Earnings Call: H1 2018

Aug 22, 2018

Ladies and gentlemen, thank you for standing by, and welcome to AAC Technologies twenty eighteen Interim Results Investor Webcast and Conference Call. At this time, all participants are in a listen only mode. I will now hand over to your host today. Please go ahead. Good evening. Welcome to our twenty eighteen interim results webcast and conference call. I am Eddie Gong, Head of IR of AAC. And joining us today, we have our CEO, Mr. Benjamin Pan and our Mandarin Director, Mr. Richard Mock. 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. I will now turn the call over to Richard for a brief review of the results before opening up the call. Hi. Good evening, everyone. Thanks for joining our call today. For the first six months in the year 2018, sluggish market and renminbi appreciation affected our performance. A slight decrease of 2.5% in our first half revenue dropped to RMB8.4 billion. Sales to Android customers achieved satisfactory growth across different business segments. Gross profit margin, down by 4.3 points to 36.7%, impacted mainly by a 7.2% renminbi appreciation in this first half period. Just the renminbi appreciation had cost 3% points. A slight change in the product mix caused a 1.3 points drop in the gross margin. Net margin was 3.4%, down to 21.1%. To confirm, the company is in a solid financial position. The Board has declared an interim dividend of HKD0.40 per ordinary share. For segment review, I shall start with acoustic. Acoustic sales rose 4% in the first half, driven by strong growth of 16% in speaker modules, including the new platform SLS. SLS experienced both ASP and volume increase based on pursuit of better stereo sound quality and there is continued migration from standalone receiver and speakers. The SLF platform offers better audio performance in terms of higher fidelity and stronger base that has continued widened market penetration. We expect more customers to adopt this SLS design in both their flagship and mid tier models. This proprietary structural design has set a new milestone in acoustic and a very clear upgrade roadmap leading to mini hi fi performance in the very near future. Correspondingly, we will expand SLS production capacity for meeting increasing demand. For acoustic, we believe the company is very much capable of improving gross margins from current level through continued better product mix and production efficiency gain from volume growth. The second segment, which we talk about the combined haptic and precision components involving mechanical, although sales have declined 17% mainly due to reduced volume shipments in haptics and in particular in the second quarter weaker customer sell through. The two sub segments have different features of development. In haptics and precision components, it is based on electromagnetic motion. There is great potential for significant growth. The added solutions are in very suitable for increasing meeting the demand for virtualization designs and provide rich tactile feedbacks. In addition, the audio display actuator is based on haptic capability as well. It's ideal for cordless design for genuine full screen design, which has become a must a trend for the latest high user experience innovation smartphone devices. Extending on the electromagnetic expertise, there are opportunities that fits very much in the company's core competencies in this area, such as what we are seeing more in the new models, the kind of stepping motor, decelerator and VCM designs. We believe in this segment, customer diversification will carry on, spec cycle upgrade will appear. In the other sub segment of precision mechanical, apart from metallic frames and casing, we have already developed advanced proprietary precision molding and glass processing learn how And that would be very, very interesting opportunity for us to resolve challenging new three d cover glass designs that our customers have in mind. This precision mechanical segment, we expect to carry on to gain market share and at the same time, will be very capable of generating higher rate of returns. And we don't perceive any significant CapEx investment will be required to match the future revenue business opportunities growth. With high efficiency and better process management, we also believe the gross margin in this sub segment will also improve. The third very interesting segment of Optics business segment, as we have said in the past, with our unique advanced highly efficient manufacturing system for the wafer level glass, hybrid lens and plastic lens, we expect to deliver the next generation optical specs demanded by the market and our customers. Revenue for this segment for the first half derived from sale of plastic lens amounted to more than RMB240 million. Our plastic lens monthly production capacity, million per month, is fully utilized and expansion plan is in progress. We strongly believe production yields and margins will continue to improve when capacity expands. The production expertise as well as capacity from plastic lens will serve us well in preparation for scaling up production of WLG hybrid lens. We believe differentiation of the hybrid LAN solutions will enable the company to have additional source of income in the market. Finally, in the managed component segment, we are pleased to report the increase of revenue of 25% on a year on year basis based on shipment growth. We continue to focus on technology upgrade and vertical integration. Not only have we strengthened in house capabilities on MEMS designs, we continue to allocate R and D resources of MEMS technology to develop more advanced applications. This strategy enables our footprint to extend from the current smartphones market into the smart speaker areas. Going forward, we will be able to offer a broader range of solutions of meeting requirements from different tiers of customers and to gain market share. And now, we would be pleased to answer your queries or your questions. Thank you. Thank you. We will now begin the question and answer question will now begin and Our first question is coming from the line of Yucheng Cai from Morgan Stanley. Yunsheng, I'm going to answer in English. It's kind of universal for the participants. I think early on the year, have issued some guidance. As we have reported first half revenue results, at this moment in time, we are not going to make further comments on the guidance anymore. We believe on a more important basis, the company, as we have pointed out in the announcement, the second half will be a traditional peak period. The company will strongly be prepared and work on delivering successful business with all our major customers in the second half. So we are not going to comment on the sales guidance. Thank you. Okay. So the follow-up question is on the Android side. So you commented in the first half, they all have quite satisfactory growth. And I wonder if the growth here into the second half, will that accelerate? Or do you think that will maintain quite the same level as in the first half? I think there are, for example, different development for individual business segments of acoustic, haptics, precision components and mechanical and also optics and MEMS components. So in Android phones, as you know, we have a very successful track record of developing and penetrating in all the Android customers. In the first half, I think we have disclosed in the interim results that the top five customers of our mobile phone industry kind of contribute more than 90%. And we believe similar kind of contributions will be made by this kind of large group of customers we have. In terms of growth, I think it is not strictly appropriate just to refer to growth of Android as such. I think growth of Android in all our business segment is an area that warrants different growth rates. For example, in our optic plastic lens, we have successfully extended our customer base and now we are shipping to different Android customers already. And in terms of our mechanical structure solution as well, not only we have continued to be penetrating in the high tier devices of our customer, but also we are shipping to most of our Android customer in the mid segment as well. So I would answer by saying the growth in Android and the particular penetration increase in Android Auto are very much on progress and is more than satisfactory. Your next question is coming from the line of William Yang from Citi. Please ask your question. My question is about haptics. What's the chance we will see more than one haptics for smartphone in the next twelve eighteen months? And the second one is there any trends on the tablet product as well? So that's my question. You. Thank you for your question. I think haptics ongoing as we have said in the past, not only AAC has kind of obtained industry recognition that we are a very strong hardware solution provider, We also kind of work very hard in the ecosystem understanding the software as such. But at the end of the day, I think we use the description of tactile feedback. I think tactile feedback to create new user experience can come from, I think, what we call in terms of the areas of the virtualization, but also from gaming applications as well. And these two areas demand different tactile feedback precision specification. So I think equally the opportunity is the proposition to see more than one haptics or stronger haptics, etcetera. At the end of the day, I think what is most important is that user experience generated from haptics continue to demand better design, more complicated structure, better performance and also consideration for the form factor and how it fits with the overall inner design of the smartphone. That has not changed. Your next question is coming from the line of Wei Chen from Goldman Sachs. My question is on gross margin. So you have disclosed in the first half both acoustic and haptic precision component gross margin was about 37.539.6%. So both look quite healthy, but the corporate gross margin is lower at 36.7%. So I think the logic here is that it's adjusting that other businesses is seeing very low profitability in the second quarter, bringing down the average. So I think the question for Richard is, is this thinking correct? And what is actually dilute the margin? Is it a WLG business that's ramping up in the process? And generally, detailed explanations on how product mix is impacting gross margin in the second quarter. Thank you. Thank you. Thank you for your question. I think first of all, as we pointed out, the overall gross margin of the growth in the first half and also to a large extent also in the second half because the renminbi appreciation continue throughout the three months in the second quarter as well. So in the first half, as we have explained it, for the first half, 3% adverse effect was caused by renminbi appreciation. And to some extent, I think that happened a lot, that effect is also significant in the second quarter. The revenue contribution from Optics segment as we have disclosed over RMB240 million income accounted for roughly 3% of our revenue. Thus, at the moment, we believe there is improvement in terms of working coal production efficiency of yields and also as capacity expands. As you heard just now, are full utilization for the current capacity of 20,000,000 and we intend to enlarge our capacity, thus creating even further opportunity for gross margin improvement. So overall, I think also I think we tried to explain that the acoustic segment, which at the moment the first half accounted for more than 50%, 51% of revenue continues to play a positive healthy contribution most likely because of the fact that SLS is a proprietary design of AAC. We have very good kind of ramping up already achieved in first half as we grow our customer base and projects, we certainly would like to leverage each opportunity to deliver better and better gross margins. So think the remaining last segment to discuss is about haptics and what we call haptics and precision components with mechanical. I think as we have said, I think we have a much clearer that haptic progress is bound to happen because of the full screen, the virtualization and also on stronger tactile requirements by our customer. So haptic components or solutions that AAG are working on with customers definitely in terms of complications, in terms of ASP trends are very positive. And to some extent, I think as we have stressed in the strategy part, electromagnetic is a core knowledge that AAC has a very strong base, not only in terms of design, but in terms of automation and production process in place. We sure should be able to drive better return on net assets related to haptics, equipment and machinery. And there's no reason that we are kind of changing our strategy in terms of providing high technology value in haptics components. In mechanical structure, I think it's very clear that this year, we now have successfully been acknowledged by the customers in the Android PLC market that our mechanical solutions are of very good kind of cooperation and meet their requirements. And with more and more kind of in terms of volume project, definitely as we improve on the scale, the gross margins of mechanical business on the uptrend. So I think all in all, gross margins of the growth, including some specific clear upgrade trends of ASP and complicated spec, higher spec should give AAC opportunities to deliver better gross margins. Okay. Thank you, Richard, for a very detailed explanation. I have a follow-up for Ben. Ben wants to reiterate that it is our it has always been our priority to align ourselves to determine how we could provide our expertise fittingly in considering the value we're providing solutions to customer in terms of user experience. He mentioned the two components that divide from our strong electromagnetic capability of SLS acoustic platform and haptics. Both of these are capabilities that we have been developed and test out in the customers' application, but also from the fact that the machinery that we equipped for the automation production of these solutions are well kind of fittingly adaptable to the ongoing upgrade of the design of the components or the complicated solutions that our customers are seeking to differentiate themselves. We believe at certain point in time, our competitors maybe due to some of the different background reason may come in a short time basis to present what we call short term pricing competition. But at the end of a focused user experience solution provider, we believe our value of creating the genuine user experience upgrade, the customers have acknowledged AAC position very clearly and have entrusted us in the past and will continue to do so. On top of this, we believe this is a very clear kind of path that this kind of solution will we are definitely targeting for kind of what we call double digit percentage growth in this business opportunity because of the fact that as we have experienced the upgrade in the solutions, like the customer have demand in the next generation devices. So AAC continue to not only defend but outperform competition not only because we pay attention to the user experience and the general usage of our production equipment, but also we always bear in mind the kind of what we call the leader of costing and delivering long term user experience solution. Our next question is coming from the line of Nachi Chang from JPMorgan. Please ask your question. In terms of Plastic Lands, Ben confirmed that for this month already, we have already exceeded the RMB20 million number and is on target to deliver 25,000,000 to 30,000,000. The previous plan of reaching 40,000,000 in for the third quarter has not changed. So the progress on plastic land expansion is on track. In terms of WMT preparation, again, ever or in terms of what we have expected have changed. We are going forward, we're building up tooling capacity, molding capability in the range we have indicated. If we don't reach 10,000,000, it will be definitely approaching the 10,000,000 capacity per month capacity. And from the market side, the customers' intention or instruction or indications of strong interest in adopting WIOG hybrid LAN solutions have not changed. So we remain very confident about the optics business development. We agree that what you have pointed out is the interest for the audio display actuator has markedly increasing interest in the market, especially I think next year 2019, clearly, some customers' projects are looking at that direction. And we are very much expected to be a major player in this new business. What's more important is that we have already been working on the preparations to see performance upgrade in the design from its current performance. But at the same time, we are very cautious that in terms of kind of what we be able to offer is a stability in the pricing increase that the market could adopt. Needless to say, we have already established a strong portfolio of related IPs. I think the competition, like all the other interesting business segments that AAC are in, will clearly try and enter into similar area. But what's more important is that as we have pointed out just now, not only we have been proving our haptics capability or our understanding of electromagnetics to build a strong R and D roadmap, but also from the fact that we already have been deploying fixed production assets, platforms in the production of haptic components, including what we have briefly mentioned, stacking motors and decelerators haptic precision components. I think those are key differentiated parameters that would add to our distance or differentiation with competition coming in this area. Your next question is coming from the line of Leoping Huang from CICC. Please ask your question. Thank you for taking my question. We strongly believe the uptrend for gross margins to deliver 40% above is very clear that we is within achievable. Mainly, the new SIS platform is only in its beginning of adoption early this year in the Android camps as we have discussed that the Android customers will have more penetration in the different Android customers. And in terms of kind of generation of spec upgrade in SLS, we are very much very positive on that to deliver the next upgrade. And on top, as we have said, the automation efficiency of the current production process, etcetera, we see a lot of improvement scope. These are all very genuine, very kind of achievable targets that in the past, AAC and we continue to do so on good execution to obtain what we have target for our gross margins.