Good afternoon. Welcome to our 2019 interim results broadcasting conference call. My name is Joyce Kwok, and I am the Head of Investor Relations at AAC. I am glad to have our senior management team join this call today with Mr. Benjamin Pan, our Chief Executive Officer, and Mr. Richard Mok, our Managing Director. Before we start, we would like to remind you that copies of our result 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 slides 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 RMB 7.6 billion. It was a challenging period with reduced global smartphone shipments.
If we focus on second quarter revenue, it has shown a sequential improvement with 1% year-on-year increase, and that has mitigated some of the decline in the first quarter. 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 nine 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 the good progress on business development and R&D for the acoustics business, where our proprietary product, SLS, has further gained market share in the Android market. We'll also like to highlight optics as one of our key and strategic growth driver for this year and onwards, with a strong growth potential and economy of scale.
We are going to further elaborate on this in the later session. Net profit dropped 57% year-on-year to RMB 717 million, mainly due to the reduced gross profit, as just mentioned, and some increase in R&D expenses, mainly on the optics. 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 HKD 0.40 per share, which is the same as last year. We continue to make satisfactory progress on the business development and R&D in the second quarter. For acoustics and for our proprietary product, SLS, we have successfully penetrated into the mid-tier Android models. For optics, 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 Nanjing for these. We also have an R&D center in Finland that focuses on developing innovative optical technologies and new applications. For electromagnetic drives, the stepper motor module has started mass production and shipment to mainstream Android customers as a new revenue driver for us. We are ready to embrace the 5G era. We have launched six different 5G antenna solutions for mobile phone and base stations during the Mobile World Congress in June this year. 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 through the details of each business segment, we would like to draw your attention to our strong balance sheet, which is particularly important when this world is full of uncertainties and volatilities.
Our net gearing remains healthy at below 10% as of the first half this year. We have ample gross cash on hand, around half in RMB, another half in USD. Our strong operating cash flow is also more than enough to cover dividend payments and share buybacks. We also emphasize on returns to shareholders. They can be by at least two ways, which are dividends and share buyback. We have declared the interim dividend of HKD 0.40, which is the same as last year. While we do not have an explicit dividend policy, in the last five years, the DPS has been at the 40% of the EPS. In the first half, we have spent around RMB 1.4 billion on paying dividends and buying back shares.
Despite the uncertainty around the world and ups and downs along the global smartphone cycle, we are dedicated to invest for our future growth. Our R&D centers are all over the world, including China, Finland, Denmark, Singapore, Korea, Japan, and the U.S. The R&D expenses has gone up 15% year-on-year, and it increases mainly on the optics, which is in line with our strategy to make it a key growth driver for the future. The other segment R&D expenses has dropped in line with the revenue trend. R&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. This slide just quickly shows that we have rather diversified manufacturing bases all over Asia Pacific.
For the optics, we have reinforced this as our key and strategic growth driver. In fact, we have already become top three global supplier in the plastic lens supply chain. Our average monthly shipment in the second quarter has already doubled from last year's second quarter, and we target to make it another double by this year-end, and the profitability to also improve. Now we go to a bit more details for each business segment. Okay. For acoustics, revenue dropped 15% year-on-year to RMB 3.65 billion. Gross margin dropped by 7% percentage points to 30%, so gross profit dropped 32% year-on-year to now RMB 1.1 billion. 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 continued to gain market share in Android smartphones.
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. For this segment, the revenue accounts for 14% of our total revenue. The revenue dropped 12% year-on-year. Electromagnetic drives showed a decline, precision mechanics showed a significant growth. Even though the revenue for EM drives dropped, the margin has been largely maintained, thanks to our operational efficiency. Precision mechanics has been doing great with revenue increase, this segment tends to have a lower margin, 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. MEMS 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 second quarter. We've been working hard on increasing the in-house MEMS size and digital ASIC chips in our MEMS microphone so as to improve the margins. We're also to broaden the application of our MEMS to new devices, such as those in the smart home market. We include this slide here in the pack as we have put tremendous efforts on the sustainability. It's within our core value, and we believe we are one of the leaders on this regard, whether it's among the tech companies in Asia or among the major stocks listed in Hong Kong Stock Exchange.
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 too. That's all for my presentation. We will now open the floor for the Q&A session. Thank you.
Thank you. We will now begin the question and answer session. If you wish to ask question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press the pound or hash key. We are limiting to two questions at each time. The first question comes from the line of Susanna Chui from DBS. Please ask the question.
Oh, excuse me. Thank you for taking my question.
Hello.
Hello. Thank you for taking my question. I understand that AAC has planned for the mass production for the hybrid lens design. Could we understand the mass production is for which client? Is this for the flagship model? How is your expected shipment and ASP for that? Could you disclose if you have any capacity expansion plan for hybrid lens in 2020? Thank you.
Hi, Susanna. Thank you for your question. As we have said earlier, our hybrid lens strategy comprise of a successful recognition of the capability of a stronger differentiating to what the current classic lens could deliver. We have received significant interest from all our customers on the capability of hybrid lens, and whereby the important component there is our mass production.
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. At the moment, I cannot disclose any kind of clear specifics on shipment numbers or project details. 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 had more than 20 molding machine equipment in operations. 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 proposition 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 three-year period.
Thank you, Benjamin and Richard. I actually have a second question, follow-up question. Very good that AAC has six [antenna] solutions to be launched. Do you have any expected revenue contribution in 2022, which is a big year for 5G, and maybe coming two to three years? Any target margins, is it can reach the [core peak] 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. As 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 describe WLG and our unique capability in plastics, 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 you mentioned the year 2020. I think as we see more and more change in the design to cope with 5G 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 designs in order to cope with the future 5G era. Hence, I think the year 2020 will offer very exciting opportunities for all of these our segments, acoustic, haptics, optics, and precision mechanics. I think including the new interesting, innovative design for electromagnetic drive. Those have all very kind of interesting opportunities.
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Benjamin describes further details. I think in our first half, we have taken the opportunity to prepare for more technological foundation in this period of transition. In the medium term, we believe all of our, or each of the four 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 RMB 10 billion 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&D that we have been leading in. We have no doubt that in the medium term, these will bring sales revenue of over RMB 10 billion. In haptics, I think this period, we already see Android phones moving on higher specs requirements.
Also, not only in smartphone, there are different phases of discussions with the new automobile market or the new applications in the automobile market. Within these discussions, we strongly believe that, I think in the next one to two years, 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. In terms of optic lens, I think we discussed briefly in the previous question about the WLG. I think we want to reinforce the arguments or the main applications, the three main applications that hybrid lens will strongly present a differentiating performance parameter. I think, first of all, the front lens.
The front lens design requires specific spec, and as we believe the hybrid lens can be easily and quickly be designed into that purpose. More interestingly, I think as we see the main camera, as the user experience demands higher resolution, going up as high as over 100 million mega resolution. Those design of the plastic lens, see height have 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 reduce this height design problem. Finally, at the first functionality, I think the hybrid lens can deliver, definitely will find its way, is what we call the under display camera.
The glass lens definitely have a higher transparency index and could work far better than a plastic lens design. The fourth 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 mechanic outphasing or metallic case design for 5G. We've learned from the market that a metallic case design for 5G is possible. It requires higher precision, AAC is well-positioned to utilize our experience, not only on metallic casing, but also our years of experience in LDS. I think this year, we also have experienced very interesting know-how developing in terms of in the areas of heat dissipation and coming up with different layers of LCP. Those will help us to formulate and propose very interesting proposition design for the 5G casing business.
Admittedly, I think in the precision mechanics business, the overall industry return, if we compare to what is 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 three product lines' gross margins. Nevertheless, the return on assets employed in the precision mechanics should prove to be a high satisfactory return. There is no reason why we do not expect to grow precision mechanics business again to achieve annual sales revenue of over RMB 10 billion.
Thank you. The next question comes from the line of Leping Huang from CICC. Please ask a question.
Thank you to take my question. Can you hear me? Wait. Can you hear me?
Hello, hi.
Hi. Pardon me. I have two questions. One question is about the gross margin of your acoustic business. In your statement, you expect margin recovery in the second half. Can you share the reason behind? Is it because of your higher mix of the SLS or it is because of a stabilization of the competition environment in the U.S. customer? Thank you. [Foreign language]
[Non-English content] We are not commenting on the business related to the US 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 wide adoption of a stronger acoustic performance in acoustic.
What is important is that we have already prepared a 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 a strengthening, a very noted user experience upgrade. 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. Through that, this is the reason why we believe our margins performance will gradually improve.
[Non-English content] The second question is about the optical business. If we look at the industry, the largest player is around RMB 10 billion in terms of revenue, and it's about 70% gross margin.
The number two player is around HKD 5 billion sales, which is around 45% gross margin. If you look at your company, then your revenue is around, I think, if I guess, it's around HKD 1 billion-HKD 1.5 billion revenue for this year. The gross margin seems to be extremely much lower than your peers. Whether it's mainly due to product mix issue, or is it mainly due to scale issues?
[Non-English content] In the first six months, we are pleased that our preparation for capacity of 60 million for plastic lens has been fully laid out.
I think going forward, maybe individual process may require a couple of equipment. Other than that, we believe our investment in terms of preparing for 60 million plastic lens output is all in place. As we have announced, I think by the end of June, we are only shipping out around a monthly 30 million. Out of the 60 million capacity, we are shipping out 30 million 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 optic business.
All along we have stressed that 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 our industry gross margin standard, but also to outperform our competitor in this regard. We are continuing with our plans of increasing capacity to over 70 million per month, maybe I think quite early next year. What is important is that we recognize that we have successfully penetrated in all our major customers already.
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 a mix of projects, design, and our internal U rate. We are confident that not only at the current stage, because of the mix of our continued investment in the glass WLG, whereby the R&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 from Citi. Please ask a question.
Benjamin [Non-English content] Richard [Non-English content] So let me explain my question in English. How you solve the WLG the modeling stability and the mass production related issue, and when we 可以 see the cost parity with the whole plastic lens?
Follow-up question is the supply chain. How you do this supply chain for the WLG? Thank you. This is my first question.
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I think we discussed about two 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 it in our production process for our 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. 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. That's one target that we have set ourselves in terms of how we could achieve higher stability for the molding process.
Also, I think we discussed the yield, the process of the 2-inch 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 out of 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 precision can be improved to what we call 0.5 micromillimeters. Whereby we are 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.
That is happening in the demo, and we are setting up a facility in the Czech Republic 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 or capability achieved in plastic lens is a necessity for us to promote hybrid lens, because the hybrid lens make use of the production process in plastic lens as well. We have to not only focus on the molding stability achievement in WLG, but also the overall yield in plastic lens. I think at this moment, already, I think the priority of the WLG 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.
Thank you. My final question is the CapEx. Can you break down the CapEx by the main market? Thank you.
Yeah. I think, earlier on, we discussed a CapEx budget of around RMB 2 billion. I think that is not changed in a material way. Maybe RMB 2.1 billion is what we forecast for the whole of this year. As before, we said around 30%-35% is related to infrastructure. The remaining 65%-ish, I think half of that will be focused on optics-related. We will divide that mostly, I think, as we have already said, the 60 million plastic lens capacity, the machinery is already ready. Most of that part will be for our WLG setup. The remaining, something around 30%, is almost equally divided between the remaining three product lines of acoustic, haptic, and precision mechanics RF.
Thank you. The next question comes from the line of Yunchen Tsai from Morgan Stanley. Please ask the question.
Hi. Thank you for taking my question. My first question is actually regarding what Ben just said.
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We believe that the timeline for not giving a forecast of definitive sales revenue. I think this year is 2019, I think we're talking about the year 2022, that varying 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. Whether there are opportunities that we can deliver earlier, I think definitely is AAC's interest and we are prepared to do so. Having said that, in acoustic, and as announced, we have some initiatives 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 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 stepper module design, it clearly have a very specific user experience of letting the application 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. 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. The know-how that AAC is very strong in. Again, we are very confident that enhancing such expansion of applications would help us to achieve the aforementioned sales annual revenue target. In optics, we've discussed a little bit in this call already.
We also discussed about higher OIS requirement involving SMA. In optics, we are again very confident. Finally, in the 5G era, our capability in heat dissipation and design of LCP 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. That would be a contributing factor for us to deliver the sales revenue that we are aiming.
Thank you. My second question is a bit more detailed. It is also a follow-up to the Android acoustic margin. Just comparing the second quarter and the first quarter, the Android acoustic margin, has it improved? Because overall, I would imagine in the second quarter, the Android acoustic revenue, they should have a larger mix. Again, I think the SLS mix has increased, but the second quarter acoustic margin is still declining. I just want to make sure if this part, I mean, the margin has improved in the second quarter, and also in looking into the second half, if we are anticipating an improvement, is it more due to better pricing, better yield, or the higher automation level? Thank you.
I think there are two very exciting developments for SLS in the Android market in the second quarter 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. 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. After all, we are a very much automation, proprietary, production-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. There is a very strong upgrade in the acoustic performance and also a strong upgrade in ASP % 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 are on the second last page of this presentation slide. Thank you.