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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 Fourth Quarter 2017 Earnings Conference Call. Today's call is hosted by Mr. William Wang, President and Executive Director; and Mr. Danny Wang, Executive Vice President and Chief Financial Officer. [Operator Instructions]
The earnings press release and fourth quarter 2017 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. William Wang, President and Executive Director. Thank you.
Good afternoon, everyone. Thank you for participating in our conference call. We ended the year on a very strong note. The fourth quarter performance was nothing, if not stellar. The USD 808.1 million revenues came from virtually all segments, especially bank card, ID card, super-junction IGBT and the power management ICs.
Gross margin and the net profit margin grew substantially over 2016, thanks to the commitment and engagement of all customers and employees. Once again, our company reconfirmed the success of our strategy and clearly demonstrated our relentless commitment to growth and profitability. As discussed in previous earnings releases, the consistent strong demand for the company's 8-inch wafer business far exceeds our capacity, leading to the need for substantially more capacity, a need that can be satisfied best with a new 12-inch fab. In addition, several of our customers also have requirements that can be met with 12-inch technologies, and potential new customers needing significantly 12-inch capacity wait in the wings.
For these reasons, we are going to establish a joint venture to build a 12-inch wafer fab in Wuxi, in conjunction with the National IC Fund and the Wuxi government. We are convinced that augmenting our 8-inch business with 12-inch production is the next best step, both to obtain needed capacity and to enable innovation down to 65 nanometers.
Our embedded nonvolatile memory, RF, power management and related IPs, just to name a few of our highly successful technologies, all can be transferred to and implemented on 12-inch equipment rapidly and with reasonable effort. In summary, our Wuxi project will provide the much needed capacity and technologies to fulfill the demand coming from all segments of our customer base, fixing our capacity bottleneck for the foreseeable future. Furthermore, and equally importantly, Wuxi will also enable a significant expansion of that customer base. Now I'd like to hand the call over to our CFO, Mr. Daniel Wang for his comments.
Thank you, William. Hi, everyone. Thank you for joining us today. I will begin with the summary of our financial performance for the fourth quarter and the recap of the whole year 2017, followed by our revenue and the margin for the first quarter 2018. And we will then move on to the question-and-answer session. First, let me summarize financial performance as of the first -- fourth quarter. Revenue was $216.9 million, 3.3% over 3Q 2017 and 11.8% higher than Q4 2016. Cost of sales was $143.8 million, 5.8% higher than 3Q 2017, primarily due to increased wafer shipments, and 7.4% above 4Q 2016, mainly due to increased wafer shipments and depreciation expenses.
Gross margin was 33.7%, 1.5 percentage points lower than 3Q 2017, primarily due to an accrual of year-end bonus, and 2.7 percentage points above 4Q 2016, largely due to the improved average selling price and product mix, partially offset by increased depreciation expenses.
Operating expenses were $36.8 million, 25.4% over Q3 2017, primarily due to: one, the accrual of year-end bonus; and two, impairment provision for certain tools, and 23.7% above Q4 2016, mainly due to increased labor, R&D expenses and a foreign exchange impact as a result of RMB appreciation.
Our income net was $12.2 million, 174.9% higher than Q3 2017, primarily due to increased share of profits from an associate, and 15.5% lower than Q4 2016, mainly due to a foreign exchange loss, partially offset by increased share of profits from an associate. Income tax expense decreased to $7 million, 48.8% lower than Q3 2017, primarily due to an end-of-year adjustment of income tax deductibles.
Profit for the period was $41.5 million, 17.4% over Q3 2017 and 8.7% above Q4 2016. Net profit margin was 19.1%, 2.3 percentage points over Q3 2017 and 0.6 percentage point lower than Q4 2016.
Earnings per share was $0.04, up by $0.01 from Q3 2017 and flat to Q4 2016. Annualized return on equity was 10%, 1.2 percentage points better than Q3 2017. Now let me provide you with more details on our revenues from Q4 2017. From a geographical perspective, revenue from China reached $122.4 million, contributing 56.3% of our total revenue and an increase of 5% compared to Q3 2017, chiefly driven by increased demand for smart card IC.
Revenue from the United States was $41.1 million, an increase of 8.6% compared to Q3 2017, predominantly due to increased demand for MCU and super-junction products, partially offset by decreased demand for logic products.
Revenue from Asia was $22.2 million, a decrease of 15.4% compared to Q3 2017, principally due to decreased demand for logic and the general MOSFET products.
Revenue from Europe was $15.6 million, an increase of 6.9% compared to Q3 2017, primarily due to increased demand for general MOSFET products.
Revenue from Japan was $15.5 million, an increase of 6.1% compared to Q3 2017, largely due to increased demand for MCU, flash, super junction, other power management IC products, partially offset by decreased demand for logic products. With respect to technology platform, revenue from embedded nonvolatile memory was $85.9 million, an increase of 13.3% compared to Q3 2017, largely due to increased demand for smart card IC and MCU.
Revenue from discrete was $62.3 million, an increase of 7.7% compared to Q3 2017, primarily due to increased demand for super junction and general MOSFET products.
Revenue from analog and power management IC was $40.6 million, an increase of 2% compared to 3Q 2017, primarily driven by increased demand for other power management IC products.
Revenue from logic and radio frequency was $19.2 million, a decrease of 32.6 million percent -- 32.6%, excuse me, compared to Q3 2017, primarily due to decreased demand for logic products.
Revenue from standalone nonvolatile memory was $8.3 million, up by 9.6% compared to Q3 2017, principally due to increased demand for flash products. Now let us take a look at the cash flow statement. Net cash flows generated by operating activities were $88.3 million, up by 17.1% quarter-over-quarter, mainly due to increased government subsidies and decreased payroll and utility payments.
Capital expenditures were $17.8 million in Q4 2017 compared to $33.8 million in Q3 2017.
Other net cash generated from investment activities was [ $56.34 million ] (sic) [ $38.7 million], including payout of $54.6 million from the investment in time deposits and $1.8 million of interest income.
Net cash flows generated by financing activities were $200,000, including $2.8 million of proceeds from share option exercise, partially offset by: one, $2 million repayment of bank borrowings; and two, $600,000 payment of interest expenses. Let's move to the balance sheet. Cash and cash equivalents increased to $374.9 million on December 31, 2017, compared to $243.9 million on September 30, 2017. Restricted and time deposits decreased from $246.9 million on September 30, 2017 to $193.5 million on December 30, 2017, primarily due to payout of $54.6 million from investment in time deposits.
Property, plants and equipment decreased from $737.7 million as of September 30, 2017 to $733.5 million as of December 31, 2017. Total assets increased from $1,989,900,000 on September 30, 2017 to $2,078,300,000 on December 31, 2017.
Our total bank borrowings decreased to $92.9 million on December 31, 2017, from $94.3 million on September 30, 2017, primarily due to $2 million repayment of bank borrowings. Total liabilities increased to $383.1 million on December 31, 2017, from $365.6 million on September 30, 2017, primarily due to increased other accounts payables and income tax payables. Debt ratio increased to 18.4% on December 30, 2017, flat compared to the previous quarter. Now I would like to give you a recap of our performance for the entire year of 2017. Revenue was $808.1 million, an increase of 12% over 2016. Gross margin was 33.1%, 2.6 percentage points over 2016, primarily due to improved average selling price and product mix, partially offset by increased depreciation expenses.
Operating expenses were $115.9 million, 11.2% over 2016, primarily due to increased labor, R&D expenses and a foreign exchange impact as a result of RMB appreciation. Other income net was 12 -- $21.2 million, 43.2% lower than 2016, largely due to a foreign exchange loss versus a gain in 2016.
Income tax expenses was $27.2 million, an increase of 10.5% over 2016, primarily due to increased taxable profit. Net profit reached $145.3 million, an increase of 12.8% over 2016. Earnings per share was $0.14, up by $0.02 over 2016. ROE, return on equity, was 9.1%, 0.5 percentage points higher than 2016. Finally, let me give you a very top-level outlook for the first quarter 2016 (sic) [ 2018]. We expect revenue to be between $209 million and $210 million and gross margins to be approximately 30%. The slight decrease in revenue quarter-over-quarter is due to seasonality and annual maintenance of our 2 fabs. On a year-over-year basis, revenue is expected to grow 14% to 15%.
We also plan to declare a dividend for the accounting year 2017 during the Annual General Meeting in May 2018, in accordance with the company's dividend policy, i.e., the average dividends paid in 3 consecutive years will be no less than 30% of the average distributable net profit of these 3 years. This concludes my financial remarks. Now I would like to open up the call for question and answer. Operator, please assist. Thank you.
[Operator Instructions] We have our first question from the line of Randy Abrams from Crédit Suisse.
The first question, I wanted to ask on the gross margin guidance for 30%. Just how much was from the, like, annual maintenance, like, fewer working days, like, low season? And then if there were any other factors for the decline back to 30%?
Randy, it's -- well, it is -- first of all, I mean, it's the seasonality, again. Then secondly, it's the maintenance. And the third thing is the depreciation expense has also gone up a little bit. Royalty going up a little bit. So these are the major reasons. But we expect we should be able to go back to the regular level, meaning our normal level in the following quarters.
Okay. I mean, it's -- I guess, the 2 follow-ups, is the normal -- because the last few quarters have been pretty strong. Is the new normal level, I guess, for 8-inch, is it kind of back to what we achieved -- what you achieved, where it was, like, 33%, 34% the last few quarters? And if you could give, I guess, a view on both the CapEx and depreciation for 2018? And how much, I guess, within that CapEx, if there's any, for the new fab?
Yes -- I mean, no. Let's just talk about CapEx for this year. It will be around $100 million on the -- for the 3 -- the aged facility, okay? Facilities. So it will be around $100 million. We'll continue to expand within the space that we still have. I think we can still generate some capacity there, in particular, Fab3. So we plan to do that. We'll continue to do that. What's the other question? Depreciation expenses?
Yes. Depreciation, and then, I guess, what you kind of consider normal if it's -- if the new norm is like 33% to 35%, like that might be where we can come back to?
Yes. Absolutely. That's the plan. I mean, it's where -- overall, I think, the depreciation expense for the year, it will be up. It's going to be $124 million. That's the expectation. Last year, what the actual was $104 million.
Okay. Great. Okay. And...
We're continuing to be very positive. It's going to be a strong year for us.
Okay. Good. On those notes, there has been strong kind of pricing, both, I think, from mix improvement and you've been able to lift pricing a little bit. The -- in fourth quarter, it looked like the pricing, just based on shipments, was flat to down a little bit. And I don't know if there was a mix change. But if you could give an outlook kind of what you're seeing on the pricing, like, if you get more from mix or like-for-like pricing in 2018?
So Randy, so actually, we continue to improve our -- the price situation by more new products and new technology released to our customer. Especially, we emphasis on our differential technology on nonvolatile memory and power discretes. That's what we do.
Yes, Randy -- I mean, look, we continue to expect growth throughout this year. The combination of -- we continue to expect a combination of price improvement and, even further, product mix improvement.
Okay. Great. And the last question just on the OpEx. If -- maybe an expectation because there was some bonus and tool impairment, like the baseline OpEx going forward? And there was also the $8 million profit from associate, if that's kind of a onetime profit? Or you might start to achieve -- like get more? If you could talk about what you're getting from the associate income?
Oh, yes. That's basically -- it's -- I would say that's kind of a one -- considered to be onetime. It's basically from the investment valuation base. That came from investment valuation, real estate investment valuation.
Okay. And then -- and I guess, the basic OpEx where -- like it went up for the tool impairment and bonus accrual if, like, first quarter, if it should go back to third quarter levels? Or you expect to increase, spending some?
Yes. Normally, we would do a year-end bonus accrual in the fourth quarter, okay? And that we expect first quarter to third quarter will be at last year's level with some slight adjustment, for example, on the annual adjustment.
Our next question is coming from the line of Donald Lu from Goldman Sachs.
All right. [Foreign Language] My first question is on depreciation. Just to confirm, you said, Daniel, it will be $124 million in 2018?
That's the expectation. Yes, that is the plan, $124 million. So it's up by $20 million compared to last year.
Got it. What about the guidance for...
Sorry?
Oh, sorry. What is the guidance for CapEx? And also for the government subsidies of this year?
The CapEx for this year, 2018, is -- I just said, it's around $100 million, okay? Part of that is going to be -- it's going to be maintenance. And a part of that will be the capital expenditures, okay? And the government grants, I would just -- the ballpark number is going to be somewhere 10 -- for your model, it would be $10 million to $15 million.
And that $100 million is for your existing fab, and the one in Wuxi, it's -- would that be on your balance sheet, the CapEx, et cetera? Would you consolidate that?
Absolutely. We'll do that. Yes. But next year, we're going to be -- basically start the construction for 2018. Basically, we're going to start the construction for 2018.
What would be the CapEx there? Will that be included in the $100 million?
No, no, no. That's separate. The $100 million is just for the 8-inch facilities, okay, for that 3 fab production.
And Donald, so we will have a general meeting on the 14th this month. After this meeting and approved, so more detailed information will be reconfirmed and disclosed to you all. And the next -- maybe next quarter, it should be more clear.
Yes. I mean, everything is going well, according to the plan with the new joint venture, okay? We're having the shareholder meeting on the 14th.
Got it. My last question is that your next-door neighbor have said today at their -- at its conference call that there is a severe pricing erosion, not only at 8-inch -- at its 8-inch fab. And -- but since, like, yours are holding up really well, what is the reason?
Donald, so I guess, I have not read the latest -- their earnings report. But as we said, I mean, we -- I have said earlier and I'd like to reiterate, we feel it's going to be -- continue to be a very strong year for us, okay? We will -- we expect we'll continue to -- we'll have growth this year on our top line, okay? And it's going to -- where there'll be some new capacity from the -- from our 8-inch fabs. And so the growth will come from both: one is the ASP improvement; and secondly, it would be the product mix improvement.
Yes. Donald, I have some comments. I also didn't read any news from the neighbor today, but I have to focus on my strategy. Again, as we promised 3.5 years before IPO roadmap -- IPO roadshow, so we'll focus on our 8-inch differentiated technology. And this kind of strategy already demonstrated from our financial data in the last year and this last quarter, I think more thanks to our long-term strategic customer and also our employees' contribution. So we hope this kind of strategy can be demonstrate more stronger data in the coming months or quarters.
Sure. Yes. You are -- definitely, we see that difference in the results.
Thank you, Donald.
Our next question is coming from the line of Ning Ding from CICC.
My first question is about your new Wuxi fab. Can you elaborate more on the capacity and the yield ramp up plan from 2019? And also, when do you expect that the new fab will contribute any positive earnings to your net profit?
Ning, as I said earlier, we're getting the final approval. We will have a shareholder meeting next week, on the 14th. And when that is over, then we will definitely share with you -- with more information on that.
Okay, okay. Sure. And then my second question, about the competitive landscape in 8-inch fab. And you just mentioned that you are about to increase 8-inch price this year maybe. And can you give us more color on the price uplift, like how much is due to the upstream raw wafer cost increase? And how much is about your plan to raise the price?
Well, we surely -- yes. There has been some increase on raw materials. That is the fact, okay? But we expect that part of the cost will be absorbed by our customers.
Okay. So I have to say something. No, we are not generally increase the ASP for all products. So we absorbed the most of the cost increase last year, and then we also absorbed mostly this year. But we found that some technology contribution from last year from our technology team and with our customers' support, we generated more value-added margin to our customer. And frankly speaking, we just share this kind of new margin with our customer, by the way, to increase some product price. I'm sorry, I cannot, one by one, to state it, but our customers support our strategy because it can get more value added for their products in the end, in that market.
[Operator Instructions] There are no further questions at this time. I would now like to hand back the conference to Mr. Daniel Wang for closing remarks.
Well, thank you very much for joining us today. We hope you will join us again next quarter. We wish you have a very good -- very, very good day. Thank you very much.
Ladies and gentlemen, thank you for your attendance. You may now all disconnect.