Good evening. Welcome to our 2018 Q3 result conference call. I am Eddie Kung, Head of Investor Relations of AAC. 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 changes could turn out differently. Now, I would like to go through the results before opening up the questions. For the first nine months 2018, the weaker global smartphone market continued to cause a negative impact on the company. Revenue for nine months 2018 dropped 4.8% year-on-year to RMB 13.3 billion, in line with the consensus market sentiment. However, driven by Android customer adoption of innovative solutions, their sales contribution increased by 3.6% year-on-year for nine months 2018.
Gross profit margins increased 4.2 percentage points, mainly caused by appreciation of RMB for nine months 2018, which contributed to 1.5 percentage points and a weaker upgrade cycle created unfavorable product mix and reduction in shipment volume. The company always emphasizes on financial discipline in managing a strong balance sheet. The solid balance position enabled the company to maintain investment for future growth. For nine months 2018, the company generated strong cash inflow from operations of approximately RMB 5 billion. After deduction of CapEx and dividend paid, cash on hand was more than RMB 3 billion as of September 13, 2018. Let's look at individual segment performance. Acoustic. For nine months 2018, sales of the acoustic segment increased 2% year-on-year to RMB 9.8 billion. Despite sluggish market, the launch of super-linear structure, SLS, for Android customer, along with the continued upgrade of acoustic component, drove the dollar content growth.
However, mainly due to the price pressure from the legacy products, gross profit margins on a year-on-year basis for nine months 2018 decreased by 3.7 percentage points to 37.9%. Accelerating the upgrading process of new technology platforms and existing SLS version will sooner evolve to an upgraded version for Android flagship in delivering better sound qualities. 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 this segment can be further enhanced through the wider adoption of the SLS platform. For the haptics and precision component, precision mechanical segment, sales performance was adversely affected by the current drop in the cyclical specific upgrades in the first nine months 2018. Limited change in functionality and redesign caused a decrease in average selling price and lowered the shipment volume.
Revenue of this combined segment decreased by 18.3% year-on-year to RMB 5.3 billion, and gross profit margin dropped 4.0 percentage points to 39.1% for the nine 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 stepper motor module, and also our sophisticated 3D shaped glass casing, will drive business growth of this segment. In terms of optics, business revenue for nine months 2018 has increased strongly as expected, which grew at more than four times year-on-year to RMB 414 million. Shipment volume from optic business has been expanded and successfully penetrated into all of our major PRC customers. Monthly production capacity is on track to increase to 40 million by the end of 2018 for meeting the increasing demand. On the other hand, the design upgrade roadmap of hybrid lens 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 optic segment. MEMS component segment revenue increase of 5.5% year-on-year in the first nine months of 2018. Gross profit margin has improved largely by 6.2% and 8.2% points year-on-year to 26.5% and 35.7% for the nine month and quarter three 2018, respectively. The strategy of increasing utilization of in-house MEMS and ASIC die 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. If you wish to ask a question, please press star one on the 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. Once again, if you wish to ask a question, please press star one on your telephone and wait for your name to be announced. 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 reduction in scale, utilization rate, or slower Android upgrade, or either pricing pressure due to competition.
Thank you for your question, Cherry. It's Richard here. I think the third quarter, 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. I think what we are seeing in the third quarter 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, AAC 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 third quarter, the overall kind of market is slightly depressed. We see for the market, smaller volume of total handset. For AAC, we do see some reduced shipment, and that has, to some extent, affected a small extent of our margins. 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 et cetera. It's a mixture of little things that cause the small short-term dip in the margin.
Thank you. 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. We remain cautious. We are also positive to the extent that I think in acoustic, in haptics, in optics, 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 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 Yun 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 uncertainty on outlook in terms of the trade dispute. Is there any plan to move the plant out of China? If there is, where is the potential consideration of the direction? Also, whether that would have impact to next year's outlook, since if there is moving plans, there might be some issues. 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. By no means they are the exact kind of capacity build to replace what we already have in China, namely in Changzhou, Suzhou, and Shenzhen. What we have done is to obviously plan for the worst. 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. 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.
What we are saying here is, first of all, we don't expect the worsening impact because of a worsening dispute. Nevertheless, contingency plans are made. We believe it is in our best efforts to control the maximum impact on our short-term financial performances. Nevertheless, I think in any trade dispute situation, I think it's our advantage to show off our proprietary comparative advantage in leading the technology manufacturing. We will not change our directions in terms of that. In terms of immediately shifting out of China, we are making internal plans to control the maximum impact on it, but it's not 100% replacement consideration.
Ben reminded me to add the fact that what we have been arranging for investing into, for example, recently, we make 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. At the same time, our production process and our focus on 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 first six 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 is very appropriate for many, what we call multi-product production lines.
The flexibility involved gives us a very good cost advantage. 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. In all, these arrangements in 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 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. This is a multi kind of strategy which will consolidate and propagate AAC's leading capability.
Thank you. Our next question comes line of Alice Chen from UBS. Please ask a question.
Hi. Thank you for taking my question. My first question is about the acoustic component segment. As you mentioned in the press release, that speaker module actually grows by about 20% year-on-year in the third quarter. Can we have a rough idea is mainly driven by shipment or the ASP? Also for this SLS penetration rate, do you have a rough idea of what kind of penetration rate in 2018 and what will be your expectation towards 2019 with this increasing adoption in the mid-range module? That's my first question. Thank you.
Yes. Thank you for your question. You can hear us murmuring in the background, just checking on the numbers. I think on the year-on-year, the third quarter, 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. 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. Both parallel tracks are to promote, not only push the current spec onto the next better performance, but also enable the current generation, entry generation, to penetrate into what we call the mid-segment as well. Those strategy are working.
The blended ASP for the third quarter on a year-on-year basis has risen.
Okay. Do you have an estimate of the penetration rate of these kind of designs?
SLS, I think we are already successfully penetrated in the Android phones already. 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 Wei Chen from Goldman Sachs. Please ask a question.
Okay. Thank you. Hi, Richard. I wanted to follow up on the margin question since there is a lot of interest here. Last quarter, you talked about gross margin target for acoustic to hit 40%. 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? You talked about in the third quarter, there is some issues with legacy products, but that should go away in the fourth quarter. Does that mean margin improves? Also in the first half of 2018, 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, as you know, is a very important measurement that the company looks at when we look at our capability to differentiate what our competitor, or in terms of the value we are creating for our customers. 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 product requirements from our very customers. As we mentioned that we are setting up the Vietnam plant to do so. The margins in any quarter generally will depend upon precise product mix from each customer. 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. 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 fourth quarter will 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. We are, at this moment, not going to give guidance on any precise margins anymore. We feel confident that we would, if not, maintain the better margins, not only in 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%? Just give us some granularity.
I think, first of all, the overall kind of mix of different legacy products with SLS, et cetera, and the volume of each of our customer projects do contribute to the actual margins we achieve. 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. 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. I would have thought, I think at the end of the day, the upgrading will be an very important contributing factor.
Thank you. Our next question, cover line of Narci Chang from JPMorgan. Please ask your question.
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Thank you for helping us to talk more on this very important segment. I think when in the announcement that we talk about a current kind of low point or trough in an upgrade cycle, it is the fact that in the last quarter or in the last kind of nine months, 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. 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, etc. There are many exciting new projects involving haptics, involving stronger design, etc. More complicated design.
We believe those projects that we are actively working on indicate strong business potential opportunities in the not so far away, and it will happen very soon. Precise timing, there is a lot of software, customers, market, etc., that will make that happen. Nevertheless, we believe the low point, we have almost passed already. Yes, Ben helped 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 pop-up design of camera, etc. Those involve our understanding of haptics and turning that into new components to create these new user experience. What is important to note here is that the fundamental kind of technology that AAC possess and the already kind of invested CapEx machinery are already appropriate for the production of these new products.
We believe there will be a very good continued utilization of such CapEx and production machinery. In the third quarter, the utilization in the months July and August were relatively on a low level. Already we have reached a turning point. In the last two months, the utilization continued to rise, 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. This haptics segment is a segment that we are quite confident that we have a positive outlook in the year 2019.
Thank you. Our next question comes from line of Kyna Wong from Credit Suisse. Please ask your question.
Good afternoon, Benjamin and Richard. I have a question about the optics business. In the lens shipment, I think in the second quarter, the month shipment can reach 25 million to 30 million per month. Looking into the third quarter, how about one way? We see the capacity continue to increase. Is there any impact in the utilization given the weaker smartphone demand? Second is about the impact from OFILM expanding their in-house lens productions. Would there be any pressure that's driven by the customer? One more is actually related to the lens as well. It's about the hybrid lens. We see your roadmap is actually recognized by customer. May I confirm if there's any mass productions happening in the second half this year?
Given the company continue invest in the R&D in this field, like setting up the R&D center in Finland and also Singapore, if the operation will start from second half 2020, can we expect a meaningful contribution from optics from that time? Thanks.
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 market and the 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. Having said that, there are projects that we are already achieving what we call the industry yields, and we are very happy with such performance. We're not 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 PRC Android customers of shipment of our plastic lens. In hybrid lens, we continue to work on the 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. The important word is a little delay. We're not seeing massive change in our time frames. As all things, we are very eager to see to start mass production and mass adoption by the market. 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 first nine months, I think optics revenue has jumped tremendously. I think continued improvement, more importantly, on our margins as well. 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 Kylie Huang from Daiwa Capital Markets. Please ask a question.
Thank you, Benjamin and Richard, taking my question. My first question is a follow-up on the optics. Could you share with us about what is the capacity for hybrid lens right now? You mentioned some delay schedule. I am just wondering, it is more driven by our client side or our side in terms of production yields cause the delay? Going to next year, when we will start to see hybrid lens has a meaningful revenue contribution for our company. That is my first question. Thanks.
The delay, Ben, is helping me to give you some specific answer. The shipment schedule of our equipment was delayed by roughly more than a month. That is the major reason.
How about the capacity of the hybrid lens by year-end? What is the outlook for first half next year? Will we start to see a certain volume of revenue contribution for our company?
I think previously, and also at the moment, we have maintained what we have set out the target of approximately 10 million per month. Subject to this one month or so delay, we should get there. In terms of the capacity, it is on track, but subject to the one month delay. Other than that, I think optics revenue, next year we are projecting a growing contribution. From the likely calculation, I think maybe the contribution from the plastic side will be a little bit more than the hybrid side. Nevertheless, I think next year, we believe hybrid lens projects will begin to make meaningful contributions.
Thank you. Our next question comes out of Susanna Chui from DBS. Please ask your question.
Thank you for taking my question. My question is also in the optics side. Could management expect the hybrid lens adoption will move to the sensing to imaging? Is there any differences of the view way between the hybrid lens for sensing and imaging? That's for my first question. Thanks.
Ben confirmed that the current projects mostly are imaging for the use of hybrid lens. On taking pictures on the imaging side.
Okay, that's great. My second question is about also on the optics. I would like to ask if the 3D sensing changed from the structured light to the TOF, which is the lower power one. What will be the impact on the hybrid lens? Could management share with us your view? Thanks.
The structured light and TOF.
Imaging.
Ben clarified or mentioned that at the moment it seems in the Android segment, there is not huge amount of interest in applications of 3D structured light, hence our project with hybrid lens is more on the imaging side.
Thank you. Our next question comes line of Laura Chen from BNP. Please ask your question.
Hi. Good afternoon, and thank you for taking my question. My question is also a follow-up on haptics and the precision business. I'm just wondering that, for the new design for audio display, how would that impact the ASP of the haptics product? How would that impact the current speaker or acoustic design? Thanks.
First of all, the audio display is not to replace haptic components as such, but its design is to make use of the full screen to replace the receiver function. What is important is that, as we have mentioned, that the manufacture or the design process is something in-house that AAC is very familiar with in terms of not only audio display but also the stepping motor design. Especially in the audio display, we have an actuator, whereby those are fundamental technology capabilities coming from existing haptic-related production equipment. Hence the utilization or the increasing return on CapEx would be able to be improved. We expect this is a long-term contribution, long-term improvement to the possibility of what we term as haptic segment, which includes these haptic components.
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Complimentary 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 screen function and strengthen the importance of the overall acoustic user experience on new products. Sorry, Laura, did I interrupt you? You were adding something in your question.
Sorry, I'm just wondering that for that kind of design, is there any kind of trend of patent or any specialty design that we know there's some patent of small companies when we do this kind of design, any concern on a patent? I'm just wondering any penetration we may expect into next year for that kind of audio display? Thanks.
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The actuator itself, the design and production related to, I think we can recall now more than 20 IPs we already possess, but we believe the other related function are also very strong in our portfolio related to electromagnetics. 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 a question.
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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. We can only comment that the ASP of haptic components in the Android phone will be what we describe as reasonable, but the important contribution is the start of increasing shipment volume. 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. We will be able and we are confident to achieve that through this strategy and this outlook in the adoption of haptics by Android.
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Thank you. We have reached the end of our question 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 the end of March next year for our full year result of 2018. Have a good day. Thank you.