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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen, thank you for standing by, and welcome to Hua Hong Semiconductor's First Quarter 2019 Earnings Conference Call. Today's call is being hosted by Mr. Junjun Tang, President and Executive Director; and Mr. Daniel Wang, Executive Vice President and Chief Financial Officer. [Operator Instructions] The earnings press release and first quarter 2019 summary slides are available to download at our company's website, www.huahonggrace.com. Without further ado, I would like to introduce you to Mr. Daniel Wang, Executive Vice President and Chief Financial Officer. Thank you.
Good afternoon, everyone. Thank you for -- thank you all for joining us, our first quarter 2019 conference. We're always -- as always, we are very excited to have this discussion with everyone here. Today, we will first have Mr. Junjun Tang, our new Executive Director and President, to make some remarks on our first quarter performance.
President Tang will address in Chinese, and we will ask -- have [ Kathy Chen, ] our Head of IR, to translate the English.
After that, I will highlight our financial performance and give guidance for the next quarter. This will be followed by our question-and-answer session. I will now turn the call over to our Executive Director and President, Mr. Junjun Tang.
[Interpreted] Good afternoon, everyone. Thank you for joining our earnings call. I'm pleased to announce Hua Hong Semiconductor's first quarter 2019 performance. Once again, we're beating our expectations despite an overall slowness in the semiconductor market, which only goes to show the power and quality of our differentiated offering, fine-tuned to the available demand. Our revenue of USD 220.8 million was an increase of 5.1% year-over-year, and 11.4% lower than 4Q 2018, largely due to seasonality, annual maintenance of 2 of our fabs and reduced demand. Gross margin remained strong at 32.2%, 0.1 percentage point higher than 1Q 2018 and 1.8 percentage points lower than 4Q 2018, largely due to lower utilization. Net profit margin was 21.1%, 2 percentage points up year-over-year and 1.6 percentage points over 4Q 2018. Though there are uncertainties that are challenging under the current environment, we're optimistic and we believe that our strategy of differentiated technologies will continue to prevail. We have seen signs of recovery for several of our technology platforms, in particular, MCU and power discrete. Therefore, as soon as my new role become effective, I have instructed and lead a team to accelerate the pace of capacity expansion and upgrade for certain manufacturing corridors in the 200-millimeter wafer facilities. We want to make sure our capacity will be available as soon as the market turns around. Investment on this additional capacity and upgrades are minimal, but the payoff will be huge. The 300-millimeter project is in its critical stage. Therefore, I'm virtually there half of the time. Overall, I'm very pleased with the progress of the project. We do expect to complete the construction of the building and clean room by June to start moving equipment in during the second quarter and begin the rest of production in 4Q 2019.
Our technology development, engineering and sales marketing people are working very closely on a number of [ takeouts ] which will go right into the initial production of the new 300-millimeter wafer production line.
Though this is a huge responsibility, I'm very excited and honored to be leading this incredibly talented and dedicated group of people. I am grateful for the support of our shareholders and the confidence the Board of Directors placed upon me.
Let us together make Hua Hong Semiconductor the greatest company in the world. Now I would like to hand the call over to our CFO, Mr. Daniel Wang, for his comments.
Thank you, Mr. Tang, for the very inspiring comments. Now let me begin with a summary of our financial performance for the first quarter, followed by our outlook on revenue and margin for the second quarter of 2019. And then we will move on to the question-and-answer session. First, let me summarize financial performance as of the first quarter. Revenue was $220.8 million, an increase of 5.1% over the prior quarter, benefited from increased average selling price and improved product mix. And 11.4% lower than Q4 2018 due to seasonality, annual maintenance of 2 of our fabs and a reduced demand. Cost of sales was $149.8 million, 4.9% above Q1 2018 primarily due to increased labor costs and a unit cost of raw material -- raw wafers. And 9% lower than Q4 2018 due to a accrual of year-end bonus in the previous period and a decreased wafer shipments. Gross margin was 32.2%, 0.1 percentage point over Q1 2018, and a 1.8 percentage points lower than Q4 2018, primarily due to lower capacity utilization. Operating expenses were $31.7 million, 24.7% above Q1 2018, largely due to increased labor and technology development expenses. And 18.3% lower than Q4 2018, primarily due to an impairment provision and a accrual of year-end bonus in Q4 2018. Other income net was $5.5 million versus a other loss net of USD 2 million in Q1 2018, primarily due to fair value gains of financial assets at fair value through profit or loss and increased interest income, and 53% down quarter-over-quarter, primarily due to increased foreign exchange loss and decreased share of profit from associate, partially offset by increased interest income. Income tax benefit was $1.9 million, 508.9% over Q1 2018 due to a reversal of dividend withholding tax accrued for the prior year. Profit for the period was $46.6 million, 15.9% above Q1 2018, and 4% lower than Q4 2018. Net profit margin was 21.1%, 2 percentage points over Q1 2018 and 1.6 percentage points over Q4 2018. Basic earnings per share was $0.037, was $0.002 lower than Q1 2018 and $0.005 lower than Q4 2018. The increase in outstanding shares is due to $400 million equity investment by the National IC Fund in November 2014. Now please let me provide you with more details on our revenue from Q1 2019. From geographic perspective, revenue from China was $116.6 million, contributing 52.8% of our total revenue, and a decrease of 0.7% compared to Q1 2018, chiefly due to decreased demand for analog products. Revenue from United States was $41.1 million, an increase of 2.1% compared to Q1 2018, mainly driven by increased demand for general MOSFET products. Revenue from Asia was $25 million, an increase of 4.5% compared to Q1 2018, mainly driven by increased demand for MCU products. Revenue from Japan was $19.6 million, an increase of 61.8% compared to Q1 2018, primarily driven by increased demand for logic and MCU products. Revenue from Europe was $18.5 million, an increase of 12.3% compared to Q1 2018, mainly driven by increased demand for smart card ICs and general MOSFET products. With respect to technology platform. Revenue from embedded non-volatile memory was $84.7 million, an increase of 1.1% compared to Q1 2018, mainly driven by increased demand for MCU, partially offset by decreased demand for smart card ICs. Revenue from discrete was $83.8 million, an increase of 26.6% compared to Q1 2018, mainly driven by increased demand for super junction, general MOSFET and IGBT products. Revenue from analog and power management was $23.7 million, a decrease of 33% compared to Q1 2018, mainly due to decreased demand for other power management IC products, LED lighting and analog products. Revenue from logic and RF was $24.4 million, an increase of 26.7% compared to Q1 2018, mainly driven by increased demand for RF and the logic products. Revenue from stand-alone non-volatile memory was $4 million, a decrease of 25.3% compared to Q1 2018, primarily due to decreased demand for flash products. Now let's take a look at the cash flow statement. Net cash flow generated from operating activities were $78.9 million, up by 37% year-over-year, primarily due to increased collection of trade and notes receivables. Capital expenditures were $110.2 million in Q1 2019, including $84.9 million for Hua Hong Wuxi; and $25.3 million for Hua Hong Shanghai.
Other net cash generated from investment activities were $86.1 million, including one payout of $79.6 million from investment in financial assets as fair value through profit or loss and $6.5 million of interest income.
Net cash flow generated from financing activities were $317.7 million, including $317 million of equity injection to Hua Hong Wuxi, our JV subsidiary; and two, $0.8 million proceeds from issue of shares, partially offset by $100,000 payment of interest expenses. Balance sheet -- now let's take a quick look at the balance sheet. Cash and cash equivalents increased to $1,155,300,000 on March 31, 2019, compared to $777 million on December 31, 2018.
Trade and notes receivable decreased from $176.98 million on December 31, 2018, to $160 million on 31st March 2019, primarily due to decreased revenue.
Inventory increased from $129.6 million on December 31, 2018 to $140.3 million on March 31, primarily due to increased -- due to increase in raw materials. Property, plants and equipment increased from $773.2 million as of December 31, 2018 to $853.8 million as of the 31st March 2019. Total assets increased from $3,078,300,000 on December 31, 2018, to $3,521,400,000 on March 31, 2019.
Our total bank borrowings were $31.2 million on March 31, 2019. Total liabilities increased to $400.3 million on March 31, 2019 from $373.9 million on December 31, 2018.
That ratio decreased to 11.4% on March 31, 2019 from 22 -- 12.1% -- I'm sorry, 12.1% on December 31, 2018.
Finally, let me give you a very top-level outlook for the second quarter 2019. We expect revenue to be approximately $230 million, flat compared to a year ago and a 4.2% increase over Q1 2019. We further expect gross margin to be approximately 30%. So this concludes my financial remarks. Now I would like to open up the call for question and answers. Operator, please help. Thank you.
[Operator Instructions] Your first question comes from the line of Randy Abrams from Crédit Suisse.
I wanted to ask the first question, maybe for Mr. Tang. On the new appointment on President, congratulations. But I wanted to ask, I guess, just on overall strategy for the company, if any shift in investment strategy on the 8 and 12 inch and any meaningful change in the operational strategy or its kind of intent to maintain the existing business as it was.
[Interpreted] I'm very glad and honored to join the team. As you know, Hua Hong Grace is a great company. We have already structured a very competitive 8-inch line. And the majority of my job is to prevail -- optimize the overall flow. And now Hua Hong Wuxi is in progress. We are now accelerate the work and target to achieve the [ risk ] production target by end of 2019.
[Foreign Language]
Great. Thanks.
Second question just I wanted to ask on, maybe more on the guidance. If the business profile -- maybe take us through what's going on in the analog where you're seeing good momentum in discrete, whether you expect that like the MOSFET super junction, that to continue. And then the other side of the analog power management has been declining, if there has been some factor driving the decline and if you see that rebounding. And I guess, overall, beyond the analog, how you see the other applications trending over the next couple of quarters between like the MCU, smart cards and some of the other applications.
Randy, thanks for the question. I think we just hit the points. Discrete continued to be a very, very important segment for us. I mean for Q1, just -- when you look at discrete, continued be a very strong area. When you look at the super junction, IGBT, others, it continued to do very, very well. The strength -- the momentum was there, the strength was there virtually. That area was flat to Q4, okay? When you compare to Q4 last year, and you know Q4 was perhaps the best quarter we ever had, right?
And we expect that will continue. I mean when we look at Q2, I think discrete segment, when you look at whether it's super junction, IGBT or the general MOSFET, I think each area will have a -- from what I see, will have a strong growth. I mean I'm literally talking about a double-digit growth, okay?
And I think even in the smart card area, we still see some growth there as well, especially the sim card. I think maybe just because of the seasonality as well as some other cards like ID cards, okay?
So I think we expect -- I mean we clearly, we see some signs of recovery at this point. So we definitely and I know we had -- our utilization was low for Q1, but we see -- we definitely, I think, Q2 will have a better utilization. Utilization rate will definitely improve in Q2. So we expect that will -- hopefully, it will take us back to the normal sort of rate of utilization.
Okay. If I can ask on the blended -- it looks like the ASP has a pretty good lift in the [indiscernible] quarter. Just if you could maybe talk on the ASP trend, if you continue to see that direction or after the slowdown, maybe any reversal or where pricing could start to come in and be a little more aggressive.
I mean, yes. I mean, we are even in the low season, low quarter, I think our ASP continued to be very strong. I think it had a very nice, almost close to a 5% growth.
So it was -- no, to be precise, it was 4.9% growth. So hopefully, that will continue. I think we -- overall, we still expect our ASP will continue to prevail, okay?
Basically, when you look at by segment, I think the embedded non-volatile memory, we had the very nice single-digit growth there. Discrete was very strong. Analog also went up slightly. Logic and RF also had a very nice growth there. So overall, we had a very nice close to 5% growth in the ASP. Yes?
Okay. And then the other side of it, the gross margin -- I mean given the ASPs have been pretty good and utilization picking up, for the gross margin, the guidance to 30%, maybe go through the factors. And also if it's -- some of it's depreciation coming up, but the factors, and how you see margin trending like as we go towards second half, if 30 is the level or it could come back up into the low to mid-30s again?
I mean overall, this company has always been very conservative in the past. When we give a guidance, we want to make sure we will always reach and meet, eventually, hopefully, we can beat again.
Yes. So when it comes down to per cost, manufacturing cost, there's always a time difference. So part of that, it was a result of just overall in general a weakness -- a general weakness in the market. Therefore, it's a lower utilization rate, I mean, in Q1. So part of that is because of that. And we are hoping that 30% is the lowest. It's the bottom. And hopefully, from this point out, we believe we will continue to do well.
I mean it's -- it was because of maintenance, seasonality and overall there's just a reduced demand in Q1. And I think we clearly, at this point, we expect Q2 will be better. So hopefully, this 30% will -- is the bottom, the lowest that we could -- we will -- hopefully, from this point on, things will improve.
Okay. We should still use 150 for depreciation this year? Or have you changed on that schedule?
Yes, yes, that's very good. I mean, Randy, you're always good on these things. Pretty much it is, the way I look at it is, last year it was $120 million, yes? The full depreciation, amortization expenses. For this year it's $150 million. $130 million comes from -- we expect it's going to come from Wuxi -- I mean, Shanghai, the 3 8-inch fabs; and then we expect there to be $20 million coming from Wuxi.
Your next question comes from the line of Sebastian Hou from CLSA.
So my first question is to follow on the gross margin for second quarter that -- it looks like the second quarter, as Daniel just mentioned, the -- there's a recovery, and you guys' user rate is improving. But they look like the guidance is -- it seems like the gross margin will have a dip. I understand the company tried to be conservative, but if we compare the first -- the guidance of this quarter versus the guidance of last quarter, it seems like still a decline. So can you walk us through what are the factor that's driving this? Is it because of the higher depreciation or other factors in second quarter?
Thank you, Sebastian. That was a good question. As I've said earlier, so when it comes down to manufacturing cost, there's always a time delay. So basically, part of the reason that the -- we expect the gross margin is going to have slight dip up to 30% is because -- largely because the utilization rate in Q1 was lower, okay? We expect the utilization will come -- will recover and Q2 will be better, okay? And -- but part of manufacturing cost will actually come into Q2. So therefore, that's part of the reason that the gross margin will be affected in Q2. But overall, the utilization will -- utilization rate will recover in Q2. There's a time difference, Sebastian.
Okay. Okay. Got it. Okay, I see. It is more because of the lower UTR, so the products, the wafer that you produced in Q1, that actually carried a higher cost? And when you sell it and you recognize the cost of goods sold, but that cost is higher. So that dropped -- that caused the Q2 margin dip. Am I getting that right?
Exactly, exactly, exactly. I mean virtually, 50% of the stuff we produced Q1 will get shipped into Q2. That's always the case. So there are no -- basically, it's a timing difference.
Okay. Got it. In terms of the ...
We expect 30% is -- it's basically -- it's -- that's -- hopefully, this is the most we -- I mean from this point on, we should move up.
Right. That's good. In terms of the full year outlook, do you have any guidance or forecast for the -- for overall 8-inch foundry industry or in Hua Hong net growth for this year?
We are still -- as I said earlier to Randy, basically, I think, we see some good signs at this point. We have -- for the past 3, 4 weeks, consistently we have seen these quick orders, fast orders, in particular in the segments of super junction, IGBT and general MOSFET. I have also said, even within smart cards, we see for sim cards, some other cards that some high margin stuff, actually we have a pretty good bookings -- I mean, orders for Q2, okay?
So these are good signs for Q2, okay? So hopefully, like everybody else, like all our peers, hopefully we'll see a true recovery in Q2. But we're still very, very positive about Q3 and Q4. At this point, I mean, we expect things will turn better. We have already seen good signs. Hopefully, the second half will even be better.
Okay. Okay. One of your peer, Vanguard, they talked about -- a couple of weeks ago, they talked about the 8-inch foundry industry to show a negative growth of this year. So is Hua Hong confident that it can beat that numbers?
You're -- well, I don't want to comment about other company, but we understand that particular company has a negative growth quarter-over-quarter like that, so as the guidance goes, right? Well, we basically -- we're positive about this number -- this revenue number we're giving out at this point. Hopefully, we can do even better.
Great. Okay.
We are positive.
Great, great. I have questions on the -- because the other day, there's a -- there is some speculation on the third-generation ID card in China, that internet -- I'm just wondering when -- have you -- are you seeing that in the pipeline right now? And when do you expect that to happen? And supposedly that should be a good tailwind for us.
It's happening now. We're fully ready. In fact, we're working on a few things on the -- basically, on the 90-nanometer technology, some of that is in production. Some of that, we're doing the testing work at this point. All of those are done at our 8-inch fabs, okay? Let me ask if Mr. Tang has also some -- can give us some commentaries on that.
Yes. So I mean -- so, yes, it's moving very, very quickly. And part of the reason that Q2, our smart card has gone up is because of that.
Okay. So these third-generation ID card is -- or the design has been done and it's actually already in production right now?
Yes. That is -- at least starting...
Okay. So Q2 will be the first quarter for this new generation ID card to begin production?
Well, let's put it this way. Q2, we should be see some pretty growth -- pretty decent growth for the ID cards.
Okay. Last question from me is the -- in terms of the subsidy reduction of the -- some of the electric vehicles, on the low-spec of the electric vehicle, do you see that having any impacts on discrete demand for us?
Well, not really. I mean, at this point, the super junction has, for example, in -- for Q2, we still see a pretty strong growth for super junction. It's a very nice double-digit growth. So from our end, I think we're -- it doesn't really impact us.
Your next question comes from line of Szeho Ng from China Renaissance.
I have a question regarding the OpEx in Q1. It was up 25% year-over-year. Is there any one-off items last quarter with OpEx?
So Szeho, let's look at that. Operating expenses compared to a year ago?
Quite a lot. Yes, yes, yes. Is there any one-off item there?
You have to realize, we have start some work in Wuxi already. So I would assume some headcounts, general G&A expenses and even some R&D expenses will actually increase in these areas. But overall, they are manageable.
Okay. All right. And...
And that was primarily -- these are the reasons why the operating expense has gone up compared to a year ago, by pretty much around like maybe $5 million.
Okay. All right. And then for the Wuxi plant, when should we expect it to contribute to the top line?
Sorry. I can't hear you, Szeho.
For fab 7 [indiscernible] when should we expect a revenue contribution?
Maybe I have Mr. Tang to answer that question.
[Interpreted] So the Wuxi project is already in progress, and we're targeting to start with production by end of the year. So technically, we will see revenue contribution by end of this year.
Your next question comes from the line of Aaron Jeng from Nomura.
My first question is about your -- I know that earlier you already said pricing in Q1 was pretty strong. And I wonder how the pricing outlook across product lines into second half of this year? And I cannot expect that because I was thinking your 2-inch fab capacity will be ramping more into 2020, and you are going to migrate off your smart card.
Now manufacture 8-inch to these 2-inch fabs. So that probably you're going to have more -- some more capacities for 8-inch over the next 1 year. And would this be impacting your pricing strategy into second half this year? That's my first question.
Aaron, yes, I mean we have the -- as I said earlier, we have the nice quarter-to-quarter, even though it's a lower quarter, but I think that we still -- our ASP still did pretty well. I think it was 4.9% up.
It's -- yes, I mean I think our ASP will continue to hold at this -- at the level. We are hoping that we can continue to make some improvement on that through ASP improvement and product mix improvement through ASP increase and the product mix improvement. I think we have a good chance because I think the -- in particular, as I said, the discrete area, we continue to see strong demand there.
So we have limited capacity. And it was for the same reason that since Mr. Tang joined the company, he has decided to -- we should start to accelerate the capacity expansion in the 8-inch space. We're going to add hopefully by 5,000 to 10,000 capacity for discrete this year. That will continue to open the manufacturing corridor for discrete. Therefore, it can improve the product mix better. So that is a very important area they're working on, we are focusing on.
And we still see some strong signs in smart card ICs, as I said earlier, for example, ID cards and also MCUs. MCU price continues to be very, very stable, okay? So that is something we're doing. Hopefully, we can continue to improve the ASPs throughout the year. But we'll continue to at least at minimal, we hope, at this level. Our ASP for Q1 is at the very nice, very respectable $483 per wafer, this is not very, very easy for any 8-inch business, thanks to our specialty technology.
Yes. And earlier, your guidance was for Wuxi fab to have 10,000 pieces of wafer capacity by the end of the year, and the 20,000 pieces of capacity by end of next year, 2020. Any update on these numbers?
No. That plant is still on schedule, okay? We -- by end of this year, we will have 10,000 wafer capacity. In fact, as I said earlier, we have said we're going to complete the building of the Wuxi fab, the construction and clean room, for building the clean room and facility by end of June. In fact, I think the schedule has even bring a little bit closer. I think sometime early in June, we should complete the fab building. And then we can start the -- start moving the equipment in Q3. And definitely have the capacity by end of Q4. And we really want to have some shipment in Q4.
And may I come back to the first question [ on the beat. ] I fully understand that your discrete business is super strong, [indiscernible] super junction leading the growth, IGBT delivering a growth. So ASP -- blended ASP [ how's there ] should be pretty decent. But given that your discrete capacity cannot be shared with the other product capacity, so my question is for this non-discrete capacity in the products, are you also seen pricing increase -- blended price increase? Or for this segment -- I mean non-discrete segment, it can be higher pricing pressure?
Well, we had some nice ASP improvement for embedded non-volatile memory segment. It was small. It was a 3% increase. It mostly come from MCU. We also had a little -- the smart card also went up slightly, okay? Discrete was very strong. Analog and power management by IC also went up slightly. It largely came from power management IC and analog. Logic and RF was also very strong, has a very nice high single-digit growth.
Yes. I was asking -- go ahead.
Sorry. Can you -- just go ahead, please.
I mean -- yes, I was asking into second half.
Oh, second half?
Yes.
Well, we're hoping we can still keep our ASP at the same level. I can't promise you that we're -- you just can't have 5% quarterly growth each quarter, right? It's going to be difficult, but we're hoping that we can still hold it at the same level. We are very particular about price, okay? I mean even if you look at our Q1, utilization was a little bit lower, but the ASP continued to be very, very strong. That is our -- where we believe in price.
And my last very small question is if you look at the -- your depreciation cost in 1Q versus 2Q, how's the comparison? Is 2Q going to be higher or lower, or what kind of level should we expecting for second quarter depreciation versus 1Q?
The Q2 depreciation expense were probably up a few million dollars. Like, for example, maybe slightly under $2 million.
Okay. Up? Below $2 million?
Yes. So Q1 total depreciation expense was $31 million. We expect that would go up probably by $1 million.
[Operator Instructions] There are no further questions at this time. I'll now hand back to Mr. Daniel Wang for closing remarks.
Well, again, thank you all for joining us today. It's -- as always, it's very, very informative. There was great conversation. We hope that you will join us again next quarter. And thank you all, and have a nice weekend.
Ladies and gentlemen, thank you for your attendance. You may all disconnect. [Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]