AAC Technologies Holdings Inc. (2018) Earnings Call Transcript & Summary

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[Audio Gap] in our leadership position as well as investing in new businesses to capture new market opportunities. During this period, we have continued the organizational transformation project, focusing on enhancing our organizational structure and improving operational efficiency. Going forward, we strive to establish a more efficient and agile structure to achieve our mission and to establish a solid foundation for long-term sustainable growth. For the second quarter, healthy improvements have been shown across all 4 business segments, and all segment revenues reported year-on-year growth. Optics business continued its fast growth trend. Revenue grew significantly by 43.1% year-on-year to RMB 380 million, accounting for about 9% of the group's total revenue, up from 7% in Q1. Gross margin continued to increase to 13.8% on the back of improved ASP and yield. Acoustics business showed a strong recovery in Q2, with revenue up by 34.2% Q-on-Q and 7.9% year-on-year, respectively, to RMB 1.91 billion. Acoustics segment blended ASP in Q2 maintained a year-on-year growth with a healthy gross margin of 26.4%. For Electromagnetic Drives and Precision Mechanics business, the Q2 combined revenue has increased by 11.4% year-on-year on the back of shipment volume growth, with blended gross margin stood at 22.8%. Haptics business continued its solid growth trend in shipment volume, with penetration rate increase further into mid- and lower-tier smartphone markets. For Precision Mechanics business, gross margin improved compared to Q1 on the back of higher capacity utilization rates. MEMS segment revenue grew by 14.5% to RMB 259 million, with a healthy growth in shipment volumes. During Q2, net operating cash inflow amounted to RMB 1.46 billion with CapEx of RMB 2.32 billion. Out of the total CapEx, 70% of our production equipment and around 50% of which are for optics business. Net gearing stood at a healthy level of 10.4%, with a cash position of RMB 5.09 billion as at end of June. The Board of Directors have declared an interim dividend of HKD 0.10 per share to be paid in cash on 25th September. Amid the uncertain global economic outlook, the group will remain prudent in financial management and strong in cash position to continue investing in technology road map across various business segments so as to create long-term value for our shareholders. Next, we will look at the performance for each business segment. During Q2 2020, revenue from optics business grew significantly by 55.4% Q-on-Q and 43.1% year-on-year, respectively, to RMB 380 million, and gross margin further increased to 13.8% from 9.8% in the previous quarter, demonstrating our improved profitability. For the first half of 2020, optics revenue grew close to 50% to RMB 625 million. As shown in the graph, both ASP and shipment volume have exhibited remarkable increase due to improved capacity utilization rate and higher percentage of high-spec plastic lens in the overall product portfolio. In Q2, shipment volume and ASP of plastic lens has increased to 102 million units and RMB 3.74, respectively, resulting in a higher gross margin. We are making good progress to improve our gross margin with certain projects achieving higher than 35% gross margin currently. With a speculated approach utilizing simulation and data modeling, we're confident to improve production efficiency and yield in order to bring the gross margin of our projects to be best in line in the industry over time. Steady progress has been made in new product development, including tele-zoom, wide-angle, small head, main camera and ToF. Our proprietary WLG hybrid lens exhibiting the superior optical performance in light intake and image resolution has been considered by the market to be one of the major future directions in optics upgrade. Compared to plastic lens with the same number of lenses, our hybrid lens could reduce the thickness by 10%, increase light intake by 15% and increase resolution by 5.8 -- 5% to 8%. We're proactively promoting our WLG hybrid lens products. There are 2 main approaches. First is a platform approach to provide fully compatible products for replacing traditional plastic lens. We target to have shipment in the second half of this year. The second approach is to produce customized hybrid lens with high specs and high resolution, targeting to complete specification by this year with mass production next year. We're making steady progress in WLG lens production and target to produce 30 million pieces of WLG glass lens for 2020. Camera module business, as a strategic business position for us, is important to promote optic lens business and provide a holistic optical solution to our customers with vertical integration of lens, modules and algorithm going forward. Acoustics segment exhibited a considerable recovery in Q2. Q2 revenue from acoustics business significantly increased to 34.2% Q-on-Q and 7.9% year-on-year, respectively, to RMB 1.91 billion. Our acoustics blended ASP maintained a year-on-year growth due to changes in product portfolio. Q2 gross margin of acoustics business remained at a healthy level of 26.4%, demonstrating a stable profitability. Overall, due to the adverse impact from Q1, in the first half of 2020, revenue and gross profit margin declined by 8.7% and 3.8 percentage points year-on-year to RMB 3.33 billion and 26.3%, respectively. Stereo acoustic has been widely adopted by high-tier models this year, with further penetration expected to take place to mid- and low-tier models next year. This will allow stereo acoustics to become a new standard feature for smartphones and provide greater market opportunities to our acoustics segment. The penetration of SLS platform in terms of our total shipment volume of Android models has maintained at a high level of 70%. With a higher proportion of classical SLS version in total shipment volume, we expect ASP for Android acoustic products to stabilize. The upgraded classical SLS speaker box with diaphragm vibration amplitude of plus/minus 0.75 millimeters is scheduled for mass production and begin shipments by second half of 2020. As a global leader in miniaturized acoustics technology, we will continue to invest in our proprietary SLS product platform and bring advanced acoustic experience to end consumers. During Q2 2020, the combined revenue from Electromagnetic Drives and Precision Mechanics segment has increased by 11.4% year-on-year. Meanwhile, the blended gross margin lowered by 4.1 percentage points to 22.8% due to higher sales contribution from Precision Mechanics changing the revenue breakdown of this segment. For the first half of 2020, the revenue of this combined segment increased 9.7% year-on-year to RMB 3.42 billion, whereas blended margin declined by 6.3 percentage points to 23.2%. Our x-axis haptic motors have been widely adopted by Android flagship models and penetrated further into mid- and low-tier smartphone markets. We see positive growth momentum in Android haptic market, as traditional motors and z-axis haptics are being replaced by our x-axis haptic motors over time. At the same time, the gross margin of Android haptics has shown healthy increase on the back of improved production efficiency and scale. The group will gradually develop vertical integration capabilities to combine software and hardware solutions so as to provide consumers with better user experiences. Precision Mechanics business has been playing a strategic role to help the group better understand the smartphone upgrade trend. In Q2, our Precision Mechanics business showed a sequential recovery compared to the previous quarter. Higher proportion of 5G smartphone metal casing projects further enhanced the shipment volume and ASP. Gross margin of the segment has improved compared to Q1. We have been ranked as the preferred supplier for our major Android customer, and we're proactively expanding our customer base. We will also adjust the production capacity flexibly according to the market demand. Going forward, we will strive to outperform the first-tier peers to ensure satisfactory profitability for this segment on the back of improved capacity utilization rate and expanded customer base. During Q2, revenue from MEMS components grew steadily by 14.5% year-on-year. For the first half 2020, revenue increased 20.4% to RMB 460 million whereas gross margin declined by 7.3 percentage points to 16.2%. The strong demand from MEMS microphones was fueled by the improvement of intelligent speech interaction in the past 2 years, increasing the number of MEMS microphones installed per handset, alongside the popularity of wearable and smart home appliances, also helped to boost market expansion of the segment. Our high-end miniaturized microphone product with high signal-to-noise ratio and low energy consumption has gradually been adopted by laptop markets. To satisfy the market demand, we plan to expand our production capacity and increase our market share. We will also increase the proportion of in-house production of MEMS chip to further lower our production costs and improve gross margins. On sustainability and ESG, we have published our seventh sustainability report in May. We will continue to strive for best practice for ESG in the industry. We established sustainability working group, which reports to the Board on a regular basis. This helped to strengthen our governance structure to ensure continuous effort from the Board level all the way to each level of the company, paving the way for realizing our ESG strategy and achieving sustainability growth. We aim to achieve best practices on ESG, which are highly recommended in the hardware industry. Our disclosure adheres to the top international standards. We have been part of the 30 constituent stocks of the Hang Seng Corporate Sustainability Index for several consecutive years. In addition, we have been included as a constituent of the FTSE4Good Index Series, which demonstrates broad recognition of the group's commitment to corporate social responsibilities. This conclude the overview of our second quarter results. There are more supplementary information in the appendix section of the PPT for your reference. And our management, Mr. Pan and Richard are both here to answer your questions. Thank you.

[Operator Instructions] Our first question comes from the line of Leping Huang from CICC.

I have 2 questions. So the first question is about the MEMS business. So I remember in previous quarter you mentioned that you target 100 million units per MEMS shipment maybe by end of June or early July. Do you have any visibility on -- now on the shipping volume in third quarter? And based on that, so what's our view if you can reach higher volume? What's the profitability? What's the gross margin you reached, especially -- I think you mentioned that you reached 68 million MEMS shipment volume in June already. What's the gross margin in June?

[Foreign Language]

Thank you for that question, Leping. When we look -- when we talk about optics sales revenue and when we look at the sales we made to specific customer, we have to acknowledge that it's actually what we call a platform production approach, i.e., when we produced from our factory, the production lines can churn out the final products to different individual customers. Hence, for us, it's much more meaningful and relevant to look at what we call production statistics, i.e., production yields or what we call production gross margins. Basically, in second quarter and for the rest of the year, the direction and what we have achieved have not differed to what we have set out from the previous quarters or from the beginning of the year. For the second quarter, when I looked at -- when the CEO looked at the internal production gross margin number for the second quarter, we have achieved gross margins of 25.9% gross margins in terms of production gross margins. And the latest production gross margin for the month of July, for the past month, we have actually achieved 31% already, 3-1 percent. When we looked at shipment targets and plans by end of third quarter, I think, in the earlier targets, we have set out 100 million per month, I think we are not far from that. I think between the third and the fourth quarter, we are going to deliver something in between 80 million to 90 million per month. And we're -- bearing in mind the production gross margin we already have achieved for July, we think the gross margins of 40% by that time of 80 million to 90 million something, 40% is highly achievable. More information about what we are thinking for the rest of the year when we enhance our product portfolio. We believe a realistic range for our AAC sales of optic products will range from ASP [ RMB $4 to RMB $4.50 ]. Possibly, that is a strategy of stabilizing a high production gross margin production yield and enhancement of costing. We strongly believe that by the year 2021, next year, we could see a longer-term target of 50% gross margin in this optics business. So there is no change in terms of what we have set out in the earlier kind of discussion of our business.

[Foreign Language]

Please continue.

[Foreign Language]

As we have said earlier on in previous calls, we aimed to build up the hybrid lens momentum this year. In terms of stock building for WLG, the glass lenses, as of today, we have already built 2 million in stock already. And I think before we have target for -- by the end of the year, something 30 million, 3-0 million. I think we are not -- again, we are not far, but maybe we turn up a little bit short from that, something around 20 million by end of the year, but that would not affect the progress of the market adoption. Generally, as we have said before, there are 2 different paths that we are promoting, the hybrid lens and WLG. The more -- I think the more closer to what we will see is the replacement or adoption of hybrid lens in terms of delivering a 64 million resolution pixel design, in -- similar to plastic lens, we believe it's a platform approach, whereby I think we can achieve mass production of products of something like 100 million, but we can handle different many projects from different individual customers, covering maybe 48 or 64 resolution design, whereby I think the WLG has a very strong competitive pricing. As we have said before, we do not aim to price out or price too much higher than the pure plastic lens designs. We expect something like [ RMB $5 ]. And in terms of 48 resolution periscope design, around not more than, I think, USD 1.50 is what we are expecting to see. But more importantly, I think we are seeing the glass lens costing definitely have a very strong advantage. In terms of comparing to the other traditional GMO process, we believe the glass lens can deliver something like 1/3 of the GMO glass lenses. So this is the platform approach. On top of that, we definitely are also working on and developing and promoting to different customers on higher-spec hybrid lens design, 7P, the periscope, et cetera. Again, our time line is not changed. I think, overall, we would see a couple of projects in mass production before the end of the year.

[Foreign Language]

We are confident and we are well prepared not only for the business side of what we just talked about, but more importantly, and as we have mentioned in the past, we have facilities in Denmark and Czech Republic. We have already have 120, 1-2-0, direct, what we describe as, professional precision technicians, and some of them are classified as professional engineers. But these direct technicians, precision professionals have been receiving our training already in the past few months already. This expertise is not about paying them salaries, but it really is about investing in training, enhancing their know-how and putting the efficiency into the preparation of the tooling production lines. In terms of financial investment, I think we only estimated something like 40, 4-0, CNY 40 million has been spent already, of which 15, 1-5, CNY 15 million directly related to the technicians salary cost. This cost is something that we believe actually is not only in terms of financial barriers...

[Foreign Language]

The CNY 15 million includes the R&D people who work in the WLG.

[Foreign Language]

The R&D and the production and the precision technicians that I described are included in the CNY 15 million, 1-5 million, cost that CEO just described. So more importantly, this is -- we believe, through the training, through the tiny investment that we have already invested and the logistics setup, we are well established in terms of the preparations for the required tooling to deliver the mass production backup to support the onslaught of the hybrid lens business.

May I take the next question? The next question comes from the line of Kyna Wong of Crédit Suisse.

[Foreign Language]

[Foreign Language]

The cycle of a rolling inventory is a typical arrangement for business to match production to the sales plan or forecast from customer. We believe an average of maybe -- when we talk about the production, we prepare a forward-looking sales plan. Maybe we're talking about a time gap of 1 to 1.5 months. So generally, I think we can work on the basis that the sales performance kind of lags behind production by 1.5 months to reflect the rolling inventory that keeps in the company. But more importantly, I think we need to focus on the -- what we call a stabilized achieved efficiency in terms of yield, in terms of tooling...

[Foreign Language]

I think we need to focus on the stabilized yield -- production yield and the arrangements for tooling. And from that, we can definitely perform fine-tuning enhancement to the base, whereby we use, as we have mentioned before, data simulation to continue to improve. Hence, I think the focus here is to establish a sustained, stabilized, high efficiency on a certain mass volume plan and turn that into what we call 1.5 months later of sales performance. [Foreign Language]

[Foreign Language]

We are quite positive that the CapEx required or incurred -- or to be incurred in the second half is going to be less than the first half amount. Mostly, we are focusing on the optics business, whereby we are looking at developments and preparations for plastic lens and some for hybrid lens and, thirdly, for the module, camera module business. In terms of the preparation for 90 million to 100 million a month plastic lens, as we have said before, most of the major equipment have already been in place. I think we are left with adding some, what we call, mold-forming machines. [Foreign Language] These are the final kind of adding to the capacity, which I think, by that, we can look at -- by the end of -- later this year, maybe some more additional capacity to take capacity beyond the 120 million to 140 million per month. But mostly, I think we also want to make sure that the portion of hybrid lens of shipments are increasing and hence making use of the hybrid lens, the increasing of the molding machinery for WLG glass lenses. Finally, the module production lines, as we have said before, we have 10 lines already in place, delivering 8 million per month capacity. But whether -- I think by the end of the year when we have us -- assessing customers' project development, I think by that time we will make some more judgment whether we are to add another 5 to 10 lines.

I will now move on to the next question from [ Yang Lingxiu of Citic Securities ].

[Foreign Language]

[Foreign Language]

I think it's only realistic that the inventory cycle kind of behaves to the implementation as we grow the business. I think, at the moment, when we describe 1.5 months, I don't think we have reached that kind of duration yet. Maybe at the moment, it's slightly more than a month. We anticipate the largest kind of duration is 1.5 months. I think clearly, as we see the cycle possibly peaks or climax by Chinese New Year next year, thereby, I think from then on we will work to reduce that cycle lag period to around 3 weeks. But certainly, we have to bear in mind we need to look at the market demand and the time to set up kind of match the market demand to AAC shipments capability because the shipment of plastic lens is not a very, very flexible, very kind of quick setup in terms of -- for example, when we looked at the operators that are responsible for the escalated gross margins that we have delivered, we are looking at the same kind of laborers or the number of optics operators, workers that we have since November last year. So it does take investment in terms of training your teams of people, setting up the -- our own kind of production lines as well. So I think it, realistically speaking, at the moment is a month and a little bit more, but the maximum is 1.5 months, but the longer term is to reduce that to something like 3 weeks but -- and we will pay attention to the market demand.

[Foreign Language]

To talk about -- obviously, we briefly talked about the CapEx outlook for optics business in the previous question. I think the reduction of holding inventory and the review of market demand has a lot of relevance when we look at the incremental extra CapEx required. And hence, as we have said just a while ago, we don't anticipate any big significant CapEx on the plastic lens. But then, again, I think we are already in talks and in discussions with customers outside the smartphone industry in terms of these droids, devices, automobiles. We believe these projects are of interest not only to these potential customers but also to verify our WLG capability and our optic capability as well. I think we also described, and we are very, very confident that the WLG capability, the design process and the production process has a marked advantage in terms of comparing to the traditional GMO process. Also, in terms of new momentum in the new sector, we have several joint ventures ongoing. So all these are in progress, and we believe the optics business is a good start at this moment, but we have not neglect the capability of its strength in terms of user experience in the other markets.

We'll now move on to the next question from Susanna Chui of DBS.

I have 2 questions. The first question would be, I would like to update the product mix. May we know the 6P shipment contribution in the second quarter and 15% to 20% contribution by the end of 2020 is still on the track? And may we also know how -- about the 7P target shipment in Q2 as well? And my second question is actually about competitive landscape. Because your peers, largest peers, saw the slow smartphone camera spec upgrade in first half, so how you view the optic spec upgrade outlook in second half or -- and also 2021? And do you think that AAC could take advantages of the slow upgrade? That's all for my questions.

[Foreign Language]

At the moment, we are developing and progressing well with 6P. But at this moment, product mix-wise, 6P is not a major percentage. Our ASP at the moment, CNY 3.75, I think, slightly falls short of our competitors. But at this moment, we see -- we're already seeing orders and shipment request for 6P up to 5 million per month in the third quarter, going up to 7 million by fourth quarter, thereby enhancing the overall product mix and increasing the blended ASP. But more importantly, although as we have said previously, we expect 1 million shipment of 7P projects, we still prefer to focus and promote the alternate hybrid lens design in terms of 6P. I think the differentiation of hybrid lens is very clear in terms of its user experience proposition for different customers. And with that, we believe that, I think, going forward next year, the continued enhancement of the product mix will more be able to deliver a higher kind of 6P plus hybrid lens 6P projects.

In the interest of time, I'll now take the last questions from Fang He from HSBC.

[Foreign Language]

[Foreign Language]

The 20 million that we talked about earlier in the call, we are referring to a total output. We don't, by any means, we are quoting a shipment number. What is important is here, as we have said, the hybrid lens based on the WLG is more like a platform approach, whereby we believe cellphone customers are already expressing interest and could be satisfied with 1 to 2 platforms, i.e., the capacity of -- the capability of building up a mass production of not only in terms of a stabilized monthly production output, but also in terms of making sure these are -- go through the production verification by our customers. It's also very important. Hence, we don't mean 20 million by the end of -- shipment number to the customers. But more importantly, we have already said that we have already achieved 2 million per month capacity, and we are expanding that by October. The new facility, a 4-inch facility in Chongqing. I think it's going to be online in October time, thereby increasing well substantial amounts to more than the 2 million per month as of today. So it's a capability that our customer, not only through the adoption of hybrid lens design, but also a verification of AAC preparations in terms of capacity, readiness and also the building up of inventory. Hence, we talked about 20 million as an important number, but by no means we need a shipment target before the end of the year. Let us clarify that point.

[Foreign Language]

VCM.

[Foreign Language]

The -- both VCM, we are already in the process of qualification with our customers. We expect the time line maybe 12 months that we will see projects shipments and customers' projects actively involving of AAC design of these VCMs.

[Foreign Language]

We'd like to -- I'd like to -- sorry, I apologize for the translation error. I think by Q1, Q2 next year, we will see the VCM design come out. I think we have answered -- we have taken the last question. If I may, I would ask, I think, our CEO, Mr. Pan, who would like to give a few concluding remarks before we end the call today. [Foreign Language]

[Foreign Language]

CEO wants to conclude on -- give conclusions on the recent development, not only on what we have discussed in lens about optics but also on acoustics. In optics, I think we have plenty of questions and answers. We believe the development not only give us to deliver the momentum in rising sales revenue, but also the continued uptrend, deliver a better -- betterment of gross margins in terms of plastic lens and coming online the hybrid lens project. And also, lastly but not the least, we talked about the time line of AAC proprietary VCMs coming to the market, shipment stage in Q1, Q2 next year. I think those are quite certain that we are going to deliver. In acoustic, I think we did not talk much about our acoustics at all during this call. But for those who are familiar with our acoustic development, I think some 7, 8 years ago, we already see quite a significant upturn and kind of deliver of our strong -- strength not only in design but working with different customers that we gradually conquer the market on transition from what we call single speaker design to a speaker box design some 7 and 8 years ago, whereby -- I think we are at a stage whereby we are seeing many of our Android customers coming to the market. We are working with them on many kind of different smaller projects that leads to a fragmentation of design, whereby kind of impacting the gross margins that we used to deliver in speaker box projects. But we are pleased to hear the feedback on the recent kind of our sales and design migration to actuate what we call an integrated speaker box design, whereby we believe, through our automation projects and through our continued research and implementation of new material, we will be able to pass on some of the latest innovative design in terms of savings, kind of making the speaker box smaller and smaller, but cling that on a what we call a game platform approach without -- not at the expense of the acoustics performance. And we've -- I'd add that -- and already at this stage, most of our Android customers are very positive in responding to this, what we call, minimalization design of integrated speaker box. We are very confident that this will be a very good opportunity for us to deliver better and better kind of road map but also better and better enhanced financial performance in terms of margins as well. I think that on this stage we believe as quick as, I think, later this year and maybe early next year, the integrated minimized design speaker box will conquer or take something like 20% to 30%, what we call, penetration rate. And clearly, the long-term target is to see something like 70% to 80% penetration. We believe this is a very strong opportunity for AAC to deliver solid and good gross margins like what we have already done so some 7 to 8 years ago when we launched the speaker box design. I think that's the 2 major conclusions that CEO wants to kind of emphasize. But at this point in time, I'd like to thank all the shareholders and investors for their interest for this Q2 interim results call. I think our IR team will get to work this week, and we will talk more about the different business segments that all of us are interested in. [Foreign Language]

[Foreign Language]

[Foreign Language] Thank you.

Thank you for your participation. And this concludes today's conference. You may go ahead and disconnect.