Ladies and gentlemen, thank you for standing by, and welcome to Hua Hong Semiconductor's First Quarter 2019 Earnings Conference Call. Today's call is hosted by Mr. Junjun Tang, President and Executive Director, and Mr. Daniel Wang, Executive Vice President and Chief Financial Officer. Please be advised that your dial-ins are in a 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 first quarter 2019 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. Daniel Wang, Executive Vice President and Chief Financial Officer. Thank you.
Good afternoon, everyone. Thank you all for joining us. Our first quarter 2019 conference. As always, we are very excited to have this discussion with everyone here. Today, we will first have Mr. Junjun Tang, our new Executive Director and President, to make some remarks on our first quarter performance. President Tang will address in Chinese, and we will also have Kathy Chien , our Head of IR, to translate in English. After that, I will highlight our financial performance and give guidance for the next quarter. This will be followed by our question and answer session. I will now turn the call over to our Executive Director and President, Mr. Junjun Tang. [Foreign language].
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Good afternoon, everyone. Thank you for joining our earnings call.
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I am pleased to announce Hua Hong Semiconductor first quarter 2019 performance. Once again, we are beating our expectations despite an overall slowness in the semiconductor market, which only goes to show the power and quality of our differentiated offerings fine-tuned to the available demand. Our revenue of $220.8 million with an increase of 5.1% year-over-year and 11.4% lower than full Q2 2018, largely due to seasonality, annual maintenance of and reduced demand. Gross margin remains strong at 32.2%, 0.1 percentage point higher than 1Q 2018 and 1.8 percentage points lower than 4Q 2018, largely due to lower utilization. Net profit margin was 21.1%, two percentage points up year-over-year and 1.6 percentage points over 4Q 2018.
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Though there are uncertainties and challenges under the current environment, we are optimistic and believe that our strategy of differentiated technologies will continue to prevail. We have seen signs of recovery for certain of our technology platforms, in particular MCU and power discrete. Therefore, as soon as my new role became effective, I have instructed and lead a team to accelerate the pace of capacity expansion and upgrades for certain manufacturing corridors in the 200mm wafer facilities. We want to make sure our capacity will be available as soon as the market turns around. Investment on this additional capacity and upgrades are minimal, but the payoff will be huge.
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The 300mm project is in its critical stage. Therefore, I'm virtually there half of the time. Overall, I'm very pleased with the progress of the project. We still expect to complete the construction of the building and clean room by June, to start moving equipment in during the second quarter, and begin risk production in 4Q 2019. Our technology development, engineering, and sales marketing people are working very closely on a number of tape outs, which will go right into the initial production of the new 300mm wafer production line.
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Though this is a huge responsibility, I'm very excited and honored to be leading this incredibly talented and dedicated group of people. I'm grateful for the support of our shareholders and the confidence the board of directors placed upon me. Let us together make Hua Hong Semiconductor the greatest company in the world.
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Now, I would like to hand the call over to our CFO, Mr. Daniel Wang, for some comments.
Thank you, Mr. Tang, for the very inspiring comments. Now, let me begin with the summary of our financial performance for the first quarter, followed by our outlook on revenue and margin for the second quarter of 2019. Then we will move on to the question and answer session. First, let me summarize financial performance as of the first quarter. Revenue was $220.8 million, an increase of 5.1% over the prior quarter, benefited from increased average selling price and improved product mix. 11.4% lower than Q4 2018 due to seasonality, annual maintenance of two our fabs, and a reduced demand. Cost of sales was $149.8 million, 4.9% above Q1 2018, primarily due to increased labor costs and the unit cost of the raw wafers. 9% lower than Q4 2018 due to accrual of year-end bonus in the previous period and a decreased wafer shipments.
Gross margin was 32.2%, 0.1 percentage point over Q1 2018 and 1.8 percentage points lower than Q4 2018, primarily due to lower capacity utilization. Operating expenses were $31.7 million, 24.7% above Q1 2018, largely due to increased labor and technology development expenses. 18.3% lower than Q4 2018, primarily due to impairment provision and accrual of year-end bonus in Q4 2018. Other income net was $5.5 million versus other loss net of $2 million in Q1 2018, primarily due to fair value gains on financial assets at fair value through profit or loss, and increased interest income. 53% down quarter-over-quarter, primarily due to increased foreign exchange loss and decreased share of profit from associate, partially offset by increased interest income. Income tax benefit was $1.9 million, 508.9% over Q1 2018 due to a reversal of dividend withholding tax accrued for the prior year.
Profit for the period was $46.6 million, 15.9% above Q1 2018 and 4% lower than Q4 2018. Net profit margin was 21.1%, 2 percentage points over Q1 2018 and 1.6 percentage points over Q4 2018. Basic earnings per share was $0.037, which is $0.002 lower than Q1 2018 and $0.005 lower than Q4 2018. The increase in outstanding shares is due to $400 million equity investment by the National Integrated Circuit Industry Investment Fund in November 2014. Now, please let me provide you with more details on our revenue from Q1 2019. From geographic perspective, revenue from China was $116.6 million, contributing 52.8% of our total revenue, and a decrease of 0.7% compared to Q1 2018, chiefly due to decreased demand for Analog products. Revenue from U.S. was $41.1 million, an increase of 2.1% compared to Q1 2018, mainly driven by increased demand for general MOSFET products.
Revenue from Asia was $25 million, an increase of 4.5% compared to Q1 2018, mainly driven by increased demand for MCU products. Revenue from Japan was $19.6 million, an increase of 61.8% compared to Q1 2018, primarily driven by increased demand for logic and MCU products. Revenue from Europe was $18.5 million, an increase of 12.3% compared to Q1 2018, mainly driven by increased demand for smart card ICs and general MOSFET products. With respect to technology platform, revenue from embedded non-volatile memory was $84.7 million, an increase of 1.1% compared to Q1 2018, mainly driven by increased demand for MCU, partially offset by decreased demand for smart card ICs. Revenue from discrete was $83.8 million, an increase of 26.6% compared to Q1 2018, mainly driven by increased demand for Super Junction, general MOSFET, and IGBT products.
Revenue from Analog and power management was $23.7 million, a decrease of 33% compared to Q1 2018, mainly due to decreased demand for other power management IC products, LED lighting, and Analog products. Revenue from logic and RF was $24.4 million, an increase of 26.7% compared to Q1 2018, mainly driven by increased demand for RF and logic products. Revenue from standalone non-volatile memory was $4 million, a decrease of 25.3% compared to Q1 2018, primarily due to decreased demand for flash products. Now, let's take a look at the cash flow statement. Net cash flow generated from operating activities were $78.9 million, up by 37% year-over-year, primarily due to increased collection of trade and notes receivables. Capital expenditures were $110.2 million in Q1 2019, including $84.9 million for Hua Hong Wuxi and $25.3 million for Hua Hong Shanghai.
Other net cash generated from investment activities were $86.1 million, including, one, payout of $79.6 million from investment in financial assets at fair value through profit or loss, and $6.5 million of interest income. Net cash flow generated from financing activities were $317.7 million, including $317 million of equity injection to Hua Hong Wuxi, our JV subsidiary. Two, $2.8 million proceeds from issue of shares, partially offset by $100,000 payment of interest expenses. Now, let's take a quick look at the balance sheet. Cash and cash equivalents increased to $1 billion 155.3 million on March 31st, 2019, compared to $777 million on December 31st, 2018. Trade and notes receivable decreased from $176.98 million on December 31st, 2018 to $160 million on March 31st, 2019, primarily due to decreased revenue. Inventory increased from $129.6 million on December 31st, 2018 to $140.3 million on March 31st, primarily due to increase in raw materials.
Property, plants, and equipment increased from $773.2 million as of December 31st, 2018 to $853.8 million as of March 31st, 2019. Total assets increased from $3 billion 078.3 million on December 31st, 2018 to $3 billion 521.4 million on March 31st, 2019. Our total bank borrowings were $31.2 million on March 31st, 2019. Total liabilities increased to $400.3 million on March 31st, 2019, from $373.9 million on December 31st, 2018. Debt ratio decreased to 11.4% on March 31st, 2019, from 12.1% on December 31st, 2018. Finally, let me give you a very top-level outlook for the second quarter 2019. We expect revenue to be approximately $230 million, flat compared to a year ago, and a 4.2% increase over Q1 2019. We further expect gross margin to be approximately 30%. This concludes my financial remarks. Now, I would like to open up the call for question and answers. Operator, please help. Thank you.
Thank you. Ladies and gentlemen, we will now begin the question and answer session. If you wish to ask a question now, please press star 1 on your telephone and wait for your name to be announced. If you wish to cancel your request, please press the pound or hash key. Once again, ladies and gentlemen, it's star one for questions. Your first question comes from the line of Randy Abrams from Credit Suisse. Please ask your question.
Okay. Yes, thank you. I wanted to ask the first question, maybe for Mr. Tang on the new appointment on President. Congratulations. I wanted to ask, I guess, just on overall strategy for the company, if any shift in investment strategy on the 8-inch and 12-inch and any meaningful change in the operational strategy, or it is kind of intent to maintain the existing business as it was.
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I am very glad and honored to join the team. As you know, Hua Hong Semiconductor is a great company. We have already established a very competitive 8-inch line, and the majority of my job is to optimize the overall flow. Hua Hong Semiconductor (Wuxi) Limited is in progress. We are now accelerating the work and target to achieve the risk production target by end of 2019.
Great. Thanks.
Okay. Yeah. Thank you. The second question, I wanted to ask maybe more on the guidance. If the business profile, maybe to go through what has been going on in the Analog, where you are seeing good momentum in discrete, whether you expect that, like the MOSFET, Super Junction, that to continue. The other side of the Analog power management has been declining. If there has been some factor driving the decline and if you see that rebounding. I guess overall, beyond the Analog, how you see the other applications trending over the next couple of quarters between the MCU smart cards and some of the other applications.
Randy, thanks for the question. I think you just hit the points. Discrete continue to be a very important segment for us. For Q1, just when you look at discrete, continue to be a very strong area. When you look at Super Junction, IGBT, others, it continued to do very well. The momentum was there, the strength was there. Virtually, that area was flat to Q4 when you compare to Q4 last year. Q4 perhaps was the best quarter ever we had. We expect that will continue. When we look at Q2, I think discrete segment, when you look at whether it is Super Junction, IGBT or the general MOSFET, I think each area, from what I see, will have a strong growth. I am literally talking about a double-digit growth.
I think even in the smart card area, we still see some growth there as well, especially the SIM card, I think maybe just because of the seasonality, as well as some other cards like ID cards. I think clearly we see some signs of recovery at this point. Our utilization was low for Q1, but I think Q2 will have a better utilization. Utilization rate will definitely improve in Q2. So we expect that hopefully will take us back to the normal rate of utilization.
Okay. If I could ask on the blended, it looks like the ASPs had a pretty good lift in the-
Yeah
Quarter. Just if you could maybe talk on the ASP trend, if you are continuing to see that direction, or after the slowdown, any reversal, or pricing could start to come in and be a little more aggressive.
Yeah. Even it was in a low season, low quarter, I think our ASP continued to be very strong. I think it had a very nice, almost close to a 5% growth. To be precise, it was 4.9% growth. Hopefully, that will continue. I think overall, we still expect our ASP will continue to prevail. Okay? Basically, when you look at by segment, I think the embedded non-volatile memory, we had that very nice single-digit growth there. Discrete was very strong. Analog also went up as well, slightly. Logic and RF also had a very nice growth there. So overall, we had a very nice close to 5% growth in ASP. Yeah?
Okay. The other side of it, the gross margin, given the ASPs have been pretty good and utilization picking up. For the gross margin, the guidance to 30%, maybe go through the factors, and also if some of it's depreciation coming up, but the factors and how you see margin trending, like as we go towards second half, if 30% is the level or it could come back up into the low to mid-30s again.
Overall, this company has always been very conservative in the past. When we give a guidance, we want to make sure we will always reach and meet eventually. Hopefully, we can beat again. When it comes down to cost, manufacturing cost, there's always a time difference. Part of that was a result of just overall, a general weakness in the market, therefore it's a lower utilization rate in Q1. Part of that is because of that, and we're hoping that 30% is the lowest, it's the bottom. Hopefully from this point out, we believe we will continue to do well. It was because of maintenance, seasonality and overall, there's just a reduced demand in Q1. I think, clearly, at this point, we expect Q2 will be better. Hopefully, this 30% is the bottom, the lowest we could.
Hopefully from this point out, things will improve.
Okay. We should still use $150 million for depreciation this year? Or any change on that schedule?
Yeah. That's very good. Randy, you're always good on these things. Pretty much the way I look at it is, last year was $120 million. The total depreciation, the amortization expenses. For this year, it's $150 million. $130 million, we expect it's going to come from Shanghai. The three aged fabs, and then we expect it'll be $20 million coming from Wuxi.
Okay. Yeah. Okay, great. Thanks a lot. I appreciate the color, and also good luck to Mr. Tang as well.
Thank you. Your next question-
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Your next question comes from the line of Sebastian Hou from CLSA. Please ask the question.
Hi, thank you for taking my question. My first question is to follow on the gross margin for second quarter. It looks like the second quarter, as Daniel Wang just mentioned, there is a recovery and utilization rate is improving. But it looks like the guidance seems like the gross margin will have a dip. I understand that companies try to be conservative, but if we compare the guidance of this quarter versus the guidance of last quarter, it seems like still a decline. Can you walk us through what is the factor that driving this? Is it because of the higher depreciation or other factors in second quarter?
Thank you, Sebastian. That was a good question. As I said earlier, when it comes down to manufacturing costs, there is always a time delay. Basically, part of the reason that we expect the gross margin is going to have slight dip up to 30% is largely because the utilization rate in Q1 was lower. We expect the utilization will recover, in Q2 will be better. But part of manufacturing costs will actually come into Q2. Therefore, that is part of the reason that the gross margin will be affected in Q2. But overall, the utilization rate will recover in Q2. There is a time difference, Sebastian.
Okay. Got it. Okay, I see. Is it more because of the lower utilization rate? The products, the wafer that you produced in Q1, that actually carried a higher cost.
Yeah.
When you sell it and you recognize the cost of goods sales, that cost is higher, so that caused the Q2 margin dip. Am I getting that right?
Exactly. Virtually 50% of the stuff we produce in Q1 will get shipped in Q2. That is always the case.
Okay.
Basically, it is a timing difference.
Okay, got it. In terms of the-
We expect 30% is, hopefully this is the last. From this point on, we should move up.
Right. Great. That's good. In terms of the full year outlook, do you have any guidance or forecast for overall 8-inch foundry industry or in Hua Hong, the growth for this year?
As I said earlier to Randy, basically, I think we see some good signs at this point. For the past three, four weeks consistently, we have seen these quick orders, fast orders, in particular in the segments of Super Junction, IGBT, and general MOSFET. I've also said even within smart cards, we see for SIM cards, some other cards, that some high margin stuff, actually, we have a pretty good bookings, orders for Q2. Okay?
These are good signs for Q2. Hopefully, like everybody else, like all our peers, hopefully we will see a true recovery in Q2. But we are still very positive about Q3 and Q4.
Right.
At this point, we expect things will turn better. We have already seen good signs. Hopefully, the second half will even be better.
One of your peers, Vanguard International Semiconductor Corporation, a couple of weeks ago, they talked about that they expect the 8-inch foundry industry to show a negative growth this year.
Yeah.
Is Hua Hong Semiconductor confident that it can beat that numbers?
I do not want to comment on other company, but we understand that particular company has a negative growth quarter-over-quarter. As far as the guidance goes, basically, we are positive about this number, this revenue number we are giving out at this point. Hopefully, we can do even better.
Great. Okay.
We are positive.
Great. I have a question on the, because the other day, there is some speculation on the third generation ID card in China. I just wondering, are you seeing that in the pipeline right now, and when do you expect that to happen? Supposedly that should be the good tailwind for us.
It's happening now. We're fully ready. In fact, we're working on a few things basically on the 90nm technology. Some of that is in production. Some of that we're doing the testing work at this point. All of those are done at our 8-inch fabs. Let me ask if Mr. Tang has also some- Can give us some commentaries on that. Yeah, it's moving very quickly. And part of the reason that Q2, our smart card has gone up is because of that.
This third generation ID card, the design has been done and is actually already in production right now.
Yes. That is at least-
In Q2-
Starting.
Okay, Q2 will be the first quarter for this new generation ID card to begin production.
Well, let's put this way. Q2, we should see some pretty decent growth for the ID cards.
Okay. Last question from me is, in terms of the subsidy reduction of some electric vehicles on the low specs of the electric vehicle, do you see that having any impacts on the discrete demand for us?
Well, not really. At this point, the Super Junction has, for example, for Q2, we still see a pretty strong growth for Super Junction. It's a very nice double-digit growth. From our end, I think it doesn't really impact us.
Okay. Got it. Okay. Thank you. That's all from me.
Thanks.
Thank you. Your next question comes from the line of Szeho Ng from China Renaissance. Please ask your question.
Hi, and good afternoon. Question regarding the OpEx in Q1, it was up 25% year-over-year. Is there any one-off items last quarter in the OpEx?
Szeho, let's look at that. Operating Expenses?
Right.
Compared to a year ago?
By a lot. Yeah. Is there any one-off items?
You have to realize, we have started some work in Wuxi already. I would assume some headcounts, general G&A expenses, and even some R&D expenses will actually increase in these areas. But overall, they are manageable.
Okay. All right.
That was primarily that these are the reasons why the operating expense has gone up compared to a year ago.
Okay, good.
By pretty much around like maybe $5 million.
Okay. All right. For the Wuxi fab, when should we expect it contribute to the top line?
Sorry, I cannot hear you, Szeho Ng.
For HH Fab 7, the JV, when should we expect the revenue contribution?
Maybe I will have Mr. Tang to answer that question.
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The Wuxi project is already in progress, and we are targeting to start with production by end of year. Technically, we will see revenue contribution by end of this year.
Okay. Got you. Okay. Thank you.
Thank you.
Thank you. Your next question comes from the line of Aaron Jeng from Nomura. Please go ahead.
Okay. Thanks for taking my question. My first question is about your I know that earlier you already said the pricing in Q1 was pretty strong, but I wonder how the pricing outlook across product lines into second half this year. I cannot put this question because I was thinking your 12-inch fab capacity will be ramping more into 2020, and you are going to migrate some of your smart card now manufactured at 8-inch to the 12-inch fab, so that probably you are going to have some more capacities for 8-inch over the next one year. Would this be impacting your pricing strategy into second half this year? This is my first question. Thanks.
Hi, Aaron. As I said earlier, we had the nice quarter-to-quarter, even though it's a low quarter, but I think our ASP still did pretty well. I think it's 4.9% up. I think our ASP will continue to hold at that level. We are hoping that we can continue to make some improvement on that through ASP improvement and product mix improvement. Through ASP increase and the product mix improvement. I think we have a good chance because I think, in particular, as I said, the discrete area, we continue to see strong demand there. We have limited capacity, and it was for the same reason that since Mr. Tang joined the company, he has decided we should start to accelerate the capacity expansion in the 8-inch space. We're going to add hopefully by 5,000 to 10,000 capacity for discrete this year.
That will continue to open the manufacturing corridor for discrete, therefore, can improve the product mix better. That is a very important area they're working on, we're focusing on. We still see some strong signs in smart card ICs, as I said earlier, for example, ID cards and also MCUs. MCU prices continue to be very, very stable. That is something we're doing. Hopefully, we can continue to improve ASPs throughout the year. But we'll continue to, at least at minimum, will hold at this level. Our ASP for Q1 is at a very nice, very respectable $483 per wafer. This is not very, very easy for any 8-inch business. Thanks to our specialty technology.
Yeah. Thank you. Earlier, the guidance was for Wuxi Fab to have 10,000 pieces of wafer capacity by end of this year and 20,000 pieces of capacity by end of next year, 2020. Any update on this number?
No. That plan is still on schedule. By end of this year, we're going to have 10,000 wafer capacity. In fact, as I said earlier, we have said we're going to complete the building of the Wuxi Fab, the construction and clean room. For the building, the clean room, and the facility by end of June. In fact, I think the schedule has even bring a little bit closer. I think sometime early in June, we should complete the fab building. Then we can start moving the equipment in Q3, and definitely have capacity by end of Q4. We really want to have some shipment in Q4.
Okay. Thank you. May I come back to the first question a bit. I fully understand that your discrete business is super strong, performance enhancement, Super Junction leading the growth, attributed in the growth. So branded ASP out there should be pretty decent. But given that your discrete capacity cannot be shared with the other product capacity, my question is, for this non-discrete capacity and the products, are you also seeing pricing increase, branded price increase? Or for this segment, non-discrete segment, it can be higher pricing pressure?
Well, we had some nice ASP improvement for embedded and auto memory segment. It was small. It was a 3% increase. It mostly come from MCU. The smart card also went up slightly. Discrete was very, very strong. Analog and Power Management IC also went up slightly. Its logic came from Power Management IC and Analog. Logic and RF was also very strong, has a very nice high single-digit growth.
Yeah. I was asking-
We-
Please go ahead.
Sorry, can you just go ahead, please.
I mean, I was asking into second half.
Oh, second half?
Yeah.
Well, we're hoping we can still keep our ASP at the same level. I can't promise you that, you just can't have 5% quarterly growth each quarter, right? It's going to be difficult. But we're hoping that we can still hold it at the same level.
Okay. Thank you very much.
We're very particular about price, okay? Even if you look at our Q1, utilization was a little bit lower, but the ASP continued to be very, very strong. We believe in price.
Okay. Thank you. My last very small question is, if you look at your depreciation cost in 1Q versus 2Q, what's the comparison? Is 2Q going to be higher or lower, or what kind of level should we expecting for second quarter depreciation versus 1Q?
The Q2 depreciation expense will probably up a few million dollars. For example, maybe slightly under $2 million.
Okay. Up below $2 million.
Yeah.
Okay. Thank you very much.
Q1 total depreciation expense was $31 million. We expect that would go up probably by $1 million.
Thank you. That concludes my question. Thanks.
Thank you once again, ladies and gentlemen, this is dial one for questions. There are no further question at this time. We will now hand back to Mr. Daniel Wang for closing remarks.
Well, again, thank you all for joining us today. As always, it is very, very informative. It was great conversation. We hope that you will join us again next quarter. Thank you all, and have a nice weekend.
Ladies and gentlemen, thank you for your attendance. You may all disconnect.