Earnings Call: H1 2019

Aug 23, 2019

Good afternoon. Welcome to our 2019 Interim Results Webcast and Conference Call. My name is Joyce Kwok, and I'm the Head of Investor Relations at AAC. I am glad to have a senior management team joining this call today with Mr. Benjamin Peng, our Chief Executive Officer and Mr. Richard Mok, our Managing Director. Before we start, we would like to remind you that the copies of our results announcement and presentation are all available on our website. We would like to draw your attention to the disclaimer on the last page of this presentation slide as well. Some information we discuss today might contain forward looking statements. I will now present the 2019 interim results. The revenue for the first half this year has dropped 10% year on year to RMB7.6 billion. It was a challenging period with reduced global smartphone shipments. However, if we focus on 2nd quarter revenue, it has shown a sequential improvement with 1% year on year increase and that has mitigated some of the declines in the Q1. As you can see from the pie chart, acoustics, electromagnetic drives and precision mechanics remain our key revenue contributors and Optics also start to contribute more revenue as well. Gross profit margin decreased by 9 percentage points from last year to now 27.5% as some of our new design solutions were still in their early cycles. A key positive of the results is a good progress on business development and R and D for the Acoustics business where our proprietary product SLS has further gained market share in the Android market. We would also like to highlight Optus as one of our key and strategic growth driver for this year and onwards with a strong growth potential in an economy of scale. We are going to further elaborate on this in the later session. Net profit dropped 57% year on year to RMB717 million, mainly due to the reduced gross profit, as Jeff mentioned and some increase in R and D expenses mainly on the OpEx. EPS dropped a little bit less than the net profit drop reflecting the reduced number of shares after some share buybacks in the last 12 months. The Board declared an interim dividend of $0.40 per share, which is the same as last year. We continue to make satisfactory progress on the business development and R and D in the Q2. For Acoustics and for our proprietary product SLS, we have successfully penetrated into the mid tier Android modules. For Optus, the average monthly shipment has doubled year on year. We have accelerated the technological development and mass production of WLG lenses. We are proactively developing new imaging lens modules and building a new factory in Nanning for these. We also have an R and D center in Finland that focuses on developing innovative optical technologies and new applications. For electromechanical drives, the stepper motor module has started mass production and shipment to mainstream Android customer as a new revenue driver for us. We are ready to embrace the 5 gs era and we have launched 6 different 5 gs antenna solutions for mobile phone and base station during the Mobile World Congress in June this year. And as for the patents, we now own close to 4,000 patents, an increase of 18% from year end of last year. Before we go to the details of each business segment, we'd like to draw your attention to our strong balance sheet, which is particularly important when this world is full of uncertainties and volatility. Our net gearing remains healthy at below 10% for the first half this year. And we have ample gross cash on hand and around half in renminbi and other half in U. S. Dollar. Our strong operating cash flow is also more than enough to cover dividend payments and share buyback. We also emphasize on returns to shareholders and it can be by at least 2 ways, which are dividends and share buyback. We have declared the interim dividend of $0.40 which is the same as last year. While we do not have an explicit dividend policy, in the last 5 years, the EPS has been at the 40% of the EPS. In the first half, we have spent around RMB1.4 billion on paying dividend and buying back shares. Despite the uncertainties around the world and ups and downs along the global smartphone cycle, we are dedicated to invest for our future growth. Our R and D centers are all over the world, including China, Finland, Denmark, Singapore, Korea, Japan and the U. S. The R and D expenses has gone up 15% year on year and the increase is mainly on the OpEx, which is in line with our strategy to make it a key growth driver for the future. The other segment's R and D expenses has dropped in line with the revenue trend. R and D expenses in first half accounts for around 10% of the revenue and CapEx in first half accounts for around 17% of revenue, although we tend to look at both of these on a full year basis. So this slide just quickly show that we have rather diversified manufacturing basis all over Asia Pacific. For the office, we have reinforced this as our key and strategic growth driver. In fact, we have already become top 3 global supplier in the plastic van supply chain. Our average monthly shipment in Q2 has already doubled from last year's Q2 and we target to make it inevitable by this year end and the profitability to also improve. So now we go to a bit more details of each business segment. Okay. So for Acoustics, revenue dropped 15% year on year to RMB3.65 billion. Gross margin dropped by 7 percentage points to 30%. So gross profit dropped 32% year on year to now RMB1.1 billion. And acoustic revenue accounts for 48% of our total revenue. This segment has been affected by the reduced global smartphone shipments and extended cycles for spec upgrades. Having said that, our SLS product platform continue to gain market share in Android smartphones. Overall, we expect a better second half than the first half as we expect an uptrend for both shipment and ASP and potentially the gross margin as well. So for this segment, the revenue accounts for 40% of our total revenue. The revenue dropped 12% year on year. Electrolux and Electric Drive showed a decline, but Precision Mechanics showed significant growth. Even though the revenue for Yian Drugs dropped, the margin has been largely maintained, thanks to our operational efficiency. Precision Mechanics has been doing great with revenue increase, but this segment tend to have a lower margin. So the overall margin for this whole segment has dropped. We are positive on the outlook for this segment for second half this year and next year, especially in terms of capacity utilization. MEM segment has been doing great during the first half as well. Top line is up 11% year on year and together with margin expansion, gross profit up 34% year on year. Both shipment and ASP has been up in the 2nd quarter. We've been working hard on increasing the in house MEMS DAS and digital AZ chips in our MEMS microphone so as to improve the margins. We're also the broadening application of our MEMS to new devices such as those in the smart home market. We included slides here in the past as we have put tremendous efforts on the sustainability. It's within our core value and we believe we are one of the leaders in this regard whether it's among the tech companies in Asia or among the major stocks listed in Hong Kong Stock Exchange. So please refer to the bullet points here for what we've done and achieved here and we will have a full sustainability report to be published soon for fiscal year 2019. So that's all for my presentation. We will now open the floor for the Q and A session. Thank you. Thank you. We will now begin the question and answer session. The first question comes from the line of Susana Choi from DBS. Please ask your question. Excuse me? Thank you for taking my questions. Hello. Thank you for hello, hello, hello. Thank you for taking my questions. Understand that AAC has signed for the mass production for the Hibbett B side, HIBEX B5. So could we understand the mass production is for which client? Is this for the flagship model? And how is your expected shipment and ASP for that? And could you disclose if you have any capacity expansion time for Harvestlands in Zhuo Zhuo? Thank you. Hi, Susanna. Thank you for your question. As we have said earlier, our hybrid land strategy comprised of a successful recognition of the capability of a stronger differentiating to what the current plastic lens could deliver. We have received significant interest from all our customers on the capability of hybrid LANs and whereby the important component there is our mass production with good satisfactory yield on WLG wafer level glass. We are maintaining our plan. I think towards the year end, we are preparing for a higher volume mass production. But at the moment, I don't I cannot disclose any kind of clear specifics on shipment numbers or project details. But I believe hybrid lens is going to be an important trend in delivering higher optical specifications. In the first half, in our Denmark facility, we have already have more than 20 molding machine equipment in operations and we have hired and taken on more than 100 employees and they are undergoing what we call a training phase. The data that we've been seeing from the facility have proven very clearly the composition that in terms of the precision and the optical performance that WLG lens can achieve is much, much better than what the plastic lens can offer. Our current interaction or the successful penetration in all our Android customers have led to a very clear direction that they are interested in the stronger optical applications that WLG can offer. We believe the optic strategy for AAC will be proven of very high contribution value, significant to our business in the next 3 year period. Thank you, Benjamin and Richard. And I actually have a second question, a follow-up question. Very good that AEC has 6 active solutions to be launched. And do you have any expected revenue contribution in 202, which is a big year for 5 gs and maybe coming 2 to 3 years? And any target margins, is it can reach the CapEx long term margin, for example, 40%? Thank you. Susanna, thank you for asking this question. I think there is no change in our expectations on what we can deliver of gross margins for what we call the core technologies solutions that AAC is delivering to the market. In the past, as we have seen that in acoustic and haptics, we have maintained a very high level of gross margins. And we and at the current time, there are projects that demonstrate our core competency are still rewarding us with 40% plus gross margins. Hence, there is no reason why we should not believe that, for example, that we described WLG and our unique capability in classic that we should not be able to deliver gross margins of about 40% when these business reach their, what we call, full bloom in terms of production, in terms of adoption by the industry, in terms of market customers penetration. I think also I think you mentioned the year 2020. I think as we see more and more change in the design to cope with 5 gs complex antenna system design, I think not only our acoustic and haptics and optics will be able to further contribute to growth of business, but also our precision mechanics business, whereby I think in the first half of this year, we already seen a lot of our business in the precision mechanics is geared to a much more complicated, what we call, design in order to cope with the future 5 gs era. And hence, I think the year 2020 will offer very exciting opportunities for all of these our segments, acoustic, haptics, optics and precision mechanics, and I think including the new interesting innovative design for electromagnetic drive, Those have all very kind of interesting opportunities. We Benjamin describes further details. I think in our first half, we've seen we have taken opportunity to prepare for more technological foundation in this period of transition. In the medium term, we believe all of our for each of the 4 product lines we have, namely acoustic haptic, optics and the precision mechanics with antenna capability, These four product lines each should achieve more than sales revenue of RMB10 1,000,000,000 each. I think we do not need to elaborate too much on the preparation we have already on the SLS and the various acoustic design or R and D that we have been leading in. We have no doubt that in the medium term, we would these will bring sales revenue of over CNY10 1,000,000,000. In haptics, I think this period, we've already seen Android phones moving on higher specs requirements. But also not only in smartphone, there are different phases of discussions with the new automobile market or the new we will see our haptic solutions extending or penetrating into this automobile market. In the medium term, I think we believe that haptics sales revenue or the annual sales haptics revenue has a strong possibility that it will outgrow the highest sales revenue of what we have achieved in the past. And plastic and in terms of optic lens, I think we discussed briefly in the previous question about WILG. But I think we want to reinforce the arguments or the main applications, the 3 main applications that hybrid lens will strongly present a differentiating performance parameter. And I think first of all, the front lens, as the front lens design requires specific specs and we believe the hybrid lens can be easily and quickly be design into that purpose. But more interestingly, I think as we see the main camera, as we as the user experience demands higher resolution going up as high as over 100,000,000 mega resolution. Those design of the plastic lens sea height has exceeded 8 millimeter already and whereby in terms or approaching 8 millimeter height already, whereby the thickness of smartphone restricted the design of such kind of thick main camera. I think with the design of 1 to 2 pieces of glass lenses in the main camera, we can help to resolve or definitely review this height design problem. Finally, the first functionality I think that hybrid lens can deliver definitely will find its way is what we call the under display camera. The glass lens design. The 4th product line, clearly, we talked about we have invested and accumulated experience in the precision mechanics business. I think in the past there have been talks about metallic outfacing or metallic case designs for 5 gs. We've learned from the market that metallic case design for 5 gs is possible. It requires higher precision. And AAC is well positioned to utilize our experience not only on metallic casing, but also our years of experience in LDS. And I think this year we also had experienced very interesting know how developing in terms of in the areas of heat dissipation and coming out with different layers of LCP. Those will help us to formulate and propose very interesting proposition design for the 5 gs casing business. But immediately, I think in the precision mechanics business, the overall industry return, if we compare to what we highly feasible for the other three product lines of well above 40%, I think this clearly in terms of precision mechanics, it may not be as high as the other 3 product lines gross margins. But nevertheless, the return on assets employed in the precision mechanics should prove to be a high satisfactory return. And there is no reason why we do not expect to grow precision mechanics business again to achieve annual sales revenue of over RMB10 1,000,000,000. Thank you. The next question comes from the line of Lebing Huang from CICC. Please ask your question. Thank you for taking my question. Can you hear me? Wei? Hello. Hello. Hi. Hi. So I have two questions. So one question is about the gross margin of your acoustic business. So in your statement, you see you expect a margin recovery in the second half cashier. The reason behind is it because of your higher mix of the SLS or is it because of stabilization of the competition environment in the U. S. Customer? Yes. Thank you. We are not commenting on the business related to the U. S. Customer. But in terms of our penetration in the Android business, I think last year, we have said we estimated our penetration to be around 35%. And I think over the recent periods, gradually, it has gone up to more than 50%. I think by throughout this year, we have target, we aim to take higher penetration to around 70% to demonstrate that the widely adoption of a stronger acoustic performance in acoustic. What is important is that we have already prepared an upgrade version to the previous entry version, whereby the vibration or the movement of the diaphragm can double from, for example, roughly 35 to 65. Clearly that would provide strengthening a very noted user experience upgrade. And I think by the end of this year, there are clear market response or indications that the upgrade of acoustic will continue to next year. And we are confident that AAC is the major technology provider for this upgrade. And through that, this is the reason why we believe our margins performance will gradually improve. So the second question is about the optical optics business. So if we book the industry, the largest player is around RMB10 1,000,000,000 in terms of R and D sales and it's about 70% gross margin. The number 2 player is around 5,000,000,000 sales and which is around 45% gross margin. So and if you look at your company, then your revenue is around, I think, by that, it's around RMB1000000000 to RMB1.5 billion revenue for this year. So the gross margin seems to be extremely much lower than your peers. So whether it's been mainly due to product mix issue or is it mainly due to scale In the 1st 6 months, we are pleased that our preparation for capacity of RMB60 1,000,000 for plastic lens has been fully laid out. I think going forward, maybe individual process may require a couple of equipment balance and that we believe our investment in terms of preparing for CLP60 1,000,000 of length output is all in place. As we have announced, I think by the end of June, we are only shipping out around a monthly RMB 30,000,000. So out of the RMB 50,000,000 capacity, we are shipping out RMB 30,000,000 and it is a fact that at the moment, there is still some designs which are more of what we call lower resolution design 4P ish. We believe as we improve our shipment volume, the mix should turn into a much more favorable one, whereby 5P plus some 6P should help to improve the performance of the OpEx business. And all along, we have stressed that we our own tooling and our own fixtures continue to play an important part in a continual process of improving our yield, which I think is going to be a very important criteria for us to not only to achieve industry gross margin standards, but also to outperform our competitor in this regard. We do are continuing with our plan of increasing capacity to over 70,000,000 per month, maybe I think quite early next year. But what is important is that we recognize that all of we have successfully penetrated in all our major customers already, whereby it is a known fact that in terms of the costing of optics business, the material play a relatively fixed portion. The important criteria is the mix of projects design and our internal U. Ray. And we are confident that not only that at the current stage because of the mix of our continued investment in the glass WLG whereby the R and D expenses will in a way impact our operating performance. But it also laid out very important strong basis for us to move on and to include hybrid lens into our portfolio of Optic Performance business whereby we do believe our gross margins or performance will be improved significantly. Thank you. The next question comes from the line of Arthur Lai from Citi. Please ask your question. So let me explain my question in English. How you solve the WLG, the molding stability and the mix production related issue? And when we can see the cost parity with the whole plastic lens? And then follow-up question is the supply chain. How you do this supply chain for the WLO? Thank you. This is my first question. It's I think we discussed about 2 aspects. First of all, how we tackle the stability of molding of glass lenses. I think in some of the other suppliers, the glass lens is molded piece by piece individually. What we have described in our production process for WLG, at the moment, we are referring to a cycle of life of something like 3,000 times before we need to maintain or repair or change the molding equipment or the accessories. We have clear performance roadmaps solely. We are clear to work on how to elongate this cycle before we have to repair this molding part. And we saw a very strong possibility of elongating it to 5,000 cycles. So that's one target that we have set ourselves in terms of how we could achieve higher stability for the molding process. But also, I think we discussed the yield, the process of the 2 inches wafer and how we set our target to come out with higher precision in terms of achieving what we call 0.5 micromillimeters, whereby at the moment we are seeing something like our 100 pieces, we can see around 50. Again, our internal roadmap or target or improvement in process, we hope to be able to improve that to out of the 100 output, we will be able to deliver something like 80 pieces and the precisions can be improved to what we call 0.5 micro millimeters whereby we're talking about improvement enhancement of 2 parameters, which at the end of the day will lead us to better kind of improvement in process and also yield. And that is happening in Denmark and we are setting up a facility in Czechoslovakia to implement this process where we believe there are the provision of such skilled engineer to help us to achieve that. The second part of the question, I think, relates to the importance for us to recognize not only that the yield capability achieved in passive lens is a necessity for us to promote hybrid lens, because the hybrid lens make use of the production process in Panasonic Lens as well. So we have to not only focus on the molding stability achievement in WLG, but also the overall yield in plastic lens. And I think at this moment, we are already I think the priority of the WIG goes towards internal use. We will satisfy our own demand first. But we will also consider providing WLG Lens to other module operators as well, so as to promote the hybrid lens. So my final question is the CapEx. Can you break down the CapEx by the main market? Thank you. Yes. I think earlier on, we discussed a CapEx budget of around RMB2 1,000,000,000. I think that is not changed in a material way, maybe RMB2.1 billion is what we forecast for the whole of this year. Around as before, we said around 30% to 35% is related to infrastructure. The remaining 65% -ish, I think half of that will be focused on optics related. And we will divide that mostly. I think as we have already said, the 60,000,000 plastic lens capacity, the machinery is already ready. So most of that part will be for our WLG setup. So the remaining something around 30% is almost equally divided between the remaining three border lines of acoustic, haptic and precision mechanics RF. Thank you. The next question comes from the line of Yunchan Cai from Morgan Stanley. Please ask your question. Hi. Thank you for taking my questions. So my first question is actually regarding what Ben just said. We believe that the timeline for not giving a forecast of definitive sales revenue. But I think this year is 2019. I think we're talking about the year 2022 that bearing market conditions and uncontrollable kind of development of the various markets, we hope to see these four product lines achieving the sales revenue that we discussed. But whether there are opportunities that we can deliver earlier, I think definitely it's AAC's interest and we are prepared to do so. Having said that, in acoustic, we are and as announced, we have some initiatives in in other markets other than smartphone, but we believe the penetration or the expansion may be slower than what we see for haptics, whereby in haptics, we are already in talks with applications of customers outside the smartphone applications, for example, in wearables, in smart household devices, and as we discussed earlier on in automobiles as well. I think two propositions for stronger haptics extension into non smartphone application is clearly that, for example, in these step module design, it clearly have a very specific user experience of letting the applicant know that a functionality is on or off. That is a clear desirable design. The second part of the attraction is a kind of revolving wider kind of angle of 180 or 360 degree. But the importance is all these new applications and interesting user experiences, we can deliver these devices or components based on what we already have as general equipment, what we have already invested in. And the know how that AAC is very strong in, there is no again, we are very confident that in haptics such extension of applications would help us to achieve the aforementioned sales and new revenue target. In optics, we've discussed a little bit in this call already. And we also discussed about higher OIS requirement evolving SMA. So in optics, we are again very confident. Finally, in the 5 gs era, our capability in heat dissipation and design of LCPE layers, Again, I think within the timeframe that we discussed, we are working hard to deliver that. Benjamin firmly wants to mention that our achieved status with SLS at the moment is only a beginning as we have already discussed about further enhancing not only user experience, but technical possibility of pushing a stronger, better sound in all high end and different applications of the SLS platforms. And that would be a contributing factor for us to deliver the sales revenue that we are aiming. Thank you. So my second question is a bit more detail. It's also a follow-up to the Android acoustic margin. So just comparing the Q2 and the Q1, is the Android acoustic margin, has it improved? Because overall, I would imagine in the Q2, the acoustic Android revenue, it should be they should have a larger mix. And also again, I think the SOS mix has increased, but the Q2 of our gross margin is still declining. So I just want to make sure if this part actually has mean the margin has improved in the Q2. And also looking into second half, if we can if we are anticipating an improvement, is it due to more due to a price a better pricing, better yield or the higher automation level? Thank you. I think there are 2 very exciting developments for SLS in the Android market in the Q2 already. I think first of all, as we have said, we already have seen the upgraded version being adopted by a couple of major customer. That's one thing. And there is a slight betterment of ASP in a slight upgraded version. But more importantly, we are seeing some customers already extending SLS adoption to what we call mid segment tier phones to extend market share of SLS as well. Through these two factors, I think there is a continued trend, not only on ASP, but not only on volume. The overall after all, we are a very much automation, proprietary, reduction focused. There is no factor that in those favorable factors that we should not see an improvement in our profitability and operating margins in SLS. What is more kind of coming later this year, not only we have an upgrade version, but we have what we call a classic version whereby we briefly talk about the vibration extending to 0.65 movement. And there is a very strong upgrade in the acoustic performance and also a strong upgrade in ASP percentages as well. Of this, we believe we could see achievement of better gross margins. Thank you. We have reached the end of our question and answer session. I would now like to turn the floor back over to the host today for closing comments. Thank you. In view of the time, we are calling the end. Once again, thank you for joining us in this audio webcast and conference call. If you have further questions, please do not hesitate to contact the IR team. Our contact is on the 2nd last page of this presentation slide. Thank you.