Earnings Call: Q3 2018

Nov 8, 2018

Good evening. Welcome to our 2018 Q3 results conference call. I'm Eddie Gong, Head of Investor Relations of AAC. And joining us today, we have our CEO, Mr. Benjamin Pan and our Managing Director, Mr. Richard Mok. Before we start, we would like to remind you some information you may hear during our discussion today may contain forward looking statements. Actual results or trends could turn out differently. Now I would like to go through the results before opening up the questions. For the 1st 9 months 2018, the weaker global smartphone market continued to cause a negative impact on the company. Revenue for 9 months 2018 dropped 4.8% year on year to RMB13.3 billion in line with the congestion market shipment. However, driven by Android customer adoption of innovative solutions, their sales contribution increased by 3.6 year on year for 9 months twenty 18. Gross profit margins decreased 4.2 percent points mainly caused by appreciation of RMB for 9 months 2018, which contributed to 1.5% points and a weaker upgrade cycle create unfavorable product mix and reduction in 3 month volume. The company always emphasized on financial discipline in managing a strong balance sheet. The solid balance position enabled the company to maintain investment for future growth. For 9 months 2018, the company generated strong cash inflow from operations of approximately RMB5 1,000,000,000. After deduction of capital expenditure and dividend paid, Cash on hand was more than RMB3 1,000,000,000 as at 13th September 2018. Let's look at individual segment performance. Acoustics for 9 month 2018 sales of the Acoustics segment was increased 2% year on year to RMB9.8 billion. Despite of sluggish market, the launch of Superlinear Structural SLS for Android customer along with the continued upgrade of our exclusive component drove the dollar content growth. However, mainly due to the price pressure from the legacy products, gross profit margins on year on year basis for 9 months 2018 decreased by 3.7% to 37.9%. Accelerating the upgrading process of new technology platforms and existing SLS version will sooner evolve to an upgrade for Android flagship in delivering better sound quality. At the same time, a modified version of existing SLS will be launched for penetrating into mid tier smartphone. The company believes both revenue and gross profit margin of these segments can be further enhanced through the wider absorption of the SLS platform. For the haptics and precision component precision mechanical staff, sales performance were adversely affected by the current shock in the cycle cyclical specific upgrade in 1st 9 months 2018. Limited change in functionality and redesigned caused a decrease in FX selling price and lower the shipment volume. Revenue of this combined segment decreased by 18.3% year on year to RMB5.3 billion and gross profit margin dropped 4.0 percent to a year to 39.1% for the 9 months 2018 year on year. Nevertheless, we believe the demand for haptics and precision components such as audio display actuator as well as the new stepping motor module and also our sophisticated 3 d shaped glass casing will drive business growth of this segment. In terms of optics, business revenue for 9 months 2018 has increased strongly as expected, which growth has more than 4 times year over year to RMB414 1,000,000. Shipment volumes of Optic business have been extended and successfully penetration into all of our major PRC customers. Monthly progression capacity is on track to increase to 14,000,000 by end of 2018 for meeting the increasing demand. On the other hand, the design upgrade roadmap of high maintenance has been recognized by customers. Production capacity is ready for mass production. Together with the continued improvement in production yield and margins in line with the expanding scale, the company is set to deliver high growth in Optics segment. MEMS Components segment, revenue increase of 5.5% year on year in the 1st 9 months of 2018. Gross profit margin has improved largely by 6.2% and 8.2% points year on year to 26.5% and 35 0.7% for the 9 months and quarter 3 2018 respectively. The strategy of increasing utilization of in house names and ASIC diodes is beginning to pay off. Now we should open the floor for questions. Thank you. Thank you. We will now begin the question and answer session. Our first question comes from the line of Cherry Ma from CLSA. Please ask your question. Hello, Benjamin. Hello, Richard. Thank you for taking my question. My first question is related to 3Q Acoustic segment. Can you give us some color on the reasons behind the 3Q acoustic sales and gross margin decline on a year on year basis? If it was impacted by either production scale, you rate or slower Android upgrade or either pricing pressure due to competition? Thank you for your question, Sherry. It's Richard here. I think the Q3, we have expected to ramp up. And as you know, usual is the new product launch quarter. I think there's nothing unusual about or anything exceptionally that AAC could not deliver. I think we are striving to continue to make the improvements on efficiency, not only on existing platforms, but new platforms such as SLS in the Android phone. I think the quarterly margins on not only acoustic segment, but each segment is really dependent upon the precise product mix for that quarter. So I think what we are seeing in the Q3 is not an indicative of any deteriorating kind of direction in our acoustic products. Just to follow-up, if there's no deterioration in product mix and if there's no unusual problem in product ramp up, what was the key reason for the margin to decline on a year on year basis, given usually on a bigger scale AEC is able to achieve 40% or more margin? What we have tried to point out also in the announcement that generally I think in the Q3 the overall kind of market is slightly depressed. We see for the market smaller volume of total handset. But for AAC, we do see some reduced shipment and that has to some extent affected a small extent of our margins. But also I think as we also said in the announcement, there were some platform what we term as legacy products, whereby there will be obviously pricing pressure etcetera. So it's a mixture of little things that cause the small short term dip in the margin. Thank you. And my second question is related to outlook. In the press release, company mentioned you're cautious but positive for 2019. Is it possible to give us some color in terms of sales growth, margin trend and CapEx for next year? Of course, I think the current economics environment and the various kind of uncertainty of the current trade disputes, I don't think we have a certain kind of deciding view of what's going to happen next. So we remain cautious. But we are also positive in our mechanical structures and also if I go back to haptics, our haptic components, our preparations are fully and ready for better business in all these four segments that led us to a positive outlook. We believe, having said that, we no longer gave guidance for annual results nor quarterly financial performances. We can we are confident that in all these segments that I've mentioned that the opportunity from our existing customers are great and we are ready to reap the potential kind of margins that we are targeted and the volume growth that we are seeking. Thank you. Our next question comes from the line of Chen Yu from Morgan Stanley. Please ask your question. Hi, Benjamin, Richard, thank you for taking my question. I actually just only have one question. You just mentioned that there is uncertain outlook in terms of the trade dispute. So is there any plan to move the plan out of China? And if there is, where is potential consideration of the direction? And also, whether that would have impact to next year's outlook since if there is moving points, there might be some issues. I mean, initially, there might take some time to ramp up the yield? Thank you. Yes, thank you for your question. I think as you know we have been operating for example outside China in Vietnam and we have a small factory in the Philippines as well. But by no means they are the exact kind of capacity built to replace what we already have in China namely in Changzhou, Shuyang and Shenzhen. But what we have done is to obviously plan for the worst. And we don't I think to be honest, we can't say the current plan is that we can 100% mitigate the worst effects of a worsening trade situation to move all our production outside from China. But nevertheless, I think what is prudent and sensible for us to have is to have different contingency plans to what we call minimize the impact and to control and to quickly recover the situation. So what we are seeing here is we don't expect first of all we don't expect the worsening impact because of a worsening dispute, but nevertheless contingency plans are made. We believe it is in our best kind of efforts to control the maximum impact have on our short term financial performances. But nevertheless I think in any trade side of dispute situation, I think it's our advantage to kind of show off our proprietary kind of comparative advantage in leading the technology manufacturing. So we will not change our directions in terms of that, but in terms of immediately shifting out of China, we are making internal plans to control the maximum impact on it, but it's not a 100% kind of replacement consideration. Ben reminded me to add the fact that what we have been arranging for investing into for example recently we made announcement of our continuous investment in Singapore. To a major extent is not related to the current U. S. And China trade dispute. What we have already been preparing not this year but in the past is to recognize the rising labor costs in China, but at the same time, our production process and our focus on raising increasing automation and raising productivity per worker is a goal that we are gradually achieving as already as we have published the lessening of workers' number in the 1st 6 months and continue to do so. In Vietnam as of today, we have very good successful record of producing our speaker box, especially in considering our semi automation arrangements, which fit, which is very appropriate for many what we call multi product production lines. The flexibility involved gives us a very good cost advantage. And similarly in the Philippines such repeat of such production mode is likely to happen very quickly. The objective here is to satisfy the many multi product requirements from different customers, but also put into very good use of the existing semi automation production facilities, which will also be modified for some new products in the haptics segment. So in all, these arrangements in the Vietnam and the Philippines not only provide the quality targets we need, not only control or help us to maintain competitive costing, but also help us to create good return on capital already invested. In Singapore, not only we have been positioning for high end research and development, but not only in the MEMS segment as we have already disclosed, but also in the 3 other segments such as acoustic, haptics and optics. We have existing plans, operational plans to expand our operations in Singapore. Some of those will be related to what we are already doing in Europe such as in our Denmark subsidiary. The point or the objective there is to create a very clear divide from China. We believe that will help us to protect or what we call stopping such access to such technology and capability from our competitor. So this is a multi kind of strategy which will consolidate and propagate AAC's leading capability. Thank you. Our next question comes from the line of Alice Chen from UBS. Please ask your question. What will be your expectation for 2019 with these increasing adoption in the mid range smartphone? I will ask my first question. Thank you. Yes, Lida? Thank you for your question. You can hear us murmuring in the background just checking on the numbers. I think on year on year Q3, I think the growth to a large extent comes from increase in the blended ASP in the acoustic segment proving the adding value to our acoustic design, mainly from our existing platform. And may I continue to add that this trend of increasing ASP, I think as we mentioned before, we have a very strong, very clear path not only to upgrade what the current entry version And on top of that, parallel, we will have an enhanced version. So both parallel track are to promote not only push the current specs on to the next better performance, but also enable the current generation, entry generation to penetrate into what we call the mid segment as well. So those strategy are working. The blended ASP for the Q3 on a year on year basis has risen. Do you have an estimate of the penetration rate of these kind of designs? As well as I think we are already successfully penetrated in the Android phones already. So we will continue to take advantage of that and widen the gap between ourselves and our competitors on the acoustic front. Thank you. Our next question comes from the line of Chen Wei from Goldman Sachs. Please ask your question. Okay. Thank you. So hi, Richard. I want to follow-up on the margin question since there's a lot of interest here. So last quarter, you talked about gross margin target for acoustic to hit 40%. So I want to know how are you doing getting back into this range in terms of what do we need to see? Is it better pricing? Or you talked about in the Q3, there are some issues with legacy products, but that should go away in the Q4. So does that mean margin improves? And also in the first half of twenty eighteen, you reduced headcount by 27% from automation, as you mentioned in the financial reports. How do we see this kind of play into improving margins? This is my first question. Thank you. I think margins is, as you know, is a very important measurement that the company looked at when we looked at our capability to differentiate what our competitor or in terms of the value we are creating for our customers. So when we look at acoustic, we've been stressing on the fact that not only we are promoting a new design platform for our Android customers, but at the same time we are improving on the multi kind of products requirements from our very customers as we mentioned that we are setting up the Vietnam plant to do so. So the margins in any quarter generally will depend upon precise product mix from each customer. But at the end of the day, I think it's the technology content and the value that we create for customers for that quarter and the volume of shipments, all these factors contribute to the margins we can achieve. We have not changed our target of 40% or above for all our technology segments. But whether how quickly we can get there or whether we are being challenged by any competition is a medium, long term kind of consideration that we take seriously. Whether Q4 we'll be able to do that, I think there are a few uncertainty factors, but there are also some positive reasons that we could strive towards making that happen. But we are at this moment not going to give guidance on any precise margins anymore. But we feel confident that we would if not maintain the better margins, not only in the acoustic segments. Okay. Thanks. Are you able to kind of break down or prioritize, is it pricing or shipment volumes or upgrades that would be the most impactful for margins to get back to 40%. I mean, just kind of give us some granularity. I think, first of all, the overall kind of mix of different legacy products with SL ad, etcetera, and the volume of each of our customer projects do contribute to the actual margins we achieve and how because Benjamin also mentioned the return on existing equipment, although we talked about the semi automatic as well. But in acoustic, when we have a lot of very high level automation as well, so how quickly we can ramp up the full utilization of automation and modify the existing automation equipment towards the new generation and the kind of ASP increase we get from the next generation, all contributed. It's very difficult to say which of those matters, but I would have thought I think at the end of the day, the upgrading will be a very important contributing factor. Thank you. Our next question comes from the line of Nancy Chang from JPMorgan. Please ask the question. Thank you for helping us to talk more on this very important segment. I think in the announcement that we talked about a current kind of low point or trough in an upgrade cycle, it's the fact that in the last quarter or in the last kind of 9 months, we did not see any we did not see a lot of new design or new applications. What we are seeing already is there are many, many projects involving a stronger kind of design, a more complicated design and new applications which will create new user experience. And those are a result of different factors, different use of the full screen or ideas that lead to better functioning of the kind of perhaps you have read something about different potential screens, etcetera. And there are many exciting new projects involving tactics, involving stronger design, etcetera, more complicated design. And we believe those projects that we are actively working on indicate strong business potential opportunity in the not need so far away and it will happen very soon. But precise timing, there's a lot of software, customers, market, etcetera that will make that happen. So, but nevertheless we believe the low point we have almost passed already. Yes. Ben helped me to remind me to talk about we also pointed out that there are trends that customers are promoting what we call the audio display and also the kind of top up design of camera etcetera. And those involves our understanding of haptics and turning that into new components could create these new user experience. What is important to note here is that the fundamental kind of technology that AAC process and the already kind of invested CapEx machinery are already appropriate for the production of these new products. And we believe there will be a very good continued utilization of such CapEx and production machinery. In the 3rd quarter, the utilization in the month July August was relatively kind of on a low level. But already we have reached a turning point. In the last 2 months, the utilization continued to rise. And especially on the Android front, AAC is embarking on a major project and so on and so forth. We do not see the pricing pressure to continue especially when we go into 2019 outlook. When we are also paying a lot of attention to continuously improving our efficiency while increasing utilization of our production machinery as well. Hence, this haptic segment is a segment that we are quite confident that we are positive we have a positive outlook in the year 2019. Thank you. Our next question comes from the line of Kaina Wong from Credit Suisse. Please ask your question. Good afternoon, Benjamin and Richard. I have a question about the optics business. So in the lens shipment, I think in the Q2, the monthly shipment can like reach to 25,000,000 to 30,000,000 per month. And looking into Q3, is this how about a one way? And but we see the capacity continue to increase. And is there any impact in the utilization given the weaker smartphone demand? And second is about the impact like from Opium expanding their in house LANs positions. And would there be any like pressure that driven by the customer? Maybe one more is actually related to the lens as well about the hybrid lens because we see your WOMAN is actually recognized by customer. But may I confirm if there is any mass productions happen in the second half this year? And given the company continue to invest in the R and D in this field like setting up the R and D center in Finland and also Singapore. If their operation will start from second half twenty twenty, Can we expect a meaningful contribution from Optics like from that time? Thank you. Thank you for your question. I think it's a very important segment that we are very excited about. You mentioned about weakened smartphone smart market and competition. I think what is important for AAC is that we continue to improve not only to build up our own internal proprietary capability on the tooling and on the automation production, But it's also important to improve our yields. I think there are rooms for further improvement. But having said that, there are projects that we are already achieving what we call the industry yields and we are very complacent about the current kind of capacity and we are going on track to expand our capacity as well. I think there will be continued progress early next year when we move into more complicated lens design production. What we have already achieved is that we have firmly penetrated into all PRG Android customers of shipment of our plastic lens. In hybrid lens, we are continuing to work on shipment. I think there is only what we call maybe a little bit delay as such whereby we are putting all the equipment in place. But the important word is a little delay. We're not seeing massive change in our time frames. But as all things, we are very eager to see to start mass production and mass adoption by the market. And at the moment our progress and our customers' feedback are still very, very positive and encouraging. We are moving very quickly on implementing our plans on our expansion of business to start the potential of hybrid lens. I think you mentioned the timeline for optics to make contribution. I think as we have said, not only in this quarter, but in the 1st 9 months, I think Optics revenue has jumped tremendously. I think continued improvement more importantly on our margins as well. So there isn't a timeline whereby it will be an important segment to AAC. It is already a very important technology segment because it reflects our proprietary capability on a fully kind of independent and we don't need to rely on any external source to improve or to expand our production. Hence, we are on track to deliver the exciting growth we expect in optics. Thank you. Our next question comes from the line of Kylie Huang from Daiwa Capital Market. Please ask your question. Thank you, Benjamin and Rich for taking my question. My first question is a follow-up on the optics. Could you share us about what's the capacity for hybrid lens right now? And you mentioned some delay schedule. I'm just wondering, it's more driven by client side or our side in terms of production yield cost of delay. And going to next year, when we will start to see hybrid lens has a meaningful revenue contribution for our company? That's my first question. Thanks. The delayed ban is helping me to give you some specific answer. The shipment schedule of our equipment was delayed by roughly more than a month. So that is the major reason. So how about So how about the capacity of the hybrid lens by year end? And what's the outlook for like first half next year where we start to see a certain volume of revenue contribution of our company? I think previously and also at the moment, we are not we have maintained what we have set out the target of approximately RMB10 1,000,000 per month, but subject to this 1 month or so delay, we should get there. So in terms of the capacity, we're on track, but subject to the 1 month delay. Other than that, I think optics revenue, next year, are projecting a growing contribution. From the lightning calculation, I think maybe the contribution from the classic side will be a little bit more than the hybrid side. But nevertheless, I think next year we believe hybrid lands projects will begin to make meaningful contributions. Thank you. Our next question comes from the line of Susanna Cui from DBS. Please ask your question. Thank you for taking my question. My question is also in the OpEx side. Could management expect a hyperplans adoption will move to the sensing to imaging? And is there any differences of the new way between the hybrid LAN for sensing and imaging? That's my first question. Thanks. Ben confirmed that the current projects mostly are imaging on for the use of hybrid lens. So I'm taking pictures on the imaging side. Okay. That's great. And my second question is about also on the OpEx. I would like to ask if the 3 d sensing change from the structure light to the TOF, which is the lower power ones, what will be the impact on the high back lens? Could management have shared with us your belief? Thanks. Ben, clarify or mention that at the moment it seems in the Android segment there is not huge amount of interest in applications of high d structure light. Hence, our project with hybrid lens is more on the imaging side. Thank you. Our next question comes from the line of Laura Chen from BNP. Please ask your question. Hi, good afternoon and thank you for taking my question. My question how would that impact the ASP of the haptics product? And also how would that impact the current speaker or acoustic design? Thanks. So first of all, display is not to replace haptics components as such, but it's designed to make use of the full screen to replace the receiver function. And what is important is that we as we have mentioned that the manufacturer or the design process is something in house that AAC is very familiar with in terms of not only auto display, but also the step up motor design. Especially in the auto display, we have an actuator whereby those are fundamental technology capabilities coming from existing haptic related production equipment. And hence the utilization or the increasing return on capital would be able to be improved. And we expect that this is a long term contribution, long term improvement to the possibility of what we term as haptic segment, which includes these haptic components. And complementary important note is that the audio display is not meant to diminish the importance of upgraded stronger stereo possibility, acoustic performance from adopting better kind of speaker boxes. It only kind of adds to the design aesthetics to improve the full skin function and strengthen the importance of the overall acoustic user experience on new products. Sorry, Laura, did I interrupt? You were adding something in your question. Sorry, I'm just wondering that for that kind of design, is there any constraint of like pattern or any specialty design that may like we know like there's some pattern on small companies we would do when we do this kind of design, any concern on like a pattern? And also, I'm just wondering any penetration we may expect into next year for that kind of audio display? Thanks. The actuator itself already kind of the design and production related to I think our we can recall now more than 20 IPs we already possess, But we believe the other related function are also strong. We are very strong in our portfolio related to electromagnetics. And hence, we don't see a problem as such in terms of the ownership of related IPs. Thank you. Our last question comes from Nancy Chang, JPMorgan. Please ask your question. I think the haptic dollar content will be more impacted or changed by the progress in Android phones. As we mentioned in the call, we are embarking on an important major project in Android phone, which we believe will start the propagation in Android phones adoption of haptics components. But we can only comment that the ASP or haptic components in the Android phone will be what we described as reasonable, but the important contribution is the start of increasing shipment volume. And also in the call we mentioned that what is important is also the continued effort in increased return on already invested CapEx or invested capital in this segment and we will be able and we are confident to achieve that through this strategy and this outlook in adoption of haptics by Android. Thank you. We have reached the end of our question and answer session. I'll now turn the floor back to the host for closing comments. Thank you for joining us today. We will speak with you again at end of March next year for our full year result of 2018. Have a good day. Thank you.