Hua Hong Grace Semiconductor Limited (1347) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to Hua Hong Semiconductor's Second Quarter 2021 Earnings Conference Call. Today's 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 2021 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, and thank you all for joining our second quarter 2021 earnings conference. Today, we will first have Mr. Junjun 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. I will now turn the call over to Mr. Tang.

[Foreign Language]

[Interpreted] Good afternoon, everyone. Thank you for joining our earnings call.

[Foreign Language]

[Interpreted] The second quarter of 2021 was another record-breaking quarter for Hua Hong Semiconductor with an unprecedented quarterly revenue of USD 346.1 billion, an increase of 53.6% year-on-year and 13.5% quarter-on-quarter. Both sales volume and unit prices improved significantly benefiting from growing demand on the domestic market. Market demand for MCU, RF, PMIC, NOR and super junction is maintaining its strong momentum, which provides a solid foundation for stable growth.

[Foreign Language]

[Interpreted] In the second quarter, the combined gross margin of the company's 8-inch business and 12-inch business was 24.8%, a year-on-year decrease of 1.2 percentage points mainly due to the increase in 12-inch sales revenue share and accompanying substantial depreciation. However, the gross margin increased by 1.1% from the previous quarter due to the increase in unit prices and the record high in capacity utilization. The company's shipments surged in the second quarter and its profitability also increased significantly with a net profit of USD 37.2 million, a year-on-year increase of 2,848.3% and a quarter-on-quarter increase of 37.7%.

[Foreign Language]

[Interpreted] This was the best quarter ever for the [ 3 ] 8-inch fabs. Revenue reached a record high of USD 262 million. Gross margin increased to 31.6% from 27.3% in Q1 2021 due to improved pricing and operating efficiency. Net profit was USD 51.3 million, representing 19.6% of total revenue. The 3 8-inch fabs continued to be a lucrative business. We will continue finding opportunities to extend our advantages and generate higher profits.

[Foreign Language]

[Interpreted] Hua Hong Wuxi’s 12-inch fabs revenue in the second quarter reached USD 84.1 million, an increase of 786.8% year-on-year and an increase of 54% from the previous quarter. EBITDA was USD 29.9 million, an increase of 208.3% compared to the prior quarter. Our advanced specialty technology has demonstrated its strong market vitality, the smooth and swift rollout of platforms such as embedded flash memory, analog and power devices and the efficient introduction of customers' products have boosted the growth of capacity. The product mix is reasonable and in line with the market demand.

[Foreign Language]

[Interpreted] As of May 2021, the monthly capacity of the 12-inch line reached 48,000 wafers and was fully utilized. We will foster closer cooperation with vendors to secure every step of the ramp-up plan and steadily achieved a monthly capacity of 65% -- 65,000 wafers by the end of this year. We will continue to invest in manufacturing capacity and optimize technology road map planning to meet a strong demand and thrive together with the industrial supply chain.

[Foreign Language]

[Interpreted] With the continuous optimization of the 3 8-inch fabs in Shanghai and the rapid expansion of 12-inch fab in Wuxi, Hua Hong Semiconductor has entered a new development stage with stability and quality. The company, as a vital link in the supply chain, will continue to unswervingly implement and advance our Specialty IC + Power Discrete strategy. Both 8-inch and 12-inch fabs will support R&D and innovation at the best, fastest and most stable expansion pace, provide customers with comprehensive and high-quality technical services and assist in alleviating the global chip shortage.

[Foreign Language]

[Interpreted] Now I would like to turn the call over to our CFO, Mr. Daniel Wang, for his comments.

Thank you, Mr. Tang for the inspiring comments. Now let me begin with a summary of our financial performance for the second quarter followed by an outlook on revenue and margin for the third quarter. And then we will move on to the question-and-answer session. First, let me summarize financial performances of the second quarter. Revenue reached an all-time high of $346.1 million, 53.6% over the prior year and 13.5% above the prior quarter. Cost of sales was $260.4 million, 56.1% above Q2 2020 and 11.9% over Q1 2021, mainly due to increased wafer shipments and depreciation costs. Gross margin was 24.8%, 1.2 percentage points lower than Q2 2020, primarily due to increased depreciation costs, partially offset by the improved average selling price and capacity utilization and 1.1 percentage points above Q1 2021, primarily driven by improved average selling price and capacity utilization. Operating expenses were $45.9 million, 26.6% below Q2 2020 and a 22.9% below Q1 2021, mainly due to increased government grants for research and development. Other income net was $11.9 million, flat compared to Q2 2020. It was 67.1% above Q1 2021, primarily due to a foreign exchange gain versus a foreign exchange loss in the prior period. The income tax expense was $14.5 million compared to $6.7 million in Q2 2020, primarily due to increased taxable profit and compare up to an income tax credit of $1.1 million in Q1 2021, mainly due to a reversal of the dividend withholding tax in the prior period. Profit for the period was $37.2 million versus $1.3 million in Q2 2020 and $20.9 million in Q1 2021. Net profit attributable to shareholders of the parent company was $44.1 million compared to $17.8 million in Q2 2020 and $33.1 million in Q1 2021. Basic earnings per share was $0.034 versus $0.014 in Q2 2020 and $0.025 in Q1 2021. Annualized ROE was 6.8%, 3.6 percentage points over Q2 2020 and 1.6 percentage points above Q1 2021. Now I will discuss the operating results for both the Hua Hong 8-inch wafer fabs and the Hua Hong Wuxi 12-inch fabs. First, let's have a look at the Hua Hong 8-inch wafer fabs. Revenue reached a record high of $262 million, 21.4% over Q2 2020 and 4.7% above Q1 2021. Gross margin was 31.6%, 3.9 percentage points over Q2 2020 and 4.3 percentage points above Q1 2021, primarily driven by improved average selling price and capacity utilization. Operating expenses were $20.8 million, 20.9% below Q2 2020 and 35.9% below Q1 2021, primarily due to allocation of costs to Hua Hong Wuxi. Profit before tax was $65.8 million, 57.3% over Q2 2020 and 47.6% over Q1 2021. Now let's have a look at the performance of the Hua Hong Wuxi wafer fab. Revenue was $84.1 million versus $9.5 million in Q2 2020 and $54.6 million in Q1 2021. Operating expenses were $25.1 million, 30.7% lower than Q2 2020 and 7.1% lower than Q1 2021, mainly due to increased government grants for research and development, partially offset by increased service expenses. EBITDA was $29.9 million compared to minus $18.5 million in Q2 2020 and $9.7 million in Q1 2021. Now I'll provide more details on our revenue from Q2 2021. From a geographical perspective, revenue from China was $255.2 million, contributing 73.8% of total revenue and an increase of 85.5% over Q2 2020, mainly driven by increased demand for nearly all platforms. Revenue from Asia was $38.5 million, an increase of 34.9% over Q2 2020, mainly driven by increased demand for MCU and logic products. Revenue from the United States was $29.5 million, a decrease of 12.5% over Q2 2020, chiefly due to decreased shipments for MCU products. Revenue from Europe was $16.3 million, a decrease of 14.5% compared to Q2 2020, mainly due to decreased shipments for smart card ICs. Revenue from Japan was $6.5 million, flat compared to Q2 2020. With respect to technology platforms, revenue from embedded nonvolatile memory was $103.6 million, an increase of 34.7% over Q2 2020, mainly driven by increased demand for MCU products. Revenue from a standard alone nonvolatile memory was $18.3 million, an increase of nearly 5x over Q2 2020, primarily driven by increased demand for NOR Flash products. Revenue from discrete was $119.8 million, an increase of 38% over Q2 2020, mainly driven by increased demand for general MOSFET, super junction and IGBT products. Revenue from logic and RF was $57 million, an increase of 113.4% over Q2 2020, largely driven by increased demand for CIS and logic products. Revenue from analog and power management IC was $46.9 million, an increase of 48.8% over Q2 2020, mainly driven by increased demand for other power management IC products. Let's now take a look at the cash flow statement. Net cash flows generated from operating activities was $99.1 million, 2.7% lower than Q2 2020, primarily due to increased payments for materials, payroll payables and decreased receipts of VAT refunds, largely offset by increased receipts from customers as a result of improved customer credit management. Capital expenditures were $136.5 million in Q2 2021, including $119.1 million for the Wuxi fab and $17.4 million for the Hua Hong 8-inch fabs. Other cash flow generated from investing activities was $1.8 million in Q2 2021. Net cash flows generated from financing activities was $40.6 million including $47.6 million proceeds from bank borrowings and $0.1 million proceeds from share option exercises, partially offset by $4 million of interest expenses for bank borrowings, $2.3 million of repayment of bank borrowings and $0.8 million of lease payments. Now let's move to the balance sheet. Cash and cash equivalents was $974.5 million on June 30, 2021 compared to $961.5 million on March 31, 2021. Inventories increased from $283.8 million on March 31, 2021 to $355.9 million on June 30, 2021, primarily due to increased customers' demand. Other current assets increased from $142.5 million on March 31, 2021, to $175.6 million on June 30, 2021, primarily due to increased VAT refund receivables. Property, plant and equipment was $2.710 billion on June 30, 2021, compared to $2. 4985 billion on March 31, 2021. Total assets increased from $4.6824 billion on March 31, 2021, to $4.991 billion on June 30, 2021. Our total bank borrowings increased to $754.9 million on June 30, 2021 from $709.2 million on March 31, 2021. Total liabilities increased to $1.5394 billion on June 30, 2021 from $1.3269 billion on March 31, 2021, primarily due to increased payables for capital expenditures and bank borrowings. That ratio increased to 30.8% on June 30, 2021, from 28.3% on March 31, 2021. Finally, let me give you a high-level outlook for the third quarter 2021. We expect revenue to be approximately $410 million and our gross margin to be between 25% and 27%. This concludes my financial remarks. Now we would like to start the question-and-answer session. Operator, please assist. Thank you.

[Operator Instructions] The first question comes from the line of Leping Huang from Huatai.

[Foreign Language]

Okay, thank you very much for your very, very wonderful question. I think that it's very, very clear. Wuxi is ramping up very, very fast. So the most of the growth is coming from Wuxi. I think at the same time, we're going to see ASP improvement as well for both Hua Hong Wuxi and as well as the 3 8-inch fabs, okay? So I'm not going to be commenting on the ASP specifically, but we expect the ASP will continue to improve. I think our gross margin for the 3 8-inch fabs will continue to improve over time. I think you're going to see -- I mean, as I said before, every quarter, we're going to have 3%, 4%, 3% to 5% ASP improvement for both 8-inch and 12-inch fab. This is very, very important because this would give us more than -- hopefully, more than 10% growth, I mean, growth of ASP over the year. And the volume will continue to increase. But as for the volume for the 8-inch fabs, I think we will continue to be able to drive more efficiency throughout the 3 8-inch fabs. I think 3 8-inch fabs will continue to be able to give us more volume over time because of manufacturing efficiency. Thank you.

Let me ask the second question. The second question is about your mix in the Wuxi fab. So since your Wuxi fab have grown very quickly, so what's the current -- you talked about [ share ]. What's the mix between the power and the logic. And I think you have 40,000 wafer now. And given the very strong demand currently in this mature 12-inch fab. So when you explain to the end of this year, and when you plan the new capacity for the next year? So what will be the new process or what will be the major products you are bringing to the Wuxi fab. [Foreign Language]

[Foreign Language]

[Interpreted] Thanks for your question. So thanks for all the partners' contribution, we have a very fast construction speed. And based on more than 20 years process experience, we have a very fast R&D process. We established our technology platforms, maybe through 1.5 years.

[Foreign Language]

[Interpreted] So as of May, we have completed the construction target as of 48,000 wafer monthly capacity. So we first start 48,000 wafers in June. And the product mix is 1800 -- 18,000 power and 30,000 IC.

[Foreign Language]

[Interpreted] So given the strong market demand, we started Phase 1 capacity expansion in the end of 2020, we will expand from 48,000 to 65,000. So among the 65,000, we keep the power discrete as 18,000 and expand the IC capacity to 47,000.

[Foreign Language]

[Interpreted] We still have some space in the clean room. We are still actively planning for further capacity expansion.

[Foreign Language]

[Interpreted] So in IC products, mainly CIS, NOR Flash and our own embedded eFlash.

[Foreign Language]

[Interpreted] There will mainly be super junction, IGBT and SGT for the power discrete.

[Foreign Language]

[Interpreted] So customers require more capacity in both IC and power discrete, and it's a very solid foundation for our net debt capacity expansion.

[Foreign Language]

[Interpreted] Along with all the applications, we have a very strong and solid base of the capacity utilization improvement. Thank you.

Yes. So when you expand the capacity next year. [Foreign Language]

[Foreign Language]

[Interpreted] We will achieve 65,000 capacity by the end of this year. So on year-on-year basis, we will have double-digit growth in the first half next year. And for the further expansion, the mainly point will be the tool delivery. If the tool delivery can be faster, so we -- our pace of capacity expansion can be also faster.

[Foreign Language]

[Interpreted] By the end of the year, the wafer starts every month will be above 60,000 per month.

The next question comes from the line of [indiscernible] from Everbright Securities.

[Foreign Language]

[Foreign Language]

[Interpreted] The average wafer start for the third quarter will be 50,000 to 52,000 per month. In December, the wafer start will be around 60,000.

[Foreign Language]

[Interpreted] The major capacity expansion will be IC for 55 nanometers and [ later ] 90 nanometers.

[Foreign Language]

[Foreign Language] So overall, our CapEx expenditures. For the 3 8-inch fab, it will be around about $140 million for the year, okay? So the first half, we spent about $40 plus million, expect we -- in the second half, we'll probably spend another $95 million, okay? And as far as the Wuxi, the 12-inch fab, we have spent about close to $260 million in the first half. This thing the speed will actually get picked up. I think by -- for the second half, we're looking at about $1 billion because we have to start pay for the equipment that were secured for the first phase and also the money -- the capital expenditure we have to pay for the second phase, which is go from a 40,000 wafer capacity to about 65,000 wafer capacity. So in total, I think the 12-inch fab will be around $1.3 billion, okay? And then the 8-inch fabs will be around $140 million.

The next question comes from the line of Randy Abrams from Credit Suisse.

Good results. I wanted to ask a follow-up on the pricing. Daniel, where you mentioned the 3% to 5% per quarter. Were you referring -- is that for second half where you expect 3% to 5%? And curious, for 2022, if you contracted out pricing and also if you're considering any long-term agreement with your customers to lock in pricing further out?

Thank you, Randy. I mean it was pretty clear if you look at our Q1 -- the past Q1 and Q2, I think we have a pretty steady growth on ASP, okay? I always said, I said many times before that you're going to see a quarterly basis every quarter, you are going to see a -- hopefully 3% to 5% growth on ASP. And I think we have done that. We're hoping that we can continue to do that in the next 2 quarters throughout the second half. But I'm very confident we -- this year, we're going to be able to -- in terms of pricing, I think we should be -- overall, we should do pretty well for both 8-inch and 12-inch.

Okay. And have you started -- is it too early to talk about 2022, if you still see that direction you're locking in? And maybe the other question is for the gross margin, we're showing improvement in guidance. Do you think the direction also factoring depreciation, you expect gross margin looks like it's on the track to continue expanding? Or how do you see that trending?

I think the gross margin, well, if you look at our guidance, I think our guidance show we have -- we're pretty confident we're going to be doing better with gross margin. I think we're going to see a very stable growth in the 8-inch space, I think the gross margin will continue to grow for the 8-inch fabs. And as far as for the 12-inch fab, I think we're going to keep the margin going to be very, very -- I think the margin is going to be -- gross margin will be very, very stable. I think they will, at a certain point, once you reach the scale, I think you are going to see a quick sort of pickup on gross margin for the 12-inch fab as well. But in general, I think the gross margin would definitely would be positive. Now it is in single digit. But I think once we're at a certain scale, I think the margin should improve very, very quickly for the 12-inch fab.

For the OpEx, could you talk about -- because in the decline sequentially, how much was the subsidy? And then was there a depreciation shift into COGS? So how much were those? And then from here, what's the way to think about how much the right run rate for OpEx?

I think for this year -- I mean, for the 8-inch -- for the 3 8-inch fabs, the operating expense should be very, very stable. This year, it will be around just overall. I think for the 8-inch fab will be around $140 million. This includes the government grants, okay? And for the 12-inch fab, it is also around $140 million, okay? That's the OpEx.

So should it go back to about $70 million? Because there's only $46 million. So it should go back up towards about $70 million a quarter total, where would there be grants or offset?

The OpEx for -- quarterly OpEx is what you're saying?

Yes. No, it just seems like the quarterly OpEx is running below that now, so it would come back up.

Well, I think for the 8-inch fab -- for 3 8-inch fab should be very -- should be pretty much in that rate. It will be somewhere around I mean, around $30 million to $40 million each quarter, okay? That's a pretty big number already. So -- but throughout the year, it will be about $140 million this year, I think. Next year, I would expect around $120 million, but the OpEx for the Wuxi fab, it will be $140 million this year, that's a ballpark number. But I think next year, it may go up because some addition of R&D activities.

Okay. The last question, just on the expansion. So it's been aggressive to go to 65,000. So the 2 steps beyond that go to 80,000, if you have the timing? And beyond that, would you have another site within Wuxi or another location? Because it seems like by next year, you'll -- you need to start planning if you're expanding beyond next?

Yes. good question. 65,000, is something we will try to achieve by end of this year. We'll get to 65,000, equipment for 65,000 will be installed, be tested by end of this year. So we can't -- we definitely have 65,000 to work on for next year. We still have some space there. I think the plan is to go from 65,000 and then 90,000 to 95,000. That is the plan we're looking at. As Mr. Tang earlier has talked about. So this is something we'll try to do in the next phase. And then you know that we have a piece of -- a big piece of land there. We can potentially build, in total, 3 similar fabs there in Wuxi. So that if we -- if the demand continues, yes, sure, we will have plan to build additional fabs.

The next question comes from the line of Andrew Lu from Sinolink Securities.

[Foreign Language]

[Foreign Language] Basically, for the income tax, it is around 15% income tax, corporate income tax [Foreign Language] okay? The reason we had a credit was because we also do withholding for the -- we decide -- each year, we try to accrue the -- some dividend, okay? So last year, we accrued 30% after the income tax of the net income. So with that -- so we assume 10% withholding tax. But it turned out to be that the Board basically decide not to issue dividend last year. So we had to reverse that, okay? So the credit was virtually coming from the reversal of the withholding tax, 10% that happened in Q1.

[Foreign Language]

[Foreign Language] And on top of that, we assume 30% dividend, okay? [Foreign Language]

[Foreign Language]

[Foreign Language] Depreciation expense will become very, very stable, okay? I would not be surprised [indiscernible] should be easily get into between 10% to 20%, okay, 10% to 20% gross margin. [Foreign Language] Gross margin is driven by ASP, okay? So at some point, it's going to be reach the peak. [Foreign Language]. Forget about gross margin. [Foreign Language] So gross margin is just going to be next thing. But this is not something you need to focus right now. Right now, it should be cash flow, it should be revenue growth. [Foreign Language]

[Foreign Language]

[Foreign Language] We are going to get to 65,000, okay? And then the next stage is we're going to get to 90,000, 95,000, okay? Once you're at the 90,000, 95,000 with the moderate ASP [Foreign Language] So potentially, once you're at the level [Foreign Language]

[Foreign Language]

[Foreign Language]

[Foreign Language]

[Foreign Language]

[Foreign Language]

[Foreign Language]

[Foreign Language]