Ladies and gentlemen, thank you for standing by, and welcome to Hua Hong Semiconductor's fourth quarter 2018 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 your dial-ins are in listen-only mode. However, at the conclusion of the 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 2018 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 are extraordinarily pleased with Hua Hong's fourth quarter 2018 performance. Despite the general weakness in the market, our momentum continued to strengthen. Revenue once again climbed to a new high, reaching $249.1 million, an increase of 14.8% over 2017's final quarter, and 3.3% over the third quarter 2018, driven largely by increased demand for bank ICs, MCU, super junction, and general MOSFET products. As a result of high factory loading, increased selling prices on certain products, and an ever-improved product mix, our gross margin continued at a respectable 34%. We feel a great sense of accomplishment for 2018. Overall revenue achieved $930.3 million, an increase of 15.1% over 2017, driven by strong demand for our specialty technology offerings, in particular for embedded non-volatile memory, discrete technology platforms.
Gross margin continued to be strong and grew to 33.4%, attributable to consistently high utilization and improved average selling prices. Our net profit as a percentage of revenue rose to 20%, two percentage points over the prior year. Return on equity increased to 10.2%, an improvement of 1.1 percentage points. We owe this exceptional success entirely to the support of our shareholders, our board, and the hard work, creativity, and dedication of our employees. The Wuxi fab is moving forward smoothly according to plan. We expect to complete the construction of the building and the clean room by the end of the second quarter to start moving equipment in during the second half of the year and to begin production of 12 in wafers in Q4 this year.
Engineering activities started a few months ago, and our technology development and marketing people have laid out plans for customers, technology, and products for the initial ramp-up. As the Wuxi fab comes online, it will certainly provide great relief for our constrained capacity and provide us with the enhanced means to meet overall customer demand. It will move the company to the next level. I love our team very much, which is always present with relentless energy and dedication, never resting on its laurels, always pursuing excellence. I believe in our strategy of specialty technologies that has been proven many times ago. These two elements work together nicely and will take us far. Now, I'd like to hand the sale over to our CFO, Mr. Daniel Wang, for his comments.
Thank you, William, for your wonderful and generous comments. Good afternoon, everyone. Thank you for joining us today. Let me begin with a summary of our financial performance for the fourth quarter and the recap of the whole year 2018, followed by our outlook on revenue and margin for Q1 2019. We will then move on to the question and answer session. First, let me summarize financial performance as of the fourth quarter. Revenue reached another new high of $249.1 million, an increase of 14.9% from prior year, and 3.3% over Q3 2018. Cost of sales was $164.5 million, 14.4% above Q4 2017, primarily due to increased wafer shipments and depreciation expenses, and is 3.3% higher than Q3 2018, primarily due to accrual of year-end bonus.
Gross margin was 34%, 0.3 percentage point higher than Q4 2017, mainly due to increased selling prices of certain products and an improved product mix, and flat to Q3 2018. Operating expenses were $38.8 million, 5.6% above Q4 2017, largely due to increased labor expenses, and 22.1% over Q3 2018, primarily due to an accrual of year-end bonus. Other income net was $11.6 million, 4.8% lower year-over-year, mainly due to, one, decreased share of profits from an associate and decreased general subsidies. Two, increased foreign exchange loss, partially offset by increased fair value gains on financial assets at fair value through profit or loss and increased interest income. 18.9% down quarter-over-quarter, primarily due to foreign exchange loss after a gain in the previous period, partially offset by increased share of profits from an associate and increased interest income.
Income tax expense was $8.8 million, 25.4% over Q4 2017, due to increased taxable profit, and 34.9% lower than Q3 2018, primarily due to an end-of-year adjustment of income tax deductibles. Profit for the period was $48.6 million, 17% above Q4 2017, and 4.6% lower than Q3 2018. Net profit margin was 19.5%, 0.4 percentage point up by Q4 2017, and 1.6 percentage points below Q3 2018. Basic earnings per share was $0.042, was $0.002 above Q4 2017, and $0.004 lower than Q3 2018. Annualized ROE was 9.6%. Now, please let me provide you with more details on our revenue from Q4 2018. From geographical perspective, revenue from China was $136.3 million, contributing 54.6% of our total revenue, an increase of 11.4% compared to Q4 2017, chiefly driven by increased demand for general MOSFET MCU products.
Revenue from Asia was $34.3 million, an increase of 54.4% compared to Q4 2017, mainly driven by increased demand for MCU and general MOSFET products. Revenue from Europe was $19.1 million, an increase of 22.4% compared to Q4 2017, mainly driven by increased demand for bank ICs and general MOSFET products. Revenue from Japan was $18.1 million, an increase of 16.3% compared to Q4 2017, primarily driven by increased demand for logic and super junction products, partially offset by decreased demand for flash and MCU products. With respect to technology platform, revenue from embedded non-volatile memory was $99.4 million, an increase of 15.7% compared to Q4 2017, mainly driven by an increased demand for MCU and bank ICs. Revenue from discrete was $86.9 million, an increase of 39.4% compared to Q4 2017, mainly driven by increased demand for general MOSFET, super junction, and IGBT products.
Revenue from analog and power management IC was $31.4 million, a decrease of 22.6% compared to Q4 2017, mainly due to decreased demand for LED lighting, analog, and other power management IC products. Revenue from logic and RF was $27.6 million, an increase of 43.9% compared to Q4 2017, mainly driven by increased demand for logic and RF products. Revenue from standalone non-volatile memory was $3.6 million, a decrease of 57% compared to 2017, primarily due to decreased demand for flash products. Let's now take a quick look at the cash flow statement. Net cash flows generated from operating activities were $91.9 million, up by 4.1% year-over-year, primarily due to increased collection of trade notes receivables. Capital expenditures were $61 million in Q4 2018, including $32.9 million of Hua Hong Wuxi. Other net cash generated from investment activities was $111.3 million.
One payoff of $98.5 million from the investment in financial assets at fair value through profit or loss. Two, $12.8 million of interest income. Net cash flows generated from financing activities were $341.7 million, including $400.5 million proceeds from issue of shares, partially offset by $58.3 million of repayments of bank borrowings and $500,000 payment of interest expenses. Balance sheet. Let's now move to the balance sheet. Cash and cash equivalents increased to $777 million on December 31st, 2018, compared to $284.3 million on September 30th, 2018. Financial assets at a fair value through profit or loss decreased from $775.3 million on September 30th, 2018, to $667 million on December 31st, 2018, primarily due to payout from investment in financial products.
Trade and notes receivables increased from $124.9 million on September 30th, 2018, to $176.8 million on December 31st, 2018, primarily due to increased revenue and accounting reclasses from related parties. Other current assets decreased from $57.4 million on September 30th, 2018, to $23.3 million on December 31st, 2018, primarily due to accounting reclasses to treat and notes receivables. Property plants and equipment increased from $752 million as of September 30th, 2018, to $773.2 million as of December 31st, 2018. Total assets increased from $2,641.2 million on September 30th, 2018, to $3,078.3 million on December 31st, 2018. Our total bank borrowings decreased from $88.9 million on September 30th, 2018, to $30.6 million on December 31st, 2018, due to repayments of bank borrowings. Total liabilities decreased to $373.9 million on December 31st, 2018, from $396.4 million on September 30th, 2018.
Our debt ratio decreased to 12.1% on December 31st, 2018, from 15% on September 30th, 2018. Now I would like to give you a recap of our performance for the entire year of 2018. Revenue rose to an all-time high of $930.3 million, an increase of 15.1% over 2017. Cost of sales was $619.1 million, an increase of 14.4% over 2017, primarily due to increased wafer shipments and increased depreciation in labor expenses. Gross margin was 33.4%, 0.3 percentage point above 2017, mainly due to consistently high utilization and increased average selling prices, partially offset by increased depreciation in the labor expenses. Operating expenses were $130.1 million, 12.2% over 2017, mainly due to increased labor, professional expenses, and impairment provisions.
Other income net was $40 million, 88.5% over 2017, mainly due to, one, fair value gains on financial assets at a fair value through profit or loss, and two, increased interest income partially offset by increased foreign exchange loss. Income tax expenses was $35.3 million, 30.2% over 2017, mainly due to increased taxable profit. Profit for the year was $185.6 million, 27.8% above 2017. Net profit margin was 20%, 2 percentage points over the prior year. Basic earning per share was $0.171, is $0.031 above 2017. ROE was 10.2%, an improvement of 1.1 percentage points. Finally, let me give you a very top level outlook for the first quarter 2019. We expect revenue to be approximately $220 million. Year-over-year revenue is expected to grow approximately 4.7%. As you know, Q1, the quarter-to-quarter decline is largely due to seasonality and the annual maintenance of our two fabs.
We expect our growth margin to be approximately 32%. We also plan to decide on our dividend distribution plan for the economy year 2018 during the annual general meeting in May 2019. This concludes my financial remarks. Now I would like to open up the call for question and answers. Operator, please assist. Thank you.
Ladies and gentlemen, we will now begin the question and answer session. If you wish to ask questions, please press star one followed by the relevant key pad, and wait for your name to be announced. If you wish to cancel your request, please press the star or hash key. The first question comes from the line of Leping Huang from CICC. Please ask your question.
Hello. Thank you to take my questions. First, congratulations for the very good result. The first question is about the Wuxi fab. In the call, in the statement you say that you will start equipment moving from, I think, the summer of 2019. Can you elaborate further which application you plan to migrate from the current Shanghai fab to Wuxi? Should we modeling any revenue for input for the Wuxi fab in the fourth quarter this year? Thank you.
Hello, Leping. I am pleased to find you. Our plan in the summer, we are moving the tools. The first products, as usual, will be a logical base to help our product line engine to use smoothly. We hope under this kind of trend and with our customers' help, this year, we can find some risk production and some product mass production through for this year. All the things depend on the help of a customer and, right now, the qualification of the first large products.
Okay. The second question is, in the fourth quarter, we see that your ASP, the wafer ASP, a good thing for me is that the ASP start to go up again after the two quarter of decline. Can you comment on the reason behind? Also, I think the reason we see the 12 in, especially the mature process of 12 in fab, the utilization rate was quite weak. Can you comment on your view on this 8 in supply-demand relation in 2019? Thank you.
Leping. At this point, I think, overall, I mean, the market is weak. We all understand that. For us, I think we are very fortunate. I think our fab continue to perform at very high utilization rate. We are literally talking about above 95%. Okay?
Right.
Now, given the fact that we are going to be doing some annual maintenance in Q1 for HH Fab1 to HH Fab3. We expect two of these fabs will be taken down. Each will be taken down for about four to five days. That will affect our overall utilization rate for the quarter. Okay? But I think it is still going to be comparable. In terms of utilization rate, it is still going to be comparable to first quarter of last year. Therefore, we expect we are going to generate more revenue. We are going to ship out more wafers in this quarter.
Can we expect from Paul, how we should modeling the 8 in fabs ASP for this year? Should we still expect the ASP up this year or because of the capacity?
Yeah. I mean, our ASP has been going pretty strong. Excuse me. If you look at the past two years, 2017, we went up by 7.4%, as you remember. Last year was 6.8%. Okay? I think the trend will continue. Plus, I would not give you a projection on that- but I'm pretty confident. I would not give you a projection on that. We still expect some good growth for this year. Part will come from increased capacity. Part of that will come from ASP improvement. Okay? I would not give you a projection on that, but I can tell you our ASP, I'm pretty confident our ASP will not come down.
Cool. That's great. Yeah. Thank you.
Thank you. The next question comes from the line of Haas Liu from Credit Suisse. Please ask your question.
Hi. This is Haas on behalf of Randy. Congratulations on the good results, and thanks for taking my questions. My first is regarding the slowdown in first quarter. Your guidance is pretty similar to your aim here. Could you please provide more color on the main factors leading to the slowdown and sales trend by segment?
Well, Haas, it's good to hear your voice through the phone here. As I stated earlier, the primary reason for the drop is due to seasonality and annual maintenance of our two fabs. When you look at our overall technology platforms, I think it's probably going to be across all technology platforms. But I think MCUs and discrete will continue to be very, very strong. I expect discrete will continue to grow. But for some other technology platforms, for example, smart card ICs, logic and RF, power management IC, I think they probably will slightly down compared to last quarter. But I think discrete is still going very, very strong for us. We expect our HH Fab2 will continue to be running at a very, very high utilization. It's good that we actually had that fab run annual maintenance in December.
That would really help us.
Okay, that's very clear. Should we expect that HH Fab1 and HH Fab3 will start recovering from second quarter? How should we think about the full year outlook?
Hey, we're still looking for growth this year. As I said, overall, the market is weak, but I think we're doing better than a lot of other people. Things are still going strong for us. We expect there will be growth for us this year. Yes, we expect that Q2 will be a much stronger quarter than Q1.
Yeah, I have to say more as Haas. Actually, our HH Fab1 and HH Fab3 is under planned seasonal annual maintenance. Right now, HH Fab1, both fabs already being very smoothly finished their maintenance, and all the engines have been polished, waiting for the recovery for the end market.
Okay, thank you. That's very clear. My second question is regarding your gross margins. Your margins hold up better in a slowdown. How did you manage margins at 32%? Should we expect the gross margin in Q1 to be the bottom of the year, or will it be pretty similar through the year with depreciation from 12 in gradually comes online?
I think our margin has been holding pretty well for the past several quarters. Q1 is largely because it's slightly lower utilization and it's just a lower revenue. Therefore, you expect the fixed costs will all slightly go up a little bit. Plus the depreciation expense overall is going to go up this year, even for the 8 in fabs. I think the depreciation expense philosophy is $120 million for all three 8 in fabs. We expect that would go up by probably around $10 million for all three of the 8 in fabs. There will be additional depreciation expenses for the Wuxi fab in Q4 as well. Overall, we're looking at. Yeah, sorry.
Could you quantify the depreciation from Wuxi fab?
Wuxi, it will be very small. I would say around maybe $20 million a year for this year.
Full year, the gross margin.
Roughly, it's a ballpark number. We are very conservative with these numbers. It's about $150 million. But I don't expect Wuxi will go more than $20 million this year.
Yeah. Regarding the CapEx and capacity expansion plan, could you please update your plan if there's any change in 12 inch in 2019?
You're talking about for the CapEx, right?
The CapEx and capacity plan.
Well, for our CapEx, we expect this year, for the 8 in fabs, the total is around going to be about $170 million. $120 million, we're going to use that for capacity expansion. About $50 million we're going to use for maintenance. So that's about $170 million. We have planned to add another 10,000 wafer capacity, mainly for discrete for this year. We can still add in total, maybe 20,000 wafer capacity in our HH Fab3. But this year, we probably will add 10,000. It's going to cost $120 million. Then $50 million for annual maintenance. As far as the Wuxi fab, as I said, it's going to run around $600 million, maybe slightly more than that in terms of budget, not really the cash flow.
The cash flow is going to be a little bit slower because the budget is approximately about $600 million a year. That is what we had last year. But it is also going to be the number for this year for the 12 in fab.
Just on the M&A side, Vanguard International Semiconductor recently announced an inch fab acquisition to support the growing inch demand. For Hua Hong, will you consider to build or seek opportunity to acquire existing inch fab in the market in addition to your current 12 in fab plan?
Actually, we are putting an eye on the market. We are looking for good opportunity to maintain a gross margin of this company to balance the capacity expansion. At the same time, we are consider our internal bottleneck tools expansion. I think every sector we are putting an eye on.
My last question was regarding your share count. Could you clarify how the share count will change over time from the equity funding? Thank you.
Well, we only did once, which happened in October last year. It increased by $240 million+. We raised $400 million from the National Integrated Circuit Industry Investment Fund for our Wuxi project. The total proceeds from that was $400 million, and the price was around I think HK 12.90 per share. At this point, we don't expect to issue any more shares, at least not for 2019.
Okay. The share count will be pretty similar to current level?
Yes. It's slightly $1.2 billion, slightly over. I'm sorry, slightly over 1.2 billion shares.
Okay. Thank you so much. Happy Chinese New Year.
Thank you, Haas.
Thank you. The next question comes from the line of Szeho Ng from China Renaissance. Please ask the question.
Hi. Good afternoon, gentlemen. Actually, could you comment about your order visibility right now compared with, let's say, one quarter ago or two quarters ago?
Yeah, it is very clear. As just now Daniel mentioned, we see very clear market demand for our focused technology. It means embedded non-volatile memory and also the power-related products. We also see the weakness on the end market about smartphone, but I hope these kind of things can be more clear on the second quarter of this year. We will continue strengthening our present focused technology, but we also did not skip any opportunity when the market will recovery, especially smartphone-related products.
Okay. All right. Second question, Daniel Wang, maybe it's a question for you. Could you give some idea about the tax, how we should model the tax for this year?
It will be approximately, you know the normal tax rate is about 15%, right?
Right.
But then there's also the dividend part. So, in the past, we pay around 30% of the profit. That part, you have to pay 10% on tax. So roughly around 20%, 21%. It used to be 5%, but now it's 10%.
Okay. All right. Okay. I got you. Okay. Thank you very much. Happy New Year.
Happy New Year.
Thank you.
Thank you. The next question comes from the line of [Matt Curran] from BlackRock. Please ask your question.
Hi, Daniel. Good afternoon. Thanks for the call, and congratulations on the good results. I want to talk about the capital intensity. I noticed that just looking year-for-year, 2017 CapEx as a percentage of sales went from just under 17% to last year were closer to 26%. I am just wondering how you think about the business going forward, with our capital intensity. That is my first question. The second question is if you have any comment on the Vanguard acquisition of the GlobalFoundries fab. It sounds like they are getting 40,000 additional wafers. Those are wafers that are producing today, and I think it is around $260 million acquisition. I am not sure the nodes, you probably know much better than I do. I guess that they are giving an equivalent capacity addition that we are getting with the Wuxi fab, at around half the cost.
Now I know they're different technology platforms and end markets, but just wanted to kind of get your idea on how you view that deal. Just those two questions. Thank you.
Hi, Matt. I am going to leave the second question to William. I will answer your first question in terms of capacity intensity. We have been doing pretty well. We very thrifty with capacity expenditures. Last year, we overall, in terms of cash out, look, I am going to separate Shanghai and Wuxi, because Wuxi is still during the construction stage. Roughly, Wuxi is going to be. Last year, the budget was about $800 million for Wuxi. But in terms of cash out, we only spent $114 million because, in terms of cash, you always pay later. We expect it will happen this year. Roughly, Wuxi is going to be around $600 million a year. You should really take that CapEx out because it's really during the construction stage. But when you look at the 8 in, last year, total budget for 8 in was $95 million.
Overall, we only spent, the PRPO was $94 million, but the cash out was $200 million. I am sorry, it's $124 million. Part of that was from the year before. Overall, our ratio CapEx versus revenue is somewhere 10%-15%. That's in the ratio. This year, I said we're going to be spending about, the budget is about $170 million. We're looking at potentially, it could be anywhere above $930 million. This is what we have done for 2018. It's going to be anywhere north of 930+ , hopefully a nice percentage, depending on the market. I would say we're still going to look at around 17%.
Sure. Thanks.
William?
I have to remind the second question. We also found the news yesterday that Vanguard purchasing 35,000 facility, and after the deal they will be expanding to 40,000 wafer. These kind of tools and [the [NAMS] related IP will help Vanguard to do the expansion to relieve their capacities constraints. It is very good news. It means 8 in still have big business opportunities for the customer. We also have to remind last month, TSMC also released the similar information, saying they will continue to expansion their 8 in. They will help us to continue deliver our strategy as we did four years before. We are continuing to find a business opportunity on 8 in wafer fabrication and find more customer in China and around the world to continue to deliver more dividends and more profit to our shareholder. It is very good news for us.
Matt, the other thing is, you see that TSMC has recently decided moving to the 8 in business. They are going to add more capacity for 8 in. Then now we just heard Vanguard has decided to just close this deal with GlobalFoundries. That says a lot about the 8 in strategy. I think 8 in business will continue to grow. I think there is a lot of demand for that globally, in particularly China. We are very happy to see that. I think we are on the right path, and I think we are going to really benefit from this, especially when the market is getting weak. It is the best time, people. That is just my personal view, that expand your capacity. Hopefully it can get a low-cost equipment.
Sure. If I could ask. Thank you very much. Very clear. If I could ask a follow-up. I have heard, and I could be totally wrong, but I have heard that SMIC is also transitioning some of its 8 in equipment to do more types of wafers that we do, particularly in the discrete and MCUs, that they have historically been a bit underrepresented in. Do we worry about domestic supply coming online that we had not perhaps budgeted for 6-12 months ago?
Certainly there is a big market for MCU. There is also big market for discrete. Last year, our discrete business grew more than 40%. Our MCU grew more than 20%. You see great demand there. At the end of the day, it is about what you have, what can you offer. We have been doing this embedded and non-volatile memory business technology for a long time. It has been 20 years now. Smart card ICs, MCUs. We have a very strong technology platform with many technology partners. These people we have been working from day one for a long time. We have built a very strong technology partnership. We will continue that business. We see strong need for that, in particularly in China. I am sure there are a lot of people looking at that area. I think it would be great. Enjoy the party.
Okay. Thank you, and enjoy your Chinese New Year.
Thank you.
Thank you. The next question comes from Sebastian Hou from CLSA. Please ask your question.
Hey, good afternoon, gentlemen. I have three questions. The first one is that, can you talk about the book-to-bill ratio you have so far? Is it roughly above one or below one?
Sebastian, how are you doing?
I am doing okay. Thank you.
It has been strong. This is a pretty confidential question because this is a lot about the business, right? We have been pretty healthy. I think we are always above one.
Okay.
Yeah. It is very healthy still. Very, very healthy.
Okay. The second question is it possible to offer a full year growth outlook for this year, at this point?
Sebastian, I don't think right now is a very good time, because as just now mentioned, our 12 in capacity will begin the risk production end of this year. We hope we can see more bright future with our Wuxi fab together with our 8 in fab strategy. More customers will migration to 12 in updates. I think we will broaden our 8 in custom portfolio. Maybe, I think the end of this year will be more clear.
Okay. I remember in the first half of last year, I think the company was pretty confident to give a guidance that the year-over-year growth for 2018 will be higher than the year-over-year growth in 2017. I just wonder, is the Wuxi fab or customer migration the only reason behind your not giving the full year guidance right now, or is there anything else that we missed?
Sebastian, our 8 in fabs are going very strong. We have a very healthy booking orders. Virtually, the demand for all platforms are still strong. The only reason that some of the minor technology platforms growth was not there because of capacity limitation for us. Yeah, look, once the Wuxi fab is ready, we're talking about 25% kind of figure growth for the next three, four years.
Okay. Thank you.
But yeah. Overall, I think we're still very positive about this year.
Okay, great. Last question from me is, I think last year or since the second half 2017, because the raw wafer substrate cost has increased. So including, I think most of the, not all, but most of the 8 in foundry, including Hua Hong, has also negotiated with customers to share the cost burden. So some of the wafer price increase last year was because of the cost increase. I just wondered about in this year, it seems like the raw wafer is not so tight as before. My first part of this questions would be, how's your outlook of that? Is there any chance for you to see some cost saving from that?
And my second half of that question would be that if there is a possibility of some cost saving, then would you be able to save or pass some of the cost saving benefit or give this benefit back to the customers?
Sebastian, I think we have to re-definition just now your stand. Actually, we are very good relationship with our wafer vendor. We have very long time, very good relations with them. We didn't find any wafer supply congestion or shortage in the previous two years. And actually, you are right, we share the wafer cost change because of the market price change with our vendor and also with our customer, and also swallowed by ourself. But right now, I don't think it's very good time to say it's time to cut our major wafer fabrication partners' price to maintain the future continuous growth. We will renegotiate with our partner, no matter the vendor and our customer, to see the future wafer supply. So we hope this company will continue keep this kind of good relationship, no matter the vendor or the customer.
Okay. Thank you. If possible, can I squeeze in another questions? Earlier, I think Daniel mentioned, first quarter this year, two fabs are under maintenance. So what was the schedule like in 1Q18 and 1Q17? Back then, were also the two fabs under maintenance?
Well, in fact, we're currently doing that right now, okay? They're pretty much getting very close to finish. Each fab takes about four to five days.
Okay. All right. I'm just wondering that in first quarter 2018, did you also do maintenance on the two fabs back then?
Yes. Yes, we did that.
But I have to emphasize these two fab, previous two years' capacity is different as this year. So you can find the change is quite different.
Okay. Got it.
They have more capacity.
Right. Okay. Thank you, gentlemen. Have a happy Chinese New Year.
Thank you.
Thank you. The next question comes from Donnie Te ng from Nomura Securities. Please ask the question.
Good afternoon, management. Happy Chinese New Year. My first question is relating to CapEx. Daniel mentioned about the CapEx for 8 in, like $170 million and another $600 million for Wuxi fab. In the model, how much CapEx should we book in the cash flow?
Sorry. Don, can you?
Yes.
I didn't get what you're saying.
We have $170 million CapEx for 8 in foundry and another $600 million CapEx for Wuxi fab. How much CapEx exactly we should book into the cash flow in the Hua Hong financial-
In terms of cash flow? Cash flow?
Yeah.
Roughly, that should be the number you put in there. It is about $800 million.
Oh, okay. Basically, like $700, I think, million CapEx.
Yeah. Just put $800 million in there. That is a pretty close number because we still have to catch up with some of the payments for last year.
Okay, got it. Follow-up question is for the HH Fab3 expansion. You mentioned about another 10K wafer per month capacity this year. Have we already secured the equipment?
Yes. We already found enough tools, and also we found a good lead time for this kind too.
Okay, thank you. My second question is related to Wuxi fab. We should see some sales contribution from Wuxi fab in Q4 this year, right? But I think one thing about Wuxi fab is, we should have some government subsidy. But I am not sure how we should recognize the government subsidy? Because in the past, subsidy mostly went to R&D expense or non-operating income. But, due to the depreciation cost will rise, I am not sure whether our subsidy can directly go into cost of goods sold or not. Thank you.
Well, Don, that is a complex question. I would prefer not to answer that question at this point because basically, we have agreement with the government in terms of total amount, in terms of how much each year we are going to amortize that subsidy. I think over the next two quarters, once we start production, that is where we are going to start to utilize that subsidy.
Got it.
I would work with you when things get a little more close to Q4.
Got it.
As we get there.
Should we expect we will see some gross margin dilution into fourth quarter when Wuxi fab enter into mass production?
This year, there really shouldn't be much because we're only going to start in Q4. I think if you see anything, we try to keep it as little as possible. Minimum.
Okay, got it. My third question is related to second quarter outlook. Maybe we don't have that long visibility yet, but I'm just wondering if you are still seeing some growth in second quarter, what product lines or what kind of applications can contribute more? Also, when do you think customers' inventory correction will be ended? Thank you.
Actually, I cannot say what kind of product line is recovering, but we already found nearly all the inventory in the distributor channel has been dropped very low. We hope after Chinese New Year, meaning February, we found that this kind of indicates soon.
Got it. Sorry, one last question is regarding to other competitors' capacity expansion. Previously, some analysts already asked about 8 in peers' activities, but actually for some IDM companies like Alpha and Omega and Infineon, they are all spending new 12 in capacity for discrete products. Wondering if the manager can have some comment on that. What kind of products maybe they are going to do, and will they have any impact to Hua Hong's current discrete product? Thank you.
Yeah. It's a very good question. I think these competitor, also some of them is our customer.
Yes.
They already found a huge opportunity in the future for much bigger demand on power discrete, no matter the present products or the new products. It's a very good indicator to say in the power MOSFET and the power-related products have very huge amount, especially related with electric vehicle and the other products. We didn't see huge pressure on our product line, but we stand more opportunity in the futures product line.
Got it. Thank you so much, and Happy New Year.
Happy New Year.
Thank you.
Thank you. The last questions comes from Ken Liu from [Trace Global]. Please ask the question.
Congratulations on solid results, and Happy Chinese New Year. Just want a bit of clarification. I did not hear very clearly what Daniel mentioned about the receivables in the quarter. It seems to have taken a bit more than usual. Can you comment on that? Thank you.
Well, it is accounting reclass. What happened was, we have these connected parties. Some of them have actually What happened was, one of our, the [Shanghai Huahong Group], one of the shareholders at the group level, have sold their shares recently. All the companies that relate to that shareholder, their transactions will be reclassed from a connected party transaction to a regular transaction. That is why. In total, there was around $40 million. That is the dollar amount.
I see. So it is really just accounting reclassification and not really-
Yes. It is phase.
Okay.
What do you think it was?
Well, so it is really not a reflection of trouble collecting or anything like that?
We never had that issue, Ken. Never had that issue.
All right. Great. Thank you.
It is a reclass. Clearly, it is accounting reclass.
Got it. Thank you.
Thank you. Well, yeah, it's okay. Operator?
Ladies and gentlemen, that's all the time we have for questions. I will now hand back to Mr. Daniel Wang for closing remarks.
Well, again, thank you all for joining us today. We hope you will join us again next quarter. We wish you have a happy and a very wonderful Lunar New Year. Thank you.
Ladies and gentlemen, thank you for your attendance. You may now disconnect.