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Ladies and gentlemen, thank you for standing by, and welcome to Hua Hong Semiconductor's Second Quarter 2023 Earnings Conference Call. The call is 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 second quarter 2023 summary slides are available to download at our company's website, www.huahonggrace.com.Without further ado, I'd like to introduce you to Mr. Daniel Wang, Executive Vice President and Chief Financial Officer. Thank you.
Thank you. I want to thank you all for joining our second quarter 2023 earnings conference. Today, we will first have Mr. Tang, our Executive Director and President make some remarks on our second quarter performance. President Tang will address in Chinese and Kathy Chien, our Deputy Director of Investor Relations, will be the translator. After that, I will discuss our financial results and provide guidance for the next quarter. This will be followed by our question-and-answer session. The call will be conducted in English. So, please ask your questions in English.Without further ado, I would now turn the call to Mr. Tang.
[Foreign Language]
[Interpreted] Good afternoon, everyone. Thank you for joining our earnings call. Despite the fact that the semiconductor market has not yet recovered from the downward cycle, Hua Hong Semiconductor weathered the storm in Q2 2023 and delivered a remarkable performance. By the end of the second quarter, the company's 8-inch equivalent monthly production capacity increased to 347,000 wafers. Leveraging our technology capabilities and business skills in diversifying specialty technology platforms, the company's full production lines remained fully utilized.The second quarter revenue was $631.4 million, up 1.7% year-over-year and a flat quarter-over-quarter. Gross margin was 27.7%, exceeding our previously announced guidance, down 5.9 percentage points year-over-year and 4.4 percentage points quarter-over-quarter, primarily due to higher depreciation and utility costs and a lower average selling price.On August 7, 2023, Hua Hong Semiconductor successfully completed its initial public offering of 8 shares on the stock market, raising more than RMB 20 billion, demonstrating the recognition and support of investors and fueling our rapid growth in the future.As the world's leading specialty technology foundry, the company will continue to optimize specialty technologies, further consolidate our leading position, and reward investors with even better performance.\Now, I would like to hand the call over to our CFO, Mr. Daniel Wang, for his comments.
Thank you, Mr. Tang. Now, let's begin with a summary of our financial performance for the second quarter, followed by an outlook on revenue and margin for the third quarter of 2023. And then we will move on to the question-and-answer session.First, let me summarize financial performance as of the second quarter. Revenue reached $631.4 million, up 1.7% over a year ago, and flat to prior quarter. Gross margin was 27.7%, 5.9 percentage points lower than Q2 2022, primarily due to decreased average selling price, increased depreciation and utility costs, and 4.4 percentage points lower than Q1 2023, primarily due to decreased average selling price.Operating expenses were $76.7 million, 8.5% over Q2 2022, mainly due to increased engineering wafer costs, and flat to Q1 2023. Other lost net was $54.7 million, 3.5% lower than Q2 2022, mainly due to increased government subsidies and interest income, primarily offset by increased financial costs and foreign exchange losses.Other income net gain was $6.1 million in Q1 2023, mainly due to foreign exchange gains in Q1 2023 versus a $54.7 million net loss in Q2 2023, mainly due to foreign exchange losses.Income tax expenses was $35.9 million, 26.8% above Q2 2022, primarily due to increased taxable income. The income tax credit of $8.9 million in Q1 2023 was mainly due to a reversal of dividend withholding tax accrued for the prior year.Profit for the period was $7.8 million, compared to $53.2 million in Q2 2022, and $140.9 million in Q1 2023. Net profit attributable to shareholders of the parent company was $78.5 million, compared to $83.9 million in Q2 2022, and $152.2 million in Q1 2023.Basic earnings per share was $0.06 compared to $0.064 in Q2 2022, and $0.116 in Q1 2023. Annualized ROE was 10%, compared to 11.5% in Q2 2022, and 19.6% in Q1 2023.Revenue. Now, I will provide more details on our revenue from Q2 2023. From a geographical perspective, revenue from China was $489.3 million, contributing 77.5% of total revenue and an increase of 8.6% over Q2 2022, mainly due to increased demand for IGBT, MCU, and Super Junction products, partially offset by decreased demand for NOR flash, CIS, and other power management IC products.Revenue from North America was $48.5 million, a decrease of 33.7% compared to Q2 2022, mainly due to decreased demand for other power management IC and MCU products. Revenue from Asia was $45.2 million, a decrease of 22% compared to Q2 2022, mainly due to decreased demand for Logic, General MOSFET, and other power management IC products.Revenue from Europe was $40 million, an increase of 39.7% over Q2 2022, mainly due to increased demand for smart car ICs and IGBT products.Revenue from Japan was $8.4 million, a decrease of 20.7% over Q2 2022, primarily due to decreased demand for MCU products.With respect to technology platforms, revenue from embedded nonvolatile memory was $208.3 million, an increase of 18.9% over Q2 2022, mainly due to increased demand for MCU and smart card ICs.Revenue from standalone nonvolatile memory was $33.4 million, a decrease of 52.1% over Q2 2022, primarily due to decreased demand for NOR flash products. Revenue from discrete was $251.4 million, an increase of 33% over Q2 2022, mainly due to increased demand for IGBT and super junction products.Revenue from Logic and RF was $57.2 million, a decrease of 25.8% compared to Q2 2022, mainly due to decreased demand for CIS and logic products. Revenue from analog and power management IC was $80.5 million, a decrease of 26.4% over Q2 2022, mainly due to decreased demand for other power management IC products.Now let's take a look at the cash flow statement. Net cash flows generated from operating activities was $161.2 million in Q2 2023, 24.1% below Q2 2022, primarily due to decreased receipts from customers partially offset by decreased payroll payments. Capital expenditures were $165 million in Q2 2023, including $148.3 million for the Wuxi fab and $16.7 million for the Hua Hong 8-inch fabs.Other cash flow generated from investing activities was $14.3 million in Q2 2023 from receipts of interest income. Net cash flow used in financing activities was $300.2 million in Q2 2023, including $167.7 million of pledged deposits for bank borrowings, $85.6 million of bank principal repayments, $52.7 million of interest payments, $3.3 million of lease payments, and $0.4 million of listing fees, partially offset by $8.1 million proceeds from bank borrowings and $1.4 million proceeds from share option exercise.Now let's move to the balance sheet. Cash and cash equivalents were $1,851 million on June 30, 2023, compared to $2,218.5 million on March 31, 2023. Restricted and timed deposits increased from $1.1 million on March 31, 2023, to $167.1 million on June 30, 2023, mainly due to increased pledged deposits.Inventories decreased from $593.9 million on March 31, 2023 to $558.3 million on June 30, 2023, mainly due to decreased work in progress and finished goods. Property, plants, and equipment was $3,256.6 million on June 30, 2023, compared to $3,436.7 million on March 31, 2023.Total assets decreased from $7,378.3 million on March 31, 2023, to $6,950.3 million on June 30, 2023. Our total bank borrowings were $1,796.3 million on June 30, 2023, compared to $1,905.1 million on March 31, 2023.Total liabilities decreased to $2,555.2 million on June 30, 2023, from $2,747.7 million on March 31, 2023, primarily due to repayments of bank borrowings and payments for income tax for 2022 in Q2, 2023. Debt ratio decreased to 36.8% on June 30, 2023, from 37.2% on March 31, 2023.Finally, let me give you a high-level outlook for the third quarter. We expect revenue to be approximately $560 million to $600 million, and our gross margin to be in the range of 16% to 18%.This concludes my financial remarks. Now we would like to start the question-and-answer session. Operator, please assist.
We will take our first question. And the first question comes from the line of Leping Huang from Huatai.
So, and congratulations for the very successful Asia IPO. So, my first question is about your third quarter guidance. So, we see a quite significant decline of your gross margin in the third quarter versus the second quarter. Can you share some we -- can you break down the reason of this decline between the ASP of your products and the rising depreciation costs?
Leping, that is a very, very good question. It's basically over the past 2 quarters, we've been releasing capacities from the 12-inch fab. So, currently, the capacity at -- the wafer capacity at the 12-inch fab is in total it's about 95,000 wafers. Okay.Currently, we're running at 75,000 to 80,000, okay, depending on the month. So, our goal is to get to 95,000. That's one thing. Certainly, the depreciation cost has been -- will be basically going up throughout this year, okay.And for the 12-inch fab, the depreciation cost, well, basically around -- probably around for the whole year, it is going to be about $380 million to $390 million, okay, for the year. And the 3-inch fab is going to be pretty stable. It's just going to be about $130 million for the year.So, the release of the capacity that certainly will increase -- cause the increase of the depreciation cost. At the same time, there are some pressures for certain technology platforms in particular for embedded and nonvolatile memory, and also power management IC. I think these 2 technology platforms are facing some pricing pressure.But you know what? We are still pretty confident. We give a range from $560 million to $600 million for Q3. And our goal is to do better even though we believe we are still in the sort of low point at this point. I think that the semiconductor market globally still has not fully recovered -- has not recovered, okay.We are hopeful things will start to do that in the second half of 2023. But the main reason for the declining margins is largely because of the ASP drop and also the additional increased depreciation costs.
Okay. Related question is that if you look at the presentation material, if you look at Page 9, that basically in second quarter, the nonvolatile memory and these -- the power discrete account for -- each account for 1/3 of your revenue. So how is the market demand is changing? What's the outlook, especially I think, you are doing very well in the MCU and the power discrete product line, not only in China, but globally. So what are the outlook for these 2 product lines? And what's the impact which translates to your ASP? If you can -- it would be very helpful to if you have more clear guidance on the ASP trend. I think your ASP decline -- if I calculated correctly, declined Q-on-Q 6% in second quarter, whether the decline will be larger in third quarter or not?
I mean, if you look at the -- I've talked about this with various investors recently, especially during our IPO process, during the road shows. I talked about overall the ASP drop is going to be somewhere -- for the year is going to be somewhere 3% to 5% percent. Else -- our ASP really hasn't changed that much for the first half, okay?But we did -- most of the ASP adjustment, we did was in end of last year in Q1, during end of last year in -- sometime in December in Q1 2023. So most of that would become – start to hit the P&L sometime in Q2 and Q3. So we expect overall the companies the ASP drop is going to be -- for the year is going to be anywhere between 3% to 5%. That is our anticipation, okay?So when you look at the Q3, the -- I think the power discrete will continue to be very strong, in particular for IGBT and super junction. Logic and RF, particularly RF will continue to be strong. And the logic and power management IC also will be strong. I think it's going to be a good quarter.But we got some pressure from the embedded nonvolatile memory area and also from the NOR flash products, okay? For these 2 segments, we see pricing pressure. At the same time, I think, the demand is also not as strong.
The question comes from the line of Randy Abrams from Credit Suisse.
Okay. Yes. I wanted to follow-up on that last question from Leping. Just for those areas under more correction, the embedded flash microcontrollers and also the NOR flash, could you, I guess, give some visibility or some feel where you think we are in the correction as far as do you expect it to extend a couple more quarters or see any signs of bottoming out in these areas?
I think we have been experiencing some, as I said, pressure and also just overall demand for these 2 areas -- from these 2 areas, embedded, particularly for smart cards and MCU. So demand for these 2 products at this point are, in general, it is low at this point.So I think just over the next quarter or so, I think, there is going to be a drop on revenue compared to Q2 and Q1. But I think hopefully this is going to be, I think, temporary, okay, temporary. And we are hoping that things will start to pick up and start somewhere in Q4 this year.And for standalone, for the NOR products, I think it is the same. I think it's the same, just in general, flash, whether it's embedded or NOR flash, I think the demand is slow. I think they're going through a correction stage. I think there's some inventories out there for these products, but things will --I think, will change. We expect things will change towards the end of the year. But other platforms will continue to be very, very strong.
Okay. And maybe 2 follow-ups to that. At this stage, do you think third quarter marks your low point, or we should still see the seasonality? And do you see any risk on the other areas that have actually held up, logic, IGBT, or that still looks to see good demand continuing in those areas?
Well, we're hoping that Q3, it is a low point, and things will start to recover in Q4. But at this point, we still have a good chance. We'll be able to do well in Q3. We give a range from $560 million to $600 million. We're looking at many different ways to make sure we can definitely hit the high end of that number at the range, and hopefully we can even exceed.So this is only a guidance at this point, if there's any change within the next few weeks or month, and I think we can definitely adjust that guidance.
Okay. If I could ask you, just on the cost side, depreciation, the level you're at in second half this year, are you fully depreciating the capacity you brought on for Wuxi, or would there be a further ramp-up from second half levels into next year? Just try to understand the headwinds into 2024.
Right, right. That's just a good question. Basically, I think at this point, we're looking at for Wuxi, we're looking at about $380 million to $390 million for depreciation costs for 2023. I think if we fully ramp it to 95k, I think the depreciation expenses will get up to $450 million, so there's another still $50 million, $60 million additional depreciation costs can add on to next year. So our plan is to run the fab at 95k fully for next year. If at that stage, I think the depreciation expense will get to about $450 million for the whole year.
Okay. And the last question, just to get to 95k, how do you feel the application mix will change, where now it's MCU and NOR, it looks like that's the gap, but as you target next year for application, is it recovery of these areas that have corrected, or how do you see mix evolving into next year?
I think, for the 95k, I think 1/3 would definitely go to power discrete, in particular IGBT and Super Junction, okay, and I would say at least, you know, I would say 40% will be shared, most of that will go to embedded non-volatile memory, MCU smart cards, and somewhere around 10% will go to NOR flash, but that also can potentially increase, grow -- continue to grow in the next few years, because, there's great demand for NOR.
Okay. And if you were to get back to that near the – oh, go ahead, sorry.
Yes. I mean, Randy, so, we're talking about 1/3 going to discrete, or maybe even slightly more than 1/3, I would say even we could get to like 40% going to discrete, and then maybe 30% between embedded and NOR, standalone NOR, and then the rest, another 20% to 30% would be anywhere between, the power management IC and RF.
Okay. And if you, how do you think about profitability, like, fully loaded as you ramp up 95k? If we get back to recovering utilization, fully depreciated, where do you think a reasonable gross margin, just after we've gone through a downturn with a bit lower pricing now?
Very good question. If we're in a fully recovered mode, I would say, we can, for the 3-inch fabs, we'll get to very close to 50% gross margin, 3-inch fabs, the 12-inch fab, our goal is to get to 30% gross margin, when the depreciation expense is still at its prime.
We will take our next question. Your next question comes from the line of Szeho Ng from China Renaissance.
Hi, gentlemen. Congratulations on the IPO. I have 2 questions. The first one regarding the proceeds that we got, right now we are sitting on a huge remedy process. Do we have any plan to pay down the U.S. dollar bank borrowing, because right now the – it's finance cost seems to be a bit on the high side?
Good question. The finance cost is high for the interest, especially, we're talking about the interest rate is high for borrowing the U.S. dollars. No, I mean, the money that we just raised, it's mainly going to be used to expand capacity. It's going to be most of that were used to build our next fab, okay. The money is pretty much all secured. The first phase, the 83,000 wafer, the next 83,000 wafer capacity, our first phase of our second fab will be around $6.7 billion. So the money is all committed, so it's fully prepared to move forward that project. And then the rest of the money we're going to be using for R&D and some, continue to improve our product mix for the 3-inch fabs.
I see, I see. And same question, in the IPO prospectus, the company actually mentioned the plan to acquire Huali, right, within 3 years after the IPO. So basically, what are the reasons behind and also why is the need to set a time frame?
That we, you know, during the IPO process, we made a commitment to the local stock exchange that we will acquire the fab within the next 3 years, just to make sure that there's no competing business between us and our brother company.
I see. So basically, we are going to acquire within 3 years, right?
Within the next three years.
Oh, okay. All right. Okay. All right.
[Operator Instructions] There seems to be no further questions at this time. I would like to hand back to Mr. Daniel Wang for closing remarks.
Again, thank you all for joining us today and asking all the meaningful questions. We hope you will join us again next quarter. Please continue to stay safe and healthy. Looking forward to meeting you in person in the near future. Thank you.
Ladies and gentlemen, thank you for your attendance. You may disconnect now.