Earnings Call: Q1 2018

May 14, 2018

At this time, all participants are in listen only mode. There will be a presentation followed by the question and answer session. I would now like to hand the conference over to your host today. Please go ahead. Thanks, Grace. Good evening. Welcome to our 2018 Q1 conference call. I'm Eddie Kung, Head of Investor Relations of AAC. And joining us today, we have our CEO, Mr. Benjamin Pan and our Managing Director, Mr. Richard Mark. 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 to questions. Richard? Hi, good evening. Thanks for joining us on the call today. For the Q1, although there was a weak seasonality in smartphone supply chain, we reported strong year on year revenue and net profit growth, 10% and 6%, respectively, to RMB4.6 billion and RMB1.1 billion respectively. Gross margin although down 3.6 percentage points to 38% and that is mainly due to a significant U. S. Dollar depreciation against rmb in the Q1 when we compare that in the same period of last year, given our currency mix of revenue. Net profit margin is down less than 1 percentage point, 0.9 percentage point to 24.3%. We have the benefit of mitigating that with a fair value gain on our investments and favorable taxation achieved in the Q1. In this slide, the performance of different business segments are shown and acoustic experienced strong growth of 27%, driven by acoustic specs upgrade cycle and of course our new SLS solution, which has already been adopted by a major flagship model launched during the Q1. Although in the segment of haptics and radio frequency mechanical structures, sales had declined 11% due to some product mix factor. However, very good progress is going on in Android smartphones as they pursue advanced haptics for upgrading the tactile user experience. And we are also glad to report that high end metallic frames and 3 d coupled glass solutions had already started shipping in the Q1. In optics, sales is on track to deliver the single digit of total revenue for this year. At the same time, there is increasing demand of the unique WLG Hybrid LAN solution. We will continue to expand production capacity for both the plastic lens and WLG. Finally, for the MEMS microphone, in this quarter, sales was up 65%, shipments growth in line with our sales expectations. The 27% increase in acoustic sales year on year was driven by both shipments and ASV growth of the speaker module. When speakers and receivers continue to operate to more complex design, which caused some migration from the standards of speaker module. And that's why on a standalone basis, the speaker and receiver components shipments declined. Higher selling price of the SLS platform to some extent explained ASP growth of the speaker module. I would like to take the opportunity to reiterate 2 updates recent updates that we posted and broadcasted last week. For the first time, Moody's has issued a BAA1 credit rating to the company and the related outlook on the rating is stable and we are very pleased with that. Also last week, we issued the sustainability report for the year 2017. We welcome feedbacks from investors and yourselves and other stakeholders as usual. We are mindful of our commitment to further provide improvement and strong performance on initiatives we started on AAC overall manufacturing roadmap to become a responsible company. We welcome and we will continue our efforts on that. Now I think we are ready to open the floor for Q and A. Please raise your questions. We will now begin the question and Your first question comes from the line of Cherry Ma from CLSA. Please ask your question. Good afternoon, Benjamin and Richard. Thank you for taking my question. My first question is related to gross margin. Gross margin had not dipped below 40% since 2008 and external factors like currency is hard to manage, but product mix and product efficiency should be within the company's control. So I'm wondering which product or specific group of customers was the main contributor of this margin erosion besides FX? And FX aside, is this a structural change in profitability that we should expect into Q or rest of the year? Cherry, hi, this is Richard. Thank you for your question. We don't see any long term structural changes to our cost structure as such. We believe our target and achievable gross margins on all our products platforms, including the new optics business, Again, we are aiming for them to deliver more than 40% gross margins. Think in the Q1, on a year to year basis, renminbi has appreciated 7.5% and that on its own has caused a 3.2% drop in gross margins. And having said that, I think the Q2 as of today, if we looked at how renminbi has performed since 1st April to today, I think renminbi has remained quite strong. So to some extent, I think that there will still be an impact on the gross margins for Q2, but nevertheless the fundamental of our capability of delivering, achieving gross margins of about 40% in most of our business we expect for the growth as a whole definitely over 40%. And to follow-up to my first question, when we negotiate price with our customers, do we take this RMB strength into account when we negotiate a new pricing based on U. S. Dollars? To some extent there are different kind of business arrangements when we look at the project. So some customers we would be discussing the business in renminbi and some customers in U. S. Dollar. But nevertheless, I think the extent of appreciation or in the past some depreciation of renminbi have been outside the kind of framework of the business arrangements. So it is a variable arrangement. Thank you. My second question is in optics. I would like to ask in terms of shipment volume of plastic lens, how was it in 1Q? And have we reached our 20,000,000 monthly shipment target? When will we start mass production of hybrid lens and what sort of specs would it be and our capacity expansion plan for the second half? I think as we said and as we announced, again, Anthony, this is Richard. As we announced and as we said in the past, we are progressing very well with the optics business in terms of both plastic lens and WLG hybrid lens solution. Our plan of preparing a capacity of 20,000,000 pieces per month, I think we have reached that. And I think in the second quarter, we have strong confidence that, that capacity in the second quarter will turn into shipment. So that is very much on track. And the hybrid lens, I think as we spoke last time, I think in the Q3, we will be shipping the hybrid LAN solution. So that is not changed. And again, the company is confident that it will be a start of a very important new capability, which the industry has been anticipating. Ben has added to give some numbers for the May shipment. I think for the month May, we will likely to reach a range of 16,000,000 to 17,000,000 pieces in the month May. And there's a very high probability that in the following month in June, something close to 25,000,000 may be the shipment that we are expecting. So the overall longer term or medium plan for this year is that most likely in the 5 or in the Q3, the capacity for plastic launch will be in the range of $25,000,000 to $30,000,000 And whether in the Q4, we will consider further expansion along with our CapEx plan to increase capacity, say, to 50,000,000. That is something that we are ready to kind of pay attention. At the same time, in the next 2 months we are seeing very strong, very steady progress in terms of building up the capacity and shipments. For WLNG, the current recession as expected is very, very positive. The capacity each month reached RMB5 1,000,000. We are there. And possibly, I think most likely by year end, it will get to RMB10 1,000,000 per month. And in terms of projects delivery shipments, mostly will take place in the 3rd Q4. The importance there is to build up our capability at this stage. But the long term strategy as we have said last time or many occasions is that with the plastic lens, the focus definitely is for a 5P design. There will be small portions of 4P design. But the aim of plastic lens capability is really focusing on replacing the plastic lens solutions with WLG. Hence, whether we get to the 50,000,000 capacity is really a kind of question of how much we could prove to the market. The WLG is a long term capability and it's welcomed by the market. Next question comes from the line of Yunshim Cai from Morgan Stanley. Please ask your question. Hi, this is Richard again. Thank you for your question. I think what we like to say at the current stage is that the guidance for the 2018 sales most likely will be a double digit growth on a year basis instead of quantifying giving a number. But again, I think you're right in saying that because AAC business is not only concerned about the next 90 day cycle, we are in this for a long kind of building up our foundation for miniature technologies. Hence, it's more important for us to make sure the preparations and the business cycle are in sync whereby AAC growth is on a sustainable strong platform background. So on that, we like to say obviously this year, perhaps in some of the years before, a stronger second half would definitely be a would not be unlikely. I think would be likely pattern to see how our sales progress. Well, I think as we said, the Android business in terms of the performance, not only in acoustic, but in RF mechanical and haptics and to some extent we described a little bit about optics development for the Android models. I think those are very strong growth factor. So the percentage I think really is a play out between how these progress in the second half of the year. But whether the split will be a very kind of market divide, I doubt it. And maybe it's very kind of device. But at this stage, I think it's too early to be certain to be able to give you a fixed kind of decision on which portion, but I think they will come very close to one another. Ben added that clearly with Optics making a meaningful contribution to revenue this year and helped by extra 3 d covered glass and haptics growth in Android business and Android business segment, it's very likely that non acoustic definitely would be a larger portion compared to Acoustic. Not only for this year, but for future years' trend to come on the developments of these 3 business segments. We expect nonrecoustic to continue to be a larger portion. Ben confirmed that he believes from the numbers forecast, the shipment for this year should remain quite positive. Next question comes from the line of Nancy Chen from JPMorgan. Please ask your question. In the Q1, we believe both the volume and ASP contribute to the growth. I think the volume growth is higher in terms of the speaker, especially what we call the speaker module. Definitely, it's a strong double digit growth. In terms of ASP, I think it's a meaningful, okay, close, I would say, lower double digit growth in ASP. So each contribute differently, but both are very healthy, very positive trend. Ben added that the WILG hybrid LAN solutions that we are focusing for delivery in the Q3. The first project is related to sensing and after that followed by various projects related to imaging and the imaging design mostly is what we call a hybrid and 6P structure, whereby it's not the 6 pieces, it's really what we call 1 GaAs 5P design, and we are on track to deliver. Next question comes from the line of Wei Chen from Goldman Sachs. Please ask your question. Yes. Hello, Ben. Hello, Richard. Yes, I have a question on gross margin. So you mentioned about 3.2% is due to currency, but can you kind of talk about how are the gross margin for each segment in the Q1 and how do you see that moving forward? Thank you for your question. Overall, I think in the we don't split first of all, we don't split the detailed segments within the non acoustic, but we are very glad to report that on even on a quarter on quarter basis, the margins are very positive. There is no big changes to the margins in most of the segments we talked about. So really the major cost for the overall gross margin drop is not due to one individual product line. It's more really just because of the currency mix and appreciation of renminbi. And as we expand our capacity in optics, as we said before, the economy of scale and we are on a very steep learning curve, We are improving on margins. Again, the different projects we are will have different kind of performances. But overall, we are definitely approaching our target to continue to improve the gross margins and focusing on the related what we call production yields, etcetera. And in the Q3, those are very, very healthy. There is no adverse kind of problem we see in any one of the product lines. Okay. And more specifically, can you talk about the pricing dynamic for Acoustic from a competition perspective because there's a lot of rumors on your new entrants really offering very low pricing? And then also with the higher mix of SLS structure, how does that kind of impact your acoustic gross margin? We have already reached a very high automation kind of process for the NIO platform SLS. And again, we are quite happy. We are quite pleased that our production team's people are delivering very, very good results in terms of yields, in terms of gross margins for the SLS platform. So we have high hopes to see that would actually make a strong positive contribution to the overall gross margins of dynamic components as such. Especially in quarters to come, we are going to continue to penetrate the other 1st tier Android models as well. But at the same time, I think it's also fair to say, we are also ready for stronger penetration in the mid segment design phones, whereby there is again no reason that AAC should see any erosion in the gross margins of standalone speaker or receiver. And in terms of price kind of pressure or coming down, I think AEC is very, very accustomed to price down pressure, but continuously our automation, our already invested automation lines should be able to help us to achieve the margins we are seeking. And hence, right in the beginning of this call, both myself and Ben has reiterated the gross margins of not only AAC as a whole, but also our Acoustic business segment. We should not we do not see any strong reason for why we would not be able to deliver a 40% plus gross margin. Got it. So one last question, just to clarify. When you on the previous question on the full year, year on year growth, the previous guidance was at 25%. And so what's the latest outlook? And what really drove the more cautious tone versus beginning of the year? Thank you. I said for 2018, we are forecasting a double digit top line growth year on year basis. I think we have reported a 10% top line growth in the Q1. We continue to work on improving kind of the penetration of SLS platforms, improving the optics contribution, etcetera. But I think overall, there have been some kind of adjustments to the projects, adjustments to the forecast by our customers. I think as a good practice, we should be updating the latest business environment and the situation. And we are still very confident that this year is a growth year whereby our gross margins should remain. Again, new segments of offtake should be going on as planned. The further improvement in the mechanical business with the shipment of 3 d covered glass should all help us to be able realistically to deliver a double digit top line growth. So that is for sure. Next question comes from the line of Kina Wong from Credit Suisse. Please ask your question. Thanks for taking my questions. I have a follow-up question on the hybrid vans. May I ask actually if purchase or could you like quantify like how many projects that will adopt hyperlink or there's some potential to adopt? And what's the ramp up progress versus the plastic line business? I mean, in the plastic lens, we see the ramp up progress is quite smooth and the pickup is very strong since last year. And what should we expect for the hybrid lens this year and next year in terms of the ramp up pattern? That will be the first question. And the second question is about the haptic solutions. What's the future development in terms of haptic solutions in smartphone or in other new business that we see I mean, we should say there's no ceiling for the haptic at this moment or you can see more innovative design that will come in because haptic is one of the very strong and leading porters from AAC? Thanks. Thank you for your question. It's Richard. In terms of the numbers of projects of hybrid lands that we are targeting, we believe around 5 to 6 possibly in Q3 and Q4. Definitely as we have said, the capacity we have built, we should not be committing to deliver shipments deliver numbers whereby our capacity could not meet customers' requirement. So in a way, definitely we also discussed about increasing the capacity to 10,000,000 pieces per month by the end of the year. So that's very much give us the additional flexibility to catch on new projects if there are customers kind of follow-up on good reception, which we do expect very good reception on the hybrid lens capability. As Ben has pointed out, we already have 3 d sensing project and also imaging projects. I think the very kind of interesting optical performance of hybrid lens with WLG is very well not only kind of review, but actually tested and it's in a very kind of solid roadmaps of user experience and design in new models to come, not only for this year, but models to come and hence the exciting user experience that WLG can bring about. I think similar kind of characteristics for haptics for the Android as well. Recently, I think the industry has received strong and enthusiastic kind of reception when smartphones are turning into specialist smartphones for game players whereby haptics user experience plays a very interesting innovative, a must have feature for these game design smartphones. And through that, we believe the user experience whereby the advanced haptic solutions that AAC is so strong, held in IP and also in our manufacturing, we could quickly accelerate the adoption of this design in the Android phones. So we talked about a target of 30,000,000 to 50,000,000 shipments for Android phones this year. We remain confident of delivering that. And again, I think you can see the range, there's a flexibility. But definitely from the current dialogues and interactions from the customers, we are confident that the haptics kind of adoption of the advanced user experience, again, it's only a first phase in the Android segment. Next question comes from the line of Alice Chen from UBS. Please ask your question. In fact, the performance in acoustic gross margins, what we call dynamic components, there is really just in terms of if we look by line by line basis carefully, our speaker module has performed very well due to the contribution of the new platform and the existing kind of efficiency on a design that we are very familiar with. I think there may be a slight kind of impact from receiver, but there is a very small impact on margin and the major really impact is on the renminbi appreciation. Okay. Got it. Thank you. And my second question is about the acoustic growth. Just want to clarify that. Benjamin just mentioned for acoustic growth maybe lower than the non acoustic part, but I remember last time we still expecting the acoustic growth to be still driven by this advanced design. So just want to make sure if the story of this upgraded site for acoustic still intact in the next maybe 1 to 2 years? Yes. I think what Ben was transmitting is not the growth as such. I think both Ben and myself are very confident that not only SLS, but our acoustic kind of upgrade cycle is very strong. We are in the beginning stage of an acoustic upgrade cycle and the growth is very, very interesting. I think when we discuss about the portion of the business non acoustic and compare that to acoustic, we believe that optics and RF mechanical and haptics have got very strong business foundation and because those 3 add together it's most likely that not only for this year, but for years to come will be a bigger portion than Acoustic. But in terms of growth, we have meant to say strong growth in acoustic and very, very exciting growth in the new optics business contributing to the growth of non acoustic as well. We didn't mean to say acoustic has slowed down at all. I apologize for the confusion. But no, Acoustic very strong growth, upgrading cycle, SLS to contribute. We are preparing for the 2nd generation of SLS. We are also targeting, we have solutions for improving penetration in the mid segment as well as to some extent the lower end segment of smartphones with AAC Acoustic Solutions. Next question comes from the line of David Dai from Bernstein. Please ask your question. Hi, Panjung, Richard, and Eddie. My two questions here. The first question is regarding the metal casing and 3 d glass, cover glass, could you give outlook about the in terms of unit shipment and ASP, how does it look as compared to last year? Thank you. Hi, this is Richard. We believe, first of all, as we have said, our CapEx in this RF mechanical structure for this year 2018 is very minimal as we believe our capacity planning or the related CapEx machinery we have already invested in the last 2, 3 previous years already. So with that in mind, we believe what we are talking about is a higher utilization of our CNC and related production capacity to be more efficient in terms of shipments, whereby we are still expecting to deliver something like around 4,000,000 pieces per month in terms of what we call metallic frames or cases capacity, fully utilizing or improving the utilizing of our 7,000 plus CNC machines. And we are on target to, again, fully expanding our 3 d tempered glass capacity step by step gradual because the trend of more 3 d covered glass design is very slow. Last year, we reached 3 d covered glass 1,000,000 per month capacity. I think most likely during this year, we should be aiming to double that kind of capacity. So with that in mind, the overall segment for RF mechanical structure, definitely with the incremental contribution by 3 d Global Glass is in a strong growth. And in addition, we expect our gross margins performance to further improve in this segment because of the fact that we have already kind of worked with most of the Android phones last year already. We fully understand our customer. Our customers understand how quickly, how responsive AAC is. We further improved on the management process, focusing on yields, focusing on potential kind of steps in automations in between processes. But there is no reason again that we should not be able to deliver an improvement on gross margins of the mechanical structure business. Thank you. The second question I have is from the presentation, you mentioned that you're exploring new opportunities in smart vehicle, ARVR, IoT and robotics. Could you give some examples of what kind of opportunities are there? And also are these opportunities that we can potentially see the results in the near term, say like 1 to 2 years or is it more for long term 3 years or 5 years? Thank you. Yes. Thank you for helping us to talk a little bit more about this kind of initiative. Breaking into a new industry definitely takes time for new customers or projects to realize how important the miniaturizations of hardware in order to integrate with new products, not only in the household smart speaker, VRAR, but also more importantly to some extent smart automobiles as the industry is developing very, very fast. I would say the cycle of developing smart automobiles has to be quicker than the cycle in the traditional automobile. And hence, with that kind of environment, the miniaturization capability, for example, we talked about SLS platform, we talked about designs that AAT already are thinking how we should make use of what we call the form factor, but bearing in mind the performance required by these clever designers in the smart vehicles, how they should kind of think of AAC capability in turning out customized solution. Although I must stress, these are early stages, it's very, very important that AAC understand at the same time for customers, potential customers in this new industry appreciate our R and D, but also our manufacturing capability for kind of responsive in terms not only in the performance of each segment, but in terms of the different kind of variations and the potential late changes, etcetera, AAC should be ready. And at this time when we mentioned this, we are in the preparation stage. By no means, we are saying we are ready to see a big contribution in our revenue. But most importantly, I think this is something that we started and so far active interactions with new potential kind of market players have been very positive, have been healthy and we will continue to report and talk about this. And I think at the end of the day, I think differentiation of what capability that AAC can bring to miniaturization in acoustic, in the optical sensor, in the HACS design, which gives the user experience required in these new segments. It's something that AAC understands very, very well. And I think both Fan and myself and our sales marketing team are working very hard on this to make sure this potential is captured at an early stage. Next question comes from the line of Kylie Huang from Daiwa Capital Markets. Please ask your question. Hello, Benjamin, Richard and IR team. This is Carly from Daiwa. I have two questions here. The first question, I just want to clarify. Benjamin mentioned actually the business contribution from the non acoustic will be still higher than acoustic this year. And given it seems acoustic actually grows still very strong. So I want to clarify in terms of not acoustic between different segments like haptics, I. E. Mechanical and arctica, each business will still have a growth this year or some business actually will be more flattish to offset the other segment growth? Yes, this is Richard. I think when we talk about the growth kind of trend from each of these segments, clearly in the Q1, Acoustics has done very well. But we are very confident and we are pleased that the SLS platform will continue to contribute to a very good growth in this year. But nevertheless, I think for example in optics, we are starting from a very low base compared to last year and we are expecting for Optics to deliver a single digit contribution to our revenue. And again, we have some numbers that we talked about for the haptic shipments of Android phones. I think they will play a very important part in contributing to the growth of haptics for Android phones, not only in the second half, but in the second quarter and thereafter. So we are expecting the non acoustic segment kind of business to have a more kind of what we call evenly growth achieved throughout this year, whereby at the background of that, acoustic growth can be kind of more project customer related. But overall, we are seeing a double digit growth of the whole company should be contributed in that kind of proportion whereby at the end, by the end of this year we should see the combination of 3 business segments kind of add together awaiting the acoustic. Okay. Thank you. My second question is about the pricing environment for the upticks. Could you give us an update about the plastic right now blended pricing? And also for the hybrid lens, given it's likely we will start to have shipment in Q2 or Q3, Could you also give us an update most likely pricing ahead? We already as we have said, we already started high ticket management last year. In this Q1, we continue to improve and recorded more businesses. So far, we have not seen, I think it will be confirmed by analysts like yourself that there have been no kind of significant price drop or price changes to plastic plans solution. And we don't expect that to change in the short time, whereby I think the test plans is still very much in demand. It's all about some buyers coming out with good quality, good yields, etcetera, and AAC is very well positioned to deliver that. I think for hybrid LAN solution before we have kind of quoted something around a US2 dollars range for hybrid LAN solution. We are sticking to that kind of price level. Last question comes from the line of Yuera Chen from BNP. Please ask your question. Your last question comes from the line of Brian Lee from BNP Capital. Please ask your question. Hi, Ben and Richard. Thanks for your presentation. Just want to have something to follow-up. Just want to clarify that, so the slower growth is actually coming from haptics volume or ASP? Can you give us some color on in terms of the volume of ASP change? And in terms of the Android haptics, does that also contribute towards the margin decrease on the haptic sector? And lastly, the final questions come, is there any decision from the management thinking of applying hedges on the FX to smooth out this FX volatility that we're experiencing this sector this quarter? Thank you. Hi, this is Richard. Thank you for your question. But at the moment, we have not hit out the margins by haptics or by other mechanical because I think we are not at the stage to be able to do that yet. Nevertheless, as we said, in the Androids, in the haptic solution for Android, as it's becoming more sophisticated, as the performance becoming more kind of specific, the ASP for the Android Haptic solution has been on an increasing trend and we expect that continue because from the previous design to what we call a big axis, There's no reason for ASP to drop. And correspondingly, as we have shared before in manufacturing process and in the design, the haptics component is very much an electromagnetic kind of design component whereby ADC is very strong in terms of design and also in the automation process. Again, we do not expect any variation to our good high gross margins that we can achieve for these haptics, especially in the new enterprise business and all these advanced solutions. You asked about potential hedges to renminbi appreciation. I think at the moment there is not much a kind of perfect solution for that. I think as we have maybe have an opportunity previously when we have seek kind of what we call borrowing facility when we faced with a floating interest rate situation, we have used what we call fixed rate swap to kind of tie down the cost of borrowing. Whether we would continue to do that, I think that depends on whether there would be new kind of facility that the company enters into, but I think it's a situation that myself as in charge for the financial aspects of the group will seek internal review and also professional advice on this matter. Again, as you understand, hedges only work in one way and it's still a kind of risky kind of instrument. As we have said in the past, we are not very comfortable. And in the past, we have not had to say into any speculative kind of financial instruments at all. But when we have a very clear picture of how exchange rates evolve, to some extent it will be my job to consider that. 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. We have to process the development of different business segments and we are able to create further depreciation and increase the return of shareholders by focusing on our effort for long term growth. Thank you for all joining us today. We will speak with you again at 22nd August for our Q2 results of 2018. Thank you. Good day. Thank you for your participation. And this concludes today's conference. You may go ahead and disconnect.