% compared to Q3 2017, principally due to decreased demand for logic and general MOSFET products. Revenue from Europe was $15.6 million, an increase of 6.9% compared to Q3 2017, primarily due to increased demand for general MOSFET products. Revenue from Japan was $15.5 million, an increase of 6.1% compared to Q3 2017, largely due to increased demand for MCU, flash, Super Junction, other power management IC products, partially offset by decreased demand for logic products.
With respect to technology platform, revenue from embedded non-volatile memory was $85.9 million, an increase of 13.3% compared to Q3 2017, largely due to increased demand for smart card IC and MCU. Revenue from discrete was $62.3 million, an increase of 7.7% compared to Q3 2017, primarily due to increased demand for super junction and general MOSFET products. Revenue from analog and power management IC was $40.6 million, an increase of 2% compared to Q3 2017, primarily driven by increased demand for other power management IC products. Revenue from logic and radio frequency was $19.2 million, a decrease of 32.6% compared to Q3 2017, primarily due to decreased demand for logic products. Revenue from standalone non-volatile memory was $8.3 million, up by 9.6% compared to Q3 2017, principally due to increased demand for flash products. Now let us take a look at the cash flow statement.
Net cash flows generated by operating activities were $88.3 million, up by 17.1% quarter-over-quarter, mainly due to increased government subsidies and decreased payroll and utility payments. Capital expenditures were $17.8 million in Q4 2017 compared to $33.8 million in Q3 2017. Other net cash generated from investment activities was $56.34 million, including $54.6 million from investment in time deposits and $1.8 million of interest income. Net cash flows generated by financing activities were $200,000, including $2.8 million of proceeds from share option exercise, partially offset by $2 million repayment of bank borrowings and $600,000 payment of interest expenses. Let's move to the balance sheet. Cash and cash equivalents increased to $374.9 million on December 31st, 2017 compared to $243.9 million on September 30th, 2017. Restricted and time deposits decreased from $246.9 million on September 30th, 2017 to $193.5 million on December 30th, 2017.
Primarily due to payout of $54.6 million from investment in time deposits. Property, plants, and equipment decreased from $737.7 million as of September 30th, 2017 to $733.5 million as of December 31st, 2017. Total assets increased from $1.9899 billion on September 30th, 2017 to $2.0783 billion on December 31st, 2017. Our total bank borrowings decreased to $92.9 million on December 31st, 2017 from $94.3 million on September 30th, 2017, primarily due to $2 million repayment of bank borrowings. Total liabilities increased to $383.1 million on December 31st, 2017 from $365.6 million on September 30th, 2017, primarily due to increased other accounts payables and income tax payables. Debt ratio increased to 18.4% on December 30th, 2017, flat compared to the previous quarter. Now, I would like to give you a recap of our performance for the entire year of 2017. Revenue was $808.1 million, an increase of 12% over 2016.
Gross margin was 33.1%, 2.6 percentage points over 2016, primarily due to improved average selling price and product mix, partially offset by increased depreciation expenses. Operating expenses were $115.9 million, 11.2% over 2016, primarily due to increased labor, R&D expenses, and a foreign exchange impact as a result of RMB appreciation. Other income net was $21.2 million, 43.2% lower than 2016, largely due to a foreign exchange loss versus gain in 2016. Income tax expenses was $27.2 million, an increase of 10.5% over 2016, primarily due to increased taxable profit. Net profit reached $145.3 million, an increase of 12.8% over 2016. Earnings per share was $0.14, up by $0.02 over 2016. ROE return on equity was 9.1%, 0.5 percentage point higher than 2016. Finally, let me give you a very top-level outlook for the first quarter 2016.
We expect revenue to be between $209 million and $210 million, and gross margin to be approximately 30%. The slight decrease in revenue quarter-over-quarter is due to seasonality and annual maintenance of our two fabs. On a year-over-year basis, revenue is expected to grow 14%-15%. We also plan to declare a dividend for the current year 2017 during the annual general meeting in May 2018, in accordance with the company's dividend policy, i.e., the average dividends paid in three consecutive years will be no less than 30% of the average distributable net profit of these three years. This concludes my financial remarks. Now, I would like to open up the call for question and answer. Operator, please assist. Thank you.
Thank you, sir. We'll now begin the question and answer session. If you want to ask a question, press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press the pound or the hash key. We have our first question from the line of Randy Abrams from Credit Suisse. Please ask your question.
Okay. Yes, thank you. The first question I wanted to ask on the gross margin guidance, for 30%, just how much was from the annual maintenance, like fewer working days, like low season, and then if there were any other factors for the decline back to 30%?
Randy, first of all, it's the seasonality again. The second one is the maintenance. The third thing is the depreciation expense has also gone up a little bit. Well, it'll be going up a little bit. These are the major reasons, but we expect we should be able to go back to the regular level, meaning our normal level, in the following quarters.
Okay. I guess the two follow-ups, because the last few quarters have been pretty strong, is the new normal level, I guess for 8-in, is it kind of back to what you achieved, where it was like 33%-34% the last few quarters? If you could give, I guess, a view on both the CapEx and depreciation for 2018, and how much, I guess, within that CapEx, if there's any for the new fab.
Yeah. Let's just talk about CapEx for this year. It will be around $100 million for the 8-in facilities. So it will be around $100 million. We will continue to expand within the space that we still have. I think we can still generate some capacity there, in particular Fab 3. So we plan to do that. We will continue to do that. What's the other question? Depreciation expenses?
Yeah. Depreciation, and then, I guess, what you consider normal, if the new norm is like 33% to 35%, like that might be where we can come back to.
Yeah, absolutely. That's the plan. Overall, I think the depreciation expense for the year, it's going to be $124 million. That's the expectation.
Okay.
Last year, what the actual was $104 million.
Okay. Great.
Overall.
Okay. And eight-
We continue to be very positive. It's going to be a strong year for us.
Okay, good. On those notes, there has been strong pricing, both I think from mix improvement, and you have been able to lift pricing a little bit. In 4Q, it looked like the pricing, just based on shipments, was flat to down a little bit. I do not know if it was a mix change. If you could give an outlook, what you are seeing on the pricing, if you get more from mix or like-for-like pricing in 2018.
Randy, actually, we continue to improve the price situation by more new products and new technology released to our customer. Especially, we emphasis on our differential technology on the embedded memory and power discrete corridor.
Okay.
Yeah, Randy. Look, we continue to expect growth throughout this year. We continue to expect a combination of price improvement and even further product mix improvement.
Okay, great. The last question I had, just on the OpEx. Maybe expectation, because there was some bonus and tool impairment, like the baseline OpEx going forward. There was also the CNY 8 million profit from associate. If that is a one-time profit, or you might start to get more, if you could talk about what you are getting from the associate income.
Oh, yeah. I would say that's what considered to be one time. It's basically from the investment valuation, basically. It came from the investment valuation, real estate investment valuation.
Okay. I guess the basic OpEx, like it went up for the tool impairment and bonus accrual. If like first quarter, could you go back to third quarter levels, or you expect to increase spending some?
Yeah. Normally, we would do a year-end bonus accrual in the fourth quarter, okay? We expect first quarter to third quarter will be at the last year's level.
Okay, great.
Some slight adjustment. For example, on the annual adjustment.
Right. Okay. Makes sense. Okay. Thanks a lot, and good results.
Thank you.
Our next question is coming from the line of Donald Lu from Goldman Sachs. Please ask your question.
Hey, [Non-English content] My first question is on depreciation. Just to confirm, you said, Daniel, it will be $124 million in 2018?
That's the expectation. Yeah, that is the plan, $124 million.
Okay.
It's up by $20 million compared to last year.
Got it. What about the guidance for
Sorry?
Oh, sorry. What is the guidance for CapEx and also for the government subsidies this year?
The CapEx for this year, 2018, I just said it is around $100 million. Part of that it is going to be maintenance, and part of that will be the capital expenditures.
Thank you.
The government grants, the ballpark number for your model, it would be $10 million-$15 million.
Okay. 10-15. The $100 million is for your existing fab. The one in Wuxi, would that be on your balance sheet, the CapEx, et cetera? Would you consolidate that?
Absolutely, we'll do that. Yes. Next year, we're going to basically start construction for 2018. Basically, we're going to start construction for 2018.
Mm-hmm. What would be the CapEx there? Is that included in the $100 million?
No, that's separate. The $100 million is just for the 8-in facilities, okay, for that three fab in Shanghai.
Donald, we will have a general meeting on the 14th this month. After this meeting approved, more detailed information will be reconfirmed and disclosed to your analyst. Maybe next quarter should be more clear.
Yeah. Everything is going well according to the plan with that new joint venture. Okay, we're having the shareholder meeting on the 14th.
Got it. My last question is that your next door neighbor have said today at its conference call that there is a severe pricing erosion, not only at its 8-in fab. But seems like yours are holding up really well. What is the reason?
Donald, I guess I have not read the latest earnings report. But as we said, I have said earlier, and I like to reiterate, we feel it's going to continue to be a very strong year for us. Okay. We expect we'll have growth this year, our top line. Okay? And there will be some new capacity from our 8-in fabs. the growth will come from both. One is the ASP improvement, and the second way will be the product mix improvement.
Yeah. Donald, I have some comments. I also didn't read any news from the neighbor today, but I have to focus on my strategy again. As we promised three and a half years before on IPO roadshow, we're focused on 8-in differentiated technology. This kind of strategy already demonstrates from our financial data. Last year means last quarter, I think more thanks to our long-term strategic customer and also our employees' contribution. We hope this kind of strategy can demonstrate more stronger data in the coming months or quarters.
Sure. Thank you. Yeah, definitely we see that difference and that result. Thank you so much.
Thank you, Donald.
Our next question is coming from the line of Ning Ding from CICC. Please ask your question.
Hi. Thank you for taking my questions. My first question is about your new Wuxi fab. Can you elaborate more on the capacity and yield ramp-up plan from 2019? Also, when do you expect that the new fab will contribute any positive earnings to your net profit? Thank you.
Hi, Ning. As I said earlier, we are getting the final approval. We will have a shareholder meeting next week on the 14th, and once that is over, we will definitely share with you with more information on that.
Okay, sure. My second question about the competitive landscape in 8-in fab, you just mentioned that you are about to increase 8-in price this year, maybe. Can you give us more color on the price uplift, like how much is due to the upstream raw wafer cost increase, and how much is about your plan to raise the price? Thanks.
Well, there has been some increase on raw materials. That is the fact, okay? We expect that part of the cost will be absorbed by our customers. Okay.
Yeah. I have to say something. As you know, we are not generally increased ASP for all products. We absorbed most cost increase last year, and we also absorbed mostly this year. We found some technology contribution from last year from our technology team and with our customer support. We generate more value-added margin to our customer. Frankly said, we just share this kind of new margin with our customer, by the way, to increase some product price. I am sorry, I cannot one by one to state it, but our customer supports our strategy because they can get more value added from their products in the end market.
Okay, fair enough. Thanks.
Once again, if you wish to ask a question, please press star one on your telephone and wait for your name to be announced. Once again, ladies and gentlemen, if you wish to ask a question, please press star one on your telephone keypad and wait for your name to be announced. There are no further questions at this time. I would now like to hand back the conference to Mr. Daniel Wang for closing remarks.
Well, thank you very much for joining us today. We hope you will join us again next quarter. I wish you have a very good day. Thank you very much.
Ladies and gentlemen, thank you for your attendance. You may now all disconnect.